Form 10-Q
Table of Contents

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 

(Mark one)

x   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

AND EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2003

 

¨   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934 (No Fee Required)

 

For the transition period from                          to                         .

 

Commission file number 0-25034

 


 

GREATER BAY BANCORP

(Exact name of registrant as specified in its charter)

 

California   77-0387041
(State or other jurisdiction of
Incorporation or organization)
  (I.R.S. Employer Identification No.)

 

2860 West Bayshore Road, Palo Alto, California 94303

(Address of principal executive offices)(Zip Code)

 

Registrant’s telephone number, including area code: (650) 813-8200

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x  No  ¨

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).  Yes  x  No  ¨

 

Outstanding shares of Common Stock, no par value, as of July 31, 2003: 52,045,162

 



Table of Contents

GREATER BAY BANCORP

 

INDEX

 

    Part I. Financial Information     

Item 1.

 

Consolidated Financial Statements

    
   

Consolidated Balance Sheets as of June 30, 2003 and December 31, 2002

   3
   

Consolidated Statements of Operations for the Three Months and Six Months Ended June 30, 2003 and 2002

   4
   

Consolidated Statements of Comprehensive Income for the Three Months and Six Months Ended June 30, 2003 and 2002

   5
   

Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2003 and 2002

   6
   

Notes to Consolidated Financial Statements

   7

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   20

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

   51

Item 4.

 

Controls and Procedures

   55
    Part II. Other Information     

Item 1.

 

Legal Proceedings

   56

Item 2.

 

Changes in Securities and Use of Proceeds

   56

Item 3.

 

Defaults Upon Senior Security

   56

Item 4.

 

Submission of Matters to a Vote of Securities Holders

   56

Item 5.

 

Other Information

   57

Item 6.

 

Exhibits and Reports on Form 8-K

   57

Signatures

   58

 

2


Table of Contents

GREATER BAY BANCORP AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

(Dollars in thousands)


  

June 30, 2003

(unaudited)


   

December 31,

2002


 

ASSETS

                

Cash and due from banks

   $ 278,989     $ 300,514  

Federal funds sold

     15,000       14,000  

Other short-term securities

     243       —    
    


 


Cash and cash equivalents

     294,232       314,514  

Investment securities:

                

Available for sale, at fair value

     2,560,705       2,458,421  

Other securities

     78,767       104,565  
    


 


Investment securities

     2,639,472       2,562,986  

Total loans:

                

Commercial

     1,992,499       2,067,142  

Term real estate - commercial

     1,650,330       1,610,277  
    


 


Total commercial

     3,642,829       3,677,419  

Real estate construction and land

     671,666       710,990  

Real estate other

     244,955       251,665  

Consumer and other

     162,928       166,331  

Deferred loan fees and discounts

     (14,803 )     (15,245 )
    


 


Total loans, net of deferred fees

     4,707,575       4,791,160  

Allowance for loan and lease losses

     (130,030 )     (129,613 )
    


 


Total loans, net

     4,577,545       4,661,547  

Property, premises and equipment, net

     52,298       52,069  

Goodwill

     145,005       144,181  

Other intangible assets

     44,294       47,722  

Interest receivable and other assets

     331,168       292,708  
    


 


Total assets

   $ 8,084,014     $ 8,075,727  
    


 


LIABILITIES AND SHAREHOLDERS’ EQUITY

                

Deposits:

                

Demand, noninterest-bearing

   $ 975,122     $ 1,028,672  

MMDA, NOW and savings

     2,873,737       2,673,973  

Time certificates, $100,000 and over

     808,723       829,717  

Other time certificates

     890,669       739,911  
    


 


Total deposits

     5,548,251       5,272,273  

Borrowings

     1,295,373       1,737,243  

Company obligated mandatorily redeemable cumulative trust preferred securities of subsidiary trusts holding solely junior subordinated debentures

     204,000       204,000  

Other liabilities

     301,793       165,502  
    


 


Total liabilities

     7,349,417       7,379,018  
    


 


Preferred stock of real estate investment trust subsidiaries of the Banks

     15,302       15,650  
    


 


Commitments and contingencies

                

SHAREHOLDERS’ EQUITY

                

Preferred stock, no par value: 4,000,000 shares authorized

     —         —    

7.25% convertible preferred stock, stated value $50.00: recorded at fair value at issuance; 2,356,606 reserved shares; 1,630,504 and 1,673,898 shares issued and outstanding as of June 30, 2003 and December 31, 2002, respectively

     80,441       80,900  

Common stock, no par value: 80,000,000 shares authorized; 51,982,864 and 51,577,795 shares issued and outstanding as of June 30, 2003 and December 31, 2002, respectively

     239,636       234,627  

Unearned compensation

     (735 )     (1,450 )

Accumulated other comprehensive income

     20,365       18,624  

Retained earnings

     379,588       348,358  
    


 


Total shareholders’ equity

     719,295       681,059  
    


 


Total liabilities and shareholders’ equity

   $ 8,084,014     $ 8,075,727  
    


 



See notes to consolidated financial statements.

 

3


Table of Contents

GREATER BAY BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

 

     Three months ended June 30,

     Six months ended June 30,

(Dollars in thousands, except per share amounts)


   2003

   2002

     2003

   2002

INTEREST INCOME

                             

Loans

   $ 81,139    $ 83,254      $ 162,016    $ 165,829

Investment securities:

                             

Taxable

     19,921      43,756        43,710      87,075

Tax-exempt

     1,241      1,780        2,464      3,212
    

  

    

  

Total interest on investment securities

     21,162      45,536        46,174      90,287

Other interest income

     1,149      2,002        2,604      4,101
    

  

    

  

Total interest income

     103,450      130,792        210,794      260,217
    

  

    

  

INTEREST EXPENSE

                             

Deposits

     16,045      20,801        32,578      41,735

Long-term borrowings

     4,901      5,875        7,805      12,192

Trust Preferred Securities

     4,222      5,025        9,029      10,005

Other borrowings

     4,478      10,444        11,411      20,084
    

  

    

  

Total interest expense

     29,646      42,145        60,823      84,016
    

  

    

  

Net interest income

     73,804      88,647        149,971      176,201

Provision for loan and lease losses

     6,700      9,000        13,195      25,000
    

  

    

  

Net interest income after provision for loan and lease losses

     67,104      79,647        136,776      151,201
    

  

    

  

NON-INTEREST INCOME

                             

Insurance agency commissions and fees

     27,945      27,601        58,587      38,492

Gain on sale of investments, net

     3,136      3,004        5,159      3,351

Service charges and other fees

     2,995      2,762        5,826      5,590

Loan and international banking fees

     2,421      2,273        4,459      4,800

Trust fees

     819      894        1,576      1,800

ATM network revenue

     445      628        851      1,211

Gain on sale of loans

     364      210        1,907      706

Other income

     4,196      2,138        8,720      6,152
    

  

    

  

Total

     42,321      39,510        87,085      62,102
    

  

    

  

OPERATING EXPENSES

                             

Compensation and benefits

     42,001      38,647        87,433      67,222

Occupancy and equipment

     10,171      10,267        19,813      19,105

Legal and other professional fees

     4,390      1,915        9,352      3,604

Telephone, postage and supplies

     1,878      1,918        3,624      3,551

Marketing and promotion

     1,822      1,617        2,937      3,069

Correspondent bank and ATM network fees

     1,717      1,508        3,418      2,849

Amortization of intangibles

     1,671      1,650        3,342      2,212

Data processing

     1,407      1,196        2,658      2,325

Insurance

     1,283      892        2,519      1,540

Depreciation - equipment leased to others

     1,072      —          1,807      —  

Other real estate owned, net

     518      —          519      —  

FDIC insurance and regulatory assessments

     482      417        980      880

Dividends paid on preferred stock of real estate investment trusts

     454      464        907      928

Client services

     318      557        662      1,204

Directors fees

     293      324        631      613

Trust Preferred Securities early retirement expense

     —        975        —        975

Other expenses

     2,769      3,142        4,986      5,425
    

  

    

  

Total operating expenses

     72,246      65,489        145,588      115,502
    

  

    

  

Income before provision for income taxes

     37,179      53,668        78,273      97,801

Provision for income taxes

     14,054      20,132        30,051      36,663
    

  

    

  

Net income

   $ 23,125    $ 33,536      $ 48,222    $ 61,138
    

  

    

  

Net income per common share - basic

   $ 0.42    $ 0.64      $ 0.87    $ 1.18
    

  

    

  

Net income per common share - diluted

   $ 0.41    $ 0.62      $ 0.86    $ 1.14
    

  

    

  

Cash dividends per share of common stock

   $ 0.135    $ 0.125      $ 0.27    $ 0.24
    

  

    

  


See notes to consolidated financial statements.

 

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Table of Contents

GREATER BAY BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(UNAUDITED)

 

     Three months ended June 30,

       Six months ended June 30,

 

(Dollars in thousands)


   2003

    2002

       2003

    2002

 

Net income

   $ 23,125     $ 33,536        $ 48,222     $ 61,138  
    


 


    


 


Other comprehensive income:

                                   

Unrealized net gains on securities:

                                   

Unrealized net holding gains arising during period (net of taxes of $6.3 million and $11.2 million for the three months ended June 30, 2003 and 2002, and $3.7 million and $11.1 million for the six months ended June 30, 2003 and 2002, respectively)

     8,704       15,367          5,085       15,300  

Less: reclassification adjustment for net gains included in net income

     (1,817 )     (1,741 )        (2,989 )     (1,942 )
    


 


    


 


Net change

     6,887       13,626          2,096       13,358  

Cash flow hedge:

                                   

Net losses arising during period (net of taxes of $(317,000) and $(258,000) for the three months and six months ended June 30, 2003, respectively)

     (437 )     —            (355 )     —    
    


 


    


 


Net change

     (437 )     —            (355 )     —    

Other comprehensive income

     6,450       13,626          1,741       13,358  
    


 


    


 


Comprehensive income

   $ 29,575     $ 47,162        $ 49,963     $ 74,496  
    


 


    


 



See notes to consolidated financial statements.

 

5


Table of Contents

GREATER BAY BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

     Six months ended June 30,

 

(Dollars in thousands)


   2003

    2002

 

Cash flows - operating activities

                

Net income

   $ 48,222     $ 61,138  

Reconcilement of net income to net cash from operations:

                

Provision for loan and lease losses

     13,195       25,000  

Depreciation and amortization

     14,064       4,902  

Amortization of intangible assets

     3,342       2,212  

Accretion of discount on CODES

     812       750  

Deferred income taxes

     (172 )     (555 )

Gain on sale of OREO

     (98 )     —    

Gain on sale of loans

     (1,907 )     (706 )

Gain on sale of investments, net

     (5,159 )     (3,351 )

Changes in assets and liabilities net of effects from purchase of ABD:

                

Accrued interest receivable and other assets

     (27,117 )     (58,381 )

Accrued interest payable and other liabilities

     16,360       74,157  

Deferred loan fees and discounts, net

     (2,352 )     992  
    


 


Operating cash flows, net

     59,190       106,158  
    


 


Cash flows - investing activities

                

Maturities and partial paydowns on investment securities:

                

Available for sale

     1,264,480       939,760  

Other securities

     26,358       —    

Purchase of investment securities:

                

Available for sale

     (1,564,606 )     (1,575,725 )

Other securities

     (560 )     (9,280 )

Proceeds from sale of available for sale securities

     312,494       436,994  

Loans, net

     57,199       (215,547 )

Proceeds from sale of portfolio loans

     17,953       4,674  

Payment for business acquisition

     (1,883 )     (40,793 )

Proceeds from sale of other real estate owned

     495       —    

Purchase of property, premises and equipment

     (5,712 )     (2,127 )

Purchase of bank owned life insurance policies

     (7,718 )     (21,100 )
    


 


Investing cash flows, net

     98,500       (483,144 )
    


 


Cash flows - financing activities

                

Net change in deposits

     275,978       309,056  

Net change in other borrowings - short-term

     (541,705 )     (99,496 )

Proceeds from other borrowings - long-term

     —         212,956  

Principal repayment - long-term borrowings

     (48,901 )     —    

Proceeds from issuance of company obligated mandatorily redeemable preferred securities of subsidiary trusts holding solely junior subordinated debentures

     —         5,000  

Proceeds from Senior Notes Series A

     147,924       —    

Proceeds from sale of common stock

     5,724       12,908  

Cash dividends on convertible preferred stock

     (2,956 )     (1,578 )

Cash dividends on common stock

     (14,036 )     (12,231 )
    


 


Financing cash flows, net

     (177,972 )     426,615  
    


 


Net change in cash and cash equivalents

     (20,282 )     49,629  

Cash and cash equivalents at beginning of period

     314,514       215,404  
    


 


Cash and cash equivalents at end of period

   $ 294,232     $ 265,033  
    


 


Cash flows - supplemental disclosures

                

Cash paid during the period for:

                

Interest

   $ 64,121     $ 70,560  
    


 


Income taxes

   $ 11,728     $ 33,000  
    


 


Non-cash transactions:

                

Additions to other real estate owned

   $ 2,500     $ 509  
    


 


Purchase of investment securities settled subsequent to period end

   $ 119,931     $ —    
    


 



See notes to consolidated financial statements.

 

6


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

As of June 30, 2003 and December 31, 2002 and for the

Three Months and Six Months Ended June 30, 2003 and 2002

 

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

The Consolidated Balance Sheet as of June 30, 2003, and the Consolidated Statements of Operations and Comprehensive Income for the three months and six months ended June 30, 2003 and Consolidated Statements of Cash Flows for the six months ended June 30, 2003 have been prepared by Greater Bay Bancorp (“Greater Bay” on a parent-only basis, and “we” or “our” on a consolidated basis) and are not audited. The interim financial data as of June 30, 2003 is unaudited; however, in our opinion, the interim data includes all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of the results for the interim periods. The results of operations for the quarter ended June 30, 2003 are not necessarily indicative of the results expected for any subsequent quarter or for the entire year ending December 31, 2003.

 

Organization and Nature of Operations

 

Greater Bay is a financial holding company with 11 bank subsidiaries: Bank of Petaluma, Bank of Santa Clara, Bay Area Bank, Bay Bank of Commerce, Coast Commercial Bank, Cupertino National Bank, Golden Gate Bank, Mid-Peninsula Bank, Mt. Diablo National Bank, Peninsula Bank of Commerce, and San Jose National Bank. We also have a commercial insurance brokerage subsidiary, ABD Insurance and Financial Services (“ABD”). We also conduct business through the following divisions: CAPCO, Greater Bay Bank Contra Costa Region, Greater Bay Bank Fremont Region, Greater Bay Bank Carmel, Greater Bay Bank Marin, Greater Bay Bank Santa Clara Valley Group, Greater Bay Bank SBA Lending Group, Greater Bay Corporate Finance Group (“Corporate Finance”), Greater Bay International Banking Division, Greater Bay Trust Company, The Matsco Companies, Inc., Pacific Business Funding and the Venture Banking Group.

 

In addition to these divisions, we have the following consolidated subsidiaries which issued trust preferred securities and purchased Greater Bay’s junior subordinated deferrable interest debentures: GBB Capital II, GBB Capital III, GBB Capital IV, GBB Capital V, GBB Capital VI, and GBB Capital VII. We also created CNB Investment Trust I (“CNBIT I”), CNB Investment Trust II (“CNBIT II”), MPB Investment Trust (“MPBIT”), and SJNB Investment Trust (“SJNBIT”), all of which are Maryland real estate investment trusts and wholly owned subsidiaries of Cupertino National Bank, Mid-Peninsula Bank, and San Jose National Bank, respectively. These entities were formed in order to provide flexibility in raising capital.

 

We provide a wide range of commercial banking services to small and medium-sized businesses, property managers, business executives, real estate developers, professionals and other individuals. We operate community banking offices throughout the San Francisco Bay Area including the Silicon Valley, San Francisco and the San Francisco Peninsula, the East Bay, Santa Cruz, Marin, Monterey, and Sonoma Counties. ABD provides commercial insurance brokerage, employee benefits consulting and risk management solutions to business clients throughout the United States. We also own a broker-dealer, which executes mutual fund transactions. CAPCO’s office is located in Bellevue, Washington and it operates in the Pacific Northwest. Matsco markets its dental and veterinarian financing services nationally.

 

Consolidation and Basis of Presentation

 

The consolidated financial statements include the accounts of Greater Bay, its subsidiaries and operating divisions. All significant intercompany transactions and balances have been eliminated. Certain reclassifications have been made to prior periods’ consolidated financial statements to conform to the current presentation. Our accounting and reporting policies conform to generally accepted accounting principles and the prevailing practices within the banking industry.

 

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Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

As of June 30, 2003 and December 31, 2002 and for the

Three Months and Six Months Ended June 30, 2003 and 2002

 

Use of Estimates in the Preparation of Financial Statements

 

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of certain assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of certain revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Comprehensive Income

 

Statement of Financial Accounting Standards (“SFAS”) No. 130, “Reporting Comprehensive Income” requires us to classify items of other comprehensive income by their nature in the financial statements and display the accumulated other comprehensive income separately from retained earnings in the equity section of the balance sheet. The changes to the balances of accumulated other comprehensive income are as follows:

 

(Dollars in thousands)


     Unrealized
gains
on securities


     Cash flow
hedges


     Accumulated
other
comprehensive
income


Balance - March 31, 2003

     $ 14,205      $ (290 )    $ 13,915

Current period change in fair value

       6,887        (437 )      6,450
      

    


  

Balance - June 30, 2003

     $ 21,092      $ (727 )    $ 20,365
      

    


  

Balance - March 31, 2002

     $ 3,699      $ —        $ 3,699

Current period change in fair value

       13,626        —          13,626
      

    


  

Balance - June 30, 2002

     $ 17,325      $ —        $ 17,325
      

    


  

 

(Dollars in thousands)


     Unrealized
gains
on securities


     Cash flow
hedges


     Accumulated
other
comprehensive
income


Balance - December 31, 2002

     $ 18,996      $ (372 )    $ 18,624

Current period change in fair value

       2,096        (355 )      1,741
      

    


  

Balance - June 30, 2003

     $ 21,092      $ (727 )    $ 20,365
      

    


  

Balance - December 31, 2001

     $ 3,967      $ —        $ 3,967

Current period change in fair value

       13,358        —          13,358
      

    


  

Balance - June 30, 2002

     $ 17,325      $ —        $ 17,325
      

    


  

 

Stock-Based Compensation

 

In October 1995, the Financial Accounting Standards Board issued SFAS No. 123 “Accounting for Stock-Based Compensation” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation” (“SFAS No. 123 and No. 148”). Under the provisions of SFAS No. 123 and No. 148, we are encouraged, but not required, to measure compensation costs related to our employee stock compensation plans under the fair value method. If we elect not to recognize compensation expense under this method, we are required to disclose the pro forma net income and net income per share effects based on the SFAS No. 123 and No. 148 fair value methodology. We implemented the requirements of SFAS No. 123 and No. 148 and have elected to adopt the disclosure provisions of these statements.

