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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20529
FORM 10-KA
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(b) OF THE SECURITIES
FOR THE TRANSITION PERIOD N/A TO N/A
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 333-16951
BSM BANCORP
(Exact name of registrant as specified in its charter)
California 77-0442667
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2739 Santa Maria Way
Santa Maria, CA 93455
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code : (805) 937-8551
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock-No par value
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the common stock held by non-affiliates of the
registrant as of February 27, 1998 was $61,384,095.
The number of shares of common stock of the registrant outstanding as of
March 18, 1998 was 3,007,639.
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FORM 10-K
TABLE OF CONTENTS AND CROSS REFERENCE SHEET
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PAGE # IN
10-KA
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PART I
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Item 1 Business 1
Item 2 Properties 15
Item 3 Legal Proceedings 16
Item 4 Submission of Matters to a Vote of Security Holders 16
PART II
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Item 5 Market for Registrant's Common Equity and Related
Stockholder Matters 16
Item 6 Selected Financial Data 17
Item 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations 18
Item 8 Financial Statements and Supplementary Data 30
Item 9 Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 52
PART III
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Item 10 Directors and Executive Officers of Registrant 53
Item 11 Director and Executive Officer Compensation 55
Item 12 Security Ownership of Certain Beneficial Owners and
Management 60
Item 13 Certain Relationships and Related Transactions 61
PART IV
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Item 14 Exhibits, Financial Statement Schedules and Reports on 8-K 61
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PART 1
ITEM 1. BUSINESS
GENERAL
BSM BANCORP
BSM Bancorp (referred to herein on an unconsolidated basis as "BSM" and on a
consolidated basis as the "Company") is a bank holding company incorporated
in California on November 12,1996, and registered under the Bank Holding
Company Act of 1956, as amended. The Company commenced business on March 12,
1997 when, pursuant to a reorganization, it acquired all of the voting stock
of Bank of Santa Maria (the "Bank"). The Bank is the Company's principal
asset.
The Company's principal business is to serve as a holding company for the
Bank and for other banking or bank related subsidiaries which the Company may
establish or acquire. The Company has not engaged in any other activity to
date. As a legal entity separate and distinct from its subsidiaries, BSM's
principal source of funds is, and will continue to be, dividends paid by and
other funds advanced by primarily the Bank. Legal limitations are imposed on
the amount of dividends that may be paid and loans that may be made by the
Bank to BSM. See "Note L-Regulatory Matters" in the Annual Report to
Shareholders. At December 31, 1997, the Company had $344.0 million in total
consolidated assets, $189.2 million in total consolidated net loans and $306.3
million in total consolidated deposits.
BSM's authorized Capital Stock consists of 25,000,000 of Preferred Stock,
none of which is outstanding, and 50,000,000 of Common Stock of which
2,990,939 was outstanding as of December 31, 1997.
The principal executive offices of the Company and the Bank are located at
2739 Santa Maria Way, Santa Maria, California.
MERGER WITH MID-STATE BANK
On January 29, 1998, Mid-State Bank ("Mid-State") entered into an Agreement
to Merge and Plan of Reorganization (the "Agreement") with the Company
pursuant to which, among other things, (i) Bank will merge with and into
Mid-State, (ii) BSM will become the holding company for Mid-State and change
its name to Mid-State Bancshares ("MSB"), and (iii) the shareholders of
Mid-State will become shareholders of MSB in accordance with an exchange
ratio set forth in the Agreement, all subject to the terms and conditions
specified in the Agreement
Consummation of the Agreement and the transactions contemplated therein, is
subject to regulatory and shareholder approval, as well as other conditions
set forth in the Agreement. No assurance can be given that the Agreement and
the transactions contemplated therein will be consummated. Should the
transaction be consummated, current Company shareholders will hold
approximately 30% of the shares of the newly renamed holding company.
BANK OF SANTA MARIA
The Bank was incorporated under the laws of the State of California on June
27, 1977, was licensed by the California State Banking Department and
commenced operations as a California state chartered bank on March 18, 1978.
The Bank's accounts are insured by the Federal Deposit Insurance Corporation
("FDIC"), but like most banks of its size in California, is not a member of
the Federal Reserve Bank. The Bank's authorized Capital Stock consists of one
class of Common Stock, of which there were 100 shares outstanding as of
December 31, 1997, which was held by BSM.
The Bank currently operates 13 retail banking offices along the central coast
of California. The main office and two branch offices are located in the City
of Santa Maria with additional offices located in the communities of
Guadalupe, Oak Knolls, Vandenberg Village, Nipomo, Grover Beach, Pismo Beach,
Paso Robles and Templeton. On January 10, 1997, El Camino National Bank, with
one office in Lompoc, merged into Bank of Santa Maria. On February 3, 1997,
the Bank opened a banking office in Atascadero. The Bank has its headquarters
in the City of Santa Maria at 2739 Santa Maria Way, Santa Maria, California
93455. Its telephone number is (805) 937-8551.
The Bank has expanded from its initial branches in the larger community of
Santa Maria both to the North and to the South, along a corridor following
U.S. Highway 101. The economy in this area of California is based upon
agriculture, oil, tourism, light industry, the aerospace industries and
nuclear energy production. Services to support those employed in these
industries, (including medical, financial, and educational services), have
expanded the two county areas increasing the population of the Bank's service
area to
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approximately 175,000. Certain economic activities are unique to the area
such as the space launching facility at Vandenberg Air Force Base (which is
now being actively used by large commercial enterprises) and the production
of seeds for numerous flowers grown worldwide. While major oil companies have
elected to do business elsewhere (due to the very stringent county business
regulations), smaller production companies have moved in to continue the oil
industry in the area. The moderate climate allows a year round growing season
for numerous vegetables and fruits. Vineyards and cattle ranches make large
contributions to the local economy. Access to numerous recreational
activities, including both mountains and beaches, provide a fairly stable
tourist industry from larger metropolitan areas to the North, South and East.
The commercial space industry will continue to bring "high tech" employment
into the area. Due to the diversity of the industries within the Bank's
market area, the Central Coast, while not immune to economic fluctuations,
tends to enjoy more stability than many areas of both the California
marketplace and the country in general.
ACQUISITION OF TEMPLETON NATIONAL BANK
Following all necessary regulatory approvals, on September 8, 1995, the Bank
acquired Templeton National Bank ("Templeton") pursuant to an Agreement and
Plan of Reorganization dated March 10, 1995, providing for the merger of
Templeton into the Bank. The Agreement provided for Templeton shareholders to
receive shares of the Bank Common Stock based upon the comparative book
values of the banks at the closing plus a premium of $500,000. The Bank
issued 397,561 shares of its Common Stock to the former shareholders of
Templeton. As of the merger date, Templeton's deposits were approximately $24
million and loans were approximately $18 million. Templeton had one office
and two offsite ATM locations. Since the acquisition, one of the offsite ATM
locations was closed and the second has been relocated to the Atascadero
Police Station. This acquisition was treated as a pooling transaction for
accounting purposes.
ACQUISITION OF CITIZENS BANK OF PASO ROBLES, N.A.
Following all necessary regulatory approvals, on May 3, 1996, the Bank
acquired Citizens National Bank of Paso Robles, N.A. ("Citizens") pursuant to
an Agreement and Plan of Reorganization dated October 30, 1995, providing for
the merger of Citizens into the Bank. The Agreement provided for the
shareholders of Citizens to receive cash at the rate of 1.6 times book value
per share of Citizens stock as of the end of the month preceding the closing.
The exchange value used in the merger was $16.94 of each share of Citizens
stock surrendered. The transaction was treated as a purchase for accounting
purposes and approximately $1.9 million of goodwill was recorded. Acquired
deposits were recorded at approximately $29 million and acquired loans at $18
million. Citizens had two offices at the time of the merger. In August 1997,
the Bank closed the former Citizens branch in Templeton.
ACQUISITION OF EL CAMINO NATIONAL BANK
Following all necessary regulatory approvals, on January 10, 1997, the Bank
acquired El Camino National Bank ("El Camino") pursuant to an Agreement and
Plan of Reorganization dated July 16, 1996, providing for the merger of El
Camino into the Bank. The Agreement provided for the shareholders of El
Camino to receive shares of Bank Common Stock based upon the comparative book
values of the banks as of the end of the month preceding the closing. As of
the closing date, El Camino's deposits were approximately $16 million, and
loans were approximately $12 million. This acquisition was treated as a
pooling transaction for accounting purposes. The exchange value used in the
merger was .7332 shares of Bank Common Stock for each share of El Camino
Common Stock. The Bank issued 201,678 shares to complete this transaction. El
Camino had only one office in Lompoc, California, and the Bank continues to
operate from this location.
SERVICES
The Bank offers a full range of commercial banking services including the
acceptance of checking and savings deposits, money market checking and
savings accounts, time certificates of deposit of varying maturities,
individual retirement accounts, the making of commercial loans, various types
of consumer loans and real estate loans and provides safe deposit, travelers
cheques, notary public and other customary non-deposit banking services. The
Bank is a merchant depository for Master Charge and Visa drafts enabling
merchants to deposit both types of drafts with the Bank.
Banks in California have been empowered to conduct certain insurance
activities and to market such services to the public. The Bank did obtain its
Organizational Insurance License in the fall of 1989, but has not elected to
offer products which require this license.
The Bank's organization and operations have been designed to serve the
banking needs of individuals and small to medium sized businesses located in
the Northern Santa Barbara and San Luis Obispo County areas of California.
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DEPOSIT AND LIABILITY MANAGEMENT
Deposits represent the Bank's primary source of funds. As of December 31,
1997, the Bank had approximately 18,500 demand, money market checking/savings
deposits and NOW accounts representing approximately $157.1 million with an
average balance of approximately $8,500 per account. Of those deposits,
approximately $82.4 million, or 52%, were interest bearing accounts. The Bank
had approximately 11,600 savings accounts representing approximately $32.5
million in total deposits, with an average balance of approximately $2,800
per account. The Bank had approximately 4,800 time certificates of deposit,
representing approximately $116.4 million in total deposits with an average
balance of approximately $24,300 per account. Of the total deposits as of
December 31, 1997, approximately $38.0 million were in the form of
certificates of deposit in denominations of $100,000 or more and all other
time deposits were approximately $79.0 million. During the twelve months
ending December 31, 1997, demand deposits increased approximately $7.4
million, money market and NOW accounts increased approximately $3.4 million,
savings accounts remained essentially flat and time certificates of deposit
increased approximately $9.4 million.
The Bank is not dependent on a single or a few customers for its deposits,
most of which are obtained from individuals and small to medium businesses.
This results in relatively small average balances, but makes the Bank less
subject to adverse effects from the loss of a substantial depositor. As of
December 31, 1997, no individual, corporate, or public depositor accounted
for more than 1.0% of the Bank's total deposits and the five largest deposit
accounts represented only 3.0% of the total deposits.
Liquidity is the Bank's ability to meet fluctuations in deposit levels and to
provide for the credit needs of its customers. The objective in liquidity
management is to maintain a balance between the sources and uses of funds.
Principal sources of liquidity include interest and principal payments on
loans and investments, proceeds from the maturity of investments and growth
in deposits. The Bank holds overnight Federal funds as a cushion for
temporary liquidity needs. During the year ended 1997, Federal funds averaged
$11.9 million, or 3.7% of total average assets. In addition, the Bank
maintains Federal funds credit lines with major correspondents aggregating
$11.1 million, subject to the customary terms for such arrangements.
The Bank's liquidity ratio, which measures the percentage of deposits which
are used to fund cash, cash equivalents and marketable securities, was 42.0%
as of December 31, 1997. This ratio is substantially in excess of the Bank's
minimum percentage of 20%.
LOANS
The Bank makes loans in four main areas, including (1) loans to individuals
for household, family and other consumer expenditures, (2) commercial and
industrial loans, (3) real estate loans and (4) agriculture loans. During
1997, the loan portfolio mix continued to show growth in the percentage of
agricultural loans now representing over 19% of the Bank's portfolio.
Commercial loans have also experienced an increase in the percentage of loans
outstanding constituting over 30% of the portfolio. This change has resulted
from declines in both consumer and real estate loan categories.
The Bank maintains a reserve for possible loan losses in the loan portfolio.
Additions to the reserve are made by charges to operating expenses. All loans
deemed to be uncollectible are charged to the reserve; subsequent recoveries
are credited to the reserve. The loan loss provision is based on current
factors which, in management's judgment, deserve recognition in estimating
possible losses. These factors include the current economic climate, past
loan loss history and management's forecast for the coming year.
As of December 31, 1997, the reserve for loan losses was approximately 1.11%
of loans outstanding, a level believed adequate by management. The reserve
for possible loan losses is maintained on an aggregate basis only and is not
allocated among the various types of loans made by the Bank. Outside factors,
not within the Bank's control, such as adverse changes in the economy, can
effect the adequacy of the reserves and there can be no assurance that, in
any given period, the Bank might not suffer losses which are substantial in
relation to the size of the reserve. During the year ending December 31,
1997, the Bank sustained net charge-offs of approximately $618,000 or .35% of
the Bank's average loans.
INVESTMENT SECURITIES
The Bank maintains a portfolio of investment securities to provide income and
to serve as a secondary source of liquidity for its operations in conjunction
with funds sold overnight in the Federal funds market. The Bank's Investment
Policy provides for the purchase of United States Treasury Securities, United
States Government Agency Securities, Corporate Securities and State, County
and Municipal Securities. As of December 31, 1997, the aggregate book value
of the Bank's investment securities was approximately $108.8 million. Of this
total, approximately $18.6 million was in U.S. Government Securities,
approximately $57.4 million was in U.S. Government Agency Securities,
approximately $2.6 million was in Corporate Securities and approximately
$30.2 million was in securities issued by State and local subdivisions
thereof. The type of investments held in the Bank's portfolio are influenced
by several factors. Among these are: rate of return, maturity and risk.
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It is the Bank's policy to stagger the maturities of its securities to
maintain a liquid portfolio and to meet other Bank needs. The sale of
"Federal Funds" (short-term loans to other banks), are also made as alternate
investments for available excess funds. Approximately $658,000 of the Bank's
operating income in 1997, represented interest on Federal Funds sold.
Acceptable securities may be pledged to secure public deposits from state and
public agencies. As of December 31, 1997, the Bank had Public Funds totaling
approximately $2,160,000 secured by approximately $6,006,000 in eligible
securities.
SUPERVISION AND REGULATION
Bank holding companies and banks are extensively regulated under both federal
and state law. Set forth below, is a summary description of certain laws
which relate to the regulation of BSM and the Bank. The description does not
purport to be complete and is qualified in its entirety by reference to the
applicable laws and regulations.
BSM BANCORP
BSM, as a registered bank holding company, is subject to regulation under the
Bank Holding Company Act of 1956, as amended (the "BHCA"). BSM is required to
file with the Federal Reserve Board quarterly, semi-annual and annual
reports, and such additional information as the Federal Reserve Board may
require pursuant to the BHCA. The Federal Reserve Board may conduct
inspections of the BSM and its subsidiary. The first of such inspections
occurred in September, 1997.
The Federal Reserve Board may require that BSM terminate an activity or
terminate control of or liquidate or divest certain subsidiaries or
affiliates when the Federal Reserve Board believes the activity or the
control of the subsidiary or affiliate constitutes a significant risk to the
financial safety, soundness or stability of any of its banking subsidiaries.
The Federal Reserve Board also has the authority to regulate provisions of
certain bank holding company debt, including authority to impose interest
ceilings and reserve requirements on such debt. Under certain circumstances,
BSM must file written notice and obtain approval from the Federal Reserve
Board prior to purchasing or redeeming its equity securities.
Under the BHCA and regulations adopted by the Federal Reserve Board, a bank
holding company and its non-banking subsidiaries are prohibited from
requiring certain tie-in arrangements in connection with any extension of
credit, lease or sale of property or furnishing of services. Further, BSM is
required by the Federal Reserve Board to maintain certain levels of capital.
See "Item 1 - Prompt Corrective Regulatory Action."
BSM is required to obtain prior approval of the Federal Reserve Board for the
acquisition of more than 5% of the outstanding shares of any class of voting
securities or substantially all of the assets of any bank or bank holding
company. Prior approval of the Federal Reserve Board is also required for the
merger or consolidation of BSM and another bank holding company.
BSM is prohibited by the BHCA, except in certain statutory prescribed
instances, from acquiring direct or indirect ownership or control of more
than 5% of the outstanding voting shares of any company that is not a bank or
bank holding company and from engaging directly or indirectly in activities
other than those of banking, managing or controlling banks or furnishing
services to its subsidiary. However, BSM, subject to the prior approval of
the Federal Reserve Board, may engage in, or acquire shares of companies
engaged in, any activities that are deemed by the Federal Reserve Board to be
so closely related to banking or managing or controlling banks as to be a
proper incident thereto. In making any such determination, the Federal
Reserve Board is required to consider whether the performance of such
activities by BSM or an affiliate can reasonably be expected to produce
benefits to the public, such as greater convenience, increased competition or
gains in efficiency, that outweigh possible adverse effects, such as undue
concentration of resources, decreased or unfair competition, conflicts of
interest or unsound banking practices. The Federal Reserve Board is also
empowered to differentiate between activities commenced DE NOVO and
activities commenced by acquisition, in whole or in part, of a going concern.
In 1996, the Economic Growth and Regulatory Paperwork Reduction Act of 1996
(the "Budget Act"), eliminated the requirement that the bank holding
companies seek Federal Reserve Board approval before engaging DE NOVO in
permissible nonbanking activities listed in Regulation Y, which governs bank
holding companies, if the holding company and its lead depository institution
are well-managed and well-capitalized and certain other criteria specified in
the statute are met. For purposes of determining the capital levels at which a
bank holding company shall be considered "well-capitalized" under this
section of the Budget Act and Regulation Y, the Federal Reserve Board adopted
as an interim rule, risk-based capital ratios (on a consolidated basis) that
are, with the exception of the leverage ratio (which is lower), the same as
the levels set for determining that a state member bank is well-capitalized
under the provisions established under the prompt corrective action
provisions of federal law. See "Item 1 Prompt Corrective Regulatory Action."
Under Federal Reserve Board regulations, a bank holding company is required
to serve as a source of financial and managerial strength to its subsidiary
banks and may not conduct its operations in an unsafe or unsound manner. In
addition, it is the Federal Reserve Board's policy that in serving as a
source of strength to its subsidiary banks, a bank holding company should
stand ready to use available resources to provide adequate capital funds to
its subsidiary banks during periods of financial stress or adversity and
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should maintain the financial flexibility and capital-raising capacity to
obtain additional resources for assisting its subsidiary banks. A bank
holding company's failure to meet its obligations to serve as a source of
strength to its subsidiary banks, will generally be considered by the Federal
Reserve Board to be an unsafe and unsound banking practice in violation of
the Federal Reserve Board's regulations or both.
BSM is also a bank holding company within the meaning of Section 3700 of the
California Financial Code. As such, BSM and its subsidiary are subject to
examination by, and may be required to file reports with, the Department of
Financial Institutions.
Finally, BSM is subject to the periodic reporting requirements of the
Securities Exchange Act of 1934, as amended, including but not limited to,
filing annual, quarterly and other current reports with the Securities and
Exchange Commission, (the "Commission").
AVAILABLE INFORMATION
Reports filed with the Commission can be viewed on the internet. The
Commission maintains a Web Site that contains reports, proxy and information
statements and other information. The address of the site is http://www.sec.gov.
BANK OF SANTA MARIA
Banks are extensively regulated under both federal and state law. The Bank,
as a California state chartered bank, is subject to primary supervision,
periodic examination and regulation by the Commissioner of Financial Insitutions
and the FDIC.
The Bank is insured by the FDIC, which currently insures deposits of each
member bank to a maximum of $100,000 per depositor. For this protection, the
Bank, as is the case with all insured banks, pays a quarterly statutory
assessment and is subject to the rules and regulations of the FDIC. Although
the Bank is not a member of the Federal Reserve System, it is nevertheless
subject to certain regulations of the Federal Reserve Board.
Various requirements and restrictions under the laws of the State of
California and the United States affect the operations of the Bank. State and
federal statutes and regulations relate to many aspects of the Bank's
operations, including reserves against deposits, interest rates payable on
deposits, loans, investments, mergers and acquisitions, borrowings, dividends
and locations of branch offices. Further, the Bank is required to maintain
certain levels of capital.
There are statutory and regulatory limitations on the amount of dividends
which may be paid to the stockholders by the Bank. California law restricts
the amount available for cash dividends by state-chartered banks to the
lesser of retained earnings or the bank's net income for its last three
fiscal years (less any distributions to stockholders made during such
period). In the event a bank has no retained earnings or net income for its
last three fiscal years, cash dividends may be paid in an amount not
exceeding the net income for such bank's last preceding fiscal year only
after obtaining the prior approval of the Commissioner.
The FDIC also has authority to prohibit the Bank from engaging in activities
that, in the FDIC's opinion, constitutes an unsafe or unsound practice in
conducting its business. It is possible, depending upon the financial
condition of the bank in question and other factors, that the FDIC could
assert that the payment of dividends or other payments might, under some
circumstances, be an unsafe or unsound practice.
Banks are subject to certain restrictions imposed by federal law on any
extensions of credit to, or the issuance of a guarantee or letter of credit
on behalf of its affiliates, the purchase of or investments in stock or other
securities thereof, the taking of such securities as collateral for loans and
the purchase of assets of such affiliates. Such restrictions prevent
affiliates from borrowing from the Bank unless the loans are secured by
marketable obligations of designated amounts. Further, such secured loans and
investments by the Bank to any other affiliate is limited to 10% of the
Bank's capital and surplus (as defined by federal regulations) and such
secured loans and investments are limited, in the aggregate, to 20% of the
Bank's capital and surplus (as defined by federal regulations). California
law also imposes certain restrictions with respect to transactions involving
other controlling persons of the Bank. Additional restrictions on
transactions with affiliates may be imposed on the Bank under the prompt
corrective action provisions of the FDIC Improvement Act.
POTENTIAL AND EXISTING ENFORCEMENT ACTIONS
Commercial banking organizations, such as the Bank, may be subject to
potential enforcement actions by the FDIC and the Commissioner for unsafe
or unsound practices in conducting their businesses or for violations of any
law, rule, regulation or any condition imposed in writing by the agency or
any written agreement with the agency. Enforcement actions may include the
imposition of a conservator or receiver, the issuance of a cease-and-desist
order that can be judicially enforced, the termination of insurance of
deposits, the imposition of civil money penalties, the issuance of directives
to increase capital, the issuance of formal
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and informal agreements, the issuance of removal and prohibition orders
against institution-affiliated parties and the imposition of restrictions and
sanctions under the prompt corrective action provisions of the FDIC
Improvement Act.
