<PAGE>
Filed Pursuant to Rule 424(b)(3)
Registration No. 333-40384
HERITAGE COMMERCE CORP
150 ALMADEN BOULEVARD
SAN JOSE, CALIFORNIA 95113
Dear Shareholder:
You are cordially invited to attend a special meeting of shareholders of
Heritage Commerce Corp at 3:30 p.m. local time on August 24, 2000, to vote on a
proposal to approve a merger among Heritage, Western Holdings Bancorp and its
subsidiary Bank of Los Altos Bank. In the merger, Western Holdings would be
merged with and into Heritage.
If the merger is approved and completed, Western Holdings shareholders will
receive 1.2264 shares of Heritage common stock for each share of Western
Holdings common stock that they own. This exchange ratio may be adjusted if the
number of outstanding shares of Western Holdings common stock or options for
common stock changes or if the average market price of Heritage common stock is
below $8.00 when we receive notice of Federal Reserve approval of the merger.
Heritage common stock is traded on the Nasdaq National Market under the
symbol "HTBK." On July 13, 2000, Heritage common stock closed at $10.75 per
share. Based on that closing price, a Western Holdings shareholder would receive
Heritage common stock with a value of $13.18 for each share of Western Holdings
common stock. Heritage may issue up to 3,760,000 shares of its common stock in
the merger.
COMPLETION OF THE MERGER INVOLVES CERTAIN RISKS AND UNCERTAINTIES DESCRIBED
IN THE SECTION OF THE DOCUMENT ENTITLED "RISK FACTORS" ON PAGE 18.
We believe the merger is in your best interests as shareholders, and we hope
you will support it. Information about the proposed merger is included in the
enclosed document. Please give these materials your careful attention. Your
board of directors has unanimously approved the merger and recommends that you
vote to approve it as well.
Very truly yours,
/s/ Brad L. Smith
Brad L. Smith
CHIEF EXECUTIVE OFFICER
NEITHER THIS TRANSACTION NOR THE SECURITIES OF HERITAGE HAVE BEEN APPROVED
OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE
SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS DOCUMENT. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
THE DATE OF THIS DOCUMENT IS JULY 14, 2000,
AND IT IS FIRST BEING MAILED TO SHAREHOLDERS OF HERITAGE ON OR ABOUT JULY 21,
2000.
<PAGE>
HERITAGE COMMERCE CORP
150 ALMADEN BOULEVARD
SAN JOSE, CALIFORNIA 95113
(408) 947-6900
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
---------------------
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<S> <C>
Time....................... 3:30 p.m. on Thursday, August 24, 2000
Place...................... 150 Almaden Boulevard
San Jose, California 95113
Items of business.......... (1) To approve the merger agreement among Heritage
Commerce, Western Holdings Bancorp and Bank of Los Altos,
including the resulting issuance of common shares of
Heritage in connection with the merger;
(2) To consider such other business as may properly come
before the meeting.
Record date................ You are entitled to vote if you were a shareholder at the
close of business on July 14, 2000.
Voting by proxy............ Please submit a proxy by mail as soon as possible so that
your shares can be voted at the meeting in accordance with
your instructions. For specific instructions, please refer
to the Questions and Answers beginning on page 4 of this
document and the instructions on the proxy card.
Dissenters' rights......... Heritage shareholders may have dissenters' rights of
appraisal if they vote against the merger and send a written
demand for purchase of their shares to the company before
the meeting is held, but only if holders of at least 5% of
Heritage common stock make such demand. See page 37 for more
information.
</TABLE>
BY ORDER OF THE BOARD OF DIRECTORS
/s/ Rebecca A. Levey
CORPORATE SECRETARY
WHETHER OR NOT YOU PLAN TO ATTEND THE SPECIAL MEETING IN PERSON, PLEASE
COMPLETE, DATE, SIGN AND RETURN THE ENCLOSED PROXY CARD IN THE ENCLOSED
ENVELOPE. NO POSTAGE IS REQUIRED IF YOU MAIL THE PROXY CARD IN THE UNITED
STATES. IF YOU ATTEND THE SPECIAL MEETING, YOU MAY VOTE IN PERSON IF YOU WISH,
EVEN IF YOU HAVE PREVIOUSLY RETURNED YOUR PROXY CARD.
<PAGE>
WESTERN HOLDINGS BANCORP
4546 EL CAMINO REAL
LOS ALTOS, CALIFORNIA 94022
Dear Shareholder:
You are cordially invited to attend a special meeting of shareholders of
Western Holdings Bancorp at 5:30 p.m. local time on August 24, 2000, to vote on
a proposal to approve a merger among Heritage Commerce Corp, Western Holdings
and its subsidiary Bank of Los Altos. In the merger, Western Holdings would be
merged with and into Heritage.
If the merger is approved and completed, you will would receive 1.2264
shares of Heritage common stock for each share of Western Holdings common stock
that you own. This exchange ratio is subject to adjustment if the number of
outstanding shares of Western Holdings common stock or options for common stock
changes or if the average market price of Heritage common stock is below $8.00
when we receive notice of Federal Reserve approval of the merger.
Heritage common stock is traded on the Nasdaq National Market under the
symbol "HTBK." On July 13, 2000, Heritage common stock closed at $10.75 per
share. Based on that closing price, a Western Holdings shareholder would receive
Heritage common stock with a value of $13.18 for each share of Western Holdings
common stock. Heritage may issue up to 3,760,000 shares of its common stock in
the merger.
COMPLETION OF THE MERGER INVOLVES CERTAIN RISKS AND UNCERTAINTIES DESCRIBED
IN THE SECTION OF THE DOCUMENT ENTITLED "RISK FACTORS" ON PAGE 18.
We believe the merger is in your best interests as shareholders, and we hope
you will support it. Information about the proposed merger is included in the
enclosed document. Please give these materials your careful attention. Your
board of directors has unanimously approved the merger and recommends that you
vote to approve it as well.
Very truly yours,
/s/ James C. Wall
James C. Wall
PRESIDENT
NEITHER THIS TRANSACTION NOR THE SECURITIES OF HERITAGE HAVE BEEN APPROVED
OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE
SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS DOCUMENT. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
THE DATE OF THIS DOCUMENT IS JULY 14, 2000,
AND IT IS FIRST BEING MAILED TO SHAREHOLDERS OF WESTERN HOLDINGS ON OR ABOUT
JULY 21, 2000.
<PAGE>
WESTERN HOLDINGS BANCORP
4546 EL CAMINO REAL
LOS ALTOS, CALIFORNIA 94022
(650) 941-9300
------------------------
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
---------------------
<TABLE>
<S> <C>
Time....................... 5:30 p.m. on Thursday, August 24, 2000
Place...................... Bank of Los Altos,
4546 El Camino Real
Los Altos, California 94022
Items of business.......... (1) To approve the merger agreement among Heritage Commerce
Corp, Western Holdings Bancorp and Bank of Los Altos;
(2) To consider such other business as may properly come
before the meeting.
Record date................ You are entitled to vote if you were a shareholder at the
close of business on July 14, 2000.
Voting by proxy............ Please submit a proxy by mail as soon as possible so that
your shares can be voted at the meeting in accordance with
your instructions. For specific instructions, please refer
to the Questions and Answers beginning on page 4 of this
document and the instructions on the proxy card.
Dissenters Rights.......... If the merger is consummated, shareholders of Western
Holdings who do not vote "FOR" the merger may be entitled to
certain dissenters' appraisal rights under Chapter 13 of the
California General Corporation Law as described in the proxy
statement accompanying this notice. A copy of Chapter 13 is
included as Appendix C to the proxy statement.
</TABLE>
BY ORDER OF THE BOARD OF DIRECTORS
/s/ Susan G. Turner
CORPORATE SECRETARY
WHETHER OR NOT YOU PLAN TO ATTEND THE SPECIAL MEETING IN PERSON, PLEASE
COMPLETE, DATE, SIGN AND RETURN THE ENCLOSED PROXY CARD IN THE ENCLOSED
ENVELOPE. NO POSTAGE IS REQUIRED IF YOU MAIL THE PROXY CARD IN THE UNITED
STATES. IF YOU ATTEND THE SPECIAL MEETING, YOU MAY VOTE IN PERSON IF YOU WISH,
EVEN IF YOU HAVE PREVIOUSLY RETURNED YOUR PROXY CARD.
<PAGE>
TABLE OF CONTENTS
<TABLE>
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PAGE
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<S> <C>
QUESTIONS AND ANSWERS ABOUT VOTING ON THE MERGER............ 4
SUMMARY..................................................... 5
Western Holdings shareholders will receive 1.2264 shares of
Heritage common stock in the merger....................... 5
Comparative market price data............................... 5
Reasons for the merger...................................... 6
The merger is intended to be a tax-free transaction in which
Western Holdings shareholders will not recognize gain or
loss...................................................... 6
Western Holdings and Heritage boards recommend shareholder
approval.................................................. 6
Financial advisors give opinions that consideration is fair
to Western Holdings and Heritage shareholders............. 6
Heritage shareholder meeting to be held on August 24,
2000...................................................... 6
Western Holdings shareholder meeting to be held on
August 24, 2000........................................... 7
Record dates set at July 14, 2000; vote required for
approval of merger........................................ 7
Dissenters' rights of appraisal............................. 7
Information regarding Heritage and Western Holdings......... 7
Heritage to use pooling of interests accounting treatment... 8
Benefits to certain officers and directors in the merger.... 8
Conditions that must be satisfied for the merger to occur... 8
Stock option agreements..................................... 8
Regulatory approvals we must obtain for the merger to
occur..................................................... 9
Termination of the merger agreement......................... 9
Expenses; liquidated damages................................ 9
Selected financial information about Heritage............... 11
Selected financial information about Western Holdings....... 13
Selected Unaudited Pro Forma Combined Consolidated Financial
Data...................................................... 15
COMPARATIVE PER COMMON SHARE DATA........................... 17
RISK FACTORS................................................ 18
INFORMATION REGARDING FORWARD LOOKING STATEMENTS............ 18
WESTERN HOLDINGS AND HERITAGE SHAREHOLDER MEETINGS.......... 19
Date, time and place of meetings............................ 19
The meetings................................................ 19
Record dates and voting rights.............................. 19
Vote required............................................... 20
Voting by proxy............................................. 20
Revocability of proxies..................................... 20
Adjournments................................................ 20
Solicitation of proxies..................................... 20
Other matters............................................... 20
THE MERGER.................................................. 21
General..................................................... 21
Background of the merger.................................... 21
Reasons for the merger; recommendations of the boards of
directors................................................. 23
Opinion of financial advisors............................... 25
Regulatory approvals required............................... 33
Nasdaq listing.............................................. 34
Interests of certain officers and directors in the merger... 34
Effect on Western Holdings' employee benefit plans.......... 35
</TABLE>
1
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<TABLE>
<CAPTION>
PAGE
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<S> <C>
Accounting treatment........................................ 35
Certain federal income tax consequences..................... 35
Dissenters' rights of appraisal............................. 36
Resales of Heritage common stock............................ 38
THE MERGER AGREEMENT........................................ 39
Structure of the merger; effective time..................... 39
Conversion of Western Holdings common stock................. 39
Options..................................................... 40
Exchange agent; exchange procedure.......................... 41
Representations and warranties.............................. 41
Conduct of business pending the merger...................... 42
Conditions to completion of the merger...................... 43
Extension; waiver........................................... 44
Termination................................................. 44
Expenses; liquidated damages................................ 45
Amendment................................................... 46
STOCK OPTION AGREEMENTS BETWEEN HERITAGE AND WESTERN
HOLDINGS.................................................. 46
Exercise of stock options................................... 47
Termination of stock options................................ 48
Adjustment of number of shares subject to options........... 48
Repurchase of options and option shares..................... 48
Registration rights......................................... 49
Effect of stock option agreements........................... 49
OPERATIONS FOLLOWING THE MERGER............................. 49
UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL
STATEMENTS................................................ 49
INFORMATION ABOUT HERITAGE.................................. 55
General..................................................... 55
Competition................................................. 56
Employees................................................... 56
Branch offices and facilities............................... 56
Legal proceedings........................................... 58
The effect of government policy on banking.................. 58
Regulation and supervision of bank holding companies........ 58
Financial services modernization legislation................ 59
Bank supervision and regulation............................. 61
Capital standards........................................... 61
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS OF HERITAGE..................... 63
INFORMATION ABOUT WESTERN HOLDINGS.......................... 86
Banking services............................................ 86
Properties.................................................. 86
Legal proceedings........................................... 87
Supervision and regulation.................................. 87
Competition................................................. 87
Security ownership of certain beneficial owners and
management................................................ 88
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS OF WESTERN HOLDINGS............. 88
MARKET PRICE AND DIVIDEND INFORMATION....................... 108
Market quotations........................................... 108
Dividends................................................... 108
</TABLE>
2
<PAGE>
<TABLE>
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PAGE
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<S> <C>
DESCRIPTION OF HERITAGE COMMON STOCK........................ 109
Common stock................................................ 109
Preferred stock............................................. 110
Trust preferred securities.................................. 110
DESCRIPTION OF WESTERN HOLDINGS COMMON STOCK................ 110
Common stock................................................ 111
CERTAIN DIFFERENCES IN RIGHTS OF SHAREHOLDERS............... 111
Cumulative voting........................................... 111
Classified board of directors............................... 111
Dissenters' rights in mergers and other reorganizations..... 111
OTHER MATTERS............................................... 112
EXPERTS..................................................... 112
LEGAL MATTERS............................................... 112
INFORMATION CONCERNING HERITAGE MANAGEMENT.................. 112
WHERE YOU CAN FIND ADDITIONAL INFORMATION................... 113
HERITAGE COMMERCE CORP FINANCIAL STATEMENTS................. F-1
WESTERN HOLDINGS BANCORP FINANCIAL STATEMENTS............... F-35
APPENDIX A--MERGER AGREEMENT................................ A-1
APPENDIX B-1--OPINION OF HOEFER & ARNETT INCORPORATED....... B1-1
APPENDIX B-2--OPINION OF BAXTER FENTRISS & COMPANY.......... B2-1
APPENDIX C--CHAPTER 13 OF THE CALIFORNIA CORPORATIONS
CODE...................................................... C-1
APPENDIX D--STOCK OPTION AGREEMENTS......................... D-1
</TABLE>
3
<PAGE>
THIS DOCUMENT INCORPORATES BY REFERENCE IMPORTANT BUSINESS AND FINANCIAL
INFORMATION RELATING TO HERITAGE WHICH IS NOT PRESENTED IN THIS DOCUMENT OR
DELIVERED WITH IT. THIS INFORMATION IS AVAILABLE WITHOUT CHARGE, EXCLUDING ALL
EXHIBITS UNLESS SPECIFICALLY INCORPORATED BY REFERENCE IN THIS DOCUMENT, BY ORAL
OR WRITTEN REQUEST TO: HERITAGE COMMERCE CORP, ATTENTION: REBECCA LEVEY,
CORPORATE SECRETARY, 150 ALMADEN BOULEVARD, SAN JOSE, CALIFORNIA 95113,
(408) 497-6900. IF YOU WOULD LIKE TO REQUEST DOCUMENTS FROM HERITAGE, PLEASE DO
SO BY AUGUST 14, 2000, TO RECEIVE THEM BEFORE THE MEETING.
QUESTIONS AND ANSWERS ABOUT VOTING ON THE MERGER
Q: HOW DO I VOTE?
A: Simply indicate on your proxy card how you want to vote and then sign and
mail your proxy card in the enclosed return envelope as soon as possible so that
your shares may be represented at the special meeting.
Q: IF MY SHARES ARE HELD IN "STREET NAME" BY MY BROKER, WILL MY BROKER VOTE MY
SHARES FOR ME?
A: Your broker will not vote your shares for you unless you provide
instructions to your broker on how to vote. It is important therefore that you
follow the directions provided by your broker regarding how to instruct your
broker to vote your shares. If you fail to instruct your broker how to vote your
shares, the effect will be the same as a vote against the merger agreement.
Q: CAN I CHANGE MY VOTE AFTER I HAVE MAILED MY SIGNED PROXY CARD?
A: Yes. You may change your vote at any time before your proxy is voted at the
special meeting. If your shares are held in your name you may do this in one of
three ways. First, you may send a written notice stating that you would like to
revoke your proxy. Second, you may complete and submit a new proxy card. If you
choose either of these two methods, you must submit your notice of revocation or
your new proxy card to Western Holdings if you are a Western Holdings
shareholder or Heritage if you are a Heritage shareholder at the address at the
top of the Notice of special meeting in time so that the Company receives it
before the vote at the special meeting. Third, you may attend the meeting and
vote in person if you tell the Secretary that you want to cancel your proxy and
vote in person. Simply attending the special meeting, however, will not revoke
your proxy. If you have instructed a broker to vote your shares, you must follow
directions received from your broker to change your vote or to vote at the
meeting.
Q: SHOULD I SEND IN MY CERTIFICATES NOW?
A: No. After the merger is completed, we will send Western Holdings
shareholders written instructions for exchanging your stock certificates.
Q: WHEN DO YOU EXPECT THIS MERGER TO BE COMPLETED?
A: We are working toward completing this merger as quickly as possible. We
currently expect to complete this merger in the fourth quarter of 2000.
4
<PAGE>
SUMMARY
This summary, together with the "Questions and Answers" on the preceding
page, highlights important selected information from this document. To
understand the merger fully and for a more complete description of the legal
terms of the merger, you should read carefully this entire document and the
other information available to you. See "Where You Can Find More Information" on
page 113. We have included page references in parentheses to direct you to a
more complete description of the topics presented in this summary.
WESTERN HOLDINGS SHAREHOLDERS WILL RECEIVE 1.2264 SHARES OF HERITAGE COMMON
STOCK IN THE MERGER (PAGE 40)
When the merger is completed, you will receive 1.2264 shares of Heritage
common stock for each share of Western Holdings common stock that you hold,
subject to certain possible adjustments. For example, if you hold 1,000 shares
of Western Holdings common stock, you will have the right to receive 1,226.4
shares of Heritage common stock in the merger. You will receive cash instead of
fractional shares. Therefore, you would only receive 1,226 shares of Heritage
common stock. You would also receive a check in an amount equal to 0.4 of a
share multiplied by the closing price of the Heritage common stock on the
trading day before the "closing date," the date on which the transactions
relating to the merger are completed.
If Heritage's average closing price is less than $8.00, Western Holdings may
terminate the merger, but Heritage may, but is not required to, increase the
exchange ratio so that Western Holdings shareholders receive the economic value
they would have received with an exchange ratio of 1.2264 if the average price
of Heritage common stock were $8.00; i.e., $9.81 per Western Holdings share.
Heritage's average closing price for this purpose will be determined over the 20
trading days ending on the date Western Holdings receives notice that the
Federal Reserve has approved the merger.
COMPARATIVE MARKET PRICE DATA
Heritage common stock is quoted on the Nasdaq National Market. Western
Holdings common stock is privately held, with fewer than 100 shareholders and
with trades effected occasionally between individuals or through a brokerage
company with an office in Los Altos.
The following table sets forth historical per share market values for
Heritage common stock and Western Holdings common stock. It also shows the
equivalent pro forma market values (i) on May 9, 2000, the last trading day
prior to public announcement of the merger and (ii) on July 13, 2000. The
historical values represent the last sale prices on or before the dates
indicated. The values for Heritage may be higher or lower than the average
closing price of Heritage common stock as that term is defined in the merger
agreement or as disclosed in this document. The equivalent pro forma market
value per share of Western Holdings common stock reflects an exchange ratio of
1.2264 and assumes an average closing price equivalent to the market price for
Heritage common stock shown in the table.
<TABLE>
<CAPTION>
WESTERN HOLDINGS
HISTORICAL MARKET PRICE EQUIVALENT
--------------------------- PRO FORMA
HERITAGE WESTERN HOLDINGS MARKET VALUE
-------- ---------------- ----------------
<S> <C> <C> <C>
May 9, 2000........................... $10.88 $11.00 $13.34
July 13, 2000......................... 10.75 11.00 13.18
</TABLE>
The historical market price for Western Holdings' common stock is based on
information provided to management by various sources, but not verified by
Western Holdings. Western Holdings has not been a party to any trades reflected
in that information.
5
<PAGE>
Heritage cannot assure you that the price of its stock will be the same or
greater than the prices shown in the table at the time of the merger, or at any
time after the completion of the merger. Once Western Holdings is acquired by
Heritage, there will be no further public market for Western Holdings common
stock. However, Heritage common stock will continue to be traded on the Nasdaq
National Market.
REASONS FOR THE MERGER (PAGE 23)
Heritage and Western Holdings have entered into the merger agreement because
their boards of directors believe that the combined companies will have several
advantages over their existing independent operations, such as potential
economies of scale, and that their shareholders will benefit from such
advantages. The Western Holdings board believes its shareholders will also
benefit from the relatively greater market liquidity of Heritage common stock.
THE MERGER IS INTENDED TO BE A TAX-FREE TRANSACTION IN WHICH WESTERN HOLDINGS
SHAREHOLDERS WILL NOT RECOGNIZE GAIN OR LOSS (PAGE 35)
The merger is intended to be a tax-free reorganization so that neither
Heritage nor Western Holdings nor their respective shareholders will recognize
any gain or loss for federal income tax purposes, except for the cash that
Western Holdings shareholders will receive instead of fractional shares.
WESTERN HOLDINGS AND HERITAGE BOARDS RECOMMEND SHAREHOLDER APPROVAL (PAGE 24)
Both Heritage's board of directors and Western Holdings' board of directors
believe that the merger is in the best interests of their respective companies
and shareholders. Each has unanimously approved the merger agreement and
recommends that their shareholders vote "FOR" approval of the merger agreement.
FINANCIAL ADVISORS GIVE OPINIONS THAT CONSIDERATION IS FAIR TO WESTERN HOLDINGS
AND HERITAGE SHAREHOLDERS (PAGE 25)
HERITAGE. In deciding to approve the merger, the Heritage board of
directors considered the opinion of its financial advisor, Hoefer & Arnett
Incorporated about the fairness of the merger to Heritage shareholders from a
financial point of view. This opinion is attached as Appendix B-1 to this
document. We encourage you to read it carefully. Under an agreement with
Heritage, Hoefer & Arnett will receive the $35,000 balance of its fee of $50,000
when the merger closes.
WESTERN HOLDINGS. In deciding to approve the merger, the Western Holdings
board of directors considered the opinion of its financial advisor, Baxter
Fentriss & Company, dated as of May 9, 2000, about the fairness of the merger to
Western Holdings shareholders from a financial point of view. This opinion is
attached as Appendix B-2 to this document. We encourage you to read it
carefully. Under an agreement with Western Holdings, Baxter Fentriss & Company
will receive a fee of approximately $500,000 when the merger closes.
HERITAGE SHAREHOLDER MEETING TO BE HELD ON AUGUST 24, 2000 (PAGE 19)
We will hold the special meeting of Heritage shareholders at 3:30 p.m. on
August 24, 2000, at 150 Almaden Blvd., San Jose, California. At the special
meeting, you will be asked to approve the merger agreement.
6
<PAGE>
WESTERN HOLDINGS SHAREHOLDERS MEETING TO BE HELD ON AUGUST 24, 2000 (PAGE 19)
We will hold the special meeting of Western Holdings shareholders at 5:30
p.m. on August 24, 2000, at Bank of Los Altos, 4546 El Camino Real, Los Altos,
California. At the special meeting, you will be asked to approve the merger
agreement.
RECORD DATE SET AT JULY 14, 2000 FOR HERITAGE SHAREHOLDERS MEETING; VOTE
REQUIRED FOR APPROVAL OF MERGER (PAGE 19)
You can vote at the Heritage special meeting if you owned Heritage common
stock at the close of business on July 14, 2000. A majority of the outstanding
shares of Heritage common stock must vote to approve the merger agreement in
order for the merger to occur.
RECORD DATE SET AT JULY 14, 2000 FOR WESTERN HOLDINGS SHAREHOLDERS MEETING; VOTE
REQUIRED FOR APPROVAL OF MERGER (PAGE 19)
You can vote at the Western Holdings special meeting if you owned Western
Holdings common stock at the close of business on July 14, 2000. A majority of
the outstanding shares of Western Holdings common stock must vote to approve the
merger agreement in order for the merger to occur.
DISSENTERS' RIGHTS OF APPRAISAL (PAGE 36 AND APPENDIX C)
WESTERN HOLDINGS. If you hold Western Holdings common stock you may be
entitled to cash equal to the fair value of your Western Holdings shares before
announcement of the merger if you perfect your dissenters' rights.
HERITAGE. If you hold Heritage common stock you will be entitled to
dissenters' rights only if you vote against the merger, you submit an
appropriate demand before the meeting is held and holders of at least 5% of the
outstanding shares of Heritage common stock have perfected their dissenters'
rights in accordance with Chapter 13 of the California General Corporation Law.
INFORMATION REGARDING HERITAGE AND WESTERN HOLDINGS (PAGES 55 AND 86)
Heritage Commerce Corp
150 Almaden Boulevard
San Jose, CA 95113
(408) 947-6900
www.herbank.com
Heritage Bank of Commerce, a California banking corporation, began operation
in 1994. In 1997, management organized Heritage Commerce Corp under the laws of
the State of California as a holding company for the bank. Heritage is a bank
holding company registered under the Bank Holding Company Act of 1956 ("BHC
Act"). It is the parent of Heritage Bank of Commerce, Heritage Bank East Bay
(organized in 1998), and Heritage Bank South Valley (organized in 1999). The
Heritage banks have a total of four branches in Santa Clara, Alameda and Contra
Costa counties. At December 31, 1999 on a consolidated basis, Heritage had total
assets of $477 million, deposits of $419 million and shareholders' equity of
$44.5 million.
Western Holdings Bancorp
4546 El Camino Real
Los Altos, CA 94022
(650) 941-9300
www.bankoflosaltos.com
7
<PAGE>
Western Holdings is a California corporation incorporated in 1997. It is
also a registered bank holding company. Its wholly owned subsidiary Bank of Los
Altos is a state banking corporation licensed by the California Department of
Financial Institutions as a commercial bank. It was established in 1975 as
Foothill Bank. Bank of Los Altos conducts a general commercial banking business
through its main office and two other full service branches and one construction
and real estate lending office. At December 31, 1999, on a consolidated basis,
Western Holdings had assets of $200.5 million, deposits of $182.9 million, and
shareholders' equity of $12.0 million.
HERITAGE TO USE POOLING OF INTERESTS ACCOUNTING TREATMENT (PAGE 35)
Heritage expects to account for the merger as a pooling of interests. Under
this method of accounting, Western Holdings' assets and liabilities will be
reflected on Heritage's future financial statements at their historic book
values, and the financial statements of Heritage and Western Holdings will be
restated to combine their balance sheets and income statements as though they
had been a combined company for all periods reported.
BENEFITS TO CERTAIN OFFICERS AND DIRECTORS IN THE MERGER (PAGE 34)
In considering the recommendation of the board of directors of Western
Holdings to approve the merger agreement, you should be aware that certain
officers and directors of Western Holdings have certain interests in, and will
receive benefits as a consequence of, the merger that are different from the
benefits to Western Holdings shareholders generally. These interests include:
- Certain officers, an employee-director and other directors of Western
Holdings will receive options to acquire Heritage common stock in place of
existing options to acquire Western Holdings common stock;
- James C. Wall, William Walters, Susann Trevena and Robert Holden, each an
executive officer of Western Holdings, are parties to existing agreements
that would result in substantial payments to them in case the merger is
completed and their employment with Western Holdings is terminated. The
parties anticipate that Heritage and each of these individuals will enter
into new employment agreements that will supersede the existing agreements
and eliminate the right to such substantial payments regarding this
merger.
CONDITIONS THAT MUST BE SATISFIED FOR THE MERGER TO OCCUR (PAGE 43)
We will not complete the merger unless a number of conditions are met. These
include:
- approval of the merger agreement by Western Holdings and Heritage
shareholders,
- receipt of all required regulatory approvals,
- absence of material adverse changes in the parties, and
- absence of any orders suspending the effectiveness of the registration
statement filed by Heritage to register the shares to be issued to Western
Holdings shareholders.
STOCK OPTION AGREEMENTS (PAGE 46)
When we signed the merger agreement, we also signed two stock option
agreements. Under these agreements, Heritage and Western Holdings each have an
option to purchase common stock of the other equal to approximately 19.9% of the
outstanding shares of common stock of the other under certain circumstances.
Heritage's option to purchase Western Holdings shares has an exercise price of
$11.00 per share, and Western Holdings' option to purchase Heritage shares has
an exercise price of $10.52 per share.
8
<PAGE>
Heritage and Western Holdings agreed to grant these options to induce each
other to enter into the merger agreement. The options could have the effect of
discouraging other companies from trying to acquire either of them.
The stock option agreements are attached to this document as Appendix D.
REGULATORY APPROVALS WE MUST OBTAIN FOR THE MERGER TO OCCUR (PAGE 33)
The merger requires the prior approval of the Board of Governors of the
Federal Reserve System and the California Department of Financial Institutions.
TERMINATION OF THE MERGER AGREEMENT (PAGE 44)
One or both of the parties may terminate the merger agreement before
completion, before or after the shareholders of Heritage and/or Western Holdings
have approved the merger, as follows:
- if any material provision of the merger agreement is judicially determined
to be illegal, invalid or unenforceable or any required regulatory
application is denied;
- if any condition to a party's obligations cannot be satisfied before
November 30, 2000, except due to breach by the party seeking to terminate;
- if we fail to gain the approval of Heritage and Western Holdings
shareholders;
- if a party breaches any provision of the agreement and fails to cure the
breach within 30 days after written notice from the other party; or
- after November 30, 2000, if the merger has not been consummated by then,
unless the failure to consummate the merger was due to the failure of the
party requesting termination to perform an obligation under the Agreement.
Western Holdings can terminate the merger agreement during the two business
days after the date on which Heritage notifies Western Holdings of the receipt
of Federal Reserve approval of the merger if the Heritage's average closing
price over the 20 trading days ending the date Western Holdings receives notice
of Federal Reserve approval of the merger is less than $8.00. If Western
Holdings gives notice of termination for this reason, Heritage has five business
days in which it may elect to avoid termination by, in effect, agreeing to
increase the exchange ratio of 1.2264 by multiplying it by the following
fraction:
$8.00
-------------------------------
Heritage's average closing price
As adjusted the exchange ratio is intended to provide to shareholders of Western
Holdings the same economic value they would have received with an exchange ratio
of 1.2264 if the price of Heritage common stock at the time were $8.00, or $9.81
per Western Holdings share.
EXPENSES; LIQUIDATED DAMAGES (PAGE 45)
Generally, each party has agreed to bear its own expenses in this
transaction. Heritage and Western Holdings will each bear the costs of
distributing these proxy materials and of conducting a meeting of its
shareholders, but each party will pay one-half of the printing costs.
If the transactions contemplated by the merger agreement are not
consummated, Western Holdings must reimburse certain of Heritage's legal fees
and costs related to its conduct of due diligence up to a maximum of $100,000.
Heritage will pay the fees and costs related to the listing of the shares of
Heritage common stock for trading on the Nasdaq National Market.
9
<PAGE>
Western Holdings is required to pay Heritage $2.0 million in liquidated
damages under the following circumstances:
- if the Western Holdings meeting does not take place or the board of
directors of Western Holdings fails to recommend approval of the merger or
adversely alters or modifies its favorable recommendation; AND the
shareholders fail to vote for approval; AND Heritage is not in material
breach of the merger agreement; or
- if an acquisition proposal occurs before the Western Holdings meeting, and
the shareholders of Western Holdings fail to approve the merger, AND
Heritage was not in material breach of the merger agreement, AND within
15 months after termination of the merger agreement Western Holdings or
any of its subsidiaries either signs a definitive agreement for or
consummates an acquisition proposal.
Heritage is required to pay Western Holdings $2.0 million in liquidated
damages if Western Holdings terminates the merger agreement because Heritage
willfully or deliberately refuses to deliver to Western Holdings closing
documents under its control which are required by the merger agreement, or if
Heritage in material breach of the merger agreement refuses to consummate the
merger.
10
<PAGE>
SELECTED FINANCIAL INFORMATION ABOUT HERITAGE
The table below presents selected supplemental historical financial
information as of and for the three months ended March 31, 2000 and 1999, and
each of the years in the five-year period ended December 31, 1999. The financial
information as of and for the three months ended March 31, 2000 and 1999 has
been derived from the unaudited consolidated financial statements of Heritage,
which are included in this document and incorporated by reference. In the
opinion of management of Heritage, all adjustments, consisting of normal
recurring accruals, considered necessary for the fair presentation of the
results for the periods presented have been included. Annual historical figures
as of December 31, 1999 and 1998 and for the three years then ended have been
derived from the audited consolidated financial statements of Heritage, which
are included in this document and incorporated by reference. The historical
figures for the other years presented have been derived from the audited
consolidated financial statements. The annual historical information presented
below should be read together with the consolidated audited financial statements
of Heritage, included in this document and incorporated by reference. Financial
information for the years prior to 1998 represents the financial operations and
condition of Heritage Bank of Commerce prior to the formation of Heritage
Commerce Corp.
<TABLE>
<CAPTION>
AT AND FOR THREE
MONTHS ENDED
MARCH 31,(7) AT AND FOR YEAR ENDED DECEMBER 31,
----------------------- --------------------------------------------------------------
(IN THOUSANDS, EXCEPT SHARE 2000 1999 1999 1998 1997 1996 1995
AMOUNTS AND RATIOS) ---------- ---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Interest income........................ $ 9,881 $ 7,164 $ 31,221 $ 26,678 $ 16,203 $ 10,525 $ 6,421
Interest expense....................... 3,433 2,171 10,444 7,936 4,204 2,646 1,696
---------- ---------- ---------- ---------- ---------- ---------- ----------
Net interest income before provision
for probable loan losses............. 6,448 4,993 20,777 18,742 11,999 7,879 4,725
Provision for probable loan losses..... 600 643 1,911 1,576 1,060 830 496
---------- ---------- ---------- ---------- ---------- ---------- ----------
Net interest income after provision for
probable loan losses................. 5,848 4,350 18,866 17,166 10,939 7,049 4,229
Noninterest income..................... 483 1,224 4,984 1,914 638 296 71
Noninterest expenses................... 4,733 4,587 19,274 15,605 9,168 5,724 4,098
---------- ---------- ---------- ---------- ---------- ---------- ----------
Income before income taxes............. 1,598 987 4,576 3,475 2,409 1,621 202
Provision for income taxes............. 560 360 1,550 1,325 844 220 1
---------- ---------- ---------- ---------- ---------- ---------- ----------
Net income............................. $ 1,038 $ 627 $ 3,026 $ 2,150 $ 1,565 $ 1,401 $ 201
========== ========== ========== ========== ========== ========== ==========
PER SHARE DATA(1):
Basic net income(2).................... $ 0.15 $ 0.10 $ 0.46 $ 0.37 $ 0.29 $ 0.29 $ 0.05
Diluted net income(3).................. $ 0.13 $ 0.09 $ 0.41 $ 0.34 $ 0.27 $ 0.28 $ 0.05
Book value(4).......................... $ 6.47 $ 5.06 $ 6.33 $ 5.02 $ 4.11 $ 3.97 $ 3.66
Weighted average number of shares
outstanding--basic................... 7,034,615 6,112,611 6,545,373 5,766,768 5,431,286 4,805,233 4,034,105
Weighted average number of shares
outstanding--diluted................. 7,703,507 7,053,638 7,377,399 6,428,442 5,744,043 5,006,022 4,086,932
Shares outstanding at period end....... 7,034,882 6,117,824 7,031,576 6,110,007 5,438,233 5,165,654 3,507,131
BALANCE SHEET DATA:
Investment securities.................. $ 47,715 $ 66,280 $ 31,264 $ 76,793 $ 87,697 $ 75,268 $ 51,449
Loans, net............................. 304,389 226,997 266,852 232,482 117,120 74,789 37,771
Allowance for probable loan losses..... 5,616 4,277 5,003 3,825 2,285 1,402 572
Total assets........................... 505,605 358,368 476,664 404,931 267,575 173,303 132,160
Total deposits......................... 448,835 322,046 418,540 368,958 242,978 146,379 118,746
Total shareholders' equity............. 45,548 30,929 44,531 30,697 22,336 20,524 12,829
</TABLE>
11
<PAGE>
<TABLE>
<CAPTION>
AT AND FOR THREE
MONTHS ENDED
MARCH 31,(7) AT AND FOR YEAR ENDED DECEMBER 31,
----------------------- --------------------------------------------------------------
(IN THOUSANDS, EXCEPT SHARE 2000 1999 1999 1998 1997 1996 1995
AMOUNTS AND RATIOS) ---------- ---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
SELECTED PERFORMANCE RATIOS:
Return on average assets(5)............ 0.89% 0.69% 0.75% 0.65% 0.74% 0.96% 0.22%
Return on average equity............... 9.23% 8.20% 8.26% 8.22% 7.38% 8.56% 1.67%
Net interest margin.................... 5.99% 6.06% 5.64% 6.24% 6.17% 5.99% 5.81%
Average net loans as a percentage of
average deposits..................... 68.68% 70.41% 67.22% 54.87% 47.48% 44.06% 34.58%
Average total shareholders' equity as a
percentage of average total assets... 9.71% 8.44% 9.10% 7.90% 9.98% 11.23% 13.25%
SELECTED ASSET QUALITY RATIOS:
Net loan charge-offs to average
loans................................ 0.02% 0.33% 0.30% 0.02% 0.19% -- --
Allowance for loan losses to total
loans................................ 1.81% 1.85% 1.84% 1.62% 1.92% 1.84% 1.50%
CAPITAL RATIOS(6):
Tier 1 risk-based...................... 12.7% 10.3% 12.0% 9.2% 14.6% 21.4% 22.5%
Total risk-based....................... 14.0% 11.6% 13.2% 10.4% 15.8% 22.6% 23.6%
Leverage............................... 11.3% 8.3% 9.4% 7.5% 10.3% 13.9% 13.5%
</TABLE>
------------------------------
NOTES:
(1) All share figures are adjusted to reflect (i) a 10% stock dividend in
February 1996; (ii) a 5% stock dividend in February 1997; (iii) a 3-for-2
stock split in August 1997; (iv) a 3-for-2 stock split in February 1999;
(v) a 10% stock dividend in February 2000.
(2) Represents net income divided by the average number of shares of common
stock outstanding for the respective period.
(3) Represents net income divided by the average number of shares of common
stock and common stock-equivalents outstanding for the respective period.
(4) Represents shareholders' equity divided by the number of shares of common
stock outstanding at the end of the period indicated.
(5) Average balances used in this table and throughout this document are based
on daily averages.
(6) The risk-based and leverage capital ratios are defined in "Capital
Standards" on page 61.
(7) Ratios for interim periods are annualized.
12
<PAGE>
SELECTED FINANCIAL INFORMATION ABOUT WESTERN HOLDINGS
The table below presents selected supplemental historical financial
information as of and for the three months ended March 31, 2000 and 1999, and
each of the years in the five-year period ended December 31, 1999. The financial
information as of and for the three months ended March 31, 2000 and 1999 has
been derived from the unaudited consolidated financial statements of Western
Holdings, which are included in this document. In the opinion of management of
Western Holdings, all adjustments, consisting of normal recurring accruals,
considered necessary for the fair presentation of the results for the periods
presented have been included. Annual historical figures as of December 31, 1999
and 1998 and for the two years then ended have been derived from the audited
consolidated financial statements of Western Holdings, which are included in
this document. The historical figures for the other years presented have been
derived from the audited consolidated financial statements. The annual
historical information presented below should be read together with the
consolidated audited financial statements of Western Holdings, included in this
document. Financial information for the years prior to 1997 represents the
financial operations and condition of the Bank of Los Altos prior to the
formation of Western Holdings.