 

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Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

As of June 30, 2003 and December 31, 2002 and for the

Three Months and Six Months Ended June 30, 2003 and 2002

 

We apply Accounting Principles Board (“APB”) Opinion No. 25 and related interpretations in our accounting for stock options. Accordingly, no compensation cost has been recognized for our stock option plan. Had compensation for our stock option plan been determined consistent with SFAS No. 123, our net income per common share would have been reduced to the pro forma amounts indicated below:

 

(Dollars in thousands, except
per share amounts)


   Three months ended June 30,

     Six months ended June 30,

   2003

   2002

     2003

   2002

Stock-based employee compensation cost, net of tax, that would have been included in the determination of net income if the fair value method had been applied to all awards

   $ 1,294    $ 1,303      $ 2,634    $ 2,611

Net income:

                             

As reported

   $ 23,125    $ 33,536      $ 48,222    $ 61,138

Pro forma

   $ 21,831    $ 32,233      $ 45,588    $ 58,527

Basic net income per common share:

                             

As reported

   $ 0.42    $ 0.64      $ 0.87    $ 1.18

Pro forma

   $ 0.39    $ 0.61      $ 0.82    $ 1.13

Diluted net income per common share:

                             

As reported

   $ 0.41    $ 0.62      $ 0.86    $ 1.14

Pro forma

   $ 0.39    $ 0.59      $ 0.81    $ 1.09

 

The fair value of each option grant is estimated on the date of the grant using the Black-Scholes option-pricing model with the following weighted average assumptions for grants during the periods indicated:

 

     Three months ended June 30,

 
     2003

    2002

 

Dividend yield

   3.1 %   1.4 %

Expected volatility

   44.8 %   37.0 %

Risk free rates

   2.6 %   4.4 %

Weighted average expected life

   5.75     5.75  

 

No adjustments have been made for forfeitures. The actual value, if any, that the option holder will realize from these options will depend solely on the increase in the common share stock price over the option price when the options are exercised.

 

9


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

As of June 30, 2003 and December 31, 2002 and for the

Three Months and Six Months Ended June 30, 2003 and 2002

 

NOTE 2—BUSINESS COMBINATIONS

 

On March 12, 2002, we completed the acquisition of ABD for a purchase price of approximately $195.2 million in cash and shares of a new series of convertible preferred stock in a tax-free reorganization accounted for using the purchase method of accounting. This amount included an initial payment on consummation of the merger of $72.5 million in convertible preferred stock and $59.1 million in cash, and the present value of an earn-out payment of approximately $63.6 million in convertible preferred stock (or common stock in certain instances) and cash contingent upon ABD meeting specified performance goals annually through 2005. In addition, we capitalized merger and other related costs of $1.6 million which was recorded as goodwill. ABD’s results of operations have been included in the consolidated financial statements since the date of the acquisition. The source of funds for the acquisition was a $30.0 million term loan and available cash.

 

We have allocated the purchase price to the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition. The excess of the purchase price over the estimated fair values of the net assets acquired was $95.6 million, which was recorded as goodwill. Assets acquired included other intangibles of $50.4 million, representing the fair value of ABD’s book of business at the acquisition date. Goodwill is evaluated annually for possible impairment under the provisions of SFAS No. 142 “Goodwill and Other Intangible Assets,” (“SFAS No. 142”). Based upon our evaluation, as of December 31, 2002, no impairment exists. The other intangible assets will be amortized using a method that approximates the anticipated utilization of the expirations that will cover a period of seven years and nine months.

 

The following table presents pro forma financial information as if the acquisition of ABD had occurred on January 1, 2002.

 

       Six months ended June 30, 2002

(Dollars in thousands, except per share amounts)


     Greater Bay
Bancorp


     ABD (1)

     Pro forma

Net interest income after provision for loan and lease losses and non-interest income

     $ 213,303      $ 15,665      $ 228,968

Income before provision for income taxes

       97,801        (611 )      97,190

Net income

       61,138        (667 )      60,471

Net income per common share - basic

                       $ 1.17

Net income per common share - diluted

                       $ 1.11

(1)   Includes only ABD’s results through March 11, 2002. ABD’s post-acquisition results, including revenues of $39.1 million, income before provision for income taxes of $10.1 million and net income of $5.9 million, are included in the Greater Bay Bancorp column for 2002.

 

10


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

As of June 30, 2003 and December 31, 2002 and for the

Three Months and Six Months Ended June 30, 2003 and 2002

 

NOTE 3—SUBSEQUENT EVENT: BUSINESS COMBINATION

 

Effective July 1, 2003, we acquired the assets of Sullivan & Curtis Insurance Brokers of Washington, LLC (“S&C”). The Seattle-based insurance broker specializes in property and casualty insurance services and risk management consulting. This acquisition was accounted for using the purchase method of accounting. The source of funds for the transaction was available cash.

 

11


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

As of June 30, 2003 and December 31, 2002 and for the

Three Months and Six Months Ended June 30, 2003 and 2002

 

NOTE 4—GOODWILL AND OTHER INTANGIBLE ASSETS

 

Goodwill and other intangible assets by business segment are as follows at the dates indicated:

 

     June 30, 2003

   December 31, 2002

(Dollars in thousands)


   Goodwill

   Other
intangible assets


   Goodwill

   Other
intangible assets


Community banking:

                           

CAPCO

   $ 6,054    $ 120    $ 6,054    $ 140

Matsco

     19,707      —        18,207      —  

Other

     2,360      2,023      2,360      2,140
    

  

  

  

Total community banking

     28,121      2,143      26,621      2,280

Insurance brokerage services:

                           

ABD

     116,884      42,151      117,560      45,442
    

  

  

  

Total

   $ 145,005    $ 44,294    $ 144,181    $ 47,722
    

  

  

  

 

Based on ABD achieving its specified performance goals for 2002, we accrued for ABD’s estimated 2002 earn-out payment as of December 31, 2002. During the quarter ended March 31, 2003, we finalized procedures to determine the exact amount of the ABD earn-out payment. As a result of the final determination of the 2002 earn-out payment, we reduced the number of shares of convertible preferred stock issued by approximately 43,394 shares and reduced goodwill by $76,000. Also included in the balance of goodwill recorded in connection with the Matsco acquisition is additional goodwill of $1.5 million that was recognized during the first quarter of 2003 upon satisfaction of certain contingencies.

 

We adopted SFAS No. 142 on January 1, 2002. Upon adoption of SFAS No. 142, goodwill was no longer amortized. Prior to the adoption of SFAS No. 142, goodwill was amortized using the straight-line method over 20 years.

 

We recorded expirations of $45.4 million in connection with the ABD acquisition. Expirations represent the estimated fair value of ABD’s existing customer list (or “book of business”) that ABD had developed over a period of years through the date of acquisition by Greater Bay. The expirations are estimated to have a life of seven years and nine months. Amortization for intangibles for 2003 and each of the next five years is estimated to range between $5.0 million and $6.5 million per year.

 

All of our other intangible assets have finite useful lives. We have no indefinite lived intangible assets other than goodwill. Other intangible assets at June 30, 2003 were as follows:

 

(Dollars in thousands)


     Gross carrying
amount


     Accumulated
amortization


       Total

ABD expirations

     $ 50,375      $ (8,224 )      $ 42,151

CAPCO customer base

       200        (80 )        120

Servicing assets

       2,143        (232 )        1,911

Core deposits

       1,465        (1,353 )        112
      

    


    

Total intangible assets

     $ 54,183      $ (9,889 )      $ 44,294
      

    


    

 

SFAS No. 142 also requires an analysis of impairment of goodwill annually or more frequently upon the occurrence of certain events. During 2002, we completed the required initial impairment tests of goodwill and an annual update. Based upon our latest evaluation, our goodwill was not impaired at December 31, 2002.

 

12


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

As of June 30, 2003 and December 31, 2002 and for the

Three Months and Six Months Ended June 30, 2003 and 2002

 

NOTE 5—BORROWINGS

 

Borrowings are detailed as follows:

 

(Dollars in thousands)


     June 30,
2003


     December 31,
2002


Short-term borrowings:

                 

FHLB advances

     $ 755,051      $ 1,279,565

Securities sold under agreements to repurchase

       94,100        111,291
      

    

Total short-term borrowings

       849,151        1,390,856
      

    

Long-term borrowings:

                 

FHLB advances

       161,243        206,834

Senior Notes Series A

       148,445        —  

Zero Coupon Senior Convertible

                 

Contingent Debt Securities

       74,392        73,580

Term loan

       30,000        30,000

Securities sold under agreements to repurchase

       20,000        20,000

Other long-term notes payable

       12,142        15,973
      

    

Total long-term borrowings

       446,222        346,387
      

    

Total borrowings

     $ 1,295,373      $ 1,737,243
      

    

 

Short-term borrowings

 

During the six months ended June 30, 2003 and the year ended December 31, 2002, the average balance of short-term FHLB advances was $889.6 million and $1.2 billion, respectively, and the average interest rates during those periods were 2.24% and 2.78%, respectively. The maximum amounts outstanding at any month-end during the six months ended June 30, 2003 and the year ended December 31, 2002 were $1.1 billion and $1.4 billion, respectively. The FHLB advances are collateralized by loans and securities pledged to the FHLB. At June 30, 2003 and December 31, 2002, investment securities with a carrying value of $1.4 billion and $1.5 billion, respectively, and loans with a carrying value of $321.2 million and $322.8 million, respectively, were pledged to the FHLB for both short-term and long-term borrowings.

 

During the six months ended June 30, 2003 and the year ended December 31, 2002, the average balance of securities sold under short-term agreements to repurchase was $98.7 million and $236.8 million, respectively, and the average interest rates during those periods were 2.30% and 2.05%, respectively. The maximum amounts outstanding at any month-end during the six months ended June 30, 2003 and the year ended December 31, 2002 were $114.3 million and $400.9 million, respectively. Securities sold under short-term agreements to repurchase generally mature within 90 days of dates of purchase.

 

During the six months ended June 30, 2003 and the year ended December 31, 2002, the average balance of federal funds purchased was $485,000 and $314,000, respectively, and the average interest rates during those periods were 1.62% and 1.82%, respectively. There were no amounts outstanding at any month-end during the six months ended June 30, 2003 and the year ended December 31, 2002.

 

13


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

As of June 30, 2003 and December 31, 2002 and for the

Three Months and Six Months Ended June 30, 2003 and 2002

 

In addition, as of June 30, 2003 and December 31, 2002, we had a short-term, secured credit facility totaling $60.0 million. At June 30, 2003 and December 31, 2002, we had no advances outstanding under this facility. The credit facility provides for an interest rate of LIBOR plus 0.875%. As of June 30, 2003, we were in compliance with all financial covenants for this credit facility. We had additional short-term credit facilities with similar terms available during the year ended December 31, 2002. During the six months ended June 30, 2003 and the year ended December 31, 2002, the average balances under all of our short-term credit facilities were $0 and $16.5 million, respectively, and the average interest rates during those periods were 0% and 2.81%, respectively. The maximum amounts outstanding at any month-end under these types of facilities during the six months ended June 30, 2003 and the year ended December 31, 2002 were $0 and $45.0 million, respectively.

 

Long-term borrowings

 

The long-term FHLB advances mature between 2004 and 2011. During the six months ended June 30, 2003 and the year ended December 31, 2002, we paid an average interest rate of 3.83% and 3.73%, respectively on these advances.

 

As of June 30, 2003 and December 31, 2002, we had a secured term loan outstanding of $30.0 million that matures in 2007. For the six months ended June 30, 2003 and the year ended December 31, 2002, we paid an average rate of 3.20% on this loan. As of June 30, 2003, we were in compliance with all related financial covenants for this credit facility.

 

On March 19, 2003, we received approximately $147.9 million in net proceeds through a private placement of Senior Notes, Series A. As of June 30, 2003, there was an outstanding balance of $148.4 million on these notes. The notes were offered at an original offering price of $986.16 per $1,000 principal amount at maturity. The notes mature on March 31, 2008. The notes may not be redeemed at our option and do not require repayment at the option of the holders, in whole or in part, prior to maturity. The notes have a fixed rate of 5.25% per annum payable semi-annually on March 31 and September 30 of each year, commencing September 30, 2003. We used the net proceeds from the notes for general corporate purposes, which may include working capital, capital expenditures, acquisitions and repayment of existing indebtedness. The notes are not registered with the Securities Exchange Commission (“SEC”). In accordance with a registration rights agreement entered into with the initial purchasers, we have commenced an exchange offer which, if consummated, will permit holders to exchange their notes for a new series of notes (the “exchange notes”) that are identical in all material respects with the notes, except that the exchange notes will be registered with the SEC. If we fail to consummate the exchange offer as required under the notes, we will be required to pay additional interest on the notes at a rate of 0.25% per annum until all registration defaults have been cured.

 

NOTE 6—PER SHARE DATA

 

Basic net income per common share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the year. Diluted net income per common share is computed by dividing net income available to common shareholders and assumed conversions by the weighted average number of common shares plus common equivalent shares outstanding including dilutive stock options and convertible preferred stock. The following table provides a reconciliation of the numerators and denominators of the basic and diluted net income per common share computations for the three months and six months ended June 30, 2003 and 2002.

 

14


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

As of June 30, 2003 and December 31, 2002 and for the

Three Months and Six Months Ended June 30, 2003 and 2002

 

     For the three months ended June 30, 2003

(Dollars in thousands, except per share amounts)


   Income
(numerator)


    Shares
(denominator)


   Per share
amount


Basic net income per share:

                   

Net income

   $ 23,125             

Dividends on preferred stock

     (1,478 )           
    


          

Income available to common shareholders

     21,647     51,925,000    $ 0.42

Effect of dilutive securities:

                   

Stock options

     —       820,000       
    


 
      

Diluted net income per common share:

                   

Income available to common shareholders and assumed conversions

   $ 21,647     52,745,000    $ 0.41
    


 
      
     For the three months ended June 30, 2002

(Dollars in thousands, except per share amounts)


   Income
(numerator)


    Shares
(denominator)


   Per share
amount


Basic net income per share:

                   

Net income

   $ 33,536             

Dividends on preferred stock

     (1,314 )           
    


          

Income available to common shareholders

     32,222     50,685,000    $ 0.64

Effect of dilutive securities:

                   

Convertible preferred stock

     1,314     2,400,000       

Stock options

     —       1,415,000       
    


 
      

Diluted net income per common share:

                   

Income available to common shareholders and assumed conversions

   $ 33,536     54,500,000    $ 0.62
    


 
      
     For the six months ended June 30, 2003

(Dollars in thousands, except per share amounts)


   Income
(numerator)


    Shares
(denominator)


   Per share
amount


Basic net income per share:

                   

Net income

   $ 48,222             

Dividends on preferred stock

     (2,956 )           
    


          

Income available to common shareholders

     45,266     51,831,000    $ 0.87

Effect of dilutive securities:

                   

Stock options

     —       589,000       
    


 
      

Diluted net income per common share:

                   

Income available to common shareholders and assumed conversions

   $ 45,266     52,420,000    $ 0.86
    


 
      
     For the six months ended June 30, 2002

(Dollars in thousands, except per share amounts)


   Income
(numerator)


    Shares
(denominator)


   Per share
amount


Basic net income per share:

                   

Net income

   $ 61,138             

Dividends on preferred stock

     (1,577 )           
    


          

Income available to common shareholders

     59,561     50,446,000    $ 1.18

Effect of dilutive securities:

                   

Convertible preferred stock

     1,577     1,614,000       

Stock options

     —       1,705,000       
    


 
      

Diluted net income per common share:

                   

Income available to common shareholders and assumed conversions

   $ 61,138     53,765,000    $ 1.14
    


 
      

 

15


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

As of June 30, 2003 and December 31, 2002 and for the

Three Months and Six Months Ended June 30, 2003 and 2002

 

There were options outstanding to purchase 3,944,139 shares and 2,016,187 shares during the three months ended June 30, 2003 and 2002, respectively, that were considered anti-dilutive whereby the options’ exercise price was greater than the average market price of the common shares. There were options outstanding to purchase 4,259,555 shares and 1,955,613 shares during the six months ended June 30, 2003 and 2002, respectively, that were considered anti-dilutive.

 

The convertible preferred stock was considered anti-dilutive in the first and second quarters of 2003, whereby the preferred dividends of $1.5 million for both quarters divided by the common stock equivalent of the convertible preferred stock of 2,785,000 shares and 2,718,000 shares for the first and second quarters of 2003, respectively, were greater than the diluted earnings per common share. Net income available to common shareholders is based on total net income less preferred dividends of $1.5 million for the first and second quarters of 2003.

 

The convertible preferred stock was considered anti-dilutive for the six months ended June 30, 2003, whereby the preferred dividends of $3.0 million divided by the common stock equivalent of the convertible preferred stock of 2,751,000 shares were greater than the diluted earnings per common share. Net income available to common shareholders is based on total net income less preferred dividends of $3.0 million for the six months ended 2003.

 

NOTE 7—ACTIVITY OF BUSINESS SEGMENTS

 

The accounting policies of the segments are described in the “Summary of Significant Accounting Policies.” Segment data includes intersegment revenue, as well as charges allocating the appropriate corporate-headquarters costs to each of our operating segments. Intersegment revenue is recorded at prevailing market terms and rates and is not significant to the results of the segments. This revenue is eliminated in consolidation. We evaluate the performance of our segments and allocate resources to them based on net interest income, non-interest income, net income before income taxes, total assets and deposits.