The regulations of these various agencies govern most aspects of the Bank's
business, including required reserves on deposits, investments, loans,
certain of their check clearing activities, issuance of securities, payment
of dividends, opening of branches, and numerous other areas. As a consequence
of the extensive regulation of commercial banking activities in the United
States, the Bank's business is particularly susceptible to changes in
California and the Federal legislation and regulations which may have the
effect of increasing the cost of doing business, limiting permissible
activities, or increasing competition.
EFFECT OF GOVERNMENTAL POLICIES AND LEGISLATION
Banking is a business that depends on rate differentials. In general, the
difference between the interest rate paid by the Bank on its deposits and its
other borrowings and the interest rate received by the Bank on loans extended
to its customers and securities held in the Bank's portfolio comprise the
major portion of the Bank's earnings. These rates are highly sensitive to
many factors that are beyond the control of the Bank. Accordingly the
earnings and growth of the Bank are subject to the influence of local,
domestic and foreign economic conditions, including recession, unemployment
and inflation.
The commercial banking business is not only affected by general economic
conditions but is also influenced by the monetary and fiscal policies of the
federal government and the policies of regulatory agencies, particularly the
Federal Reserve Board. The Federal Reserve Board implements national monetary
policies (with objectives such as curbing inflation and combating recession)
by its open-market operations in United States Government securities, by
adjusting the required level of reserves for financial intermediaries subject
to its reserve requirements and by varying the discount rates applicable to
borrowings by depository institutions. The actions of the Federal Reserve
Board in these areas influence the growth of bank loans, investments and
deposits and also affect interest rates charged on loans and paid on
deposits. The nature and impact of any future changes in monetary policies
cannot be predicted.
From time to time, legislation is enacted which has the effect of increasing
the cost of doing business, limiting or expanding permissible activities or
affecting the competitive balance between banks and other financial
intermediaries. Proposals to change the laws and regulations governing the
operations and taxation of banks, bank holding companies and other financial
intermediaries are frequently made in Congress, in the California legislature
and before various bank regulatory and other professional agencies. For
example, legislation has been introduced in Congress that would repeal the
current statutory restrictions on affiliations between commercial banks and
securities firms. The likelihood of any major changes and the impact such
changes might have on the Bank are impossible to predict.
FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991
On December 19, 1991, the FDIC Improvement Act was enacted into law. Set
forth below is a brief discussion of certain portions of this law and
implementing regulations that have been adopted or proposed by the Federal
Reserve Board, the Comptroller of the Currency ("Comptroller"), the Office of
Thrift Supervision ("OTS") and the FDIC (collectively, the "federal banking
agencies").
STANDARDS FOR SAFETY AND SOUNDNESS
The FDIC Improvement Act requires the federal banking agencies to prescribe,
by regulation, standards for all insured depository institutions and
depository institution holding companies relating to internal controls, loan
documentation, credit underwriting, interest rate exposure and asset growth.
Standards must also be prescribed for classified loans, earnings and the
ratio of market value to book value for publicly traded shares. The FDIC
Improvement Act also requires the federal banking agencies to issue uniform
regulations prescribing standards for real estate lending that are to
consider such factors as the risk to the deposit insurance fund, the need for
safe and sound operation of insured depository institutions and the
availability of credit. Further, the FDIC Improvement Act requires the
federal banking agencies to establish standards prohibiting compensation,
fees and benefit arrangements that are excessive or could lead to financial
loss.
In July 1992, the federal banking agencies issued a joint advance notice of
proposed rule making requesting public comment on the safety and soundness
standards required to be prescribed by the FDIC Improvement Act. The purpose
of the notice is to assist the federal banking agencies in the development of
proposed regulations. In accordance with the FDIC Improvement Act, final
regulations must become effective no later than December 1, 1993.
In December 1992, the federal banking agency issued final regulations
prescribing uniform guidelines for real estate lending. The regulations
require insured depository institutions to adopt written policies
establishing standards, consistent with such guidelines,
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for extensions of credit secured by real estate. The policies must address
loan portfolio management, underwriting standards and loan to value limits
that do not exceed the supervisory limits prescribed by the regulations.
In February 1995, the federal banking agencies adopted final guidelines
establishing standards for safety and soundness, as required by FDICIA. The
guidelines set forth operational and managerial standards relating to
internal controls, information systems and internal audit systems, loan
documentation, credit underwriting, interest rate exposure, asset growth and
compensation, fees and benefits. Guidelines for asset quality and earnings
standards will be adopted in the future. The guidelines establish the safety
and soundness standards that the agencies will use to identify and address
problems at insured depository institutions before capital becomes impaired.
If an institution fails to comply with a safety and soundness standard, the
appropriate federal banking agency may require the institution to submit a
compliance plan. Failure to submit a compliance plan or to implement an
accepted plan may result in enforcement action.
Appraisals for "real estate related financial transactions" must be conducted
by either state-certified or state-licensed appraisers for transactions in
excess of certain amounts. State-certified appraisers are required for all
transactions with a transaction value of $1,000,000 or more; for all
non-residential transactions valued at $250,000 or more; and for "complex"
1-4 family residential properties of $250,000 or more. A state-licensed
appraiser is required for all other appraisals. However, appraisals performed
in connection with "federally related transactions" must now comply with the
agencies' appraisal standards. Federally related transactions include the
sale, lease, purchase, investment in, or exchange of, real property or
interests in real property, the financing of real property, and the use of
real property or interests in real property as security for a loan or
investment, including mortgage backed securities.
PROMPT CORRECTIVE REGULATORY ACTION
The FDIC Improvement Act requires each federal banking agency to take prompt
corrective action to resolve the problems of insured depository institutions
that fall below one or more prescribed minimum capital ratios. The purpose of
this law is to resolve the problems of insured depository institutions at the
least possible long-term cost to the appropriate deposit insurance fund.
The law requires each federal banking agency to promulgate regulations
defining the following five categories in which an insured depository
institution will be placed, based on the level of its capital ratios: well
capitalized (significantly exceeding the required minimum capital
requirements), adequately capitalized (meeting the required capital
requirements), undercapitalized (failing to meet any one of the capital
requirements), significantly undercapitalized (significantly below any one
capital requirement) and critically undercapitalized (failing to meet all
capital requirements).
In September 1992, the federal banking agencies issued uniform final
regulations implementing the prompt corrective action provisions of the FDIC
Improvement Act. Under the regulations, an insured depository institution
will be deemed to be:
- "well capitalized" if it (i) has total risk-based capital of 10% or
greater, Tier 1 risk-based capital of 6% or greater and a leverage
capital ratio of 5% or greater and (ii) is not subject to an order,
written agreement, capital directive or prompt corrective action
directive to meet and maintain a specific capital level for any
capital measure;
- "adequately capitalized" if it has total risk-based capital of 8% or
greater, Tier 1 risk-based capital of 4% or greater and a leverage
capital ratio of 4% or greater (or a leverage capital ratio of 3% or
greater if the institution is rated composite 1 under the applicable
regulatory rating system in its most recent report of examination);
- "undercapitalized" if it has total risk-based capital that is less
than 8%, Tier 1 risk-based capital that is less than 4% or a leverage
capital ratio that is less than 4% (or a leverage capital ratio that
is less than 3% if the institution is rated composite 1 under the
applicable regulatory rating system in its most recent report of
examination);
- "significantly undercapitalized" if it has total risk-based capital
that is less than 6%, Tier 1 risk-based capital that is less than 3%
or a leverage capital ratio that is less than 3%; and
- "critically undercapitalized" if it has a ratio of tangible equity
to total assets that is equal to or less than 2%.
An institution that, based upon its capital levels, is classified as well
capitalized, adequately capitalized or undercapitalized may be reclassified
to the next lower capital category if the appropriate federal banking agency,
after notice and opportunity for hearing, (i) determines that the institution
is in an unsafe or unsound condition or (ii) deems the institution is
engaging in an unsafe or unsound practice and not to have corrected the
deficiency. At each successive lower capital category, an insured depository
institution is subject to more restrictions and federal banking agencies are
given less flexibility in deciding how to deal with it.
The law prohibits insured depository institutions from paying management fees
to any controlling persons or, with certain limited exceptions, making
capital distributions if after such transaction the institution would be
undercapitalized. If an insured depository institution is undercapitalized,
it will be closely monitored by the appropriate federal banking agency,
subject to asset growth restrictions and required to obtain prior regulatory
approval for acquisitions, branching and engaging in new lines of business.
Any
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undercapitalized depository institution must submit an acceptable capital
restoration plan to the appropriate federal banking agency 45 days after
becoming undercapitalized. The appropriate federal banking agency cannot
accept a capital plan unless, among other things, it determines that the plan
(i) specifies the steps the institution will take to become adequately
capitalized, (ii) is based on realistic assumptions and (iii) is likely to
succeed in restoring the depository institution's capital. In addition, each
company controlling an undercapitalized depository institution must guarantee
that the institution will comply with the capital plan until the depository
institution has been adequately capitalized on an average basis during each
of four consecutive calendar quarters and must otherwise provide adequate
assurances of performance. The aggregate liability of such guarantee is
limited to the lesser of (a) an amount equal to 5% of the depository
institution's total assets at the time the institution became
undercapitalized or (b) the amount which is necessary to bring the
institution into compliance with all capital standards applicable to such
institution as of the time the institution fails to comply with its capital
restoration plan. Finally, the appropriate federal banking agency may impose
any of the additional restrictions or sanctions that it may impose on
significantly undercapitalized institutions if it determines that such action
will further the purpose of the prompt correction action provisions.
An insured depository institution that is significantly undercapitalized, or
is undercapitalized and fails to submit, or in a material respect to
implement, an acceptable capital restoration plan, is subject to additional
restrictions and sanctions. These include, among other things: (i) a forced
sale of voting shares to raise capital or, if grounds exist for appointment
of a receiver or conservator, a forced merger; (ii) restrictions on
transactions with affiliates; (iii) further limitations on interest rates
paid on deposits; (iv) further restrictions on growth or required shrinkage;
(v) modification or termination of specified activities; (vi) replacement of
directors or senior executive officers, subject to certain grandfather
provisions for those elected prior to enactment of the FDIC Improvement Act;
(vii) prohibitions on the receipt of deposits from correspondent
institutions; (viii) restrictions on capital distributions by the holding
companies of such institutions; (ix) required divestiture of subsidiaries by
the institution; or (x) other restrictions as determined by the appropriate
federal banking agency. Although the appropriate federal banking agency has
discretion to determine which of the foregoing restrictions or sanctions it
will seek to impose, it is required to force a sale of voting shares or
merger, impose restrictions on affiliate transactions and impose restrictions
on rates paid on deposits unless it determines that such actions would not
further the purpose of the prompt corrective action provisions. In addition,
without the prior written approval of the appropriate federal banking agency,
a significantly undercapitalized institution may not pay any bonus to its
senior executive officers or provide compensation to any of them at a rate
that exceeds such officer's average rate of base compensation during the 12
calendar months preceding the month in which the institution became
undercapitalized.
Further restrictions and sanctions are required to be imposed on insured
depository institutions that are critically undercapitalized. For example, a
critically undercapitalized institution generally would be prohibited from
engaging in any material transaction other than in the ordinary course of
business without prior regulatory approval and could not, with certain
exceptions, make any payment of principal or interest on its subordinated
debt beginning 60 days after becoming critically undercapitalized. Most
importantly, however, except under limited circumstances, the appropriate
federal banking agency, not later than 90 days after an insured depository
institution becomes critically undercapitalized, is required to appoint a
conservator or receiver for the institution. The board of directors of an
insured depository institution would not be liable to the institution's
shareholders or creditors for consenting in good faith to the appointment of
a receiver or conservator or to an acquisition or merger as required by the
regulator.
The FDIC has adopted risk-based minimum capital guidelines intended to
provide a measure of capital that reflects the degree of risk associated with
a banking organization's operations for both transactions reported on the
balance sheet as assets and transactions, such as letters of credit and
recourse arrangements, which are recorded as off-balance sheet items. Under
these guidelines, nominal dollar amounts of assets and credit equivalent
amounts of off-balance sheet items are multiplied by one of several risk
adjustment percentages, which range from 0% for assets with low credit risk,
such as certain U.S. Treasury securities, to 100% for assets with relatively
high credit risk, such as business loans.
In addition to the risk-based guidelines, the FDIC requires banks to maintain
a minimum amount of Tier 1 capital to total assets, referred to as the
leverage ratio. For a bank rated in the highest of the five categories used
by the FDIC to rate banks, the minimum leverage ratio of Tier 1 capital to
total assets is 3%. For all banks not rated in the highest category, the
minimum leverage ratio must be at least 100 to 200 basis points above the 3%
minimum, or 4% to 5%. In addition to these uniform risk-based capital
guidelines and leverage ratios that apply across the industry, the FDIC has
the discretion to set individual minimum capital requirements for specific
institutions at rates significantly above the minimum guidelines and ratios.
In August 1995, the federal banking agencies adopted final regulations
specifying that the agencies will include, in their evaluations of a bank's
capital adequacy, an assessment of the exposure to declines in the economic
value of the bank's capital due to changes in interest rates. The final
regulations, however, do not include a measurement framework for assessing
the level of a bank's exposure to interest rate risk, which is the subject of
a proposed policy statement issued by the federal banking agencies
concurrently with the final regulations. The proposal would measure interest
rate risk in relation to the effect of a 200 basis point change in market
interest rates on the economic value of a bank. Banks with high levels of
measured exposure or weak management systems generally will be required to
hold additional capital for interest rate risk. The specific amount of
capital that
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may be needed would be determined on a case-by-case basis by the examiner and
the appropriate federal banking agency. Because this proposal has only
recently been issued, the Bank currently is unable to predict the impact of
the proposal on the Bank if the policy statement is adopted as proposed.
In January 1995, the federal banking agencies issued a final rule relating to
capital standards and the risks arising from the concentration of credit and
nontraditional activities. Institutions which have significant amounts of
their assets concentrated in high risk loans or nontraditional banking
activities and who fail to adequately manage these risks, will be required to
set aside capital in excess of the regulatory minimums. The federal banking
agencies have not imposed any quantitative assessment for determining when
these risks are significant, but have identified these issues as important
factors they will review in assessing an individual bank's capital adequacy.
In December 1993, the federal banking agencies issued an interagency policy
statement on the allowance for loan and lease losses which, among other
things, establishes certain benchmark ratios of loan loss reserves to
classified assets. The benchmark set forth by such policy statement is the
sum of (a) assets classified "loss"; (b) 50 percent of assets classified
"doubtful"; (c) 15 percent of assets classified "substandard"; and (d)
estimated credit losses on other assets over the upcoming 12 months.
OTHER ITEMS
The FDIC Improvement Act also, among other things, (i) limits the percentage
of interest paid on brokered deposits and limits the unrestricted use of such
deposits to only those institutions that are well capitalized; (ii) requires
the FDIC to charge insurance premiums based on the risk profile of each
institution; (iii) eliminates "pass through" deposit insurance for certain
employee benefit accounts unless the depository institution is well
capitalized or, under certain circumstances, adequately capitalized; (iv)
prohibits insured state chartered banks from engaging as principal in any
type of activity that is not permissible for a national bank unless the FDIC
permits such activity and the bank meets all of its regulatory capital
requirements; (v) directs the appropriate federal banking agency to determine
the amount of readily marketable purchased mortgage servicing rights that may
be included in calculating such institution's tangible, core and risk-based
capital; and (vi) provides that, subject to certain limitations, any federal
savings association may acquire or be acquired by any insured depository
institution.
In addition, the FDIC has issued final and proposed regulations implementing
provisions of the FDIC Improvement Act relating to powers of insured state
banks. Final regulations issued in October 1992 prohibit insured state banks
from making equity investments of a type, or in an amount, that are not
permissible for national banks. In general, equity investments include equity
securities, partnership interests and equity interests in real estate. Under
the final regulations, non-permissible investments must be divested by no
later than December 19, 1996. The Bank has no such non-permissible
investments.
Regulations issued in December 1993, prohibit insured state banks from
engaging as principal in any activity not permissible for a national bank,
without FDIC approval. The proposal also provides that subsidiaries of
insured state banks may not engage as principal in any activity that is not
permissible for a subsidiary of a national bank, without FDIC approval.
Certain provisions of the FDIC Improvement Act, such as the recently adopted
real estate lending standards and the limitations on investments and powers
of state banks and the rules to be adopted governing compensation, fees and
other operating policies, may affect the way in which the Bank conducts its
business, and other provisions, such as those relating to the establishment
of the risk-based premium system, may adversely affect the Bank's results of
operations. Furthermore, the actual and potential restrictions and sanctions
that apply to or may be imposed on undercapitalized institutions under the
prompt corrective action and other provisions of the FDIC Improvement Act may
significantly adversely affect the operations and liquidity of the Bank, the
value of its Common Stock and its ability to raise funds in the financial
markets.
CAPITAL ADEQUACY GUIDELINES
The FDIC has issued guidelines to implement the risk-based capital
requirements. The guidelines are intended to establish a systematic
analytical framework that makes regulatory capital requirements more
sensitive to differences in risk profiles among banking organizations, takes
off-balance sheet items into account in assessing capital adequacy and
minimizes disincentives to holding liquid, low-risk assets. Under these
guidelines, assets and credit equivalent amounts of off-balance sheet items,
such as letters of credit and outstanding loan commitments, are assigned to
one of several risk categories, which range from 0% for risk-free assets,
such as cash and certain U.S. Government securities, to 100% for relatively
high-risk assets, such as loans and investments in fixed assets, premises and
other real estate owned. The aggregated dollar amount of each category is
then multiplied by the risk-weight associated with that category. The
resulting weighted values from each of the risk categories are then added
together to determine the total risk-weighted assets.
A banking organization's qualifying total capital consists of two components:
Tier 1 capital (core capital) and Tier 2 capital (supplementary capital).
Tier 1 capital consists primarily of common stock, related surplus and
retained earnings, qualifying non-
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cumulative perpetual preferred stock and minority interests in the equity
accounts of consolidated subsidiaries. Intangibles, such as goodwill, are
generally deducted from Tier 1 capital; however, purchased mortgage servicing
rights and purchase credit card relationships may be included, subject to
certain limitations. At least 50% of the banking organization's total
regulatory capital must consist of Tier 1 capital.
Tier 2 capital may consist of (i) the allowance for possible loan and lease
losses in an amount up to 1.25% of risk-weighted assets; (ii) perpetual
preferred stock, cumulative perpetual preferred stock and long-term preferred
stock and related surplus; (iii) hybrid capital instruments (instruments with
characteristics of both debt and equity), perpetual debt and mandatory
convertible debt securities; and (iv) eligible term subordinated debt and
intermediate-term preferred stock with an original maturity of five years or
more, including related surplus, in an amount up to 50% of Tier 1 capital.
The inclusion of the foregoing elements of Tier 2 capital are subject to
certain requirements and limitations of the federal banking agencies.
The FDIC has also adopted a minimum leverage capital ratio of Tier 1 capital
to average total assets of 3% for the highest rated banks. This leverage
capital ratio is only a minimum. Institutions experiencing or anticipating
significant growth or those with other than minimum risk profiles are
expected to maintain capital well above the minimum level. Furthermore,
higher leverage capital ratios are required to be considered well capitalized
or adequately capitalized under the prompt corrective action provisions of
the FDIC Improvement Act.
PREMIUMS FOR DEPOSIT INSURANCE
Federal law has established several mechanisms to increase funds to protect
deposits insured by the Bank Insurance Fund ("BIF") administered by the FDIC.
The FDIC is authorized to borrow up to $30 billion from the United States
Treasury; up to 90% of the fair market value of assets of institutions
acquired by the FDIC as receiver from the Federal Financing Bank; and from
depository institutions that are members of the BIF. Any borrowings not
repaid by asset sales are to be repaid through insurance premiums assessed to
member institutions. Such premiums must be sufficient to repay any borrowed
funds within 15 years and provide insurance fund reserves of $1.25 for each
$100 of insured deposits. The FDIC also has authority to impose special
assessments against insured deposits.
The FDIC implemented a final risk-based assessment system, as required by
FDICIA, effective January 1, 1994, under which an institution's premium
assessment is based on the probability that the deposit insurance fund will
incur a loss with respect to the institution, the likely amount of any such
loss, and the revenue needs of the deposit insurance fund. As long as BIF's
reserve ratio is less than a specified "designated reserve ratio," 1.25%, the
total amount raised from BIF members by the risk-based assessment system may
not be less than the amount that would be raised if the assessment rate for
all BIF members were .023% of deposits. The FDIC, effective September 15,
1995, lowered assessments from their rates of $.23 to $.31 per $100 of
insured deposits to rates of $.04 to $.31, depending on the condition of the
bank, as a result of the re-capitalization of the BIF. On November 15, 1995,
the FDIC voted to drop its premiums for well capitalized banks to zero
effective January 1, 1996. Other banks will be charged risk-based premiums up
to $.27 per $100 of deposits.
In 1996, Governor Pete Wilson signed Assembly Bill 3351 (the "Banking
Consolidation Bill"), authored by Assemblyman Ted Weggeland and sponsored by
the California State Banking Department (the "Department"), effective July 1,
1997, which creates the California Department of Financial Institutions
("DFI") to be headed by a Commissioner of Financial Institutions out of the
existing Department which regulates state chartered commercial banks and
trust companies in California.
The Banking Consolidation Bill, among other provisions, also (i) transfers
regulatory jurisdiction over state chartered savings and loan associations
from the Department of Savings and Loans ("DSL") to the newly-created DFI and
abolishes the DSL; (ii) transfers regulatory jurisdiction over state
chartered industrial loan companies and credit unions from the Department of
Corporations to the newly-created DFI; and (iii) establishes within the DFI
separate divisions for credit unions, commercial banks, industrial loan
companies and savings and loans. As the Banking Consolidation Bill has only
recently been enacted, it is impossible to predict with any degree of
certainty, what impact it will have on the banking industry in general and
the Bank in particular.
In 1996, the President signed into law provisions to strengthen the Savings
Association Insurance Fund (the "SAIF") and to repay outstanding bonds that
were issued to re-capitalize the SAIF's successor as result of payments made
due to insolvency of savings and loan associations and other federally
insured savings institutions in the late 1980's and early 1990's. The new law
will require savings and loan associations to bear the cost of
re-capitalizing the SAIF and, after January 1, 1997, banks will contribute
towards paying off the financing bonds, including interest. In the year 2000,
the banking industry will assume the bulk of the payments. The new law also
aims to merge the Bank Insurance Fund and SAIF by 1999, but not until the
bank and savings and loan charters are combined. The Treasury Department had
until March 31, 1997, to deliver to Congress on combining the charters.