<TABLE>
<CAPTION>
AT AND FOR THREE
MONTHS ENDED
MARCH 31,(8) AT AND FOR YEAR ENDED DECEMBER 31,
----------------------- --------------------------------------------------------------
(IN THOUSANDS EXCEPT SHARE 2000 1999 1999 1998 1997 1996 1995
AMOUNTS AND RATIOS) ---------- ---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Interest income........................ $ 4,110 $ 3,208 $ 14,231 $ 11,530 $ 8,330 $ 6,027 $ 5,618
Interest expense....................... 1,426 1,166 4,954 4,112 2,867 2,308 2,044
---------- ---------- ---------- ---------- ---------- ---------- ----------
Net interest income before provision
for probable loan losses............. 2,684 2,042 9,277 7,418 5,463 3,719 3,574
Provision for probable loan losses..... 80 80 287 230 270 -- (30)
---------- ---------- ---------- ---------- ---------- ---------- ----------
Net interest income after provision for
probable loan losses................. 2,604 1,962 8,990 7,188 5,193 3,719 3,604
Noninterest income..................... 239 285 1,033 1,249 1,491 1,608 1,735
Noninterest expenses................... 2,057 1,759 7,324 6,139 5,034 4,613 5,250
---------- ---------- ---------- ---------- ---------- ---------- ----------
Income before income taxes............. 786 488 2,699 2,298 1,650 714 89
Provision for income taxes............. 307 191 1,056 942 380 1 16
---------- ---------- ---------- ---------- ---------- ---------- ----------
Net income........................... $ 479 $ 297 $ 1,643 $ 1,356 $ 1,270 $ 713 $ 73
========== ========== ========== ========== ========== ========== ==========
PER SHARE DATA(1):
Basic net income(2).................... $ 0.18 $ 0.11 $ 0.60 $ 0.52 $ 0.52 $ 0.29 $ 0.03
Diluted net income(3).................. $ 0.17 $ 0.10 $ 0.57 $ 0.48 $ 0.49 $ 0.29 $ 0.03
Book value(4).......................... $ 4.52 $ 4.18 $ 4.40 $ 4.17 $ 3.78 $ 3.25 $ 2.98
Weighted average number of shares
outstanding--basic................... 2,732,752 2,713,789 2,723,143 2,628,833 2,420,000 2,420,000 2,420,000
Weighted average number of shares
outstanding--diluted................. 2,903,217 2,898,968 2,901,072 2,781,708 2,606,775 2,470,557 2,420,000
Shares outstanding at period end....... 2,732,752 2,713,789 2,727,819 2,710,181 2,420,000 2,420,000 2,420,000
BALANCE SHEET DATA:
Investment securities.................. $ 54,281 $ 50,349 $ 45,945 $ 50,424 $ 31,291 $ 27,236 $ 17,835
Loans, net............................. 131,814 107,420 127,877 100,380 76,956 49,465 29,590
Allowance for probable loan losses..... 1,588 1,325 1,508 1,244 985 778 822
Total assets........................... 229,491 184,213 200,455 176,473 126,547 88,645 69,981
Total deposits......................... 215,837 151,646 182,880 140,958 112,750 79,273 61,209
Short-term borrowed funds.............. -- 15,000 -- 22,500 3,500 -- --
Debt financing and notes payable....... -- 5,000 5,000 -- -- -- --
Total shareholders' equity............. 12,364 11,356 12,013 11,294 9,138 7,868 7,212
</TABLE>
13
<PAGE>
<TABLE>
<CAPTION>
AT AND FOR THREE
MONTHS ENDED
MARCH 31,(8) AT AND FOR YEAR ENDED DECEMBER 31,
----------------------- --------------------------------------------------------------
(IN THOUSANDS EXCEPT SHARE 2000 1999 1999 1998 1997 1996 1995
AMOUNTS AND RATIOS) ---------- ---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
SELECTED PERFORMANCE RATIOS:
Return on average assets(5)............ 0.89% 0.69% 0.87% 0.94% 1.27% 0.91% 0.12%
Return on average equity............... 15.76% 10.77% 14.15% 13.06% 15.12% 9.19% 1.00%
Net interest margin(6)................. 5.52% 5.16% 5.37% 5.55% 5.96% 5.20% 6.07%
Average net loans as a percentage of
average deposits..................... 64.31% 71.73% 73.75% 70.25% 70.94% 53.08% 54.77%
Average total shareholders' equity as a
percentage of average assets......... 5.68% 6.38% 6.14% 7.20% 8.38% 9.44% 11.45%
SELECTED ASSET QUALITY RATIOS:
Net loan charge-offs as a percentage of
average loans........................ -- -- 0.02% (0.03%) 0.10% 0.12% 0.30%
Allowance for loan losses as a
percentage of total loans............ 1.19% l.22% 1.17% 1.22% 1.26% 1.55% 2.69%
CAPITAL RATIOS(7):
Tier 1 risk-based...................... 9.02% 9.52% 9.45% 9.80% 11.31% 13.60% 17.50%
Total risk-based....................... 10.07% 10.61% 10.54% 10.89% 12.56% 14.90% 18.76%
Leverage............................... 6.33% 6.57% 6.58% 6.73% 7.52% 8.80% 10.93%
</TABLE>
------------------------------
(1) All share figures are adjusted to reflect (i) a 10% stock dividend in
February 1998; (ii) a 2 for 1 stock split in July 1998, and (iii) a 10%
stock dividend in February 1999.
(2) Represents net income divided by the average number of shares of common
stock outstanding for the respective period.
(3) Represents net income divided by the average number of common stock and
common stock-equivalents outstanding for the respective period.
(4) Represents shareholders' equity divided by the number of shares of common
stock outstanding at the end of the period indicated
(5) Average balances used in this table and throughout this document are based
on daily averages.
(6) Fully taxable equivalent
(7) The risk-based and leverage capital ratios are defined in "Capital
Standards" on page 61.
(8) Ratios for interim periods are annualized.
14
<PAGE>
SELECTED UNAUDITED PRO FORMA COMBINED CONSOLIDATED FINANCIAL DATA
The following unaudited pro forma combined financial statements give effect
to the merger of Heritage and Western Holdings based on the historical financial
statements of the parties on a pooling-of-interests accounting method. The
unaudited pro forma combined consolidated financial data assume the merger was
consummated as of the beginning of the first period presented. Share information
was calculated using a pro forma exchange ratio of 1.2264, which is the exchange
ratio that would have applied if the merger had been completed on March 31,
2000.
This selected unaudited pro forma combined consolidated financial data
should be read in conjunction with the historical financial statements and the
related notes of Heritage and Western Holdings included or incorporated by
reference in this document and the unaudited pro forma condensed combined
financial statements of Heritage and Western Holdings beginning on page 50. The
unaudited pro forma income statement data is not necessarily indicative of
operating results which would have been achieved had the merger been consummated
as of the beginning of the first period presented and should not be construed as
representative of future operations.
<TABLE>
<CAPTION>
AT AND FOR THREE MONTHS
ENDED MARCH 31, AT AND FOR YEAR ENDED DECEMBER 31,
------------------------- -------------------------------------
(IN THOUSANDS, EXCEPT SHARE AMOUNTS 2000 1999 1999 1998 1997
AND RATIOS) ----------- ----------- ----------- ---------- ----------
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Interest income..................... $ 13,991 $ 10,372 $ 45,452 $ 38,208 $ 24,533
Interest expense.................... 4,859 3,337 15,398 12,048 7,071
----------- ----------- ----------- ---------- ----------
Net interest income before provision
for probable loan losses.......... 9,132 7,035 30,054 26,160 17,462
Provision for probable loan
losses............................ 680 723 2,198 1,806 1,330
----------- ----------- ----------- ---------- ----------
Net interest income after provision
for probable loan losses.......... 8,452 6,312 27,856 24,354 16,132
Noninterest income.................. 722 1,509 6,017 3,163 2,129
Noninterest expenses................ 6,790 6,346 26,598 21,744 14,202
----------- ----------- ----------- ---------- ----------
Income before income taxes.......... 2,384 1,475 7,275 5,773 4,059
Provision for income taxes.......... 867 551 2,606 2,267 1,224
----------- ----------- ----------- ---------- ----------
Net income.......................... $ 1,517 $ 924 $ 4,669 $ 3,506 $ 2,835
=========== =========== =========== ========== ==========
PER SHARE DATA:
Basic net income.................... $ 0.15 $ 0.10 $ 0.47 $ 0.39 $ 0.34
Diluted net income.................. $ 0.13 $ 0.09 $ 0.43 $ 0.35 $ 0.32
Book value.......................... $ 5.58 $ 4.48 $ 5.45 $ 4.45 $ 3.74
Weighted average number of shares
outstanding--basic................ 10,386,062 9,440,802 9,885,036 8,990,769 8,399,174
Weighted average number of shares
outstanding--diluted.............. 11,264,012 10,608,932 10,935,274 9,892,079 8,984,181
Shares outstanding at period end.... 10,386,329 9,446,015 10,376,973 9,433,773 8,406,121
</TABLE>
15
<PAGE>
<TABLE>
<CAPTION>
AT AND FOR THREE MONTHS
ENDED MARCH 31, AT AND FOR YEAR ENDED DECEMBER 31,
------------------------- -------------------------------------
(IN THOUSANDS, EXCEPT SHARE AMOUNTS 2000 1999 1999 1998 1997
AND RATIOS) ----------- ----------- ----------- ---------- ----------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Investment securities............... $ 101,996 $ 116,629 $ 77,209 $ 127,217 $ 118,988
Loans, net.......................... 436,203 334,417 394,729 332,862 194,076
Allowance for probable loan
losses............................ 7,204 5,602 6,511 5,069 3,270
Total assets........................ 733,751 542,481 677,119 581,404 394,122
Total deposits...................... 664,672 473,692 601,420 509,916 355,728
Short-term borrowed funds........... -- 15,000 -- 22,500 3,500
Debt financing and notes payable.... -- 5,000 5,000 -- --
Total shareholders' equity.......... 56,567 42,285 56,544 41,991 31,474
SELECTED PERFORMANCE RATIOS:
Return on average assets............ 0.89% 0.68% 0.79% 0.74% 0.91%
Return on average equity............ 10.63% 8.87% 9.68% 9.60% 9.58%
Net interest margin................. 5.83% 5.77% 5.56% 6.03% 6.10%
Average net loans as a percentage of
average deposits.................. 71.71% 73.39% 71.88% 62.35% 58.28%
Average total shareholders' equity
as a percentage of average total
assets............................ 8.44% 7.78% 8.15% 7.68% 9.46%
SELECTED ASSET QUALITY RATIOS:
Net loan charge-offs to average
loans............................. -- 0.05% 0.20% -- 0.14%
Allowance for loan losses to total
loans............................. 1.62% 1.65% 1.62% 1.50% 1.66%
CAPITAL RATIOS:
Tier 1 risk-based................... 11.7% 10.1% 11.3% 9.4% 13.4%
Total risk-based.................... 12.9% 11.3% 12.5% 10.5% 14.7%
Leverage............................ 9.7% 7.8% 8.5% 7.3% 8.3%
</TABLE>
16
<PAGE>
COMPARATIVE PER COMMON SHARE DATA
We have summarized below the historical per share information for Heritage
and Western Holdings and additional information as if the companies had been
combined for the periods shown ("pro forma") calculated based on an exchange
ratio of 1.2264 shares of Heritage common stock per share of Western Holdings
common stock.
You should read this information with Heritage's historical financial
statements and related notes contained in this document and also in the Annual
Reports on Form 10-K that we have filed with the Securities and Exchange
Commission. See "Where You Can Find Additional Information" on page 113.
Western Holdings equivalent pro forma share amounts are calculated by
multiplying the pro forma combined book value per share and net income per share
by the exchange ratio so that the per share amounts equate to the respective
values for one share of Western Holdings common stock. You should not rely on
the pro forma information as being indicative of the historical results that we
would have had or the future results that will occur after the merger. The
equivalent pro forma data reflects the pooling of interests method of accounting
and does not reflect potential cost savings or revenue enhancements that may be
achieved.
<TABLE>
<CAPTION>
HERITAGE WESTERN HOLDINGS
AS OF AND FOR THE ---------------------- -------------------------
PRO FORMA EQUIVALENT
HISTORICAL COMBINED HISTORICAL PRO FORMA(1)
THREE MONTHS ENDED MARCH 31, 2000 ---------- --------- ---------- ------------
<S> <C> <C> <C> <C>
Book value.......................................... $6.47 $5.58 $4.52 $6.84
Net income (basic).................................. 0.15 0.15 0.18 0.18
Net income (diluted)................................ 0.13 0.13 0.17 0.16
YEAR ENDED DECEMBER 31, 1999
Book value.......................................... $6.33 $5.45 $4.40 $6.68
Net income (basic).................................. 0.46 0.47 0.60 0.58
Net income (diluted)................................ 0.41 0.43 0.57 0.53
YEAR ENDED DECEMBER 31, 1998
Book value.......................................... $5.02 $4.45 $4.17 $5.45
Net income (basic).................................. 0.37 0.39 0.52 0.48
Net income (diluted)................................ 0.34 0.35 0.48 0.43
YEAR ENDED DECEMBER 31, 1997
Book value.......................................... $4.11 $3.74 $3.78 $4.59
Net income (basic).................................. 0.29 0.34 0.52 0.42
Net income (diluted)................................ 0.27 0.32 0.49 0.39
</TABLE>
------------------------
(1) Equivalent pro forma book value per share for Western Holdings does not
represent the book value per share of Heritage common stock.
17
<PAGE>
RISK FACTORS
In deciding whether to vote in favor of the merger, shareholders of Western
Holdings and Heritage should consider the following factors, in addition to the
other matters set forth or incorporated by reference in this document:
WE MAY HAVE DIFFICULTY INTEGRATING BANK OF LOS ALTOS INTO HERITAGE AND IN
ACHIEVING ANY COST-SAVING.
Heritage believes that it will be able to achieve certain savings through
consolidation of branch operations. However, achieving savings will depend on
successfully integrating information systems and personnel while preserving the
benefit of Bank of Los Altos' goodwill in the community as an independent bank.
We cannot give any assurance that the combined companies will be able to
accomplish the integration in a timely manner or in a manner that will result in
any significant savings, or that the integration will not cause some disruption
to Bank of Los Altos' relationships with its customers.
HERITAGE WILL ASSUME THE RISK WESTERN HOLDING LITIGATION MAY CAUSE A MATERIAL
ADVERSE EFFECT ON HERITAGE.
Bank of Los Altos may have an obligation to indemnify a former director of
an affiliate corporation from certain litigation claims. For a discussion, see
"Information about Western Holdings--Legal proceedings" on page 88. Although we
believe the claims are without merit, we cannot give any assurance that, if the
plaintiffs pursue the matter and succeed in proving their claims, the result
will not have a material adverse effect on the financial condition and results
of operations of Bank of Los Altos or the combined companies after the merger.
ADDITIONAL SHARES OF HERITAGE COMMON STOCK COULD BE ISSUED WHICH COULD RESULT IN
A DECLINE IN THE MARKET PRICE OF THE STOCK
Shares of Heritage common stock eligible for future sale could have a
dilutive effect on the market for Heritage common stock and could adversely
affect the market price. Heritage has outstanding options for 1,540,703 shares
of Heritage common stock. Heritage expects to issue approximately 3,375,000
shares in connection with the merger (assuming no exercise of Western Holdings
option before closing), most of which will be immediately eligible for resale in
the market. The merger agreement does not restrict Heritage's ability to grant
more options or issue additional shares. Sales of substantial amounts of
Heritage common stock in the public market following the merger could adversely
affect the market price of Heritage common stock. There can be no assurance
given as to the market value of Heritage common stock after the merger.
INFORMATION REGARDING FORWARD LOOKING STATEMENTS
This document contains certain forward-looking statements with respect to
the financial condition, results of operations and business of Heritage and
Western Holdings in the future, including statements relating to the cost
savings which we expect to realize from the merger, the expected impact of the
merger on Heritage's financial performance and the market value of Heritage
common stock in the future (see "The Merger--Reasons for the merger;
recommendations of the boards of directors"). These forward-looking statements
involve certain risks and uncertainties. Factors that may cause actual results
to differ materially from those contemplated by such forward-looking statements
include, among others, the following possibilities:
- expected cost savings from the merger cannot be fully realized;
- deposit attrition, customer loss or revenue loss following the merger is
greater than expected;
- competitive pressure in the banking industry increases significantly;
18
<PAGE>
- costs or difficulties related to the integration of the business of
Heritage and Western Holdings are greater than expected;
- pending or threatened litigation has unexpectedly adverse results;
- changes in the interest rate environment reduce margins;
- general economic conditions, either nationally or regionally, are less
favorable than expected, resulting in, among other things, a deterioration
in credit quality;
- changes in the regulatory environment;
- changes in business conditions and inflation; and
- changes in the securities markets.
WESTERN HOLDINGS AND HERITAGE SHAREHOLDER MEETINGS
DATE, TIME AND PLACE OF MEETINGS
The special meeting of shareholders of Western Holdings will be held on
August 24, 2000, at 5:30 p.m. local time at Bank of Los Altos, 4546 El Camino
Real, Los Altos, California. The special meeting of shareholders of Heritage
will be held on August 24, 2000, at 3:30 p.m. local time at 150 Almaden
Boulevard, San Jose, California.
THE MEETINGS
At the meetings, the shareholders of both companies will be asked to
consider and vote on the merger agreement. The merger agreement is included as
Appendix A to this document and is incorporated in this document by reference.
Under the merger agreement:
- Western Holdings will merge with Heritage; and
- each share of Western Holdings common stock would be converted into the
right to receive 1.2264 shares of common stock of Heritage, subject to
increase if Heritage's average closing stock (as defined on
page 21) price before closing is below $8.00.
THE BOARDS OF DIRECTORS OF WESTERN HOLDINGS AND HERITAGE, EACH BY UNANIMOUS
VOTE, APPROVED THE MERGER AGREEMENT AND RECOMMEND A VOTE FOR APPROVAL OF THE
MERGER AGREEMENT.
RECORD DATES AND VOTING RIGHTS
Only holders of record of Western Holdings common stock at the close of
business on July 14, 2000, and of Heritage common stock at the close of business
on July 14, 2000 are entitled to notice of and to vote at the meeting.
At its record date, Western Holdings had approximately 94 shareholders of
record and 2,759,676 shares of common stock outstanding and entitled to vote.
Directors and executive officers of Western Holdings and their affiliates owned
beneficially as of the record date an aggregate of 996,964 shares of Western
Holdings common stock (excluding exercisable stock options), or approximately
36% of the outstanding Western Holdings common stock. Western Holdings directors
holding 992,294 shares or 36% of outstanding Western Holdings common stock have
agreed to vote their shares in favor of the merger.
At its record date, Heritage had approximately 1,200 shareholders of record
and 7,179,676 shares of common stock outstanding and entitled to vote. Directors
and executive officers of Heritage and their affiliates owned beneficially as of
the record date an aggregate of 2,098,719 shares of Heritage common stock
(excluding exercisable stock options), or approximately 29% of the outstanding
Heritage common stock.
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<PAGE>
Each shareholder is entitled to one vote for each share of common stock he
or she owns.
VOTE REQUIRED
Approval of the merger requires the affirmative vote of the holders of a
majority of the outstanding shares of Western Holdings common stock and a
majority of the outstanding shares of Heritage common stock.
VOTING BY PROXY
Shareholders may use the enclosed proxy if they are unable to attend the
meeting in person or wish to have their shares voted by proxy even if they
attend the meeting. All proxies that are properly executed and returned, unless
revoked, will be voted at the meeting in accordance with the instructions
indicated or, if no instruction is indicated, in favor of the merger. The
execution of a proxy will not affect the right of a shareholder to attend the
meeting and vote in person.
REVOCABILITY OF PROXIES
A person who has given a proxy may revoke it any time before it is exercised
at the meeting by filing with the Secretary of the company, a written notice of
revocation or a proxy bearing a later date or by attendance at the meeting and
voting in person. Attendance at the meeting will not, by itself, revoke a proxy.
ADJOURNMENTS
The meeting may be adjourned, even if a quorum is not present, by the vote
of the holders of a majority of the shares represented at the meeting in person
or by proxy. In the absence of a quorum at the meeting, no other business may be
transacted at the meeting.
Notice of the adjournment of a meeting need not be given if the time and
place thereof are announced at the meeting at which the adjournment is taken,
provided that if the adjournment is for more than 45 days, or if after the
adjournment a new record date is fixed for the adjourned meeting, a notice of
the adjourned meeting shall be given to each shareholder of record entitled to
vote at the meeting. At an adjourned meeting, any business may be transacted
which might have been transacted at the original meeting.
SOLICITATION OF PROXIES
The board of directors of Western is soliciting proxies for the Western
Holdings meeting, and the board of directors of Heritage is soliciting proxies
for the Heritage meeting. The companies will bear the cost of printing and
distributing the proxy material relating to the meeting. Copies of this material
will be furnished to brokerage houses, fiduciaries and custodians holding in
their names shares of Western Holdings or Heritage common stock beneficially
owned by others to forward to such beneficial owners. Western Holdings and
Heritage may reimburse such persons representing beneficial owners of its shares
for their expenses in forwarding solicitation material to beneficial owners.
Solicitation of proxies by mail may be supplemented by telephone, telegram or
personal solicitation by directors, officers or other regular employees of
Western Holdings and Heritage, who will not receive any additional compensation
for such efforts.
OTHER MATTERS
The boards of Western Holdings and Heritage are not aware of any matters to
come before the special meetings other than as stated above. If any other
matters should be brought before the meeting, or any adjournment thereof, upon
which a vote properly may be taken, the proxy holders will vote in their
discretion unless otherwise provided in the proxies.
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<PAGE>
THE MERGER
GENERAL
The boards of directors of Western Holdings and Heritage have each
unanimously approved the merger agreement, which provides for the merger of
Western Holdings with and into Heritage. This section of the document describes
certain aspects of the merger, including the background of the merger and the
parties' reasons for the merger.
In the merger, each outstanding share of Western Holdings common stock,
other than shares as to which dissenters' rights have been perfected, will be
converted into the right to receive a number of Heritage common shares equal to
3,760,000 divided by the sum of the total outstanding shares of Western Holdings
plus all of Western Holdings' outstanding stock options. As of the date of this
document, the exchange ratio is 1.2264 shares of Heritage common stock for each
share of Western Holdings common stock. Western Holdings has no present plan to
issue additional shares or grant additional options, except to new employees in
the ordinary course of business consistent with past practice.
The exchange ratio may be increased if Heritage's average closing stock
price for the 20 trading days ending when Western Holdings receives notice of
federal regulatory approval of the merger is less than $8.00. In that case,
Western Holdings may terminate the merger unless Heritage agrees to increase the
exchange ratio to a figure that results in a value of $9.81 per Western Holdings
share. Based on the number of shares of Western Holdings common stock
outstanding on the record date, Heritage will issue approximately 3,375,000
shares of Heritage common stock in the merger (assuming no exercise of Western
Holdings options before closing), representing approximately 32% of the number
of shares of Heritage common stock that will be outstanding immediately after
the merger.
The merger agreement also provides that before the merger, Heritage may
specify that the parties to the merger agreement enter into transactions that
are structured differently from the merger described in this section. No such
change, however, may materially and adversely affect the timing of the
completion of the merger or adversely affect the economic benefits, the form of
consideration or the tax effect of the merger to you. Heritage does not
contemplate any such change at this time.
BACKGROUND OF THE MERGER
Heritage and Western Holdings through their respective subsidiary banks
conduct general banking operations in the Santa Clara County and Silicon Valley
area of California. Heritage and Western Holdings have complimentary business
strategies, serving small businesses, mid-market corporations, professionals and
individuals. Additionally, each historically has focused on a community-based
approach to banking. Management of Heritage and Western Holdings have been
cognizant of the rapidly changing marketplace in the geographic area that each
serves and the impact of rapid consolidation of other independent banks within
the region. Both Heritage and Western Holdings have experienced increasing
market share and steady earnings growth.
In order to compete effectively with the larger financial institutions that
have resulted from the various consolidations and mergers in the banking
industry locally, Heritage management saw a need to expand prudently and
recognized the opportunity to build a larger regional, independent financial
institution with operations in the Santa Clara County and Silicon Valley market.
Accordingly, as a part of its effort to achieve long-term stable profitability,
Heritage has explored acquisition opportunities to achieve greater market share
in Santa Clara County, as well as in the entire Bay Area.
Western Holdings management perceived the same challenges and opportunities.
During the Fall of 1999, the Western Holdings board met to discuss a five year
business plan. The board concluded that Western Holdings should strive to grow
to total assets of $750 million to $1 billion over the five year period. In
December 1999, Western Holdings management and its Chairman, Steve Hunton,
examined its capital position in relationship to its plans for growth. They
concluded that, in order to sustain the
21
<PAGE>
growth that was projected, additional capital would be needed. The Western
Holdings board considered various strategies for achieving increased capital,
including private placement of stock, a public offering or a merger with or sale
to a better capitalized institution. The Western Holdings board also recognized
that the pooling-of-interests method of accounting was scheduled to end at the
close of 2000 and that this development could affect the ability of Western
Holdings to merge at a favorable exchange ratio.
In January, 2000, Western Holdings hired a financial adviser to informally
examine whether a sale of Western Holdings to an out of state regional banking
company would be a viable alternative to independence. The financial adviser,
over a period of three months, contacted three regional institutions but no
immediate interest was forthcoming. Concluding that this strategy would not be
successful, in February 2000 Mr. Hunton met with Brad Smith, Chairman, William
del Biaggio, Director, and John Rossell, then President and CEO, of Heritage to
preliminarily discuss whether a Western Holdings/Heritage merger might be
possible. The representatives of Heritage expressed an interest in having
Western Holdings consider becoming part of Heritage. Mr. Hunton indicated that
he would take the idea to the Western Holdings board for discussion. In late
February, Heritage sent to Western Holdings a letter expressing interest in a
merger and suggesting preliminary terms on which such a transaction might be
undertaken. Shortly after receiving the letter Western Holdings consulted Baxter
Fentriss to provide guidance on the proposal. With the authority of the Western
Holdings board, Mr. Hunton and Mr. Wall, president of Western Holdings, with the
assistance of Baxter Fentriss began negotiations with Heritage to effect a
transaction.
Negotiations between Western Holdings and Heritage continued throughout
February and March. In February 2000, Western Holdings formally retained Baxter
Fentriss as its financial adviser to perform investment banking services related
to the Heritage proposal. In this role, Baxter Fentriss provided Western
Holdings with financial summaries and public information regarding Heritage. In
addition, pro forma analyses were provided of Heritage and Western Holdings. By
mid-April 2000, Western Holdings' board was ready to proceed further with
Heritage. The Western Holdings board decided that if a sale of Western Holdings
were to take place, it would be in the best interests of the shareholders,
employees and customers of Western Holdings to negotiate exclusively with
Heritage because of the complimentary product lines, the increased lending limit
of the combined institutions, the economies of scale in the Santa Clara County
and Silicon Valley marketplace, the increased liquidity of Heritage stock and
the excellent geographic fit.
Between April 12, 2000 and May 9, 2000, the management of Heritage and
Western Holdings, together with their respective outside counsel, negotiated the
terms of the merger agreement, the stock option agreements and the shareholder
agreements. On April 19, 2000, at a meeting of the Western Holdings board,
Baxter Fentriss delivered its oral opinion that the consideration to be received
was fair to shareholders from a financial perspective. Baxter Fentriss
subsequently confirmed its oral opinion in writing as of the date of the merger
agreement. At that meeting, subject to certain modifications, the Western
Holdings board approved and adopted the merger agreement and the transactions
contemplated by the merger agreement as in the best interests of Western
Holdings and its shareholders. The Western Holdings board also authorized the
Western Holdings management to finalize the terms of the merger agreement and
the stock option agreement.
The Heritage board held a meeting on April 20, 2000, at which Heritage's
directors discussed the proposed merger in detail with Heritage's counsel and
management, including the consideration to be paid by Heritage and the related
transactions. At that meeting, Hoefer & Arnett, Inc. delivered its oral opinion
that the merger was fair to Heritage's shareholders from a financial
perspective. Hoefer & Arnett subsequently confirmed its oral opinion in writing
as of the date of the merger agreement. After considering the opinion of
Hoefer & Arnett, the Heritage board approved the merger agreement and the
various matters and related agreements contemplated thereby and authorized and
directed Heritage management to take all action reasonably necessary to effect
the merger.
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<PAGE>
From April 20 through May 9, 2000, representatives of the management of each
of Western Holdings and Heritage together with their respective counsel
finalized the terms of the merger agreement and the stock option agreements.
They exchanged disclosure schedules and completed all of the formalities
preceding the execution of the merger agreement. On May 9, 2000 Western Holdings
and Heritage finalized the terms of the agreements and executed and delivered to
each other copies of the merger agreements, stock option agreements and
shareholder agreements. After close of the market on May 9, 2000, Heritage and
Western Holdings sent out a joint press release publicly announcing the merger.
REASONS FOR THE MERGER; RECOMMENDATIONS OF BOARDS OF DIRECTORS
HERITAGE.
Heritage believes that the merger will provide it with an attractive
opportunity to expand its operations in Santa Clara County and the Silicon
Valley. Heritage believes that Western Holdings' location and business mix
complement Heritage's existing presence in Santa Clara County and will enable it
to offer its broad array of products and services to customers of Western
Holdings.
The Heritage board believes that the terms of the merger are fair and are in
the best interests of Heritage and its shareholders and recommends that the
shareholders of Heritage vote FOR approval of the merger.
In reaching its conclusion, the Heritage board considered information
provided at its meetings in January, February, March and April, 2000, including,
among other things:
- information concerning the financial performance and condition, business
operations, capital levels, asset quality, loan portfolio breakdown, and
prospects of Western Holdings;
- the terms of the merger agreement and other documents to be executed in
connection with the merger;
- the presentation of Hoefer & Arnett, Inc. and the opinion of Hoefer &
Arnett that the merger is fair to the shareholders of Heritage from a
financial point of view;
- the pro forma financial statements of the combined companies and the
capitalization of the combined companies;
- the complementary nature of Western Holdings' offices and the effect of
the combination on Heritage's strategic plan;
- the advantages of being a larger entity, including the potential for
operating efficiencies, and the effect of a higher lending limit on
Heritage's customers and prospective customers;
- the business strategies, the strength and depth of management of the
combined entity;
- the ability to retain the Bank of Los Altos identity and name and to
continue operations with the same executive officers;
- the ability of a larger institution to compete in the banking environment
and to leverage overhead costs;
- the anticipated impact on the communities served by Heritage and Western
Holdings in the merger, and the increased ability to serve the communities
through the larger network of related banks;
The board of Heritage did not assign any relative weight to any of the
foregoing factors.
For reasons stated above, the Heritage board of directors has unanimously
approved the merger agreement as in the best interest of Heritage and its
shareholders and unanimously recommends that the Heritage shareholders approve
the merger.
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<PAGE>
WESTERN HOLDINGS.
The Western Holdings board believes that the terms of the merger are fair
and are in the best interests of Western Holdings and its shareholders and
recommends that the shareholders of Western Holdings vote FOR approval of the
merger.
In reaching its conclusion, the Western Holdings board considered
information provided at its meetings in January, February, March and April,
2000, including, among other things:
- information concerning the financial performance and condition, business
operations, capital levels, asset quality, loan portfolio breakdown, and
prospects of Heritage;
- the structure of the transaction, including the fact that the Western
Holdings shareholders would receive approximately 32% of the common stock
of Heritage;
- the terms of the merger agreement and other documents to be executed in
connection with the merger, including the substantial premium over book
value and the substantial multiple of earnings of Western Holdings which
Heritage will pay to Western Holdings' shareholders;
- the presentation of Baxter Fentriss and the opinion of Baxter Fentriss
that the merger is fair to the shareholders of Western Holdings from a
financial point of view;
- the Western Holdings board's review with its legal and financial advisors
of alternatives to the merger, the range of possible values to Western
Holdings shareholders obtainable through implementation of alternatives
and the timing and likelihood of the same;
- the current and prospective economic environment and increasing regulatory
and competitive burdens and constraints facing community banks;
- the pro forma financial statements of the combined companies and the
capitalization of the combined companies;
- the geographic distribution of Heritage offices in relation to Western
Holdings' offices and strategic plan;
- the advantages of being part of a larger entity, including the potential
for operating efficiencies, and the effect of a higher lending limit on
Western Holdings' customers and prospective customers;
- the business strategies, the strength and depth of management of the
combined entity;
- the ability to retain the Bank of Los Altos identity and name and to
continue operations with the same executive officers, which was perceived
to be a significant advantage to the shareholders, employees and customers
of Western Holdings;
- the anticipated positive effect of the merger on existing shareholders,
employees, officers and customers of Western Holdings;
- the ability of a larger institution to compete in the banking environment
and to leverage overhead costs;
- the anticipated impact on the communities served by Western Holdings and
Heritage in the merger, and the increased ability to serve the communities
through the larger network of related banks;
- the unprecedented consolidation currently underway in the banking industry
and increased competition from larger independent banks in California;
- the value of the consideration offered by Heritage compared to the value
of the consideration offered in other acquisitions of financial
institutions in California in 1996-1999 and the prospects for enhanced
value of the combined entity in the future;
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<PAGE>
- the tax-free nature of the Heritage offer;
- the liquidity of Heritage common stock in trading on the Nasdaq National
Market; and
- the prospects for Western Holdings on a stand alone basis and on the basis
of alternative stand alone strategies.
The board of Western Holdings did not assign relative weight to any of the
foregoing factors.
For reasons stated above, the Western Holdings board of directors has
unanimously approved the merger agreement as in the best interest of Western
Holdings and its shareholders and unanimously recommends that the Western
Holdings shareholders approve the merger.
OPINION OF FINANCIAL ADVISORS
OPINION OF HERITAGE'S FINANCIAL ADVISOR
GENERAL. On April 6, 2000, Heritage engaged Hoefer & Arnett to act as its
financial advisor in connection with the merger. Hoefer & Arnett agreed to
assist Heritage in analyzing a transaction with Western Holdings. Heritage
selected Hoefer & Arnett because Hoefer & Arnett is a nationally recognized
investment-banking firm with substantial experience in transactions similar to
the merger and is familiar with Heritage and its business. As part of its
investment banking business, Hoefer & Arnett is continually engaged in the
valuation of businesses and their securities in connection with mergers and
acquisitions.
As part of its engagement, representatives of Hoefer & Arnett attended the
meeting of the Heritage board held on April 20, 2000 during which the board
considered the agreement. At the April 20, 2000 meeting, Hoefer & Arnett
rendered an oral opinion (subsequently confirmed in writing on May 9, 2000)
that, as of that date, the merger consideration was fair to Heritage and its
shareholders from a financial point of view. That opinion was reconfirmed in
writing as of the date of this document.
The full text of Hoefer & Arnett's updated written opinion is attached as
Exhibit B-1 to this document and is incorporated in this document by reference.
We urge you to read the opinion in its entirety for a description of the
procedures followed, assumptions made, matters considered, and qualifications
and limitations on the review undertaken by Hoefer & Arnett.
Hoefer & Arnett's opinion is directed to the Heritage board and addresses
only the merger consideration. It does not address the underlying business
decision to proceed with the merger and does not constitute a recommendation to
you as to how you should vote at the Heritage meeting with respect to the merger
or any matter related thereto.
In rendering its opinion, Hoefer & Arnett:
- reviewed, among other things:
- the merger agreement;
- annual reports to shareholders of Heritage and Western Holdings;
- annual reports on Form 10-K of Heritage;
- FFIEC reports of Western Holdings and its subsidiary Bank of Los Altos;
- quarterly reports on Form 10-Q of Heritage; and
- certain internal financial analyses for Heritage and Western Holdings
prepared by management.
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<PAGE>
- held discussions with members of senior management of Heritage and Western
Holdings regarding:
- past and current business operations;
- regulatory relationships;
- financial condition; and
- future prospects of the respective companies.
- compared certain financial and stock market information for Heritage and
Western Holdings with similar information for certain other companies with
publicly traded securities;
- reviewed the financial terms of certain recent business combinations in
the banking industry; and
- performed other studies and analyses that it considered appropriate.
In rendering its opinion, Hoefer & Arnett relied, without independent
verification, on the accuracy and completeness of the material furnished to it
by Heritage and Western Holdings and the material otherwise made available to
it, including information from published sources. With respect to the financial
information, Hoefer & Arnett assumed (with Heritage's consent) that they had
been reasonably prepared and reflected the best currently available estimates
and judgment of Heritage management. In addition, Hoefer & Arnett did not make
or obtain any independent appraisals or evaluations of the assets or
liabilities, and potential and/or contingent liabilities of Heritage or Western
Holdings. Hoefer & Arnett further relied on the assurances of Heritage and
Western Holdings management that they were not aware of any facts that would
make such information inaccurate or misleading. Hoefer & Arnett necessarily
based its opinion on the market, economic and other relevant considerations as
they existed and could be evaluated on the date of the opinion.
The projections furnished to Hoefer & Arnett and used by it in certain of
its analyses were prepared by the senior management of Heritage. Heritage does
not publicly disclose internal management projections of the type provided to
Hoefer & Arnett in connection with its review of the merger. As a result,
Heritage did not prepare such projections with a view towards public disclosure.
The projections were based on numerous variables and assumptions which are
inherently uncertain, including factors related to general economic and
competitive conditions. Accordingly, actual results could vary significantly
from those stated in the projections.
The following is a summary of the material analyses that Hoefer & Arnett
performed and presented to the Heritage Board on April 20, 2000 in connection
with its April 20, 2000 oral opinion:
ANALYSIS OF THE MERGER CONSIDERATION. Hoefer & Arnett calculated the
multiple which the merger consideration represents based on the conversion ratio
in the agreement of 1.2264 shares of Heritage common stock for each share of
Western Holdings common stock and the closing price of Heritage common stock as
of April 17, 2000. Based on the $10.00 closing price of Heritage on April 17,
2000, the merger consideration represented a per share value of $12.26 per share
for each share of Western Holdings. The multiples were calculated based on
Western Holdings' December 31, 1999 book value per share of $4.40 and its last
twelve month earnings per share of $0.57. The deal price to book value was 2.94
times and the deal price to last twelve month earnings per share was 21.5 times.
SELECTED PEER GROUP ANALYSIS. Hoefer & Arnett compared the financial
performance and market performance of Western Holdings to those of a group of
comparable banks and bank holding companies.
The comparisons were based on:
- various financial measures, including:
- earnings performance;
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<PAGE>
- operating efficiency;
- capital adequacy; and
- asset quality.
- various measures of market performance, including:
- market to book values; and
- price to earnings.
To perform this analysis, Hoefer & Arnett used the financial information as
of and for the year ended December 31, 1999 and market price information as of
April 17, 2000. The companies in the peer group were California independent
banks that had total assets ranging from approximately $130 million to
$425 million.
Hoefer & Arnett's analysis showed the following concerning Western Holdings
financial performance:
<TABLE>
<CAPTION>
PEER
WESTERN GROUP
PERFORMANCE MEASURE HOLDINGS AVERAGES
------------------- -------- --------
<S> <C> <C>
Return on average assets, last twelve months................ 0.85% 1.45%
Return on average equity, last twelve months................ 14.91% 16.58%
Net interest margin, last twelve months..................... 5.36% 5.76%
Efficiency ratio, last twelve months........................ 71.20% 57.71%
Equity to assets............................................ 5.66% 8.79%
Nonperforming assets and past due loans to total assets..... 0.01% 0.30%
Loan loss reserve to nonperforming assets and past due
loans..................................................... NM 231.11%
Price to trailing twelve months earnings.................... 19.64x 11.13x
Price to 2000 estimated earnings............................ 16.18x 7.59x
Price to book value multiples............................... 2.63x 1.76x
</TABLE>
ANALYSIS OF COMPARABLE ACQUISITION TRANSACTIONS. In rendering its opinion,
Hoefer & Arnett analyzed certain comparable merger and acquisition transactions
of both pending and completed bank deals, comparing the acquisition price
relative to book value, last twelve month earnings, premium to market price and
premium to implied price. The analysis included a comparison of the low to high
of the above ratios for completed and pending acquisitions from California
transactions from January 1, 1998 to April 17, 2000 with announced transaction
values less than $100 million, return on average assets of greater than 1.0%.