 

We are organized primarily along community banking and insurance brokerage services business segments. We have aggregated 14 operating divisions into the “community banking” segment. Community banking provides a range of commercial banking services to small and medium-sized businesses, real estate developers, property managers, business executives, professional and other individuals. The insurance brokerage services segment provides commercial insurance brokerage and employee benefits consulting services. We conduct our business within the United States; our foreign operations are not material.

 

16


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

As of June 30, 2003 and December 31, 2002 and for the

Three Months and Six Months Ended June 30, 2003 and 2002

 

The following table shows each segment’s key operating results and financial position for the six months ended June 30, 2003 and 2002:

 

    

As of and for the six months ended

June 30, 2003


  

As of and for the six months ended

June 30, 2002


(Dollars in thousands)


   Community
banking


   Insurance
agency services


   Total

   Community
banking


   Insurance
agency services (2)


   Total

Statements of operations

                                         

Net interest income after provision for loan and lease losses

   $ 147,092    $ 434    $ 147,526    $ 159,384    $ 643    $ 160,027

Non-interest income

     25,874      58,419      84,293      17,641      38,492      56,133

Operating expenses:

                                         

Direct operating expenses

     51,591      46,408      97,999      54,117      29,014      83,131

Intercompany allocation

     53,176      —        53,176      38,145      —        38,145
    

  

  

  

  

  

Total operating expenses

     104,767      46,408      151,175      92,262      29,014      121,276
    

  

  

  

  

  

Income before provision for income taxes (1)

   $ 68,199    $ 12,445    $ 80,644    $ 84,763    $ 10,121    $ 94,884
    

  

  

  

  

  

Balance sheets

                                         

Total assets

   $ 6,616,145    $ 251,996    $ 6,868,141    $ 7,194,387    $ 225,074    $ 7,419,461

Deposits

     5,548,251      —        5,548,251      5,299,126      —        5,299,126

(1)   Includes intercompany earnings allocation charge which is eliminated in consolidation.
(2)   We acquired ABD on March 12, 2002 and its results of operations are included only from the date of acquisition through March 31, 2002.

 

A reconciliation of total segment net interest income and non-interest income combined, net income before income taxes, and total assets to the consolidated numbers in each of these categories for the six months ended June 30, 2003 and 2002 is presented below.

 

(Dollars in thousands)


   Six months ended
June 30, 2003


    Six months ended
June 30, 2002


 

Net interest income and non-interest income

                

Total segment net interest income after provision for loan and lease losses and non-interest income

   $ 231,819     $ 216,160  

Parent company net interest income after provision for loan and lease losses and non-interest income

     (7,958 )     (2,857 )
    


 


Consolidated net interest income after provision for loan and lease losses and non-interest income

   $ 223,861     $ 213,303  
    


 


Income before provision for income taxes

                

Total segment income before provision for income taxes

   $ 80,644     $ 94,884  

Parent company income before provision for income taxes

     (2,371 )     2,917  
    


 


Consolidated income before provision for income taxes

   $ 78,273     $ 97,801  
    


 


Total assets

                

Total segment assets

   $ 6,868,141     $ 7,419,461  

Parent company assets

     1,215,873       1,106,761  
    


 


Consolidated total assets

   $ 8,084,014     $ 8,526,222  
    


 


 

17


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

As of June 30, 2003 and December 31, 2002 and for the

Three Months and Six Months Ended June 30, 2003 and 2002

 

NOTE 8—GUARANTEES

 

In November 2002, the FASB issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees Including Indirect Guarantees of Indebtedness to Others” (“FIN 45”), which requires us to disclose information about obligations under certain guarantee arrangements. FIN 45 defines a guarantee as a contract that contingently requires us to pay a guaranteed party based on:

 

  1)   changes in underlying asset, liability, or equity security of the guaranteed party or

 

  2)   a third party’s failure to perform under an obligating guarantee (performance guarantee).

 

We consider the following off-balance sheet lending arrangements to be guarantees under FIN 45:

 

    Financial standby letters of credit and financial guarantees are conditional lending commitments issued by us to guarantee the performance of a customer to a third party in borrowing arrangements. At June 30, 2003, the maximum undiscounted future payments that we could be required to make was $99.3 million. Of these arrangements, 62.4% mature within one year. We generally have recourse to recover from the customer any amounts paid under these guarantees;

 

    We may be required to make contingent payments to the former shareholders of ABD and The Matsco Companies, Inc. based on their future operating results. As of June 30, 2003, under the ABD acquisition agreement, the maximum gross future earn-out payments to ABD’s former shareholders is $56.4 million plus 65% of the EBITDA (as defined in the acquisition agreement) in excess of the Forecast EBITDA, as defined in the acquisition agreement, payable through 2005 in a combination of cash and noncumulative convertible preferred stock or, in certain circumstance, common stock. The Forecast EBITDA for ABD is $29.6 million, $34.6 million and $40.3 million for the years ended December 31, 2003, 2004 and 2005, respectively. As of June 30, 2003, under the acquisition agreement with The Matsco Companies, Inc., the maximum gross future earn-out payments to the former shareholders is $4.5 million through 2005; and

 

    Several of our Banks have guaranteed credit cards issued to our clients by an unaffiliated financial institution. As of June 30, 2003, the combined credit limits on those accounts are $10.6 million.

 

NOTE 9—VARIABLE INTEREST ENTITIES

 

FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”) defines variable interest entities as a corporation, partnership, trust, or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. A variable interest entity often holds financial assets, including loans or receivables, real estate or other property. A variable interest entity may be essentially passive or it may engage in research and development or other activities on behalf of another company. FIN 46 requires that a variable interest entity be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. FIN 46 also requires disclosures about variable interest entities that we are not required to consolidate but in which we have a significant variable interest. As of June 30, 2003, we did not have an interest in any unconsolidated variable interest entities.

 

18


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

As of June 30, 2003 and December 31, 2002 and for the

Three Months and Six Months Ended June 30, 2003 and 2002

 

Matsco Lease Finance, Inc. III (“MLF III”) is a special purpose corporation wholly owned by Greater Bay formed for the purpose of issuing lease-backed notes. MLF III, CNBIT I, CNBIT II, MPBIT and SJNBIT each have some characteristics of variable interest entities as defined by FIN 46. The results of and financial position of these five entities are fully consolidated with our results and financial position, and therefore these entities are exempt from the provisions of FIN 46.

 

FIN 46 may have an impact on the treatment of the trust preferred securities we have issued and ability for those instruments to provide us with Tier 1 capital. The impact of FIN 46 on these instruments is currently being evaluated by the accounting community. One potential impact of not including these trusts in our consolidated liabilities is that the trust preferred securities may no longer count towards Tier 1 capital. The Federal Reserve has issued regulations which allow for the inclusion of these instruments in Tier 1 capital regardless of the FIN 46 interpretation, although such a determination could potentially be changed at a later date. We do not expect the adoption of FIN 46 to have any additional material impact on our financial condition or operating results.

 

NOTE 10—COMMON STOCK CASH DIVIDEND

 

On June 24, 2003, we declared a cash dividend of $0.135 cents per common share payable on July 17, 2003 to shareholders of record as of July 7, 2003.

 

19


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

OVERVIEW

 

Greater Bay is a financial holding company with 11 bank subsidiaries (the “Banks”): Bank of Petaluma, Bank of Santa Clara, Bay Area Bank, Bay Bank of Commerce, Coast Commercial Bank, Cupertino National Bank, Golden Gate Bank, Mid-Peninsula Bank, Mt. Diablo National Bank, Peninsula Bank of Commerce, and San Jose National Bank. We also have a commercial insurance brokerage subsidiary, ABD. We also conduct business through the following divisions: CAPCO, Greater Bay Bank Contra Costa Region, Greater Bay Bank Fremont Region, Greater Bay Bank Carmel, Greater Bay Bank Marin, Greater Bay Bank Santa Clara Valley Group, Greater Bay Bank SBA Lending Group, Greater Bay Corporate Finance Group, Greater Bay International Banking Division, Greater Bay Trust Company, Matsco, Pacific Business Funding and the Venture Banking Group.

 

In addition to these divisions, we have the following consolidated subsidiaries which issued trust preferred securities and purchased Greater Bay’s junior subordinated deferrable interest debentures: GBB Capital II, GBB Capital III, GBB Capital IV, GBB Capital V, GBB Capital VI, and GBB Capital VII. We also created CNBIT I, CNBIT II, MPBIT, and SJNBIT, all of which are Maryland real estate investment trusts and wholly owned subsidiaries of Cupertino National Bank, Mid-Peninsula Bank, and San Jose National Bank, respectively. These entities were formed in order to provide flexibility in raising capital.

 

We provide a wide range of commercial banking services to small and medium-sized businesses, property managers, business executives, real estate developers, professionals and other individuals. We operate community banking offices throughout the San Francisco Bay Area including Silicon Valley, San Francisco and the San Francisco Peninsula, the East Bay, Santa Cruz, Marin, Monterey, and Sonoma Counties. ABD provides commercial insurance brokerage, employee benefits consulting and risk management solutions to business clients throughout the United States. We also own a broker-dealer, which executes mutual fund transactions. CAPCO’s office is located in Bellevue, Washington and it operates in the Pacific Northwest. Matsco markets its dental and veterinarian financing services nationally.

 

At June 30, 2003, we had total assets of $8.1 billion, total loans, net, of $4.6 billion, total investment securities of $2.6 billion and total deposits of $5.5 billion.

 

The following discussion and analysis is intended to provide greater details of our results of operations and financial condition. The following discussion should be read in conjunction with our consolidated financial data included elsewhere in this document. Certain statements under this caption 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, which involve risks and uncertainties. Our actual results may differ significantly from the results discussed in such forward-looking statements. Factors that might cause such a difference include but are not limited to economic conditions, competition in the geographic and business areas in which we conduct our operations, fluctuation in interest rates, credit quality and government regulation and other factors discussed in our reports filed with the Securities and Exchange Commission, including our Annual Report on Form 10-K for the year ended December 31, 2002.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

CRITICAL ACCOUNTING POLICIES

 

Our accounting policies are integral to understanding the results reported. Accounting policies are described in detail in Note 1 to the NOTES TO CONSOLIDATED FINANCIAL STATEMENTS presented in our 2002 annual report on Form 10-K. Our most complex accounting policies require management’s judgment to ascertain the valuation of assets, liabilities, commitments and contingencies. We have established detailed policies and control procedures that are intended to ensure valuation methods are well controlled and applied consistently from period to period. In addition, the policies and procedures are intended to ensure that the process for changing methodologies occurs in an appropriate manner. The following is a brief description of our current accounting policies involving significant management valuation judgments.

 

Allowance for Loan and Lease Losses

 

The allowance for loan and lease losses represents management’s best estimate of losses inherent in the existing loan portfolio. The allowance for loan and lease losses is increased by the provision for loan and lease losses charged to expense and reduced by loans charged-off, net of recoveries. The allowance for loan and lease losses is determined based on management’s assessment of several factors: reviews and evaluation of individual loans, changes in the nature and volume of the loan portfolio, current economic conditions and the related impact on specific borrowers and industry groups, historical loan loss experiences and the level of classified and nonperforming loans.

 

Loans are considered impaired if, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate stipulated in the loan agreement, except that all collateral-dependent loans are measured for impairment based on the fair value of the collateral. In measuring the fair value of the collateral, management uses assumptions and methodologies consistent with those that would be utilized by unrelated third parties.

 

Changes in the financial condition of individual borrowers, economic conditions, historical loss experience and the condition of the various markets in which collateral may be sold may all affect the required level of the allowance for loan and lease losses and the associated provision for loan and lease losses.

 

Available for Sale Securities

 

The fair value of most securities classified as available for sale is based on quoted market prices. If quoted market prices are not available, fair values are extrapolated from the quoted prices of similar instruments.

 

Goodwill and Other Intangible Assets

 

As discussed in Note 4 of the NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, we assess goodwill and other intangible assets each year for impairment. This assessment involves estimating cash flows for future periods. If the future cash flows were materially less than the recorded goodwill and other intangible assets balances, we would be required to take a charge against earnings to write down the assets to the lower value.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

Deferred Tax Assets

 

Our deferred tax assets are explained in Note 15 to the NOTES TO CONSOLIDATED FINANCIAL STATEMENTS presented in our 2002 annual report on Form 10-K. We use an estimate of future earnings to support our position that the benefit of our deferred tax assets will be realized. If future income should prove non-existent or less than the amount of the deferred tax assets within the tax years to which they may be applied, the asset may not be realized and our net income will be reduced.

 

Supplemental Employee Compensation Benefits Agreements

 

As described in detail in Note 17 to the NOTES TO CONSOLIDATED FINANCIAL STATEMENTS presented in our 2002 annual report on Form 10-K, we have entered into supplemental employee compensation benefits agreements with certain executive and senior officers. The measurement of the liability under these agreements includes estimates involving life expectancy, length of time before retirement, and expected benefit levels. Should these estimates prove materially wrong, we could incur additional or reduced expense to provide the benefits.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

RESULTS OF OPERATIONS

 

The following table summarizes income, income per common share and certain key financial ratios for the periods indicated.

 

(Dollars in thousands, except per share amounts)


   Three months ended
June 30, 2003


    Three months ended
June 30, 2002


    Six months ended
June 30, 2003


    Six months ended
June 30, 2002


 

Net income

   $ 23,125     $ 33,536     $ 48,222     $ 61,138  

Net income per common share:

                                

Basic

   $ 0.42     $ 0.64     $ 0.87     $ 1.18  

Diluted

   $ 0.41     $ 0.62     $ 0.86     $ 1.14  

Return on average assets

     1.15 %     1.60 %     1.22 %     1.50 %

Return on average shareholders’ equity

     12.97 %     22.48 %     13.80 %     21.47 %

 

Net income declined 31.0% during the second quarter of 2003 as compared to the second quarter of 2002. Net income declined 21.1% during the first six months of 2003 as compared to the same period of 2002. The $(0.21) decline in earnings per diluted share for the second quarter of 2003 and the $(0.28) decline in earnings per diluted share for the first six months of 2003, compared to the same periods a year ago, were attributable primarily to the following factors:

 

    Market interest rate reductions reduced our net interest margin by 48 basis points in the second quarter of 2003 and 43 basis points in the first six months of 2003, resulting in approximately an $(0.11) and $(0.19) decline in earnings per diluted share, respectively;

 

    Planned reduction in our interest earning asset base (primarily the investment securities portfolio) reduced earnings per diluted share by approximately $(0.07) and $(0.12) for the second quarter of 2003 and first six months of 2003, respectively;

 

    Outside consulting costs related to enterprise wide risk management and regulatory compliance amounted to approximately $1.3 million in the second quarter of 2003 and $2.2 million in the first six months of 2003, or approximately $(0.02) and $(0.03) per diluted share, respectively, and

 

    The above factors were partially offset by an $11.8 million or $0.14 per diluted share reduction in our provision for loan and lease losses as credit quality remained stable.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

Net Interest Income - Overview

 

Our interest rate risk (“IRR”) strategy focuses on mitigating IRR in our balance sheet. We primarily use balance sheet matching techniques and, to a limited extent, derivatives to manage IRR. We are proactively managing our IRR in this uncertain economic market environment to ensure that we are positioned for long-term success compared to short-term earnings goals that would not be sustainable in a rising interest rate environment. Our current strategy, which is continually reviewed in relationship to market conditions, includes a gradual reduction of the investment securities portfolio. This strategy will continue to reduce current net interest income in the near-term, but will position us to take advantage of an improving economy and rising market interest rates over the longer term. Because the balance sheet is positioned to be more asset sensitive, our net interest margin will continue to be pressured in the event of a continuing flat-to-declining interest rate environment. Our IRR model suggests that the Federal Reserve Board’s 25 basis point interest rate reduction at the end of June 2003 will result in a 10 to 20 basis point reduction in our margin. We have had many opportunities to add to our net interest income in the short-term by extending investment security maturities or expanding the balance sheet, but we believe the risks of that strategy in this low interest rate environment would not be prudent IRR management.

 

During the first six months of 2003, the investment securities portfolio increased by $76.5 million to $2.6 billion. We expect to reverse this nominal increase in the investment portfolio during the quarter ending September 30, 2003 and have a target of $2.4 billion for our investment securities portfolio by September 30, 2003 and $2.2 billion by the end of the year. While $2.2 billion is currently the target for our investment portfolio, market conditions or a different mix of fixed rate versus variable rate assets could change the ultimate portfolio size and composition.

 

Two years ago, our balance sheet had substantial IRR in a falling rate environment, as the majority of our loans had interest rates tied to the prime rate. Interest rates on those loans move downward immediately upon a market interest rate decrease, compared to our interest-bearing liabilities, that do not reprice as quickly, or to the same magnitude, as the interest rate sensitive loans. At that time, we initiated a program to shift the funding source for our specialty finance businesses, comprised of the CAPCO, Corporate Finance, Matsco and Pacific Business Funding divisions, from a core deposit base to a wholesale funding strategy. This strategy also changed our balance sheet to a more leveraged position that was designed to protect our net interest income in a declining interest rate environment.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

Net Interest Income

 

Net interest income decreased 16.7% to $73.8 million for the second quarter of 2003 from $88.6 million for the second quarter of 2002. This decrease was primarily due to the 48 basis point decrease in our net yield on interest-earning assets and to a lesser degree the $539.0 million, or 7.0%, decrease in average interest-earning assets.

 

Net interest income decreased 3.1% to $73.8 million in the second quarter of 2003 from $76.2 million during the first quarter of 2003. This decrease was primarily due to the 22 basis point decrease in our net yield on interest-earning assets and was partially offset by $74.7 million, or 1.0%, increase in our average interest-earning assets.

 

The following table presents, for the periods indicated, our condensed average balance sheet information together with interest income and yields earned on average interest-earning assets and interest expense and rates paid on average interest-bearing liabilities. Average balances are average daily balances.