Additionally, the new law provides "regulatory relief" for the banking
industry by effecting approximately 30 laws and regulations. Currently, the
costs and benefits of the new law to the Bank can not be accurately predicted.
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INTERSTATE BANKING AND BRANCHING
On September 29, 1994, the President signed into law the Riegle-Neal
Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate
Act"). Under the Interstate Act, beginning one year after the date of
enactment, a bank holding company that is adequately capitalized and managed
may obtain regulatory approval to acquire an existing bank located in another
state without regard to state law. A bank holding company would not be
permitted to make such an acquisition if, upon consummation, it would control
(a) more than 10% of the total amount of deposits of insured depository
institutions in the United States or (b) 30% or more of the deposits in the
state in which the bank is located. A state may limit the percentage of total
deposits that may be held in that state by any one bank or bank holding
company if application of such limitation does not discriminate against
out-of-state banks. An out-of-state bank holding company may not acquire a
state bank in existence for less than a minimum length of time that may be
prescribed by state law except that a state may not impose more than a five
year existence requirement.
On July 3, 1997, the President signed into law the Reigle-Neal Amendment Act
of 1997 providing that branches of state banks that operate in other states
are to be governed by the laws of their home (or chartering) states, not the
laws of the host states. State banks and state bank regulators pushed for the
legislation, believing that without it, state banks would switch to national
charters to avoid having to deal with a different a set of laws in each state
where they have established branches.
State banks will not receive any new powers under the legislation. If a host
state allows banks more powers than a bank's chartering state, the bank is
restricted to the powers granted by its chartering state. However, states
will be prohibited from discriminating against branches of banks from other
states by the requirement that states must grant branches out-of-state banks
the same privileges allowed to banks that states have chartered.
The Interstate Act also permits, beginning June 1, 1997, mergers of insured
banks located in different states and conversion of the branches of the
acquired bank into branches of the resulting bank. Each state may permit such
combinations earlier than June 1, 1997, and may adopt legislation to prohibit
interstate mergers after that date in that state or in other states by that
state's banks. The same concentration limits discussed in the preceding
paragraph apply. The Interstate Act also permits a national or state bank to
establish branches in a state other than its home state if permitted by the
laws of that state, subject to the same requirement and conditions as for a
merger transaction. Effective October 2, 1995, California adopted legislation
which "opts California into" the Interstate Act. However, the California
Legislation restricts out of state banks from purchasing branches or starting
a de novo branch to enter the California banking market. Such banks may
proceed only by way of purchases of whole banks.
The Interstate Act is likely to increase competition in the Bank's market
areas especially from larger financial institutions and their holding
companies. It is difficult to access the impact such likely increased
competition will have on the Bank' operations.
In 1986, California adopted an interstate banking law. The law allows
California banks and bank holding companies to be acquired by banking
organizations in other states on a "reciprocal" basis (i.e., provided the
other state's law permit California banking organizations to acquire banking
organizations in that state on substantially the same terms and conditions
applicable to banking organizations solely within that state). The law took
effect in two stages. The first stage allowed acquisitions on a "reciprocal"
basis within a region consisting of 11 western states. The second stage,
which became effective January 1, 1991, allows interstate acquisitions on a
national "reciprocal" basis. California has also adopted similar legislation
applicable to savings associations and their holding companies.
On September 28, 1995, Governor Wilson signed Assembly Bill No. 1482, the
Caldera, Weggeland, and Killea California Interstate Banking and Branching
Act of 1995 (the "1995 Act"). The 1995 Act, which was filed with the
Secretary of State as Chapter 480 of the Statutes of 1995, became operative
on October 2, 1995.
The 1995 Acts opts in early for interstate branching, allowing out-of-state
banks to enter California by merging or purchasing a California bank or
industrial loan company which is at least five years old. Also, the 1995 Act
repeals the California Interstate (National) Banking Act of 1986, which
regulated the acquisition of California banks by out-of-state bank holding
companies. In addition, the 1995 Act permits California state banks, with the
approval of the Commissioner of Financial Insitutions, to establish agency
relationships with FDIC-insured banks and savings associations. Finally, the
1995 Act provides for regulatory relief, including (i) authorization for the
Superintendent to exempt banks from the requirement of obtaining approval
before establishing or relocating a branch office or place of business, (ii)
repeal of the requirement of directors' oaths (Financial Code Section 682),
and (iii) repeal of the aggregate limit on real estate loans (Financial Code
Section 1230).
COMMUNITY REINVESTMENT ACT AND FAIR LENDING DEVELOPMENTS
The Bank is subject to certain fair lending requirements and reporting
obligations involving home mortgage lending operations and Community
Reinvestment Act ("CRA") activities. The CRA generally requires the federal
banking agencies to evaluate the record of financial institutions in meeting
the credit needs of their local community, including low and moderate income
neighborhoods. In addition to substantial penalties and corrective measures
that may be required for a violation of certain fair lending laws, the
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federal banking agencies may take compliance with such laws and CRA into
account when regulating and supervising other activities.
In May 1995, the federal banking agencies issued final regulations which
change the manner in which they measure a bank's compliance with its CRA
obligations. The final regulations adopt a performance-based evaluation
system which bases CRA ratings on an institutions' actual lending service and
investment performance, rather than the extent to which the institution
conducts needs assessments, documents community outreach or complies with
other procedural requirements. In March 1994, the Federal Interagency Tax
Force on Fair Lending issued a policy statement on discrimination in lending.
The policy statement describes the three methods that federal agencies will
use to prove discrimination: overt evidence of discrimination, evidence of
disparate treatment and evidence of disparate impact.
CHANGES IN ACCOUNTING PRINCIPLES
In March of 1995, the FASB issued SFAS No. 121, ACCOUNTING FOR THE IMPAIRMENT
OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF. SFAS No.
121 establishes accounting standards for the impairment of long-lived assets,
certain identifiable intangibles, and goodwill related to those assets to be
held and used and for long-lived assets and certain identifiable intangibles
to be disposed of. The statement does not apply to financial instruments
long-term customer relationships of a financial institution (core deposits),
mortgage and other servicing rights, and tax deferred assets. SFAS 121
requires the review of long-lived assets and certain identifiable intangibles
for impairment whenever events or changes in circumstances include, for
example, a significant decrease in market value of an assets, a significant
change in use of an asset, or an adverse change in a legal factor that could
affect the value of an asset. If such an event occurs and it is determined
that the carrying value of the asset may not be recoverable, an impairment
loss should be recognized and measured by the amount by which the carrying
amount of the asset exceeds the fair value of the asset. Fair value can be
determined by a current transaction, quoted market prices, or present value
of estimated expected future cash flows discounted at the appropriate rate.
The statement is effective for fiscal years beginning after December 15,
1995. The implementation of SFAS No. 121 did not have a material impact on
the Bank's results of operations or financial position.
In May of 1995, the FASB issued SFAS 122, ACCOUNTING FOR MORTGAGE SERVICING
RIGHTS. SFAS No. 122 eliminates distinctions between servicing rights that
were purchased and those that were retained upon the sale of loans. The
statement requires mortgage servicers to recognize as separate assets rights
to service loans, no matter how the rights were acquired. Institutions who
sell loans and retain the servicing rights will be required to allocate the
total cost of the loans to servicing rights and loans based on their relative
fair values if the value can be estimated. SFAS No. 122 is effective for
fiscal years beginning after December 15, 1995. Further, SFAS No. 122
requires that all capitalized mortgage servicing rights be periodically
evaluated for impairment based upon the current fair value of these rights.
This Statement which is superseded by SFAS No. 125, ACCOUNTING FOR TRANSFERS
AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF LIABILITIES, did not
have a material effect on the Bank's financial condition and results of
operations.
In October of 1995, the FASB issued SFAS No. 123, ACCOUNTING FOR STOCK-BASED
COMPENSATION, establishing financial accounting and reporting standards for
stock-based employee compensation plans. This statement encourages all
entities to adopt a new method of accounting to measure compensation cost of
all employee stock compensation plans based on the estimated fair value of
the award at the date it is granted. Companies are, however, allowed to
continue to measure compensation cost for those plans using the intrinsic
value based method of accounting, which generally does not result in
compensation expense recognition for most plans. Companies that elect to
remain with the existing accounting are required to disclose in a footnote to
the financial statements pro forma net income and, if presented, earnings per
share, as if this statement had been adopted. The accounting requirements of
this statement are effective for transactions entered into in fiscal years
that begin after December 15, 1995; however, companies are required to
disclose information for awards granted in their first fiscal year beginning
after December 15, 1994. The Bank has elected the pro forma disclosure
requirements as noted in the note to the Financial Statements.
In June of 1996, the FASB issued SFAS No. 125, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, and in
December, 1996 issued SFAS No. 127, Deferral of the Effective Date of Certain
Provisions of FASB Statement No. 125 (an amendment of FASB Statement No. 125)
establishing accounting and reporting standards for transfers and servicing
of financial assets and extinguishments of liabilities based on consistent
application of the financial-components approach. This approach requires the
recognition of financial assets and servicing assets that are controlled by
the reporting entity, the de-recognition of financial assets when control is
surrendered, and the de-recognition of liabilities when they are
extinguished. Specific criteria are established for determining when control
has been surrendered in the transfer of financial assets. Liabilities and
derivatives incurred or obtained by transferors in conjunction with the
transfer of financial assets are required to be measured at fair value, if
practicable. Servicing assets and other retained interests in transferred
assets are required to be measured by allocating the previous carrying amount
between the assets sold, if any, and the interest that is retained, if any,
based on the relative fair values of the assets on the date of the transfer.
Servicing assets retained are subsequently subject to amortization and
assessment for
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impairment. Management believes the implementation of this statement will not
have a material effect on the Banks financial condition or results of
operations.
In June 1997, the Financial Accounting Standards Board issued Statement No.
130, "REPORTING COMPREHENSIVE INCOME". This statement, which is effective for
the year ending December 31, 1998, establishes standards of disclosure and
financial statement display for reporting comprehensive income and its
components.
In June 1997, the Financial Accounting Standards Board issued Statement No.
131, "DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION".
This statement changes current practice under SFAS 14 by establishing a new
framework on which to base segment reporting (referred to as the management
approach), and also requires certain related disclosures about products and
services, geographic areas, and major customers. The disclosures are required
for the year ending December 31, 1998.
HAZARDOUS WASTE CLEAN-UP COSTS
Management is aware of recent legislation and cases relating to hazardous
waste clean-up costs and potential liability. Based on a general survey of
the loan portfolio of the Bank, conversations with local authorities and
appraisers, and the type of lending currently and historically done by the
Bank (generally, the Bank has not made the types of loans usually associated
with hazardous waste contamination problems), management is not aware of any
potential material liability for hazardous waste contamination.
OTHER REGULATIONS AND POLICIES
The federal regulatory agencies have adopted regulations that implement
Section 304 of FDICIA which requires federal banking agencies to adopt
uniform regulations prescribing standards for real estate lending. Each
insured depository institution must adopt and maintain a comprehensive
written real estate lending policy, developed in conformance with prescribed
guidelines, and each agency has specified loan-to-value limits in guidelines
concerning various categories of real estate loans.
Various requirements and restrictions under the laws of the United States and
the State of California affect the operations of the Bank. Federal
regulations include requirements to maintain non-interest bearing reserves
against deposits, limitations on the nature and amount of loans which may be
made, and restrictions on payment of dividends. The California Commissioner
of Financial Institutions approves the number and locations of the branch
offices of a bank. California law exempts banks from the usury laws.
YEAR 2000 SAFETY AND SOUNDNESS
Safety and soundness guidance on the risks posed to financial institutions by
the Year 2000 problem was issued by the Federal Financial Institutions
Examination Council. The guidance underscores that Year 2000 preparation is
not only an information systems issue, according to the FFIEC, but also an
enterprise-wide challenge that must be addressed at the highest level of a
financial institution.
The guidance sets out the responsibilities of senior management and boards of
directors in managing their Year 2000 projects. Among the responsibilities of
institution managers and directors is that of managing the internal and
external risks presented by providers of data-processing products and
services, business partners, counterparties and major loan customers.
Under the guidance, senior management must provide the board of directors
with status reports, at least quarterly, on efforts to reach Year 2000 goals
both internally and by the institution's major vendors. Senior management and
directors must allocate sufficient resources to ensure that high priority is
given to seeing that remediation plans are fulfilled, and that the project
receives the quality personnel and timely support it requires.
A Year 2000 management committee has been formed by the the Company to
identify potential problems associated with the turn of the century and to
develop resolutions to these problems. Renovation activities such as hardware
and software upgrades, system replacements, and vendor certifications are
anticipated to be completed during the fourth quarter of 1998. The Company
was examined by the FDIC in January, 1998 specifically in regards to its
efforts to meet Year 2000 compliance guidelines. The Company's efforts were
judged to be satisfactory. Current costs and estimated future expenditures do
not appear to be material and are expected to have negligible effects on the
Company's results of operations, liquidity and capital resources.
13
<PAGE>
MONETARY POLICY
Banking is a business which depends on rate differentials. In general, the
difference between the interest paid by the Bank on its deposits and its
other borrowings and the interest rate received by the Bank on loans extended
to its customers and securities held in the Bank investment portfolios will
comprise the major portion of the Bank's earnings.
The earnings and growth of the Bank will be affected not only by general
economic conditions, both domestic and international, but also by the
monetary and fiscal policies of the United States and its agencies,
particularly the Federal Reserve Board. The Federal Reserve Board can and
does implement national monetary policy, such as seeking to curb inflation
and combat recession, by its open market operations in U.S. Government
securities, limitations upon savings and time deposit interest rates, and
adjustments to the discount rates applicable to borrowings by banks which are
members of the Federal Reserve System. The actions of the Federal Reserve
Board influence the growth of bank loans, investments and deposits and also
affect interest rates charged on loans and paid on deposits. The nature and
impact that future changes in fiscal or monetary policies or economic
controls may have on the Bank's businesses and earnings cannot be predicted.
COMPETITION
The banking business in California generally, and in the Bank's primary
service areas specifically, is highly competitive with respect to both loans
and deposits and is dominated by a relatively small number of major banks
with many offices and operations over a wide geographic area. Among the
advantages such major banks have over the Bank are their ability to finance
wide-ranging advertising campaigns and to allocate their investment assets to
regions of higher yield and demand. Such banks offer certain services such as
trust services and international banking which are not offered directly by
the Bank; but which can be offered indirectly by the Bank through
correspondent institutions. In addition, by virtue of their greater total
capitalization, such banks have substantially higher lending limits than the
Bank. (Legal lending limits to an individual customer are based upon a
percentage of a bank's total capital accounts.) Other entities, both
governmental and in private industry, seeking to raise capital through the
issuance and sale of debt or equity securities also provide competition for
the Bank in the acquisition of deposits. Banks also compete with money market
funds and other money market instruments which are not subject to interest
rate ceilings.
In order to compete with other competitors in their primary service areas,
the Bank attempts to use, to the fullest extent, the flexibility which their
independent status permits. This includes an emphasis on specialized
services, local promotional activity, and personal contacts by their
respective officers, directors and employees. In particular, each of the
banks offers highly personalized banking services.
EMPLOYEES
At December 31, 1997, the Company had a total of 155 full-time employees and
63 part-time employees. The Bank believes that its employee relations are
satisfactory.
14
<PAGE>
ITEM 2. PROPERTIES
The Bank owns the land and buildings at ten of its thirteen locations. Those
locations include:
<TABLE>
<CAPTION>
OFFICE NAME ADDRESS
----------- -------
<S> <C>
MAIN OFFICE 2739 Santa Maria Way
Santa Maria, California
SOUTH BROADWAY 528 South Broadway
Santa Maria, California
OAK KNOLLS 1070 East Clark Avenue
Santa Maria, California
GUADALUPE 905 Guadalupe Street
Guadalupe, California
VANDENBERG VILLAGE 3745 Constellation
Vandenberg Village, CA
GROVER BEACH 1580 Grand Avenue
Grover Beach, California
PISMO BEACH 790 Price Street
Pismo Beach, California
TEMPLETON 1025 Las Tablas Road
Templeton, California
PASO ROBLES 840 Spring Street
Paso Robles, California
ATASCADERO 5955 E. Mall Street
Atascadero, California
</TABLE>
The Bank also leases the land where the NIPOMO branch has been built and a
portion of the land upon which the NORTH BROADWAY branch building now stands.
Both leases were long-term (25 years with an option to renew for a like
period) and do contain the right of first refusal if the lessor elects to
sell. However, neither lease has any options to purchase and therefore no
ownership is assumed.
With the addition of our LOMPOC BRANCH, the Bank acquired a lease on the
building in which the branch is located. This shopping center lease, which
became in effect on November 1, 1989, is a five year term lease with a five
year option to renew which expires in October, 1999.
In addition, the Bank now leases one off-site ATM location in Atascadero,
California.
OTHER PROPERTIES
When real estate loans are foreclosed, the Bank retains the property and
records the transaction on the Balance Sheet to the Other Real Estate Owned
account. The following is a summary of the changes in Other Real Estate Owned
for the periods ending December 31, 1997, 1996 and 1995.
<TABLE>
<CAPTION>
(In Thousands) 1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Balance at beginning of year $ 1,678 $ 1,516 $ 1,398
Additions 630 1,515 838
Provisions charged to income (55) (75) (189)
Sales of other real estate owned (1,284) (1,278) (531)
--------- -------- -------
TOTAL $ 969 $ 1,678 $ 1,516
--------- -------- -------
--------- -------- -------
</TABLE>
15
<PAGE>
ITEM 3: LEGAL PROCEEDINGS
Due to the nature of its business, the Bank is a party to claims and legal
proceedings arising in the ordinary course of business. It is management's
opinion that there are no material actions pending against the bank as of
this filing date.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5: MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED SECURITY HOLDERS
MATTERS
The common stock of the Company is not listed on any national stock exchange
or with NASDAQ. Trading in the stock has not been extensive and such trades
which have occurred would not constitute an active trading market. As of
December 31, 1997, there were approximately 2,000 shareholders, including
those listed in "street name" under various brokers. The management of the
Company is aware of three securities dealers who maintain an inventory and
make a market in the Company's common stock. The market makers are Maguire
Investments of Santa Maria, Hoefer & Arnett of San Francisco, and Sutro &
Company, with a local office in Santa Maria.
Since 1984, the Bank has consistently declared and paid a cash dividend to
the then shareholders of Bank of Santa Maria, with the equivalent of $.06
being paid since February of 1988. In 1994, the Board of Directors of the
Bank increased the per share dividend to $.10. In 1995, the Board of
Directors again increased the per share dividends to $.11 payable in
February, 1995, to the holders of their stock.
In 1996, the Board of Directors increased the cash dividend to $.20 payable
in February, 1996. At the 1996 Annual Shareholders Meeting, the Bank
announced that it would begin to pay dividends on a semi-annual basis. In
July 1996, a $.15 dividend was declared to be paid in August, 1996. In
January of 1997, the Board again declared a $.15 cash dividend payable in
February, 1997. Following the formation of the BSM Bancorp, the Directors of
the Company continued the semi-annual dividend policy. In August of 1997, the
Company paid a $.20 cash dividend. In January of 1998, the Company Board
again declared a cash dividend of $.30 per share payable on February 6, 1998.
The California Financial Code provides that a bank may not make a cash
distribution to its shareholders in excess of the lessor of the Company's
undivided profits, or the Company's net income for its last three fiscal
years; less the amount of any distribution made by the Company to
shareholders during the same period. Under these restrictions, approximately
$8,608,000 was available for payment of dividends at December 31, 1997. In
addition, as part of the Agreement with Mid-State, the Company's mid-year
cash dividend, if any, is limited to a maximum of $.10 per share.
The following quarterly summary of market activity is furnished by Maguire
Investments, Inc. of Santa Maria and by the OTC Bulletin Board. These quotes
do not necessarily include retail markups, markdowns, or commissions and may
not necessarily represent actual transactions. Additionally, there may have
been transactions at prices other than those shown below:
<TABLE>
<CAPTION>
Bid Ask
------ ------
<S> <C> <C>
1st Quarter 1996 $14.00 $14.50
2nd Quarter 1996 $13.75 $14.25
3rd Quarter 1996 $15.00 $15.75
4th Quarter 1996 $15.00 $16.00
1st Quarter 1997 $15.25 $16.75
2nd Quarter 1997 $16.13 $17.63
3rd Quarter 1997 $16.75 $18.63
4th Quarter 1997 $18.00 $27.50
</TABLE>
16
<PAGE>
ITEM 6: SELECTED FINANCIAL DATA
BSM BANCORP SUMMARY HISTORICAL FINANCIAL DATA
The following summarizes historical financial data for the five years ended
December 31, 1997. The data should be read in conjunction with the
consolidated financial statements, related notes, and other financial
information included or incorporated by reference in this Form 10-K.