The information in the following table summarizes the material information
analyzed by Hoefer & Arnett with respect to the merger. The summary is not a
complete description of the analysis performed by Hoefer & Arnett and should not
be construed independently of the other information considered by Hoefer &
Arnett in rendering its opinion. Selecting portions of Hoefer & Arnett's
analysis or isolating certain aspects of the comparable transactions without
considering all analysis and factors, could create an incomplete or potentially
misleading view of the evaluation process.
<TABLE>
<CAPTION>
COMPARABLE WESTERN HOLDINGS/
GROUP COMPARABLE COMPARABLE HERITAGE
FACTOR CONSIDERED(1) LOW MEDIAN HIGH MERGER(2)
-------------------- ---------- ---------- ---------- -----------------
<S> <C> <C> <C> <C>
Trailing twelve months earnings............. 10.6x 20.0x 33.0x 21.9x
Book value.................................. 1.3x 2.6x 5.0x 2.9x
Premium to market price..................... (26.0%) 9.4% 52.6% 11.5%
</TABLE>
------------------------
(1) Financial data as of December 31, 1999.
(2) Based on a conversion ratio of 1.2264 and Heritage price of $10.00 as of
April 17, 2000.
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<PAGE>
No company or transaction used as a comparison in the above analysis is
identical to Western Holdings, Heritage or the merger. Accordingly, an analysis
of these results is not mathematical. Rather, it involves complex considerations
and judgments concerning differences in financial and operating characteristics
of the companies and other factors that could affect the public trading value of
the companies to which they are being compared.
CONTRIBUTION ANALYSIS. Hoefer & Arnett reviewed the relative contribution
of each Western Holdings and Heritage to certain pro forma balance sheet and
income statement items of the combined entity. The contribution analysis showed:
<TABLE>
<S> <C>
WESTERN HOLDINGS CONTRIBUTION TO:
Combined shareholders' equity............................... 20.3%
Combined 1999 estimated net income without cost savings..... 34.8%
Combined total assets....................................... 29.6%
Western Holdings estimated pro forma ownership (including
options).................................................. 29.8%
</TABLE>
Hoefer & Arnett compared the relative contribution of the balance sheet and
income statement items with the estimated pro forma ownership for Western
Holdings shareholders based on a conversion ratio of 1.2264.
This summary provides a summary description of the material analyses
prepared by Hoefer & Arnett in connection with the rendering of its opinion. The
preparation of a fairness opinion is not necessarily susceptible to partial
analysis or summary description. Hoefer & Arnett believes that its analysis and
the summary above must be considered as a whole and that selecting portions of
its analysis, or selecting part of the above summary, without considering all
factors and analyses, would create an incomplete view of the process underlying
the analysis in Hoefer & Arnett's presentation and opinion. The ranges of
valuations resulting from any particular analysis described above should not be
taken to be Hoefer & Arnett's view of the actual value of Heritage or Western
Holdings. The fact that any specific analysis has been referred to in the
summary above is not meant to indicate that such analysis was given greater
weight that any other analysis.
In preparing its analysis, Hoefer & Arnett made numerous assumptions with
respect to industry performance, business and economic conditions, and other
matters, many of which are beyond the control of Hoefer & Arnett and Heritage
The analyses performed by Hoefer & Arnett are not necessarily indicative of
actual values or future results, which may be significantly more or less
favorable than suggested by such analyses and do not purport to be appraisals or
reflect the prices at which a business may be sold or the prices at which any
securities may trade at the present time or at any time in the future. In
addition, as described above, Hoefer & Arnett's opinion, along with its
presentation to the Heritage board of directors, was just one of the many
factors taken into consideration by the Heritage board of directors in approving
the agreement.
In connection with its opinion dated as of the date of this document,
Hoefer & Arnett performed procedures to update, as necessary, certain of the
analyses described above. Hoefer & Arnett reviewed the assumptions on which the
analyses described above were based and the factors considered in connection
therewith. Hoefer & Arnett did not perform any analysis in addition to those
described above in updating its April 20, 2000 oral opinion.
The Heritage board of directors has retained Hoefer & Arnett as an
independent contractor to act as financial advisor to Heritage regarding the
merger. As part of its investment banking business, Hoefer & Arnett is
continually engaged in the valuation of banking businesses and their securities
in connection with mergers and acquisitions, negotiated underwritings,
competitive biddings, secondary distributions of listed and unlisted securities,
private placements, and valuations for estate, corporate and other purposes.
Hoefer & Arnett has experience in, and knowledge of, the valuation of banking
enterprises. In the ordinary course of its business as a broker-dealer,
Hoefer & Arnett may, from time
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<PAGE>
to time, purchase securities from, and sell securities to, Heritage and Western
Holdings. As a market maker in securities Hoefer & Arnett may from time to time
have a long or short position in, and buy or sell, debt or equity securities of
Heritage and Western Holdings for Hoefer & Arnett's own account and for the
accounts of its customers.
Pursuant to its engagement letter with Heritage, Hoefer & Arnett will
receive a fee of $50,000. As of the date of this document, Hoefer & Arnett has
received $15,000 of such fee. The remainder is due upon the closing of the
merger. Heritage has also agreed to indemnify Hoefer & Arnett against certain
liabilities, including liabilities under the federal securities laws, and to
reimburse Hoefer & Arnett for certain out-of-pocket expenses.
OPINION OF WESTERN HOLDINGS' FINANCIAL ADVISOR
Baxter Fentriss has acted as financial advisor to Western Holdings in
connection with the merger. Baxter Fentriss assisted Western Holdings in
negotiating with Heritage. Baxter Fentriss delivered to Western Holdings its
opinion dated May 9, 2000, that on the basis of matters referred to herein, the
exchange ratio received by shareholders of Western Holdings common stock is fair
from a financial point of view. In rendering its opinion Baxter Fentriss
consulted with the management of Western Holdings and Heritage, and reviewed the
merger agreement. Baxter Fentriss also reviewed certain publicly-available
information on the parties and certain additional materials made available by
the management of the respective banks.
In addition Baxter Fentriss discussed with Western Holdings' and Heritage's
management their respective businesses and outlook. Baxter Fentriss was involved
in the negotiations between Western Holdings and Heritage. No limitations were
imposed by Western Holdings' Board of Directors upon Baxter Fentriss with
respect to the investigation made or procedures followed by it in rendering its
opinion. The full text of Baxter Fentriss' written opinion is attached as
Appendix B-2 to this document and should be read in its entirety with respect to
the procedures followed, assumptions made, matters considered and qualifications
and limitations on the review undertaken by Baxter Fentriss.
Baxter Fentriss' opinion is directed to Western Holdings' board of
directors, and is directed only to the fairness, from a financial point of view,
of the exchange ratio to be received by shareholders of Western Holdings common
stock. It does not address Western Holdings' underlying business decision to
effect the proposed merger, nor does it constitute a recommendation to any
Western Holdings shareholder as to how a shareholder should vote with respect to
the merger at the shareholder meeting or as to any other matter.
Baxter Fentriss' opinion was one of many factors taken into consideration by
Western Holdings' board of directors in making its determination to approve the
merger, and the receipt of Baxter Fentriss' opinion is a condition precedent to
Western Holdings consummating the merger. The opinion of Baxter Fentriss does
not address the relative merits of the merger as compared to any alternative
business strategies that might exist for Western Holdings or the effect of any
other business combination in which Western Holdings might engage.
Baxter Fentriss, as part of its investment banking business, is continually
engaged in the valuation of financial institutions and their securities in
connection with mergers and acquisitions and valuations for estate, corporate
and other purposes. Baxter Fentriss is a nationally recognized advisor to firms
in the financial services industry on mergers and acquisitions. Western Holdings
selected Baxter Fentriss as its financial advisor because Baxter Fentriss is an
investment banking firm focusing on transactions involving community banks and
thrifts and because of the firm's extensive experience and expertise in
transactions similar to the merger. Baxter Fentriss is not affiliated with
Western Holdings or Heritage.
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In connection with rendering its opinion to Western Holdings' board of
directors, Baxter Fentriss performed a variety of financial analyses. In
conducting its analyses and arriving at its opinion as expressed herein, Baxter
Fentriss considered such financial and other factors as it deemed appropriate
under the circumstances including, among others, the following:
- the historical and current financial condition and results of operations
of Western Holdings and Heritage including interest income, interest
expense, noninterest income, noninterest expense, earnings, book value,
returns on assets and equity, and possible tax consequences resulting from
the transaction;
- the business prospects of Western Holdings and Heritage;
- the economies of Western Holdings' and Heritage's respective market areas;
and
- the nature and terms of certain other merger transactions that it believed
to be relevant.
Baxter Fentriss also considered its assessment of general economic, market,
financial and regulatory conditions and trends, as well as its knowledge of the
financial institutions industry, its experience in connection with similar
transactions, its knowledge of securities valuation generally, and its knowledge
of merger transactions in California and throughout the United States.
In connection with rendering its opinion, Baxter Fentriss reviewed:
- the merger agreement;
- the annual reports to shareholders of Western Holdings for the three years
ended December 31, 1999, as well as certain current interim reports to
shareholders and regulatory agencies;
- the annual reports to shareholders of Heritage for the three years ended
December 31, 1999, as well as certain current interim reports to
shareholders and regulatory agencies;
- certain additional financial and operating information with respect to the
business, operations and prospects of Western Holdings and Heritage as it
deemed appropriate.
Baxter Fentriss also:
- held discussions with members of Western Holdings' and Heritage's senior
management regarding the historical and current business operations,
financial condition and future prospects of their respective companies;
- reviewed the historical market prices and trading activity for Western
Holdings' common stock and Heritage's common stock, as applicable, and
compared them with those of certain publicly traded companies that it
deemed to be relevant;
- compared the results of operations of Western Holdings and Heritage with
those of certain banking companies that it deemed to be relevant;
- analyzed the pro-forma financial impact of the merger on Heritage; and
- conducted such other studies, analyses, inquiries and examinations as
Baxter Fentriss deemed appropriate.
The preparation of a fairness opinion involves various determinations as to
the most appropriate and relevant methods of financial analysis and the
application of those methods to the particular circumstances. Therefore, a
fairness opinion is not readily susceptible to partial analysis or summary
description. Moreover, the evaluation of fairness, from a financial point of
view, of the consideration provided to the holders of Western Holdings common
stock was to some extent a subjective one based on the experience and judgment
of Baxter Fentriss and not merely the result of mathematical analysis of
financial data. Accordingly, notwithstanding the separate factors as summarized
below, Baxter
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<PAGE>
Fentriss believes that its analyses must be considered as a whole and that
selecting portions of its analyses and of the factors considered by it, without
considering all analyses and factors, could create an incomplete view of the
evaluation process underlying its opinion. The ranges of valuations resulting
from any particular analysis described below should not be taken to be Baxter
Fentriss' view of the actual value of Western Holdings or Heritage.
In performing its analyses, Baxter Fentriss made numerous assumptions with
respect to industry performance, business and economic conditions and other
matters, many of which are beyond the control of Western Holdings and Heritage
The analyses performed by Baxter Fentriss are not necessarily indicative of
actual values or future results, which may be significantly more or less
favorable than suggested by such analyses. Additionally, analyses relating to
the values of businesses do not purport to be appraisals or to reflect the
prices at which businesses may actually be sold. In rendering its opinion,
Baxter Fentriss assumed that, in the course of obtaining the necessary
regulatory approvals for the merger, no conditions will be imposed that will
have a material adverse effect on the contemplated benefits of the merger, on a
pro-forma basis, to Heritage.
The following is a summary of selected analyses performed by Baxter Fentriss
in connection with its opinion.
1. STOCK PRICE HISTORY. Baxter Fentriss studied the history of the trading
prices and volume for Western Holdings' common stock and compared them to other
publicly traded banks in California and to the price offered by Heritage. As of
March 31, 2000 the fully diluted book value for Western Holdings' common stock,
assuming complete exercise of outstanding options, was $4.53 per share.
2. COMPARATIVE ANALYSIS. Baxter Fentriss analyzed and compared the price
to earnings multiple, price to book multiple, price to assets, and premium on
deposits of the offer with 46 other merger transactions in California involving
community banking organizations as of their respective announcement dates during
the calendar years 1999 and 2000. The average pricing multiples for the
comparables were price to earnings of 20.38x, price to book of 2.52x, price to
assets of 22.06% and premium on deposits of 18.49%. Using an aggregate value of
$13.33 for every share of Western Holdings common stock, the total price which
Heritage Corp agreed to pay is approximately $40.9 million. Using this price,
the respective multiples for the merger are 22.41x, 3.31x, 17.82% and 13.22%.
Out of 47 transactions, the Western Holdings transaction ranks tenth on price to
earnings, eighth on price to book, twenty-eighth on price to assets and
twenty-fifth on premium on deposits.
3. PRO FORMA IMPACT. Baxter Fentriss evaluated the earnings, book value
and market value of the common stock of Heritage and considered the pro-forma
earnings, book value and potential long range impact that the merger would have
on the market value of Heritage common stock. Based on this analysis, Baxter
Fentriss concluded the transaction should have a positive long-term impact on
Heritage
4. DISCOUNTED CASH FLOW ANALYSIS. Baxter Fentriss performed a discounted
cash flow analysis to determine hypothetical present values for a share of
Western Holdings' common stock as a five and ten year investment. Under this
analysis, Baxter Fentriss considered various scenarios for the performance of
Western Holdings' common stock using a range of growth rates from 8% to 14% for
Western Holdings' earnings. A range of terminal values from 10 to 20 times
earnings was also used in the analysis as well as a range of discount rates from
13% to 14%. These ranges of growth rates, discount rates, and terminal values
were chosen based upon what Baxter Fentriss in its judgment, considered to be
appropriate taking into account, among other things, Western Holdings' past and
current performance, the general level of inflation, rates of return for fixed
income and equity securities in the marketplace generally and for companies of
similar risk profiles. In all of the scenarios considered, the present value of
Western Holdings' common stock was calculated at less than the value of
Heritage's offer. Thus, Baxter Fentriss' discounted cash flow analysis indicated
that Western Holdings shareholders
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would be in a better financial position by receiving the Heritage common stock
offered in the merger rather than continuing to hold Western Holdings common
stock.
Below is a table that summarizes the discounted cash flow analysis that
Baxter Fentriss performed in forming its fairness opinion. The table presents
the ranges of present values that were calculated using growth rates from 8% to
14%, discount rates from 13% to 14%, terminal values of 16 to 20 times earnings,
and investment time frames of five and ten years. The table uses Western
Holdings' March 31, 2000 financial data including earnings as of the latest
twelve months. An example of how to read the table is as follows:
Using a discount rate of 13%, a terminal value of 16x, and growth rates of
8% to 14%, the present value of Western Holdings' common stock is calculated to
be in the range of $7.59 to $9.95, assuming the shares are sold in five years.
The values in the range are less than the $13.33 which Heritage has offered
(based on the market price of Heritage common stock on May 9, 2000), which means
that under the assumptions of this particular scenario, a shareholder of Western
Holdings common stock would be better off taking Heritage's offer than holding
Western Holdings common stock.
The discounted cash flow analysis is a widely used methodology. The results
of such methodology are highly dependent upon the numerous assumptions that must
be made and the results thereof are not necessarily indicative of actual values
or actual future results.
SUMMARY OF BAXTER FENTRISS DISCOUNTED CASH FLOW ANALYSIS
DISCOUNT RATE OF 13.00% AND GROWTH RATE FROM 8% TO 14%
<TABLE>
<CAPTION>
RANGE OF PRESENT VALUE CALCULATIONS
--------------------------------------
TERMINAL VALUE SELL SHARES IN SELL SHARES IN
OF EARNINGS FIVE YEARS TEN YEARS
-------------- --------------- ---------------
<C> <S> <C>
16x $7.59 TO $9.95 $6.06 TO $10.40
18x $8.54 TO $11.19 $6.81 TO $11.70
20x $9.49 TO $12.44 $7.57 TO $13.00
</TABLE>
DISCOUNT RATE OF 13.50% AND GROWTH RATE FROM 8% TO 14%
<TABLE>
<CAPTION>
RANGE OF PRESENT VALUE CALCULATIONS
--------------------------------------
TERMINAL VALUE SELL SHARES IN SELL SHARES IN
OF EARNINGS FIVE YEARS TEN YEARS
-------------- --------------- ---------------
<C> <S> <C>
16x $7.43 TO $9.73 $5.79 TO $9.95
18x $8.36 TO $10.95 $6.52 TO $11.19
20x $9.28 TO $12.17 $7.24 TO $12.44
</TABLE>
DISCOUNT RATE OF 14.00% AND GROWTH RATE FROM 8% TO 14%
<TABLE>
<CAPTION>
RANGE OF PRESENT VALUE CALCULATIONS
--------------------------------------
TERMINAL VALUE SELL SHARES IN SELL SHARES IN
OF EARNINGS FIVE YEARS TEN YEARS
-------------- --------------- ---------------
<C> <S> <C>
16x $7.27 TO $9.52 $5.54 TO $9.52
18x $8.17 TO $10.71 $6.24 TO $10.71
20x $9.08 TO $11.90 $6.93 TO $11.90
</TABLE>
Using publicly available information on Western Holdings and Heritage and
applying the capital guidelines of banking regulators, Baxter Fentriss' analysis
indicated that the merger would not permanently dilute the capital and earnings
capacity of Heritage and would, therefore, likely not be opposed by the banking
regulatory agencies from a capital perspective. Furthermore, Baxter Fentriss
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<PAGE>
considered the likely market overlap and the Federal Reserve guidelines with
regard to market concentration and concluded that possible antitrust issues do
not exist.
Baxter Fentriss has relied, without any independent verification, upon the
accuracy and completeness of all financial and other information reviewed.
Baxter Fentriss has assumed that all estimates were reasonably prepared by
management, and reflect their best current judgments. Baxter Fentriss did not
make an independent appraisal of the assets or liabilities of either Western
Holdings or Heritage, and has not been furnished such an appraisal.
No company or transaction used as a comparison in the above analysis is
identical to Western Holdings, Heritage or the merger. Accordingly, an analysis
of the results of the foregoing necessarily involves complex considerations and
judgments concerning differences in financial and operating characteristics of
the companies and other factors that could affect the public trading value of
the companies used for comparison in the above analysis.
Baxter Fentriss has been, or will be, paid a transaction fee, equal to
approximately 1.25% of the aggregate consideration received by Western Holdings,
or approximately $500,000, and reasonable out-of-pocket expenses for its
services. Western Holdings has agreed to indemnify Baxter Fentriss against
certain liabilities, including certain liabilities under federal securities
laws.
REGULATORY APPROVALS REQUIRED
The merger is subject to approval by the Board of Governors of the Federal
Reserve System (the "FRB") under the Bank Holding Company Act (the "BHC Act").
This law provides that no transaction may be approved which would result in a
monopoly or which would be in furtherance of any combination or conspiracy to
monopolize or to attempt to monopolize the business of banking in any part of
the United States, or the effect of which in any section of the country may be
substantially to lessen competition, or to tend to create a monopoly or which in
any other manner might restrain trade, unless it is determined that the
anticompetitive effects of the proposed transaction are clearly outweighed in
the public interest by the probable effect of the transaction in meeting the
convenience and needs of the community to be served. In conducting a review of
any application for approval, the FRB is required to consider the financial and
managerial resources and future prospects of the institutions concerned and the
convenience and needs of the community to be served. An application may be
denied if it is determined that the financial or managerial resources of the
acquiring entity are inadequate.
A transaction approved by the FRB may not be consummated for 15 days after
such approval. During this period, the Department of Justice may commence legal
action challenging the transaction under the antitrust laws. If, however, the
Justice Department does not commence a legal action during the 15-day period, it
may not thereafter challenge the transaction except in an action commenced under
the antimonopoly provisions of Section 2 of the Sherman Antitrust Act.
The BHC Act provides for the publication of notice and the opportunity for
administrative hearings relating to the applications for approval and authorize
the FRB to permit interested parties to intervene in the proceedings. If an
interested party is permitted to intervene, the intervention could substantially
delay the regulatory approvals required for consummation of the merger.
The merger also must be approved by the California Commissioner of Financial
Institutions (the "Commissioner") pursuant to the California Financial Code. The
factors that the Commissioner will consider in determining whether to grant its
approval include the competitive effects of the merger, the convenience and
needs of the community, Heritage's financial condition, the fairness of the
merger to the depositors, creditors and shareholders of the parties and the
competence, experience and integrity of Heritage's management.
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<PAGE>
Based on current precedents, Western Holdings and Heritage believe that the
merger will be approved by the appropriate regulatory agencies and will not be
subject to challenge by the Department of Justice under the antitrust laws.
However, no assurance can be provided that the regulatory agencies or the
Department of Justice will concur in this assessment or that any approval by the
regulatory agencies will not contain conditions which are materially burdensome
to Western Holdings or Heritage.
NASDAQ LISTING
The shares of Heritage common stock to be issued in the merger will be
included for listing on the Nasdaq National Market.
INTERESTS OF CERTAIN OFFICERS AND DIRECTORS IN THE MERGER
Certain directors and officers of Western Holdings will receive benefits
from the merger that are different from or in addition to the benefits received
by other shareholders. These benefits include the following:
Executive officers, an employee-director and other directors of Western
Holdings hold options to acquire 235,726 shares of Western Holdings common
stock. In the merger, these options will be replaced by options to acquire
Heritage common stock, with the number of shares and exercise price adjusted to
reflect the exchange ratio.
As of July 14, 2000, the directors and executive officers of Western
Holdings owned an aggregate of 996,964 shares of Western Holdings common stock
(not including 168,760 shares subject to options exercisable currently or within
60 days of July 14, 2000) which, if owned by them at the effective date, will be
converted into shares of Heritage common stock with an approximate aggregate
market value of $13,139,985 (based on the $10.75 per share closing price of
Heritage common stock on the Nasdaq National Market on July 13, 2000).
Under the merger agreement, Heritage has agreed to appoint four current
directors of Western Holdings to the Heritage board of directors. These
appointees will be entitled to receive the directors' fees and benefits that
Heritage extends to its directors. Additionally, all of the current Western
Holdings directors will continue to serve on the board of directors of Bank of
Los Altos and one or more of Heritage's current directors may become members of
the board of directors of Bank of Los Altos and thereby become entitled to
receive the directors' fees and benefits that Bank of Los Altos extends to its
directors.
William Walters, Vice President of Western Holdings, Susann Trevena, Vice
President and Chief Financial Officer of Western Holdings and Robert Holden,
Vice President of Western Holdings, are parties to agreements that provide for
severance benefits upon the occurrence of a change of control such as the
merger, followed by termination of employment. Under these provisions,
Mr. Walters is entitled to payment of $624,157, Ms. Trevena $624,157 and
Mr. Holden $360,096. However, these agreements also provide for reduced payments
if necessary to avoid excise taxes on "excess parachute payments" under
Section 280G of the Internal Revenue Code. To avoid the Section 280G excise tax,
the payments to Mr. Walters would be reduced to approximately $338,000 and
Ms. Trevena to $338,000.
James C. Wall, President of Bank of Los Altos and Western Holdings, is
covered by an agreement which provides for severance benefits and annual
retirement benefits if his employment is terminated within two years following a
change in control of the Bank of Los Altos or Western Holdings. Under this
agreement, Mr. Wall would be entitled to a severance benefit of approximately
$521,000 and retirement benefits of $37,562 per year for 20 years. This
agreement expresses the parties' intention that payments will be made in a
manner, if reasonably possible, to avoid the excise taxes of Section 280G, but
does not expressly require a reduction of payments to avoid the excise taxes.
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<PAGE>
Heritage intends to offer employment contracts to the four Western Holdings
officers named above which, if accepted, would supersede the existing agreements
and eliminate the severance payments described in the preceding paragraphs for
this merger.
In addition, the merger agreement provides Western Holdings directors and
officers with certain rights to indemnification by Heritage.
EFFECT ON WESTERN HOLDINGS' EMPLOYEE BENEFIT PLANS
Western Holdings employees will be eligible to participate in Heritage's
employee benefit plans. Heritage may require Western Holdings to terminate one
or more of its employee benefits plans immediately before the closing.
ACCOUNTING TREATMENT
The parties expect to account for the merger under the pooling of interests
method of accounting. Under this method of accounting, Western Holdings' assets
and liabilities will be reflected on Heritage's future financial statements at
their historic book values, and the financial statements of Heritage will be
restated to combine their balance sheets and income statements as though they
had been a combined company for the periods reported.
CERTAIN FEDERAL INCOME TAX CONSEQUENCES
Western Holdings and Heritage expect that the merger will have the following
consequences for federal income tax purposes:
- The merger will not result in any recognized gain or loss to Western
Holdings or Heritage, and Heritage will succeed to the carryover basis and
the holding period of the assets of Western Holdings;
- Except for any cash received in lieu of any fractional share or on account
of dissenting shares, holders of Western Holdings common stock who receive
Heritage common stock in exchange for their shares of Western Holdings
common stock will not recognize any gain or loss;
- The holding period of Heritage common stock issued in exchange for Western
Holdings common stock for federal income tax purposes will include the
holding period of the Western Holdings common stock for which it is
exchanged, assuming that the shares of Western Holdings common stock are
capital assets in the hands of the holder at the effective date; and
- The basis of the Heritage common stock received in the exchange will be
the same as the basis of the Western Holdings common stock for which it
was exchanged, less any basis attributable fractional shares for which
cash is received.
A shareholder who perfects dissenters' rights and receives payment for his
or her shares will be treated as if the shares were redeemed. In general, if the
shares are held as a capital asset at the time of the merger, the dissenting
shareholder will recognize a capital gain or loss measured by the difference
between the amount of cash received and the basis of the shares in the hands of
the dissenting shareholder. However, if the dissenting shareholder owns,
directly or indirectly through the application of Section 318 of the Internal
Revenue Code, any shares of common stock as to which dissenters' rights are not
exercised and perfected and which are therefore exchanged for Heritage common
stock in the merger, the shareholder may be treated as having received a
dividend in the amount of cash paid to the shareholder in exchange for the
shares as to which dissenter's rights were perfected. Under Section 318 of the
Code, an individual is deemed to own stock that is actually owned (or deemed to
be owned) by certain members of his or her family (spouse, children,
grandchildren and parents, with certain exceptions) and other related parties,
including, for example, certain entities in
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<PAGE>
which the individual has a direct or indirect interest (including partnerships,
estates, trusts and corporations), as well as stock that such individual (or a
related person) has the right to acquire upon exercise of an option or
conversion right held by such individual (or a related person). Each shareholder
who intends to dissent from the merger (see "The Merger--Dissenters' rights of
appraisal" below) should consult his or her own tax advisor with respect to the
application of the constructive ownership rules to the shareholder's particular
circumstances.
For federal tax purposes, the highest marginal tax rate for individuals on
ordinary income is 39.6%, compared to 20% for capital gain, and the highest
marginal tax rate for corporations is 35% on ordinary income and capital gain.
Capital losses are treated differently than ordinary losses. Essentially, a
capital loss for any taxable year may be deducted by a corporation in that year
only to the extent of capital gain, and by an individual in that year only to
the extent of capital gain plus up to $3,000 of ordinary income. Capital losses
not deductible in the year they occur may be carried forward indefinitely by
individuals and may be carried back up to three years and forward up to five
years by corporations.
This document does not provide information about the tax consequences of the
merger under any state, local or foreign tax laws. We urge shareholders to
consult their own tax advisors with respect to all tax consequences of the
merger. Western Holdings and Heritage will not bear any expenses incurred by any
shareholder arising from disputes with the IRS or any state or foreign tax
agency over the tax consequences of the merger.
DISSENTERS' RIGHTS OF APPRAISAL
Shareholders of Western Holdings and Heritage may be entitled to certain
dissenters' appraisal rights if they perfect their rights in accordance with
Chapter 13 of the California General Corporation Law. Relevant excerpts of
Chapter 13 are included as Appendix C. The following discussion is not a
complete statement of the law relating to dissenters' rights and is qualified in
its entirety by reference to Appendix C. This discussion and Appendix C should
be reviewed carefully by any shareholder of who wishes to exercise dissenters'
rights or who wishes to preserve the right to do so, since failure to comply
with the procedures prescribed in Chapter 13 will result in the loss of
dissenters' rights. The parties may not complete the merger if holders of more
than 9% of the outstanding Western Holdings shares perfect their dissenters'
rights.
WESTERN HOLDINGS
If the merger is consummated, those shareholders of Western Holdings who
elect to exercise their dissenters' rights and who in a timely and proper
fashion perfect such rights will be entitled to receive the "fair market value"
of their shares in cash. "Fair market value" would be determined as of May 9,
2000, the day before the first announcement of the terms of the merger, and
therefore would not include any appreciation or depreciation caused by the
merger. The board of directors of Western Holdings has determined that the fair
market value of Western Holdings common stock for this purpose is $11.00. See
"Summary--comparative per common share data" on page 17.
In order to qualify for dissenters' rights, a Western Holdings shareholder
must not vote in favor of the merger and must make a written demand on Western
Holdings within 30 days after Western Holdings mails to shareholders the notice
of approval of the merger.
If the merger is approved, Western Holdings will, within ten days after the
meeting, mail to any shareholder who did not vote for the merger a notice that
the required shareholder approval of the merger was obtained. This notice of
approval will state the price determined by Western Holdings to represent the
"fair market value" of any dissenting shares and a brief description of the
procedures to be followed by dissenting shareholders who wish to pursue further
their statutory rights. The dissenting shareholder must deliver his or her share
certificate for receipt by Western Holdings within 30 days
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<PAGE>
after the date on which the notice of approval was mailed to the shareholder.
Western Holdings will stamp or endorse the certificate with a statement that the
shares are dissenting shares and return it to the dissenting shareholder. The
statements in the notice of approval will constitute an offer by Western
Holdings to purchase from its shareholders any dissenting shares at the price
stated, but only if the merger is consummated. However, the determination by
Western Holdings of fair market value is not binding on its shareholders.
A Western Holdings shareholder who does not accept Western Holdings'
determination of fair market value must send a written demand to Western
Holdings Bancorp, 4546 El Camino Real, Los Altos, California 94022, Attention:
Corporate Secretary. The written demand must state the number and class of
shares held of record by such shareholder which the shareholder demands that
Western Holdings purchase for cash, and it must contain a statement of the
amount which the shareholder claims to be the fair market value of the
dissenting shares as of the day before announcement of the proposed merger. That
statement will constitute an offer by the shareholder to sell his or her
dissenting shares to Western Holdings at that price.
If Western Holdings and a dissenting shareholder do not agree on the other's
proposed purchase price, the shareholder has the right for six months following
the mailing of the notice of approval to file a lawsuit to have the fair market
value determined by a court. The fair market value of dissenting shares as
determined by the court in those circumstances could be higher or lower than the
amount offered by Western Holdings in the notice of approval or the
consideration provided for in merger agreement, and any such determination would
be binding on the dissenting shareholder or shareholders involved in the lawsuit
and on Western Holdings and Heritage. Any party may appeal from the judgment.
However, the court action to determine the fair market value of shares will be
suspended if litigation is instituted to test the sufficiency or regularity of
the votes of the shareholders in authorizing the merger. No shareholder who has
appraisal rights under Chapter 13 will have any right to attack the validity of
the merger except in an action to test whether the number of shares required to
authorize the merger has been legally voted in favor of the merger.
Dissenting Western Holdings shares may lose their status as such if any of
the following events occurs:
- the merger is abandoned (in which case Western Holdings must pay on demand
to dissenting shareholders who have initiated proceedings in good faith as
provided under Chapter 13 all necessary expenses and reasonable attorneys'
fees incurred in such proceedings);
- the dissenting shares are transferred before being submitted to Western
Holdings for endorsement;
- the dissenting shareholder withdraws his or her demand with the consent of
Western Holdings; or,
- in the absence of agreement between the dissenting shareholder and Western
Holdings as to the price of his or her shares, the Western Holdings
shareholder fails to file suit or otherwise fails to become a party to
such suit within six months following the mailing of the notice of
approval.
The receipt of a cash payment for dissenting shares will result in
recognition of gain or loss for federal and California state income tax purposes
by dissenting shareholders. See "The Merger--Certain federal income tax
consequences" on page 35.
HERITAGE
Dissenters' rights will be available to the shareholders of Heritage only if
the conditions described below are satisfied. Dissenters' rights entitle
shareholders to receive an amount equal to the fair market
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<PAGE>
value of their shares as of May 9, 2000, the last business day before the public
announcement of the merger. The closing sales price for Heritage common stock on
that day was $10.88.
In order to be entitled to exercise dissenters' rights, a shareholder of
Heritage must vote AGAINST the merger. If the shareholder returns a proxy
without voting instructions or with instructions to abstain or vote for the
merger, his or her shares will automatically be voted in favor of the merger and
the shareholder will lose any dissenters' rights. In the event of a broker
non-vote of his or her shares held in street name, the shareholder will also
lose any dissenters' rights.
To preserve dissenters' rights, a Heritage shareholder must also make a
written demand on Heritage for the purchase of dissenting shares and payment to
the shareholder of their fair market value, specifying the number of shares held
by the shareholder and a statement of what the shareholder claims to be the fair
market value of those shares as of May 9, 2000. The demand must be addressed to
Heritage Commerce Corp, Attention: Rebecca Levey, Corporate Secretary, 150
Almaden Boulevard, San Jose, California 95113, and must be received by Heritage
NOT LATER THAN THE DATE OF HERITAGE'S SPECIAL MEETING. A vote against the merger
does not constitute the written demand.
No dissenters' rights will be available unless holders of at least five
percent of Heritage common stock vote against the merger and submit the required
demand before the meeting. If holders of five percent or more of the outstanding
shares submit the required demand and the merger is approved by the
shareholders, Heritage will have 10 days after the approval to send to those
shareholders who have voted against the merger written notice of the approval
accompanied by a copy of Chapter 13, a statement of the price determined by
Heritage to represent the fair market value of the dissenting shares as of
May 9, 2000, and a brief description of the procedure to be followed if a
shareholder desires to exercise dissenters' rights. Within 30 days after the
date on which the notice of the approval is mailed, the dissenting shareholder
must surrender to Heritage, at the office designated in the notice of approval,
the certificates representing the dissenting shares. Heritage will stamp or
endorse them with a statement that they are dissenting shares or exchange them
for certificates of appropriate denomination so stamped or endorsed. Any shares
of Heritage common stock that are transferred prior to their submission for
endorsement lose their status as dissenting shares.
If Heritage and the dissenting shareholder agree that the surrendered shares
are dissenting shares and agree on the purchase price, the dissenting
shareholder will be entitled to the agreed price with interest at the legal rate
on judgments from the date of the agreement. Heritage will pay the fair market
value of the dissenting shares within 30 days after the price has been agreed
upon or 30 days after any statutory or contractual conditions to the merger have
been satisfied, whichever is later, subject to the surrender of the
certificates, unless provided otherwise by agreement.
If Heritage denies that the shares surrendered are dissenting shares, or
Heritage and the dissenting shareholder fail to agree on a fair market value,
then the dissenting shareholder must, within six months after the notice of
approval is mailed, file a complaint in the Superior Court of the proper county
requesting the court to make the determinations or intervene in any pending
action brought by any other dissenting shareholder. If the shareholder does not
file a complaint or intervene in a pending action within the specified six-month
period, the dissenters' rights are lost. If the fair market value of the
dissenting shares is at issue, the court will determine, or will appoint one or
more impartial appraisers to determine, the fair market value.
A dissenting shareholder may not withdraw his or her dissent or demand for
payment unless Heritage consents to the withdrawal.
RESALES OF HERITAGE COMMON STOCK
The shares of Heritage common stock to be issued to shareholders of Western
Holdings under the merger agreement have been registered under the Securities
Act of 1933 so these shares may be freely
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traded without restriction by people who will not be affiliates of Heritage
after the merger or who were not affiliates of Western Holdings on the date of
the special meeting.
All directors and executive officers of Western Holdings are affiliates of
Western Holdings for this purpose. Those people may resell shares of Heritage
common stock to be received by them in the merger only if the shares are
registered for resale under the Securities Act or an exemption from such
registration under the Securities Act is available. Those people may be
permitted to resell the Heritage shares under the safe harbor provisions of
Rule 145 under the Securities Act (or Rule 144 in the case of such persons who
become affiliates of Heritage) or as otherwise permitted under the Securities
Act.
At the time the parties signed the merger agreement, each director and
executive officer of Western Holdings executed and delivered a written agreement
to the effect that such person will not offer or sell or otherwise dispose of
any Heritage common stock received in the merger in violation of the Securities
Act or the related rules and regulations or at any time earlier than the time
permitted by pooling accounting treatment. We encourage any such person to
obtain advice of securities counsel before reselling any Heritage shares.
THE MERGER AGREEMENT
The following is a summary of the material provisions of the merger
agreement, a copy of which is attached to this document as Appendix A. The
merger agreement is incorporated by reference into this document. We urge you to
read the merger agreement in its entirety.
STRUCTURE OF THE MERGER; EFFECTIVE TIME
The merger agreement contemplates the merger of Western Holdings with and
into Heritage. Heritage will be the surviving corporation in the merger and will
continue its corporate existence under California law. Bank of Los Altos will
continue to operate as a commercial bank and wholly owned subsidiary of
Heritage. The merger will become effective upon the filing of an agreement of
merger with the Secretary of State of the State of California, or at such time
thereafter as is provided in the agreement of merger. The closing of the merger
will take place on a date to be specified by the parties, which will be the
earliest practicable day after satisfaction of all of the conditions stated in
the merger agreement, unless Heritage and Western Holdings agree to another time
or date. See "--Conditions to the completion of the merger" on page 43.
The merger agreement provides that Heritage may change the structure of the
merger, such as by initially merging Western Holdings with a different Heritage
subsidiary and later merging it with Heritage Bank of Commerce. The alternate
structure, however, may not materially and adversely affect the timing of the
merger, or adversely affect the economic benefits, the form of consideration or
the tax effect of the merger to you. At present Heritage does not contemplate
any change in the structure of the merger.
CONVERSION OF WESTERN HOLDINGS COMMON STOCK
If you are a shareholder of Western Holdings common stock as of the
effective time of the merger, each of your shares of Western Holdings common
stock will be converted into the right to receive 1.2264 shares of Heritage
common stock, subject to certain possible adjustments. Your shares of Western
Holdings common stock will no longer be outstanding and will be automatically
canceled and retired and will cease to exist. Your stock certificate previously
representing shares of Western Holdings common stock will be exchanged for a
certificate representing whole shares of Heritage common stock.
The following table indicates the exchange ratio as a function of a possible
range of average closing prices for Heritage common stock and the corresponding
merger consideration per share of Western Holdings common stock expressed in
dollars (shown as the "Exchange Amount"). No
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assurance can be given that the actual value of each share of Heritage common
stock upon completion of the merger will be equal to the average closing price
at the time of the merger.
<TABLE>
<CAPTION>
AVERAGE CLOSING PRICE OF EXCHANGE EXCHANGE
HERITAGE COMMON STOCK(1) RATIO(2),(3) AMOUNT(2),(3)
------------------------ ------------ -------------
<S> <C> <C>
$14.00 1.2264 $17.17
13.00 1.2264 15.94
12.00 1.2264 14.72
11.00 1.2264 13.49
10.00 1.2264 12.26
9.00 1.2264 11.04
8.00 1.2264 9.81
7.00 1.4014 9.81
</TABLE>
(1) This price, which will be used to determine any adjustments to the exchange
ratio, is based on the average of the closing prices of Heritage shares for
the 20 trading days ending the date Western Holdings receives notice that
the FRB has approved the merger.