 

    

Three months ended

June 30, 2003


   

Three months ended

June 30, 2002


 

(Dollars in thousands)


   Average
balance (1)


   Interest

   Average
yield /
rate


    Average
balance (1)


   Interest

  

Average

yield /
rate


 

INTEREST-EARNING ASSETS:

                                        

Fed funds sold

   $ 135,418    $ 373    1.10 %   $ 81,932    $ 331    1.62 %

Other short-term securities

     72      1    5.57 %     3,183      39    4.91 %

Investment securities:

                                        

Taxable

     2,242,162      20,696    3.70 %     2,971,804      45,387    6.13 %

Tax-exempt (2)

     106,144      1,241    4.69 %     145,187      1,780    4.92 %

Loans (3)

     4,720,462      81,139    6.89 %     4,541,191      83,255    7.35 %
    

  

        

  

      

Total interest-earning assets

     7,204,258      103,450    5.76 %     7,743,297      130,792    6.77 %

Noninterest-earning assets

     851,704                   669,890              
    

  

        

  

      

Total assets

   $ 8,055,962      103,450          $ 8,413,187      130,792       
    

  

        

  

      

INTEREST-BEARING LIABILITIES:

                                        

Deposits:

                                        

MMDA, NOW and Savings

   $ 3,030,295      8,708    1.15 %   $ 2,461,298      9,496    1.55 %

Time deposits, over $100,000

     523,582      2,751    2.11 %     534,131      3,358    2.52 %

Other time deposits

     1,178,796      4,586    1.56 %     1,275,405      7,946    2.50 %
    

  

        

  

      

Total interest-bearing deposits

     4,732,673      16,045    1.36 %     4,270,834      20,800    1.95 %

Borrowings

     1,313,388      9,379    2.86 %     2,228,351      16,320    2.94 %

Trust Preferred Securities

     204,000      4,222    8.30 %     222,506      5,025    9.06 %
    

  

        

  

      

Total interest-bearing liabilities

     6,250,061      29,646    1.90 %     6,721,691      42,145    2.51 %

Noninterest-bearing deposits

     928,801                   923,722              

Other noninterest-bearing liabilities

     146,546                   153,870              

Preferred stock of real estate investment trust subsidiaries of the Banks

     15,646                   15,650              

Shareholders’ equity

     714,908                   598,254              
    

  

        

  

      

Total shareholders’ equity and liabilities

   $ 8,055,962      29,646          $ 8,413,187      42,145       
    

  

        

  

      

Net interest income

          $ 73,804                 $ 88,647       
           

               

      

Interest rate spread

                 3.86 %                 4.26 %

Contribution of interest free funds

                 0.25 %                 0.33 %
                  

               

Net yield on interest-earning assets (4)

                 4.11 %                 4.59 %
                  

               


(1)   Nonaccrual loans are excluded from the average balance and only collected interest on nonaccrual loans is included in the interest column.
(2)   Tax equivalent yields earned on the tax-exempt securities are 7.04% and 7.33% for the three months ended June 30, 2003 and June 30, 2002, respectively, using the federal statutory rate of 35%.
(3)   Loan fees totaling $1.2 million and $1.7 million are included in loan interest income for three months ended June 30, 2003 and June 30, 2002, respectively.
(4)   Net yield on interest-earning assets during the period equals (a) the difference between interest income on interest-earning assets and the interest expense on interest-bearing liabilities, divided by (b) average interest-earning assets for the period.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

    

Three months ended

June 30, 2003


   

Three months ended

March 31, 2003


 

(Dollars in thousands)


   Average
balance (1)


   Interest

   Average
yield /
rate


    Average
balance (1)


   Interest

  

Average

yield /
rate


 

INTEREST-EARNING ASSETS:

                                        

Fed funds sold

   $ 135,418    $ 373    1.10 %   $ 49,956    $ 139    1.13 %

Other short-term securities

     72      1    5.57 %     7,441      79    4.31 %

Investment securities:

                                        

Taxable

     2,242,162      20,696    3.70 %     2,261,348      25,026    4.49 %

Tax-exempt (2)

     106,144      1,241    4.69 %     93,890      1,223    5.28 %

Loans (3)

     4,720,462      81,139    6.89 %     4,716,930      80,877    6.95 %
    

  

        

  

      

Total interest-earning assets

     7,204,258      103,450    5.76 %     7,129,565      107,344    6.11 %

Noninterest-earning assets

     851,704                   810,245              
    

  

        

  

      

Total assets

   $ 8,055,962      103,450          $ 7,939,810      107,344       
    

  

        

  

      

INTEREST-BEARING LIABILITIES:

                                        

Deposits:

                                        

MMDA, NOW and Savings

   $ 3,030,295      8,708    1.15 %   $ 2,715,821      8,247    1.23 %

Time deposits, over $100,000

     523,582      2,751    2.11 %     539,702      2,902    2.18 %

Other time deposits

     1,178,796      4,586    1.56 %     1,109,600      5,385    1.97 %
    

  

        

  

      

Total interest-bearing deposits

     4,732,673      16,045    1.36 %     4,365,123      16,534    1.54 %

Borrowings

     1,313,388      9,379    2.86 %     1,511,075      9,836    2.64 %

Trust Preferred Securities

     204,000      4,222    8.30 %     204,000      4,807    9.56 %
    

  

        

  

      

Total interest-bearing liabilities

     6,250,061      29,646    1.90 %     6,080,198      31,177    2.08 %

Noninterest-bearing deposits

     928,801                   977,556              

Other noninterest-bearing liabilities

     146,546                   172,297              

Preferred stock of real estate investment trust subsidiaries of the Banks

     15,646                   15,650              

Shareholders’ equity

     714,908                   694,109              
    

  

        

  

      

Total shareholders’ equity and liabilities

   $ 8,055,962      29,646          $ 7,939,810      31,177       
    

  

        

  

      

Net interest income

          $ 73,804                 $ 76,167       
           

               

      

Interest rate spread

                 3.86 %                 4.03 %

Contribution of interest free funds

                 0.25 %                 0.31 %
                  

               

Net yield on interest-earning assets (4)

                 4.11 %                 4.33 %
                  

               


(1)   Nonaccrual loans are excluded from the average balance and only collected interest on nonaccrual loans is included in the interest column.
(2)   Tax equivalent yields earned on the tax-exempt securities are 7.04% and 7.94% for the three months ended June 30, 2003 and March 31, 2003, respectively, using the federal statutory rate of 35%.
(3)   Loan fees totaling $1.2 million and $1.1 million are included in loan interest income for three months ended June 30, 2003 and March 31, 2003, respectively.
(4)   Net yield on interest-earning assets during the period equals (a) the difference between interest income on interest-earning assets and the interest expense on interest-bearing liabilities, divided by (b) average interest-earning assets for the period.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

The most significant impact on our net interest income between periods is derived from the interaction of changes in the volume of, and rate earned or paid on, interest-earning assets and interest-bearing liabilities. The volume of interest-earning asset dollars in loans and investments, compared to the volume of interest-bearing liabilities represented by deposits and borrowings, combined with the spread, produces the changes in the net interest income between periods. The table below sets forth, for the periods indicated, a summary of the changes in average asset and liability balances (volume) and changes in average interest rates (rate). Changes in interest income and expense which are not attributable specifically to either volume or rate are allocated proportionately between both variances. Nonaccrual loans are excluded from average loans.

 

    

Three months ended

June 30, 2003
compared

with June 30, 2002
favorable / (unfavorable)


   

Three months ended

June 30, 2003
compared

with March 31, 2003
favorable / (unfavorable)


 

(Dollars in thousands)


   Volume

    Rate

    Net

   

Volume


   Rate

    Net

 

INTEREST EARNED ON INTEREST-EARNING ASSETS

                                             

Federal funds sold

   $ 170     $ (128 )   $ 42     $    237    $ (3 )   $ 234  

Other short-term investments

     (42 )     4       (38 )   (206)      128       (78 )

Investment securities:

                                             

Taxable

     (9,455 )     (15,236 )     (24,691 )   (200)      (4,130 )     (4,330 )

Tax-exempt

     (460 )     (79 )     (539 )   159      (141 )     18  

Loans

     3,207       (5,323 )     (2,116 )   134      128       262  
    


 


 


 
  


 


Total interest income

     (6,580 )     (20,762 )     (27,342 )   124      (4,018 )     (3,894 )
    


 


 


 
  


 


INTEREST EXPENSE ON INTEREST-BEARING LIABILITIES

                                             

Deposits:

                                             

MMDA, NOW and savings

     (1,929 )     2,717       788     (985)      524       (461 )

Time deposits over $100,000

     65       542       607     71      80       151  

Other time deposits

     564       2,796       3,360     (337)      1,136       799  
    


 


 


 
  


 


Total interest-bearing deposits

     (1,300 )     6,055       4,755     (1,251)      1,740       489  

Borrowings

     6,543       398       6,941     1,302      (845 )     457  

Trust Preferred Securities

     401       402       803     —        585       585  
    


 


 


 
  


 


Total interest expense

     5,644       6,855       12,499     51      1,480       1,531  
    


 


 


 
  


 


Net increase (decrease) in net interest income

   $ (936 )   $ (13,907 )   $ (14,843 )   $    175    $ (2,538 )   $ (2,363 )
    


 


 


 
  


 


 

The Quarter Ended June 30, 2003 Compared to the Quarter Ended June 30, 2002

 

Interest income in the second quarter of 2003 decreased 20.9%, or $27.3 million, to $103.5 million from $130.8 million in the quarter ended June 30, 2002. This was primarily due to the decline in interest rates and to a lesser degree a decrease in interest-earning assets.

 

The average yield on interest-earning assets decreased 101 basis points to 5.76% in the second quarter of 2003 from 6.77% in the same period of 2002 primarily reflecting the general decline in market rates of interest during 2002 and 2003. The average yield on taxable investment securities decreased 243 basis points to 3.70% in the second quarter of 2003 from 6.13% in the same period of 2002. The average yield on tax-exempt investment securities decreased 23 basis points to 4.69% in the second quarter of 2003 from 4.92% in the same period of 2002. The average yield on loans decreased 46 basis points to 6.89% in the second quarter of 2003 from 7.35% in the same period of 2002.

 

        Average interest-earning assets decreased $539.0 million, or 7.0%, to $7.2 billion in the second quarter of 2003, compared to $7.7 billion in the same period of 2002. Average loans increased $179.3 million, or 3.9%, to $4.7 billion for the three months ended June 30, 2003 from $4.5 billion in the same period of 2002 as a result of our relationship managers’ business development efforts. Average investment securities, Federal funds sold and other short-term securities, decreased 22.4% to $2.5 billion in the second quarter of 2003 from $3.2 billion in the same period of 2002 as a result of our IRR strategy described above. Loans represented approximately 65.5% of total interest-earning assets in the second quarter of 2003 compared to 58.6% in the same period of 2002.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

Interest expense in the second quarter of 2003 decreased 29.7%, or $12.5 million, to $29.6 million from $42.1 million in the same period of 2002, reflecting the declines in interest rates and average interest-bearing liabilities. The average rate paid on interest-bearing liabilities decreased 61 basis points to 1.90% in the second quarter of 2003 from 2.51% in the second quarter of 2002. Average interest-bearing liabilities decreased 7.0% to $6.3 billion in the second quarter of 2003 from $6.7 billion in the same period of 2002. The decrease was due primarily to the decrease in wholesale funding resulting from our IRR strategy.

 

During the second quarter of 2003, average noninterest-bearing deposits increased to $928.8 million from $923.7 million in the same period of 2002.

 

As a result of the foregoing, our interest rate spread decreased to 3.86% in the second quarter of 2003 from 4.26% in the same period of 2002, and the net yield on interest-earning assets decreased in the second quarter of 2003 to 4.11% from 4.59% in the same period of 2002.

 

The Quarter Ended June 30, 2003 Compared to the Quarter Ended March 31, 2003

 

Interest income in the second quarter of 2003 decreased 3.6%, or $3.9 million, to $103.5 million from $107.3 million in the previous quarter. This was primarily due to the decline in interest rates.

 

The average yield on interest-earning assets decreased 35 basis points to 5.76% in the second quarter of 2003 from 6.11% in the previous quarter primarily reflecting the general decline in market rates of interest during 2003. The average yield on taxable investment securities decreased 79 basis points to 3.70% in the second quarter of 2003 from 4.49% in the previous quarter. The average yield on tax-exempt investment securities decreased 59 basis points to 4.69% in the second quarter of 2003 from 5.28% in the previous quarter. The average yield on loans decreased 6 basis points to 6.89% in the second quarter of 2003 from 6.95% in the previous quarter.

 

Average interest-earning assets increased $74.7 million, or 1.0%, to $7.2 billion in the second quarter of 2003, compared to $7.1 billion in the previous quarter. Average loans increased $3.5 million, or 0.1%, during the three months ended June 30, 2003 from the previous quarter. Average investment securities, Federal Funds sold and other short-term securities increased 2.9% to $2.5 billion in the second quarter of 2003 from $2.4 billion in the previous quarter. Loans represented approximately 65.5% of total interest-earning assets in the second quarter of 2003 compared to 66.2% in the previous quarter.

 

Interest expense in the second quarter of 2003 decreased 4.9%, or $1.5 million, to $29.6 million from $31.2 million in the previous quarter, reflecting the declines in interest rates. The average rate paid on interest-bearing liabilities decreased 18 basis points to 1.90% in the second quarter of 2003 from 2.08% in the previous quarter. Average interest-bearing liabilities increased 2.8% to $6.3 billion in the second quarter of 2003 from $6.1 billion in the previous quarter. The increase was due to the increases in MMDA, NOW, and savings.

 

During the second quarter of 2003, average noninterest-bearing deposits decreased to $928.8 million from $977.6 million in the previous quarter.

 

As a result of the foregoing, our interest rate spread decreased to 3.86% in the second quarter of 2003 from 4.03% in the previous quarter, and the net yield on interest-earning assets decreased in the second quarter of 2003 to 4.11% from 4.33% in the previous quarter.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

Net Interest Income - Year to Date

 

Net interest income decreased 14.9% to $150.0 million for the six months ended June 30, 2003 from $176.2 million for the six months ended June 30, 2002. This decrease was primarily due to a 43 basis point decrease in our net yield on interest-earning assets and to a lesser degree a $476.4 million, or 6.2%, decrease in average interest-earning assets.

 

The following table presents, for the periods indicated, our condensed average balance sheet information together with interest income and yields earned on average interest-earning assets and interest expense and rates paid on average interest-bearing liabilities. Average balances are average daily balances.

 

    

Six months ended

June 30, 2003


   

Six months ended

June 30, 2002


 

(Dollars in thousands)


   Average
balance (1)


   Interest

   Average
yield /
rate


    Average
balance (1)


   Interest

  

Average

yield /
rate


 

INTEREST-EARNING ASSETS:

                                        

Fed funds sold

   $ 92,923    $ 512    1.11 %   $ 68,593    $ 554    1.63 %

Other short-term securities

     36      1    5.60 %     1,772      42    4.78 %

Investment securities:

                                        

Taxable

     2,246,473      45,801    4.11 %     2,948,757      90,580    6.19 %

Tax-exempt (2)

     105,280      2,464    4.72 %     131,569      3,212    4.92 %

Loans (3)

     4,718,705      162,016    6.92 %     4,489,108      165,829    7.45 %
    

  

        

  

      

Total interest-earning assets

     7,163,417      210,794    5.93 %     7,639,799      260,217    6.87 %

Noninterest-earning assets

     834,790                   583,036              
    

  

        

  

      

Total assets

   $ 7,998,207      210,794          $ 8,222,835      260,217       
    

  

        

  

      

INTEREST-BEARING LIABILITIES:

                                        

Deposits:

                                        

MMDA, NOW and Savings

   $ 2,871,547      16,957    1.19 %   $ 2,404,214      18,247    1.53 %

Time deposits, over $100,000

     531,597      5,650    2.14 %     553,295      7,239    2.64 %

Other time deposits

     1,144,389      9,971    1.76 %     1,238,180      16,249    2.65 %
    

  

        

  

      

Total interest-bearing deposits

     4,547,533      32,578    1.44 %     4,195,689      41,735    2.01 %

Borrowings

     1,411,953      19,216    2.74 %     2,166,054      32,276    3.00 %

Trust Preferred Securities

     204,000      9,029    8.93 %     220,265      10,005    9.16 %
    

  

        

  

      

Total interest-bearing liabilities

     6,163,486      60,823    1.99 %     6,582,008      84,016    2.57 %

Noninterest-bearing deposits

     955,424                   929,543              

Other noninterest-bearing liabilities

     159,083                   121,824              

Preferred stock of real estate investment trust subsidiaries of the Banks

     15,648                   15,338              

Shareholders’ equity

     704,566                   574,122              
    

  

        

  

      

Total shareholders’ equity and liabilities

   $ 7,998,207      60,823          $ 8,222,835      84,016       
    

  

        

  

      

Net interest income

          $ 149,971                 $ 176,201       
           

               

      

Interest rate spread

                 3.94 %                 4.29 %

Contribution of interest free funds

                 0.28 %                 0.36 %
                  

               

Net yield on interest-earning assets (4)

                 4.22 %                 4.65 %
                  

               


(1)   Nonaccrual loans are excluded from the average balance and only collected interest on nonaccrual loans is included in the interest column.
(2)   Tax equivalent yields earned on the tax-exempt securities are 7.08% and 7.34% for the six months ended June 30, 2003 and June 30, 2002. respectively, using the federal statutory rate of 35%.
(3)   Loan fees totaling $2.4 million and $3.5 million are included in loan interest income for six months ended June 30, 2003, and June 30, 2002, respectively.
(4)   Net yield on interest-earning assets during the period equals (a) the difference between interest income on interest-earning assets and the interest expense on interest-bearing liabilities, divided by (b) average interest-earning assets for the period.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

The table below sets forth, for the periods indicated, a summary of the changes in average asset and liability balances (volume) and changes in average interest rates (rate).