<TABLE>
<CAPTION>
------------------------------------------------------
(Amounts in thousands, except per share data.) AT OR FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
SUMMARY OF OPERATIONS:
Interest Income $ 24,977 $ 23,372 $ 22,367 $ 19,378 $ 18,431
Interest Expense 8,425 7,991 7,045 5,560 5,625
-------- -------- --------- -------- --------
Net Interest Income 16,552 15,381 15,322 13,818 12,806
Provisions for Loan Losses 30 227 876 340 712
-------- -------- --------- -------- --------
Net Interest Income After Provision for Loan Losses 16,522 15,154 14,446 13,478 12,094
Noninterest Income 3,504 3,098 2,728 2,448 2,550
Noninterest Expense 13,205 12,471 12,090 11,723 11,158
-------- -------- --------- -------- --------
Income Before Income Taxes 6,821 5,781 5,084 4,203 3,486
Income Taxes 2,616 2,313 1,885 1,475 1,146
-------- -------- --------- -------- --------
Net Income $ 4,205 $ 3,468 $ 3,199 $ 2,728 $ 2,340
-------- -------- --------- -------- --------
-------- -------- --------- -------- --------
Dividends on Common Stock $ 1,402 $ 964 $ 257 $ 219 $ 131
PER SHARE DATA:
Net Income-Basic $ 1.41 $ 1.17 $ 1.10 $ 0.96 $ 0.86
Net Income-Diluted $ 1.38 $ 1.16 $ 1.09 $ 0.95 $ 0.83
Dividends on Common Stock $ 0.35 $ 0.35 $ 0.11 $ 0.10 $ 0.06
Book Value $ 12.06 $ 10.97 $ 10.16 $ 9.17 $ 8.35
Tangible Book Value $ 11.45 $ 10.33 $ 10.16 $ 9.17 $ 8.35
STATEMENTS OF FINANCIAL CONDITION SUMMARY:
Total Assets $344,046 $321,397 $ 284,616 $266,987 $253,311
Total Deposits 306,292 286,278 252,544 238,954 229,137
Loans Held for Sale 1,200 1,400 1,310 958 3,644
Total Loans 191,346 179,391 166,086 164,406 164,004
Allowance for Loan Losses 2,115 2,702 2,729 2,413 2,524
Total Shareholders' Equity 36,062 32,632 29,978 26,387 22,683
SELECTED RATIOS:
Return on Average Assets 1.31% 1.15% 1.17% 1.05% 0.95%
Return on Average Equity 12.15% 11.06% 11.26% 10.99% 10.80%
Average Loans as a Percent of Average Deposits 62.44% 63.96% 63.04% 64.67% 66.94%
Allowance for Loan Losses to Total Loans 1.11% 1.51% 1.64% 1.47% 1.54%
Average Capital to Average Assets 10.76% 10.41% 10.42% 9.56% 8.79%
Tier 1 Capital to Risk-Weighted Assets 14.74% 14.10% 13.69% 12.29% 10.89%
Total Capital to Risk-Weighted Assets 15.66% 15.30% 14.96% 14.71% 12.13%
</TABLE>
17
<PAGE>
ITEM 7: MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion is intended to provide information to facilitate the
understanding and assessment of significant changes and trends related to the
results of operations and the financial condition of BSM Bancorp and its
subsidiary, Bank of Santa Maria ("the Company"). This discussion and analysis
should be read in conjunction with the Company's audited financial statements
and the notes thereto.
BSM Bancorp ("the Bancorp") was incorporated on November 12, 1996, for the
sole purpose of becoming a bank holding company for Bank of Santa Maria ("the
Bank"). Following regulatory approval and with the approval of the Bank's
shareholders, the Bank merged with BSM Merger Company, (a wholly-owned
subsidiary of the Bancorp), as of the close of business on March 11, 1997.
The resulting bank assumed the name of Bank of Santa Maria, becoming a
wholly-owned subsidiary of the Bancorp. This acquisition was accounted for
using the pooling of interest method.
Bank of Santa Maria was initially incorporated under the laws of the State of
California on June 27, 1997, and was licensed by the California State Banking
Department. The Bank commenced operations on March 18, 1978, and operated
thirteen retail locations along the central coast of California. The Bank
offers a full range of commercial banking services designed to serve the
banking needs of individuals as well as small to medium sized businesses
located within its primary market area.
As reported in Note B to the Financial Statements, the Bank has been actively
involved in the acquisition of other central coast banks during the periods
under discussion below. During 1997, El Camino National Bank was merged into
the Bank. This acquisition was accounted for by using the pooling of interest
method which requires the restatement of all previously reported numbers to
give effect for this merger. The acquisition of Citizens Bank of Paso Robles
in 1996, on the other hand, was accounted for by using the purchase method of
accounting where no restatement of prior periods numbers was required. During
1995, Templeton National Bank merged into the Bank. Like El Camino, this
acquisition was also accounted for by using the pooling of interest method
which requires the restatement of all previously reported numbers to give
effect for this merger.
RESULTS OF OPERATIONS
The Company reported net earnings of $4,205,000, or $1.41 per share, in 1997.
This represents an increase of 21.3% over 1996 where net earnings were
$3,468,000, or $1.17 per share. Net earnings in 1995 were $3,199,000, or
$1.10 per share.
The increase in profitability during 1997 is the net result of several major
factors. On a pre-tax basis, the difference between the income figures
reported in 1997 over 1996 is approximately $1,040,000. The following recaps
are presented as a preview to a more detailed discussion to follow:
<TABLE>
<CAPTION>
CHANGES BETWEEN THE 1997 AND 1996 OPERATING PERIODS
<S> <C>
Increase in interest income due to increase in the volume of earning assets $1,268,000
(Increase) in interest expenses due to increase in the volume of interest-
bearing liabilities (583,000)
Increase in net interest income due to improved net interest margin 486,000
Reduction in the provision for loan losses 197,000
Increase in non-interest income from service charges 186,000
Increase in non-interest income from mortgage loan fees 168,000
(Increase) in salary & employee benefit costs (621,000)
(Increase) in advertising & promotional expenses (141,000)
Reduction in professional fees 161,000
(Increase) in other costs (net) (81,000)
----------
Change in pretax income between 1997 and 1996 $1,040,000
----------
----------
</TABLE>
18
<PAGE>
<TABLE>
<CAPTION>
CHANGES BETWEEN THE 1996 AND 1995 OPERATING PERIODS
<S> <C>
Contribution of former Citizens branches to profitability since merger $ 230,000
(Increase) in advertising & promotional expenses (133,000)
Decline in net interest income due to reduced net interest margin (551,000)
Reduction in the provision for loan losses 649,000
Reduction in regulatory assessments 288,000
Reduction in merger-related expenses 107,000
Reduction in net losses on the sale of other real estate and fixed assets 107,000
----------
Change in pretax income between 1996 and 1995 $ 697,000
----------
----------
</TABLE>
Other key financial ratios are listed below:
TABLE 1 - KEY FINANCIAL RATIOS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------
1997 1996 1995 1994 1993
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Return on average assets 1.31% 1.15% 1.17% 1.05% 0.95%
Return on average equity 12.15% 11.06% 11.26% 10.99% 10.80%
Return on beginning equity 12.89% 11.57% 12.12% 12.03% 11.47%
Dividend payout ratio 24.82% 29.91% 10.00% 10.36% 6.97%
Average equity to average assets 10.76% 10.41% 10.42% 9.56% 8.79%
</TABLE>
NET INTEREST INCOME AND NET INTEREST MARGIN
Table 2, entitled Average Balances and Interest Rates, shows the Company's
average assets, liabilities, and stockholders' equity with the related
interest income, interest expense and rates for the years 1997, 1996, and
1995. Rates for tax preferenced investments are shown on a tax equivalent
basis using a 34% tax rate. Table 3 analyzes the reasons for change in net
interest income resulting from movement in rates and changes in average
outstanding balances. Reference should be made to both Table 2 and Table 3 to
assist in understanding this major component of Company profitability.
Net interest income is the difference between the interest and fees earned on
interest-bearing assets, such as loans and investments, and the interest paid
on interest-bearing liabilities, such as deposits. Net interest income is
similar to "Gross profits on sales" used in the financial statements for
retail sales organizations. Net interest income in 1997 was $16.6 million as
compared to $15.4 million in 1996, and $15.3 million in 1995. Net interest
income, when expressed as a percentage of total average interest-earning
assets, is referred to as net interest margin or "NIM". The Company's NIM was
5.95% in 1997, compared to 5.84% in 1996, and 6.39% in 1995.
NIM is used as a measure of the efficiency of the Company's asset/liability
management. The Company's NIM in 1997 increased by 1.9% compared to the
decrease of 8.6% in 1996. The increase in NIM noted in 1997 is primarily the
result of improved effective yield on the loan portfolio.
There are several reasons for the decline in 1996, which are best explained
by an analysis of the NIM's major components. The two components of NIM are
interest income and interest expense. Loans are the largest interest earning
assets group which contribute to interest income. Loan demand in California
during 1996 was weak. Although the average earning assets (after excluding
the effect of the purchase of Citizens assets) increased by approximately $10
million during 1996. Loans, as a percentage of earning assets, declined from
66.7% to 62.8%. The investment portfolio absorbed these dollars, increasing
their percentage of earning assets from 27.6% to 31.9%. This change in mix
from higher yielding loans to the moderate yields available in low risk
investments would have the effect of lowering interest income by over
$500,000, assuming an average 5.0% differential between the two asset groups.
In addition, the Company's average base rate declined from an average 8.83%
for the year 1996, to an average 8.27% for the year 1997. This 56 basis point
decline had a significant effect on the Company's loan portfolio because
approximately 38% of all Company loans are tied to base rates, which re-price
immediately upon movements in prime rates. Close to 60% of all loan dollars
are subject to repricing within 90 days, and more than 72% of all loan
dollars can be re-priced within any 12 month period. The actual decline in
effective rates on the loan portfolio was 49 basis points during 1997. The
effect on interest loan income of this decline in the effective interest
rates would approximate $800,000.
19
<PAGE>
Total interest income on earning assets for the year 1996 was up by $1.0
million, despite the large decline in overall interest rate yields. This can
be primarily attributable to the acquisition of earning assets obtained in
the Citizens merger, although non-acquisition growth also was a contributing
factor.
The funding of earning assets comes primarily from deposits. Between 1995 and
1997, the percentage of average interest bearing deposits remained within the
range of 78% to 79% of all deposits. However, the mix among average
interest-bearing deposits changed with time deposits growing from 40.7% to
50.4% of all average interest-bearing funds. This resulted in an increase in
the cost of interest-bearing funds by 11 basis points and, at the same time,
interest-earning assets were experiencing a decline of 37 basis points.
Within the bank's marketplace, customers appeared to be willing to forego
immediate liquidity to earning a better return on funds normally held in both
savings and money market savings accounts.
Interest expense on interest-bearing deposits increased $434,000 in 1997 over
1996, and by $946,000 in 1996 over 1995, primarily due to the increase in the
volume of time deposits which fully offset the reductions in rates during
this period.
The average interest rate from interest expense used in NIM is based upon
average earning ASSETS rather than average interest-bearing deposits.
Accordingly, fluctuations in earning assets affect the results of the
percentages used in arriving at NIM. In 1997, interest expense, as expressed
as a percentage of earning assets, increased by .7% to 2.96%, in comparison
with 1996, where the percentage was an increase of 3.1% over the previous
year.
Overall, NIM increased to 5.95% in 1997, up 10 basis points from 1996. This
was in contrast to 1996, where NIM declined by 58 basis points as a result of
the decline in interest-earning assets during the same time that increases
were occurring in interest-bearing liabilities. Changes in both the mix of
interest-earning assets and interest-bearing liabilities exacerbated the
anticipated narrowing of the interest margin which would have normally
occurred when general interest rates are on the decline.
20
<PAGE>
TABLE 2 - AVERAGE BALANCES AND INTEREST RATES
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------------------------------------------------------------------------------
1997 1996 1995
-----------------------------------------------------------------------------------------------------
Average Amount Average Amount Average Amount
INTEREST Balance of Average Balance of Average Balance of Average
EARNING ASSETS: (000'S) Interest Rate(2) (000'S) Interest Rate(2) (000'S) Interest Rate(2)
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INVESTMENT
SECURITIES
Taxable $78,333 4,723 6.03% $71,046 4,264 6.00% $54,775 $3,180 5.81%
Non-Taxable 19,071 794 6.31% 14,528 568 5.92% 12,324 463 5.70%
-------- ------ ------ ------- ------ ------ -------- ------- -------
TOTAL SECURITIES 97,404 5,517 6.08% 85,574 4,832 5.99% 67,099 3,643 5.79%
-------- ------ ------ ------- ------ ------ -------- ------- -------
Federal Funds Sold 11,865 658 5.55% 14,367 753 5.24% 13,977 775 5.54%
Net Loans (1) 175,660 18,802 10.70% 168,392 17,787 10.56% 162,397 17,949 11.05%
-------- ------ ------ ------- ------ ------ -------- ------- -------
TOTAL EARNING ASSETS 284,929 24,977 8.91% 268,333 23,372 8.82% 243,473 22,367 9.28%
TOTAL NON-EARNING
ASSETS 36,602 32,896 28,986
-------- -------- --------
TOTAL ASSETS $321,531 $301,229 $272,459
-------- -------- --------
-------- -------- --------
LIABILITIES
AND CAPITAL:
- ------------------------------------------------------------------------------------------------------------------------------------
Interest-bearing
demand/savings 110,026 2,413 2.19% 113,022 2,547 2.31% 113,217 2,954 2.61%
Time deposits
under $100,000 75,589 4,036 5.34% 67,516 3,647 5.40% 53,914 2,828 5.25%
Time deposits $100,000
or more 35,995 1,976 5.49% 32,906 1,797 5.46% 23,796 1,263 5.31%
-------- ------ ------ -------- ------ ------ -------- ------- ------
TOTAL INTEREST
BEARING DEPOSITS 221,610 8,425 3.80% 213,444 7,991 3.79% 190,927 7,045 3.69%
-------- ------ ------ -------- ------ ------ -------- ------- ------
Demand deposits 63,636 54,271 51,215
Other liabilities 1,691 2,161 1,915
Capital 34,594 31,353 28,402
-------- -------- --------
TOTAL LIABILITIES
AND CAPITAL $321,531 $301,229 $272,459
--------- -------- --------
--------- -------- --------
Spread on average
interest-bearing funds 5.11% 5.03% 5.59%
Interest income/earning assets 8.91% 8.82% 9.28%
Interest expense/earning assets 2.96% 2.98% 2.89%
Net interest margin 5.95% 5.84% 6.39%
</TABLE>
(1) Non-accrual loans have been included in net loan figures
(2) Yields are calculated on a tax equivalent basis
The impact of changes in the net interest income spread during 1997 and 1996
can also be examined by reference to Table 3, where increases or decreases in
interest income is broken down into two components. Changes due primarily to
increases or decreases in the size of the category are called volume
variances. Changes due primarily to increases or decreases in the rates
associated with each category are called rate variances.
During 1996, net interest income increased by only $59,000. However, the
method of accounting for the acquisition of Citizens tends to overshadow some
of the factors which net to a relatively nominal change in 1996. See the pro
forma analysis below which excludes the effects of net interest income from
the former Citizen's operations subsequent to the acquisition in May of that
year.
21
<PAGE>
TABLE 3 - RATE AND VOLUME ANALYSIS
(In thousands)
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------------------------------------
1997 over 1996 1996 over 1995
Increase (Decrease) Increase (Decrease)
due to change in due to change in
------------------------ --------------------------
INTEREST EARNING ASSETS: Volume Rate Total Volume Rate Total
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Investment securities
Taxable $ 440 $ 19 $ 459 $ 973 $ 111 $1,084
Non-taxable 189 37 226 86 19 105
------ ----- ------ ------ ------- -------
TOTAL SECURITIES 629 56 685 1,059 130 1,189
Federal funds sold (139) 44 (95) 21 (43) (22)
Net loans 778 237 1,015 649 (811) (162)
------ ----- ------ ------ ------- -------
TOTAL EARNING ASSETS $1,268 $ 337 $1,605 $1,729 $ (724) $1,005
------ ----- ------ ------ ------- -------
------ ----- ------ ------ ------- -------
INTEREST BEARING LIABILITIES:
- ----------------------------------------------------------------------------------------------------------
Interest-bearing demand/savings $ (18) $(116) $ (134) $ (5) $ (402) $ (407)
Time deposits under $100,000 431 (42) 389 733 86 819
Time deposits $100,000 or above 170 9 179 497 37 534
------ ----- ------ ------ ------- -------
TOTAL INTEREST
BEARING DEPOSITS $ 583 $(149) $ 434 $1,225 $ (279) $ 946
------ ----- ------ ------ ------- -------
------ ----- ------ ------ ------- -------
Increase (decrease) in interest
differential $ 685 $ 486 $1,171 $ 504 $ (445) $ 59
</TABLE>
Information is provided in each category with respect to (a) changes
attributable to changes in volume (changes in volume multiplied by prior
rate); (b) changes attributable to changes in rates (changes in rates
multiplied by prior volume); and (c) the net change. The change attributable
to the combined impact of volume and rate has been allotted proportionately
to the change due to volume and the change due to rate.
PRO FORMA 1996 RATE AND VOLUME ANALYSIS
<TABLE>
<CAPTION>
Pro forma Per Table
Volume Rate Total Three
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total Earning Assets $ 257 $(724) $(467) $1,005
Total Interest-Bearing Liabilities 363 (279) 84 946
----- ----- ----- ------
Increase (decrease) in interest differential $(106) $(445) $(551) $ 59
----- ----- ----- ------
----- ----- ----- ------
</TABLE>
The level of non-performing loans in the Company's portfolio affects the
amount of interest income. As noted in the notes to the Financial Statements,
when serious doubt exists as to the repayment of a loan, that loan is placed
on non-accrual status, and previously accrued and uncollected interest for
the current year is reversed against income. Had non-performing loans as of
December 31, 1997, complied with original terms, related interest income
would have been approximately $100,000, in which $23,000 was collected. The
difference of approximately $77,000 was not taken into income, which, if
included, would have increased NIM by 3 basis points to 5.98%.
SUMMARY OF CREDIT LOSS EXPERIENCE
The Company maintains an allowance for loan losses, which is reduced by net
loan charge-offs and increased by provisions for loan losses charged against
operating income. It is the Company's practice to maintain the allowance for
loan and lease losses at a level considered by Management to be adequate.
Each quarter, Management calculates an acceptable allowance for loan and
lease losses using an internal rating system based upon the risk associated
with various categories of loans. A portion of the calculation is based upon
the historical loss experience of the preceding five years and in some risk
categories the degree of collateralization. The risk assigned to each loan
is first determined when the loan is originated. It is then reviewed
quarterly and revised as appropriate. In addition, the Bank maintains a
monitoring system for all credits that have been identified either internally
or externally as warranting additional Management attention. These credits
are formally reported to Management by the lending officers on a quarterly
basis and are subsequently reviewed by the Loan Committee of the Board of
Directors. Reserves against these loans are based on the credit risk
assigned to the loans as described above utilizing a schedule of percentages
developed by Management in accordance with historical loss experience,
ranging from .18% to 50% of the present loan balances. These percentages may
be modified, based upon current or prospective local economic conditions.
The comments of bank examiners, the Company's independent auditors and a
third party loan review consultant hired by the Bank on a periodic basis are
also considered in revising risk category assignments. In determining the
actual allowance for loan and lease losses to be maintained, Management
augments this calculation with an analysis of the present and prospective
financial condition of certain borrowers, industry concentrations within the
portfolio, trends in delinquent and nonaccrual loans and general economic
conditions.
The primary risk element considered by Management with respect to each
installment and conventional real estate loan is lack of timely payment and the
value of the collateral. The primary risk elements with respect to real estate
construction loans are fluctuations in real estate values in the Company's
market areas, inaccurate estimates of construction costs, fluctuations in
interest rates, the availability of conventional financing, the demand for
housing in the Company's market area and general economic conditions. The
primary risk elements with respect to commercial loans are the financial
condition of the borrower, general economic conditions in the Company's market
area, the sufficiency of collateral, the timeliness of payment and with respect
to adjustable rate loans, interest rate fluctuations. Management has a policy
of requesting and reviewing annual financial statements from its commercial
loan customers and periodically reviews the existence of collateral and its
value. Management also has a reporting system that monitors all past due loans
and has adopted policies to pursue its creditor's rights in order to preserve
the Company's position.
22
<PAGE>
In addition to internal evaluation, the adequacy of the allowance for loan
losses is subject to review by regulators and outside consultants. While no
assurance can be given that economic conditions which adversely affect the
Company's service areas or other unforeseen circum-stances, will not require
increased provisions for loan losses in the future. It is management's
opinion that the allowance for loan losses as of December 31, 1997, of
$2,115,000 or 1.11% of total loans was adequate to absorb losses from any
known or inherent risks in the portfolio. Table 4 shows comparative
statistics and a more detailed breakdown of activity in the loan loss reserve
account. The low amount of the provision for 1997 reflects the overall
stability in the loan portfolio.
TABLE 4 - SUMMARY OF LOAN LOSS EXPERIENCE
(In thousands)
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------------------------------
1997 1996 1995 1994 1993
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BALANCE OF RESERVE AT
BEGINNING OF YEAR $2,703 $2,801 $2,412 $2,524 $2,650
CHARGE OFFS
Consumer 427 269 222 226 480
Commercial 193 302 242 141 171
Agricultural 0 0 0 0 64
Construction and development 0 32 0 0 151
Other real estate 103 49 129 17 134
------ ------- ------- ------ ------
TOTAL CHARGE OFFS 724 652 593 584 1,000
RECOVERIES
Consumer 27 23 41 33 64
Commercial 79 74 65 62 96
Agricultural 0 0 0 36 0
Construction and development 0 0 0 1 0
Other real estate 0 1 0 0 1
------ ------- ------- ------ ------
TOTAL RECOVERIES 106 99 106 132 161
------ ------- ------- ------ ------
NET CHARGE OFFS 618 553 487 452 839
------ ------- ------- ------ ------
Acquired Allowance from Citizens 0 228 0 0 0
------ ------- ------- ------ ------
Provision charged to operations 30 227 876 340 713
------ ------- ------- ------ ------
BALANCE AT YEAR END $2,115 $2,703 $2,801 $2,412 $2,524
------ ------- ------- ------ ------
------ ------- ------- ------ ------
Ratio of net charge-offs to average
net loans during the period 0.35% 0.33% 0.30% 0.27% 0.52%
</TABLE>
23
<PAGE>
NON-INTEREST INCOME
Non-interest income increased by $406,000 to $3.5 million in 1997, from $3.1
million in 1996, and $2.7 million in 1995. Service charges related to the
Company's deposit products account for the largest portion of non-interest
income. The increase noted in service charges and fees comes primarily from
increased service charges on many of the bank's deposit products. Merchant
discount fees are obtained in conjunction with the processing of credit card
drafts and related products. Increases in fees are generally offset by
increased costs from the bank's service provider. Other fee income includes
mortgage broker fees, servicing fees on loans sold in the secondary markets,
and other non-deposit related charges, including wires, safe deposit, ATM's,
etc. The increase noted in this category was primarily from increase in
mortgage broker activity. Other non-interest income includes net gains on
sale of fixed assets and other real estate owned, income generated from the
holding of other real estate owned and other non-fee related income. The
decrease noted in this category was from reduced net gains on the sale of
fixed assets and other real-estate owned and reduced income generated from
rents on previously owned other real estate.
NON-INTEREST EXPENSE
The Bank's total non-interest expense amounted to $13.2 million in 1997,
$12.5 million in 1996, and $12.1 million in 1995. Both the increase in 1997
of $773,000, or 5.69%, and the increase in 1996 of $380,000, or 3.1%, were
due primarily to costs associated with the expansion of the bank into San
Luis Obispo County.
Non-interest expense as a percentage of average assets has continued to
decline from 4.44% in 1995, to 4.14% in 1996, and to 4.11% in 1997.
24
<PAGE>
BALANCE SHEET ANALYSIS
Total assets as of year end increased by 7.0% in 1997 to $344.0, compared to
an 12.9% increase in 1996. The majority of the growth in assets and in
deposits during 1996 can be attributed to the acquisition of Citizens Bank.