(2) If Heritage's average closing price is less than $8.00, Western Holdings has
the right to terminate the merger unless Heritage agrees to increase the
exchange ratio to a figure that produces a value equivalent to 1.2264
(assuming no adjustment for additional options or shares) multiplied by
$8.00, or $9.81 per Western Holdings share.
(3) The exchange ratio of 1.2264 assumes that Western Holdings does not issue
any additional shares of common stock or grant any new options to acquire
common stock after the date of this document. For example, if Western
Holdings were to grant additional options for 30,000 shares, the exchange
ratio would be 1.2145 instead of 1.2264. In the merger agreement, Western
Holdings agrees to limit the number of new options it may grant to 1,000 per
new employee unless otherwise approved by Heritage.
You will not receive any fractional shares of Heritage common stock. If you
are entitled to a fraction of a share of Heritage common stock you will,
instead, receive an amount in cash. The cash amount will be equal to the closing
price as reported on the Nasdaq National Market for the Heritage common stock on
the trading day immediately preceding the closing date, multiplied by the
fraction of a share of Heritage common stock to which you would otherwise been
entitled. You will not be entitled to dividends, voting rights, interest on the
value of, or any other rights in respect of a fractional share. In the event
Heritage pays, declares or otherwise effects a stock split, reverse stock split,
reclassification or stock dividend or stock distribution with respect to
Heritage common stock between the date of the merger agreement and the effective
time of the merger, appropriate adjustments will be made to the average Heritage
closing price of Heritage common stock.
OPTIONS
At the effective time of the merger, each employee stock option to acquire
Western Holdings common stock which is outstanding and unexercised will be
converted automatically into an option to purchase shares of Heritage common
stock. The number of shares to be subject to the new option will be equal to the
product of the number of shares of Western Holdings common stock subject to the
original option and the exchange ratio, rounded down to the nearest share. The
exercise price per share of Heritage common stock under the new option will be
equal to the exercise price per share of Western Holdings common stock under the
original option divided by the exchange ratio. The exercise price will be
rounded up to the nearest cent. In the case of any options which are "incentive
stock options," as defined in Section 422 of the Internal Revenue Code, the
exercise price, the number of shares purchasable pursuant to such options and
the terms and conditions of such options will be
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determined in order to comply with Section 424(a) of the Internal Revenue Code.
The duration and other terms of the new options will be the same as those of the
original option.
EXCHANGE AGENT; EXCHANGE PROCEDURE
Under the merger agreement, Heritage has agreed to appoint Gemisys
Corporation or its successor, or any other bank or trust company mutually
acceptable to Western Holdings and Heritage, as exchange agent for the purpose
of exchanging certificates representing the Heritage common stock which are to
be issued pursuant to the merger agreement. As soon as practicable after the
effective time of the merger, upon the surrender of your Western Holdings shares
certificate for cancellation, you will be entitled to receive a certificate
representing the number of shares of Heritage common stock determined in
accordance with the merger agreement and a payment in cash with respect to any
fractional shares. DO NOT SEND IN YOUR CERTIFICATES AT THIS TIME. PLEASE WAIT
UNTIL YOU RECEIVE A TRANSMITTAL LETTER WITH MORE SPECIFIC INSTRUCTIONS ON
EXCHANGING YOUR CERTIFICATES.
You will not receive any dividends or other distributions of any kind which
are declared payable to shareholders of record of the shares of Heritage common
stock after the effective time of the merger until you surrender your
certificate for shares of Western Holdings common stock. Upon such surrender of
your Western Holdings certificate, you will be paid, without interest, any
dividends or other distributions with respect to the shares of Heritage common
stock as to which the record date and payment date occurred on or after the
effective time of the merger and on or before the date on which you surrendered
your certificate for shares of Western Holdings common stock.
If you would like your certificate for shares of Heritage common stock to be
issued in a name other than the name or names in which your exchanged Western
Holdings certificate is registered, you will have to pay to the exchange agent
any transfer costs, taxes or other expenses required by reason of the issuance
of certificates for such shares of Heritage common stock in a name other than
the registered holder of the exchanged Western Holdings certificate.
All dividends or distributions, and any cash to be paid instead of
fractional shares, if held by the exchange agent for payment or delivery to the
holders of unsurrendered Western Holdings certificates representing shares of
Western Holdings common stock and unclaimed at the end of one year from the
effective time of the merger, shall (together with any interest earned thereon)
at such time be paid or redelivered by the exchange agent to Heritage. After
such time, if you still have not surrendered your Western Holdings certificate,
you must look as a general creditor only to Heritage for payment or delivery of
such dividends or distributions of cash, as the case may be.
Neither Western Holding nor Heritage shall be liable to you for such shares
(or dividends or distributions thereon) or cash payable instead of fractional
shares delivered to a public official pursuant to any applicable abandoned
property, escheat or similar law.
REPRESENTATIONS AND WARRANTIES
In the merger agreement, each of Heritage and Western Holdings make certain
customary representations, including those related to the following:
- Incorporation, valid existence and authority to conduct business;
- Authorization to enter into the merger agreement, and the absence of any
material conflict between the merger agreement and other agreements to
which each is a party;
- Capital structure;
- The accuracy of information in regulatory filings;
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- The accuracy of representations in the merger agreement, financial
statements and this document;
- Compliance with applicable laws;
- Necessary licenses and permits;
- The absence of material litigation involving it;
- The adequacy of its allowance for loan losses;
- The status of its insurance coverage and claims;
- The filing of tax returns and payment of taxes;
- The performance of contractual obligations;
- Receipt of a fairness opinion from its financial adviser;
- Whether any claims or any basis for claims of indemnification by directors
and officers exists;
- The absence of hazardous materials on any of its properties; and
- Compliance with year-2000 readiness requirements.
Western Holdings makes additional representations concerning the following
matters:
- The absence of any regulatory agreements affecting it;
- Title to its assets;
- The status of its loan and investment portfolios;
- Its responsibility for broker's fees;
- Identification of all material contracts to which it is a party;
- Compliance with ERISA;
- Compliance of any loans to its officers, directors or employees with
regulatory requirements;
- The absence of any obligation to register any outstanding securities under
the federal or state securities laws; and
- The absence of any material adverse change or undisclosed liabilities.
CONDUCT OF BUSINESS PENDING THE MERGER
In the merger agreement, Heritage and Western Holdings make certain
covenants. Each agrees to the following:
- Conduct their business in the ordinary course;
- Provide each other with access to their records;
- Cooperate in preparing and filing a registration statement with the SEC to
register the Heritage common stock being offered to shareholders of
Western Holdings;
- Seek the approval of their respective shareholders;
- Cooperate in the filing of regulatory applications;
- Give each other notice of a material adverse change or other event that
might prevent the merger from occurring; and
- Cooperate in the preparation of any press releases.
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In the merger Agreement, Heritage and Western Holdings agree that, without
the prior written consent of the other party, they will not:
- Change their capital structures;
- Amend their articles of incorporation or bylaws;
- Borrow any money outside the ordinary course;
- Materially change their loan underwriting policies or procedures;
- Enter into any derivative or hedging transactions; or
- Take any action that would impair the completion of the merger or the use
of pooling accounting for the merger.
In addition, without the prior written consent of Heritage, which Heritage
will not unreasonably withhold, Western Holdings has agreed not to take any of
the following actions:
- Enter into or modify any employment or severance agreements;
- Make any new consumer loans over $350,000 or commercial loans over
$1,000,000 without prior notice to Heritage and resolution of any
objection Heritage might have;
- Acquire any securities other than short-term government securities;
- Materially change its deposit pricing policies;
- Grant any security interest on any of its assets except in the ordinary
course;
- Sell any material assets except in the ordinary course;
- Foreclose on any real property without obtaining an environmental report;
- Make any new capital expenditure in excess of $25,000; or
- Make any material changes in its asset and deposit mix.
CONDITIONS TO COMPLETION OF THE MERGER
Completion of the merger is subject to satisfaction of certain conditions.
The obligations of both parties to proceed are subject to the following
conditions:
- The absence of any injunction or other legal proceeding restraining the
merger;
- Receipt of required regulatory approvals and third party consents;
- Receipt of an order from the SEC declaring the registration statement of
Heritage effective;
- Receipt of an opinion from Heritage's counsel, McCutchen, Doyle, Brown &
Enersen, LLP that the merger will qualify as a tax-free reorganization
under the Internal Revenue Code;
- The Heritage common stock to be issued in the merger shall have been
approved for listing on the Nasdaq National Market;
- Receipt of approval by the shareholders of Western Holdings and Heritage.
- Receipt of customary legal opinions; and
- Receipt of an opinion of their respective independent accountants to the
effect that the merger will qualify for accounting treatment as a pooling
of interests.
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In addition, Heritage's obligation to complete the merger is subject to
satisfaction of the following conditions:
- The representations of Western Holdings shall be accurate;
- Western Holdings will have performed its obligations under the merger
agreement;
- No government action shall have been taken that would prevent the parties
from completing the merger or require Heritage to divest any material
portion of Western Holdings' assets;
- Western Holdings will not have suffered any material adverse change;
- No regulatory authority will have imposed any unduly burdensome condition
on its approval of the completion of the merger;
- Heritage will have received customary closing certificates of officers of
Western Holdings;
- Heritage will have received voting agreements and affiliate agreements
from the directors of Western Holdings;
- Holders of not more than 9% of outstanding Western Holdings common stock
will have perfected dissenters' right; and
- Certain employees of Western Holdings will have signed employment
agreements acceptable to Heritage.
The obligation of Western Holdings to complete the merger is subject to
satisfaction of the following conditions:
- The representations of Heritage shall be accurate;
- Heritage shall have performed its obligations under the merger agreement;
- Heritage shall not have suffered any material adverse change; and
- Western Holdings will have received customary closing certificates of
officers of Heritage.
EXTENSION; WAIVER
At any time before the closing of the merger, the parties may, to the extent
legally allowed, extend the time for the performance of any of the obligations
or other acts of the other party, waive any inaccuracies in the representations
and warranties contained in the merger agreement or in any document delivered
under it, and waive compliance with any of the agreements or conditions
contained in the merger agreement. To "waive" means to give up rights.
Any agreement on the part of a party to the merger agreement to any
extension or waiver will be valid only if included in a written instrument
signed on behalf of the party.
TERMINATION
Heritage or Western Holdings can agree at any time to terminate the merger
agreement without completing the merger, even if the shareholders of both
Heritage and Western Holdings have approved it. Also, the merger agreement can
be terminated either by our mutual agreement or by one of us if specified events
occur. If the merger agreement is terminated, the merger will not occur.
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Either Heritage or Western Holdings can terminate the merger agreement if
any of the following events occurs:
- if there has been a final judicial or regulatory determination that any
material provision of the merger agreement is illegal, invalid or
unenforceable or denying any regulatory application the approval of which
is a condition precedent to a party's obligations to complete the merger;
- if any of the conditions to the obligations of the other party to the
merger cannot be satisfied before November 30, 2000 for any reason other
than a breach by the party seeking to terminate;
- if the shareholders of Heritage or Western Holdings fail to approve the
merger agreement at their respective shareholders meeting;
- if the other party breaches any representation, warranty, covenant or
agreement and fails to cure the breach within 30 days after written notice
from the other party; or
- after November 30, 2000, if the merger has not been consummated by then,
unless the failure to consummate the merger was due to the failure of the
party requesting termination to perform an obligation under the Agreement.
Western Holdings can terminate the merger agreement during the two business
days after the date on which Heritage notifies Western Holdings of the receipt
of FRB approval of the merger if Heritage's average closing price over the 20
trading days ending on the date of notice is less than $8.00. If Western
Holdings gives notice of termination for this reason, Heritage has five business
days in which it may elect to avoid termination by, in effect, agreeing to
increase the exchange ratio of 1.2264 by multiplying it by the following
fraction:
$8.00
-------------------
Heritage's average closing price
As adjusted the exchange ratio is intended to provide to shareholders of Western
Holdings the same economic value they would have received with an exchange ratio
of 1.2264 if the price of Heritage common stock at the time were $8.00, or $9.81
per Western Holdings share.
If the merger agreement is terminated, it will become void, except that the
provisions regarding payment of expenses, confidentiality, payment of any
termination fees if applicable or any relevant general provisions of the merger
agreement will continue in effect. Also, if the merger agreement is terminated
due to a party's breach, the termination will not relieve the breaching party
from its liability and the non-breaching party will retain all of its legal
rights and remedies against the breaching party for its breach.
EXPENSES; LIQUIDATED DAMAGES
Generally, each party has agreed to bear its own expenses in this
transaction. Heritage and Western Holdings will each bear the costs of
distributing this proxy material and of conducting a meeting of its
shareholders, but each party will pay one-half of the printing costs.
If the transactions contemplated by the merger agreement are not
consummated, Western Holdings must reimburse Heritage for certain of its legal
fees and costs related to its conduct of due diligence, up to a maximum of
$100,000.
Heritage will pay the fees and costs related to the listing of the shares of
Heritage common stock for trading on the Nasdaq National Market.
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Western Holdings is required to pay Heritage $2.0 million in liquidated
damages under the following circumstances:
- if the Western Holdings meeting does not take place or the board of
directors of Western Holdings fails to recommend approval of the merger or
adversely alters or modifies its favorable recommendation; AND the
shareholders fail to vote for approval; AND Heritage is not in material
breach of the merger agreement; or
- if an acquisition proposal occurs before the Western Holdings meeting, the
shareholders of Western Holdings fail to approve the merger, AND Heritage
was not in material breach of the merger agreement, AND within 15 months
after termination of the merger agreement Western Holdings or any of its
subsidiaries either signs a definitive agreement for or consummates an
acquisition proposal.
Heritage is required to pay Western Holdings $2.0 million in liquidated
damages if Western Holdings terminates the merger agreement because Heritage
willfully or deliberately refuses to deliver to Western Holdings closing
documents under its control which are required by the merger agreement, or if
Heritage in material breach of the merger agreement refuses to consummate the
merger.
AMENDMENT
Heritage has the unilateral right, after consultation with Western Holdings,
to change the method of effecting the merger to the extent permitted by law.
However, no such change may change the amount or kind of the merger
consideration, diminish the benefits to be received by the directors, officers
or employees of Western Holdings as described in the merger agreement,
materially delay the consummation of the merger or adversely affect the tax
treatment of Western Holdings shareholders.
The parties may amend the merger agreement at any time before or after
approval of the merger agreement by the shareholders of Heritage and Western
Holdings. However, after the approval by the shareholders of Heritage and
Western Holdings, no amendment may change the form of consideration or the value
of the consideration to be received by the shareholders of Western Holdings or
which by law requires further approval by the shareholders. The merger agreement
may not be amended except by an instrument in writing signed on behalf of each
of the parties.
STOCK OPTION AGREEMENTS BETWEEN HERITAGE AND WESTERN HOLDINGS
When we signed the merger agreement we also signed two stock option
agreements. Under the stock option agreements, Western Holdings and Heritage
(each an "Option Issuer") each gave the other (each an "Option Holder") an
option to purchase common stock representing approximately 19.9% of the
outstanding shares of the party granting the option, exercisable only under
certain circumstances specified in the option. Heritage has the right to
purchase up to 549,175 shares of Western Holdings for $11.00 per share, and
Western Holdings has the right to purchase up to 1,399,877 shares of Heritage
for a per share price equal to the average of the bid and ask prices for Common
Stock for the five trading days preceding the execution of the merger agreement,
or approximately $10.52. Western Holdings and Heritage each agreed to grant
these options in order to induce the other to enter into the merger agreement.
The options could have the effect of discouraging other companies from trying to
acquire Western Holdings or Heritage before completion of the merger. The
following is a summary of the material provisions of the stock option
agreements, which are attached as Appendix D to this document. We urge you to
read them.
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EXERCISE OF STOCK OPTIONS
Except as otherwise noted below, the terms and conditions of the two stock
options are identical in all material respects. An Option Issuer is not required
to issue shares upon exercise of an option until all legal requirements have
been fulfilled.
Each stock option provides that the Option Holder may elect to exercise its
option in whole or in part only after the occurrence of one of the following
purchase events:
- an Option Issuer or any of its subsidiaries, without prior written consent
of the Option Holder, recommends, publicly announces an intention to
recommend, or enters into an agreement with any person (other than the
Option Holder or any of its subsidiaries) to effect any of the following
acquisition transactions:
(1) a merger, consolidation or similar transaction involving the Option
Issuer or any of its subsidiaries,
(2) a purchase, lease or other acquisition of all or substantially all
of the assets of the Option Issuer, or
(3) a purchase or other acquisition (by merger, consolidation, share
exchange or any similar transaction) of securities representing 10% or more
of the voting shares of the Option Issuer,
- any person or group of persons acting in concert (other than the Option
Issuer or any of its subsidiaries) acquires the beneficial ownership of
or the right to acquire securities representing 24.99% or more of the
voting shares of the Option Issuer;
- the shareholders of the Option Issuer fail to approve the merger at a
shareholders meeting held for that purpose, such a shareholders meeting
fails to occur prior to termination of the merger agreement, or the
Option issuer's board of directors withdraws or modifies (in a manner
adverse to an Option Holder) its recommendation to shareholders that
they approve the merger, in each case after there has been a public
announcement that any person (other than the Option Holder or any of
its subsidiaries), has
(1) made, or publicly disclosed an intention to make, a proposal to
engage in an acquisition transaction,
(2) commenced a tender offer or filed a registration statement under the
Securities Act of 1933 with respect to an exchange offer, or
(3) filed an application or notice with the DFI or other federal or
state bank regulatory authority, which is been accepted for processing, for
approval to engage in an acquisition transaction;
- any person (other than the Option Holder or other than in connection
with a transaction to which the Option Holder has given its prior
written consent) has filed an application or notice with the DFI or
other federal or state bank regulatory authority, which is accepted for
processing, for approval to engage in an acquisition transaction,
exchange offer or tender offer;
- the Option Issuer has willfully breached any covenant or obligation in
the merger agreement in anticipation of engaging in a purchase event
entitling the Option Holder to terminate the merger agreement; or
- the Option Issuer makes a public announcement of its proposed or actual
authorization, recommendation or endorsement of an acquisition
transaction, exchange offer or tender offer.
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"Exchange offer" and "tender offer" mean the commencement by any person of,
or the filing by any person of a registration statement or a tender offer
schedule with the SEC with respect to a tender offer or exchange offer to
acquire or control 10% or more of the Option Issuer's stock (other than filings
by the Option Holder or any of its subsidiaries).
TERMINATION OF STOCK OPTIONS
Each Option Holder's stock option will terminate to the extent not
previously exercised upon the earliest to occur of:
- the effective time of the merger,
- termination of the merger agreement in accordance with its terms before a
purchase event occurs (except a termination due to a breach of the merger
agreement by the Option Issuer), or
- 12 months after the termination of the merger agreement or after the
occurrence of a purchase event, whichever is earlier.
ADJUSTMENT OF NUMBER OF SHARES SUBJECT TO OPTIONS
The number and type of securities subject to the option and the purchase
price of shares will be adjusted for any stock split, reverse split, dividend,
exchange of shares or similar transaction relating to the common stock of the
Option Issuer, so that the Option Holder will receive upon exercise the same
number and type of securities as if the option had been exercised immediately
before the change. The number of shares subject to an option will also be
adjusted if the Option Issuer issues additional common stock, so that the number
of shares of common stock subject to the option represents 19.9% of issued and
outstanding common stock of the Option Issuer.
In the event of a capital reorganization, merger or consolidation of the
Option Issuer with or into another corporation, or the sale of all or
substantially all of its assets to any other person, then, as a part of any such
transaction, provision will be made so that the Option Holder will be entitled
to receive an option of the succeeding corporation or any person that controls
the succeeding corporation having a comparable value to the previous option.
REPURCHASE OF OPTIONS AND OPTION SHARES
A party can require the Option Issuer to repurchase the option or the shares
of common stock received upon exercise of the option for one year after a
repurchase event occurs. A repurchase event occurs whenever an Option Issuer
enters into an agreement:
(1) to consolidate with or merge into any person (other than the Option
Holder or one of its subsidiaries), and is not the surviving corporation,
(2) to permit any person (other than the Option Holder or one of its
subsidiaries), to merge into the Option Issuer and the Option Issuer shall be
the surviving corporation and, as a result, the Option Issuer's outstanding
shares are changed into or exchanged for stock or other securities of itself or
another person, or cash or any other property, or its outstanding shares
immediately prior to the merger represent less than 50% of the outstanding
shares and share equivalents of the merged company; or
(3) to sell or otherwise transfer all or substantially all of its assets to
any person, (other than the Option Holder or one of its subsidiaries).
The one-year period may be extended for any period during which the Option
Issuer is legally prohibited from making the repurchase.
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The repurchase price for the repurchase of shares is the highest of:
- 100% of the option exercise price,
- the highest price paid or agreed to be paid for the Option Issuer's stock
by the acquiror in any tender offer, exchange offer or other transaction
or series of related transactions involving the acquisition of 10% or more
of the Option Issuer's of common stock for the prior one-year period; and
- in the event of a sale of all or substantially all of the Option Issuer's
assets, the sum of the sale price and the current market value of the
Option Issuer's remaining assets, divided by the Option Issuer's
outstanding shares.
In case of a repurchase of the option, the Option Holder is entitled to
receive the foregoing purchase price less the option exercise price for each
share.
REGISTRATION RIGHTS
The Option Holder has certain rights to require the Option Issuer to
register with the SEC the sale of the Option Issuer's common stock purchased
pursuant to option exercise.
EFFECT OF STOCK OPTION AGREEMENTS
The stock options are intended to increase the likelihood that the merger
will be completed under the merger agreement. As a result, certain aspects of
the options may have the effect of discouraging persons who might now or before
completion of the merger be interested in acquiring all of or a significant
interest in Heritage or Western Holdings, even if they were prepared to offer
higher consideration for Western Holdings than that provided in the merger
agreement.
OPERATIONS FOLLOWING THE MERGER
Upon completion of the merger, the board of directors of Heritage will have
15 members. Before closing, the existing Heritage board will select 11 directors
from its current board, and the Western Holdings board will select four
directors from its current board.
Heritage will operate Bank of Los Altos as a separate bank subsidiary
following completion of the merger. Although we cannot assure you that any
specific level of cost savings will be achieved or as to the timing thereof,
Heritage currently expects to achieve certain cost savings in combined
operations through consolidation of branch operations and certain back-office
positions following completion of the merger.
UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
The following unaudited pro forma condensed combined financial statements
give effect to the merger of Heritage and Western Holdings on a
pooling-of-interests accounting method. The unaudited pro forma condensed
combined balance sheet assumes the merger took place on March 31, 2000 after
giving effect to adjustments. The unaudited pro forma condensed combined
statements of income assume the merger was consummated as of the beginning of
the first period presented. Share information was calculated using a pro forma
exchange ratio of 1.2264, which is the exchange ratio that would have applied if
the merger had been completed on March 31, 2000.
These unaudited pro forma condensed combined financial statements should be
read in conjunction with the historical consolidated financial statements and
the related notes of Heritage and Western Holdings included or incorporated by
reference in this document. The unaudited pro forma condensed combined
statements of income are not necessarily indicative of operating results which
would have been achieved had the merger been consummated as of the beginning of
the first period presented and should not be construed as representative of
future operations.
49
<PAGE>
HERITAGE AND WESTERN HOLDINGS
UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET
AS OF MARCH 31, 2000
<TABLE>
<CAPTION>
WESTERN PRO FORMA
HERITAGE HOLDINGS ADJUSTMENTS(1) COMBINED
(DOLLARS IN THOUSANDS) -------- -------- -------------- ---------
<S> <C> <C> <C> <C>
ASSETS:
Cash and due from banks................................. $ 23,310 $ 12,078 $(1,345) $ 34,043
Federal funds sold...................................... 82,050 21,645 -- 103,695
-------- -------- ------- --------
Total cash and cash equivalents....................... 105,360 33,723 (1,345) 137,738
Securities available-for-sale, at fair value............ 33,892 45,530 -- 79,422
Securities held to maturity, at amortized cost.......... 13,823 8,751 -- 22,574
Loan held for sale, at fair value....................... 25,960 -- -- 25,960
Loans, net of deferred fees............................. 310,005 133,402 -- 443,407
Allowance for probable loan losses...................... (5,616) (1,588) -- (7,204)
-------- -------- ------- --------
Loans, net............................................ 304,389 131,814 -- 436,203
Premises and equipment, net............................. 3,351 3,165 -- 6,516
Accrued interest receivable and other assets............ 4,816 3,524 -- 8,340
Other investments....................................... 14,014 2,984 -- 16,998
-------- -------- ------- --------
Total............................................... $505,605 $229,491 $(1,345) $733,751
======== ======== ======= ========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Liabilities:
Deposits
Demand, noninterest bearing......................... $140,738 $ 44,146 $ -- $184,884
Demand, interest bearing............................ 12,231 40,798 -- 53,029
Savings and money market............................ 157,059 68,908 -- 225,967
Time deposits, under $100,000....................... 46,288 20,690 -- 66,978
Time deposits, $100,000 and over.................... 92,519 41,295 -- 133,814
-------- -------- ------- --------
Total deposits........................................ 448,835 215,837 -- 664,672
Mandatorily redeemable cumulative trust preferred
securities of Subsidiary Grantor Trust.............. 7,000 -- -- 7,000
Accrued interest payable and other liabilities........ 4,222 1,290 -- 5,512
-------- -------- ------- --------
Total liabilities..................................... 460,057 217,127 -- 677,184
-------- -------- ------- --------
Commitments and contingencies
Shareholders' equity:
Preferred stock, no par value;........................ -- -- -- --
Common stock, no par value;........................... 41,036 10,196 -- 51,232
Accumulated other comprehensive loss, net of taxes.... (174) (1,256) -- (1,430)
Retained earnings..................................... 4,686 3,424 (1,345) 6,765
-------- -------- ------- --------
Total shareholders' equity............................ 45,548 12,364 (1,345) 56,567
-------- -------- ------- --------
Total............................................... $505,605 $229,491 $(1,345) $733,751
======== ======== ======= ========
</TABLE>
50
<PAGE>
HERITAGE AND WESTERN HOLDINGS
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENTS OF INCOME
THREE MONTHS ENDED MARCH 31, 2000
<TABLE>
<CAPTION>
WESTERN PRO FORMA
HERITAGE HOLDINGS ADJUSTMENTS COMBINED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) ---------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
INTEREST INCOME:
Loans, including fees........................ $ 8,271 $ 3,111 -- $ 11,382
Investment securities........................ 634 724 -- 1,358
Other interest income........................ 976 275 -- 1,251
---------- ---------- -------- -----------
Total interest income...................... 9,881 4,110 -- 13,991
---------- ---------- -------- -----------
INTEREST EXPENSE:
Deposits..................................... 3,413 1,386 -- 4,799
Other........................................ 20 40 -- 60
---------- ---------- -------- -----------
Total interest expense..................... 3,433 1,426 -- 4,859
---------- ---------- -------- -----------
Net interest income before provision for
probable loan losses....................... 6,448 2,684 -- 9,132
Provision for probable loan losses........... 600 80 -- 680
---------- ---------- -------- -----------
Net interest income after provision for
probable loan losses....................... 5,848 2,604 -- 8,452
NONINTEREST INCOME:
Service charges on deposit accounts.......... 102 69 -- 171
Other operating income....................... 381 170 -- 551
---------- ---------- -------- -----------
Total noninterest income................... 483 239 -- 722
NONINTEREST EXPENSE:
Salaries and employee benefits............... 2,867 1,148 -- 4,015
Occupancy expense............................ 342 201 -- 543
Equipment expense............................ 203 128 -- 331
Other operating expense...................... 1,321 580 -- 1,901
---------- ---------- -------- -----------
Total noninterest expense.................. 4,733 2,057 -- 6,790
---------- ---------- -------- -----------
Income before income tax..................... 1,598 786 -- 2,384
Provision for income taxes................... 560 307 -- 867
---------- ---------- -------- -----------
Net income................................... $ 1,038 $ 479 -- $ 1,517
========== ========== ======== ===========
EARNINGS PER SHARE:(2)
Basic........................................ $ 0.15 $ 0.18 -- $ 0.15
Diluted...................................... $ 0.13 $ 0.17 -- $ 0.13
Weighted average common shares outstanding--
Basic...................................... 7,034,615 2,732,752 618,685 10,386,062
Weighted average common shares outstanding--
Diluted.................................... 7,703,507 2,903,217 657,288 11,264,012
</TABLE>
51
<PAGE>
HERITAGE AND WESTERN HOLDINGS
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31, 1999
<TABLE>
<CAPTION>
WESTERN PRO FORMA
HERITAGE HOLDINGS ADJUSTMENTS COMBINED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) ---------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
INTEREST INCOME:
Loans, including fees........................ $ 25,727 $ 11,049 -- $ 36,776
Investment securities........................ 2,370 2,935 -- 5,305
Other interest income........................ 3,124 247 -- 3,371
---------- ---------- -------- -----------
Total interest income...................... 31,221 14,231 -- 45,452
---------- ---------- -------- -----------
INTEREST EXPENSE:
Deposits..................................... 10,409 4,093 -- 14,502
Other........................................ 35 861 -- 896
---------- ---------- -------- -----------
Total interest expense..................... 10,444 4,954 -- 15,398
---------- ---------- -------- -----------
Net interest income before provision for
probable loan losses....................... 20,777 9,277 -- 30,054
Provision for probable loan losses........... 1,911 287 -- 2,198
---------- ---------- -------- -----------
Net interest income after provision for
probable loan losses....................... 18,866 8,990 -- 27,856
NONINTEREST INCOME:
Service charges on deposit accounts.......... 343 119 -- 462
Other operating income....................... 4,641 914 -- 5,555
---------- ---------- -------- -----------
Total noninterest income................... 4,984 1,033 -- 6,017
NONINTEREST EXPENSE:
Salaries and employee benefits............... 10,587 3,907 -- 14,494
Occupancy expense............................ 1,168 865 -- 2,033
Equipment expense............................ 1,191 485 -- 1,676
Other operating expense...................... 6,328 2,067 -- 8,395
---------- ---------- -------- -----------
Total noninterest expense.................. 19,274 7,324 -- 26,598
---------- ---------- -------- -----------
Income before income tax..................... 4,576 2,699 -- 7,275
Provision for income taxes................... 1,550 1,056 -- 2,606
---------- ---------- -------- -----------
Net income................................... $ 3,026 $ 1,643 -- $ 4,669
========== ========== ======== ===========
EARNINGS PER SHARE:(2)
Basic........................................ $ 0.46 $ 0.60 -- $ 0.47
Diluted...................................... $ 0.41 $ 0.57 -- $ 0.43
Weighted average common shares outstanding--
Basic...................................... 6,545,373 2,723,143 616,520 9,885,036
Weighted average common shares outstanding--
Diluted.................................... 7,377,399 2,901,072 656,803 10,935,274
</TABLE>
52
<PAGE>
HERITAGE AND WESTERN HOLDINGS
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
WESTERN PRO FORMA
HERITAGE HOLDINGS ADJUSTMENTS COMBINED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) ---------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
INTEREST INCOME:
Loans, including fees............................... $ 19,777 $ 8,863 $ -- $ 28,640
Investment securities............................... 5,594 2,360 -- 7,954
Other interest income............................... 1,307 307 -- 1,614
---------- ---------- -------- ----------
Total interest income............................. 26,678 11,530 -- 38,208
INTEREST EXPENSE:
Deposits............................................ 7,933 3,752 -- 11,685
Other............................................... 3 360 -- 363
---------- ---------- -------- ----------
Total interest expense............................ 7,936 4,112 -- 12,048
---------- ---------- -------- ----------
Net interest income before provision for probable
loan losses....................................... 18,742 7,418 -- 26,160
Provision for probable loan losses.................. 1,576 230 -- 1,806
---------- ---------- -------- ----------
Net interest income after provision for probable
loan losses....................................... 17,166 7,188 -- 24,354
NONINTEREST INCOME:
Service charges on deposit accounts................. 229 178 -- 407
Other operating income.............................. 1,685 1,071 -- 2,756
---------- ---------- -------- ----------
Total noninterest income.......................... 1,914 1,249 -- 3,163
NONINTEREST EXPENSE:
Salaries and employee benefits...................... 7,722 3,219 -- 10,941
Occupancy expense................................... 792 632 -- 1,424
Equipment expense................................... 828 356 -- 1,184
Other operating expense............................. 6,263 1,932 -- 8,195
---------- ---------- -------- ----------
Total noninterest expense......................... 15,605 6,139 -- 21,744
---------- ---------- -------- ----------
Income before income tax............................ 3,475 2,298 -- 5,773
Provision for income taxes.......................... 1,325 942 -- 2,267
---------- ---------- -------- ----------
Net income.......................................... $ 2,150 $ 1,356 -- $ 3,506
========== ========== ======== ==========
EARNINGS PER SHARE:(2)
Basic............................................... $ 0.37 $ 0.52 $ -- $ 0.39
Diluted............................................. $ 0.34 $ 0.47 $ -- $ 0.35
Weighted average common shares outstanding--Basic... 5,766,768 2,628,833 595,168 8,990,769
Weighted average common shares
outstanding--Diluted.............................. 6,428,442 2,824,231 639,406 9,892,079
</TABLE>
53
<PAGE>
HERITAGE AND WESTERN HOLDINGS
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
WESTERN PRO FORMA
HERITAGE HOLDINGS ADJUSTMENTS COMBINED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) ---------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
INTEREST INCOME:
Loans, including fees............................... $ 10,376 $ 6,723 -- $ 17,099
Investment securities............................... 5,275 1,357 -- 6,632
Other interest income............................... 552 250 -- 802
---------- ---------- -------- ----------
Total interest income............................. 16,203 8,330 -- 24,533
---------- ---------- -------- ----------
INTEREST EXPENSE:
Deposits............................................ 4,187 2,861 -- 7,048
Other............................................... 17 6 -- 23
---------- ---------- -------- ----------
Total interest expense............................ 4,204 2,867 -- 7,071
---------- ---------- -------- ----------
Net interest income before provision for probable
loan losses....................................... 11,999 5,463 -- 17,462
Provision for probable loan losses.................. 1,060 270 -- 1,330
---------- ---------- -------- ----------
Net interest income after provision for probable
loan losses....................................... 10,939 5,193 -- 16,132
NONINTEREST INCOME:
Service charges on deposit accounts................. 173 144 -- 317
Other operating income.............................. 465 1,347 -- 1,812
---------- ---------- -------- ----------
Total noninterest income.......................... 638 1,491 -- 2,129
NONINTEREST EXPENSE:
Salaries and employee benefits...................... 4,933 2,507 -- 7,440
Occupancy expense................................... 440 404 -- 844
Equipment expense................................... 542 237 -- 779
Other operating expense............................. 3,253 1,886 -- 5,139
---------- ---------- -------- ----------
Total noninterest expense......................... 9,168 5,034 -- 14,202
---------- ---------- -------- ----------
Income before income tax............................ 2,409 1,650 -- 4,059
Provision for income taxes.......................... 844 380 -- 1,224
---------- ---------- -------- ----------
Net income.......................................... $ 1,565 $ 1,270 -- $ 2,835
========== ========== ======== ==========
EARNINGS PER SHARE:(2)
Basic............................................... 0.29 $ 0.52 -- $ 0.34
Diluted............................................. 0.27 $ 0.48 -- $ 0.33
Weighted average common shares outstanding--Basic... 5,431,286 2,420,000 547,888 8,399,174
Weighted average common shares
outstanding--Diluted.............................. 5,744,043 2,641,991 598,147 8,984,181
</TABLE>
54
<PAGE>
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
(1) Merger Costs
The following table reflects all nonrecurring incurred and estimated
merger-related costs of Heritage and Western Holdings. Estimated merger costs
are included on the March 31, 2000 unaudited pro forma condensed combined
balance sheets as a reduction to shareholders' equity net of the related tax
benefit. Estimated merger costs will be charged to expense as incurred. These
merger costs are summarized below:
<TABLE>
<CAPTION>
HERITAGE WESTERN HOLDINGS TOTAL
-------- ---------------- ----------
<S> <C> <C> <C>
Financial advisory...................................... $ 50,000 $ 500,000 $ 550,000
Professional fees....................................... 300,000 100,000 400,000
Printing................................................ 20,000 20,000 40,000
Other................................................... -- 1,080,000 1,080,000
-------- ---------- ----------
Subtotal................................................ $370,000 $1,700,000 $2,070,000
Estimated tax benefit................................... 725,000
----------
Total................................................... $1,345,000
==========
</TABLE>
(2) Common Stock
Heritage and Western Holdings combined earnings per share and outstanding
shares are calculated as the historical Heritage weighted average shares plus
the historical Western Holdings weighted average shares adjusted for the assumed
conversion ratio of 1.2264.
INFORMATION ABOUT HERITAGE
GENERAL
Heritage is registered with the Board of Governors of the Federal Reserve
System ("FRB") as a bank holding company under the BHC Act. Heritage was
organized in 1997 to be the holding company for Heritage Bank of Commerce. In
1998 Heritage also became the holding company for Heritage Bank East Bay, and in
January 2000 Heritage became the holding company for Heritage Bank South Valley.
Heritage Bank of Commerce, Heritage Bank East Bay and Heritage Bank South Valley
are sometimes collectively referred to in this section as the "Banks."
NEW BRANCHES AND SUBSIDIARIES
Heritage's primary strategy is to establish de novo banks, branches or
representative offices in contiguous geographic areas. Heritage's, as well as
the Banks', business strategy and promotional activities emphasize service and
responsiveness to local needs.
On December 22, 1998, Heritage Bank of Commerce received authorization from
the California Department of Financial Institutions to open a full service
branch in the city of Morgan Hill, California. Heritage Bank of Commerce's board
of directors saw this geographic expansion as a continuation into Heritage Bank
of Commerce's primary market area, Santa Clara County, since Morgan Hill has a
high concentration of potential clients with banking service requirements
similar to those of Heritage Bank of Commerce's current client mix. Heritage
Bank of Commerce opened the branch on March 1, 1999.
On January 18, 2000, Heritage Bank South Valley commenced business as a
California state-chartered commercial bank and a subsidiary of Heritage in the
premises previously occupied by the Morgan Hill branch of Heritage Bank of
Commerce.
55
<PAGE>
GENERAL BANKING SERVICES
Heritage's customer base consists primarily of small to medium-sized
businesses and their owners, managers, and employees residing in Santa Clara,
Alameda, and Contra Costa counties. Businesses served include manufacturers,
distributors, contractors, professional corporations/partnerships, and service
businesses. Heritage had approximately 4,900 deposit accounts at December 31,
1999.
Heritage offers a range of loans, primarily commercial, including real
estate, construction, Small Business Administration, inventory and accounts
receivable, and equipment loans. Heritage also accepts checking, savings, and
time deposits; interest bearing and money market deposit accounts; and provides
travelers' checks, safe deposit, and other customary non-deposit banking
services. Heritage issues VISA and MasterCard credit cards through the
Independent Bankers Association. Heritage does not have a trust department.
Heritage's primary market area is Santa Clara, Alameda, and Contra Costa
counties. Heritage serves a secondary market consisting of the South Bay portion
of the San Francisco Bay area and portions of other counties contiguous to its
primary market area.
RECENT MANAGEMENT CHANGE
On June 15, 2000, John E. Rossell resigned as president and chief executive
officer of Heritage. As a result, Brad L. Smith, chairman of Heritage, assumed
the role of chief executive officer of Heritage and acting president of Heritage
Bank of Commerce, and Richard Conniff, a director of Heritage and president of
Heritage Bank East Bay, assumed the role of president and chief operating
officer of Heritage. Although Heritage expects to incur severance expenses
related to this change in the second quarter of 2000, Heritage does not expect
the change to have a material adverse effect on its financial condition or
results of operations.