 

     Six months ended June 30, 2003
compared with June 30, 2002
favorable / (unfavorable)


 

(Dollars in thousands)


   Volume

    Rate

    Net

 

INTEREST EARNED ON INTEREST-EARNING ASSETS

                        

Federal funds sold

   $ 164     $ (206 )   $ (42 )

Other short-term investments

     (60 )     19       (41 )

Investment securities:

                        

Taxable

     (18,565 )     (26,214 )     (44,779 )

Tax-exempt

     (620 )     (128 )     (748 )

Loans

     8,230       (12,043 )     (3,813 )
    


 


 


Total interest income

     (10,851 )     (38,572 )     (49,423 )
    


 


 


INTEREST EXPENSE ON INTEREST-BEARING LIABILITIES

                        

Deposits:

                        

MMDA, NOW and savings

     (3,179 )     4,469       1,290  

Time deposits over $100,000

     275       1,314       1,589  

Other time deposits

     1,155       5,123       6,278  
    


 


 


Total interest-bearing deposits

     (1,750 )     10,907       9,157  

Borrowings

     10,457       2,603       13,060  

Trust Preferred Securities

     725       251       976  
    


 


 


Total interest expense

     9,432       13,761       23,193  
    


 


 


Net increase (decrease) in net interest income

   $ (1,419 )   $ (24,811 )   $ (26,230 )
    


 


 


 

The Six Months Ended June 30, 2003 Compared to Six Months Ended June 30, 2002

 

Interest income in the six months ended June 30, 2003 decreased 19.0% to $210.8 million from $260.2 million in the same period of 2002. This was primarily due to the decline in interest rates and to a lesser degree a decrease in interest-earning assets.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

The average yield on interest-earning assets decreased 94 basis points to 5.93% in the six months ended June 30, 2003 from 6.87% in the same period of 2002 primarily reflecting the general decline in market rate of interest during 2002 and 2003. The average yield on taxable investment securities decreased 208 basis points to 4.11% in the same period of 2003 from 6.19% for the same period of 2002. The average yield on tax-exempt investment securities decreased 20 basis points to 4.72% in the same period of 2003 from 4.92% for the same period of 2002. The average yield on loans decreased 53 basis points to 6.92% in the same period of 2003 from 7.45% for the same period of 2002.

 

Average interest-earning assets decreased $476.4 million, or 6.2%, to $7.2 billion in the six months ended June 30, 2003, compared to $7.6 billion in the same period of 2002. Average loans increased $229.6 million, or 5.1%, to $4.7 billion for the six months ended June 30, 2003 from $4.5 billion in the same period of 2002. This increase was offset by a decrease in average investment securities, Federal Funds sold and other short-term securities, of 22.4% to $2.4 billion in the six months ended 2003 from $3.2 billion in the same period of 2002 as a result of our IRR strategy described above. Loans represent approximately 65.9% of total interest-earning assets in the six months ended June 30, 2003 as compared to 58.8% for the same period in 2002.

 

Interest expense in the six months ended June 30, 2003 decreased 27.6% to $60.8 million from $84.0 million for the same period of 2002. This decrease was due to lower interest rates paid on interest-bearing liabilities and to a lesser degree, the decline in the average interest-bearing liabilities. The average rate paid on interest-bearing liabilities decreased 58 basis points to 1.99% in the six months ended June 30, 2003 from 2.57% in the same period of 2002. The average rate paid on interest bearing deposits decreased 57 basis points to 1.44% in the same period of 2003 from 2.01% in the same period 2002. Average interest-bearing liabilities decreased 6.4% to $6.2 billion in the six months ended June 30, 2003 from $6.6 billion in the same period of 2002.

 

During the six months ended June 30, 2003, average noninterest-bearing deposits increased to $955.4 million from $929.5 million in the same period of 2002.

 

As a result of the foregoing, our interest rate spread decreased to 3.94% in the six months ended June 30, 2003 from 4.29% in the same period of 2002. The net yield on interest-earning assets decreased in the six months ended June 30, 2003 to 4.22% from 4.65% in the same period of 2002.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

Provision for Loan and Lease Losses

 

The provision for loan and lease losses represents the current period credit cost associated with maintaining an appropriate allowance for credit losses. The loan loss provision for each period is dependent upon many factors, including loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies, assessments by management, third parties and regulators of the quality of the loan portfolio, the value of the underlying collateral on problem loans and the general economic conditions in our market area. Periodic fluctuations in the provision for loan and lease losses result from management’s assessment of the adequacy of the allowance for loan and lease losses; however, actual losses may vary from current estimates.

 

The provision for loan and lease losses in the second quarter of 2003 was $6.7 million, compared to $6.5 million in the first quarter of 2003 and $9.0 million in the second quarter of 2002. The provision for loan and lease losses for the six months ended June 30, 2003 was $13.2 million as compared to $25.0 million for the same period of 2002. The slight increase in the provision for loan and lease losses as compared to the first quarter reflects the results of our review and analysis of the loan portfolio and the adequacy of our existing allowance for loan and lease losses. The decrease in the provision for loan and lease losses for the second quarter and six month period ended 2003 as compared to the same periods of 2002 reflects the decrease in our net charge-offs for these periods as compared to the same periods of 2002. For further information on the allowance for loan and lease losses and nonperforming assets and a description of our systematic methodology employed in determining an adequate allowance for loan and lease losses, see “FINANCIAL CONDITION—Nonperforming Assets and Other Risk Factors” and “FINANCIAL CONDITION—Allowance for Loan and Lease Losses”.

 

Non-Interest Income

 

The following table sets forth information concerning non-interest income by category for the periods indicated.

 

     Three month periods ended:

(Dollars in thousands)


   June 30,
2003


   March 31,
2003


   December 31,
2002


    September 30,
2002


    June 30,
2002


Insurance agency commissions and fees

   $ 27,945    $ 30,642    $ 23,664     $ 26,359     $ 27,601

Gain on sale of investments, net

     3,136      2,023      (358 )     9,065       3,004

Service charges and other fees

     2,995      2,831      2,786       2,771       2,762

Loan and international banking fees

     2,421      2,038      2,309       2,124       2,273

Trust fees

     819      757      922       844       894

ATM network revenue

     445      406      574       629       628

Gain on sale of loans

     364      1,543      1,999       2,049       210

Other income

     4,196      4,524      3,964       6,033       2,138

Gain on early retirement of CODES

     —        —        2,605       5,770       —  

Warrant income

     —        —        —         (89 )     —  
    

  

  


 


 

Total

   $ 42,321    $ 44,764    $ 38,465     $ 55,555     $ 39,510
    

  

  


 


 

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

     Six month periods ended:

(Dollars in thousands)


  

June 30,

2003


  

June 30,

2002


Insurance agency commissions and fees

   $ 58,587    $ 38,492

Service charges and other fees

     5,826      5,590

Gain on sale of investments, net

     5,159      3,351

Loan and international banking fees

     4,459      4,800

Gain on sale of loans

     1,907      706

Trust fees

     1,576      1,800

ATM network revenue

     851      1,211

Other income

     8,720      6,152
    

  

Total

   $ 87,085    $ 62,102
    

  

 

Non-interest income decreased during the second quarter of 2003 as compared to the first quarter of 2003, primarily due to the decreases in insurance agency commissions and fees and gain on sale of loans which was partially offset by an increase in the gain on sale of investments, net. Non-interest income increased during the second quarter of 2003 as compared to the second quarter of 2002, primarily due to gains by Matsco on operating leases included in other income.

 

Non-interest income increased during the six months ended June 30, 2003 as compared to the same period of 2002, primarily due to the increases in insurance agency commissions and fees, gain on sale of investments, net, gain on sale of loans and gain by Matsco on operating leases included in other income. The increase in insurance agency commissions and fees during the six months ended June 30, 2003, as compared to the same period in 2002, is a result of the timing of the acquisition of ABD, which occurred on March 12, 2002. As a result, 2002 results only included four months of ABD’s operations.

 

Our second quarter of 2003 results included insurance agency commissions and fees totaling $27.9 million, as compared to $30.6 million recorded during the first quarter of 2003 and $27.6 million recorded during the second quarter of 2002. A portion of the decrease during the second quarter of 2003, as compared to the first quarter of 2003, is as a result of the seasonality of ABD’s revenues. During the first quarter of 2003, ABD received a significant portion of its annual override income which represents bonus payments from insurance companies based on various factors related to ABD’s production during the prior calendar year. The amount of override income is not estimable before receipt, and therefore this income is not recorded until received.

 

During the second quarter of 2003, we recorded a $3.1 million gain on sale of investments, compared to a $2.0 million gain for the first quarter of 2003, and a $3.0 million gain in the second quarter of 2002. The gain on sale of investments in the second quarter of 2003 was the result of sales undertaken in order to manage IRR and in anticipation of forthcoming increases in prepayment rates. Also, the gain on sale of investments is net of a $351,000 loss for the second quarter of 2003, $1.5 million loss for first quarter of 2003, and a $297,000 gain for second quarter of 2002 recognized on derivative instruments in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”).

 

During the second quarter of 2003, we recorded a $364,000 gain on sale of loans, compared to $1.5 million for the first quarter of 2003, and $210,000 in the second quarter of 2002. During the second quarter of 2003, the gain on sale of loans includes gains on the sale of SBA loans of $364,000, as compared to $347,000 during the first quarter of 2003 and $210,000 for the same period of last year. There was no gain related to the sale of Matsco’s loan production during the second quarter of 2003 and 2002. There was a $1.2 million gain related to the sale of $9.7 million of Matsco’s loan production during the first quarter of 2003.

 

33


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

Operating Expenses

 

The following table sets forth the major components of operating expenses for the periods indicated.

 

     Three month periods ended:

 

(Dollars in thousands)


   June 30,
2003


    March 31,
2003


    December 31,
2002


    September 30,
2002


    June 30,
2002


 

Compensation and benefits

   $ 42,001     $ 45,432     $ 41,735     $ 39,767     $ 38,647  

Occupancy and equipment

     10,171       9,642       10,225       10,035       10,267  

Legal and other professional fees

     4,390       4,962       2,835       2,462       1,915  

Telephone, postage and supplies

     1,878       1,746       2,020       1,827       1,918  

Marketing and promotion

     1,822       1,115       681       1,605       1,617  

Correspondent bank and ATM network fees

     1,717       1,701       1,866       1,802       1,508  

Amortization of intangibles

     1,671       1,671       1,658       1,650       1,650  

Data processing

     1,407       1,251       1,350       1,145       1,196  

Insurance

     1,283       1,236       944       901       892  

Depreciation - equipment leased to others

     1,072       735       454       158       —    

Expenses on other real estate owned

     518       1       20       119       —    

FDIC insurance and regulatory assessments

     482       498       491       409       417  

Dividends paid on preferred stock of real estate investment trusts

     454       453       421       465       464  

Client service expenses

     318       344       480       433       557  

Directors fees

     293       338       276       218       324  

Other expenses

     2,769       2,217       103       340       3,142  

Contribution to the Greater Bay Bancorp Foundation and related expenses

     —         —         —         479       —    

Trust Preferred Securities early retirement expense

     —         —         —         —         975  
    


 


 


 


 


Total operating expenses

   $ 72,246     $ 73,342     $ 65,559     $ 63,815     $ 65,489  
    


 


 


 


 


Efficiency ratio

     62.21 %     60.65 %     54.87 %     44.57 %     51.10 %

Total operating expenses to average assets

     3.60 %     3.75 %     3.16 %     2.99 %     3.12 %

 

Operating expenses totaled $72.2 million for the second quarter of 2003, as compared to $73.3 million for the first quarter of 2003 and $65.5 million for the second quarter of 2002. The ratio of operating expenses to average assets was 3.60% in the second quarter of 2003, 3.75% in the first quarter of 2003, and 3.12% in the second quarter of 2002.

 

     Six month periods ended:

 

(Dollars in thousands)


   June 30,
2003


    June 30,
2002


 

Compensation and benefits

   $ 87,433     $ 67,222  

Occupancy and equipment

     19,813       19,105  

Legal and other professional fees

     9,352       3,604  

Telephone, postage and supplies

     3,624       3,551  

Correspondent bank and ATM network fees

     3,418       2,849  

Amortization of intangibles

     3,342       2,212  

Marketing and promotion

     2,937       3,069  

Data processing

     2,658       2,325  

Insurance

     2,519       1,540  

Depreciation - equipment leased to others

     1,807       —    

FDIC insurance and regulatory assessments

     980       880  

Dividends paid on preferred stock of real estate investment trusts

     907       928  

Client service expenses

     662       1,204  

Directors fees

     631       613  

Expenses on other real estate owned

     519       —    

Other expenses

     4,986       5,425  

Trust Preferred Securities early retirement expense

     —         975  
    


 


Total operating expenses

   $ 145,588     $ 115,502  
    


 


Efficiency ratio

     61.42 %     48.47 %

Total operating expenses to average assets

     3.67 %     2.83 %

 

34


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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

Operating expenses totaled $145.6 million for the six months ended June 30, 2003, as compared to $115.5 million for the same period of 2002. The ratio of operating expenses to average assets was 3.67% for the six months ended June 30, 2003 and 2.83% for the same period of 2002.

 

We computed the efficiency ratio by dividing total operating expenses by net interest income and non-interest income. An increase in the efficiency ratio indicates that more resources are being utilized to generate the same (or greater) volume of income while a decrease would indicate more efficient resource allocation. Our efficiency ratio for the second quarter of 2003 was 62.21%, as compared to 60.65% in the first quarter of 2003 and 51.10% in the second quarter of 2002. Our efficiency ratio for the six months ended June 30, 2003 was 61.42%, as compared to 48.47% for the same period of 2002.

 

Operating expenses for ABD were $22.9 million for the second quarter of 2003, $23.6 million for the first quarter of 2003 and $21.5 million for the second quarter of 2002. The efficiency ratio excluding ABD was 56.04% for the second quarter of 2003, 55.28% for the first quarter of 2003 and 43.93% for the second quarter of 2002. The efficiency ratio excluding ABD is computed as operating expenses minus the operating expenses for ABD divided by total revenue minus insurance agency commissions and fees.

 

Operating expenses decreased $1.1 million during the second quarter of 2003 as compared to the first quarter of 2003. This decrease is primarily due to a $3.4 million decrease in compensation and benefits and a $572,000 decrease in legal and other professional fees. As compared to the second quarter of 2002, operating expenses during the second quarter of 2003 increased $6.8 million. This increase was primarily due to the $3.4 million in compensation and benefits, $1.3 million in regulatory related consulting costs and $1.2 million in other legal and other professional fees.

 

Operating expenses increased $30.1 million during the six months ended June 30, 2003 as compared to the same period of 2002. This increase is primarily due to a $20.2 million increase in compensation and benefits and a $2.2 million increase in regulatory related consulting costs, $3.5 million increase in other legal and other professional fees, $1.8 million increase in depreciation of equipment leased to others and $1.1 million increase in amortization of intangibles. $13.1 million of the increase in compensation and benefits was due to the ABD acquisition, as 2002 results only included four months of ABD’s operations.

 

During the quarters ended June 30, 2003, March 31, 2003 and December 31, 2002, we added personnel and resources, both internal and external, to enhance our compliance and enterprise wide risk management programs and processes. These improvements are required as a result of our substantial growth over the last several years and our response to the Cure Agreement (see “FINANCIAL CONDITION—Cure Agreement,” below). These expenditures include additional charges resulting from independent audit scope changes, expansion of internal audit services, professional and consulting fee increases, system enhancements and process improvements. These expenditures will primarily impact our compensation and benefits expense and legal and other professional fees.

 

Compensation and benefits expenses decreased in the second quarter of 2003 to $42.0 million compared to $45.4 million in the first quarter of 2003. This decrease is primarily the result of the seasonal impact of payroll taxes and benefits and expenses related to ABD’s override income. Compensation and benefits expenses increased in the second quarter of 2003 to $42.0 million compared to $38.6 million in the second quarter of 2002. In part, this increase was a result of our additions in personnel made to enhance our enterprise wide risk management.

 

Occupancy and equipment expense for the second quarter of 2003 were $10.2 million, compared to $9.6 million in the first quarter of 2003 and $10.3 million in the second quarter of 2002.

 

Depreciation – equipment leased to others represents expenses related to a small ticket lease product introduced by Matsco in 2002.

 

35


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

Income Taxes

 

Our effective income tax rate for the second quarter of 2003 was 37.8% as compared to 37.5% for the same period in 2002. Our effective income tax rate for the six months ended June 30, 2003 was 38.4% as compared to 37.5% for the same period in 2002. The effective rates were lower than the statutory rate of 42% due to benefits resulting from the non-taxable increase in life insurance cash surrender values, tax-exempt income on municipal securities and California enterprise zone interest income exclusion.

 

Income of Business Segments

 

We are organized along community banking and insurance brokerage services business segments. The net income before income taxes for the community banking business segment was $34.4 million and $46.5 million for the second quarter of 2003 and 2002, respectively. The income before income taxes for the insurance brokerage services business segment was $5.1 million and $6.6 million for the second quarter of 2003 and 2002, respectively. The net income before income taxes for the community banking business segment was $68.2 million and $84.8 million for the six months ended June 30, 2003 and 2002, respectively. The income before income taxes for the insurance brokerage services business segment was $12.4 million and $10.1 million for the six months ended 2003 and 2002, respectively. For additional information regarding our results by business segments, see Note 7 of the NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

 

FINANCIAL CONDITION

 

Total assets increased $8 million to $8,084 million at June 30, 2003, compared to $8,076 million at December 31, 2002.

 

Investment Securities

 

The investment portfolio is comprised of U.S. Treasury securities, U.S. government agency securities, mortgage-backed securities, obligations of states and political subdivisions, corporate debt instruments and a modest amount of equity securities, including Federal Reserve Bank stock and Federal Home Loan Bank (“FHLB”) stock. Investment securities classified as available for sale are recorded at fair value, while investment securities classified as held to maturity are recorded at cost. Unrealized gains or losses on available for sale securities, net of the deferred tax effect, are reported as increases or decreases in shareholders’ equity. Portions of the portfolio are utilized for pledging requirements for deposits of state and local subdivisions, securities sold under repurchase agreements, and FHLB advances. We do not include Federal Funds sold and certain other short-term securities as investment securities. These other investments are included in cash and cash equivalents.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

Investment securities increased 3.0% or $76.5 million to $2.64 billion at June 30, 2003 compared to $2.56 billion at December 31, 2002.

 

Loans

 

Total gross loans at June 30, 2003 were $4.7 billion compared to $4.8 billion at December 31, 2002.

 

Our loan portfolio is concentrated in commercial (primarily manufacturing, service and technology) and real estate lending, with the balance in leases and consumer loans. Our lending operations are located in a market area that is dependent on the technology and real estate industries and supporting service companies. Thus, a further downturn in these sectors of the economy could adversely impact our borrowers. This could, in turn, adversely impact the borrowers’ ability to repay their loans, reduce the demand for loans and decrease our net interest margin.

 

For the six months ended June 30, 2003, total loans decreased $84.0 million, or 1.7%. The contraction in the loan portfolio was a result of low loan demand resulting from the current weaknesses in the local and national economies.