INVESTMENT SECURITIES
The Company maintains a portfolio of investment securities to provide income
and to serve as a secondary source of liquidity for its operations in
conjunction with funds sold overnight in the Federal funds market. The types
of investments held in the portfolio include U.S. Treasury Bills and Notes,
Government Agency issues, short-term municipal issues, and corporate
obligations. The type of investments held in the Company's portfolio are
influenced by several factors among which are; rate of return, maturity and
risk. Note C to the Financial Statements sets forth additional information
regarding our investment portfolio, as well as Table 5 below, which reports
maturity distributions and weighted tax-equivalent rates by types of
investments.
TABLE 5 - INVESTMENT PORTFOLIO
(In thousands)
<TABLE>
<CAPTION>
Year ended December 31, 1997
------------------------------------------------------------------------------------------------------------------
After 1 But After 5 But
Total Securities Within One Year Within 5 Years Within 10 Years After 10 Years
------------------ ------------------ ------------------- ---------------- ------------------
WEIGHTED WEIGHTED WEIGHTED WEIGHTED WEIGHTED
BOOK AVERAGE BOOK AVERAGE BOOK AVERAGE BOOK AVERAGE BOOK AVERAGE
VALUE T/E YIELD VALUE T/E YIELD VALUE T/E YIELD VALUE T/E YIELD VALUE T/E YIELD
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Held to Maturity, at
Amortized Cost:
U.S. Treasury $1,000 5.65% $ 1,000 5.65% $ 0 0.00% $ 0 0.00% $ 0 0.00%
U.S. Government
Agencies 28,914 5.96% 10,459 5.73% 18,347 6.10% 108 6.52% 0 0.00%
Municipal Issues 30,238 6.50% 3,288 6.06% 16,376 6.38% 9,235 6.67% 1,339 7.76%
Other Debt Securities 2,615 5.97% 1,007 5.86% 1,608 6.04% 0 0.00% 0 0.00%
-------- ------ ------- ------ ------- ------ ------ ------ ------ ------
62,767 6.22% 15,754 5.80% 36,331 6.22% 9,343 6.67% 1,339 7.76%
Available for
Sale,
at Market:
U.S. Treasury 17,561 5.91% 6,130 5.78% 11,431 5.97% 0 0.00% 0 0.00%
U.S. Government
Agencies 28,439 6.14% 3,003 5.61% 25,436 6.20% 0 0.00% 0 0.00%
-------- ------ ------- ------ ------- ------ ------ ------ ------ ------
TOTAL SECURITIES $108,767 6.15% $24,887 5.77% $73,198 6.18% $9,343 6.67% $1,339 7.76%
-------- ------ ------- ------ ------- ------ ------ ------ ------ ------
-------- ------ ------- ------ ------- ------ ------ ------ ------ ------
</TABLE>
LOANS
Table 6, entitled LOAN PORTFOLIO ANALYSIS BY CATEGORY, sets forth the
distribution of the Company's loan portfolio for the past five years. During
1997, the loan portfolio mix continued to show growth in the percentage of
agricultural loans, now representing over 19% of the Company's portfolio.
Commercial loans also have experienced an increase in the percentage of loans
outstanding making up over 30% of the portfolio. This change has resulted
from declines in both consumer and real estate loan categories.
25
<PAGE>
TABLE 6 - LOAN PORTFOLIO ANALYSIS BY CATEGORY
(In thousands)
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
1997 1996 1995 1994 1993
-------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Consumer $42,856 $45,572 $40,548 $42,140 $41,392
Commercial 58,226 50,903 49,997 46,942 37,566
Agricultural 36,993 32,021 23,633 22,806 21,722
Construction/Development 16,778 13,748 12,619 13,227 20,780
Other Real Estate 36,493 37,147 39,290 39,291 42,543
-------- -------- -------- -------- --------
TOTAL LOANS $191,346 $179,391 $166,087 $164,406 $164,003
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
</TABLE>
The vast majority of the loans in the portfolio are either amortizing monthly
or have relatively short maturities. This helps maintain liquidity in the
portfolio. As noted, most of the loans which have floating rates are tied to
the Company's base rate or other market rate indicators. This serves to
lessen the risk to the Company from movement in interest rates, particularly
rate increases. Table 7 shows the maturity of certain loan categories
outstanding as of December 31, 1997, net of deferred fees and deferred costs.
TABLE 7 - MATURITIES AND SENSITIVITIES OF CERTAIN LOAN TYPES TO CHANGES IN
INTEREST RATES
(In thousands)
<TABLE>
<CAPTION>
Due after
Due in one ne year to Due after
year or less five years five years Total
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Commercial and Agricultural
Floating Rate $33,960 $ 8,096 $16,203 $58,259
Fixed Rate 7,390 20,484 9,085 36,959
Real Estate Construction
Floating Rate 3,336 4,161 - 7,497
Fixed Rate 6,275 3,006 - 9,281
------- ------- ------- --------
TOTAL $50,961 $35,747 $25,288 $111,996
------- ------- ------- --------
------- ------- ------- --------
</TABLE>
At December 31, 1997, non-performing assets (non-accrual loans, loans 90 days
or more past due, restructured loans and other real estate loans) totaled
$2.5 million, or .73% of total assets, down from $3.1 million or .95% from
December 31, 1996, as restated for the El Camino merger. Management believes
that these assets are generally well secured and that potential losses have
already been reflected in valuation or allowance accounts. In November of
1996, the FDIC concluded its periodic safety and soundness examination. At
that time, the internal grading system of the Company was tested against the
findings of the FDIC examiners. In July of 1997, the Department of Financial
Institutions performed their periodic review of the Company. Again, the
internal grading system of the Company was tested against their findings.
During both examinations, management was directed to downgrade only one
extension of credit, which reflects positively on management's efforts to
identify and manage credit problems on a timely basis. Management is not
aware of any information where serious doubts exist regarding any significant
borrower's ability to comply with loan repayment terms. Table 8 sets forth
information on non-performing assets for the periods indicated. The market
value of other real estate owned and collateral securing non-performing loans
is regularly monitored for changes.
26
<PAGE>
TABLE 8 - NON-ACCRUAL AND NON-PERFORMING ASSETS
(In thousands)
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------------------------
1997 1996 1995 1994 1993
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Non-Accrual $ 790 $ 981 $1,027 $2,120 $2,893
Loans currently accruing which are
past due 90 days or more 31 - 395 119 223
Restructured loans 737 407 190 35 28
Other real estate owned 969 1,678 1,516 1,726 2,225
------ ------ ------ ------ -------
TOTAL NON-PERFORMING
ASSETS $2,527 $3,066 $3,128 $4,000 $5,369
------ ------ ------ ------ -------
------ ------ ------ ------ -------
Percentage of non-performing loans
to total loans 0.81% 0.77% 0.97% 1.38% 1.92%
------ ------ ------ ------ -------
------ ------ ------ ------ -------
Percentage of non-performing
assets to total assets 0.73% 0.95% 1.10% 1.50% 2.12%
------ ------ ------ ------ -------
------ ------ ------ ------ -------
</TABLE>
DEPOSITS
As noted above, deposits have grown steadily over the reporting periods. The
average balances for deposit categories and their associated costs are
presented in Table 9.
TABLE 9 - DETAILED DEPOSIT SUMMARY
(In thousands)
<TABLE>
<CAPTION>
Year ended December 31,
--------------------------------------------------------------------
1997 1996 1995
--------------------------------------------------------------------
Average Average Average
Balance Rate Balance Rate Balance Rate
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest-bearing demand $ 30,324 1.06% $ 28,710 1.21% $ 25,913 1.48%
Savings accounts 32,269 2.20% 32,529 2.41% 35,279 2.50%
Money market savings 47,433 2.91% 49,189 2.88% 52,026 3.24%
TCD less than $100,000 75,589 5.34% 67,516 5.40% 53,914 5.24%
TCD $100,000 or more 35,995 5.49% 32,907 5.46% 23,796 5.31%
-------- ------ -------- ------ -------- ------
TOTAL INTEREST-
BEARING DEPOSITS 221,610 3.80% 210,851 3.79% 190,928 3.78%
Demand 63,636 - 56,864 - 51,215 -
-------- ------ -------- ------ -------- ------
TOTAL DEPOSITS $285,246 2.95% $267,715 2.99% $242,143 2.98%
-------- ------ -------- ------ -------- ------
-------- ------ -------- ------ -------- ------
</TABLE>
27
<PAGE>
The effective cost of all funds decreased during 1997, primarily as the
result of the increase in demand deposits as a percentage of total deposits
outstanding. Demand deposits increased by 5.0% and now represents 22% of all
deposits in the Bank. The interest-bearing deposit mix has several notable
changes, modifying the previous trend towards more liquidity and
shorter-termed accounts. Time deposits of less than $100,000, grew by 5.1%,
time deposits of $100,000 or more grew by 2.6%, while money market savings
declined by 9.5% and regular savings by 6.9%.
Table 10 sets forth the remaining maturities of large denominational time
deposits, including public funds, as of December 31, 1997.
TABLE 10 - MATURITY DISTRIBUTION OF TCD'S OF $100,000 OR MORE
(In thousands)
<TABLE>
<CAPTION>
Year ended December 31, 1997
- ---------------------------------------------------------------------------------------
<S> <C>
Three months or less $15,463
After three months to six months 9,596
After six months to one year 7,878
Over one year 5,052
--------
TOTAL $37,989
--------
--------
</TABLE>
LIQUIDITY
Liquidity is the Company's ability to meet fluctuations in deposit levels and
provide for the credit needs of its customers. The objective in liquidity
management is to maintain a balance between the sources and the uses of
funds. Principal sources of liquidity include interest and principal payments
on loans and investments, proceeds from the maturity of investments and
growth in deposits. The Company holds overnight Federal funds as a cushion
for temporary liquidity needs. During 1997, Federal funds averaged $11.9
million, or 3.7% of total average assets. In addition, the Company maintains
Federal funds credit lines with major correspondents, aggregating to $11.1
million, subject to the customary terms for such arrangements.
As shown in the consolidated statements of cash flows, cash and cash
equivalents declined by $5.6 million during 1997, to $25.9 million at
December 31, 1997. The decrease reflects $5.2 million in net cash provided
by operating activities, $30.3 million used in investing activities and $19.1
million provided by financing activities. Net cash used by investing
activities is primarily the result of increases in the security purchases and
an equal increase in loan growth. Net cash provided by financing activities
primarily reflect equal increases in both liquid and short-term deposits.
There are several accepted methods of measuring liquidity as utilized by the
regulators. One ratio, which is fairly easy to understand, is referred to as
the liquidity ratio. This ratio measures the percentage of deposits which are
used to fund cash, equivalents and marketable securities. The Company has set
a minimum standard percentage of 20% and, as of December 31, 1997, the
Company's liquidity ratio was 42.0%. The Company appears to be sufficiently
liquid to meet its operational needs.
MARKET RISK MANAGEMENT
Market risk is the possibility that changes in interest rates will impair the
fair value of the Company's financial instruments. The Asset/Liability
Committee measures and reviews the market risk of the Company and established
policies and procedures to limit its exposure to changes in interest rates.
Their policies are reviewed and approved by the Board of Directors of the
Company's subsidiary bank.
Interest rate risk is the most significant market risk regularly undertaken
by the Company. This risk is monitored through the use of three
complementary measurement methods: rate sensitivity gap, rate shocked
interest margin and rate shocked economic value of equity. Rate sensitivity
gap analysis measures interest rate risk due to volume differences, called
the gap, between repricable assets and liabilities over a specific period of
time. Rate shock is a method for stress testing the net interest margin
(NIM) over the next four quarters under several rate change levels. Rate
shock on equity is used to approximate the bank's liquidation value as
interest rates change.
At year end, the average twelve month gap as a percentage of earning assets
was 7.3%. This results in a four basis point difference for each 100 basis
points interest rate movement. Using the rate shock analysis method on NIM
results in seven basis points for each 100 basis points interest rate
movement. The mark-to-market method of rate shocking the economic value of
equity results in a 12% change for every 100 basis points change in interest
rates. All of the above approximation of interest rate risk are within the
guidelines established by the Company.
The interest rate risk position is actively managed and changes on a regular
basis as the interest rate enviroment changes. Accordingly, positions at the
end of any period may not reflect the Company's position in any subsequent
period.
CAPITAL RESOURCES
The primary source of capital for the Company is the retention of operating
profits. The Company reviews its capital needs on an ongoing basis to ensure
an adequate level of capital to support growth and to ensure depositor
protection. Total capital grew by $3.4 million or 10.5%, to $36.0 million as
of December 31, 1997. During 1997 and 1996, the Company's capital was
augmented by the exercise of stock options. During 1996, the Company
purchased land adjacent to the Paso Robles branch for the purpose of building
a permanent building. The cost of the land was approximately $900,000. The
Company had sufficient liquidity and capital to purchase the land without
financing either by debt or equity funding. Comments regarding the
established minimum capital ratios can be found in Footnote L of the
financial statements. The Company can operate safely at its current level of
capital and is positioned to grow within acceptable parameters.
MARKET INFORMATION REGARDING THE COMPANY'S COMMON STOCK
The common stock of the Company is not listed on any national stock exchange
or with NASDAQ. Trading in the stock has not been extensive and such trades
which have occurred would not constitute an active trading market. As of
December 31, 1997, there were approximately 2,000 shareholders, including
those listed in "street name" under various brokers. The management of the
Company is aware of three securities dealers who maintain an inventory and
make a market in the Company's common stock. The market makers are Maguire
Investments of Santa Maria, Hoefer & Arnett of San Francisco, and Sutro &
Company, with a local office in Santa Maria.
Since 1984, the Bank has consistently declared and paid a cash dividend to
the then shareholders of Bank of Santa Maria, with the equivalent of $.06
being paid since February of 1988. In 1994, the Board of Directors of the
Bank increased the per share dividend
28
<PAGE>
to $.10. In 1995, the Board of Directors again increased the per share
dividends to $.11 payable in February, 1995, to the holders of their stock.
In 1996, the Board of Directors increased the cash dividend to $.20 payable
in February, 1996. At the 1996 Annual Shareholders Meeting, the Bank
announced that it would begin to pay dividends on a semi-annual basis. In
July 1996, a $.15 dividend was declared to be paid in August, 1996. In
January of 1997, the Board again declared a $.15 cash dividend payable in
February, 1997. Following the formation of the BSM Bancorp, the Directors of
the Company continued the semi-annual dividend policy. In August of 1997, the
Company paid a $.20 cash dividend. In January of 1998, the Company Board
again declared a cash dividend of $.30 per share payable on February 6, 1998.
Restrictions on future dividend payments are outlined in the notes to the
financial statements.
The following quarterly summary of market activity is furnished by Maguire
Investments, Inc. of Santa Maria and by the OTC Bulletin Board. These quotes
do not necessarily include retail markups, markdowns, or commissions and may
not necessarily represent actual transactions. Additionally, there may have
been transactions at prices other than those shown below:
<TABLE>
<CAPTION>
Bid Ask
--- ---
<S> <C> <C>
1st Quarter 1996 $14.00 $14.50
2nd Quarter 1996 $13.75 $14.25
3rd Quarter 1996 $15.00 $15.75
4th Quarter 1996 $15.00 $16.00
1st Quarter 1997 $15.25 $16.75
2nd Quarter 1997 $16.13 $17.63
3rd Quarter 1997 $16.75 $18.63
4th Quarter 1997 $18.00 $27.50
</TABLE>
Selected Financial Data
The following is a summary of operations of Bank of Santa Maria for each of
the last five years ended December 31, 1997. This summary has not been
examined by an independent public accountant. However, in the opinion of
management, this summary reflects all adjustments which would be considered
necessary for a fair presentation of the results of operations for each of
these periods. This summary of operations should be read in conjunction with
the financial statements and notes relating thereto included elsewhere in
this report.
<TABLE>
<CAPTION>
(IN THOUSANDS) 1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Total assets $344,046 $321,397 $284,616 $266,989 $253,311
Net interest income $16,552 $15,154 $14,446 $13,818 $12,805
Provision for loan loss $30 $227 $876 $340 $712
Other income $3,504 $3,098 $2,728 $2,448 $2,550
Other expense $13,205 $12,471 $12,090 $11,723 $11,158
Net income $4,205 $3,468 $3,199 $2,728 $2,340
Net income per share $1.41 $1.17 $1.10 $.96 $.86
Cash dividend per share $.35 $.35 $.11 $.10 $.06
</TABLE>
29
<PAGE>
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF CERTIFIED PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors
of BSM Bancorp and Subsidiary
INDEPENDENT AUDITORS' REPORT
We have audited the accompanying consolidated balance sheets of
BSM Bancorp and Subsidiary as of December 31, 1997 and 1996, and the related
consolidated statements of income, changes in shareholders' equity, and cash
flows for each of the three years in the period ended December 31, 1997.
These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide
a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of BSM Bancorp and
Subsidiary as of December 31, 1997 and 1996, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting
principles.
/s/ Vavrinek, Trine, Day & Co.
- ---------------------------------------
Vavrinek, Trine, Day & Co.
January 8, 1998, except for Note O as to which the date is January 29, 1998.