COMPETITION
The banking and financial services business in California generally, and in
Heritage's market areas specifically, is highly competitive. The increasingly
competitive environment is a result primarily of changes in regulation, changes
in technology and product delivery systems, and the accelerating pace of
consolidation among financial services providers. Heritage competes for loans,
deposits and customers for financial services with other commercial banks,
savings and loan associations, securities and brokerage companies, mortgage
companies, insurance companies, finance companies, money market funds, credit
unions, and other non-bank financial service providers. Many of these
competitors are much larger in total assets and capitalization, have greater
access to capital markets and offer a broader array of financial services than
Heritage. In order to compete with the other financial services providers,
Heritage principally relies upon local promotional activities, personal
relationships established by officers, directors, and employees with its
customers, and specialized services tailored to meet its customers' needs. In
those instances where Heritage is unable to accommodate a customer's needs,
Heritage seeks to have those services provided in whole or in part by its
correspondent banks.
EMPLOYEES
At December 31, 1999, Heritage employed 139 persons, primarily on a
full-time basis. Heritage's employees are not represented by any union or
collective bargaining agreement and Heritage believes its employee relations are
satisfactory.
BRANCH OFFICES AND FACILITIES
Heritage Bank of Commerce's main and executive offices and Heritage's
offices are located at 150 Almaden Boulevard, San Jose, California 95113.
Heritage Bank East Bay is located at 3077 Stevenson
56
<PAGE>
Blvd., Fremont, California 94538, and Heritage Bank South Valley is located at
18625 Sutter Blvd., Morgan Hill, California 95037.
The main office at 150 Almaden Boulevard, San Jose, California, is leased
under non-cancelable operating leases with a non-affiliated third party with
terms, including renewal options, ranging from 5 to 14 years. The primary
operating area consists of approximately 13,500 square feet of space comprising
the entire usable ground floor and a portion of the second floor of a 15-story
class-A office building in downtown San Jose. This space also serves as the main
office of Heritage Bank of Commerce. The lease arrangement for the primary
operating area is a "partial gross lease" for 15 years commencing June 8, 1996
and expiring February 28, 2010. The monthly rent under the lease for the first
five-year term is $21,465. During the second five-year term the monthly rent
increases to $25,515 and will increase to 95 percent of fair rental value
starting from year eleven until the term expires. Provisions of the lease
include the right to early termination after 120 months.
In addition, Heritage leases approximately 1,255 square feet of space
contiguous to the primary operating area for meetings, staff training and
marketing events. The lease for this additional space commenced January 1, 1997
and expires December 31, 2001. The monthly rent for this additional space is
$2,259.
In August 1997, Heritage leased an area on the second floor of Heritage's
main office containing approximately 2,175 square feet of space. The monthly
rent is $4,024 until May 31, 2001, when the monthly rent will increase to $4,785
for the following five-year period. The rent for the period from May 31, 2006
until the end of the lease will be 95 percent of fair rental value at that time.
The lease for this additional space is coterminous with the original lease.
Heritage has also leased space at 100 Park Center Plaza, Suites 300 and 430,
San Jose, consisting of approximately 5,623 and 3,277 square feet of space. The
lease for Suite 300 commenced on June 1, 1998 and will terminate on May 31,
2003. The rent starts at $11,527 in the first year and ends at $12,651 in the
last year of the lease. The lease for Suite 430 commenced on April 21, 1997 and
terminated on April 30, 2000. The bank still continues to occupy Suite 430 on a
"holdover" basis until construction on its new facility on the third floor of
150 Almaden has been completed. During the holdover period, rent is waived under
a provision incorporated into the lease agreement for the third floor of 150
Almaden until July 15, 2000. Any rent due after July 15, 2000 should be holdover
period continue will be at market rate.
In February 1998, Heritage leased space for Heritage Bank East Bay's primary
office at 3077 Stevenson Blvd., Fremont, California, consisting of 6,590 square
feet of space in a stand-alone office building. The lease, which commenced
February 1, 1998, is for a ten-year period expiring January 2008. The rent for
the first twelve-month period is $13,180 per month, and the rent increases
annually thereafter by 4%. In addition to the space in Fremont, Heritage has
leased space at 12657 Alcosta Boulevard, San Ramon, California, for Heritage
Bank East Bay for use as a branch office. The monthly rent for this lease is
$3,231 and it expires on August 31, 2001.
In March of 1999, Heritage entered into an agreement to sublease an
additional 4,672 square feet of office space at 100 Park Center Plaza, Suite 365
in San Jose. The commencement date of the sublease was May 1, 1999 with monthly
rent payments set at $8,643 with no scheduled increases. The term of the
sublease was 10 months, expiring on February 28, 2000. The bank continues to
occupy on a direct month-to-month lease basis until construction on its new
facility on the third floor of 150 Almaden has been completed. During its
holdover period, rent is waived under a provision incorporated into the lease
agreement for the third floor of 150 Almaden until July 15, 2000. Any rent due
after July 15, 2000 will be paid at $13,081.60 per month.
Also in March of 1999, Heritage entered into an agreement to lease 7,260
square feet of office space for Heritage Bank South Valley's primary office in a
one-story building consisting of 26,353
57
<PAGE>
square feet, located at 18625 Sutter Boulevard in Morgan Hill, California. The
commencement date of the lease was November 1, 1999 with monthly rent payments
beginning at $11,447, subject to adjustments every 36 months thereafter based on
the percentage increase in the consumer price index as defined in the lease
agreement. The term of the lease is 15 years, expiring on October 31, 2014.
In September of 1999, Heritage entered into an agreement to sublease
approximately 2,700 square feet of office space in a one-story multi-tenant
building located at 310 Hartz Avenue in Danville, California in order to
relocate Heritage Bank East Bay's San Ramon office. The commencement date of the
sublease was September 15, 1999, with monthly rent payments beginning at $7,025,
subject to annual increases of 4%. The term of the sublease is approximately
7 1/2 years, expiring on December 31, 2007.
In April of 2000, Heritage leased the third floor of 150 Almaden Boulevard,
San Jose, California consisting of 12,824 square feet. The lease will expire on
February 28, 2010, coterminous with the lease for the main office. Rent
payments, which will begin in October of 2000, will be $42,319 per months,
subject to annual increase of 3%.
LEGAL PROCEEDINGS
From time to time Heritage is involved in legal proceedings in the ordinary
course of its business. In the opinion of management, no pending or threatened
litigation involving Heritage is likely to have a material adverse effect on its
financial condition or results of operations.
THE EFFECT OF GOVERNMENT POLICY ON BANKING
The earnings and growth of Heritage are affected not only by local market
area factors and general economic conditions, but also by government monetary
and fiscal policies. Such policies influence the growth of loans, investments
and deposits and also affect interest rates charged on loans and paid on
deposits. The nature and impact of future changes in such policies on the
business and earnings of Heritage cannot be predicted. Additionally, state and
federal tax policies can impact banking organizations. As a consequence of the
extensive regulation of commercial banking activities in the United States, the
business of Heritage is particularly susceptible to being affected by the
enactment of federal and state legislation which may have the effect of
increasing or decreasing the cost of doing business, modifying permissible
activities or enhancing the competitive position of other financial
institutions. Any change in applicable laws or regulations may have a material
adverse effect on the business and prospects of Heritage.
REGULATION AND SUPERVISION OF BANK HOLDING COMPANIES
The following is not intended to be an exhaustive description of the
statutes and regulations applicable to Heritage's or its subsidiary banks'
business. The description of statutory and regulatory provisions is qualified in
its entirety by reference to the particular statutory or regulatory provisions.
Moreover, major new legislation and other regulatory changes affecting Heritage,
its subsidiaries, banking, and the financial services industry in general have
occurred in the last several years and can be expected to occur in the future.
The nature, timing and impact of new and amended laws and regulations cannot be
accurately predicted. The company is a bank holding company subject to the BHC
Act. The company reports to, registers with, and may be examined by, the FRB.
The FRB also has the authority to examine Heritage's subsidiaries. The company
is also a bank holding company within the meaning of Section 3700 of the
California Financial Code. As such Heritage and its subsidiary banks are subject
to examination by, and may be required to file reports with, the Commissioner.
The FRB has significant supervisory and regulatory authority over Heritage
and its affiliates. The FRB requires Heritage to maintain certain levels of
capital. See "Capital standards" on page 62. The
58
<PAGE>
FRB also has the authority to take enforcement action against any bank holding
company that commits any unsafe or unsound practice, or violates certain laws,
regulations or conditions imposed in writing by the FRB.
Under the BHC Act, a company generally must obtain the prior approval of the
FRB before it exercises a controlling influence over a bank, or acquires
directly or indirectly more than 5% of the voting shares or substantially all of
the assets of any bank or bank holding company. Thus, Heritage is required to
obtain the prior approval of the FRB before it acquires, merges or consolidates
with any bank or bank holding company; any company seeking to acquire, merge or
consolidate with Heritage also would be required to obtain the prior approval of
the FRB. The company is generally prohibited under the BHC Act from acquiring
ownership or control of more than 5% of the voting shares of any company that is
not a bank or bank holding company and from engaging directly or indirectly in
activities other than banking, managing banks or providing services to
affiliates of the holding company.
FINANCIAL SERVICES MODERNIZATION LEGISLATION
On November 12, 1999, President Clinton signed into law the
Gramm-Leach-Bliley Act of 1999, also referred to as Financial Services
Modernization Act. The Financial Services Modernization Act repeals the two
affiliation provisions of the Glass-Steagall Act: Section 20, which restricted
the affiliation of Federal Reserve member banks with firms "engaged principally"
in specified securities activities; and Section 32, which restricts officer,
director or employee interlocks between a member bank and any company or person
"primarily engaged" in specified securities activities. In addition, the
Financial Services Modernization Act also contains provisions that expressly
preempt any state law restricting the establishment of financial affiliations,
primarily related to insurance. The general effect of the law is to establish a
comprehensive framework to permit affiliations among commercial banks, insurance
companies, securities firms, and other financial services providers by revising
and expanding the BHC Act framework to permit a holding company system to engage
in a full range of financial activities through a new entity known as a
Financial Holding Company. "Financial activities" is broadly defined to include
not only banking, insurance and securities activities, but also merchant banking
and additional activities that the FRB, in consultation with the Secretary of
the Treasury, determines to be financial in nature, incidental to such financial
activities or complementary activities that do not pose a substantial risk to
the safety and soundness of depository institutions or the financial system
generally.
Generally, the Financial Services Modernization Act:
- Repeals historical restrictions on, and eliminates many federal and state
law barriers to, affiliations among banks, securities firms, insurance
companies, and other financial services providers;
- Provides a uniform framework for the functional regulation of the
activities of banks, savings institutions and their holding companies;
- Broadens the activities that may be conducted by national banks, banking
subsidiaries of bank holding companies and their financial subsidiaries;
- Provides an enhanced framework for protecting the privacy of consumer
information;
- Adopts a number of provisions related to the capitalization, membership,
corporate governance, and other measures designed to modernize the Federal
Home Loan Bank system;
- Modifies the laws governing the implementation of the Community
Reinvestment Act, sometimes referred to as CRA; and
- Addresses a variety of other legal and regulatory issues affecting both
day-to-day operations and long-term activities of financial institutions.
59
<PAGE>
In order for a company to take advantage of the ability to affiliate with
other financial services providers, it must become a "Financial Holding Company"
as permitted under an amendment to the BHC Act. To become a Financial Holding
Company, a company would file a declaration with the FRB, electing to engage in
activities permissible for Financial Holding Companies and certifying that the
company is eligible to do so because all of its insured depository institution
subsidiaries are well-capitalized and well-managed. In addition, the FRB must
also determine that each of a holding company's insured depository institution
subsidiaries has at least a "satisfactory" CRA rating. Heritage meets the
requirements to make an election to become a Financial Holding Company and
management is examining strategic business plans to determine whether, based
upon market conditions, relative financial condition, regulatory capital
requirements, general economic conditions, and other factors, it would be
desirable to utilize any of the expanded powers provided in the Financial
Services Modernization Act. No such election has been made as of the date of
this document.
The Financial Services Modernization Act also permits national banks to
engage in expanded activities through the formation of financial subsidiaries. A
national bank may have a subsidiary engaged in any activity authorized for
national banks directly or any financial activity, except for insurance
underwriting, insurance investments, real estate investment or development, or
merchant banking, which may only be conducted through a subsidiary of a
Financial Holding Company. Financial activities include all activities permitted
under new sections of the BHC Act or permitted by regulation.
A national bank seeking to have a financial subsidiary, and each of its
depository institution affiliates, must be "well-capitalized" and
"well-managed." The total assets of all financial subsidiaries may not exceed
the lesser of 45% of a bank's total assets, or $50 billion. A national bank must
exclude from its assets and equity all equity investments, including retained
earnings, in a financial subsidiary. The assets of the subsidiary may not be
consolidated with the bank's assets. The bank must also have policies and
procedures to assess financial subsidiary risk and to protect the bank from such
risks and potential liabilities.
Management does not believe that the Financial Services Modernization Act
will have a material adverse effect on Heritage's operations in the near-term.
However, to the extent that it permits banks, securities firms and insurance
companies to affiliate, the financial services industry may experience further
consolidation. The Act may result in increased competition among smaller
companies offering financial products and larger ones, many of which may have
substantially more financial resources.
The FRB generally prohibits a bank holding company from declaring or paying
a cash dividend which would impose undue pressure on the capital of subsidiary
banks or would be funded only through borrowing or other arrangements that might
adversely affect a bank holding company's financial position. The FRB's policy
is that a bank holding company should not continue its existing rate of cash
dividends on its common stock unless its net income is sufficient to fully fund
each dividend and its prospective rate of earnings retention appears consistent
with its capital needs, asset quality and overall financial condition.
Transactions between Heritage and its bank subsidiaries are subject to a
number of other restrictions. FRB policies forbid the payment by bank
subsidiaries of management fees which are unreasonable in amount or exceed the
fair market value of the services rendered (or, if no market exists, actual
costs plus a reasonable profit). Heritage may only borrow from the banks if the
loan is secured by marketable obligations with a value of a designated amount in
excess of the loan. Further, Heritage may not sell a low-quality asset to a
depository institution subsidiary.
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<PAGE>
Comprehensive amendments to federal regulation governing bank holding
companies and change in bank control, known as Regulation Y, became effective in
1997, and are intended to improve the competitiveness of bank holding companies
by, among other things:
- expanding the list of permissible nonbanking activities in which well-run
bank holding companies may engage without prior FRB approval,
- streamlining the procedures for well-run bank holding companies to obtain
approval to engage in other nonbanking activities and
- eliminating most of the anti-tying restrictions imposed upon bank holding
companies and their nonbank subsidiaries.
Amended Regulation Y also provides for a streamlining and expedited review
process for bank acquisition proposals submitted by well-run bank holding
companies and eliminates certain duplicative reporting requirements when there
has been a further change in bank control or in bank directors or officers after
an earlier approved change. These changes to Regulation Y are subject to
numerous qualifications, limitations and restrictions. In order for a bank
holding company to qualify as "well-run," both it and the insured depository
institutions that it controls must meet the "well capitalized" and "well
managed" criteria in Regulation Y.
BANK SUPERVISION AND REGULATION
Heritage Bank of Commerce, Heritage Bank East Bay and Heritage Bank South
Valley are California chartered banks insured by the Federal Deposit Insurance
Corporation (the "FDIC"), and as such are subject to regulation, supervision and
regular examination by the DFI and the FDIC. As members of the Federal Reserve
System, the banks' primary federal regulator is the FRB. The regulations of
these agencies affect most aspects of their business and prescribe permissible
types of loans and investments, the amount of required reserves, requirements
for branch offices, the permissible scope of their activities and various other
requirements.
In addition to federal banking law, the banks are also subject to applicable
provisions of California law. Under California law, a state chartered bank is
subject to various restrictions on, and requirements regarding, its operations
and administration including the maintenance of branch offices and automated
teller machines, capital and reserve requirements, deposits and borrowings,
shareholder rights and duties, and investments and lending activities.
California law permits a state chartered bank to invest in the stock and
securities of other corporations, subject to a state-chartered bank receiving
either general authorization or, depending on the amount of the proposed
investment, specific authorization from the Commissioner. The FDIC Improvement
Act ("FDICIA"), however, imposes limitations on the activities and equity
investments of state chartered, federally insured banks. FDICIA also prohibits a
state bank from engaging as a principal in any activity that is not permissible
for a national bank, unless the bank is adequately capitalized and the FDIC
approves the activity after determining that such activity does not pose a
significant risk to the deposit insurance fund. The FDIC rules on activities
generally permit subsidiaries of banks, without prior specific FDIC
authorization, to engage in those that have been approved by the FRB for bank
holding companies because such activities are so closely related to banking to
be a proper incident thereto. Other activities generally require specific FDIC
prior approval, and the FDIC may impose additional restrictions on such
activities on a case-by-case basis in approving applications to engage in
otherwise impermissible activities.
CAPITAL STANDARDS
The federal banking agencies have risk-based capital adequacy guidelines
intended to provide a measure of capital adequacy that reflects the degree of
risk associated with a banking organization's
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<PAGE>
operations for both transactions reported on the balance sheet as assets and
transactions, such as letters of credit and recourse agreements, which are
recorded as off balance sheet items. A banking organization's risk-based capital
ratios are obtained by dividing its qualifying capital by its total
risk-adjusted assets and off balance sheet items. The regulators measure
risk-adjusted assets and off balance sheet items against both total qualifying
capital (the sum of Tier 1 capital and limited amounts of Tier 2 capital) and
Tier 1 capital. Tier 1 capital generally consists of common stock, retained
earnings, and certain types of qualifying preferred stock, less most other
intangible assets. Tier 2 capital may consist of a limited amount of the
allowance for loan and lease losses, certain types of preferred stock not
qualifying as Tier 1 capital, term subordinated debt and certain other
instruments with some characteristics of equity. The federal banking agencies
require a minimum ratio of qualifying total capital to risk-adjusted assets and
off balance sheet items of 8%, and a minimum ratio of Tier 1 capital to adjusted
average risk-adjusted assets and off balance sheet items of 4%.
In addition to the risk-based guidelines, federal banking regulators require
banking organizations to maintain a minimum amount of Tier 1 capital to adjusted
average total assets, referred to as the leverage capital ratio. For a banking
organization rated in the highest of the five categories used by regulators to
rate banking organizations, the minimum leverage ratio of Tier 1 capital to
total assets must be 3%. For all banking organizations not rated in the highest
category, the minimum leverage ratio must be at least 100 to 200 basis points
above the 3% minimum. The effective minimum leverage ratio, for all practical
purposes, must be at least 4% or 5%. As of December 31, 1999, Heritage's and the
Banks' respective ratios exceeded applicable regulatory requirements. See
"Capital Resources" on page 80.
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<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF HERITAGE
Heritage operates as the bank holding company for three subsidiary banks:
Heritage Bank of Commerce, Heritage Bank East Bay and Heritage Bank South Valley
(collectively the "Banks"). All are California state chartered banks which offer
a full range of commercial and personal banking services to residents and the
business/professional community in Santa Clara, Contra Costa and Alameda
counties, California. The accounting and reporting policies of Heritage Company
and its subsidiary banks conform to generally accepted accounting principles and
prevailing practices within the banking industry. The following discussion
should be read in conjunction with the consolidated financial statements and
notes thereto of Heritage which are included in this document and in the annual
report on Form 10-K which is incorporated by reference.
On January 27, 1999, Heritage's board of directors announced the declaration
of a 3-for-2 stock split effective for shareholders of record on February 5,
1999, and paid on February 19, 1999. On February 21, 2000, a 10 percent stock
dividend was paid to shareholders of record as of February 7, 2000. All
historical financial information has been restated as if the stock split and
stock dividend had been in effect for all periods presented.
RESULTS OF OPERATIONS
OVERVIEW
Net income for the three months ended March 31, 2000 was $1,038,000, up 66%
or $411,000 from $627,000 for the first quarter of 1999. Earnings per diluted
share for the first quarter of 2000 were $0.13, up 44% or $0.04 from $0.09 per
diluted share for the prior year period.
Net income for the year ended December 31, 1999 was $3,026,000, or $0.41 per
share (diluted) compared to $2,150,000 or $0.34 per share (diluted) and
$1,565,000 or $0.27 per share (diluted) for the years ended December 31, 1998
and 1997, respectively. The increase in 1999 over 1998 was primarily
attributable to the sale of the Internet credit card business and the growth in
the level of interest-earning assets, funded by new deposits at favorable
weighted average interest rates, as well as to improvements in the mix of
earning assets in favor of higher yielding assets, such as loans. The increase
in 1998 over 1997 was primarily a result of the mix and the growth in
interest-earning assets funded by new deposits at favorable rates.
For the first quarter of 2000 as compared with the same period of the
previous year, net interest income grew by $1,455,000 or 29%. Net interest
income for 1999 was up $2,035,000, or 11%, over 1998, net interest income for
1998 was up $6,743,000 or 56% over 1997. The improvement occurred primarily as a
result of growth that occurred in the Company's interest-earning assets.
Average interest earning assets for 1999 were up 23% over 1998. The increase
was primarily attributable to growth in loans offset by a reduction in the
average yields earned on loans. Average interest bearing liabilities for 1999
were up 29% over 1998, with the increase primarily attributable to growth in
interest bearing demand deposits, savings and money market accounts, time
deposits and brokered deposits. The average rate earned on interest-earning
assets was 8.48% in 1999, 8.89% in 1998 and 8.33% in 1997. The average rate paid
on interest bearing liabilities increased to 4.09% in 1999, up from 3.99% in
1998 and 3.49% in 1997. As a result, net interest margin was 5.64% in 1999,
compared to 6.24% in 1998 and 6.17% in 1997. The net interest margin was 5.99%
for the quarter ended March 31, 2000, compared with 6.06% for the quarter ended
March 31, 1999.
At March 31, 2000, noninterest income decreased $741,000, compared to
March 31, 1999, primarily due to gains on sale of securities in the first
quarter of 1999 of $771,000. Total noninterest income increased $3,070,000, or
160%, in 1999 from 1998, following an increase of $1,276,000, or 200%, in 1998
from 1997. Although many of the company's deposit accounts maintain balances at
a level which
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<PAGE>
service fees are not charged, fee income rose 50% in 1999 from 1998 following an
increase of 32% in 1998 over 1997, primarily due to the increase in total
deposits. Other components of noninterest income such as gain on sale of
securities available-for-sale rose 27% in 1999 from 1998 following an increase
of 382% in 1998 over 1997. Gains on sale of deposits and the Internet credit
card portfolio in 1999 were $240,000 and $289,000, respectively. Heritage, as a
policyholder of a life assurance company, received a one-time pre-tax gain of
$530,000 in 1999 as a result of the demutualization of that company. Internet
servicing revenue related to the credit card portfolio was $1,576,000 in 1999.
At March 31, 2000, noninterest expense increased $146,000, compared to
March 31, 1999. Total noninterest expenses increased $3,669,000, or 24%, in 1999
from 1998, following an increase of $6,743,000, or 56%, in 1998 from 1997. The
increase in noninterest expenses, primarily in salaries and benefits, was
attributable to an increase in the number of employees to support the growth of
the company.
Total assets as of March 31, 2000 were $505,605,000, an increase of
$147,237,000, or 41%, from March 31, 1999, and an increase of $28,941,000, or
6%, from total assets of $476,664,000 at December 31, 1999. Total deposits as of
March 31, 2000 were $448,835,000, an increase of $126,789,000, or 39%, from
March 31, 1999, and an increase of $30,295,000, or 7%, from total deposits of
$418,540,000 at December 31, 1999.
Total portfolio loans as of March 31, 2000 were $310,005,000, an increase of
$78,731,000, or 34%, compared to March 31, 1999. Total portfolio loans as of
December 31, 1999 were $271,855,000. The Company's allowance for loan losses was
$5,616,000, or 1.81%, of total loans as of March 31, 2000. This compares with an
allowance for loan losses of $4,277,000, or 1.85%, and $5,003,000, or 1.84% of
total loans at March 31, 1999 and December 31, 1999, respectively.
The company's nonperforming assets, comprised of loans past due 90 days or
more, were $1,333,000 as of March 31, 2000. Nonperforming assets were $2,269,000
as of March 31, 1999. As of December 31, 1999, nonperforming assets increased
slightly to $1,396,000 from $1,288,000 as of December 31, 1998. As a result of
the increase in total assets being greater than this increase, nonperforming
assets as a percent of total assets declined to 0.30% as of December 31, 1999,
compared to 0.32% in the previous year. Net loan charge-offs during 1999 were
0.30% of average loans outstanding, compared to 0.02% in 1998 and 0.19% in 1997.
Shareholders' equity at March 31, 2000 increased to $45,548,000 from
$30,929,000 as of March 31, 1999, as a result of the proceeds from the sale of
stock in 1999 and retention of earnings. Book value per share was $6.47 as of
March 31, 2000, compared to $5.06 as of March 31, 1999. The leverage capital
ratio was at 11.3% at March 31, 2000. This compared with a leverage ratio of
8.3% at March 31, 1999.
The Company's shareholders' equity at December 31, 1999 was $44,531,000,
compared with $30,697,000 as of December 31, 1998, a 45% increase which reflects
current year earnings and the $11.2 million common stock offering in 1999. Book
value per share was $6.33 as of December 31, 1999, compared to $5.02 as of
December 31, 1998. The Company's leverage capital ratio increased to 9.4% at
December 31, 2000, from 7.5% at December 31, 1998.
Annualized return on average equity for the quarter ended March 31, 2000 was
9.23%, compared to 8.20% for the same period in 1999. Return on average equity
in 1999 was 8.26%, compared to 8.22% in 1998 and 7.38% in 1997. The increase in
1999 over 1998 was the result of the increased earnings offset by the increase
in average equity of $10,493,000 primarily as a result of the stock offering
completed in 1999. Return on average assets for the quarter ended March 31, 2000
was 0.89% compared to 0.69% for the same period in 1999. Return on average
assets in 1999 increased to 0.75% from 0.65% in 1998. Return on average assets
was 0.74% in 1997.
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NET INTEREST INCOME AND NET INTEREST MARGIN
The following tables present the average balance sheet, net interest income
and the resultant yields for the periods presented:
<TABLE>
<CAPTION>
THREE MONTHS ENDED THREE MONTHS ENDED
MARCH 31, 2000 MARCH 31, 1999
------------------------------ ------------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
BALANCE EXPENSE RATE BALANCE EXPENSE RATE
(DOLLARS IN THOUSANDS) -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Assets:
Loans, gross............................... $317,420 $8,271 10.48% $248,042 $6,031 9.86%
Investments securities..................... 45,472 634 5.61% 56,957 797 5.67%
Federal funds sold......................... 70,282 976 5.59% 28,984 336 4.70%
-------- ------ ----- -------- ------ ----
Total interest earning assets............ $433,174 $9,881 9.17% $333,983 $7,164 8.70%
-------- ------ ----- -------- ------ ----
Cash and due from banks.................... 18,906 17,040
Premises and equipment, net................ 3,350 3,233
Other assets............................... 10,326 13,362
-------- --------
Total assets............................. $465,756 $367,618
======== ========
Liabilities and shareholders' equity:
Deposits:
Demand, interest bearing................... $ 11,922 $ 38 1.30% $ 9,464 $ 34 1.46%
Savings and money market................... 142,402 1,425 4.02% 131,273 987 3.05%
Time deposits, under $100,000.............. 47,287 641 5.45% 32,591 426 5.30%
Time deposits, $100,000 and over........... 85,319 1,153 5.43% 52,678 630 4.85%
Brokered deposits.......................... 10,403 157 6.05% 6,167 83 5.46%
Other borrowings........................... 1,818 19 4.36% 911 11 4.91%
-------- ------ ----- -------- ------ ----
Total interest bearing liabilities....... $299,151 $3,433 4.62% $233,084 $2,171 3.78%
-------- ------ ----- -------- ------ ----
Demand deposits............................ 117,590 96,908
Other liabilities.......................... 3,790 6,583
-------- --------
Total liabilities........................ 420,531 336,575
Shareholders' equity....................... 45,225 31,043
-------- --------
Total liabilities and shareholders'
equity................................. $465,756 $367,618
======== ========
Net interest income / margin............... $6,448 5.99% $4,993 6.06%
====== ======
</TABLE>
------------------------
Note: Gross loans include nonaccrual loans of $1,333,000 and $2,269,000 for the
three month periods ended March 31, 2000 and 1999. Yields and amounts
earned on loans include loan fees of $707,000 and $455,000 for the three
month periods ended March 31, 2000 and 1999, respectively. Interest income
is reflected on an actual basis, not a fully taxable equivalent basis, and
does not include a fair value adjustment.
The Company's net interest income for the first quarter of 2000 was
$6,448,000, an increase of $1,455,000 or 29% over the first quarter of 1999. The
increase was attributable primarily to an increase in average loans and federal
funds sold, funded by the increases in savings and time deposits. The net
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<PAGE>
yield on interest earning assets was 5.99% in the first quarter of 2000,
compared to 6.06% in the first quarter of 1999.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------------------------
1999 1998 1997
------------------------------ ------------------------------ ------------------------------
INTEREST AVERAGE INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
BALANCE EXPENSE RATE BALANCE EXPENSE RATE BALANCE EXPENSE RATE
(DOLLARS IN THOUSANDS) -------- -------- -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS:
Loans, gross................... $261,298 $25,727 9.85% $180,950 $19,777 10.93% $100,691 $10,376 10.31%
Investment securities.......... 45,096 2,370 5.26 93,944 5,594 5.95 83,671 5,275 6.27
Federal funds sold............. 61,853 3,124 5.05 25,309 1,307 5.16 10,233 552 5.39
-------- ------- ----- -------- ------- ----- -------- ------- -----
Total interest-earning
assets....................... $368,247 $31,221 8.48% $300,203 $26,678 8.89% $194,595 $16,203 8.33%
-------- ------- ----- -------- ------- ----- -------- ------- -----
Cash and due from banks........ 17,161 21,465 13,961
Premises and equipment, net.... 3,252 2,841 1,756
Other assets................... 14,224 6,893 2,350
-------- -------- --------
Total assets................. $402,884 $331,402 $212,662
======== ======== ========
LIABILITIES AND SHAREHOLDERS'
EQUITY:
Deposits:
Demand, interest bearing....... $ 9,476 $ 133 1.40% $ 7,368 $ 137 1.86% $ 4,988 $ 95 1.91%
Savings and money-market....... 133,890 4,562 3.41 122,157 4,230 3.46 80,168 2,401 3.00
Time deposits, under
$100,000..................... 38,295 2,046 5.34 16,638 878 5.28 7,530 361 4.79
Time deposits, $100,000
and over..................... 64,696 3,160 4.88 48,861 2,463 5.04 27,314 1,330 4.87
Brokered deposits.............. 8,812 508 5.76 3,826 225 5.88 -- -- --
Other borrowings............... 458 35 7.64 41 3 7.32 297 17 5.72
-------- ------- ----- -------- ------- ----- -------- ------- -----
Total interest bearing
liabilities................ $255,627 $10,444 4.09% $198,891 $ 7,936 3.99% $120,297 $ 4,204 3.49%
-------- ------- ----- -------- ------- ----- -------- ------- -----
Demand deposits................ 106,397 102,558 69,376
Other liabilities.............. 4,213 3,800 1,782
-------- -------- --------
Total liabilities............ 366,237 305,249 191,455
Shareholders' equity........... 36,647 26,153 21,207
-------- -------- --------
Total liabilities and
shareholders' equity......... $402,884 $331,402 $212,662
======== ======== ========
Net interest income / margin... $20,777 5.64% $18,742 6.24% $11,999 6.17%
======= ======= =======
</TABLE>
------------------------------
Note: Gross loans include nonaccrual loans of $1,396,000 for 1999, $1,288,000
for 1998 and none for 1997. Yields and amounts earned on loans include
loan fees of $1,961,000, $1,500,000 and $709,000 for the years ended
December 31, 1999, 1998, and 1997. Interest income is reflected on an
actual basis, not a fully taxable equivalent basis. The yield on
investment securities does not include a fair value adjustment.
Net interest income for the year ended December 31, 1999 was $20,777,000, an
increase of $2,035,000 (or 11%) over the $18,742,000 reported for 1998. Net
interest income for the year ended December 31, 1998 was an increase of
$6,743,000 (or 56%) over the $11,999,000 reported for 1997. The increase in 1999
over 1998 occurred primarily as a result of growth that occurred in earning
assets offset by the decrease in yields, primarily on loans. Average interest
earning assets were $368,247,000 in 1999, up $68,044,000 (or 23%) from the
average of $300,203,000 for 1998. Average interest earning assets in 1998 were
up $105,608,000 (or 54%) from the average of $194,595,000 for 1997. The net
yield on interest earning assets in 1999 was 5.64%, compared to 6.24% in 1998
and 6.17% in 1997.
The following tables show the changes in interest income resulting from
changes in the volume of interest-earning assets and interest-bearing
liabilities and changes in the average rates earned and paid. The total change
is shown in the column designated "Net Change" and is allocated in the columns
to
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the left, to the portions attributable to volume changes and rate changes that
occurred during the period indicated. Changes due to both volume and rate have
been allocated to the change in volume.
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
2000 VS. 1999
------------------------------------------
INCREASE (DECREASE) DUE TO CHANGE IN:
------------------------------------------
AVERAGE VOLUME AVERAGE RATE NET CHANGE
(IN THOUSANDS) -------------- ------------ ----------
<S> <C> <C> <C>
INTEREST EARNING ASSETS:
Loans, gross.......................................... $1,790 $450 $2,240
Investments securities................................ (162) (1) (163)
Federal funds sold.................................... 572 68 640
------ ---- ------
Total interest earning assets........................... $2,200 $517 $2,717
====== ==== ======
INTEREST BEARING LIABILITIES:
Demand, interest bearing.............................. $ 8 $ (4) $ 4
Money Market and Savings.............................. 108 330 438
Time deposits, under $100,000......................... 198 17 215
Time deposits, $100,000 and over...................... 439 84 523
Brokered Deposits..................................... 63 11 74
Other borrowings...................................... 10 (2) 8
------ ---- ------
Total interest bearing liabilities...................... 826 436 1,262
------ ---- ------
Net interest income..................................... $1,374 $ 81 $1,455
====== ==== ======
</TABLE>
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------------------------------------
1999 VERSUS 1998 1998 VERSUS 1997
-------------------------------- --------------------------------
INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
CHANGE IN: CHANGE IN:
-------------------------------- --------------------------------
AVERAGE AVERAGE AVERAGE AVERAGE
VOLUME RATE NET CHANGE VOLUME RATE NET CHANGE
(IN THOUSANDS) -------- -------- ---------- -------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
INTEREST EARNING ASSETS:
Loans, gross......................... $ 7,903 $(1,953) $ 5,950 $ 8,771 $ 630 $ 9,401
Investment securities................ (2,571) (653) (3,224) 616 (297) 319
Federal funds sold................... 1,846 (29) 1,817 779 (24) 755
------- ------- ------- ------- ----- -------
Total interest earning assets.......... $ 7,178 $(2,635) $ 4,543 $10,166 $ 309 $10,475
======= ======= ======= ======= ===== =======
INTEREST BEARING LIABILITIES:
Demand, interest bearing............. $ 30 $ (34) $ (4) $ 44 $ (2) $ 42
Savings and money-market............. 396 (64) 332 1,456 373 1,829
Time deposits, under $100,000........ 1,158 10 1,168 480 37 517
Time deposits, $100,000 and over..... 776 (79) 697 1,086 47 1,133
Brokered deposits.................... 288 (5) 283 225 -- 225
Other borrowings..................... 32 -- 32 (19) 5 (14)
------- ------- ------- ------- ----- -------
Total interest bearing liabilities..... $ 2,680 $ (172) $ 2,508 $ 3,272 $ 460 $ 3,732
------- ------- ------- ------- ----- -------
Net interest income.................... $ 4,498 $(2,463) $ 2,035 $ 6,894 $(151) $ 6,743
======= ======= ======= ======= ===== =======
</TABLE>
PROVISIONS FOR PROBABLE LOAN LOSSES
During the first quarter of 2000, the provision for loan losses was
$600,000, down $43,000 from $643,000 for the first quarter of 1999.
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<PAGE>
During 1999, the provision for loan losses was $1,911,000, up $335,000 (or
21%) from $1,576,000 for 1998. The provision for 1998 was up $516,000 (or 49%)
from $1,060,000 during 1997. The increase in the provision for 1999 and 1998
reflected the overall growth in the loan portfolio and the change in the mix of
loans.
The allowance for loan losses was 1.81% of total loans at March 31, 2000,
and 1.85% at March 31, 1999. The allowance for loan losses was 1.84%, 1.62%, and
1.92% of total loans at December 31, 1999, 1998, and 1997. See "Allowance for
probable loan losses" on page 76 for additional information.
NONINTEREST INCOME
The following tables indicate the various components of the company's
noninterest income for the periods indicated:
<TABLE>
<CAPTION>
INCREASE (DECREASE)
THREE MONTHS ----------------------
ENDED MARCH 31, 2000 VERSUS 1999
---------------------- ----------------------
2000 1999 AMOUNT PERCENT
(DOLLARS IN THOUSANDS) -------- -------- -------- --------
<S> <C> <C> <C> <C>
Other investment income................. $174 $ 80 $ 94 118%
Service charges and other fees.......... 102 69 33 48%
Gain on sale of loans................... 52 46 6 13%
Servicing income........................ 7 -- 7 --
Gain on sale of securities
available-for-sale.................... -- 771 (771) (100)%
Other income............................ 148 258 (110) (43)%
---- ------ ----- ----
Total................................... $483 $1,224 $(741) (61)%
==== ====== ===== ====
</TABLE>
The decrease in noninterest income for the quarter ended March 31, 2000 from
the first quarter of 1999 was primarily the result of a $771,000 gain on sale of
securities available-for-sale recognized in the first quarter of 1999. There
were no securities sold in the first quarter of 2000.
<TABLE>
<CAPTION>
INCREASE (DECREASE)
-----------------------------------------
YEARS ENDED DECEMBER 31, 1999 VERSUS 1998 1998 VERSUS 1997
------------------------------------ ------------------- -------------------
1999 1998 1997 AMOUNT PERCENT AMOUNT PERCENT
(DOLLARS IN THOUSANDS) -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Servicing income.............................. $1,576 $ -- $ -- $1,576 -- $ -- --
Gain on securities............................ 1,004 790 164 214 27% 626 382%
Gain on sale of shares of demutualized life
insurance company........................... 530 -- -- 530 -- -- --
Service charges and other fees................ 343 229 173 114 50 56 32
Gain on sale of Internet credit card
portfolio................................... 289 -- -- 289 -- -- --
Other investment income....................... 274 226 48 48 21 178 371
Gain on sale of deposits...................... 240 -- -- 240 -- -- --
Gain on sale of loans......................... 143 332 205 (189) (57) 127 62
Other income.................................. 585 337 48 248 74 289 602
------ ------ ---- ------ --- ------ ---
Total......................................... $4,984 $1,914 $638 $3,070 160% $1,276 200%
====== ====== ==== ====== === ====== ===
</TABLE>
The increase in noninterest income for the year ended December 31, 1999 from
1998 was primarily due to increased servicing income from the Internet credit
card portfolio (up $1,576,000), gain on sale of shares of a demutualized life
insurance company (up $530,000), gain on sale of the Internet credit card
portfolio (up $289,000), gain on sale of deposits (up $240,000), gains on sale
of securities available-for-sale (up $214,000), and other income (up $248,000).
The increase in noninterest income for the year ended December 31, 1998 from
1997 was primarily the result of gains recognized on the sale of securities (up
$626,000) and an increase in other
68
<PAGE>
investment income (up $178,000). The sale of securities reflected favorable
market conditions for selling securities. The increase in other investment
income was primarily due to the company's investment in certain life insurance
contracts.