 

For the six months of 2003, the commercial loan portfolio decreased $74.6 million. Real estate construction and land loans decreased by $39.3 million; real estate loans other decreased by $6.7 million; and consumer and other loans decreased by $3.4 million. These decreases were partially offset by a $40.1 million increase in term real estate – commercial.

 

The following table presents the composition of our loan portfolio at the dates indicated.

 

    

June 30,

2003


   

December 31,

2002


 

(Dollars in thousands)


   Amount

    %

    Amount

    %

 

Commercial

   $ 1,992,499     43.5 %   $ 2,067,142     44.3 %

Term real estate - commercial

     1,650,330     36.1       1,610,277     34.5  
    


 

 


 

Total commercial

     3,642,829     79.6       3,677,419     78.8  

Real estate construction and land

     671,666     14.7       710,990     15.3  

Real estate other

     244,955     5.4       251,665     5.4  

Consumer and other

     162,928     3.6       166,331     3.6  
    


 

 


 

Total loans, gross

     4,722,378     103.3       4,806,405     103.1  

Deferred fees and discounts, net

     (14,803 )   (0.3 )     (15,245 )   (0.3 )
    


 

 


 

Total loans, net of deferred fees

     4,707,575     103.0       4,791,160     102.8  

Allowance for loan and lease losses

     (130,030 )   (3.0 )     (129,613 )   (2.8 )
    


 

 


 

Total loans, net

   $ 4,577,545     100.0 %   $ 4,661,547     100.0 %
    


 

 


 

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

The following table presents the maturity distribution of our commercial, real estate construction and land, term real estate – commercial and real estate other portfolio and the allocation between fixed and variable rate loans at June 30, 2003.

 

(Dollars in thousands)


   Commercial

  

Term

real estate-

commercial


  

Real estate

construction

and land


  

Real estate

other


Loans maturing in:

                           

One year or less:

                           

Fixed rate

   $ 212,807    $ 49,695    $ 133,622    $ 2,755

Variable rate

     492,593      58,637      443,206      14,350

One to five years:

                           

Fixed rate

     527,488      421,358      24,107      14,857

Variable rate

     326,351      422,372      62,728      40,162

After five years:

                           

Fixed rate

     311,181      268,141      3,235      1,505

Variable rate

     122,079      430,127      4,768      171,326
    

  

  

  

Total

   $ 1,992,499    $ 1,650,330    $ 671,666    $ 244,955
    

  

  

  

 

Nonperforming Assets and Other Risk Factors

 

We generally place loans on nonaccrual status when they become 90 days past due, unless they are well secured and in the process of collection. When a loan is placed on nonaccrual status, any interest previously accrued and not collected is generally reversed from income. Loans are charged-off when management determines that collection has become unlikely. Restructured loans are those where we have granted a concession on either principal or interest paid due to financial difficulties of the borrower. Restructured loans which are performing in accordance with the agreed upon modified loan term are presented in the period of restructure and the three subsequent quarters. Other real estate owned (“OREO”) consists of real property acquired through foreclosure on the related collateral underlying defaulted loans.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

The following table sets forth information regarding nonperforming assets at the dates indicated.

 

(Dollars in thousands)


   June 30,
2003


    March 31,
2003


    December 31,
2002


    September 30,
2002


    June 30,
2002


 

Nonperforming loans:

                                        

Nonaccrual loans

   $ 45,278     $ 37,223     $ 37,750     $ 47,695     $ 42,349  
    


 


 


 


 


Total nonperforming loans

     45,278       37,223       37,750       47,695       42,349  

Other repossessed assets

     1,213       62       —         —         —    

OREO

     2,500       3,000       397       930       509  
    


 


 


 


 


Total nonperforming assets

   $ 48,991     $ 40,285     $ 38,147     $ 48,625     $ 42,858  
    


 


 


 


 


Restructured loans

   $ —       $ —       $ 4,500     $ 4,500     $ 4,500  
    


 


 


 


 


Accruing loans past due 90 days or more

   $ 277     $ —       $ 944     $ 6,132     $ 6,729  
    


 


 


 


 


Nonperforming loans to total loans

     0.99 %     0.79 %     0.79 %     1.02 %     0.90 %

Nonperforming assets to total assets

     0.61 %     0.51 %     0.47 %     0.58 %     0.50 %

Nonperforming assets, restructured loans and accruing loans past due 90 days or more to total loans and OREO

     1.05 %     0.85 %     0.91 %     1.26 %     1.15 %

Nonperforming assets, restructured loans and accruing loans past due 90 days or more to total assets

     0.61 %     0.51 %     0.54 %     0.71 %     0.63 %

 

We had nonperforming assets of $49.0 million at June 30, 2003, $40.3 million at March 31, 2003, $38.1 million at December 31, 2002 and $42.9 million at June 30, 2002. Our ratio of nonperforming assets to total assets at June 30, 2003 was 0.61%, as compared to 0.51% at March 31, 2003, 0.47% at December 31, 2002 and 0.50% at June 30, 2002. The net increase in nonperforming loans in the second quarter was primarily the result of placing one Shared National Credit (“SNC”)/Corporate Finance loan totaling $8.1 million on nonaccrual status. The Uniform Bank Holding Company Performance Report prepared by the Federal Reserve Board for all banks with assets between $3 billion and $10 billion reported an average ratio of nonperforming assets to total assets of 0.80% as of March 31, 2003 for the banks covered by the report. While we recognize that the economic slowdown can impact our clients’ financial performances and ultimately their ability to repay their loans, we continue to be cautiously optimistic about the key credit indicators from our loan portfolio. We believe we are proactive in managing credit risk to ensure we have a strong and well-reserved balance sheet to manage through slowing economic periods.

 

At June 30, 2003, nonperforming assets included $13.5 million in SNC/Corporate Finance loans, $12.5 million in commercial loans, $7.3 million in commercial term real estate loans, $6.8 million in real estate construction loans, $5.3 million in commercial loans and leases from our Matsco subsidiary, $1.2 million in other repossessed assets and $2.5 million in OREO.

 

In accordance with SFAS No. 114, “Accounting by Creditors for Impairment of a Loan,” as amended by SFAS No. 118, a loan is considered impaired, based on current information and events, if it is probable that we will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. In certain circumstances, the determination of the impairment of a loan is subjective and, among other factors, is dependent upon the judgment of management. Changes in the levels of impaired loans can have an impact on our nonperforming asset levels, and indirectly, our allowance for loan and lease losses. As of June 30, 2003, March 31, 2003 and December 31, 2002, our impaired loans were $45.3 million, $37.2 million and $37.8 million, respectively. As of June 30, 2003, March 31, 2003 and December 31, 2002, all of our impaired loans are on nonaccrual status and are included in our nonperforming loan total.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

In addition to the loans disclosed above as nonaccrual or restructured, management has also identified loans totaling approximately $16.4 million that on the basis of information known to us was judged to have a higher than normal risk of becoming nonperforming. Management cannot, however, predict the extent to which economic conditions may worsen or other factors that may impact our borrowers and our loan portfolio. Accordingly, there can be no assurance that other loans will not become 90 days or more past due, be placed on nonaccrual, be removed from nonaccrual, become restructured loans, or other real estate owned in the future.

 

Allowance for Loan and Lease Losses

 

The allowance for loan and lease losses is established through a provision for loan and lease losses based on management’s determination of losses incurred in our loan portfolio. The allowance is increased by provisions charged against current earnings and reduced by net charge-offs. Loans are charged-off when they are deemed to be uncollectable; recoveries are generally recorded only when cash payments are received.

 

The following table sets forth information concerning our allowance for loan and lease losses at the dates and for the period indicated.

 

     At and for the three month periods ended

 

(Dollars in thousands)


   June 30,
2003


    March 31,
2003


   

December 31,

2002


    September 30,
2002


    June 30,
2002


 

Period end loans outstanding

   $ 4,722,378     $ 4,734,242     $ 4,806,405     $ 4,710,013     $ 4,699,010  

Average loans outstanding

   $ 4,750,886     $ 4,742,974     $ 4,746,886     $ 4,688,370     $ 4,575,569  

Allowance for loan and lease losses:

                                        

Balance at beginning of period

   $ 129,818     $ 129,613     $ 128,429     $ 126,092     $ 125,331  

Charge-offs:

                                        

Commercial

     (6,089 )     (7,791 )     (8,221 )     (18,420 )     (6,624 )

Term real estate - commercial

     (1,576 )     (894 )     —         (7,531 )     (2,000 )
    


 


 


 


 


Total commercial

     (7,665 )     (8,685 )     (8,221 )     (25,951 )     (8,624 )

Real estate construction and land

     —         —         —         —         —    

Real estate other

     —         —         —         —         —    

Consumer and other

     (331 )     (329 )     (226 )     (149 )     (236 )
    


 


 


 


 


Total charge-offs

     (7,996 )     (9,014 )     (8,447 )     (26,100 )     (8,860 )
    


 


 


 


 


Recoveries:

                                        

Commercial

     1,104       2,647       2,594       650       446  

Term real estate - commercial

     338       1       —         —         20  
    


 


 


 


 


Total commercial

     1,442       2,648       2,594       650       466  

Real estate construction and land

     —         —         —         —         —    

Real estate other

     —         —         —         —         —    

Consumer and other

     66       76       37       11       155  
    


 


 


 


 


Total recoveries

     1,508       2,724       2,631       661       621  
    


 


 


 


 


Net charge-offs

     (6,488 )     (6,290 )     (5,816 )     (25,439 )     (8,239 )

Provision charged to income

     6,700       6,495       7,000       27,776       9,000  
    


 


 


 


 


Balance at end of period

   $ 130,030     $ 129,818     $ 129,613     $ 128,429     $ 126,092  
    


 


 


 


 


Quarterly net charge-offs to average loans outstanding during the period, annualized

     0.55 %     0.54 %     0.49 %     2.15 %     0.72 %

Year to date net charge-offs to average loans outstanding during the period, annualized

     0.54 %     0.54 %     1.19 %     1.43 %     1.05 %

Allowance as a percentage of period end loans outstanding

     2.75 %     2.74 %     2.70 %     2.73 %     2.68 %

Allowance as a percentage of nonperforming assets

     265.42 %     322.25 %     339.77 %     264.12 %     294.21 %

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

Our outstanding non-relationship SNC portfolio totaled $28 million at June 30, 2003, $32 million at March 31, 2003 and $43 million at December 31, 2002. The total non-relationship SNC portfolio as of June 30, 2003 had commitments of only $31 million. Subsequent to quarter-end, we further reduced our non-relationship SNC portfolio by selling a loan with a net book value of $5.07 million for $5.04 million, resulting in a $30,000 loss. After the loan sale, the non-relationship SNC portfolio comprises less than 0.5% of loans outstanding.

 

During the past year, total commitments in our SNC/Corporate Finance portfolio have been reduced by $107 million and the funded amount has been reduced by $80 million. For the second quarter of 2003, our SNC/Corporate Finance charge-offs approximated $2.8 million as compared to $1.1 million for the first quarter of 2003, $(1.5) million recovery for the fourth quarter of 2002, $3.8 million for the third quarter of 2002 and $300,000 for the second quarter of 2002. These SNC/Corporate Finance portfolio losses represented 43.4%, 16.8%, -25.6%, 15.1% and 3.6% of our net charge-offs for those periods.

 

We employ a systematic methodology for determining our allowance for loan and lease losses that includes a monthly review process and monthly adjustment of the allowance. Our process includes a periodic loan by loan review for loans that are individually evaluated for impairment as well as detailed reviews of other loans, either individually or in pools. This includes an assessment of known problem loans, potential problem loans, and other loans that exhibit deterioration.

 

Our methodology incorporates a variety of risk considerations, both quantitative and qualitative, in establishing an allowance for loan and lease losses that management believes is appropriate at each reporting date. Quantitative factors include our historical loss experience, collateral values, and other factors. Our historical loss experience analysis considers our five-year loss experience with our experience over the prior two years weighted most heavily, and is stratified by loan type. Qualitative factors include the general economic environment in our marketplace, and in particular, the state of the real estate market in the San Francisco Bay Area and the technology industries based in the Silicon Valley. Credit concentration, trends in credit quality and the pace of portfolio growth are other qualitative factors that are considered in our methodology. These qualitative factors are evaluated in connection with the unallocated portion of the allowance for loan and lease losses.

 

As we add new products, increase in complexity, and expand our geographic coverage, we will enhance our methodology to keep pace with the size and complexity of the loan portfolio. In this regard, we have periodically engaged outside firms to independently assess our methodology and, on an ongoing basis, we engage outside firms to perform independent credit reviews of our loan portfolio.

 

While this methodology utilizes historical and other objective information, the establishment of the allowance for loan and lease losses is, to some extent, based on the judgment and experience of management. Management believes that the allowance for loan and lease losses is adequate as of June 30, 2003 to cover incurred losses in the loan portfolio. However, future changes in circumstances, economic conditions or other factors could cause management to increase or decrease the allowance for loan and lease losses as necessary.

 

At June 30, 2003, the allowance for loan and lease losses was $130.0 million, consisting of a $103.3 million allocated allowance and a $26.7 million unallocated allowance. The unallocated allowance recognizes the model and estimation risk associated with the allocated allowances, and management’s evaluation of various conditions, the effects of which are not directly measured in determining the allocated allowance. The evaluation of the inherent loss regarding these conditions involves a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments.

 

41


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

Deposits

 

We emphasize developing total client relationships in order to increase our core deposit base. Deposits reached $5.5 billion at June 30, 2003, an increase of 5.2% compared to December 31, 2002. This increase is attributable to our relationship managers’ continuing efforts to generate increases in our core deposits.

 

Our noninterest-bearing demand deposit accounts decreased 5.2% to $975.1 million at June 30, 2003 compared to $1.0 billion at December 31, 2002.

 

Money market deposit accounts (“MMDA”), negotiable order of withdrawal accounts (“NOW”) and savings accounts increased 7.5% to $2.9 billion at June 30, 2003 compared to $2.7 billion at December 31, 2002.

 

MMDA, NOW and savings accounts were 51.8% of total deposits at June 30, 2003 as compared to 50.7% at December 31, 2002. Time certificates of deposit totaled $1.7 billion, or 30.6% of total deposits at June 30, 2003 compared to $1.6 billion or 29.8% of total deposits at December 31, 2002.

 

Borrowings

 

Borrowings were $1.3 billion at June 30, 2003 and $1.7 billion at December 31, 2002. At June 30, 2003, borrowings consisted of securities sold under agreements to repurchase, FHLB advances, Zero Coupon Senior Convertible Contingent Debt Securities, senior notes, a term loan and other notes payable. The overall contraction in the borrowings during 2003 was a result of the IRR strategy described above.

 

Liquidity and Cash Flow

 

The objective of our liquidity management is to maintain each Bank’s ability to meet the day-to-day cash flow requirements of our clients who either wish to withdraw funds or require funds to meet their credit needs. We must manage our liquidity position to allow the Banks to meet the needs of their clients while maintaining an appropriate balance between assets and liabilities to meet the return on investment expectations of our shareholders. We monitor the sources and uses of funds on a daily basis to maintain an acceptable liquidity position. In addition to liquidity from core deposits and repayments and maturities of loans and investments, the Banks have the ability to sell securities under agreements to repurchase, obtain FHLB advances or purchase overnight Federal Funds.

 

Greater Bay is a company separate and apart from the Banks and ABD and therefore it must provide for its own liquidity. In addition to its own operating expenses, Greater Bay is responsible for the payment of the interest on its bank credit facilities, senior notes and on the outstanding trust preferred securities, the contingent interest on the zero coupon senior convertible contingent debt securities, and the dividends on our common stock and the 7.25% noncumulative convertible preferred stock. Substantially all of Greater Bay’s revenues are obtained from management fees, interest received on its investments and dividends declared and paid by our subsidiaries. There are statutory and regulatory provisions that limit the ability of the Banks and ABD to pay dividends to Greater Bay. At June 30, 2003, the subsidiaries had approximately $104.2 million in the aggregate available to be paid as dividends to Greater Bay. We do not believe that such a limitation will adversely impact Greater Bay’s ability to meet its ongoing cash obligations.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

During 2002, Greater Bay raised approximately $200 million through a private offering of Zero Coupon Senior Convertible Contingent Debt Securities (“CODES”). During 2002, Greater Bay retired $126.4 million of these debt securities. The debt securities were offered at an original offering price of $639.23 per $1,000 principal amount at maturity. The debt securities may not be redeemed for five years from their date of issue, but Greater Bay may be required to repurchase these securities at their accreted value, at the option of the holders, on April 24, 2004, 2007, 2012 or 2017. Greater Bay pays no interest on these securities unless contingent interest or additional amounts become payable or a tax event occurs and semi-annual interest payments are paid. The debt securities accrete interest at an annual rate of 2.25%. Each $1,000 in principal amount at maturity of the debt securities is convertible into 15.3699 shares of Greater Bay common stock if the closing price of Greater Bay’s common stock exceeds the contingent conversion price or in certain other circumstances.

 

On March 19, 2003, we received approximately $147.9 million in net proceeds through a private placement of Senior Notes, Series A. The senior notes were issued to replace the CODES which were repurchased during 2002 and to provide liquidity to our holding company. The decision to repurchase the CODES was made after considering the likelihood that the CODES would be put back to us in 2004, the gain which could be recognized upon the CODES repurchase, the anticipated potential rate increases which would have resulted from refinancing the CODES in 2004 and our improving capital position which lowered the importance of the capital feature of the CODES, which is not contained in the senior notes. As of June 30, 2003, there was an outstanding balance of $148.4 million on these notes. The notes were offered at an original offering price of $986.16 per $1,000 principal amount at maturity. The notes mature on March 31, 2008. The notes may not be redeemed at our option and do not require repayment at the option of the holders, in whole or in part, prior to maturity. The notes have a fixed rate of 5.25% per annum paid semi-annually on March 31 and September 30 of each year, commencing September 30, 2003. The notes restrict our ability to sell, dispose of or encumber shares of capital stock of our bank subsidiaries. We used the net proceeds from the notes for general corporate purposes, which may include working capital, capital expenditures, acquisitions and repayment of existing indebtedness. The notes are not registered with the SEC. In accordance with a registration rights agreement entered into with the initial purchasers, we have commenced an exchange offer which, if consummated, will permit holders to exchange their notes for a new series of notes (the “exchange notes”) that are identical in all material respects with the notes, except that the exchange notes will be registered with the SEC. If we fail to consummate the exchange offer as required under the notes, we will be required to pay additional interest on the notes at a rate of 0.25% per annum until all registration defaults have been cured.