Laguna Hills, California
30
<PAGE>
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
---------------------------------
ASSETS 1997 1996
- -------------------------------------------------------------------------------
<S> <C> <C>
Cash and Due from Banks $ 18,472,719 $ 17,643,554
Federal Funds Sold 7,461,000 13,920,000
------------ ------------
TOTAL CASH & CASH EQUIVALENTS 25,933,719 31,563,554
------------ ------------
Investment Securities - Note C:
Securities available for sale 46,143,134 23,865,611
Securities held to maturity 62,767,464 68,339,127
------------ ------------
TOTAL INVESTMENT SECURITIES 108,910,598 92,204,738
Loans - Note D:
Commercial 58,225,966 50,902,945
Agricultural 36,992,494 32,020,648
Real Estate 53,271,399 50,895,476
Consumer 42,855,965 45,572,297
------------ ------------
TOTAL LOANS 191,345,824 179,391,366
Allowance for possible credit losses (2,114,684) (2,701,876)
------------ ------------
NET LOANS 189,231,140 176,689,490
Premises and equipment - Note E 12,709,127 12,648,207
Accrued interest and other assets 4,555,235 4,744,483
Goodwill 1,737,220 1,868,500
Other Real Estate Owned 968,577 1,678,313
------------ ------------
TOTAL ASSETS $344,045,616 $321,397,285
------------ ------------
------------ ------------
LIABILITIES AND SHAREHOLDERS' EQUITY
- -------------------------------------------------------------------------------
Deposits
Noninterest-bearing demand $ 74,450,817 $ 67,181,717
Interest-bearing demand and savings 114,900,337 111,528,482
Time deposits under $100,000 78,951,276 70,229,443
Time deposits of $100,000 or more 37,989,170 37,338,194
------------ ------------
TOTAL DEPOSITS 306,291,600 286,277,836
Accrued interest and other liabilities 1,691,788 2,487,932
------------ ------------
TOTAL LIABILITIES 307,983,388 288,765,768
------------ ------------
Commitments - Note J
Shareholders' Equity - Note F:
Preferred shares - authorized 25,000,000
shares outstanding - none
Common shares - authorized 50,000,000
shares; issued and outstanding
2,990,939 as of December 31, 1997;
2,973,631 as of December 31, 1996 11,636,514 11,460,488
Undivided profits 24,339,778 21,176,801
Net unrealized appreciation (depreciation)
on available for sale securities, net
of taxes of $57,291 in 1997 and $3,819
in 1996 85,936 (5,772)
------------ ------------
TOTAL SHAREHOLDERS' EQUITY 36,062,228 32,631,517
------------ ------------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $344,045,616 $321,397,285
------------ ------------
------------ ------------
The accompanying notes are an integral part of these consolidated financial statements
</TABLE>
31
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF INCOME
Year ended December 31,
-----------------------------------------------------
INTEREST INCOME 1997 1996 1995
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest and fees on loans $18,801,501 $17,787,334 $17,948,550
Interest on investment securities-taxable 4,722,703 4,264,162 3,180,013
Interest on investment securities-non
taxable 794,328 567,881 463,366
Other interest income 657,987 752,795 774,828
----------- ----------- -----------
TOTAL INTEREST INCOME 24,976,519 23,372,172 22,366,757
----------- ----------- -----------
INTEREST EXPENSE
- ---------------------------------------------------------------------------------------------------
Interest on demand and savings deposits 2,413,035 2,546,602 2,953,779
Interest on time CD's over $100,000 1,975,827 1,797,494 1,262,855
Interest on time CD's less than $100,000 4,035,997 3,647,378 2,828,677
----------- ----------- -----------
TOTAL INTEREST EXPENSE 8,424,859 7,991,474 7,045,311
----------- ----------- -----------
NET INTEREST INCOME 16,551,660 15,380,698 15,321,446
Provision for credit losses 30,000 227,000 875,500
----------- ----------- -----------
NET INTEREST INCOME AFTER
PROVISION FOR CREDIT LOSSES 16,521,660 15,153,698 14,445,946
----------- ----------- -----------
NON-INTEREST INCOME
- ---------------------------------------------------------------------------------------------------
Service charges on deposits 2,016,085 1,829,790 1,681,995
Merchant discount fees 587,357 493,031 446,075
Loan and servicing fees 527,693 358,767 243,515
Other fee income 257,564 235,014 228,524
Other non-interest income 115,512 181,197 128,133
----------- ----------- -----------
TOTAL 3,504,211 3,097,799 2,728,242
----------- ----------- -----------
NON-INTEREST EXPENSE
- ---------------------------------------------------------------------------------------------------
Salaries and employee benefits 7,162,366 6,540,602 6,327,466
Occupancy expenses 982,920 952,114 879,116
Furniture and equipment 1,409,854 1,382,105 1,316,207
Advertising and promotion 697,019 556,042 422,655
Professional 308,618 469,984 606,858
General Office 553,781 446,549 444,306
Communications 393,407 378,850 334,879
Regulatory assessments 70,225 43,220 330,739
Merchant processing costs 550,723 501,191 446,108
Other OREO expense 54,742 136,053 39,568
Other expenses 1,021,249 1,064,253 942,722
----------- ----------- -----------
TOTAL 13,204,904 12,470,963 12,090,624
----------- ----------- -----------
INCOME BEFORE TAXES 6,820,967 5,780,534 5,083,564
Income taxes - Note H 2,616,000 2,312,800 1,884,900
----------- ----------- -----------
NET INCOME $4,204,967 $3,467,734 $3,198,664
----------- ----------- -----------
----------- ----------- -----------
Earnings per share data - Note I
Net Income - Basic $1.41 $1.17 $1.10
----------- ----------- -----------
----------- ----------- -----------
Net Income - Diluted $1.38 $1.16 $1.09
----------- ----------- -----------
----------- ----------- -----------
The accompanying notes are an integral part of these consolidated financial statements
</TABLE>
32
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31,
----------------------------------------------------------------
OPERATING ACTIVITIES 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income $ 4,204,967 $ 3,467,734 $ 3,198,664
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,358,448 1,216,500 1,111,910
Provision for credit losses 30,000 227,000 875,500
Amortization of premium/discounts
on investment securities 278,076 345,514 96,824
Loans originated for sale (4,547,941) (7,839,650) (4,316,600)
Proceeds from loan sales 4,779,279 7,744,846 3,969,394
Net (gain) from sale of fixed assets (14,812) (51,912) (30,450)
Net loss (gain) on sale of other real
estate loans (101,129) 39,212 149,571
Other items- Net (669,854) 263,095 (275,382)
----------- ----------- -----------
NET CASH PROVIDED BY
OPERATING ACTIVITIES 5,245,981 5,412,339 4,779,431
INVESTING ACTIVITIES
- -----------------------------------------------------------------------------------------------------------------------------
Proceeds from maturities of securities held
to maturity 29,940,827 36,380,923 31,385,000
Proceeds from maturities of securities held
for sale 16,073,000 6,702,750 5,582,750
Purchases of held to maturity securities (27,277,773) (34,125,412) (46,118,216)
Purchases of available for sale securities (35,565,324) (25,783,500) (3,619,038)
Net (increase) decrease in loans (13,078,658) 2,889,950 (2,488,647)
Purchases of premises and equipment (1,602,476) (3,146,259) (724,388)
Proceeds from sales of other real estate owned 1,157,587 1,313,618 729,018
Proceeds from sales of fixed assets 55,890 65,706 40,949
Net cash received for purchase of Citizens Bank
of Paso Robles 8,067,071
----------- ----------- -----------
NET CASH USED BY
INVESTING ACTIVITIES (30,296,927) (7,635,153) (15,212,572)
FINANCING ACTIVITIES
- -----------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in demand deposits and
savings accounts 10,640,955 (9,596,605) 1,319,523
Net increase in time deposits 9,372,809 14,012,070 12,271,245
Payments for dividends/distributions (1,041,990) (964,191) (256,832)
Proceeds from exercise of stock options 176,026 210,200 580,294
----------- ----------- -----------
NET CASH PROVIDED BY
FINANCING ACTIVITIES 19,147,800 3,661,474 13,914,230
INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS (5,629,835) 1,438,660 3,481,089
Cash and cash equivalents at beginning of year 31,563,554 30,124,894 26,643,805
----------- ----------- -----------
CASH AND CASH EQUIVALENTS
AT END OF YEAR $25,933,719 $31,563,554 $30,124,894
----------- ----------- -----------
----------- ----------- -----------
Supplemental disclosures of cash flow information:
Cash paid during the year for interest $ 9,089,872 $ 7,824,179 $ 6,587,042
Cash paid during the year for income taxes $ 2,271,032 $ 2,244,705 $ 2,194,780
The accompanying notes are an integral part of these consolidated financial statements
</TABLE>
33
<PAGE>
CHANGES IN SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Net
Unrealized
Appreciation/
Common Shares (Depreciation)
----------------------- in Available
Number of Undivided for Sale
Shares Amount Profits Securities Total
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BALANCE AT JANUARY 1, 1995 2,878,593 $10,669,994 $15,731,426 $(14,409) $26,387,011
Proceeds from exercise of stock options 18,450 165,600 165,600
Proceeds from exercise of stock options
(Templeton only) 53,019 414,058 414,058
Proceeds from exercise of stock options
(El Camino only) 146 2,200 2,200
Partial Distribution-Templeton Merger (127) (1,564) (1,564)
Dividends paid (256,832) (256,832)
Net income 3,198,664 3,198,664
Adjustment in Available for Sale
Securities, Net of Taxes of ($43,753) 65,630 65,630
--------- ----------- ----------- -------- -----------
BALANCE AT DECEMBER 31, 1995 2,950,081 11,250,288 18,673,258 51,221 29,974,767
--------- ----------- ----------- -------- -----------
Proceeds from exercise of stock options 23,400 208,700 208,700
Issuance of organizational stock 150 1,500 1,500
Dividends paid (964,191) (964,191)
Net income 3,467,734 3,467,734
Adjustment in Available for Sale
Securities, Net of Taxes of $37,995 (56,993) (56,993)
--------- ----------- ----------- -------- -----------
BALANCE AT DECEMBER 31, 1996 2,973,631 11,460,488 21,176,801 (5,772) 32,631,517
--------- ----------- ----------- -------- -----------
Retirement of organizational stock (150) (1,500) (1,500)
Proceeds from exercise of stock options 17,600 179,725 179,725
Partial Distribution-El Camino Merger (142) (2,199) (2,199)
Dividends paid (1,041,990) (1,041,990)
Net income 4,204,967 4,204,967
Adjustment in Available for Sale
Securities, Net of Taxes of ($61,139) 91,708 91,708
--------- ----------- ----------- -------- -----------
BALANCE AT DECEMBER 31, 1997 2,990,939 $11,636,514 $24,339,778 $85,936 $36,062,228
--------- ----------- ----------- -------- -----------
--------- ----------- ----------- -------- -----------
</TABLE>
NOTES TO FINANCIAL STATEMENTS
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of BSM Bancorp and Subsidiary (the
"Company") are in accordance with generally accepted accounting principles
and conform to practices with the banking industry. A summary of the
significant accounting policies consistently applied in the preparation of
the accompanying consolidated financial statements follows:
The accompanying notes are an integral part of these consolidated financial
statements
34
<PAGE>
NOTE A (CONTINUED)
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of BSM Bancorp
(the "Bancorp") and its wholly owned subsidiary, Bank of Santa Maria (the
"Bank"). All material intercompany accounts and transactions have been
eliminated in the consolidated financial statements.
NATURE OF OPERATIONS
The Company's primary operations are related to traditional banking
activities, including the acceptance of deposits and the lending and
investing of money through the operations of the Bank. The Bank's customers
are predominantly small and middle-market businesses and individuals who are
located in the central coast area of California. The Bank operates 13
branches, with headquarters in the city of Santa Maria.
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 assets and liabilities, disclosure of
contingent assets and liabilities at the date of the financial statements,
and the reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
CASH AND DUE FROM BANKS
For purposes of reporting cash flows, cash and due from banks includes cash
on hand and amount due from banks. Cash flows from loans originated by the
Company, deposits, and federal funds sold are reported net.
The Company maintains amounts due from banks which exceed federally insured
limits. The Company has not experienced any losses in such accounts.
INVESTMENTS SECURITIES
Securities held to maturity are stated at cost, adjusted for amortization of
premiums and accretion of discounts over the period to maturity, or to an
earlier call, if appropriate, on a straight-line basis. Such securities include
those that management intends and has the ability to hold into the foreseeable
future.
Securities would be considered available for sale if they would be sold under
certain conditions, among these being changes in interest rates, fluctuations
in deposit levels or loan demand, or a need to restructure the portfolio to
better match the maturity or interest rate characteristics of liabilities
with assets. Securities classified as available for sale are accounted for at
their current fair value rather than amortized historical cost. Unrealized
gains or losses are not recognized as current income or expense, but rather
as an increase or decrease of capital through a separate reserve.
LOANS AND LOAN FEES
Loans are recorded at amount advanced less payments collected. Interest on
loans is accrued daily as earned, except where management believes that
serious doubt exists as to the full collectability of interest or principal.
When this occurs, the accrual of income is discontinued and the balance of
accrued interest is reversed against current income. Loans are generally put
on nonaccrual status when interest is ninety days or more past due, unless
the loan is well secured and in the process of collection. Subsequent cash
payments are applied fully to the principal balance. Only after the principal
is reduced to zero is interest income realized. Once a loan is placed on
nonaccrual it generally remains on nonaccrual until the loan is termed
uncollectable or the borrower's capacity and intent to make further payments
is evidenced by keeping the loan current for a period of three to six months.
35
<PAGE>
NOTE A - (CONTINUED)
Loans originated and intended for sale in the secondary market are carried at
the lower of cost or estimated market value in the aggregate. Net unrealized
losses are recognized through a valuation allowance by charges to income.
Service income is generally recognized on a cash basis over the life of the
loan. If the normal servicing fees are expected to be less than the estimated
servicing costs, a loss would be recognized when the loan was sold. The
Company also acts in a broker capacity assisting customers in obtaining
mortgage loans with other institutions. The Company earns points and
documentation fees but is otherwise not involved in the loan. Fees are
recorded when payment is received.
Loan origination fees offset by certain direct origination costs are deferred
and recognized over the contractual life of the loan as an adjustment to the
yield. The unrecognized fees and costs are reported either as a reduction of
the loan principal outstanding, or, if deferred costs are greater than
deferred fees, as additions to the applicable loan grouping. Commitment fees
are deferred and recognized over the term of the commitment. Most deferred
fees and costs are recognized using the interest method. When a loan is
repaid or sold, an unamortized net deferred balance is credited or charged to
income. Accretion of deferred loan fees is discontinued when loans are placed
on nonaccrual status.
ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS
The determination of the balance in the allowance for possible loan losses is
based on an analysis of the loan portfolio and reflects an amount which, in
management's judgment, is adequate to provide for potential loan losses after
giving consideration to the character of the loan portfolio, current economic
conditions, past loan loss experience and such other factors as warrant
recognition in estimating loan losses. In addition, various regulatory
agencies, as an integral part of their examination process, periodically
review the Bank's allowance for loan losses. Such agencies may require the
Bank to record additions to the allowance based upon their judgments on
information available to them at the time of the examination.
The Company also evaluated loans in accordance with guidelines found in SFAS
No. 114 and SFAS No. 118 from the Financial Accounting Standards Board (FASB)
regarding loan impairment, income recognition and related disclosures, which
the Company adopted in the first quarter of 1995. The Company considers a
loan to be impaired when, based upon current information and events, it
believes it is probable that the Company will be unable to collect all
amounts due on a timely basis, according to the contractual terms of the loan
agreement. Impairment of a loan is measured by the present value of the
expected future cash flows discounted at the loan's effective interest rate,
the loan's observable market price, or the fair value of the collateral if
the loan is collateral dependent. If the measure of the impaired loan is less
than the recorded investment in the loan, the Company recognizes impairment
by creating a valuation allowance with a corresponding charge to provision
for loan losses.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost, less accumulated depreciation,
which is computed principally on the straight-line method over the estimated
useful lives of the assets. Leasehold improvements are amortized over the
shorter of their economic lives or the term of the lease.
GOODWILL
The Company has classified as goodwill the cost in excess of fair value of
the net assets (including tax attributes) of businesses acquired in purchase
transactions. Goodwill is being amortized on a straight line method over
fifteen years. The Company periodically reviews goodwill to assess
recoverability from projected, undiscounted net cash flows of the related
business unit, and impairments which would be recognized in operating results
if a permanent reduction in value were to occur.
OTHER REAL ESTATE OWNED
Other real estate owned, which represents real estate acquired through
foreclosure, or deed in lieu of foreclosure, is reported at the fair value of
the property at the time of transfer to other real estate owned, reduced by
estimated selling expenses. Any subsequent operating expenses, or income,
reductions in estimated values, and gains or losses on disposition of such
properties are charged to current operations.
INCOME TAXES
Income taxes are accounted for by the asset and liability method as required
by Statement of Financial Accounting Standards No. 109, "Accounting for
Income Taxes" (SFAS 109). Deferred tax liabilities or assets are established
for temporary differences between financial and tax reporting basis and are
subsequently adjusted to reflect changes in tax rates expected to be in
effect when the temporary differences reverse. A valuation allowance is
established for any deferred tax asset for which realization is not likely.
36
<PAGE>
NOTE A - (CONTINUED)
STATEMENT OF CASH FLOWS
For purposes of reporting cash flows, cash and cash equivalents include; cash
on hand, amounts due from banks and Federal funds sold. Generally, Federal
funds are purchased and sold for one-day periods.
EARNINGS PER SHARE
Basic EPS (Earnings per Share) excludes dilution and is computed by dividing
income available to common stockholders by the weighted-average number of
common shares outstanding for the period. Diluted EPA reflects the potential
dilution that could occur if securities or other contracts to issue common
stock were exercised or converted into common stock or resulted in the
issuance of common stock that then shared in the earnings of the entity.
CURRENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement No.
130, "Reporting Comprehensive Income". This statement, which is effective for
the year ending December 31, 1998, establishes standards of disclosure and
financial statement display for reporting comprehensive income and its
components.
In June 1997, the Financial Accounting Standards Board issued Statement No.
131, "Disclosures about Segments of an Enterprise and Related Information".
This statement changes current practice under SFAS 14 by establishing a new
framework on which to base segment reporting (referred to as the management
approach), and also requires certain related disclosures about products and
services, geographic areas, and major customers. The disclosures are required
for the year ending December 31, 1998.
RECLASSIFICATION
Certain reclassifications were made to prior years' presentations to conform
to the current year. These reclassifications are of a normal recurring
nature. All prior years' numbers have been restated to give affect for the
acquisition of El Camino National Bank and Templeton National Bank by Bank of
Santa Maria, and Bank of Santa Maria by BSM Bancorp, on a pooling of interest
basis.
NOTE B - MERGERS AND ACQUISITIONS
On March 11, 1997, BSM Bancorp acquired Bank of Santa Maria by issuing
2,973,539 shares of Bancorp common stock in exchange for the surrender of all
outstanding shares of the Bank's common stock. There was no cash involved in
this transaction. The acquisition was accounted for as a pooling of interest
and the consolidated financial statements contained herein have been restated
to give full affect to this transaction.
Prior to this acquisition, the Bank acquired three other local financial
institutions either through the exchange of stock or by cash payment. Details
regarding these acquisitions can be found below.
MERGER WITH EL CAMINO NATIONAL BANK
At the close of business on January 10, 1997, Bank of Santa Maria consummated
a merger with El Camino National Bank. This merger was accounted for by the
pooling of interest method, whereby the Company's Financial Statements have
been restated as if the two banks were historically one unit. A total of
201,678 common shares were issued to the shareholders of El Camino National
Bank in connection with this merger.
37
<PAGE>
NOTE B - (CONTINUED)
The following summarizes the separate revenue and net income of Bank of Santa
Maria and El Camino National Bank that have been reported in the restated
financial statements included herein:
<TABLE>
<CAPTION>
1996 1995
----------- -----------
<S> <C> <C>
Interest and Nonintest Income:
Bank of Santa Maria $24,627,927 $23,021,319
El Camino National Bank 1,842,044 2,073,680
----------- -----------
$26,469,971 $25,094,999
----------- -----------
----------- -----------
Net Income:
Bank of Santa Maria $ 3,718,740 $ 3,149,392
El Camino National Bank (250,206) 49,272
BSM Merger Company (800) -
----------- -----------
$ 3,467,734 $ 3,198,664
----------- -----------
----------- -----------
</TABLE>
MERGER WITH CITIZENS BANK
On May 3, 1996, the Bank acquired 100% of the outstanding common stock of
Citizens Bank of Paso Robles, N.A. (Citizens) for $4,129,000 in cash.
Citizens had total assets of approximately $31,858,000. The acquisition was
accounted for using the purchase method of accounting in accordance with
Accounting Principles Board Opinion No. 16. "Business Combinations". Under
this method of accounting, the purchase price was allocated to the assets
acquired and deposits and liabilities assumed based on their fair values as
of the acquisition date. The financial statements include the operations of
Citizens from the date of the acquisition. Goodwill arising from the
transaction totaled approximately $1,958,000 and is being amortized over
fifteen years on a straight-line basis.
The following table sets forth selected unaudited pro forma combined
financial information of the Bank and Citizens for the years ended December
31, 1996, and 1995. The pro forma operating data reflects the effect of the
acquisition of Citizens as if it was consummated at the beginning of each
year presented. The pro forma results are not necessarily indicative of the
results that would have occurred had the acquisition been in effect for the
full years presented, nor are they necessarily indicative of the results of
future operations.
<TABLE>
<CAPTION>
1996 1995
----------- -----------
<S> <C> <C>
Interest and Noninterest Income:
Bank of Santa Maria restated $26,469,971 $25,094,999
Citizens Bank of Paso Robles 1,024,332 3,187,381
Interest on Purchase Price (218,800) (229,600)
----------- -----------
$27,275,503 $28,052,780
----------- -----------
----------- -----------
Net Income:
Bank of Santa Maria Restated $ 3,467,734 $ 3,198,664
Citizens Bank of Paso Robles 19,134 331,682
----------- -----------
3,486,868 3,530,346
----------- -----------
----------- -----------
Merger Related Adjustments (16,927) (196,332)
----------- -----------
Pro forma Net Income $ 3,469,941 $ 3,334,014
----------- -----------
----------- -----------
Pro forma Net Income Per Share - Basic $ 1.17 $ 1.14
----------- -----------
----------- -----------
Pro forma Net Income Per Share - Diluted $ 1.16 $ 1.13
----------- -----------
----------- -----------
</TABLE>
38
<PAGE>
NOTE - B (CONTINUED)
Merger related adjustments include adjustments to interest income from the
payment of the purchase price in cash, goodwill amortization, depreciation,
professional expenses related to the merger, data processing, and other
operating costs and related tax effects.
MERGER WITH TEMPLETON NATIONAL BANK
At the close of business on September 8, 1995, Bank of Santa Maria consummated a
merger with Templeton National Bank. This merger was accounted for by the
pooling of interest method, whereby the Balance Sheets and the Statements of
Income are combined and restated as if the two banks were historically one unit.
A total of 397,561 common shares were issued to the shareholders of Templeton
National Bank in connection with this merger.
The following summarizes the historical separate revenue and net income of Bank
of Santa Maria and Templeton National Bank that have been reported in the
restated financial statements included herein:
<TABLE>
<CAPTION>
Eight month
period ended
August 31, 1995
------------------
<S> <C>
Interest and non-interest income
--------------------------------------
Bank of Santa Maria $13,608,014
Templeton National Bank 1,754,146
--------------
$15,362,160
--------------
--------------
Net Income
--------------------------------------
Bank of Santa Maria $ 2,061,359
Templeton National Bank 199,598
--------------
$ 2,260,957
--------------
--------------
</TABLE>
39
<PAGE>
NOTE C - INVESTMENT SECURITIES
Securities have been classified in the Balance Sheets according to management's
intent. The carrying amount of securities and their approximate fair values at
December 31, were as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------------- ------------ ------------ --------------
<S> <C> <C> <C> <C>
1997:
Available for Sale Securities:
U.S. Treasury securities $17,560,736 $52,037 $3,009 $17,609,764
U.S. Government and agency
securities 28,439,171 124,560 30,361 28,533,370
--------------- ------------ ------------ --------------
$45,999,907 $176,597 $33,370 $46,143,134
--------------- ------------ ------------ --------------
--------------- ------------ ------------ --------------
1997:
Held to Maturity Securities:
U.S. Treasury securities $999,750 - $69 $999,681
U. S. Government and agency
securities 28,913,811 71,152 86,281 28,898,683
Obligations of states and
political subdivisions 30,238,482 333,100 1,931 30,569,651
Other debt securities 2,615,421 6,773 16,205 2,605,989
--------------- ------------ ------------ --------------
$62,767,464 $411,025 $104,486 $63,074,004
--------------- ------------ ------------ --------------
--------------- ------------ ------------ --------------
1996:
Available for Sale Securities:
U.S. Treasury securities $3,981,598 $26,867 - $4,008,464
U.S. Government and agency
securities 19,893,604 27,101 63,559 19,857,146
--------------- ------------ ------------ --------------
$23,875,202 $53,968 $63,559 $23,865,610
--------------- ------------ ------------ --------------
--------------- ------------ ------------ --------------
1996:
Held to Maturity Securities:
U.S. Treasury securities $4,798,202 $117,139 $2,915 $4,912,426
U.S. Government and agency
securities 45,190,581 84,635 188,581 45,086,635
Obligations of states and
political subdivisions 15,294,241 - 6,278 15,287,963
Other debt securities 3,056,103 10,372 22,604 3,043,870
--------------- ------------ ------------ --------------
$68,339,127 $212,146 $220,378 $68,330,894
--------------- ------------ ------------ --------------
--------------- ------------ ------------ --------------
</TABLE>
There were no gross realized gains or gross realized losses on sales of
available for sale securities. The Company does not expect to realize either
gains or losses shown in the above schedule. The Company fully expects to hold
these securities to maturity/call date at which time the amortized cost and
market value will be the same as the par value of the bond.
The Company has no derivative financial instruments as defined by SFAS No.
119, "Disclosure About Derivative Financial Instruments and Fair Value of
Financial Instruments."
At December 31, 1997, and 1996, investment securities having an amortized cost
of approximately $6,006,000 and $6,224,000 respectively, were pledged to secure
public deposits and for other purposes as required or permitted by law.
40
<PAGE>
NOTE C - (CONTINUED)
The amortized cost and estimated market value of all debt securities as of
December 31, 1997, by contractual maturity, are shown below. Expected maturities
will differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
Held to Maturity Available for Sale
---------------- ------------------
Amortized Estimated Amortized Estimated
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Due in one year or less $15,754,095 $15,756,674 $9,133,101 $9,133,144
Due after one year to five years 36,331,320 36,473,327 36,866,806 37,009,990
Due after five years to ten years 9,342,945 9,490,224 - -
Due after ten years 1,339,104 1,353,779 - -
------------ ------------ ------------ ------------
TOTAL $62,767,464 $63,074,004 $45,999,907 $46,143,134
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
</TABLE>
NOTE D - LOANS
The Company's loan portfolio consists primarily of loans to borrowers within
Santa Barbara and San Luis Obispo Counties. Although the Company seeks to avoid
concentrations of loans to a single industry, loans to the agricultural
community are listed separately, as in total they exceed 10% of all loans
outstanding as of December 31, 1997, and 1996. Concentrations also can occur
based upon a single class of collateral. Real estate and real estate associated
businesses are among the principal industries in the Company's market area and,
as a result, the Company's loan and collateral portfolios are to some degree
concentrated in those industries. Real estate related loans, net of deferred
fees and costs at December 31, 1997, and December 31, 1996, were as follows:
Real estate related:
<TABLE>
<CAPTION>
1997 1996
------------ ------------
<S> <C> <C>
Construction and land development $16,778,000 $13,797,000
Home equity credit lines 18,727,000 20,465,000
Residential properties 14,304,000 17,253,000
Commercial properties 49,099,000 42,057,000
Farmland 11,101,000 6,971,000
------------ ------------
$110,009,000 $100,543,000
------------ ------------
------------ ------------
</TABLE>
41
<PAGE>
NOTE D - (CONTINUED)
The Company also originates real estate loans for sale to governmental agencies
and institutional investors. At December 31, 1997, and at December 31, 1996, the
Company had approximately $1,200,000 and $1,400,000 held for sale respectively,
and was servicing approximately $36,900,000 and $39,600,000, respectively, in
loans previously sold.