NONINTEREST EXPENSE
The following tables indicate the various components of the company's
noninterest expenses for the periods indicated:
<TABLE>
<CAPTION>
THREE INCREASE (DECREASE)
MONTHS ENDED ----------------------
MARCH 31, 2000 VERSUS 1999
---------------------- ----------------------
2000 1999 AMOUNT PERCENT
(DOLLARS IN THOUSANDS) -------- -------- -------- --------
<S> <C> <C> <C> <C>
Salaries and benefits.................. $2,867 $2,422 $ 445 18%
Client services........................ 369 661 (292) (44)%
Occupancy.............................. 342 232 110 47%
Loan origination costs................. 206 116 90 78%
Furniture and equipment................ 203 297 (94) (32)%
Professional fees...................... 185 170 15 9%
Advertising and promotion.............. 89 149 (60) (40)%
Stationery & supplies.................. 65 79 (14) (18)%
Telephone expense...................... 63 50 13 26%
All other.............................. 344 411 (67) (17)%
------ ------ ----- ---
Total.................................. $4,733 $4,587 $ 146 3%
====== ====== ===== ===
</TABLE>
<TABLE>
<CAPTION>
INCREASE (DECREASE)
-----------------------------------------
YEARS ENDED DECEMBER 31, 1999 VERSUS 1998 1998 VERSUS 1997
------------------------------------ ------------------- -------------------
1999 1998 1997 AMOUNT PERCENT AMOUNT PERCENT
(DOLLARS IN THOUSANDS) -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Salaries and benefits................... $10,587 $ 7,722 $4,933 $2,865 37% $2,789 57%
Client services......................... 1,527 2,426 1,169 (899) (37) 1,257 108
Professional fees....................... 1,217 718 372 499 69 346 93
Furniture and equipment................. 1,191 828 542 363 44 286 53
Occupancy............................... 1,168 792 440 376 47 352 80
Advertising and promotion............... 826 786 450 40 5 336 75
Loan origination costs.................. 539 449 326 90 20 123 38
Stationery & supplies................... 300 247 144 53 21 103 72
Telephone expense....................... 208 172 95 36 21 77 81
All other............................... 1,711 1,465 697 246 17 768 110
------- ------- ------ ------ --- ------ ---
Total................................... $19,274 $15,605 $9,168 $3,669 24% $6,437 70%
======= ======= ====== ====== === ====== ===
</TABLE>
The increase in noninterest expenses for the first quarter of 2000 from the
first quarter of 1999 reflects the growth in infrastructure to support loan and
deposit growth and the opening of Heritage Bank South Valley.
The increase in salaries and benefits expenses was primarily attributable to
both an increase in salaries and an increase in the number of employees to
support loan and deposit growth. The company employed 147 people at March 31,
2000, up five from 142 employees at March 31, 1999. Client services expenses are
related to certain deposits at the company and include courier and armored car
costs, imprinted check costs, and other client services costs, all of which are
directly related to the level of deposits in these accounts. The expense
decreased from the prior year due to lower balances in these specific accounts
in the first quarter of 2000. The increase in occupancy expense was primarily
attributable to the opening of Heritage Bank South Valley.
69
<PAGE>
Total noninterest expenses increased $3,699,000, or 24%, in 1999 from 1998,
following an increase of $6,437,000, or 70%, in 1998 from 1997. The primary
increase in salaries and benefits was attributable to an increase in the number
of employees to support loan and deposit growth. The increase in furniture and
equipment expenses and in occupancy expenses was primarily attributable to an
increase in the number of employees and new banking locations. The increase in
professional fees was primarily due to consultants the company used for a
variety of ongoing projects.
INCOME TAXES
The company files consolidated federal and combined state income tax
returns. Amounts provided for income tax expense are based on income reported
for financial statement purposes and do not necessarily represent amounts
currently payable under tax laws.
The provision for income taxes for the three months ended March 31, 2000 was
$560,000 compared to $360,000 for the first quarter of 1999. The difference in
the effective tax rate compared to the statutory tax rate and the reduction in
the effective tax rate is primarily the result of the company's investment in
certain life insurance contracts and municipal securities.
Provisions for income taxes were $1,550,000, $1,325,000, and $844,000, for
the years ended December 31, 1999, 1998, and 1997, respectively. The company's
effective tax rates were 33.8%, 38.1%, and 35.0% for the years ended
December 31, 1999, 1998, and 1997, respectively. The lower effective tax rate
was due to the purchase of additional corporate owned life insurance policies on
executive officers of the Company and of municipal securities.
FINANCIAL CONDITION
SECURITIES PORTFOLIO
The following table sets forth the carrying value of investment securities
at the dates indicated:
<TABLE>
<CAPTION>
DECEMBER 31,
MARCH 31, ------------------------------
2000 1999 1998 1997
(IN THOUSANDS) ---------- -------- -------- --------
<S> <C> <C> <C> <C>
Securities available-for-sale (at fair value)
U.S. Treasury.......................................... $20,840 $11,003 $40,123 $35,671
U.S. Agencies.......................................... 6,726 -- 3,051 16,572
Municipals............................................. 6,326 5,353 2,708 4,663
Preferred stock........................................ -- -- 2,072 2,260
Commercial paper....................................... -- -- 2,295 2,000
------- ------- ------- -------
Total securities available-for-sale.................. $33,892 $16,356 $50,249 $61,166
======= ======= ======= =======
Securities held-to-maturity (at amortized cost)
U.S. Treasury.......................................... $ -- $ -- $ 2,034 $ 4,048
U.S. Agencies.......................................... -- -- 1,509 6,033
Municipals............................................. 13,823 13,834 23,001 16,450
------- ------- ------- -------
Total securities held-to-maturity...................... $13,823 $13,834 $26,544 $26,531
======= ======= ======= =======
</TABLE>
70
<PAGE>
The following tables summarize the amounts and distribution of the company's
investment securities and the weighted average yields as of the dates indicated:
<TABLE>
<CAPTION>
MARCH 31, 2000
MATURITY
-------------------------------------------------------------------------------------
AFTER ONE YEAR AFTER FIVE YEARS
AND WITHIN AND WITHIN
WITHIN ONE YEAR FIVE YEARS TEN YEARS AFTER TEN YEARS
------------------- ------------------- ------------------- -------------------
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
(DOLLARS IN THOUSANDS) -------- -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Securities
available-for-sale:
Agencies.................... $ -- -- $ 6,746 6.83% $ -- -- $ -- --
U.S. Treasury............... 6,033 4.92% 14,948 6.11% -- -- -- --
Municipals--taxable......... 380 6.51% -- -- -- -- -- --
Municipals--nontaxable...... -- -- -- -- 4,509 4.76% 1,525 5.02%
------ ---- ------- ---- ------- ---- ------ ----
Total
available-for-sale...... $6,413 5.01% $21,694 6.33% $ 4,509 4.76% $1,525 5.02%
Securities held-to-maturity:
Municipals--taxable......... $1,880 6.34% $ 4,013 6.54% $ 514 6.45% $ -- --
Municipals--nontaxable...... -- -- 604 4.90% 6,202 4.50% 610 4.62%
------ ---- ------- ---- ------- ---- ------ ----
Total held-to-maturity.... $1,880 6.34% $ 4,617 6.33% $ 6,716 4.65% $ 610 4.62%
------ ---- ------- ---- ------- ---- ------ ----
Total..................... $8,293 5.31% $26,311 6.33% $11,225 4.69% $2,135 4.91%
====== ==== ======= ==== ======= ==== ====== ====
<CAPTION>
MARCH 31, 2000
MATURITY
-------------------
TOTAL
AMORTIZED COST
-------------------
AMOUNT YIELD
(DOLLARS IN THOUSANDS) -------- --------
<S> <C> <C>
Securities
available-for-sale:
Agencies.................... $ 6,746 6.83%
U.S. Treasury............... 20,981 5.77%
Municipals--taxable......... 380 6.51%
Municipals--nontaxable...... 6,034 4.83%
------- ----
Total
available-for-sale...... $34,141 5.82%
Securities held-to-maturity:
Municipals--taxable......... $ 6,407 6.47%
Municipals--nontaxable...... 7,416 4.54%
------- ----
Total held-to-maturity.... $13,823 5.43%
------- ----
Total..................... $47,964 5.71%
======= ====
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1999
MATURITY
-------------------------------------------------------------------------------------
AFTER ONE YEAR AFTER FIVE YEARS
AND WITHIN AND WITHIN
WITHIN ONE YEAR FIVE YEARS TEN YEARS AFTER TEN YEARS
------------------- ------------------- ------------------- -------------------
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
(DOLLARS IN THOUSANDS) -------- -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Securities
available-for-sale:
U.S. Treasury............... $3,012 4.79% $ 8,101 5.28% $ -- --% $ -- --%
Municipals--taxable......... -- -- 380 6.51 -- -- -- --
Municipals--tax exempt...... -- -- -- -- 4,236 4.76 828 4.5
------ ---- ------- ---- ------- ---- ------ ----
Total
Available-for-sale...... $3,012 4.79% $ 8,481 5.34% $ 4,236 4.76% $ 828 4.5%
Securities held-to-maturity:
Municipals--taxable......... $1,880 6.30% $ 4,021 6.54% $ 515 6.45% $ -- --%
Municipals--tax exempt...... -- -- 461 4.86 6,346 4.51 611 4.62
------ ---- ------- ---- ------- ---- ------ ----
Total held-to-maturity.... $1,880 6.30% $ 4,482 6.37% $ 6,861 4.66% $ 611 4.62%
------ ---- ------- ---- ------- ---- ------ ----
Total Securities.......... $4,892 5.37% $12,963 5.69% $11,097 4.74% $1,439 4.55%
====== ==== ======= ==== ======= ==== ====== ====
<CAPTION>
DECEMBER 31, 1999
MATURITY
-------------------
TOTAL
AMORTIZED COST
-------------------
AMOUNT YIELD
(DOLLARS IN THOUSANDS) -------- --------
<S> <C> <C>
Securities
available-for-sale:
U.S. Treasury............... $11,113 5.15%
Municipals--taxable......... 380 6.51
Municipals--tax exempt...... 5,064 4.73
------- ----
Total
Available-for-sale...... $16,557 5.05%
Securities held-to-maturity:
Municipals--taxable......... $ 6,416 6.46%
Municipals--tax exempt...... 7,418 4.54
------- ----
Total held-to-maturity.... $13,834 5.43%
------- ----
Total Securities.......... $30,391 5.22%
======= ====
</TABLE>
------------------------------
Note: Yields on tax exempt municipal securities are not presented on a fully tax
equivalent basis.
During 1999, the company transferred approximately $11,670,000 of certain
securities from the held-to-maturity to available-for-sale classification as
allowed by SFAS No. 133, "Accounting for Derivative Instrument and Hedging
Activities." The gross realized and gross unrealized gains or losses on the
securities transferred were not significant.
As of December 31, 1999, the only securities of a single issuer for which
the aggregate book value of the company's investment exceeded 10% of
shareholders' equity were direct obligations of the U.S. government or U.S.
government agencies.
The company pledges securities to meet requirements imposed as a condition
of deposit by some depositors, such as political subdivisions (public funds) or
of other funds such as bankruptcy trustee deposits. Securities with amortized
cost of $9,080,000 at March 31, 2000, $11,100,000 at December 31, 1999 and
$43,296,000 at December 31, 1998 were pledged to secure public and certain other
deposits as
71
<PAGE>
required by law or contract. The reduction in pledged securities at
December 31, 1999 was attributable to the sale of the bankruptcy trustee deposit
business in the first quarter of 1999.
LOANS
Total gross loans increased 14% to $310,174,000 at March 31, 2000, compared
to $271,931,000 at December 31, 1999. The increase in loan balances was due to
the business development efforts of the company's loan teams.
The loan portfolio is based in commercial (primarily to companies engaged in
manufacturing, wholesale and service businesses) and real estate lending, with
the balance in consumer loans. However, while no specific industry concentration
is considered significant, the company's lending operations are located in the
company's market areas that are dependent on the technology and real estate
industries and their supporting companies. Real estate values in portions of
Santa Clara County and neighboring San Mateo County are among the highest in the
country at present. The company's borrowers could be adversely impacted by a
downturn in these sectors of the economy which could reduce the demand for loans
and adversely impact the borrowers' abilities to repay their loans.
The following table presents loans outstanding at the dates indicated by
loan type:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------------------------------------------
MARCH 31, % OF % OF % OF % OF
(DOLLARS IN 2000 TOTAL 1999 TOTAL 1998 TOTAL 1997 TOTAL 1996
THOUSANDS) ---------- -------- -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial, financial
and agricultural...... $124,717 40% $117,918 43% $ 79,567 34% $ 54,468 46% $37,724
Real estate--land and
construction.......... 87,868 28% 68,152 25 49,270 21 25,780 21 11,918
Real estate--mortgage... 95,490 31% 83,698 31 57,216 24 38,446 32 26,070
Installment loans/credit
card.................. 2,099 1% 2,163 1 50,349 21 824 1 558
-------- -------- -------- -------- -------- ------- -------- --- -------
Total loans........... 310,174 100% $271,931 100% $236,402 100% $119,518 100% $76,270
Deferred loan fees...... (169) (76) (95) (113) (79)
Allowance for loan
losses................ (5,616) (5,003) (3,825) (2,285) (1,402)
-------- -------- -------- -------- -------- ------- -------- --- -------
Loans, net.............. $304,389 $266,852 $232,482 $117,120 $74,789
======== ======== ======== ======== =======
<CAPTION>
DECEMBER 31,
------------------------------
% OF % OF
(DOLLARS IN TOTAL 1995 TOTAL
THOUSANDS) -------- -------- --------
<S> <C> <C> <C>
Commercial, financial
and agricultural...... 49% $19,172 50%
Real estate--land and
construction.......... 16 5,105 13
Real estate--mortgage... 34 13,345 35
Installment loans/credit
card.................. 1 735 2
--- ------- ---
Total loans........... 100% $38,357 100%
Deferred loan fees...... (14)
Allowance for loan
losses................ (572)
--- ------- ---
Loans, net.............. $37,771
=======
</TABLE>
The change in the loan portfolio is primarily due to the increase in the
commercial and real estate loan portfolio offset by a decline in the consumer
portfolio resulting from the sale of the Internet credit card portfolio in 1999.
Commercial loans are made for the purpose of providing working capital,
financing the purchase of equipment or for other business purposes. Such loans
include loans with maturities ranging from 30 days to one year and "term loans,"
with maturities normally ranging from one to 25 years. Short-term business loans
are generally intended to finance current transactions and typically provide for
periodic principal payments, with interest payable monthly. Term loans normally
provide for floating interest rates, with monthly payments of both principal and
interest.
The company is an active participant in the SBA and California guaranteed
lending programs, and has been approved by the SBA as a lender under the
Preferred Loan Program. The company regularly makes SBA-guaranteed loans, the
guaranteed portion of which the company holds for possible resale in the
secondary market. In the event of the sale of a guaranteed portion SBA loan, the
company retains the servicing rights for the sold portion. As of March 31, 2000,
the company serviced $8.1 million in SBA loans for others. As of December 31,
1999, 1998, and 1997, the company serviced $8.4 million, $9.1 million, and
$6.0 million in SBA loans for others. The company generally considers its SBA
loans to be investment loans, but has from time to time sold the guaranteed
portion of some loans.
72
<PAGE>
Real estate term loans consist primarily of loans made based on the
borrower's cash flow and are secured by deeds of trust on commercial and
residential property to provide a secondary source of repayment. It is the
company's policy to restrict real estate term loans to no more than 80% of the
lower of the property's appraised value or the purchase price of the property,
depending on the type and use of property. The company offers both fixed and
floating rate loans. Maturities on such loans are generally restricted to
between five and seven years (on an amortization schedule ranging from 15 to
25 years with a balloon payment due at maturity). However, SBA and certain other
real estate loans easily sold in the secondary market may be granted for longer
maturities.
Real estate land and construction loans are primarily interim loans made to
finance the construction of commercial and single family residential properties.
These loans are typically short term. The company utilizes underwriting
guidelines to assess the likelihood of repayment from sources such as sale of
the property or permanent mortgage financing before making the construction
loan.
The company makes consumer loans for the purpose of financing automobiles,
various types of consumer goods and other personal purposes. The company also
offers equity lines of credit and equity loans. Consumer loans generally provide
for the monthly payment of principal and interest. Most consumer loans are
secured by the personal property being purchased, or, in the instances of equity
loans or lines, real property.
With certain exceptions, the company's subsidiary banks are permitted to
make extensions of its credit to any one borrowing entity up to 15% of a bank's
capital and reserves for unsecured loans and up to 25% of the bank's capital and
reserves for secured loans. For Heritage Bank of Commerce, these lending limits
were $8.5 million and $5.1 million at December 31, 1999. For Heritage Bank East
Bay, these lending limits were $1.6 million and $1.0 million at December 31,
1999. Heritage Bank South Valley had not yet commenced operations at
December 31, 1999.
The company does not have any concentrations in its loan portfolio by
industry or group of industries. However, 57% and 46% of its net loans were
secured by real property as of December 31, 1999 and 1998, respectively.
The following table shows the maturity distribution of the company's loans
at the dates indicated. The table also shows the distribution of such loans
between those loans with predetermined (fixed) interest rates and those with
variable (floating) interest rates. Floating rates generally fluctuate with
changes in the prime rate as reflected in the western edition of The Wall Street
Journal. At March 31, 2000 and December 31, 1999, approximately 82% and 79% of
the company's loan portfolio consisted of floating interest rate loans.
<TABLE>
<CAPTION>
MARCH 31, 2000
-------------------------------------------------------------
OVER ONE YEAR
DUE IN BUT LESS THAN
ONE YEAR OR LESS FIVE YEARS OVER FIVE YEARS TOTAL
(IN THOUSANDS) ---------------- ------------- --------------- --------
<S> <C> <C> <C> <C>
Commercial, financial and agricultural... $116,485 $ 7,618 $ 445 $124,548
Real estate--land and construction....... 87,768 100 -- 87,868
Real estate--mortgage.................... 40,297 39,765 15,428 95,490
Installment loans/credit card............ 1,190 902 7 2,099
-------- ------- ------- --------
Total loans............................ $245,740 $48,385 $15,880 $310,005
======== ======= ======= ========
Loans with variable interest rates....... $236,413 $18,814 $ 416 $255,643
Loans with fixed interest rates.......... 9,327 29,571 15,464 54,362
-------- ------- ------- --------
Total loans............................ $245,740 $48,385 $15,880 $310,005
======== ======= ======= ========
</TABLE>
------------------------
Note: Total shown is net of deferred loan fees of $169,000 at March 31, 2000.
73
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31, 1999
-------------------------------------------------------------
OVER ONE YEAR
DUE IN BUT LESS THAN
ONE YEAR OR LESS FIVE YEARS OVER FIVE YEARS TOTAL
(IN THOUSANDS) ---------------- ------------- --------------- --------
<S> <C> <C> <C> <C>
Commercial, financial and agricultural... $110,111 $ 7,030 $ 701 $117,842
Real estate--land and construction....... 66,499 1,653 -- 68,152
Real estate--mortgage.................... 32,431 32,526 18,741 83,698
Installment loans/credit card............ 1,219 934 10 2,163
-------- ------- ------- --------
Total loans............................ $210,260 $42,143 $19,452 $271,855
======== ======= ======= ========
Loans with variable interest rates....... $200,989 $13,993 $ 881 $215,863
Loans with fixed interest rates.......... 9,271 28,150 18,571 55,992
-------- ------- ------- --------
Total loans............................ $210,260 $42,143 $19,452 $271,855
======== ======= ======= ========
</TABLE>
------------------------
Note: Total shown is net of deferred loan fees of $76,000 as of December 31,
1999.
NONPERFORMING ASSETS
Nonperforming assets consist of nonaccrual loans, loans past due 90 days and
still accruing, troubled debt restructurings and other real estate owned. The
following table shows nonperforming assets at the dates indicated
<TABLE>
<CAPTION>
DECEMBER 31,
MARCH 31, ----------------------------------------------------
2000 1999 1998 1997 1996 1995
(DOLLARS IN THOUSANDS) --------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Nonaccural loans.................................. $1,333 $1,396 $1,288 -- -- --
Loans 90 days past due and still accruing......... -- -- -- -- -- --
Restructured loans................................ -- -- -- -- -- --
------ ------ ------ --- --- ---
Total nonperforming loans....................... 1,333 1,396 1,288 -- -- --
Foreclosed assets................................. -- -- -- -- -- --
------ ------ ------ --- --- ---
Total nonperforming assets...................... $1,333 $1,396 $1,288 -- -- --
====== ====== ====== === === ===
Nonperforming assets as a percentage of period end
loans plus foreclosed assets.................... 0.43% 0.51% 0.55% -- -- --
</TABLE>
Although nonperforming assets increased $108,000 in 1999 from 1998,
nonperforming assets as a percentage of total portfolio loans decreased from
0.55% to 0.51% from December 31, 1998 to December 31,1999. For the years ended
December 31, 1999 and 1998, the company had forgone interest income of $63,000
and $35,000. The company recognized $17,000 of interest income when it was
received from nonaccrual loans in 1997.
The company assigns a risk grade consistent with the system recommended by
regulatory agencies to all of its loans. Grades range from "Pass" to "Loss,"
depending on credit quality, with "Pass" representing loans that involve an
acceptable degree of risk. Management conducts a critical evaluation of the loan
portfolio monthly. This evaluation includes an assessment of the following
factors: past loan loss experience, known and inherent risks in the portfolio,
adverse situations that may affect the borrower's ability to repay, collateral
value, loan volumes and concentrations, recent loss experience in particular
segments of the portfolio, bank regulatory examination results, and current
economic conditions.
This process attempts to assess the risk of loss inherent in the portfolio
by segregating loans into four components for purposes of determining an
appropriate level of the allowance: "watch," "special mention," "substandard"
and "doubtful." Additionally, the company maintains a program for regularly
74
<PAGE>
scheduled reviews of certain new and renewed loans by an outside loan review
consultant. Any loans identified during an external review process that expose
the company to increased risk are appropriately downgraded and an increase in
the allowance for loan losses is established for such loans. Further, the
company is examined periodically by the FDIC, FRB, and the California Department
of Financial Institutions, at which time a further review of loan quality is
conducted.
Loans that demonstrate a weakness, for which there is a possibility of loss
if the weakness is not corrected, are categorized as "classified." Classified
loans may result from problems specific to a borrower's business or from
economic downturns that affect the borrower's ability to repay or that cause a
decline in the value of the underlying collateral (particularly real estate).
At March 31, 2000, the principal balance of classified loans was $7,481,000.
These loans constituted 2% of total loans and 15% of capital and reserves at
that date. As of December 31, 1999, the principal outstanding balances of
classified loans were $5,541,000. These loans constituted 2% of total loans and
11% of capital and reserves as of that date. As of December 31, 1998, classified
loans were $7,819,000. These loans constituted 3% of total loans and 23% of
capital and reserves as of that date. Other than those loans already classified
at March 31, 2000, the company has not identified any other potential problem
loans. Through March 31, 2000, the company had not made loans to any foreign
entities.
ALLOWANCE FOR PROBABLE LOAN LOSSES
It is the policy of management to maintain the allowance for loan losses at
a level adequate for risks inherent in the loan portfolio. Based on information
currently available to analyze loan loss delinquency and a history of actual
charge-offs, management believes that the loan loss provision and allowance are
adequate. However, the loan portfolio can be adversely affected if California
economic conditions and the real estate market in the company's market area were
to weaken. The effect of such events although uncertain at this time, could
result in an increase in the level of nonperforming loans and increased loan
losses, which could adversely affect the company's future growth and
profitability. No assurance of the ultimate level of credit losses can be given
with any certainty. Loans are charged against the allowance when management
believes that the collectibility of the principal is unlikely. See "Provision
for probable loan losses" on page 68.
75
<PAGE>
The following table summarizes the company's loan loss experience as well as
provisions and charges to the allowance for loan losses and certain pertinent
ratios for the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
MARCH 31 YEAR ENDED DECEMBER 31,
------------------- ----------------------------------------------------
2000 1999 1999 1998 1997 1996 1995
(DOLLARS IN THOUSANDS) -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, beginning of period.................... $5,003 $3,825 $3,825 $2,285 $1,402 $ 572 $ 76
Charge-offs:
Domestic:
Commercial, financial and agricultural...... -- (191) (203) (108) (223) -- --
Real estate--land and construction.......... -- -- -- -- -- -- --
Real estate--mortgage....................... -- -- -- -- -- -- --
Installment loans/credit card............... -- -- (603) (65) (1) -- --
Total charge-offs............................... -- (191) (806) (173) (224) -- --
Recoveries:
Domestic:
Commercial, financial and agricultural...... 13 -- 64 137 47 -- --
Real estate--land and construction.......... -- -- -- -- -- -- --
Real estate--mortgage....................... -- -- -- -- -- -- --
Installment loans/credit card............... -- -- 9 -- -- -- --
Total recoveries................................ 13 -- 73 137 47 -- --
Net (charge-offs) recoveries.................... 13 -- (733) (36) (177) -- --
Provision for loan losses....................... 600 643 1,911 1,576 1,060 830 496
------ ------ ------ ------ ------ ------ ----
Balance, end of period.......................... $5,616 $4,277 $5,003 $3,825 $2,285 $1,402 $572
====== ====== ====== ====== ====== ====== ====
RATIOS:
Net (charge-offs) recoveries to average loans
outstanding(1)................................ 0.02% 0.33% 0.30% 0.02% 0.19% --% --%
Allowance for loan losses to average loans...... 1.91% 1.82% 2.04% 2.27% 2.49% 2.44% 2.08%
Allowance for loan losses to total loans at end
of period..................................... 1.81% 1.85% 1.84% 1.62% 1.92% 1.84% 1.50%
Allowance for loan losses to nonperforming
loans......................................... 421% 188% 358% 297% --% --% --%
</TABLE>
--------------------------
(1) Ratios for periods ended March 31, 2000 and 1999 are annualized.
Charge-offs reflect the realization of losses in the portfolio that were
recognized previously though provisions for loan losses. The increase in
charge-offs in 1999 was primarily due to the Internet credit card portfolio,
which was sold in 1999. However, historical net charge-offs are not necessarily
indicative of the amount of net charge-offs that the company will realize in the
future.
The following tables summarize the allocation of the allowance for loan
losses by loan type and the allocated allowance as a percent of loans
outstanding in each loan category at the dates indicated:
<TABLE>
<CAPTION>
MARCH 31, 2000 MARCH 31, 1999
----------------------- -----------------------
PERCENT OF PERCENT OF
ALL IN EACH ALL IN EACH
CATEGORY TO CATEGORY TO
ALLOWANCE LOANS ALLOWANCE LOANS
(DOLLARS IN THOUSANDS) --------- ----------- --------- -----------
<S> <C> <C> <C> <C>
Commercial, financial and agricultural............. $2,802 2.25% $1,829 2.05%
Real estate--land and construction................. 1,227 1.40% 917 1.72%
Real estate--mortgage.............................. 402 0.42% 231 0.40%
Installment loans/credit card...................... 35 1.67% 1,013 3.31%
Unallocated........................................ 1,150 -- 287 --
------ ---- ------ ----
Total.............................................. $5,616 1.81% $4,277 1.85%
====== ==== ====== ====
</TABLE>
76
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------------------------------------------------------------
1999 1998 1997 1996
----------------------- ----------------------- ----------------------- -----------------------
PERCENT OF PERCENT OF PERCENT OF PERCENT OF
ALL IN EACH ALL IN EACH ALL IN EACH ALL IN EACH
CATEGORY TO CATEGORY TO CATEGORY TO CATEGORY TO
(DOLLARS IN ALLOWANCE TOTAL LOANS ALLOWANCE TOTAL LOANS ALLOWANCE TOTAL LOANS ALLOWANCE TOTAL LOANS
THOUSANDS) --------- ----------- --------- ----------- --------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial, financial
and agricultural... $2,635 2.23% $1,567 1.98% $ 821 1.70% $ 512 1.74%
Real estate--land and
construction....... 1,076 1.58 815 1.65 379 1.47 227 1.90
Real estate--
mortgage........... 356 0.43 224 0.39 205 0.53 117 0.45
Installment loans/
credit card........ 32 1.48 1,146 2.26 7 0.85 6 1.08
Unallocated.......... 904 73 873 540
------ ---- ------ ---- ------ ---- ------ ----
Total................ $5,003 1.84% $3,825 1.62% $2,285 1.92% $1,402 1.84%
====== ==== ====== ==== ====== ==== ====== ====
<CAPTION>
DECEMBER 31,
-----------------------
1995
-----------------------
PERCENT OF
ALL IN EACH
CATEGORY TO
(DOLLARS IN ALLOWANCE TOTAL LOANS
THOUSANDS) --------- -----------
<S> <C> <C>
Commercial, financial
and agricultural... $267 1.46%
Real estate--land and
construction....... 54 1.06
Real estate--
mortgage........... 102 0.76
Installment loans/
credit card........ 6 0.82
Unallocated.......... 143
---- ----
Total................ $572 1.50%
==== ====
</TABLE>
The increase in the allowance for loan losses reflects the growth in the
company's overall level of loans, primarily commercial and real estate loan
portfolio, offset by the decrease resulting from the sale of Internet credit
card portfolio in 1999.
Loans are charged against the allowance when management believes that the
collectibility of the principal is doubtful. The company's methodology for
assessing the appropriateness of the allowance consists of several key elements,
which include specific allowances, the formula allowance and the unallocated
allowance.
Specific allowances are established in cases where management has identified
significant conditions or circumstances related to a credit that management
believes indicate the probability that a loss may be incurred in excess of the
amount determined by the application of the formula allowance.
The formula allowance is calculated by applying loss factors to outstanding
loans and certain unused commitments. Loss factors are based on management's
experience and may be adjusted for significant factors that, in management's
judgment, affect the collectibility of the portfolio as of the evaluation date.
Due to the company's limited historical loss experience, management utilizes
their prior industry experience to determine the loss factor for each category
of loan.
The unallocated allowance is based upon management's evaluation of various
conditions that are not directly measured in the determination of the formula
and specific allowances. The evaluation of the inherent loss with respect to
these conditions is subject to a higher degree of uncertainty because they are
not identified with specific problem credits or portfolio segments.
In an effort to improve its analysis of risk factors associated with its
loan portfolio, the company continues to monitor and to make appropriate changes
to its internal loan policies. These efforts better enable the company to assess
risk factors prior to granting new loans and to assess the sufficiency of the
allowance for loan losses.
Management believes that it has adequately provided an allowance for
estimated probable losses in the credit portfolio. Significant deterioration in
Northern California real property values or economic downturns could impact
future operating results, liquidity or capital resources and require additional
provisions to the allowance or cause losses in excess of the allowance.
77
<PAGE>
DEPOSITS
Deposits totaled $448,835,000 at March 31, 2000, an increase of 7%, compared
to total deposits of $418,540,000 at December 31, 1999. The increase in deposits
was primarily due to increases in noninterest bearing deposits, primarily from
title companies and other local businesses. Noninterest bearing deposits were
$140,738,000 at March 31, 2000, compared to $109,432,000 at December 31, 1999.
Interest bearing deposits were $308,097,000 at March 31, 2000, as compared to
$309,108,000 at December 31, 1999.
As of March 31, 2000, the company had a deposit mix of 35% in savings and
money market accounts, 31% in time deposit, 3% in interest-bearing demand
accounts, and 31% in noninterest-bearing demand deposits. On the same date,
approximately $3,804,000 or less than 1% of deposits were from public sources
and $37,454,000 or 8% of deposits were from title companies. As of March 31,
1999, the company had a deposit mix of 35% in savings and money market accounts,
29% in time deposit, 3% in interest-bearing demand accounts, and 29% in
noninterest-bearing demand deposits. On the same date, approximately $2,128,000
or less than 1% of deposits were from public sources and $43,353,000 or 13% of
deposit were from the title companies.
As of December 31, 1999, the company had a deposit mix of 39% in savings and
money market accounts, 32% in time deposits, 3% in interest-bearing demand
accounts, and 26% in noninterest bearing demand deposits. On the same date,
approximately $3,804,000 or less than 1%, of deposits were from public sources
and $22,334,000, or 5%, of deposits were from title companies. As of
December 31, 1998, the company had a deposit mix of 38% in savings and money
market accounts, 25% in time deposits, 3% in interest-bearing demand accounts,
and 34% in noninterest-bearing demand deposits. On the same date, approximately
$2,228,000, or less than 1%, of deposits were from public sources and
$63,893,000, or 17%, of deposits were from title companies. As of December 31,
1997, the company had a deposit mix of 40% in savings and money market accounts,
17% in time deposits, 3% in interest-bearing demand accounts, and 40% in
noninterest-bearing demand deposits. On the same date, approximately $758,000,
or less than 1%, of deposits were from public sources and approximately
$32,402,000, or 13%, were from title companies. Net interest income is enhanced
by increasing the percentage of noninterest bearing deposits.
The company obtains deposits from a cross-section of the communities it
serves. The company's business is not seasonal in nature. The company had
brokered deposits totaling approximately $9,857,000 at March 31, 2000, and
$10,651,000 at December 31, 1999. These brokered deposits generally mature
within one year period. The company is not dependent upon funds from sources
outside the United States.
The following table indicates the maturity schedule of time deposits of
$100,000 or more as of the dates indicated.
<TABLE>
<CAPTION>
AT MARCH 31, 2000 AT DECEMBER 31, 1999
--------------------- ----------------------
BALANCE % OF TOTAL BALANCE % OF TOTAL
(DOLLARS IN THOUSANDS) -------- ---------- --------- ----------
<S> <C> <C> <C> <C>
Three months or less.................................. $42,147 46% $38,673 44%
Over three months through six months.................. 30,696 33 16,887 19
Over six months through 12 months..................... 17,754 19 26,678 30
Over 12 months........................................ 1,922 2 5,557 7
------- --- ------- ---
Total............................................... $92,519 100% $87,795 100%
======= === ======= ===
</TABLE>
The company focuses primarily on servicing business deposit accounts that
are frequently over $100,000 in average size. Certain types of accounts that the
company makes available are typically in excess of $100,000 in average balance
per account, and certain types of business clients whom the company serves
typically carry deposits in excess of $100,000 on average. The account activity
for some
78
<PAGE>
account types and client types requires appropriate liquidity management
practices by the company to ensure its ability to fund deposit withdrawals.
LIQUIDITY AND ASSET/LIABILITY MANAGEMENT
To meet liquidity needs, the company maintains a portion of its funds in
cash deposits in other banks, in Federal funds sold and in investment
securities. At March 31, 2000, the company's primary liquidity ratio was 28.3%,
comprised of $27.9 million in investment securities available-for-sale with
maturities (or probable calls) of up to five years, less $9.0 million of
securities that were pledged to secure public and certain other deposits as
required by law and contract, Federal funds sold of $82.1 million, and
$23.3 million in cash and due from banks, as a percentage of total unsecured
deposits of $439.9 million. The decline in liquidity ratio from December 31,
1999 was due to the use of liquid assets to fund loan growth in the first
quarter 2000.
As of December 31, 1999, the company's primary liquidity ratio was 34.0%,
comprised of $11.4 million in investment securities available-for-sale of
maturities (or probable calls) of up to five years, less $11 million securities
that were pledged to secure public and certain other deposits as required by law
and contract, Federal funds sold of $128.1 million, and $10.0 million in cash
and due from banks, as a percentage of total unsecured deposits of
$407.5 million. As of December 31, 1998, the company's primary liquidity ratio
was 15.1%, comprised of $45.8 million in investment securities
available-for-sale of maturities (or probable calls) of up to five years, less
$43.3 million of securities that were pledged to secure public and certain other
deposits as required by law and contract, Federal funds sold of $28.6 million,
and $18.0 million in cash and due from banks, as a percentage of total unsecured
deposits of $325.7 million. As of December 31, 1997, the company's primary
liquidity ratio was 26.3%, comprised of $40.6 million in investment securities
available-for-sale of maturities (or probable calls) of up to five years, less
$27.0 million of securities that were pledged to secure public and certain other
deposits as required by law and contract, Federal funds sold of $27.1 million,
and $16.1 million in cash and due from banks, as a percentage of total unsecured
deposits of $216.0 million. Liquid asset growth exceeded deposit growth in 1999
over 1998.
The following table summarizes the company's borrowings under its federal
funds purchased, security repurchase arrangements and lines of credit at the
dates indicated:
<TABLE>
<CAPTION>
DECEMBER 31,
MARCH 31 ------------------------------------
2000 1999 1998 1997
(DOLLARS IN THOUSANDS) -------- -------- -------- --------
<S> <C> <C> <C> <C>
Average balance during the year............................ $ -- $ 458 $ 41 $ 297
Average interest rate during the year...................... --% 7.64% 7.32% 5.72%
Maximum month-end balance during the year.................. $ -- $9,000 -- --
Average rate............................................... --% 11.98% -- --
</TABLE>
The company has Federal funds purchase lines and lines of credit of totaling
$35,000,000. At March 31, 2000, the company had no amounts outstanding on these
lines. As of December 31, 1999, the company borrowed $7,000,000 from the Federal
Home Loan Bank of San Francisco and $2,000,000 from a correspondent bank.
79
<PAGE>
CAPITAL RESOURCES
The following table summarizes risk-based capital, risk-weighted assets, and
risk-based capital ratios of Heritage:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
------------------- ------------------------------
2000 1999 1999 1998 1997
(DOLLARS IN THOUSANDS) -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Capital components:
Tier 1 Capital.............. $ 52,594 $ 30,535 $ 44,530 $ 29,850 $ 21,899
Tier 2 Capital.............. 5,173 3,713 4,646 3,825 1,885
======== ======== ======== ======== ========
Total risk-based capital.... $ 57,767 $ 34,248 $ 49,176 $ 33,675 $ 23,784
======== ======== ======== ======== ========
Risk-weighted assets.......... $413,410 $296,388 $371,322 $323,117 $150,418
Average assets................ $465,879 $366,918 $475,295 $399,092 $251,767
</TABLE>
<TABLE>
<CAPTION>
MINIMUM
REGULATORY
REQUIREMENTS
------------
<S> <C> <C> <C> <C> <C> <C>
Capital ratios:
Total risk-based capital...... 14.0% 11.6% 13.2% 10.4% 15.8% 8.0%
Tier 1 risk-based capital..... 12.7% 10.3% 12.0% 9.2% 14.6% 4.0%
Leverage ratio(1)............. 11.3% 8.3% 9.4% 7.5% 10.3% 4.0%
</TABLE>
------------------------
(1) Tier 1 capital divided by average assets (excluding goodwill).
The table above presents the capital ratios of Heritage computed in
accordance with applicable regulatory guidelines and compared to the standards
for minimum capital adequacy requirements under the FDIC's prompt corrective
action authority as of December 31, 1999. The risk-based and leverage capital
ratios are defined in "Capital standards" on page 62.
At March 31, 2000, the company's capital met all minimum regulatory
requirements. As of March 31, 2000, Heritage Bank of Commerce, Heritage Bank
East Bay and Heritage Bank South Valley were considered "well capitalized."
At December 31, 1999 and 1998, the company's capital met all minimum
regulatory requirements. As of December 31, 1999, Heritage Bank of Commerce and
Heritage Bank East Bay were considered "well capitalized". Heritage Bank South
Valley had not yet commenced operations as of December 31, 1999.
On August 16, 1999, Heritage closed a best efforts public stock offering
after selling 758,138 registered shares at $15.00 per share. Total proceeds from
this offering were $11,200,000 after deducting expenses of $172,000. Heritage
used $7,000,000 offering to capitalize Heritage Bank South Valley, which
commenced operation on January 18, 2000.