 

As of June 30, 2003, Greater Bay had $30.0 million outstanding under a term loan that matures in 2007. At June 30, 2003, the interest rate on this term loan was 3.20%. The term loan is secured by a pledge of all of the stock of Coast Commercial Bank. The term loan also requires Greater Bay to comply with certain debt covenants, including (a) prohibitions on the imposition of any encumbrance or lien on certain of Greater Bay’s property; and (b) the maintenance of certain capital and financial performance ratios. In addition, as of June 30, 2003, Greater Bay had a short-term, secured credit facility totaling $60.0 million. At June 30, 2003, we had no advances outstanding under this facility. The credit facility provides for an interest rate based on LIBOR plus 0.875%. This credit facility is secured by a pledge of all of the stock of Mid-Peninsula Bank. The credit facility also requires Greater Bay to comply with certain debt covenants, including (a) prohibitions on the imposition of any encumbrance or lien on certain of Greater Bay’s or its subsidiaries’ properties; (b) the merger or consolidation of Greater Bay or any of its subsidiaries with any other person, subject to certain exceptions; (c) incurrence of additional debt; (d) the maintenance of certain capital and financial performance ratios; and (e) the maintenance of a minimum net worth of Mid-Peninsula Bank. Greater Bay is in compliance with all related financial covenants for these notes and credit facilities.

 

43


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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

As of June 30, 2003, Greater Bay did not have any material commitments for capital expenditures.

 

Net cash provided by operating activities totaled $59.2 million for the six months ended June 30, 2003 and $106.2 million for the same period in 2002. Net cash available for investing activities totaled $98.5 million in the six months ended June 30, 2003 and net cash used for investment activities totaled $483.1 million in the same period of 2002. The comparatively large balance of cash available for investing purposes during the six months ended June 30, 2003 primarily reflects our decline in loans and our program to deleverage the balance sheet as described in “RESULTS OF OPERATIONS—Net Interest Income—Overview” above.

 

For the six months ended June 30, 2003, net cash used by financing activities was $178.0 million, compared to net cash provided by financing activities of $426.6 million in the same period of 2002. Historically, our primary financing activity has been through deposits. For the six months ended June 30, 2003 and 2002, deposit gathering activities generated cash of $276.0 million and $309.1 million, respectively. For the six months ended June 30, 2003 short-term and long-term borrowings decreased $442.7 million from December 31, 2002. Cash flows from borrowings increased $118.5 million for the six months ended June 30, 2002 from December 31, 2001. The decrease in borrowings for the six months ended June 30, 2003 was the result of the implementation of our process to de-leverage the balance sheet by reducing the size of the investment portfolio and the amount of wholesale borrowings in the first quarter.

 

Capital Resources

 

Shareholders’ equity at June 30, 2003 increased to $719.3 million from $681.1 million at December 31, 2002. Greater Bay declared dividends of $0.27, and $0.49 per common share during the six months ended June 30, 2003 and the year ended December 31, 2002, respectively. We paid cash dividends on the noncumulative convertible preferred stock of $0.90625 per share during each of the first and second quarters of 2003 at the annual rate of $3.625 per preferred share.

 

A banking organization’s total qualifying capital includes two components: core capital (Tier 1 capital) and supplementary capital (Tier 2 capital). Core capital, which must comprise at least half of total capital, includes common shareholders’ equity, qualifying perpetual preferred stock, trust preferred securities and minority interests, less goodwill. Supplementary capital includes the allowance for loan losses (subject to certain limitations), other perpetual preferred stock, trust preferred securities, certain other capital instruments and term subordinated debt. Our major capital components are shareholders’ equity and Trust Preferred Securities in core capital, and the allowance for loan losses in supplementary capital.

 

At June 30, 2003, the minimum risk-based capital requirements to be considered adequately capitalized were 4.0% for core capital and 8.0% for total capital. Federal banking regulators have also adopted leverage capital guidelines to supplement risk-based measures. The leverage ratio is determined by dividing Tier 1 capital as defined under the risk-based guidelines by average total assets (not risk-adjusted) for the preceding quarter. The minimum leverage ratio is 3.0%, although most banking organizations are expected to exceed that amount by 1.0% or more, depending on their circumstances.

 

Pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991, the Federal Reserve, the Office of the Comptroller of the Currency and the FDIC have adopted regulations setting forth a five-tier system for measuring the capital adequacy of the financial institutions they supervise. Our capital levels as of the dates indicated and the two highest levels recognized under these regulations are as follows:

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

     Tangible
equity


    Leverage
ratio


    Tier 1
risk-based
capital ratio


   

Total
risk-based

capital ratio


 

Company:

                        

June 30, 2003

   6.91 %   9.29 %   12.29 %   13.55 %

December 31, 2002

   6.40 %   8.61 %   11.71 %   12.97 %

June 30, 2002

   5.43 %   7.77 %   10.66 %   12.26 %

Well-capitalized

   N/A     5.00 %   6.00 %   10.00 %

Adequately capitalized

   N/A     4.00 %   4.00 %   8.00 %

 

In addition, at June 30, 2003, each of our subsidiary banks had levels of capital that exceeded the well-capitalized guidelines.

 

Our tangible equity to asset ratio has improved from 5.43% at June 30, 2002 to 6.91% at June 30, 2003. In evaluating our tangible equity ratio, we believe it is important to consider the composition of the goodwill and other intangibles that is deducted from total equity to arrive at tangible equity. At June 30, 2003, total goodwill and other intangibles was $189.3 million, the majority of which is related to the ABD acquisition. Based on ABD’s performance and current comparable valuations based upon the recent sales of peer insurance agencies, we believe that ABD is worth more than the recorded goodwill and other intangibles value.

 

When our capital ratios are compared to those of the top 75 U.S. Banks (by asset size) at March 31, 2003, we (ranked 62nd by asset size) had tangible equity, leverage, Tier 1 and total risk-based capital ratios equal to or exceeding the top 75 U.S. Banks’ average ratios.

 

During this last quarter, we engaged an outside firm to help us develop a capital allocation model that incorporates economic factors, historical factors and our actual operating results to measure our capital levels in relation to our risk profile. The preliminary results of this project indicate that our risk profile and capital position should provide us with the flexibility to continue to manage capital in the best interests of our shareholders

 

Cure Agreement

 

In 1996, Mid-Peninsula Bancorp and Cupertino National Bancorp merged to form Greater Bay, which had two bank subsidiaries and approximately $600 million in consolidated assets. As a result of internal growth and the establishment through acquisition of nine additional bank subsidiaries, three specialty finance units and a commercial insurance brokerage subsidiary, Greater Bay has grown to approximately $8.1 billion in consolidated assets. Our substantial growth and multi-bank charter structure has increased our risk profile and presented operational challenges that we continue to address and mitigate through risk management programs and procedures. During regulatory examinations of Greater Bay and its subsidiaries in 2002, the bank regulatory agencies identified weaknesses in our enterprise wide risk management programs and following completion of these examinations, Greater Bay received on January 3, 2003 a notice from the Federal Reserve Board advising us that as a result of these weaknesses, we did not meet the continuing financial holding company requirements. In response to the notice, Greater Bay delivered to the Federal Reserve Board a corrective action plan designed to enhance its enterprise wide risk management program. Prior to receipt of the notice from the Federal Reserve Board, Greater Bay had already dedicated significant time and resources to addressing these items, and commenced many of the action items contained within the corrective action plan, including the appointment in December 2002 of a Chief Risk Officer to oversee Greater Bay’s Enterprise Wide Risk Management Group.

 

On February 17, 2003, Greater Bay entered into a cure agreement with the Federal Reserve Board which incorporated the terms of Greater Bay’s corrective action plan. On June 27, 2003 the Federal Reserve Board notified Greater Bay that we had fully satisfied all of the terms and conditions of the cure agreement.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

To improve Greater Bay’s risk management program, the corrective action plan required enhancements to policies and procedures relating to interest rate sensitivity, liquidity and capital management, asset risk management and compliance. In the area of interest rate sensitivity, Greater Bay now performs additional stress testing of its IRR exposure under best case and worse case scenarios, reviews its IRR limits and tests its core deposit assumptions. Liquidity management has been augmented by stress testing the liquidity position under various scenarios and by developing a more sophisticated monitoring system for Greater Bay’s funding strategy. In addition, Greater Bay has established a process to quantify and support the appropriateness of established capital limits relative to its risk profile. In the area of asset risk management, Greater Bay has established commercial real estate concentration limits, improved the documentation supporting the allowance for loan and lease losses and strengthened systems relating to loan and investment policies. Greater Bay has also enhanced the processes for identifying and monitoring legal risks to ensure future compliance with all applicable laws and regulations, including the Bank Secrecy Act and anti-money laundering laws

 

To maintain its financial holding company status, Greater Bay had to complete the corrective action plan by July 7, 2003. Having completed all required actions in advance of the July 7, 2003 date, Greater Bay is in full compliance with all regulatory requirements associated with its financial holding company status.

 

As part of its enterprise wide risk management program, Greater Bay continually evaluates the impact of its multi-bank charter structure on its operations, business, clients and regulatory compliance. While no decision has been made, we are exploring whether a simplified structure might enhance our risk management program and alleviate some of the issues addressed in the cure agreement. By maintaining our individual bank names, local bank management, our relationship style of banking and strong community involvement, a simplified structure may enable us to continue to operate under our Regional Community Banking Philosophy and, at the same time, enhance our risk management program.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

Off-Balance Sheet Arrangements and Aggregate Contractual Obligations

 

The definition of “off-balance sheet arrangements” includes any transaction, agreement or other contractual arrangement to which an entity is a party under which we have:

 

    Any obligation under a guarantee contract that has the characteristics as defined in paragraph 3 of FIN 45;

 

    A retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity or market risk support to that entity for such assets, such as a subordinated retained interest in a pool of receivables transferred to an unconsolidated entity;

 

    Any obligation, including a contingent obligation, under a contract that would be accounted for as a derivative instrument, except that it is both indexed to the registrant’s own stock and classified in stockholders’ equity; or

 

    Any obligation, including contingent obligations, arising out of a material variable interest, as defined in FIN 46, in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to the registrant, or engages in leasing, hedging or research and development services with the registrant.

 

In the ordinary course of business, we have issued certain guarantees which qualify as off-balance sheet arrangements. As of June 30, 2003, those guarantees include the following:

 

    Financial standby letters of credit and financial guarantees are conditional lending commitments issued by us to guarantee the performance of a customer to a third party in borrowing arrangements. At June 30, 2003, the maximum undiscounted future payments that we could be required to make was $99.3 million. Of these arrangements, 62.4% mature within one year. We generally have recourse to recover from the customer any amounts paid under these guarantees;

 

    We may be required to make contingent payments to the former shareholders of ABD and The Matsco Companies, Inc. based on their future operating results. As of June 30, 2003, under the ABD acquisition agreement, the maximum gross future earn-out payments to ABD’s former shareholders is $56.4 million plus 65% of the EBITDA (as defined in the acquisition agreement) in excess of the Forecast EBITDA, as defined in the acquisition agreement, payable through 2005 in a combination of cash and noncumulative convertible preferred stock or, in certain circumstance, common stock. The Forecast EBITDA for ABD is $29.6 million, $34.6 million and $40.3 million for the years ended December 31, 2003, 2004 and 2005, respectively. As of June 30, 2003, under the acquisition agreement with The Matsco Companies, Inc., the maximum gross future earn-out payments to the former shareholders is $4.5 million through 2005; and

 

    Several of our Banks have guaranteed credit cards issued to our clients by an unaffiliated financial institution. As of June 30, 2003, the combined credit limits on those accounts are $10.6 million.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

FIN 46 defines variable interest entities as a corporation, partnership, trust, or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. A variable interest entity often holds financial assets, including loans or receivables, real estate or other property. A variable interest entity may be essentially passive or it may engage in research and development or other activities on behalf of another company. FIN 46 requires that a variable interest entity be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. FIN 46 also requires disclosures about variable interest entities that we are not required to consolidate but in which it has a significant variable interest. As of June 30, 2003, we did not have an interest in any unconsolidated variable interest entities.

 

MLF III is a special purpose corporation wholly owned by Greater Bay formed for the purpose of issuing lease-backed notes. MLF III, CNBIT I, CNBIT II, MPBIT and SJNBIT each have some characteristics of variable interest entities as defined by FIN 46. The results of and financial position of these five entities are fully consolidated with our results and financial position, and therefore these entities are exempt from the provisions of FIN 46.

 

FIN 46 may have an impact on the treatment of the trust preferred securities we have issued and ability for those instruments to provide us with Tier 1 capital. The impact of FIN 46 on those instruments is currently being evaluated by the accounting community. One potential impact of not including these trusts in our consolidated liabilities is that the trust preferred securities may no longer count towards Tier 1 capital. The Federal Reserve has issued regulations which allow for the inclusion of these instruments in Tier 1 capital regardless of the FIN 46 interpretation, although such a determination could potentially be changed at a later date. We do not expect the adoption of FIN 46 to have any additional material impact on our financial condition or operating results.

 

The following table provides the amounts due under specified contractual obligations for the periods indicated as of June 30, 2003.

 

(Dollars in thousands)


   Less than
one year


  

One to

three years


   Four to
five years


   More than
five years


   Total

Commitment to fund loans

   $ 1,129,744    $ —      $ —      $ —      $ 1,129,744

Commitments under letters of credit

     99,328      —        —        —        99,328

Deposits

     4,471,986      81,126      20,004      11      4,573,127

Borrowings

     849,151      192,580      178,445      75,197      1,295,373

Trust Preferred Securities

     20,000      —        —        184,000      204,000

Capital lease obligations

     —        —        —        —        —  

Operating lease obligations

     10,312      50,155      22,581      28,493      111,541

Purchase obligations

     12,488      —        —        —        12,488

Other liabilities

     281,624      —        —        20,169      301,793

 

The obligations are categorized by their contractual due dates. Approximately $264.5 million of the commitments to fund loans relate to real estate construction and a significant percentage is expected to fund within the next 12 months. However, the remainder relates primarily to revolving lines of credit or other commercial loans, and many of these commitments are expected to expire without being drawn upon. Therefore the total commitments do not necessarily represent future cash requirements. We may, at our option, prepay certain borrowings and trust preferred securities prior to their maturity date. Furthermore, the actual payment of certain current liabilities may be deferred into future periods.

 

A “purchase obligation” is an agreement to purchase goods or services that is enforceable and legally binding on the registrant and that specifies all significant terms including (1) fixed or minimum quantities to be purchased, (2) fixed, minimum or variable price provisions, and (3) the approximate timing of the transaction. The definition of “purchase obligations” includes capital expenditures for purchases of goods or services over a five-year period. At June 30, 2003, we had potential future venture capital funding requirements of $12.5 million.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

RECENT EVENT

 

Effective July 1, 2003, we acquired the assets of Sullivan & Curtis Insurance Brokers of Washington, LLC. The Seattle-based insurance broker specializes in property and casualty insurance services and risk management consulting. This acquisition was accounted for using the purchase method of accounting. The source of funds for the transaction was available cash.

 

RECENT ACCOUNTING PRONOUNCEMENTS

 

Accounting for Stock-Based Compensation – Transition and Disclosure

 

In January 2003 the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation” (“SFAS No. 148”). SFAS No. 148 amends SFAS No. 123, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. If awards of stock-based employee compensation were outstanding and accounted for under the intrinsic value method of APB Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”), certain disclosures have to be made for any period for which an income statement is presented.

 

SFAS No. 148 shall be effective for financial statements for fiscal years ending after December 15, 2003. We continue to apply APB No. 25 in accounting for stock-based compensation and have adopted the disclosure requirements of SFAS No. 123 and SFAS No. 148.

 

Derivative Instruments and Hedging Activities

 

In April 2003 the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (“SFAS No. 149”). The provisions of SFAS No.149 that relate to SFAS No. 133 and No. 138 implementation issues that have been effective for fiscal quarters that began prior to June 15, 2003, should continue to be applied in accordance with their respective effective dates. In addition, provisions of SFAS No. 149 which relate to forward purchases or sales of when-issued securities or other securities that do not yet exist, should be applied to both existing contracts and new contracts entered into after June 30, 2003. The changes in SFAS No. 149 improve financial reporting by requiring that contracts with comparable characteristics be accounted for similarly. In particular, SFAS No. 149 (1) clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative discussed in paragraph 6(b) of SFAS No. 133 and No. 138, (2) clarifies when a derivative contains a financing component, (3) amends the definition of an underlying to conform it to language used in FIN 45, and (4) amends certain other existing pronouncements. Those changes will result in more consistent reporting of contracts as either derivatives or hybrid instruments.

 

SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, except as stated above and for hedging relationships designated after June 30, 2003. In addition, except as stated above, all provisions of SFAS No.149 should be applied prospectively.

 

We do not expect the adoption of SFAS No. 149 to have a material impact on our financial condition or operating results.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS (CONTINUED)

 

Certain Financial Instruments with Characteristics of both Liabilities and Equity

 

In May 2003 the FASB issued SFAS No. 150 “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS No. 150”). This statement requires that an issuer classify financial instruments that are within its scope as a liability. Many of those instruments were classified as equity under previous guidance.

 

Most of the guidance in SFAS No. 150 is effective for all financial instruments entered into or modified after May 31, 2003, and otherwise effective at the beginning of the first interim period beginning after June 15, 2003.

 

We are currently evaluating the provisions of this statement, and do not believe that it will have an impact on our consolidated financial statements.

 

Consolidation of Variable Interest Entities

 

In January 2003 the FASB issued FIN 46. FIN 46 explains how to identify variable interest entities and how an enterprise assesses its interests in a variable interest entity to decide whether to consolidate that entity. FIN 46 requires existing unconsolidated variable interest entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse risks among parties involved. Variable interest entities that effectively disperse risks will not be consolidated unless a single party holds an interest or combination of interests that effectively recombines risks that were previously dispersed.

 

FIN 46 applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003.

 

FIN 46 may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated.