A summary of the changes in the allowance for possible credit losses follows:
<TABLE>
<CAPTION>
1997 1996 1995
------------- ----------- -----------
<S> <C> <C> <C>
Balance at beginning of year $2,701,876 $2,801,396 $2,412,427
Additions to the allowance charged to expense 30,000 227,000 875,500
Recoveries on loans charged off 106,300 97,476 106,149
Allowance on loans acquired from Citizens
Bank - Note B - 228,022 -
------------- ----------- -----------
Subtotal 2,838,176 3,353,894 3,394,076
Less loans charged off 723,692 652,018 592,680
------------- ----------- -----------
TOTAL $2,114,484 $2,701,876 $2,801,396
------------- ----------- -----------
------------- ----------- -----------
</TABLE>
The following is a summary of the investment in impaired loans, the related
allowance for loan losses, and income recognized on a cash basis as of December
31:
<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Recorded Investment in Impaired Loans $1,572,021 $1,390,561
----------- -----------
----------- -----------
Related Allowance for Loan Losses $ 425,461 $ 351,544
----------- -----------
----------- -----------
Average Recorded Investment in Impaired Loans $1,733,151 $1,506,478
----------- -----------
----------- -----------
Interest Income Recognized for Cash Payments $ 61,569 $ 39,128
----------- -----------
----------- -----------
</TABLE>
Loans having carrying value of $419,669, $1,151,581 and $698,909 were
transferred to other real estate owned in 1997, 1996, and 1995, respectively.
During 1997 and 1996, loans totaling $144,000 and $122,900 respectively, were
made to facilitate the sale of other real estate owned.
NOTE E - PREMISES AND EQUIPMENT
A summary of premises and equipment follows:
<TABLE>
<CAPTION>
1997 1996
------------- -------------
<S> <C> <C>
Land $3,349,597 $3,225,913
Buildings and improvements 8,721,744 8,598,715
Leasehold improvements 12,210 109,199
Furniture, fixtures, and equipment 7,581,153 7,162,786
------------- -------------
Subtotal 19,664,704 19,096,613
Less accumulated depreciation/amortization 6,955,577 6,448,406
------------- -------------
TOTAL $12,709,127 $12,648,207
------------- -------------
------------- -------------
</TABLE>
42
<PAGE>
NOTE F - STOCK OPTION PLAN
In 1996, the Company adopted a stock option plan under which the Company's
common shares may be issued to directors, officers and key employees of the
Company and its subsidiary, as well as consultants and business associates, at
not less than 100% of the fair market value at the date the options were
granted. Of the 892,542 shares available to be issued under the new plan,
159,400 were immediately issued to replace options outstanding under Bank of
Santa Maria's stock option plans.
The fair value of each option grant was estimated on the date of grant using the
Black-Scholes option pricing model with the following assumptions for 1997, 1996
and 1995, respectively: risk-free rates of 5.8%, 6.1%, and 5.4%; dividend yields
of 2.0%, 2.0%, and 2.0%; volatility of 20% for 1997, and 15% for 1996, and 1995.
A summary of the status of the Company's plan and the Bank's two expired fixed
stock option plans as of December 31, 1997, 1996, 1995, and changes during the
years ending on those dates, is presented below:
<TABLE>
<CAPTION>
1997 1996 1995
------------------------- ------------------------- ---------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------------------------- ------------------------- ---------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 158,400 $12 153,900 $11 153,300 $10
Granted 4,000 16 31,500 15 23,500 14
Exercised (17,600) 10 (23,400) 9 (18,450) 9
Forfeited (3,600) 15 3,600) 7 (4,450) 10
-------- --------- ---------
Outstanding at end of year 141,200 12 158,400 12 153,900 11
-------- --------- ---------
-------- --------- ---------
Options exercisable at year-end 72,000 59,500 53,400
Weighted-average fair value of
options granted during the year $ 3.79 $ 3.10 $ 2.70
Options available for future grant 733,942 11 86,520 10 118,420 9
</TABLE>
The following table summarizes information about fixed stock options outstanding
at December 31, 1997:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------------------------------------------------------------------
Weighted-Average
Exercise Number Remaining Weighted Average Number Weighted
Price Outstanding Contractual Life Exercise Price Exercisable Exercise Price
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$6 14,000 2 years $6 12,500 $6
$10 to $12 72,400 1.3 11 44,600 11
$13 to $17 54,800 3.2 14 14,900 14
--------- --------
$6 to $17 141,200 2.0 12 72,000 11
--------- --------
--------- --------
</TABLE>
43
<PAGE>
NOTE G - RETIREMENT PLAN
The Company has a noncontributory retirement plan covering substantially all of
its employees. The plan is a defined contribution plan with annual contributions
established at the discretion of the Board of Directors. The retirement plan
expense was $425,000 for 1997, $380,000 for 1996, and $340,000 for 1995.
In 1988, the Company's subsidiary established a Profit Sharing and Salary
Deferral 401(K) Plan to allow employees to defer a portion of their current
compensation until retirement. Since 1991, the Board of Directors of the Bank,
at their discretion, have elected to make a matching contribution at a
predetermined percentage of deferred dollars up to 2% of the participant's gross
salary. In 1997, the Board increased the percentage to 3%. The expense of the
matching contribution was $111,000 for 1997, $79,000 for 1996, and $74,000 for
1995. As of December 31, 1997, there were $7,366,000 in funds held for the
benefit of Bank employees in the aforementioned plans.
The estimated annual benefit payable upon retirement for any participant is
dependent upon the participant's salary levels for each of the years until
retirement coupled with the election of the Bank's Board to make annual
contributions for any given year, as well as the returns generated by the
investment choices selected by the individual employee over the period prior to
retirement.
NOTE H - INCOME TAXES
The provisions for income taxes included in the Statements of Income consist of
the following:
<TABLE>
<CAPTION>
1997 1996 1995
----------- ------------ -----------
<S> <C> <C> <C>
Current:
Federal $1,617,000 $1,436,000 $1,480,900
State 683,000 607,800 619,000
----------- ------------ -----------
2,300,000 2,043,800 2,099,900
Deferred 316,000 269,000 (215,000)
----------- ------------ -----------
$2,616,000 $2,312,800 $1,884,900
----------- ------------ -----------
----------- ------------ -----------
</TABLE>
A comparison of the federal statutory income tax rates to the Company's
effective income tax rates follow:
<TABLE>
<CAPTION>
1997 1996 1995
Amount Rate Amount Rate Amount Rate
---------- ------- ----------- ------ ----------- -------
<S> <C> <C> <C> <C> <C> <C>
Federal tax rate $2,319,000 34.0% $1,965,000 34.0% $1,728,000 34.0%
California franchise taxes,
net of federal tax benefit 500,000 7.3% 448,000 7.8% 379,000 7.6%
Tax savings from exempt
loan and investment income (273,000) (4.0%) (197,000) (3.4%) (166,000) (3.3%)
Other items - net 70,000 1.0% 96,800 1.6% (56,100) (1.2%)
---------- ------- ----------- ------ ----------- -------
$2,616,000 38.3% $2,312,800 40.0% $1,884,900 37.1%
---------- ------- ----------- ------ ----------- -------
---------- ------- ----------- ------ ----------- -------
</TABLE>
44
<PAGE>
NOTE H - (CONTINUED)
The following is a summary of the components of the net deferred tax asset and
liability accounts recognized in the accompanying Balance Sheets:
<TABLE>
<CAPTION>
1997 1996
----------- ----------
<S> <C> <C>
Deferred Tax Assets:
Allowance for Credit Losses Due to Tax Limitations $570,000 $855,000
Other Assets/Liabilities 351,000 437,000
----------- ----------
921,000 1,292,000
Deferred Tax Liability:
Premises and Equipment Due to Depreciation
Difference (496,000) (490,000)
----------- ----------
Net Deferred Taxes $425,000 $802,000
----------- ----------
----------- ----------
</TABLE>
NOTE I - EARNINGS PER SHARE (EPS)
The following is a reconciliation of net income and shares outstanding to the
income and number of shares used to compute EPS.
<TABLE>
<CAPTION>
1997 1996 1995
Income Shares Income Shares Income Shares
------------ ----------- ----------- ----------- ------------- ----------
<S> <C> <C> <C> <C> <C> <C>
Net Income as Reported $4,204,967 $3,467,734 $3,198,664
Shares Outstanding at Year End 2,990,939 2,973,631 2,950,081
Impact of Weighting Shares
Purchased During the Year - (14,406) - (14,047) - (38,007)
------------ ----------- ----------- ----------- ------------- ----------
Used in Basic EPS 4,204,967 2,976,533 3,467,734 2,959,584 3,198,664 2,912,074
Dilutive Effect of Stock Options - 62,296 - 33,590 - 31,066
------------ ----------- ----------- ----------- ------------- ----------
Used in Dilutive EPS $4,204,967 3,038,829 $3,467,734 2,993,174 $3,198,664 2,943,140
------------ ----------- ----------- ----------- ------------- ----------
------------ ----------- ----------- ----------- ------------- ----------
</TABLE>
NOTE J - FINANCIAL COMMITMENTS
In the normal course of business, the Company enters into financial commitments
to meet the financing needs of its customers. These financial commitments
include commitments to extend credit and standby letters of credit. Those
instruments involve, to varying degrees, elements of credit and interest rate
risk not recognized in the Company's financial statements.
The Company's exposure to credit loss in the event of nonperformance on
commitments to extend credit and standby letters of credit is represented by the
contractual amount of those instruments. The Company uses the same credit
policies in making commitments as it does for loans reflected in the financial
statements.
45
<PAGE>
NOTE J - (CONTINUED)
As of December 31, 1997, the Company had the following outstanding financial
commitments whose contractual amount represents credit risk:
<TABLE>
<CAPTION>
<S> <C>
Commitments to extend credit $ 53,823,796
Standby letters of credit 2,046,426
-------------
$ 55,870,222
-------------
-------------
</TABLE>
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Standby
letters of credit are conditional commitments to guarantee the performance of a
Company customer to a third party. Since many of the commitments and standby
letters of credit are expected to expire without being drawn upon, the total
amounts do not necessarily represent future cash requirements. The Company
evaluates each customer's credit worthiness on a case-by-case basis. The amount
of collateral obtained, if deemed necessary by the Company, is based on
management's credit evaluation of the customer. The majority of the Company's
commitments to extend credit and standby letters of credit are secured by real
estate.
NOTE K - RELATED PARTY TRANSACTIONS
In the ordinary course of business, the Company has granted loans to certain
officers and directors and the companies with which they are associated. In the
Company's opinion, all loans and loan commitments to such parties are made on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with other persons. An
analysis of the activity with respect to such loans to related parties is as
follows:
<TABLE>
<CAPTION>
1997 1996
----------- -------------
<S> <C> <C>
Balance at Beginning of Year $5,643,829 $5,677,776
Advances 2,815,721 5,993,138
Repayments (3,888,618) (6,027,085)
----------- -------------
Balance at End of Year $4,570,932 $5,643,829
----------- -------------
----------- -------------
</TABLE>
NOTE L - REGULATORY MATTERS
The Company is subject to various regulatory capital requirements administered
by federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory - and possibly additional discretionary - actions by
regulators that, if undertaken, could have a direct material effect on the
Company's financial statements. Under capital adequacy guidelines, and the
regulatory framework for prompt corrective action, the Company must meet
specific capital guidelines that involve quantitative measures of the Company's
assets, liabilities, and certain off-balance sheet items as calculated under
regulatory accounting practices. The Company's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company to maintain minimum amounts and ratios of total and Tier 1
capital (as defined in the regulations) to risk-weighted assets (as defined);
and of Tier 1 capital (as defined) to average assets (as defined). Management
believes, as of December 31, 1997, that the Company meets all capital adequacy
requirements to which it is subject.
46
<PAGE>
NOTE L - (CONTINUED)
The Company's actual capital amounts and ratios are presented in the following
table.
<TABLE>
<CAPTION>
Capital Needed
--------------
To be Well
For Capital Capitalized Under
Adequacy Prompt Corrective
Actual Purposes Provisions
------------------- ------------------- --------------------
IN THOUSANDS Amount Ratio Amount Ratio Amount Ratio
- ----------------------------- --------- -------- ------- ------- ------- ------
<S> <C> <C> <C> <C> <C> <C>
BANCORP
As of December 31, 1997:
Total Capital to Risk-Weighted Assets $36,366 15.6% $18,630 8.0% $23,287 10.0%
Tier 1 Capital to Risk-Weighted Assets $34,251 14.7% $ 9,315 4.0% $13,972 6.0%
Tier 1 Capital to Average Assets $34,251 10.7% $12,789 4.0% $15,986 5.0%
BANK
As of December 31, 1997:
Total Capital to Risk-Weighted Assets $36,041 15.6% $18,527 8.0% $23,159 10.0%
Tier 1 Capital to Risk-Weighted Assets $33,926 14.6% $ 9,264 4.0% $13,895 6.0%
Tier 1 Capital to Average Assets $33,926 10.2% $13,364 4.0% $16,705 5.0%
BANK
As of December 31, 1996:
Total Capital to Risk-Weighted Assets $33,047 15.3% $17,287 8.0% $21,609 10.0%
Tier 1 Capital to Risk-Weighted Assets $30,537 14.1% $ 8,644 4.0% $12,966 6.0%
Tier 1 Capital to Average Assets $30,537 9.7% $12,581 4.0% $15,726 5.0%
</TABLE>
The California Financial Code provides that a bank may not make a cash
distribution to its shareholders in excess of the lessor of the Company's
undivided profits, or the Company's net income for its last three fiscal years;
less the amount of any distribution made by the Company to shareholders during
the same period. Under these restrictions, approximately $8,608,000 was
available for payment of dividends at December 31, 1997.
Banking regulations require that all banks maintain a percentage of their
deposits as reserves at the Federal Reserve Bank. During the year ended December
31, 1997, required reserves averaged approximately $2,281,000.
NOTE M - FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial instruments is
made in accordance with the requirements of Financial Accounting Standards No.
107, "Disclosures About Fair Value of Financial Instruments". For financial
instruments, whether or not recognized in the Balance Sheets, the Company is
required to disclose the fair value of those instruments for which it is
practicable to estimate that value. In addition, the Company is required to
disclose the methods and significant assumptions used to estimate those fair
values.
Considerable judgment is necessarily required to interpret market data to
develop the estimates of fair value. Accordingly, the estimates presented herein
are not necessarily indicative of the amounts the Company could realize in a
current market exchange. This disclosure of the fair value of financial
instruments should not be viewed as equivalent to the valuation of the Company
as a whole.
Fair value estimates, methods, and assumptions are set forth below:
CASH, DUE FROM BANKS, AND FED FUNDS SOLD
For these short-term instruments, the carrying amount approximates fair value.
47
<PAGE>
NOTE M - (CONTINUED)
INVESTMENT SECURITIES
For investment securities, fair value equals quoted market prices where
available, or, if unavailable, the fair value is based upon similar securities.
LOANS
For those loans with floating interest rates, it is presumed that estimated fair
value generally approximates the carrying value. The fair value of other types
of loans is estimated by discounting the future cash flows using the current
rates at which similar loans would be made to borrowers with similar credit
ratings and for the same remaining maturities.
The fair value of non-accrual loans with a recorded book value of $963,000 was
not estimated because it was not practicable to reasonably estimate the amount
or timing of future cash flows for such loans.
DEPOSITS
The fair value of demand deposits, savings, and money market accounts is the
amount payable on demand at the reporting date. The fair value of fixed-maturity
certificates of deposit is estimated using rates currently offered for deposits
of similar remaining maturities.
COMMITMENTS TO EXTEND CREDIT AND LETTERS OF CREDIT
Commitments to extend credit and letters of credit are written at current market
rates. The Company does not anticipate any interest rate or credit factors that
would materially affect the fair value of these commitments or letters of credit
outstanding at December 31, 1997.
The estimated fair values of the Company's financial instruments at December 31,
1997 and December 31, 1996, are as follows (dollar amounts in thousands):
<TABLE>
<CAPTION>
1997 1997 1996 1996
Carrying Carrying
Amount Fair Value Amount Fair Value
---------- -------------- ---------- --------------
<S> <C> <C> <C> <C>
Financial Assets:
Cash and Due from banks $18,473 $18,473 $17,644 $17,644
Fed funds sold 7,461 7,461 13,920 13,920
Investment securities 108,911 109,217 92,205 92,198
Loans 192,136 190,394 180,372 179,037
Less: Non-Accruals (790) (790) (981) (981)
Allowance for losses (2,115) (2,115) (2,702) (2,702)
---------- -------------- ---------- --------------
Net Loans $189,231 $187,489 $176,689 $175,354
Financial Liabilities:
Deposits $306,292 $306,167 $286,278 $286,556
</TABLE>
48
<PAGE>
NOTE N - PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information of BSM Bancorp (parent only) follows:
BSM BANCORP
Condensed Balance Sheet
December 31, 1997, and 1996
<TABLE>
1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash in Bank of Santa Maria $ 185,140 $ 17,136
Investment in Bank of Santa Maria 35,739,148 -
Investment in BSM Merger Company - 200
Other assets 151,440 54,106
------------- ------------
Total assets $ 36,075,728 $ 71,442
------------- ------------
------------- ------------
LIABILITIES & SHAREHOLDERS' EQUITY
Short-term note payable $ - $ 40,000
Accrued liabilities 13,500 30,742
------------- ------------
Total liabilities 13,500 70,742
Shareholders' equity 36,062,228 700
------------- ------------
Total liabilities and shareholders' equity $ 36,075,728 $ 71,442
------------- ------------
------------- ------------
</TABLE>
49
<PAGE>
NOTE N - (CONTINUED)
BSM BANCORP
Condensed Statements of Income
Years Ended December 31, 1997, and 1996
<TABLE>
1997 1996
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<S> <C> <C>
INCOME:
Cash Dividends from Bank of Santa Maria $ 850,000 $ -
EXPENSES:
Operating Expenses 174,057 -
------------- ------------
Earnings before income taxes and equity in
undistributed net earnings of
Bank of Santa Maria 675,943 -
Provision (Income tax benefit) (67,000) -
------------- ------------
Earnings before equity in undistributed
net earnings of Bank of Santa Maria 742,943 -
Equity in undistributed net earnings of
Bank of Santa Maria 3,462,024 -
Equity in undistributed net loss of BSM Merger
Company - (800)
------------- ------------
Net earnings (loss) $ 4,204,967 $ (800)
------------- ------------
------------- ------------
</TABLE>
50
<PAGE>
NOTE N - (CONTINUED)
BSM BANCORP
Condensed Statements of Cash Flows
Years Ended December 31, 1997, and 1996
<TABLE>
1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from operation activities:
Net income (loss) $ 4,204,967 $ (800)
Adjustments to reconcile net income to net cash
provided by operating activities:
Undistributed net (income) loss of consolidated (3,462,024) 800
subsidiaries
Amortization of organizational expenses 14,829 -
Other (129,405) (23,364)
------------- ------------
Net cash provided by operating activities 628,367 (23,364)
------------- ------------
Cash flows from investing activities:
Decrease (increase) of investment in
subsidiaries 200 (1,000)
------------- ------------
Net cash provided by (used in)
investing activities 200 (1,000)
------------- ------------
Cash flows from financing activities:
Net change in short-term note payable (40,000) 40,000
Proceeds from the issuance of
organizational stock - 1,500
Proceeds from the exercise of stock options 176,925 -
Payment to redeem organizational stock (1,500) -
Dividends paid (595,988) -
------------- ------------
Net cash provided by (used in)
financing activities (460,563) 41,500
------------- ------------
Net increase in cash 168,004 17,136
Cash, beginning of year 17,136 -
------------- ------------
Cash, end of year $ 185,140 $ 17,136
------------- ------------
------------- ------------
</TABLE>
NOTE O - INTENT TO MERGE AND PROPOSED CHANGE OF CONTROL
On January 29, 1998, the Company jointly announced with Mid-State Bank that they
have entered into an Agreement to Merge and Plan of Reorganization dated January
29, 1998, whereby the Bank of Santa Maria and Mid-State Bank would merge
together under BSM Bancorp. Upon consummation, which is anticipated to occur in
the third quarter of 1998, BSM Bancorp is expected to change its name to Mid
State Bancshares and Mid-State Bank would become the surviving bank. Under the
merger terms, existing Mid-State Bank stock would be exchanged for shares of the
Holding Company in a ratio based upon a value of $29.37 for each share of BSM
Bancorp and the fair market value of Mid-State Bank stock just prior to the
close of the merger. It is estimated that Mid-State Bank shareholders will own
approximately 70% and the BSM Bancorp shareholders will own approximately 30% of
the holding company following the consummation of the merger.
51
<PAGE>
NOTE O - (CONTINUED)
This transaction is subject to the approval by holders of a majority of the
outstanding shares of the Company's common stock and by regulatory authorities.
All unexercised stock options of BSM Bancorp will become exercisable in full in
the event that this proposed transaction is consummated. In addition, as part of
the Agreement with Mid-State, the Company's mid-year cash dividend, if any, is
limited to a maximum of $.10 per share.
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None
52
<PAGE>
PART III
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS
The following table sets forth as to each of the persons who are currently
directors of the Bancorp, such person's age as of February 17, 1998, principal
occupation during the past five (5) years, and the period during which such
person has served as a director of the Bancorp and also the Bank, its
wholly-owned subsidiary.