In the first quarter of 2000, Heritage issued $7,000,000 aggregate principal
amount of 10 7/8% subordinated debentures due 2030 to a subsidiary trust, which
in turn issued a similar amount of trust preferred securities. See "Description
of Heritage Capital Stock--Trust preferred securities" on page 111. Under
applicable regulatory guidelines the trust preferred securities qualify as Tier
I capital.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities". The Statement will require the Company to
recognize all derivatives on the balance sheet at fair value. SFAS No. 133
requires that derivative instruments used to hedge be identified specifically to
assets, liabilities, firm commitments or anticipated transactions and measured
as effective and
80
<PAGE>
ineffective when hedging changes in fair value or cash flows. Derivative
instruments that do not qualify as either a fair value or cash flow hedge will
be valued at fair value with the resultant gain or loss recognized in current
earnings. Changes in the effective portion of fair value hedges will be
recognized in current earnings along with the change in fair value of the hedged
item. Changes in the effective portion of the fair value of cash flow hedges
will be recognized in other comprehensive income until realization of the cash
flows of the hedged through current earnings. Any ineffective portion of hedges
will be recognized in current earnings. The company adopted the provisions of
SFAS No. 133 in 1999. The adoption of SFAS No. 133 did not significantly impact
the Company's earnings or financial position.
MARKET RISK
Market risk is the risk of loss to future earnings, to fair values or to
future cash flows that may result from changes in the price of a financial
instrument. The value of a financial instrument may change as a result of
changes in interest rates, foreign currency exchange rates, commodity prices,
equity prices and other market changes that affect market risk sensitive
instruments. Market risk is attributed to all market risk sensitive financial
instruments, including securities, loans, deposits, borrowings, its trading
activities for its own account, and its role as a financial intermediary in
customer-related transactions. The objective of market risk management is to
avoid excessive exposure of the company's earnings and equity to loss and to
reduce the volatility inherent in certain financial instruments.
INTEREST RATE RISK
The planning of asset and liability maturities is an integral part of the
management of an institution's net yield. To the extent maturities of assets and
liabilities do not match in a changing interest rate environment, net yields may
change over time. Even with perfectly matched repricing of assets and
liabilities, risks remain in the form of prepayment of loans or investments or
in the form of delays in the adjustment of rates of interest applying to either
earning assets with floating rates or to interest bearing liabilities. The
company has generally been able to control its exposure to changing interest
rates by maintaining primarily floating interest rate loans and a majority of
its time certificates with relatively short maturities.
The following tables set forth the interest rate sensitivity of the
company's interest-earning assets and interest-bearing liabilities at the dates
indicated, using the rate sensitivity gap ratio. For purposes of
81
<PAGE>
the following tables, an asset or liability is considered rate-sensitive within
a specified period when it can be repriced or when it is scheduled to mature
within the specified time frame:
<TABLE>
<CAPTION>
MARCH 31, 2000
---------------------------------------------------------------------
DUE IN
WITHIN THREE TO DUE AFTER
THREE TWELVE ONE TO FIVE DUE AFTER NOT RATE-
MONTHS MONTHS YEARS FIVE YEARS SENSITIVE TOTAL
(DOLLARS IN THOUSANDS) -------- -------- ----------- ---------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
INTEREST EARNING ASSETS:
Federal funds sold................................. $ 82,050 $ -- $ -- $ -- $ -- $ 82,050
Securities......................................... 2,000 6,236 26,205 13,274 -- 47,715
Total loans........................................ 255,196 16,504 48,385 15,880 -- 335,965
-------- -------- ------- -------- --------- --------
Total interest earning assets.................. 339,246 22,740 74,590 29,154 -- 465,730
-------- -------- ------- -------- --------- --------
Cash and due from banks.............................. -- -- -- -- 23,310 23,310
Other assets......................................... -- -- -- -- 16,565 16,565
-------- -------- ------- -------- --------- --------
Total assets................................... $339,246 $ 22,740 $74,590 $ 29,154 $ 39,875 $505,605
======== ======== ======= ======== ========= ========
INTEREST BEARING LIABILITIES:
Demand, interest bearing........................... $ 12,231 $ -- $ -- $ -- $ -- $ 12,231
Savings and money market........................... 157,059 -- -- -- -- 157,059
Time deposits...................................... 62,945 70,745 5,017 100 -- 138,807
-------- -------- ------- -------- --------- --------
Total interest bearing liabilities............. 232,235 70,745 5,017 100 -- 308,097
-------- -------- ------- -------- --------- --------
Noninterest demand deposits.......................... 49,383 -- -- -- 91,355 140,738
Other liabilities.................................... -- -- -- -- 11,222 11,222
Shareholders' equity................................. -- -- -- -- 45,548 45,548
-------- -------- ------- -------- --------- --------
Total liabilities and shareholders' equity..... $281,618 70,745 5,017 100 $ 148,125 $505,605
======== ======== ======= ======== ========= ========
Interest rate sensitivity GAP........................ $ 57,628 $(48,005) $69,573 $ 29,054 $(108,250) --
======== ======== ======= ======== ========= ========
Cumulative interest rate sensitivity GAP............. $ 57,628 $ 9,623 $79,196 $108,250 -- --
Cumulative interest rate sensitivity GAP ratio....... 11.40% 1.90% 15.66% 21.41% -- --
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1999
---------------------------------------------------------------------
DUE IN
WITHIN THREE TO DUE AFTER
THREE TWELVE ONE TO FIVE DUE AFTER NOT RATE-
MONTHS MONTHS YEARS FIVE YEARS SENSITIVE TOTAL
(DOLLARS IN THOUSANDS) -------- -------- ----------- ---------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
INTEREST EARNING ASSETS:
Federal funds sold................................. $128,100 $ -- $ -- $ -- $ -- $128,100
Securities......................................... -- 4,871 12,872 13,521 -- 31,264
Total loans, including loans held-for-sale......... 220,170 12,334 42,143 19,451 -- 294,098
-------- -------- ------- -------- --------- --------
Total interest earning assets.................. 348,270 17,205 55,015 32,972 -- 453,462
-------- -------- ------- -------- --------- --------
Cash and due from banks.............................. 10,049 10,049
Other assets......................................... 13,153 13,153
-------- -------- ------- -------- --------- --------
Total assets................................... $348,270 $ 17,205 $55,015 $ 32,972 $ 23,202 $476,664
======== ======== ======= ======== ========= ========
INTEREST BEARING LIABILITIES:
Demand, interest bearing........................... $ 9,898 $ -- $ -- $ -- $ -- $ 9,898
Savings and money market........................... 164,060 -- -- -- -- 164,060
Time deposits...................................... 49,181 76,502 9,467 -- -- 135,150
-------- -------- ------- -------- --------- --------
Total interest bearing liabilities............. 223,139 76,502 9,467 -- -- 309,108
-------- -------- ------- -------- --------- --------
Demand non-interest bearing.......................... 32,596 76,836 109,432
Accrual interest payable and other liabilities....... 13,593 13,593
Shareholders' equity................................. -- -- -- -- 44,531 44,531
-------- -------- ------- -------- --------- --------
Total liabilities and shareholders' equity..... $255,735 $ 76,502 $ 9,467 $ -- $ 134,960 $476,664
======== ======== ======= ======== ========= ========
Interest rate sensitivity GAP........................ $ 92,535 $(59,297) $45,548 $ 32,972 $(111,758) $ --
======== ======== ======= ======== ========= ========
Cumulative interest rate sensitivity GAP............. $ 92,535 $ 33,238 $78,786 $111,758 $ -- $ --
Cumulative interest rate sensitivity GAP ratio....... 19.41% 6.97% 16.53% 23.45% -- --
</TABLE>
82
<PAGE>
The foregoing table demonstrates that Heritage had a positive cumulative one
year gap of $9.6 million, or 1.90% of total assets, at March 31, 2000 and
$33.2 million, or 6.97% of total assets, at December 31, 1999. In theory, this
would indicate that more in assets than liabilities would reprice if there was a
change in interest rates over the next year. If interest rates were to increase,
the positive gap would tend to result in a higher net interest margin. However,
changes in the mix of earning assets or supporting liabilities can either
increase or decrease the net margin without affecting interest rate sensitivity.
This characteristic is referred to as a basis risk and, generally, relates to
the repricing characteristics of short-term funding sources such as certificates
of deposit.
Interest rate changes do not affect all categories of assets and liabilities
equally or at the same time. Varying interest rate environments can create
unexpected changes in prepayment levels of assets and liabilities, which may
have a significant effect on the net interest margin and are not reflected in
the interest sensitivity analysis table. Because of these factors, an interest
sensitivity gap report may not provide a complete assessment of the exposure to
changes in interest rates. To supplement traditional GAP analysis, the company
performs simulation modeling to estimate the potential effects of changing
interest rate environments.
The process allows the company to explore the complex relationships within
the GAP over time and various interest rate environments. For additional
information on the company's simulation model and the methodology used to
estimate the potential effects of changing interest rates, see "Quantitative and
qualitative disclosures about market risk" below.
Liquidity risk represents the potential for loss as a result of limitations
on the company's ability to adjust for future cash flows, to meet the needs of
depositors and borrowers, and to fund operations on a timely and cost-effective
basis. The liquidity policy approved by the board requires annual review of the
company's liquidity by the asset/liability committee, which is composed of
senior executives, and the finance and investment committee of the board of
directors.
The company's internal asset/liability committee and the finance and
investment committee of the board each meet monthly to monitor the company's
investments, liquidity needs and to oversee its asset/liability management. The
company evaluates the rates offered on its deposit products on a weekly basis.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As a financial institution, Heritage's primary component of market risk is
interest rate volatility. Fluctuations in interest rates will ultimately impact
both the level of income and expense recorded on most of the company's assets
and liabilities, and the market value of all interest-earning assets, other than
those which have a short term to maturity. Since all of the company's
interest-bearing assets and liabilities are located at the subsidiary banks, all
of the company's interest rate risk exposure lies at that level, as well. As a
result, all interest rate risk management procedures are performed at the banks'
level. Based upon the nature of the company's operations, the company was not
subject to foreign exchange or commodity price risk. The company does not own
any trading assets. As of March 31, 2000 and December 31, 1999, the company did
not use interest rate derivatives to hedge its interest rate risk.
The company's exposure to market risk is reviewed on a regular basis by the
asset/liability committee. Interest rate risk is the potential of economic
losses due to future interest rate changes. These economic losses can be
reflected as a loss of future net interest income and/or a loss of current fair
market values. The objective is to measure the effect on net interest income and
to adjust the balance sheet to minimize the inherent risk while at the same time
maximize income. Management realizes certain risks are inherent, and that the
goal is to identify and accept the risks. Management uses two methodologies to
manage interest rate risk: 1) a standard GAP analysis; and 2) an interest rate
shock simulation model. The company has no market risk sensitive instruments
held for trading purposes.
83
<PAGE>
The detail from the company's GAP analysis is included under the caption
"Interest rate risk" on page 80 and is not discussed here. The company applies a
market value (MV) methodology to gauge its interest rate risk exposure as
derived from its simulation model. Generally, MV is the discounted present value
of the difference between incoming cash flows on interest earning assets and
other investments and outgoing cash flows on interest bearing liabilities and
other liabilities. The application of the methodology attempts to quantify
interest rate risk as the change in the MV which would result from a theoretical
200 basis point (1 basis point equals 0.01%) change in market interest rates.
Both a 200 basis point increase and a 200 basis point decrease in market rates
are considered.
At December 31, 1999, the company estimated that its MV would increase 13.3%
in the event of a 200 basis point increase in market interest rates. The
company's MV at the same date would decrease 14.7% in the event of a 200 basis
point decrease in market interest rates.
Presented below, as of December 31, 1999 and 1998, is an analysis of the
company's interest rate risk as measured by changes in MV for instantaneous and
sustained parallel shifts of 200 basis points in market interest rates:
<TABLE>
<CAPTION>
1999 1998
--------------------------------------------- -----------------------------------------------
MARKET VALUE AS A MARKET VALUE AS A
% OF PRESENT % OF PRESENT
VALUE OF ASSETS VALUE OF ASSETS
$ CHANGE % CHANGE IN ------------------- $ CHANGE IN % CHANGE IN -------------------
(DOLLARS IN THOUSANDS) IN MARKET MARKET CHANGE MARKET MARKET CHANGE
CHANGE IN RATES VALUE VALUE MV RATIO (BP) VALUE VALUE MV RATIO (BP)
---------------------- --------- ----------- -------- -------- ----------- ----------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
+ 200 bp............. $ 8,440 8.9% 20.5% 190 $ 10,460 17.6% 17.2% 257
0 bp................. -- -- 18.6% -- -- -- 14.6% --
- 200 bp............. $(10,516) (11.1)% 16.6% (220) $(12,021) (20.2)% 11.7% (295)
</TABLE>
Management believes that the MV methodology overcomes three shortcomings of
the typical maturity gap methodology. First, it does not use arbitrary repricing
intervals and accounts for all expected future cash flows. Second, because the
MV method projects cash flows of each financial instrument under different
interest rate environments, it can incorporate the effect of embedded options on
an institutions' interest rate risk exposure. Third, it allows interest rates on
different instruments to change by varying amounts in response to a change in
market interest rates, resulting in more accurate estimates of cash flows.
However, as with any method of gauging interest rate risk, there are certain
shortcomings inherent to the MV methodology. The model assumes interest rate
changes are instantaneous parallel shifts in the yield curve. In reality, rate
changes are rarely instantaneous. The use of the simplifying assumption that
short-term and long-term rates change by the same degree may also misstate
historic rate patterns, which rarely show parallel yield curve shifts. Further,
the model assumes that certain assets and liabilities of similar maturity or
period to repricing will react the same to changes in rates. In reality, certain
types of financial instruments may react in advance of changes in market rates,
while the reaction of other types of financial instruments may lag behind the
change in general market rates. Additionally, the MV methodology does not
reflect the full impact of annual and lifetime restrictions on changes in rates
for certain assets, such as adjustable rate loans. When interest rates change,
actual loan prepayments and actual early withdrawals from certificates may
deviate significantly from the assumptions used in the model. Finally, this
methodology does not measure or reflect the impact that higher rates may have on
adjustable-rate loan clients' ability to service their debt. All of these
factors are considered in monitoring the company's exposure to interest rate
risk.
Liquidity risk represents the potential for loss as a result of limitations
on the company's ability to adjust future cash flows to meet the needs of
depositors and borrowers and to fund operations on a timely and cost-effective
basis. The liquidity policy approved by the board requires annual review of the
company's liquidity by the asset/liability committee, which is composed of
senior executives, and the finance and investment committee of the board of
directors.
84
<PAGE>
SELECTED QUARTERLY FINANCIAL INFORMATION
The following tables disclose selected quarterly financial information for
Heritage.
<TABLE>
<CAPTION>
FOR THE QUARTER ENDED
---------------------------------------------------------------
MARCH 31, DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
(DOLLARS IN THOUSANDS, 2000 1999 1999 1999 1999
EXCEPT PER SHARE AMOUNTS) --------- ------------ ------------- -------- ---------
<S> <C> <C> <C> <C> <C>
Interest income............................. $9,881 $9,056 $7,876 $7,125 $7,164
Interest expense............................ 3,433 3,416 2,646 2,211 2,171
------ ------ ------ ------ ------
Net interest income......................... 6,448 5,640 5,230 4,914 4,993
Provision for probable loan losses.......... 600 428 356 484 643
------ ------ ------ ------ ------
Net interest income after provision for
probable loan losses...................... 5,848 5,212 4,874 4,430 4,350
Noninterest income.......................... 483 1,270 1,802 687 1,224
Noninterest expense......................... 4,733 5,021 5,503 4,163 4,587
------ ------ ------ ------ ------
Net income before taxes..................... 1,598 1,461 1,173 954 987
Provision for income taxes.................. 560 490 420 280 360
------ ------ ------ ------ ------
Net income.................................. $1,038 $ 971 $ 753 $ 674 $ 627
====== ====== ====== ====== ======
Net income per share--basic................. $ 0.15 $ 0.14 $ 0.11 $ 0.11 $ 0.10
Net income per share--diluted............... $ 0.13 $ 0.13 $ 0.10 $ 0.10 $ 0.09
</TABLE>
<TABLE>
<CAPTION>
FOR THE QUARTER ENDED
---------------------------------------------------
DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
(DOLLARS IN THOUSANDS, 1998 1998 1998 1998
EXCEPT PER SHARE AMOUNTS) ------------ ------------- -------- ---------
<S> <C> <C> <C> <C>
Interest income........................................ $8,062 $7,469 $6,049 $5,120
Interest expense....................................... 2,592 2,350 667 1,342
------ ------ ------ ------
Net interest income.................................... 5,470 5,119 4,382 3,778
Provision for probable loan losses..................... 516 550 350 160
------ ------ ------ ------
Net interest income after provision for probable loan
losses............................................... 4,954 4,569 4,032 3,618
Noninterest income..................................... 937 596 243 131
Noninterest expense.................................... 4,977 4,148 3,462 3,018
------ ------ ------ ------
Net income before taxes................................ 914 1,017 813 731
Provision for income taxes............................. 321 443 283 278
------ ------ ------ ------
Net income............................................. $ 593 $ 574 $ 530 $ 453
====== ====== ====== ======
Net income per share--basic............................ $ 0.09 $ 0.09 $ 0.10 $ 0.08
Net income per share--diluted.......................... $ 0.09 $ 0.08 $ 0.08 $ 0.07
</TABLE>
85
<PAGE>
INFORMATION ABOUT WESTERN HOLDINGS
Western Holdings is a California corporation incorporated in 1997. It is
registered as a bank holding company under the Bank Holding Company Act of 1956,
as amended (the "Bank Holding Company Act"). On December 8, 1997, the
shareholders of Bank of Los Altos exchanged all of their outstanding common
shares for an equal number of common shares in Western Holdings, and Western
Holdings acquired 100% of the outstanding common shares in the Bank.
Bank of Los Altos is a California state chartered bank established in 1975
and headquartered in Los Altos. On February 6, 1995, an investor group purchased
all of the issued and outstanding stock of the then named Foothill Bank from the
previous owner, a subsidiary of Pacific National Financial Company, a Canadian
corporation.
Western Holdings operates Bank of Los Altos with two full service branches
in Los Altos, California, one full service branch in Mountain View, California,
and a Real Estate and Construction Lending office in Los Altos, California. The
Real Estate and Construction Lending office is located in a building owned by
Bank of Los Altos. The full service branches are located in leased office
buildings.
Competitors of the bank include commercial banks, savings and loan
associations, securities brokerage firms, and credit unions.
The principal office of Western Holdings is located at the headquarters of
Bank of Los Altos, 4546 El Camino Real, Los Altos, California 94022, telephone
number (650) 941-9300. Western Holdings has no employees. The bank has
approximately 65 employees (62 full-time equivalents).
BANKING SERVICES
Western Holdings, through Bank of Los Altos, provides a wide range of
commercial banking services to small and medium-sized businesses, real estate
developers, business executives, professionals and other individuals in northern
Santa Clara County, California, including primarily Los Altos, Los Altos Hills,
Mountain View and the various contiguous communities. Bank of Los Altos offers
single family real estate secured mortgages and real estate mortgage broker
services, along with real estate construction financing, primarily for single
family residences. In addition, Bank of Los Altos offers some specialized
lending products to assist smaller businesses. Two such products are the Small
Business Administration lending, providing SBA guaranteed loans, and accounts
receivable financing. The Bank also provides Internet banking services through
its website, www.bankoflosaltos.com.
PROPERTIES
Bank of Los Altos owns a two-story, 2,800 square feet office building near
downtown Los Altos, California, at 477 S. San Antonio Road. The bank's
construction and real estate lending functions are housed in this building.
All other locations are maintained in leased properties. The main office for
Bank of Los Altos and Western Holdings is located at 4546 El Camino Real, Los
Altos, California. The Bank executed the lease of approximately 7,900 square
feet of space in April 1995, to expire in April 2005, with options to renew at
that time. The lease calls for annual consumer price index adjustments between
2% and 5%. Current monthly rent at this facility is $14,173.
The San Antonio branch is located at 369 S. San Antonio Road, Los Altos,
California. The lease covers approximately 3,500 square feet and has a ten year
term from October 1998 through September 2008, with options to renew available
at that time. Current monthly rent is $12,634 and increases 4% each year.
The Mountain View branch is located at 175 El Camino Real, Mountain View,
California. The lease is for approximately 4,800 square feet and has a ten year
term from August 1998 through
86
<PAGE>
July 2008, with options to renew available at that time. Current monthly rent is
$10,890, and beginning June 2000 will be adjusted for consumer price index
adjustments between 3% and 6% annually.
LEGAL PROCEEDINGS
There are no pending or, to management's knowledge, threatened, material
legal proceedings to which Western Holdings or Bank of Los Altos is a party or
to which any of their properties are subject, except for the following:
For a period ending in 1992, a former officer and director of Bank of Los
Altos served as a director of Pacific National Financial Company when a Pacific
National subsidiary was Bank of Los Altos's parent company. In December 1998,
Bank of Los Altos received a request for indemnity from the former officer under
an indemnity agreement entered into by Bank of Los Altos in December 1992. The
request for indemnity related to three complaints naming the former officer and
seven other former directors of Pacific National. The complaints seek damages of
approximately $166 million ($Canadian 240 million) arising from the defendants'
role as Pacific National directors. The largest of the three actions alleges
that the defendants breached their fiduciary duties to Pacific National,
resulting in its 1992 bankruptcy. The former officer has requested that Bank of
Los Altos pay for his defense and indemnify him in connection with such actions.
Although Bank of Los Altos has reserved its rights under the indemnity
agreement, it has conditionally agreed to be responsible for payment of the
former officer's defense costs. The Bank is not aware of any material activity
in any of these actions since they were served. Based on the representations of
the former officer and discussions with legal counsel, Western Holdings
management and board of directors have no reason to believe that the
indemnification will result in any material adverse impact on Bank of Los Altos,
but management cannot presently state the likelihood of a favorable or
unfavorable outcome or estimate any ultimate loss or costs for which it could be
responsible.
SUPERVISION AND REGULATION
As a California state-licensed bank, Bank of Los Altos is subject to
regulation, supervision and periodic examination by the DFI and the FDIC. Bank
of Los Altos is not a member of the Federal Reserve System, but is nevertheless
subject to certain regulations of the FRB. Bank of Los Altos' deposits are
insured by the FDIC to the maximum amount permitted by law, which is currently
$100,000 per depositor in most cases. The regulations of these state and federal
bank regulatory agencies govern most aspects of Bank of Los Altos' business and
operations, including but not limited to, the scope of its business, its
investments, its reserves against deposits, the nature and amount of any
collateral for loans, the timing of availability of deposited funds, the
issuance of securities, the payment of dividends, bank expansion and bank
activities, including real estate development and insurance activities, and the
maximum rates of interest allowed on certain deposits. Bank of Los Altos is also
subject to the requirements and restrictions of various consumer laws and
regulations.
COMPETITION
The banking business in California generally, and in the primary service
area of Western Holdings specifically, is highly competitive with respect to
loans, leases, and deposits, and is dominated by a relatively small number of
major banks with many offices operating over a wide geographic area. Among the
advantages such major banks have over Western Holdings is the ability to finance
wide-ranging advertising campaigns and to allocate their investment assets to
regions of highest yield and demand. Such banks offer certain services such as
trust services and international banking services which are not offered directly
by Western Holdings (but are offered indirectly through correspondent
institutions) and, by virtue of their greater total capitalization (legal
lending limits to an individual customer are limited to a percentage of a bank's
total capital accounts), such banks have substantially higher lending limits.
Other entities, both governmental and in private industry, seeking to raise
capital through the issuance and sale of debt or equity securities, as well as
money market mutual funds, also
87
<PAGE>
provide competition for Western Holdings in the acquisition of deposits. Those
competitors include savings and loan associations and finance companies that
provide consumer loans, loan production offices, and financial conglomerates
which provide deposit-like investment plans and credit and checking services
that can attract bank customers. In addition, thrift and loans and credit unions
in California offer competitive deposit and lending services.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table provides information as of the record date for the
special meeting pertaining to beneficial ownership (including options
exercisable within 60 days) of Western Holdings common stock by current
directors and executive officers of Western Holdings and all directors and
executive officers as a group. This information is based on Western Holdings'
records or information furnished directly by the individual to Western Holdings.
To the knowledge of Western Holdings, no other person owns five percent or more
of the company's outstanding stock.
<TABLE>
<CAPTION>
SHARES
BENEFICIALLY EXERCISABLE PERCENT OF
NAME OF BENEFICIAL OWNER RELATIONSHIP OWNED OPTIONS TOTAL CLASS
------------------------ -------------------- ------------ ----------- --------- ----------
<S> <C> <C> <C> <C> <C>
Hugh Barton.................. Director 241,937 -- 241,937 7.9%
Robert A. Grimm.............. Director 119,893 10,890 130,783 4.3
Kurt G. Hammerstrom.......... Director 110,054 3,024 113,078 3.7
Robert S. Holden............. Vice President -- 5,000 5,000 0.2
Murray Horton................ Director 42,493 10,890 53,383 1.7
Steve Hunton................. Director 177,853 -- 177,853 5.8
Roy E. Lave.................. Director 80,144 10,890 91,034 3.0
Paul Nyberg.................. Director 115,290 10,890 126,180 4.1
Mary Prochnow................ Director 14,663 21,780 36,443 1.2
Gregory Sollers.............. Director 7,500 1,375 8,875 0.3
Susann C. Trevena............ Vice President & CFO -- 20,872 20,872 0.7
James C. Wall................ Director & President 26,070 47,437 73,507 2.4
William R. Walters........... Vice President 4,670 14,822 19,492 0.6
Howard J. Weiland............ Director 56,397 10,890 67,287 2.2
------- --------- --------- -----
All directors and executive
officers as a group........ 996,964 168,760 1,165,724 38.0%
</TABLE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF WESTERN HOLDINGS
The following discussion should be read in conjunction with the financial
statements, including the related notes, of Western Holdings, which are included
in this document. Western Holdings was incorporated on June 18, 1997, and
commenced operations on December 8, 1997. For periods prior to the existence of
Western Holdings, the discussion relates to Western Holdings's only subsidiary,
Bank of Los Altos. The accounting and reporting policies of Western Holdings and
its subsidiary bank conform to generally accepted accounting principles and
prevailing practices within the banking industry. The discussion covers the
quarter ended March 31, 2000, compared to the quarter ended March 31, 1999, and
years ended December 31 as indicated.
RESULTS OF OPERATIONS
SUMMARY
QUARTER ENDED MARCH 31, 2000 COMPARED TO THE QUARTER ENDED MARCH 31,
1999. Net income increased to $479,000 in the three months ended March 31,
2000, representing an increase of 61.3% over net income of $297,000 in the three
months ended March 31, 1999. Basic earnings per share in
88
<PAGE>
the three months ended March 31, 2000 were $0.18 compared to $0.11 in the three
months ended March 31, 1999. Fully diluted earnings per share in the three
months ended March 31, 2000 were $0.17 compared to $0.10 in the three months
ended March 31, 1999.
1999 COMPARED TO 1998. Net income increased to $1,643,000 in 1999,
representing an increase of 21.2% over net income of $1,356,000 in 1998. Basic
earnings per share in 1999 were $0.60 compared to $0.52 in 1998. Fully diluted
earnings per share in 1999 were $0.57 compared to $0.48 in 1998.
1998 COMPARED TO 1997. Net income increased to $1,356,000 in 1998,
representing an increase of 6.8% over net income of $1,270,000 in 1997. Basic
earnings per share in 1998 were $0.52 compared to $0.52 in 1997. Fully diluted
earnings per share in 1998 were $0.48 compared to $0.49 in 1997.
NET INTEREST INCOME
Western Holdings's primary source of revenue is net interest income, which
is the difference between interest income and fees derived from loans and the
interest paid on deposits and other interest-bearing liabilities.
QUARTER ENDED MARCH 31, 2000 COMPARED TO THE QUARTER ENDED MARCH 31,
1999. Net interest income of $2,684,000 in the three months ended March 31,
2000 reflected an increase of 31.4% over net interest income of $2,042,000 in
the three months ended March 31, 1999. Interest income increased by $902,000 in
the three months ended March 31, 2000 over the three months ended March 31, 1999
primarily due to increases in the average balances of loans and investment
securities, including federal funds sold, of $26,257,000 and $9,891,000,
respectively. In addition, the average yield on interest-earning assets improved
by 35 basis points over the same period a year earlier, due primarily to higher
prime rate in 2000. Interest expense increased by $260,000 in the three months
ended March 31, 2000, as compared to the three months ended March 31, 1999,
primarily due to increases in the balances of interest-bearing liabilities of
$26,892,000, and increased rates.
1999 COMPARED TO 1998. Net interest income of $9,277,000 in 1999 reflected
an increase of 25.1% over net interest income of $7,418,000 in 1998. Interest
income increased by $2,701,000 in 1999 over 1998, primarily due to increases in
the average balances of loans and investment securities of $29,928,000 and
$8,264,000 respectively. This increase was offset by a 38 basis point decrease
in the average yield. The decreases in average yields were reflections of
increased competition during 1999, and prime rate decreases averaging 34 basis
points. Interest expense increased by $842,000 in 1999, primarily due to
increases in average balances of time deposits of $7,094,000, NOW, savings, and
money market deposits of $19,202,000, and an increase in the average balance of
other borrowings of $9,640,000. This was offset by a 39 basis point decrease in
the average yield on interest-bearing liabilities.
1998 COMPARED TO 1997. Net interest income of $7,418,000 in 1998 increased
by 35.8% over net interest income of $5,463,000 in 1997. Interest income
increased by $3,200,000 in 1998 over 1997, primarily due to increases in the
average balances of loans and investment securities of $24,467,000 and
$17,015,000, respectively, offset by a 48 basis point decrease in the average
yield on those interest earning assets. Interest expense increased by $1,245,000
in 1998, primarily due to the increase in the average balance of time deposits
of $4,889,000, NOW and money market deposits of $22,114,000, and other
borrowings of $6,711,000. The average yield on interest-bearing liabilities
decreased 10 basis points between 1997 and 1998.
89
<PAGE>
The following two tables present, for the periods indicated, unaudited
information regarding average earning assets, liabilities and shareholders'
equity, the amounts of interest income and expense and the yields on earning
assets and rates on deposits.
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
---------------------------------------------------------------
2000 1999
------------------------------ ------------------------------
INTEREST RATES INTEREST RATES
AVERAGE INCOME/ EARNED/ AVERAGE INCOME/ EARNED/
BALANCE EXPENSE PAID BALANCE EXPENSE PAID
(DOLLARS IN THOUSANDS) -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Assets:
Federal funds sold...................... $ 19,488 $ 276 5.69% $ 7,866 $ 90 4.66%
Investment securities................... 45,329 711 6.31 47,060 711 6.13
Loans................................... 129,858 3,110 9.63 103,600 2,378 9.31
FHLB stock.............................. 901 13 5.92 2,121 29 5.48
-------- ------ ---- -------- ------ ----
Total interest earning assets........... 195,576 4,110 8.45% 160,647 3,208 8.10%
-------- ------ ---- -------- ------ ----
Nonearning assets, net of allowance for
loan losses........................... 19,521 14,813
-------- --------
Total assets.......................... $215,097 $175,460
======== ========
Liabilities and shareholders' equity:
Interest bearing deposits:
Money market checking and savings....... $ 92,416 $ 625 2.72% $ 71,860 $ 475 2.68%
Savings................................. 6,213 31 1.98 5,234 26 2.02
Time.................................... 58,642 730 5.01 35,790 422 4.78
Other borrowed funds.................... 2,586 40 6.20 20,081 243 4.91
-------- ------ ---- -------- ------ ----
Total interest bearing liabilities...... 159,857 1,426 3.59 132,965 1,166 3.56
-------- ------ ---- -------- ------ ----
Demand deposits......................... 42,315 29,784
Other liabilities....................... 709 1,522
-------- --------
Total liabilities....................... 202,881 164,271
Shareholders' equity.................... 12,216 11,189
-------- --------
Total liabilities and shareholders'
equity................................ $215,097 $175,460
======== ========
Net interest income..................... $2,684 $2,042
====== ======
Net interest margin..................... 5.52% 5.16%
</TABLE>
------------------------
Note: Gross loans include nonaccrual loans of $3,000 and $60,000 for the three
month periods ended March 31, 2000 and 1999. Yields and amounts earned on
loans include loan fees of $204,000 and $162,000 for the three month
periods ended March 31, 2000 and 1999, respectively. Interest income is
reflected on an actual basis, not a fully taxable equivalent basis, and
does not include a fair value adjustment.
90
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------------------------
1999 1998 1997
------------------------------ ------------------------------ ------------------------------
INTEREST RATES INTEREST RATES INTEREST RATES
AVERAGE INCOME/ EARNED/ AVERAGE INCOME/ EARNED/ AVERAGE INCOME/ EARNED/
BALANCE EXPENSE PAID BALANCE EXPENSE PAID BALANCE EXPENSE PAID
(DOLLARS IN THOUSANDS) -------- -------- -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Assets:
Federal funds sold............ $ 5,084 $ 247 4.86% $ 5,954 $ 307 5.15% $ 4,600 $ 250 5.43%
Investment securities......... 46,647 2,853 6.12% 37,513 2,318 6.18% 21,852 1,348 6.17%
Loans......................... 119,388 11,049 9.26% 89,460 8,863 9.91% 64,993 6,723 10.35%
FHLB stock.................... 1,528 82 5.36% 767 42 5.46% 140 9 6.26%
-------- ------- ---- -------- ------ ---- -------- ------ -----
Total interest earning
assets...................... 172,647 14,231 8.24% 133,694 11,530 8.62% 91,585 8,330 9.10%
-------- ------- ---- -------- ------ ---- -------- ------ -----
Nonearning assets, net of
allowance for loan losses... 16,470 10,395 8,609
-------- -------- --------
Total assets.................. $189,117 $144,089 $100,194
======== ======== ========
Liabilities and shareholders'
equity:
Interest bearing deposits:
Money market checking and
savings..................... $ 77,224 $ 2,020 2.62% $ 59,162 $1,792 3.03% $ 37,285 $1,088 2.92%
Savings....................... 5,518 109 1.98 4,378 95 2.17 4,141 92 2.23
Time.......................... 42,395 1,964 4.63 35,301 1,865 5.28 30,412 1,681 5.53
Other borrowed funds.......... 16,435 861 5.24 6,795 360 5.29 84 6 6.77
-------- ------- ---- -------- ------ ---- -------- ------ -----
Total interest bearing
liabilities................. 141,572 4,954 3.50% 105,636 4,112 3.89% 71,922 2,867 3.99%
-------- ------- ---- -------- ------ ---- -------- ------ -----
Demand deposits............... 34,853 26,887 18,530
Other liabilities............. 1,082 1,188 1,342
-------- -------- --------
Total liabilities............. 177,507 133,711 91,794
Shareholders' equity.......... 11,610 10,378 8,400
-------- -------- --------
Total liabilities and
shareholders' equity........ $189,117 $144,089 $100,194
======== ======== ========
Net interest income........... $ 9,277 $7,418 $5,463
======= ====== ======
Net interest margin........... 5.37% 5.55% 5.96%
</TABLE>
------------------------------
Note: Gross loans include nonaccrual loans of $6,000 for 1999, $67,000 for 1998
and $61,000 for 1997. Yields and amounts earned on loans include loan fees
of $858,000 , $574,000 and $498,000 for the years ended December 31, 1999,
1998, and 1997. Interest income is reflected on an actual basis, not a
fully taxable equivalent basis. The yield on investment securities does
not include a fair value adjustment.
91
<PAGE>
The following tables show the changes in interest income and interest
expense from changes in average assets and liability balances (volume) and
changes in average interest rates for the periods indicated. Changes not solely
attributable to volume or rates have been allocated in proportion to the
respective volume and rate components.
<TABLE>
<CAPTION>
ANALYSIS OF CHANGES IN INTEREST
INCOME AND EXPENSES INCREASE
(DECREASE) DUE TO CHANGE IN THE
THREE MONTHS ENDED MARCH 31,
2000 OVER THE THREE MONTHS
ENDED MARCH 31, 1999
--------------------------------------
VOLUME RATE TOTAL
(IN THOUSANDS) -------- -------- --------
<S> <C> <C> <C>
INTEREST INCOME:
Loans....................................................... $ 603 $129 $ 732
Investments & Fed funds..................................... 121 48 169
----- ---- -----
Total average earning assets.............................. $ 724 $177 $ 901
----- ---- -----
INCREASE (DECREASE) IN INTEREST EXPENSE:
Money market savings & checking............................. $ 137 $ 10 $ 147
Savings deposits............................................ 5 -- 5
Time deposits............................................... 269 39 308
Other borrowings............................................ (209) 8 (201)
----- ---- -----
Total average interest-bearing liabilities................ 202 57 259
----- ---- -----
Net increase (decrease) in interest income.................. $ 522 $120 $ 642
===== ==== =====
</TABLE>
<TABLE>
<CAPTION>
ANALYSIS OF CHANGES IN INTEREST INCOME AND
EXPENSES INCREASE (DECREASE) DUE TO CHANGE IN
---------------------------------------------------------------
1999 OVER 1998 1998 OVER 1997
------------------------------ ------------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
(IN THOUSANDS) -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
INTEREST INCOME:
Loans................................................ $2,965 $(779) $2,186 $2,531 $(391) $2,140
Investments & Fed funds.............................. 544 (29) 515 1,066 (6) 1,060
------ ----- ------ ------ ----- ------
Total average earning assets....................... $3,509 $(808) $2,701 $3,597 $(397) $3,200
------ ----- ------ ------ ----- ------
INCREASE (DECREASE) IN INTEREST EXPENSE:
Money market savings & checking...................... $ 547 $(319) $ 228 $ 639 $ 65 $ 704
Savings deposits..................................... 25 (10) 15 5 (3) 2
Time deposits........................................ 375 (276) 99 270 (86) 184
Other borrowings..................................... 510 (10) 500 455 (100) 355
------ ----- ------ ------ ----- ------
Total average interest-bearing liabilities......... 1,457 (615) 842 1,369 (124) 1,245
------ ----- ------ ------ ----- ------
Net increase (decrease) in interest income........... $2,052 $(193) $1,859 $2,228 $(273) $1,955
====== ===== ====== ====== ===== ======
</TABLE>
PROVISION FOR LOAN LOSSES
The provision for loan losses corresponds directly to the level of the
allowance that management deems sufficient to offset potential loan losses. The
balance in the loan loss allowance reflects the amount which, in management's
judgment, is adequate to provide for these potential loan losses after weighting
the mix of the loan portfolio, current economic conditions, past loan experience
and such other factors as deserve recognition in estimating loan losses.
Management allocated $80,000 in each of the three months ended March 31,
2000 and 1999. For the years ended December 31, 1999 and 1998, management
allocated $287,000 and $230,000. The
92
<PAGE>
increase in the provision from 1998 to 1999 was the result of greater potential
loan loss inherent in the increased loan growth. The provision in 1997 was
$270,000. The decrease from 1997 to 1998 was primarily the result of the planned
reduction and ultimate sale of a lease portfolio, and replacement of those
assets with higher quality loans. The level of classified assets decreased to
$169,000 at March 31, 2000, from $187,000 at December 31, 1999, $810,000 at
December 31, 1998, and $982,000 at December 31, 1997. As a percent of total
capital, classified assets were approximately 1.4%, 1.6%, 7.2% and 10.8% as of
March 31, 2000, December 31, 1999, 1998, and 1997. The decrease in classified
assets in 1999 from 1998 was also attributable to sale of the lease portfolio.
For further information regarding the allowance for loan losses, see the
"Summary of loan loss experience" on page 101.
NONINTEREST INCOME
The following tables disclose the components of noninterest income for the
three month periods ended March 31, 2000 and 1999, and for the years ended
December 31, 1999, 1998, and 1997.