 

We are currently evaluating the impact of FIN 46. The impact of FIN 46 on the treatment of the trust preferred securities we have issued is currently being evaluated by the accounting community. Under one potential interpretation of FIN 46, the trusts which have issued our trust preferred securities would no longer be consolidated. Conversely, SFAS No. 150 requires the consolidation of these subsidiaries and the presentation of the related debt instruments as a liability. The accounting community is currently working to resolve this contradictory guidance. Our current presentation is in compliance with the requirements of SFAS No. 150. One potential impact of not including these trusts in our consolidated liabilities is that the trust preferred securities may no longer count towards Tier 1 capital. The Federal Reserve has issued regulations which allow for the inclusion of these instruments in Tier 1 capital regardless of the FIN 46 interpretation, although such a determination could potentially be changed at a later date. We do not expect the adoption of FIN 46 to have any additional material impact on our financial condition or operating results.

 

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QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Our financial performance is impacted by, among other factors, IRR and credit risk. We do not utilize derivatives to mitigate our credit risk, relying instead on an extensive loan review process and our allowance for loan and lease losses. See “—Allowance for Loan and Lease Losses” herein.

 

IRR is the risk of a change in market value of portfolio equity due to changes in interest rates. This risk is addressed by our Management Asset & Liability Committee (“ALCO”), which includes senior management representatives. The ALCO monitors IRR by analyzing the potential impact to the net portfolio value and net interest income from potential changes to interest rates and considers the impact of alternative strategies or changes in balance sheet structure. The ALCO manages our balance sheet in part to maintain the potential impact on net portfolio value and net interest income within acceptable ranges despite changes in interest rates.

 

Our exposure to IRR is reviewed on at least a quarterly basis by the Board ALCO and the Management ALCO. IRR exposure is measured using interest rate sensitivity analysis to determine our change in net portfolio value in the event of hypothetical changes in interest rates. If potential changes to net portfolio value and net interest income resulting from hypothetical interest rate changes are not within the Board-approved limits, the Board may direct management to adjust its asset and liability mix to bring IRR within Board-approved limits.

 

In order to reduce the exposure to interest rate fluctuations, we have implemented strategies to more closely match our balance sheet composition. Although we are doing so to a lesser extent than in prior years, we have generally focused our investment activities on securities with terms or average lives averaging approximately three and a half years which effectively lengthens the average duration of our assets. We have utilized short-term borrowings and deposit marketing programs to shorten the effective duration of our liabilities. In addition, we have utilized two interest rate swaps and an interest rate collar to manage the IRR of certain long term debt instruments and deposit liabilities. When these derivative instruments were acquired, they were determined to be highly effective and were accounted for as hedges under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” as amended by SFAS No. 138, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133 and 138”). During 2001, we determined that the designation of these derivatives as hedges was no longer appropriate. Subsequent to that determination, changes in the value of the derivative contracts were recorded to current income. During 2002, we elected to reassert our designation of one of the interest rate swaps as a cash flow hedge. Subsequent to that designation, changes to the fair value of that hedge are included in other comprehensive income to the extent that the swap is deemed effective. Changes in value attributed to ineffectiveness are recorded in current income.

 

Market Value of Portfolio Equity

 

Interest rate sensitivity is computed by estimating the changes in net market value of portfolio equity, or market value over a range of potential changes in interest rates. The market value of portfolio equity is the market value of our assets minus the market value of our liabilities plus the market value of any off-balance sheet items. The market value of each asset, liability, and off-balance sheet item is its net present value of expected cash flows discounted at market rates after adjustment for rate changes. We measure the impact on market value of portfolio equity for an immediate and sustained 100 basis point increase and decrease (“shock”) in interest rates. The following table shows our projected change in net portfolio value for this set of rate shocks as of the dates indicated.

 

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QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (CONTINUED)

 

Change in

interest rates

(Dollars in millions)


   June 30, 2003

    June 30, 2002

 
  

Net portfolio

value


   Projected change

   

Net portfolio

value


   Projected change

 
      Dollars

    Percentage

       Dollars

    Percentage

 

100 basis point rise

   $ 1,191    $ 46     4.0 %   $ 1,196    $ 5     0.4 %

Base scenario

     1,145      —       —         1,191      —       —    

100 basis point decline

     1,049      (96 )   -8.4 %     1,160      (30 )   -2.5 %

 

The preceding table indicates that as of June 30, 2003 an immediate and sustained 100 basis point increase in interest rates would increase our market value of portfolio equity by approximately 4.0% and an immediate and sustained 100 basis point decrease in interest rates would decrease our market value of portfolio equity by approximately 8.4%. The foregoing analysis attributes significant value to our noninterest-bearing deposit balances.

 

The market value of portfolio equity is based on the net present values of each product in the portfolio, which in turn is based on cash flows factoring in recent market prepayment estimates from public sources. The discount rates are based on recently observed spread relationships and adjusted for the assumed interest rate changes. Some valuations are provided directly from independent broker quotations.

 

The net portfolio value of equity as of June 30, 2003 was $1.1 billion as compared to $1.2 billion as of June 30, 2002. The major reason for the decrease was the overall decline in interest rates which reduced the discount rate used in the calculation of the net present value. The reduced discount rate most significantly impacted non-term deposits, resulting in a significant reduction in their contribution to the calculation of the net portfolio value of equity as of June 30, 2003 as compared to June 30, 2002. The second reason for the change in the market value of equity relates to a significant shift within the non-term deposits to shorter duration liabilities also reducing their contribution to the calculation of the net portfolio value of equity.

 

In addition, there has been significant movement in the projected change of market value of portfolio equity due to a 100 basis point rise or decline in interest rates between June 30, 2003 and 2002. This is primarily due to two factors. During 2002, we substantially reduced the size of our aggregate fixed rate investment portfolio. At the same time higher prepayment rates on mortgage products reduced the lives of the remaining investments. The reduction in size and life of the investment portfolio decreased the average life and duration of total assets. In addition, in the fourth quarter of 2002 we reclassified our Trust Preferred Securities to a debt security classification, which caused the Trust Preferred Securities to be included in the calculation, whereas previously in the first quarter of 2002 the Trust Preferred Securities were treated as equity securities and therefore not included. The reduction of fixed rate assets and increase in fixed rate liabilities resulted in a small gain in value in rates up compared to a small reduction in the prior year.

 

Net Interest Income

 

The impact of interest rate changes on net interest income and net income are measured using income simulation. The various products in our balance sheet are modeled to simulate their income (and cash flow) behavior in relation to interest rates. Income for the next 12 months is calculated for current interest rates and for immediate and sustained rate shocks.

 

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QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (CONTINUED)

 

The income simulation model includes various assumptions regarding the repricing relationships for each product. Many of our assets are floating rate loans, which are assumed to reprice immediately, and to the same extent as the change in market rates according to their contracted index. Our non-term deposit products reprice more slowly, usually changing less than the change in market rates and at our discretion. As of June 30, 2003, the analysis indicates that our net interest income for the next 12 months would increase by 1.8% if rates increased 100 basis points, and decrease by 2.9% if rates decreased 100 basis points.

 

This analysis indicates the impact of change in net interest income for the given set of rate changes and assumptions. It assumes the balance sheet grows modestly, but that its composition remains similar to the composition at quarter-end. It does not account for all the factors that impact this analysis including changes that management may make in the balance sheet composition to mitigate the impact of interest rate changes or secondary impacts such as changes to our credit risk profile as interest rates change. Furthermore, loan prepayment rate estimates and spread relationships change regularly. Interest rate changes create changes in actual loan prepayment rates that will differ from the market estimates incorporated in the analysis. In addition, the proportion of adjustable-rate loans in our portfolio could decrease in future periods if market interest rates remain at or decrease below current levels. Changes that vary significantly from the assumptions may have significant effects on our net interest income.

 

Gap Analysis

 

In addition to the above analysis, we also perform a gap analysis as part of the overall IRR management process. This analysis is focused on the maturity structure of assets and liabilities and their repricing characteristics over future periods. An effective IRR management strategy seeks to match the volume of assets and liabilities maturing or repricing during each period. Gap sensitivity is measured as the difference between the volume of assets and liabilities in our current portfolio that is subject to repricing at various time horizons. The main focus is usually on the one-year cumulative gap. The difference is known as interest sensitivity gaps.

 

The following table shows interest sensitivity gaps for different intervals as of June 30, 2003:

 

(Dollars in thousands)


  Immediate
or one day


   

2 days to

6 months


    7 months to
12 months


   

1 Year

to 3 years


   

4 years

to 5 years


   

More than

5 years


    Total rate
sensitive


   

Total

non-rate
sensitive


    Total

 

As of June 30, 2003

                                                                       

Assets:

                                                                       

Cash and due from banks

  $ —       $ 11,792     $ —       $ —       $ —       $ —       $ 11,792     $ 267,440     $ 279,232  

Federal Funds Sold

    15,000       —         —         —         —         —         15,000       —         15,000  

Investment securities

    67,787       820,790       215,634       701,933       317,034       489,610       2,612,788       26,684       2,639,472  

Loans

    2,031,478       831,471       359,619       855,604       546,522       80,398       4,705,092       2,483       4,707,575  

Allowance for loan and lease losses

    —         —         —         —         —         —         —         (130,030 )     (130,030 )

Other assets

    —         —         —         —         —         —         —         572,765       572,765  
   


 


 


 


 


 


 


 


 


Total assets

  $ 2,114,265     $ 1,664,053     $ 575,253     $ 1,557,537     $ 863,556     $ 570,008     $ 7,344,672     $ 739,342     $ 8,084,014  
   


 


 


 


 


 


 


 


 


Liabilities and Equity:

                                                                       

Deposits

  $ 2,859,794     $ 1,498,514     $ 113,678     $ 81,126     $ 20,004     $ 11     $ 4,573,127     $ 975,124     $ 5,548,251  

Borrowings

    3,835       685,191       184,651       420,160       —         1,536       1,295,373       —         1,295,373  

Trust preferred securities

    —         20,000       —         —         —         184,000       204,000       —         204,000  

Other liabilities

    —         —         —         —         —         —         —         301,793       301,793  

Shareholders’ equity

    —         —         —         —         —         —         —         734,597       734,597  
   


 


 


 


 


 


 


 


 


Total liabilities and equity

  $ 2,863,629     $ 2,203,705     $ 298,329     $ 501,286     $ 20,004     $ 185,547     $ 6,072,500     $ 2,011,514     $ 8,084,014  
   


 


 


 


 


 


 


 


 


Gap

  $ (749,364 )   $ (539,652 )   $ 276,924     $ 1,056,251     $ 843,552     $ 384,461     $ 1,272,172     $ (1,272,172 )   $ —    

Cumulative Gap

  $ (749,364 )   $ (1,289,016 )   $ (1,012,092 )   $ 44,159     $ 887,711     $ 1,272,172     $ 1,272,172     $ —       $ —    

Cumulative Gap/total assets

    -9.27 %     -15.95 %     -12.52 %     0.55 %     10.98 %     15.74 %     15.74 %     0.00 %     0.00 %

As of June 30, 2002

                                                                       

Gap

  $ (338,830 )   $ (1,026,326 )   $ (182,216 )   $ 1,170,988     $ 846,944     $ 581,774     $ 1,052,334     $ (1,052,334 )   $ —    

Cumulative Gap

  $ (338,830 )   $ (1,365,156 )   $ (1,547,372 )   $ (376,384 )   $ 470,560     $ 1,052,334     $ 1,052,334     $ —       $ —    

Cumulative Gap/total assets

    -3.97 %     -16.01 %     -18.15 %     -4.41 %     5.52 %     12.34 %     12.34 %     0.00 %     0.00 %

 

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QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (CONTINUED)

 

The foregoing table indicates that we had a one year cumulative negative gap of $1.0 billion, or 12.5% of total assets, at June 30, 2003. In theory, this would indicate that at June 30, 2003, $1.0 billion more in liabilities than assets would reprice if there were a change in interest rates over the next 365 days. Thus, if interest rates on assets and liabilities were to increase in equal amounts, the gap would tend to result in a lower net interest margin. However, changes in the mix of earning assets or supporting liabilities can either increase or decrease the net interest margin without affecting interest rate sensitivity. In addition, the interest rate spread between an asset and its supporting liability can vary significantly while the timing of repricing of both the asset and its supporting liability can remain the same, thus impacting net interest income. This characteristic is referred to as a basis risk and, generally, relates to the repricing characteristics of short-term funding sources such as certificates of deposit.

 

The cumulative gap for the immediate or one-day period increased approximately $410.5 million between June 30, 2002 and 2003. This decrease in the immediate or one-day period was due to an increase in non-term deposits which are included in this category (see below for a further discussion regarding non-term deposits) and a decrease in variable rate loans on a period-to-period basis. The cumulative gap for the 2-days to 6-months category declined $76.1 million, but the composition of the cumulative gap changed due to the shorter duration of the fixed income investment portfolio offset by the increase in the amount of deposits. The cumulative gap for the 12-months period as of June 30, 2003 showed a decline in interest rate sensitivity as compared to June 30, 2002. This decline is mainly due to the reduction of short-term borrowings and, to a lesser extent, the investment portfolio at June 30, 2003 as compared to June 30, 2002 offset slightly by an increase in deposits.

 

Gap analysis has certain limitations. Measuring the volume of repricing or maturing assets and liabilities does not always measure the full impact on the portfolio value of equity or net interest income. Gap analysis does not account for rate caps on products; dynamic changes such as increasing prepay speeds as interest rates decrease, basis risk, or the benefit of non-rate funding sources. The relation between product rate repricing and market rate changes (basis risk) is not the same for all products. The majority of our loan portfolio reprices quickly and completely following changes in market rates, while non-term deposit rates in general move more slowly and usually incorporate only a fraction of the change in rates. Products categorized as non-rate sensitive, such as noninterest-bearing demand deposits, in the Gap analysis behave like long term fixed rate funding sources. Both of these factors tend to make our actual behavior more asset sensitive than is indicated in the Gap analysis. In fact we expect to experience higher net interest income when rates rise, opposite of what is indicated by the Gap analysis. Therefore, management uses income simulation, net interest income rate shocks and market value of portfolio equity as its primary IRR management tools.

 

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CONTROLS AND PROCEDURES

 

In accordance with Rule 13a-15(b) of the Securities Exchange Act of 1934 (the “Exchange Act”), as of the end of the quarter ended June 30, 2003, we carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective.

 

During the quarter ended June 30, 2003, there have been no changes in our internal controls over financial reporting that has materially affected, or is reasonably likely to materially affect, these controls.

 

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PART II. OTHER INFORMATION

 

ITEM 1. Legal Proceedings—Not applicable

 

ITEM 2. Changes in Securities and Use of Proceeds—Not applicable

 

ITEM 3. Defaults Upon Senior Securities—Not applicable

 

ITEM 4. Submission of Matters to a Vote of Security Holders

 

(a) The Company held its annual meeting of shareholders on May 20, 2003.

 

(b) The following directors were elected at the annual meeting to serve for a three-year term:

 

Robert A. Archer

David L. Kalkbrenner

Rex D. Lindsay

Arthur K. Lund

Glen McLaughlin

Linda R. Meier

Warren R. Thoits

 

The following directors continued in office after the annual meeting:

 

Frederick J. de Grosz

Susan B. Ford

John M. Gatto

James E. Jackson

Stanley A. Kangas

Daniel G. Libarle

George M. Marcus

Duncan L. Matteson

Donald H. Seiler

James C. Thompson

Thaddeus. J. Whalen Jr.

 

(c) At the annual meeting, shareholders approved (1) the election of the Company’s Class III directors; (2) the amendment of the Company’s Restated Articles of Incorporation to increase the authorized number of shares of preferred stock from 4,000,000 to 10,500,000; (3) the ratification of the selection of PricewaterhouseCoopers LLP as the Company’s independent public accountants for the fiscal year ending December 31, 2003; and (4) a shareholder proposal regarding the elimination of the classified Board of Directors. The results of the voting were as follows:

 

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Matter


   Votes For

  

Votes

Against


  

Votes

Withheld


   Abstentions

  

Broker

Non-Votes


Election of Directors

                        

Robert A. Archer

   45,996,504         1,746,882          

David L. Kalkbrenner

   46,151,552         1,591,834          

Rex D. Lindsay

   46,043,377         1,700,009          

Arthur K. Lund

   46,086,128         1,657,258          

Glen McLaughlin

   46,063,676         1,679,710          

Linda R. Meier

   46,203,163         1,540,223          

Warren R. Thoits

   45,917,763         1,825,623          

Articles Amendment

   28,678,097    8,084,059         301,902    10,679,328

Separate Class Vote For Common Stock

   27,163,790    8,042,556         301,902    10,679,328

Separate Class Vote For Series B Preferred Stock

   906,771    22,964         0    0

Independent Public Accountants

   45,184,662    2,369,990         188,734    0

Shareholder Proposal

   19,789,058    16,512,521         762,478    10,679,329

 

  (d)   Not applicable.

 

ITEM 5. Other Information—Not applicable

 

ITEM 6. Exhibits and Reports on Form 8-K

 

The Exhibits listed below are filed or incorporated by reference as part of this Report.

 

(a)   Exhibits

 

Exhibit No.

  

Description of Exhibits


4.1    Certificate of Amendment of Restated Articles of Incorporation of Greater Bay Bancorp (increasing authorized preferred shares)
10.1    Amendment No. 1 to Employment Agreement, dated as of April 14, 2003, by and between Greater Bay Bancorp and Byron Scordelis (1).
10.2    Mutual Release and Settlement Agreement, dated June 24, 2003, effectively July 1, 2003, by and between Greater Bay Bancorp and Susan Black (1).
31    Certifications of Chief Executive Officer and Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002.
32    Certifications of Chief Executive Officer and Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002.

(1)   Represents executive compensation plans and arrangements of Greater Bay Bancorp

 

(b)   Reports on Form 8-K

 

During the quarter ended June 30, 2003, Greater Bay filed the following Current Reports on Form 8-K: (1) April 23, 2003 (containing a press release announcing first quarter 2003 results); (2) June 11, 2003 (containing a press release and slide presentation for analysts’ conference); (3) June 30, 2003 (containing a press release announcing the satisfactory completion of the Cure Agreement).

 

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Signatures

 

In accordance with the requirements of the Securities Exchange Act of 1934, as amended, the registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Greater Bay Bancorp

(Registrant)

By:

 

/s/    STEVEN C. SMITH


STEVEN C. SMITH

    Executive Vice President and

    Chief Financial Officer

Date: August 6, 2003

 

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