<TABLE>
<CAPTION> YEAR FIRST YEAR FIRST
BUSINESS EXPERIENCE APPOINTED AS ELECTED AS BANK
NAME AND OFFICE HELD AGE DURING THE PAST FIVE YEARS BANCORP DIRECTOR DIRECTOR
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Armand R. Acosta 72 Retailer, Retired 1996 1977
Richard E. Adam 67 Farmer 1996 1977
Fred L. Crandall, Jr., DDS 69 Dentist 1996 1978
A J. Diani 76 Construction 1996 1977
Chairman of the Board
Bank of Santa Maria
BSM Bancorp
William A. Hares 63 Commercial Banking 1996 1981
President and CEO
Bank of Santa Maria
BSM Bancorp
Roger A. Ikola, MD 66 Pediatrician 1996 1977
Toshiharu Nishino 71 Wholesale Produce 1996 1977
Joseph Sesto, Jr. 85 Investments, Retired 1996 1977
William L. Snelling 66 Business Manager, Consultant 1996 1977
Secretary
Bank of Santa Maria
BSM Bancorp
Mitsuo Taniguchi 71 Wholesale Produce, Retired 1996 1977
Joseph F. Ziemba, MD 80 Physician, Retired 1996 1978
</TABLE>
53
<PAGE>
Upon consummation of the acquisition of Bank of Santa Maria, (see Item
I-Business-Acquisition by Mid-State Bank), all but three of the above directors
have agreed to resign as directors of the Company and its subsidiary. The three
directors who will remain as a part of Mid-State Bancshares are Messieurs Diani,
Hares and Snelling. The seven directors of Mid-State Bank will then be appointed
to fill the vacancies at both the Bank and Company level and the number of
directors of the Company will be reduced to ten. The names of the directors to
be appointed to both the Company and the Bank's Board following the consummation
of the merger are as follows:
Gracia B. Bello
Clifford H. Clark
Daryl L. Flood
Raymond E Jones
Albert L Maguire
Gregory R. Morris
Carrol R Pruett
EXECUTIVE OFFICERS
The following table sets forth as to each of the persons who are currently
executive officers of the Bancorp, such person's age as of February 17, 1998,
principal occupation during the past five (5) years, and the period during which
such person has served as a director of the Bancorp and also the Bank, its
wholly-owned subsidiary.
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE YEAR FIRST APPOINTED
NAME AGE DURING PAST FIVE YEARS AS EXECUTIVE OFFICER
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
William A. Hares 63 President and Chief Executive Officer 1996
of the Bancorp since November, 1996.
President and Chief Executive Officer
of the Bank since 1981
Carol Bradfield(1) 43 Executive Vice President of the 1996
Bancorp since November, 1996
Executive Vice President/Administration
of the Bank since 1996
F. Dean Fletcher 50 Executive Vice President and 1996
Chief Financial Officer of the
Bancorp since November, 1996
Executive Vice President and
Chief Financial Officer of the
Bank since 1991
Susan Forgnone (2) 36 Executive Vice President of the 1996
Bancorp since November, 1996.
Executive Vice President and
Loan Administrator of the
Bank since 1994
James D. Glines 55 Executive Vice President of the 1996
Bancorp since November, 1996.
Executive Vice President-
Branch Administrator of the
Bank since 1997
Executive Vice President since 1992
Manager-Santa Maria Way Branch since 1983
</TABLE>
54
<PAGE>
(1) Ms. Bradfield joined the Bank in April, 1988. She was formally Senior
Vice President - Human Resources prior to her appointment as an executive
officer of the Bank.
(2) Ms. Forgnone joined the Bank in October, 1988. She has worked in various
aspects of lending with the Bank prior to her appointment as an executive
officer.
None of the directors, nominees or executive officers of the Bancorp were
selected pursuant to any arrangement or understanding, other than with the
directors and executive officers of the Bancorp, acting within their capacities
as such. There are no family relationships between the directors and executive
officers of the Bancorp, except between Director Nishino and Director Taniguchi
who are brothers-in-law, and none of the directors or executive officers of the
Bancorp serve as directors of any company which has a class of securities
registered under, or which is subject to the periodic reporting requirements of,
the Securities Exchange Act of 1934 or any investment company registered under
the Investment Company Act of 1940, as amended, although all of the directors
and executive officers hold similar positions with the Bank, which, until
acquired by the Bancorp, was subject to the above periodic reporting
requirements.
None of the directors or executive officers of the Bancorp have, during the last
five years, been involved in any legal proceedings that are material to an
evaluation of the ability or integrity of any director or executive officer of
the Company.
ITEM 11: DIRECTORS AND EXECUTIVE OFFICER COMPENSATION
During 1997, the Bancorp did not pay any cash compensation to its executive
officers nor were the directors compensated for their attendance at Bancorp
meetings.
The following Summary Compensation Table shows compensation earned from the Bank
for services rendered during fiscal years 1997, 1996, and 1995 by each of the
Bank's executive officers whose salaries and bonuses exceeded $100,000 in 1997.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Long-term
Annual Compensation
Compensation(1) Awards
----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Securities All Other
Salary Bonus Underlying Compensation
Name and Principal Position Year ($)(2) ($)(4) Options(#)(5) ($)(3)
- --------------------------------------------------------------------------------------------------------------------------------
William A. Hares 1997 $ 185,000 $ 190,000 $ 18,285
President and Chief 1996 170,000 165,000 17,750
Executive Officer 1995 160,000 150,000 10,000 16,843
Carol Bradfield 1997 90,000 70,000 17,715
Executive Vice President 1996 68,104 35,000 5,000 11,051
Administration 1995 N/A N/A N/A N/A
F. Dean Fletcher 1997 100,000 80,000 17,135
Executive Vice President 1996 96,000 60,000 - 13,776
and Chief Financial Officer 1995 93,000 45,000 - 15,223
Susan Forgnone 1997 95,000 70,000 15,041
Executive Vice President 1996 85,000 50,000 - 12,767
and Loan Administrator 1995 80,000 45,000 - 9,241
James D. Glines 1997 95,000 70,000 17,311
Executive Vice President 1996 89,000 50,000 - 14,614
Branch Administrator 1995 85,000 45,000 - 12,025
</TABLE>
55
<PAGE>
(1) The column for other annual compensation has been omitted since the only
items reportable thereunder for the named persons are perquisites, which did
not exceed the lessor of $50,000 or 10% of salary and bonus for any of the
named persons.
(2) Includes all contributions to the Bank's 401(k) Plan, and the Bank's
Flexible Spending Account for medical and child care expenditures made
through salary reductions and deferrals.
(3) All employees of the Bank who have at least one year of service having
worked at least 1,000 hours during that year and are at least 18 years of age
are eligible to participate in the Bank's Profit Sharing and the 401(k)
Salary Deferral Plan. The Salary Deferral Plan is a self funded voluntary
plan that offers certain tax savings with tax deferred investment earnings.
The amount contributed by the participants is fully vested from the date of
deposit. The directors of the Bank at their discretion may elect to match an
amount equal to $.50 for every $1.00 the 401(k) participant invests, not to
exceed 2% of their gross compensation. This contribution is made as of June
30th and December 31st of each year. All matching contributions follows a
seven year vesting schedule. Contribution to the Bank's Profit Sharing Plan
are also at the discretion of the Bank's directors. Any amount that is
contributed is allocated to accounts established for each participating
employee, and is based on a percentage of their gross income. These are
subject to a seven year vesting schedule with 100% vesting occurring after
seven years of service. Funding for the plan always occurs in January of each
year. Participants contributions toward the 401(k) are included in amounts
shown as "Salary," above. The Bank's matching contributions are as well as
the Profit Sharing contribution are aggregated and included under "All Other
Compensation," above.
(4) Cash bonuses are reported in the year earned and may be paid in that year
or in January of the following year at the discretion of the officer. Bonuses
are recommended by the Compensation Committee of the Board and are approved
by the full board at the December meeting. Bonuses are discretionary, but are
generally based upon the operating results of the Bank.
(5) Options shown were issued under the Bank's Incentive Stock Option Plans.
These plans are administered by the Compensation Committee. Options granted
have an exercise price equal to the fair market value on the date of grant,
vest over a term of 5 years, and expire 5 years from the date of grant unless
otherwise noted.
STOCK OPTION GRANTS IN 1997
There were no grants of stock options to any of the named persons during 1997.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES
The following table sets forth the number of shares acquired by any of the
named persons upon exercise of stock options in 1997, the value realized
through the exercise of such options, and the number of unexercised options
held by the such person, including both those which are presently
exercisable, and those which are not presently exercisable.
<TABLE>
Shares Number of
Acquired Share Underlying Value of Unexercised
Upon Unexercised In-the
Option Value Options Money Options
Name Exercise (#) Realized($) at 12-31-97 (#) at 12-31-97 ($)(1)
- ---- ------------ ----------- --------------------------------- -----------------------------------
<S> <C> <C> <C> <C> <C> <C>
Not Not
Exercisable Exercisable Exercisable Exercisable
------------ ------------ ----------- -----------
William A. Hares 1,000 $ 19,625 19,500 9,500 $ 355,563 $ 139,437
Carol Bradfield 2,500 38,125 1,000 4,000 12,750 51,000
F. Dean Fletcher
Susan Forgnone 5,000 2,500 74,750 37,125
James D. Glines 5,000 41,500
</TABLE>
(1) Potential unrealized value is determined by multiplying the number of shares
by the net of the fair market value at fiscal year end ($26.50) less the option
exercise price.
COMPENSATION FOR NON-EMPLOYEE DIRECTORS There were no fees paid to directors of
the Bancorp.
During 1997, each non-officer director received $900 for each Board of Directors
meeting attended. The Chairman of the Board and the Secretary received an
additional $900 and $300 respectively each month. Members of the Executive
Committee received $900 per month no matter how many meetings held per month.
Members of all other committees received $300 for each committee meeting
attended.
56
<PAGE>
CONTRACTS WITH EXECUTIVE OFFICERS
In March, 1997, the Board of Directors of both the Bancorp and the Bank approved
severance pay agreements for their executive officers which would be triggered
by a change in control of either the Bancorp or the Bank, for valid reasons as
defined in the agreements. The principal purposes of these agreements are to
help assure that key executives give impartial consideration in evaluating and
negotiating a potential business combination which is in the best interest of
BSM Bancorp's shareholders, but which may result in the loss of, or reduction
in, the executive's job.
The benefits under these agreements are triggered if, within one year following
a change in control, the executive officer's employment is terminated without
cause or the executive officer resigns for reasons such as a substantial
reduction in the officer's responsibilities, an assignment of responsibilities
inconsistent with the executive officer's former responsibilities, a reduction
in the executive officer's annual salary or benefits, or a job relocation of
more than 50 miles.
Severance benefits payable to executive officers covered by Agreements are
determined by multiplying base monthly salary by a component of 24 months for
the President and by 18 months for the other four executive officers. The sum is
payable in monthly installments, or at the discretion of the executive officer,
in one lump sum. In addition, the executive officers are entitled certain fringe
benefits including health and other medical benefits for either the 18 or 24
month period.
Generally, a "change in control" will be deemed to have occurred in any of the
following circumstances:
- A merger or consolidation where the Bank and/or the Bancorp is not the
surviving corporation.
- A transfer of all or substantially all of the assets of the Bank and/or
the Bancorp.
- An acquisition of more than 25% of the outstanding stock coupled with or
followed by a change in the majority of the directors of either the Bank
or the Bancorp.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Bank's Compensation Committee is comprised of A. J. Diani, Carol Bradfield,
William A. Hares, Roger A. Ikola, Joseph Sesto, Jr. and William L.
Snelling. Both Mr. Hares and Ms. Bradfield served as Executive Officers of the
Bank during 1997. All of the above directors have had loans from the
Bank during 1997.
Neither Ms. Bradfield nor Mr. Hares participated in the discussion of their
respective compensation or performance when such matters were addressed by
the committee.
COMPENSATION COMMITTEE REPORT
The compensation committee meets annually to review the salaries and bonuses of
all officers of the Bank. Upon their recommendation, the Bank's full board then
approves salary modifications and bonuses, if any, for all Bank officers. While
all officers are reviewed, particular emphasis is placed upon the salaries paid
to executive officers.
The goal of the compensation program is to align compensation with business
objective and performance, and to enable the Bank to attract and reward
executive officers whose contributions are critical to the long-term success of
the Bank. The Bank is committed to maintaining a pay program that helps attract
and retain the best people in the industry. To ensure that pay is competitive,
the Bank regularly compares its pay practices with those of other leading
independent banks and sets its pay parameters based upon this review.
Executive officers are rewarded based upon corporate performance, and individual
contribution. Bank performance is evaluated by reviewing the extent to which
strategic and business plan goals have been met. Individual contribution is
evaluated by reviewing the progress of the Bank against set objectives in the
individuals area of responsibility.
57
<PAGE>
CEO COMPENSATION
William A. Hares has been President and Chief Executive Officer ("CEO") of the
Bank since January 1982, and President and CEO of the Company since it was
formed in November of 1996. In setting Mr. Hares' compensation, the Compensation
Committee made an overall assessment of Mr. Hares' leadership in achieving the
Company's long-term strategic and business goals. During 1997, particular
emphasis was placed on enhancing shareholders' value. The Committee paid
specific attention to variation in budget projections and well as executive
compensation surveys from the California Banking Association, Department of
Financial Institutions and banks headquartered in the Company's local market
area. Mr. Hares' salary reflects a consideration of both competitive forces and
the Company's performance.
COMPENSATION COMMITTEE
A. J. Diani, Chairmen
Carol Bradfield
William A. Hares
Roger A. Ikola
Joseph Sesto, Jr.
William L. Snelling
58
<PAGE>
PERFORMANCE GRAPH
The chart shown below compares Mid-State Bank's cumulative five-year total
shareholder return with both the S & P 500 Index and an index developed by SNL
Securities that represents Southern California banks.
COMPARISON OF FIVE YEAR CUMULATIVE TOTAL RETURN
AMONG BSM BANCORP, S & P 500 INDEX AND INDUSTRY INDEX
BSM BANCORP
CHART
<TABLE>
<CAPTION>
Period Ending
Index 12/13/92 12/13/93 12/13/94 12/13/95 12/13/96 12/13/97
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
BSM Bancorp/Bank of Santa Maria 100.00 110.00 115.99 138.57 167.88 287.05
S & P 100.00 110.08 111.53 153.44 188.52 251.44
Southern California Proxy 100.00 122.27 139.49 176.91 267.07 510.65
</TABLE>
59
<PAGE>
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Management of the Bancorp does not know of any person who owns beneficially or
of record more than 5% of the Bancorp's outstanding common stock. The following
table sets forth certain information as of March 18, 1998, concerning the
beneficial ownership of the Bancorp's outstanding common stock by each of the
directors of the Bancorp and by all directors and executive officers of the
Bancorp as a group. As noted in "Item 1 - Business", the proposed merger with
Mid-State Bank would result in a change of control for the Company.
As used throughout this Form 10-K, the term "executive officer" means the
President and Chief Executive Officer of the Bancorp, and the four Executive
Vice Presidents of the Bancorp.
Neither the Chairman of the Board or the Secretary of the Bancorp are treated as
executive officers.
<TABLE>
<CAPTION>
TITLE OF NAME OF BENEFICIAL AMOUNT OF PERCENT OF
CLASS OWNER AND TITLE BENEFICIAL OWNERSHIP (1) OF CLASS (2)
<S> <C> <C> <C>
Common Armand R. Acosta, Director 24,220(3) .8%
Common Richard E. Adam, Director 100,734(3) 3.3%
Common Fred L. Crandall, Jr., Director 82,176(3) 2.7%
Common A. J. Diani, Chairman 86,588(3) 2.9%
Common William A. Hares, President/CEO 50,310(4) 1.7%
Common Roger A. Ikola, Director 74,408(3) 2.5%
Common Toshiharu Nishino, Director 92,674(3) 3.1%
Common Joseph Sesto, Jr. 14,000(3) .5%
Common William L. Snelling, Secretary 81,140(3) 2.7%
Common Mitsuo Taniguchi, Director 74,524(3) 2.5%
Common Joseph F. Ziemba, Director 46,956(3) 1.6%
Common All Directors and Executive
Officers (15 in number) 785,133(5) 25.6%
</TABLE>
(1) Beneficial owner of a security includes any person who, directly or
indirectly, through any contract, arrangement, understanding, relationship, or
otherwise has or shares: (a) voting power, which includes the power to vote, or
to direct the voting of such security; and/or (b) investment power which
includes the power to dispose, or to direct the disposition of such security.
Beneficial owner also includes any person who has the right to acquire
beneficial ownership of such security as defined above within 60 days of the
date specified.
(2) Shares subject to options held by directors and executive officers that were
exercisable within 60 days after March 18, 1998 ("vested"), are treated as
issued and outstanding for the purpose of computing the percentage of class
owned by such person (or group) but not for the purpose of computing the
percentage of class owned by any other individual person.
(3) Includes 4,000 vested shares from the 1997 Bancorp stock option plan.
60
<PAGE>
(4) Includes 8,000 vested shares from the 1997 Bancorp stock option plan and
7,237 shares over which Mr. Hares has sole investment powers.
(5) Includes 6,000 vested shares and 23,750 shares owned directly and 34,890
shares whose voting powers can be exercised by the executive officers not listed
individually.
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Some of the Company's Directors and executive officers and their immediate
families, as well as the companies with which they are associated, are customers
of, or have had banking transactions with, the Bank in the ordinary course of
the Bank's business, and the Bank expects to have banking transactions with such
persons in the future. In management's opinion, all loans and commitments to
lend included in such transactions were made in the ordinary course of business,
in compliance with applicable laws on substantially the same terms, including
interest rates and collateral, as those prevailing for comparable transactions
with other persons of similar creditworthiness and, in the opinion of
management, did not involve more than a normal risk of collectibility or present
other unfavorable features.
PART IV
ITEM 14: EXHIBITS, FINANCIAL STATEMENTS, AND REPORTS ON FORM 8-K
(A) Financial Statements
See Item # 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA, which is
part of this Form 10-K.
(B) Reports on Form 8-K
During the fourth quarter of 1997, the Company did not file any
Current Reports on Form 8-K
During the first quarter of 1998, the Company filed two Current
Reports on Form 8-K, one as of January 16, 1998 and the second as of
February 3, 1998.
(C) Exhibits
<TABLE>
<CAPTION>
EXHIBIT NO.
-----------
<S> <C>
2.1 Plan of Reorganization and Merger Agreement dated
November 20, 1996 - Annex 1 of Written Consent
Statement/Prospectus*
2.2 Plan of Reorganization and Merger Agreement dated
January 29, 1997***
3.1 Articles of Incorporation of Registrant*
3.2 Amendment to Articles of Incorporation of Registrant*
3.3 Amendment to Articles of Incorporation of Registrant*
3.4 Bylaws of the Registrant*
10.1 Form of Indemnification Agreement*
10.2 BSM Bancorp 1996 Stock Option agreement as approved by
California Department of Corporations**
10.3 Form of Written Consent*
10.4 Nipomo Branch Land Lease*
10.5 Lompoc Branch Lease*
10.6 Form of "Change in Control" Employment Contract**
10.7 Plan of Reorganization and Merger Agreement dated
January 29, 1998***
21 Subsidiary of Registrant
Registrant has one subsidiary, Bank of Santa Maria,
a California State Chartered Bank
23 Consent of Independent Accountants
27 Financial Data Schedule (for SEC use only)
27.3 Financial Data Schedule (for SEC use only)
</TABLE>
*Incorporated by reference to the Registration Statement of the Company
filed on Form S-4 (Commission File No 333-16951). The effective date was
January 29, 1997
61
<PAGE>
**This exhibit is contained in the Company's Quarterly Report on Form 10-Q
for the period ended March 31, 1997. filed with the Commission on May 15,
1997 (Commission File No. 333-16951), and incorporated by reference.
***This exhibit is contained in the Company's Current Report on Form 8-K as of
February 3, 1998 and incorporated by reference.
(D) Financial Statements-Other
All schedules are omitted because they are not required, not
applicable or because the information is included in the financial
statements or notes thereto or is not material.
SIGNATURE
Pursuant to the requirement of Section 13 of the Securities Exchange Act of
1934, the Company has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Dated: May 7, 1998 BSM BANCORP
--------------
(Registrant)
By:/s/ F. Dean Fletcher
-----------------------
F. Dean Fletcher
Executive Vice President
Chief Financial Officer
62
<PAGE>
Pursuant to the Requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
<TABLE>
<S> <C> <C> <C>
/s/ William A. Hares 5/7/98 /s/ Susan D. Forgnone 5/7/98
- --------------------------------- ------- --------------------------- -------
William A. Hares Date Susan D. Forgnone Date
President/CEO/Director Executive Vice President,
Loan Administrator
/s/ F. Dean Fletcher 5/7/98 /s/ James D. Glines 5/7/98
- --------------------------------- ------- --------------------------- -------
F. Dean Fletcher Date James D. Glines Date
Executive Vice President/CFO Executive Vice President
Branch Administrator
/s/ Carol Bradfield 5/7/98 /s/ Mata L. Landry 5/7/98
- --------------------------------- ------- --------------------------- -------
Carol Bradfield Date Mata L. Landry Date
Executive Vice President, Assistant Vice President,
Administration Controller
/s/ Armand Acosta 5/7/98 /s/ Richard E. Adam 5/7/98
- --------------------------------- ------- --------------------------- -------
Armand Acosta Date Richard E. Adam Date
Director Director
/s/ Fred L. Crandall, Jr., D.D.S. 5/7/98 /s/ A. J. Diani 5/7/98
- --------------------------------- ------- --------------------------- -------
Fred L. Crandall, Jr., D.D.S. Date A. J. Diani Date
Director Chairman, Board of Directors
/s/ Roger A. Ikola, M.D. 5/7/98 /s/ Toshiharu Nishino 5/7/98
- --------------------------------- ------- --------------------------- -------
Roger A. Ikola, M.D. Date Toshiharu Nishino Date
Director Director
/s/ Joseph Sesto, Jr. 5/7/98 /s/ William L. Snelling 5/7/98
- --------------------------------- ------- --------------------------- -------
Joseph Sesto, Jr. Date William L. Snelling Date
Director Director
/s/ Mitsuo Taniguchi 5/7/98 /s/ Joseph F. Ziemba, M.D. 5/7/98
- --------------------------------- ------- --------------------------- -------
Mitsuo Taniguchi Date Joseph F. Ziemba, M.D. Date
Director Director
</TABLE>
63
<PAGE>
[LETTERHEAD]
Exhibit 23
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the inclusion of our Independent Auditor's Report dated
January 30, 1998 regarding the consolidated balance sheets of BSM Bancorp and
Subsidiary as of December 31, 1997 and 1996, and the related consolidated
statements of income, changes in shareholders' equity, and cash flows for each
of the three years in the period ended December 31, 1997, in the Form 10-KA
filed with the Securities and Exchange Commission (SEC) and included as
Appendix F to the Form S-4 filed by BSM Bancorp with the SEC and the
reference to our firm as experts.
/s/ VAVRINEK, TRINE, DAY & CO., LLP
May 7, 1998
Laguna Hills, California