<TABLE>
<CAPTION>
THREE MONTHS
ENDED MARCH 31,
-----------------------
2000 1999
(IN THOUSANDS) -------- --------
<S> <C> <C>
Service charges on deposit accounts......................... $ 69 $ 47
Gain on sale of SBA loans................................... -- 67
Brokered loan fees.......................................... 61 72
Earnings on cash surrender value of insurance policies...... 40 36
Other....................................................... 69 63
---- ----
Total..................................................... $239 $285
==== ====
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
(IN THOUSANDS) -------- -------- --------
<S> <C> <C> <C>
Service charges on deposit accounts......................... $ 217 $ 178 $ 144
Operating lease income...................................... -- 309 762
Gain on sale of SBA loans................................... 119 103 --
Brokered loan fees.......................................... 327 316 105
Gain on sale of OREO........................................ -- -- 335
Gain on sale of leased equipment............................ -- 50 --
Gain on sale of lease portfolio............................. -- 91 --
Earnings on cash surrender value of insurance policies...... 155 -- --
Other....................................................... 216 202 145
------ ------ ------
Total..................................................... $1,033 $1,249 $1,491
====== ====== ======
</TABLE>
Noninterest income totaled $239,000 in the three months ended March 31,
2000, which was $46,000, or 16.1%, less than in the three months ended
March 31, 1999. This decrease was due primarily to the Bank's decision to retain
the guaranteed portion of SBA loans to benefit from the interest income. If
premiums offered for the sale of these types of loans are attractive, the Bank
will generally sell them in the secondary market to recognize immediate gains on
the sales. Management decided that at current prices, it was advantageous to
retain the loans.
Noninterest income for 1999 totaled $1,033,000 which was $216,000, or 17.3%,
less than in 1998. This decrease was primarily the result of the sale of the
lease portfolio in late 1998. Some of this reduction was offset by earnings on
cash surrender value of insurance policies, increased service charges on deposit
accounts, and increased brokered loan fees. Significant components of
non-interest income were operating lease income of $0 in 1999 and $309,000 in
1998; service charges on deposit accounts
93
<PAGE>
$217,000 in 1999 and $178,000 in 1998, brokered loan fees of $327,000 in 1999
and $316,000 in 1998, earnings on cash surrender value of life insurance
policies $155,000 in 1999 and $0 in 1998.
Noninterest income decreased $242,000, or 16.2%, to $1,249,000 in 1998 from
$1,491,000 in 1997 primarily due to the declining lease portfolio and the sale
of foreclosed property in late 1997. These reductions in 1998 were somewhat
offset by gains on sales of SBA loans, increased service charges on deposit
accounts, and increased brokered loan fees. Significant components of
non-interest income were gains realized on the sale of other real estate,
totaling $0 in 1998 and $335,000 in 1997; operating lease income $762,000 in
1997 and $309,000 in 1998; and gain on sale of SBA loans $0 in 1997 and $103,000
in 1998.
NONINTEREST EXPENSE
The following tables compare the various elements of noninterest expense in
dollars for the three month period ending March 31, 2000 and 1999, and years
ended December 31, 1999, 1998, and 1997, and as a percentage of average assets.
Total noninterest expense, as a percentage of average assets, was 0.96% in the
three months ended March 31, 2000, 1.00% in the three months ended March 31,
1999, 3.87% in 1999, 4.26% in 1998, and 5.02% in 1997.
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
-----------------------------
2000 1999
(DOLLARS IN THOUSANDS) ---------- ----------
<S> <C> <C>
Average assets.............................................. $215,097 $175,460
</TABLE>
<TABLE>
<CAPTION>
EXPENSES AMOUNT PERCENT AMOUNT PERCENT
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C>
Salaries and benefits....................................... $1,148 0.53% $ 982 0.56%
Occupancy................................................... 201 0.10 227 0.13
Professional Fees........................................... 121 0.06 91 0.05
Furniture & equip........................................... 128 0.06 111 0.06
Marketing................................................... 90 0.04 60 0.04
Lease servicing fees........................................ -- -- -- --
Operating lease amort....................................... -- -- -- --
Software.................................................... 49 0.02 36 0.02
Other....................................................... 320 0.15 252 0.14
------ ---- ------ ----
Total..................................................... $2,057 0.96% $1,759 1.00%
====== ======
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------
1999 1998 1997
(DOLLARS IN THOUSANDS) -------------- -------------- --------------
<S> <C> <C> <C>
Average assets............................... $189,117 $144,089 $100,194
</TABLE>
<TABLE>
<CAPTION>
EXPENSES AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
-------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Salaries and benefits........................ $3,906 2.07% $3,219 2.23% $2,507 2.50%
Occupancy.................................... 865 0.46 632 0.44 404 0.40
Professional Fees............................ 442 0.23 323 0.22 248 0.25
Furniture & equip............................ 485 0.26 356 0.25 237 0.24
Marketing.................................... 287 0.15 215 0.15 150 0.15
Lease servicing fees......................... -- -- 157 0.11 252 0.25
Operating lease amortization................. -- -- 33 0.02 404 0.40
Software..................................... 179 0.09 120 0.08 68 0.07
Other........................................ 1,160 0.61 1,084 0.75 764 0.76
------ ---- ------ ---- ------ ----
Total...................................... $7,324 3.87% $6,139 4.26% $5,034 5.02%
====== ====== ======
</TABLE>
94
<PAGE>
Noninterest expense of $2,057,000 in the three months ended March 31, 2000
was $328,000 higher than the three months ended March 31, 1999. This 19.0%
increase was primarily due to expenses related to the continued growth of the
Bank. Although noninterest expenses increased, Western Holdings's efficiency
ratio (the ratio of noninterest expenses to net interest income plus other
income) improved from 74.3% in the three months ended March 31, 1999 to 70.4% in
the three months ended March 31, 2000.
Noninterest expense of $7,324,000 in 1999 was $1,185,000 higher than 1998.
This 19.3% increase was primarily due to expenses related to the continued
growth of the Bank, including opening a new full service branch office in
Mountain View. Noninterest expenses increased $1,185,000, and the Bank's
efficiency ratio decreased slightly to 71.0% in 1999 from 70.8% in 1998.
Noninterest expense of $6,139,000 in 1998 was $1,105,000 greater than 1997.
This 22.0% increase was primarily due to expenses related to the continued
growth of the Bank, including opening a new full service branch office in
Mountain View in mid-1998. Although noninterest expenses increased by
$1,105,000, the efficiency ratio improved to 70.8% in 1998 from 72.4% in 1997.
INCOME TAXES
Income tax expense was $307,000 in the three months ended March 31, 2000,
$191,000 in the three months ended March 31, 1999, $1,056,000 in 1999, $942,000
in 1998 and $380,000 in 1997, with effective tax rates of 39.1% in the three
months ended March 31, 2000 and 1999, and 39.1% in 1999, 41.0% in 1998 and 23.0%
in 1997. As of December 31, 1999, Western Holdings had federal net operating
loss carryforwards available to reduce future taxable income of approximately
$2,300,000. These net operating loss carryforwards expire in 2007.
FINANCIAL CONDITION
SUMMARY
MARCH 31, 2000 COMPARED TO MARCH 31, 1999. Total assets at March 31, 2000
were $229,491,000, representing a 24.6% increase over total assets of
$184,213,000 at March 31, 1999. This increase was primarily due to increases in
the loan portfolio, partially offset by a reduction in Federal Home Loan Bank
("FHLB") borrowings funded by deposit growth. Total deposits at March 31, 2000
were $215,837,000, representing a 42.3% increase over total deposits of
$151,646,000 at March 31, 1999. The increase was primarily due to growth in both
business and individual deposits. Total shareholders' equity at March 31, 2000
was $12,364,000 compared to $11,356,000 at March 31, 1999, an 8.9% increase, due
to net operating income $1,825,000, offset by an increase in unrealized losses
on the security portfolio of $896,000.
1999 COMPARED TO 1998. Total assets at December 31, 1999 were $200,455,000,
representing a 13.6% increase over total assets of $176,473,000 at December 31,
1998. This increase was primarily due to increases in the loan portfolio,
partially offset by a reduction in FHLB borrowings funded by deposit growth.
Total deposits at December 31, 1999 were $182,880,000, representing a 29.7%
increase over total deposits of $140,958,000 at December 31, 1998. The increase
was due to growth in both business and individual deposits.
Total shareholders' equity at December 31, 1999 was $12,013,000 compared to
$11,294,000 at December 31, 1998, a 6.4% increase. This increase in capital was
due to net operating income of $1,643,000 and the exercise of stock options by
employees totaling $77,000, offset by an increase of $1,001,000 in the net
unrealized loss on available-for-sale securities, net of tax.
95
<PAGE>
1998 COMPARED TO 1997. Total assets at December 31, 1998 were $176,473,000,
representing a 39.5% increase over total assets of $126,547,000 at December 31,
1997. This increase was primarily due to increases in the loan portfolio, along
with increases in the securities portfolio, the latter funded by FHLB
borrowings.
Total deposits at December 31, 1998 were $140,958,000, representing a 25.0%
increase over total deposits of $112,750,000 at December 31, 1997. The net
increase was due to increases in consumer and business accounts, offset by a
decrease in certificates of deposit of $100,000 or more.
Total shareholders' equity at December 31, 1998 was $11,294,000 compared to
$9,138,000 at December 31, 1997, a 23.6% increase. The increase in equity was
due to net operating income $1,356,000, the exercise of stock options by
employees and directors totaling $1,060,000, offset by $130,000 due to the
repurchase of some stock, and an increase of $130,000 in the net unrealized loss
on available-for-sale securities, net of tax.
INVESTMENT PORTFOLIO
Western Holdings maintains a securities portfolio consisting of U.S.
Treasury, U.S. Government agencies, state and political subdivisions and other
debt securities. Investment securities are held in safekeeping by an independent
custodian.
The objective of the investment securities held to maturity is to strengthen
the portfolio yield and to provide collateral to pledge for federal, state and
local deposits. All held to maturity investments are fixed rate securities.
Investment securities available for sale are generally used to supplement
the Bank's liquidity. Unrealized net gains and losses on these securities are
recorded in other comprehensive income (loss) as an adjustment to shareholders'
equity, net of taxes, and are not reflected in current earnings. If a security
is sold, any gain or loss is recorded as a charge to earnings and the equity
adjustment is reversed. At March 31, 2000, investment securities classified as
available for sale totaled $47,593,000. At March 31, 2000, an unrealized loss of
$2,063,000, net of taxes of $807,000 related to these securities, was recognized
as other comprehensive loss in shareholders' equity.
Western Holdings had no trading securities at March 31, 2000, and 1999, and
December 31, 1999 and 1998. For more information on investment securities, see
Notes 1 and 2 to the consolidated financial statements.
The following tables show the amortized cost and estimated fair values of
investment securities as of March 31, 2000 and December 31, 1999 and 1998.
MARCH 31, 2000:
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
(IN THOUSANDS) --------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
U.S. Treasury securities............................. $ 500 $-- $ (1) $ 499
U.S. Agency securities............................... 27,263 -- (1,176) 26,087
U.S. Agency mortgage-backed securities............... 16,794 -- (1,053) 15,741
Collateralized mortgage obligation................... 2,373 -- (153) 2,220
Municipal bonds...................................... 7,725 3 (191) 7,537
FHLB stock........................................... 690 -- -- 690
Other investments.................................... 999 -- (32) 967
------- --- ------- -------
Total.............................................. $56,344 $ 3 $(2,606) $53,741
======= === ======= =======
</TABLE>
96
<PAGE>
DECEMBER 31, 1999:
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
(IN THOUSANDS) --------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
U. S. Treasury securities............................ $ 500 $-- $ (1) $ 499
U. S. Agency securities.............................. 22,491 -- (1,025) 21,466
U. S. Agency mortgage-backed securities.............. 17,354 -- (946) 16,408
Collateralized mortgage obligation................... 2,403 -- (163) 2,240
Municipal bonds...................................... 2,717 -- (193) 2,524
FHLB stock........................................... 1,316 -- -- 1,316
Other investments.................................... 999 -- (21) 978
------- --- ------- -------
Total.............................................. $47,780 $-- $(2,349) $45,431
======= === ======= =======
</TABLE>
DECEMBER 31, 1998:
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
(IN THOUSANDS) --------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
U. S. Treasury securities............................ $ 2,503 $ 9 $ -- $ 2,512
U. S. Agency securities.............................. 28,655 58 (176) 28,537
U. S. Agency mortgage-backed securities.............. 14,475 27 (90) 14,412
Collateralized mortgage obligation................... 2,887 16 (2) 2,901
Municipal bonds...................................... -- -- -- --
FHLB stock........................................... 2,101 -- -- 2,101
Other investments.................................... -- -- -- --
------- ---- ----- -------
Total.............................................. $50,621 $110 $(268) $50,463
======= ==== ===== =======
</TABLE>
DECEMBER 31, 1997:
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
(IN THOUSANDS) --------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
U. S. Treasury securities............................ $12,747 $24 $ -- $12,771
U. S. Agency securities.............................. 18,520 30 (6) 18,544
U. S. Agency mortgage-backed securities.............. -- -- -- --
Collateralized mortgage obligation................... -- -- -- --
Municipal bonds...................................... -- -- -- --
FHLB stock........................................... 368 -- -- 368
Other investments.................................... -- -- -- --
------- --- ---- -------
Total.............................................. $31,635 $54 $ (6) $31,683
======= === ==== =======
</TABLE>
The following table discloses the relative maturities and yields of the
Bank's investment securities (stated at amortized cost) at March 31, 2000.
Weighted average yields have been computed by dividing annual interest income,
adjusted for amortization of premium and accretion of discount, by the amortized
cost of the related security. Yields on securities of state and political
subdivisions have been adjusted to a fully taxable equivalent basis.
97
<PAGE>
MARCH 31, 2000:
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS)
AFTER FIVE
ONE YEAR AFTER ONE YEAR YEARS
OR LESS TO FIVE YEARS TO TEN YEARS AFTER TEN YEARS TOTAL
------------------- ------------------- ------------------- ------------------- AMORTIZED
AVAILABLE-FOR-SALE AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD COST
------------------ -------- -------- -------- -------- -------- -------- -------- -------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasuries............... $ 500 5.3 % $ -- 0.0% $ -- 0.0% $ -- 0.0% $ 500
U.S. Government agencies...... 500 6.1 % 18,264 6.1% 8,499 6.1% -- 0.0% 27,263
Mortgage-backed securities.... 225 5.8 % -- 0.0% -- 0.0% 10,190 6.5% 10,415
Other debt securities......... -- 0.0 % 999 6.7% -- 0.0% -- 0.0% 999
Municipal bonds............... 1,788 4.6 % 3,219 4.8% 1,974 4.3% 744 4.4% 7,725
FHLB Stock.................... -- 0.0 % -- 0.0% 690 6.0% -- 0.0% 690
------ ------ ------- ------- ------- ---- ------- ---- -------
Total..................... $3,013 5.1 % $22,482 5.9% $11,163 5.8% $10,934 6.3% $47,592
------ ------ ------- ------- ------- ---- ------- ---- -------
HELD-TO-MATURITY
------------------------------
Mortgage-backed securities.... $ -- 0.0 % $ -- 0.00% $ -- 0.0% $ 8,752 6.4% $ 8,752
------ ------ ------- ------- ------- ---- ------- ---- -------
Total Securities............ $3,013 5.1 % $22,482 5.9% $11,163 5.8% $19,686 6.3% $56,344
====== ====== ======= ======= ======= ==== ======= ==== =======
<CAPTION>
(DOLLARS IN THOUSANDS)
AVAILABLE-FOR-SALE YIELD
------------------ --------
<S> <C>
U.S. Treasuries............... 5.3 %
U.S. Government agencies...... 6.1 %
Mortgage-backed securities.... 6.5 %
Other debt securities......... 6.7 %
Municipal bonds............... 4.6 %
FHLB Stock.................... 6.0 %
-------
Total..................... 5.9 %
-------
HELD-TO-MATURITY
------------------------------
Mortgage-backed securities.... 6.4 %
-------
Total Securities............ 6.0 %
=======
</TABLE>
LOAN PORTFOLIO
The following table shows the composition of the Bank's loan portfolio by
type of loan for the dates indicated:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
--------- ----------------------------------------------------
2000 1999 1998 1997 1996 1995
(IN THOUSANDS) --------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Real
Estate--Construction.... $ 28,361 $ 28,716 $ 36,832 $31,239 $17,564 $11,749
Real
Estate--Residential..... 37,382 38,994 26,586 19,359 8,504 1,557
Real
Estate--Non-residential.. 30,436 30,826 17,068 8,558 11,405 3,676
Commercial................ 27,570 23,183 16,020 14,592 7,105 2,831
SBA....................... 5,568 3,187 1,586 -- -- --
Consumer.................. 4,273 4,698 3,707 2,974 1,966 799
Other..................... -- -- 14 1,509 3,947 9,871
-------- -------- -------- ------- ------- -------
Total................... $133,590 $129,604 $101,813 $78,231 $50,491 $30,483
Less:
Deferred loan fees...... (188) (219) (189) (290) (248) (71)
Allowance for loan
losses................ (1,588) (1,508) (1,244) (985) (778) (822)
-------- -------- -------- ------- ------- -------
Total net loans......... $131,814 $127,877 $100,380 $76,956 $49,465 $29,590
======== ======== ======== ======= ======= =======
</TABLE>
The Bank's largest historical lending categories continue to be residential,
non-residential and construction real estate loans. These categories represented
the following percentages of total loans: approximately 28%, 23% and 21%,
respectively, at March 31, 2000, 30%, 24% and 22%, respectively at December 31,
1999. At December 31, 1998 and 1997, these categories represented the following
percentages of total loans: 26%, 17% and 36% at December 31, 1998 and 25%, 11%
and 40% at December 31, 1997. The steady increase in loans reflects emphasis on
loans to local businesses, including starting an SBA department, and a new
initiative to increase mortgage loans secured by local single family residences.
98
<PAGE>
The following table sets forth the amounts of loans outstanding as of
March 31, 2000, and December 31, 1999, which, based on the remaining scheduled
repayments of principal, have the ability to be repriced or are due in less than
one year, in one to five years, or in more than five years. It also shows the
amounts of total loans outstanding which have fixed interest rates and floating
interest rates and have remaining scheduled repayments of principal in less than
one year, in one to five years, or in more than five years.
<TABLE>
<CAPTION>
MARCH 31, 2000
-----------------------------------------
WITHIN 1 1 TO 5 AFTER 5
YEAR YEARS YEARS TOTAL
(IN THOUSANDS) -------- -------- -------- --------
<S> <C> <C> <C> <C>
Real estate--construction................ $28,361 $ -- $ -- $ 28,361
Real estate--residential................. 24,156 12,822 404 37,382
Real estate--non-residential............. 7,310 23,126 -- 30,436
Commercial............................... 27,570 -- -- 27,570
SBA...................................... 5,568 -- -- 5,568
Consumer................................. 4,273 -- -- 4,273
------- ------- ---- --------
Total loans............................ $97,238 $35,948 $404 $133,590
======= ======= ==== ========
Loans with fixed rates................... $ 5,935 $ -- $ -- $ 5,935
Loans with floating rates................ 91,303 35,948 404 127,655
------- ------- ---- --------
Total loans............................ $97,238 $35,948 $404 $133,590
======= ======= ==== ========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1999
-----------------------------------------
WITHIN 1 1 TO 5 AFTER 5
YEAR YEARS YEARS TOTAL
(IN THOUSANDS) -------- -------- -------- --------
<S> <C> <C> <C> <C>
Real estate--residential................. $23,715 $15,278 $ -- $ 38,993
Real estate--non-residential............. 8,249 22,577 -- 30,826
Real estate--construction................ 28,716 -- -- 28,716
Commercial............................... 23,183 -- -- 23,183
SBA...................................... 3,187 -- -- 3,187
Consumer................................. 4,698 -- -- 4,698
------- ------- ---- --------
Total loans............................ $91,748 $37,855 $ -- $129,603
======= ======= ==== ========
Loans with fixed rates................... $ 4,698 $ -- $ -- $ 4,698
Loans with floating rates................ 87,050 37,855 -- 124,905
------- ------- ---- --------
Total loans............................ $91,748 $37,855 $ -- $129,603
======= ======= ==== ========
</TABLE>
The following table shows the Bank's loan commitments at the dates
indicated:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
---------- ------------------------------
2000 1999 1998 1997
(IN THOUSANDS) ---------- -------- -------- --------
<S> <C> <C> <C> <C>
Construction........................... $19,422 $19,102 $16,854 $16,888
Real Estate............................ 19,301 17,997 14,707 7,881
Commercial............................. 24,988 23,225 21,482 11,743
SBA.................................... 174 431 525 --
Consumer............................... 7,750 6,480 3,999 2,904
------- ------- ------- -------
Total................................ $71,635 $67,235 $57,567 $39,416
======= ======= ======= =======
</TABLE>
Based upon prior experience and prevailing economic conditions, the Bank
anticipates that approximately 75% of construction commitments and 25% of all
other commitments at March 31, 2000
99
<PAGE>
will be exercised during 2000. All commercial commitments in the preceding table
are commitments to grant such loans.
SUMMARY OF LOAN LOSS EXPERIENCE
As a natural corollary to the Bank's lending activities, some loan losses
are experienced. The risk of loss varies with the type of loan being made and
the creditworthiness of the borrower over the term of the loan. To the extent
possible, the Bank takes into account the degree of perceived risk in
establishing the structure of, and interest rate and security for, specific
loans and for various types of loans. The Bank attempts to minimize its credit
risk exposure by the use of thorough loan application and approval procedures.
The Bank maintains an internal program of systematic review of existing
loans. Loans are initially graded for their overall quality at origination, and
the grades are subsequently reevaluated when potential issues are identified.
The Bank also utilizes the services of an external loan file review firm to
evaluate its assigned grades. Loans that management has determined require
further monitoring are included on the Bank's Watch List and Classified Loan
Report. In addition, all problem loans are reviewed on a monthly basis by the
Directors' Loan Committee.
The Bank's classified assets of the dates indicated are summarized below:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
------------------- ----------------------------------------------------
2000 1999 1999 1998 1997 1996 1995
(IN THOUSANDS) -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Classified loans.................... $169 $705 $187 $810 $982 $236 $484
Other real estate owned............. -- -- -- -- -- 450 499
---- ---- ---- ---- ---- ---- ----
Total............................. $169 $705 $187 $810 $982 $686 $983
==== ==== ==== ==== ==== ==== ====
</TABLE>
All of the Bank's classified loans at March 31, 2000 are unsecured.
Loans for which it is probable that the Bank will be unable to collect all
amounts due (including principal and interest) are considered to be impaired.
The average recorded investment in impaired loans totaled $3,000 in the first
quarter of 2000, $6,000 in 1999 and $67,000 in 1998. In addition, when principal
or interest on a loan is past due 90 days or more, loans are placed on
nonaccrual status unless both well secured and in the process of collection.
Interest previously accrued on loans placed on nonaccrual status is charged
against interest income. When the ability to fully collect nonaccrual loan
principal is in doubt, the Bank applies cash payments received against the
principal balance of the loans until such time as full collection of the
remaining recorded balance is expected. The Bank records any additional payments
received after that point as interest income on a cash basis. Performing
nonaccrual loans are reinstated to accrual status when improvements in credit
quality eliminate the doubt as to the full collectibility of both interest and
principal. The Bank also classifies loans on nonaccrual status as impaired.
The following table summarizes the Bank's nonaccrual loans at the dates
indicated:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
--------------------- ------------------------------------------------------
2000 1999 1999 1998 1997 1996 1995
(IN THOUSANDS) ---------- -------- ---------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Construction........................ $ -- $-- $ -- $-- $-- $-- $--
Real estate......................... -- -- -- -- -- -- --
Commercial.......................... -- 41 -- 44 56 67 78
Consumer............................ 3 19 6 23 5 -- --
---------- --- ---------- --- --- --- ---
Total nonaccrual.................. $ 3 $60 $ 6 $67 $61 $67 $78
========== === ========== === === === ===
</TABLE>
The Bank had no loans which were 90 days or more past due and still accruing
interest or troubled debt restructurings at March 31, 2000, December 31, 1999
and 1998, respectively. The reduction in nonaccrual loans in the three months
ended March 31, 2000 over the three months ended March 31, 1999, and in year
ending December 31, 1999 over 1998, was the result of collections of amounts
due.
100
<PAGE>
The Bank's allowance for loan losses provides for loan losses which the Bank
can reasonably anticipate. The Bank's management determines the amount of the
allowance after considering the current financial condition of its borrowers,
the value of collateral securing loans, recommendations of the regulatory
agencies, the Bank's historical loss experience, prevailing economic conditions
and their impact on various industries and borrowers and other factors. The
allowance for loan losses is established through charges to operating expenses
in the form of provisions for loan losses. Because these estimates and
evaluations are primarily based on judgmental factors, no assurance can be given
that the Bank may not sustain loan losses substantially higher in relation to
the size of the allowance or that subsequent evaluations of the loan portfolio
may not require substantial changes in the allowance.
At March 31, 2000, December 31, 1999, 1998 and 1997, the allowance was
1.19%, 1.17%, 1.22% and 1.26% of loans then outstanding on those dates.
The following schedule summarizes the loan loss experience of the Bank for
the years indicated:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, YEAR ENDED DECEMBER 31,
------------------- ----------------------------------------------------
2000 1999 1999 1998 1997 1996 1995
(DOLLARS IN THOUSANDS) -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Average loans for period........... $129,858 $103,601 $119,388 $89,460 $64,993 $37,624 $30,858
Loans at end of period............. 133,402 108,745 129,385 101,624 77,941 50,242 30,412
Nonperforming loans at end of
period........................... 3 60 6 67 61 67 78
Balance, beginning of period....... 1,508 1,244 1,244 985 778 822 943
Charge-offs:
Commercial....................... -- -- -- -- -- -- --
Real estate--land and
construction................... -- -- -- -- -- -- --
Real estate--mortgage............ -- -- -- -- -- -- --
Installment...................... -- -- (26) (3) (7) (1) (3)
Other............................ -- -- -- (3) (107) (170) (318)
-------- -------- -------- ------- ------- ------- -------
Total charge-offs.................. -- -- (26) (6) (114) (171) (321)
Recoveries:........................ -- -- -- -- -- -- --
Commercial....................... -- -- 3 135 51 -- --
Real estate--land and
construction................... -- -- -- -- -- -- --
Real estate--mortgage............ -- -- -- -- -- -- --
Installment...................... -- -- -- 3 -- 2 10
Other............................ -- 1 3 32 51 124 220
-------- -------- -------- ------- ------- ------- -------
Total recoveries................... -- 1 3 35 51 126 230
Net (charge-offs) recoveries....... -- 1 (23) 29 (63) (44) (91)
Provision for loan losses.......... 80 80 287 230 270 -- (30)
-------- -------- -------- ------- ------- ------- -------
Balance, end of period............. $ 1,588 $ 1,325 $ 1,508 $ 1,244 $ 985 $ 778 $ 822
======== ======== ======== ======= ======= ======= =======
RATIOS:
Net (charge-offs) recoveries to
average loans outstanding...... --% --% 0.02% (0.03)% 0.10% 0.12% 0.29%
Allowance for loan losses to
average loans.................. 1.22% 1.28% 1.26% 1.39% 1.52% 2.07% 2.66%
Allowance for loan losses to
total loans at end of period... 1.19% 1.22% 1.17% 1.22% 1.26% 1.55% 2.70%
Allowance for loan losses to
nonperforming loans............ 52933% 2208% 25133% 1857% 1615% 1161% 1054%
</TABLE>
The increase in the allowance for loan losses reflects the growth in the
Bank's loan portfolio.
101
<PAGE>
The following tables present the allocation of the allowance for loan losses
as of the dates indicated:
<TABLE>
<CAPTION>
MARCH 31, 2000
-------------------------
AMOUNT TO
TOTAL LOANS IN
AMOUNT CATEGORY
(DOLLARS IN THOUSANDS) -------- --------------
<S> <C> <C>
Real estate residential..................................... $ 355 0.95%
Real estate nonresidential.................................. 327 1.08%
Real estate construction.................................... 266 0.94%
Commercial.................................................. 489 1.77%
Consumer.................................................... 110 2.58%
SBA......................................................... 40 0.73%
------ ----
Total..................................................... $1,588 1.19%
====== ====
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------------------------------------------------
1999 1998 1997 1996
------------------- ------------------- ------------------- -------------------
AMOUNT AMOUNT AMOUNT AMOUNT
TO TOTAL TO TOTAL TO TOTAL TO TOTAL
LOANS IN LOANS IN LOANS IN LOANS IN
AMOUNT CATEGORY AMOUNT CATEGORY AMOUNT CATEGORY AMOUNT CATEGORY
(DOLLARS IN THOUSANDS) -------- -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate residential... $ 345 0.89% $ 222 0.84% $153 0.79% $ 82 0.96%
Real estate
nonresidential.......... 324 1.05 171 1.00 86 1.00 118 1.04
Real estate
construction............ 267 0.93 358 0.97 297 0.95 255 1.45
Commercial................ 434 1.87 394 2.46 350 2.40 162 2.28
Consumer and other........ 109 2.33 91 2.47 99 2.22 161 2.71
SBA....................... 28 0.86 7 0.46 -- -- -- --
------ ---- ------ ---- ---- ---- ---- ----
Total................... $1,508 1.17% $1,224 1.22% $985 1.26% $778 1.55%
====== ====== ==== ====
<CAPTION>
DECEMBER 31,
-------------------
1995
-------------------
AMOUNT
TO TOTAL
LOANS IN
AMOUNT CATEGORY
(DOLLARS IN THOUSANDS) -------- --------
<S> <C> <C>
Real estate residential... $ 23 1.48%
Real estate
nonresidential.......... 57 1.55
Real estate
construction............ 262 2.23
Commercial................ 83 2.93
Consumer and other........ 397 3.72
SBA....................... -- --
---- ----
Total................... $822 2.70%
====
</TABLE>
DEPOSITS
Western Holdings primarily attracts deposits from small and middle-market
businesses and individuals living in its geographical service area. The
following table shows average deposits for each of the periods indicated below:
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
MARCH 31, YEAR ENDED DECEMBER 31,
------------------- ---------------------------------------------------------------
2000 1999 1998 1997
------------------- ------------------- ------------------- -------------------
AVERAGE PERCENT AVERAGE PERCENT AVERAGE PERCENT AVERAGE PERCENT
BALANCE OF TOTAL BALANCE OF TOTAL BALANCE OF TOTAL BALANCE OF TOTAL
(DOLLARS IN THOUSANDS) -------- -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Demand deposits.................... $ 42,315 21% $ 34,853 22% $ 26,887 21% $18,530 21%
Money market checking.............. 40,518 20 30,520 19 20,260 17 11,338 13
Money market savings............... 51,898 26 46,704 29 38,902 31 25,947 29
Savings deposits................... 6,213 3 5,518 3 4,378 3 4,141 5
Time deposits under $100,000....... 21,233 11 20,128 13 16,516 13 15,028 17
Time deposits $100,000 and over.... 37,409 19 22,267 14 18,785 15 15,384 17
-------- --- -------- --- -------- --- ------- ---
Total deposits................... $199,586 100% $159,990 100% $125,728 100% $90,368 100%
======== === ======== === ======== === ======= ===
</TABLE>
In the three months ended March 31, 2000, total average deposits increased
$39,597,000, or 24.8% from December 31, 1999 due to growth in all deposit types,
as a result of marketing efforts to attract new deposits.
102
<PAGE>
In 1999, total average deposits increased $34,262,000, or 27.3% from 1998
due to increases in all deposit types as a result of marketing efforts to
attract new deposits. In 1999, Western Holdings had an average deposit mix of
22% in demand, 48% in money market checking and savings, 3% in savings and 27%
in time deposits.
In 1998, total average deposits increased $35,360,000 or 39.1% from 1997 due
to growth in all deposit types, as a result of marketing efforts to attract new
deposits. In 1998, Western Holdings had an average deposit mix of 21% in demand,
48% in money market checking and savings, 3% in savings and 28% in time
deposits.
The following table indicates the maturity schedule of the Bank's time
deposits as of March 31, 2000:
<TABLE>
<CAPTION>
BALANCES BALANCES
UNDER $100,000 $100,000 OR MORE
(IN THOUSANDS) -------------- ----------------
<S> <C> <C>
3 months or less................................ $ 7,968 $19,122
Over 3 months through 12 months................. 11,333 21,216
Over twelve months.............................. 1,590 756
------- -------
Total......................................... $20,891 $41,094
</TABLE>
Business deposit customers served by the Bank typically maintain balances in
excess of $100,000 in average size, including certificates of deposits.
Certificates of deposits for customers who maintain larger customer
relationships with the Bank are generally considered core deposits.
CAPITAL RESOURCES
The current and projected capital position of Western Holdings and the
impact of capital plans and long term strategies are reviewed regularly by
management. Its capital position represents the level of capital available to
support continued operations and expansion.
Western Holdings and the Bank are subject to various regulatory requirements
administered by federal Banking agencies. Under capital adequacy guidelines, the
Bank must meet specific capital guidelines that involve quantitative measures of
the Bank's liabilities and certain off-balance sheet items as calculated under
regulatory accounting practices. The following table summarizes risk-based
capital, risk-weighted assets, and risk-based capital ratios of Western
Holdings:
<TABLE>
<CAPTION>
DECEMBER 31,
MARCH 31, ------------------------------
2000 1999 1998 1997
(DOLLARS IN THOUSANDS) --------- -------- -------- --------
<S> <C> <C> <C> <C>
Capital components:
Tier 1 Capital.................... $ 13,606 $ 13,080 $ 11,294 $ 8,858
Tier 2 Capital.................... 1,588 1,508 1,244 979
-------- -------- -------- --------
Total risk-based capital........ $ 15,193 $ 14,588 $ 12,446 $ 9,837
======== ======== ======== ========
Risk-weighted assets................ $150,837 $138,426 $114,284 $ 78,303
Average assets...................... 215,097 198,793 166,332 117,857
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31 MINIMUM
MAR 31 ------------------------------------ REGULATORY
2000 1999 1998 1997 REQUIREMENT(1)
-------- ---------- ---------- ---------- --------------
<S> <C> <C> <C> <C> <C>
Leverage Ratio....... 6.33% 6.58% 6.73% 7.52% 4.0%
Tier 1 Risk-Based
Capital Ratio...... 9.02% 9.45% 9.80% 11.31% 4.0%
Total Risk-Based
Capital Ratio...... 10.07% 10.54% 10.89% 12.56% 8.0%
</TABLE>
------------------------
(1) For an "adequately capitalized" institution.
103
<PAGE>
All ratios exceed the regulatory minimum requirements as well as the
regulatory minimum requirements for an "adequately capitalized" institution.
ASSET AND LIABILITY MANAGEMENT
Western Holdings maintains a portion of its funds in cash deposits in other
banks, in Federal funds sold, and in investment securities. As of March 31,
2000, the primary liquidity ratio was 32%, comprised of $45,530,000 in
available-for-sale investment securities, less $10,185,000 of securities that
were pledged to secure public and certain other deposits as required by law and
contract, Federal funds sold of $21,645,000, and $12,078,000 in cash and due
from banks, as a percentage of total deposits of $215,837,000.
As of December 31, 1999, Western Holdings' primary liquidity ratio was 17%,
comprised of $36,782,000 in investment securities available-for-sale, less
$22,741,000 securities that were pledged to secure public and certain other
deposits as required by law and contract, Federal funds sold of $7,800,000, and
$9,275,000 in cash and due from banks, as a percentage of total deposits of
$182,880,000.
Western Holdings has Federal funds lines of credit with its correspondent
banks. Western Holdings also has a line of credit with the Federal Home Loan
Bank subject to various pledging options. The amount of the credit line varies
according to the mortgage loan base and other factors. When Western Holdings has
excess funds over its reserve requirements or short-term liquidity needs, it
increases its securities investments, sells federal funds or both. The following
table summarizes borrowings as of the period ending indicated:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
--------- ------------------------------
2000 1999 1998 1997
(DOLLARS IN THOUSANDS) --------- -------- -------- --------
<S> <C> <C> <C> <C>
Average balance during the period...... $ 2,586 $16,435 $ 6,795 $ 84
Average interest rate during the
period............................... 6.20% 5.24% 5.29% 5.86%
Average rate at period end............. n/a 6.11% 5.07% 6.74%
Available credit at period end......... $47,091 $41,427 $15,735 $25,460
</TABLE>
Policies have been developed by management and approved by the board of
directors which establish guidelines for investments and liquidity. These
policies include an investment policy and an asset/liability management policy.
The goals of these policies are to provide liquidity to meet the financial
requirements of customers, maintain adequate reserves as required by regulatory
agencies and maximize earnings.
While deposits may fluctuate up and down somewhat with local and national
economic conditions, management does not believe that any deposits, or the
business of Western Holdings in general, are seasonal in nature. Asset/liability
management is monitored by the asset/liability management committee and
investment committee, which meet quarterly.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and
rates. Western Holdings' market risk arises primarily from interest rate risk
inherent in its investment, loan and deposit functions and management actively
monitors and manages this interest rate risk exposure. Western Holdings does not
have any market risk sensitive instruments entered into for trading purposes.
Management uses an interest rate risk model to measure and monitor its interest
rate risk. One measure of exposure to interest rate risk is gap analysis. A
positive gap for a given period means that the amount of interest-earning assets
maturing or otherwise repricing within such period is greater than the amount of
interest-bearing liabilities maturing or otherwise repricing within the same
period.
104
<PAGE>
Western Holdings' overall cumulative positive gap is the result of
noninterest bearing deposits of $44,152,000, which represents 118% of the
$37,539,000 gap. On the liability side, the majority of time deposits have
average terms of approximately six months while savings accounts and other
interest-bearing transaction accounts are recorded for gap analysis in the next
day to three month category because they do not have a contractual maturity
date.
Taking into consideration that savings accounts and other interest-bearing
transaction accounts typically do not react immediately to changes in interest
rates, management has taken the following steps to manage its positive gap
position. Western Holdings has reduced interest rates on time deposits and
focused on increasing noninterest-bearing deposits and floating rate loans. In
addition, the Bank holds the majority of its investment securities in the
available-for-sale category for purposes of liquidity and asset and liability
management.
The following table sets forth the distribution of repricing opportunities
of interest-earning assets and interest-bearing liabilities, the interest rate
sensitivity gap (i.e. interest rate sensitive assets less interest rate
sensitive liabilities), the cumulative interest rate sensitivity gap and the
cumulative gap as a percentage of total interest-earning assets as of March 31,
2000 and December 31, 1999. The table also sets forth the time periods during
which interest-earning assets and interest-bearing liabilities will mature or
may reprice in accordance with their contractual terms. The interest rate
relationships between the repriceable assets and repriceable liabilities are not
necessarily constant. The table should, therefore, be used only as a guide as to
the possible effect changes in interest rates might have on the net margins of
Western Holdings.
MARCH 31, 2000:
<TABLE>
<CAPTION>
NEXT DAY TO OVER 3 THRU OVER 1 YR OVER 5
3 MONTHS 12 MONTHS THRU 5 YRS YEARS TOTAL
(DOLLARS IN THOUSANDS) ----------- ----------- ---------- -------- --------
<S> <C> <C> <C> <C> <C>
Assets:
Federal funds sold...................... $ 21,645 $ -- $ -- $ -- $ 21,645
Investment securities................... 500 713 24,982 27,396 53,591
Loans................................... 111,192 5,137 15,551 1,519 133,399
FHLB Stock.............................. -- -- -- 690 690
-------- -------- ------- ------- --------
Total interest-earning assets............. $133,337 $ 5,850 $40,533 $29,605 $209,325
Liabilities:
Money market and savings deposits....... $109,707 $ -- $ -- $ -- $109,707
Time deposits........................... 27,090 32,549 2,346 -- 61,985
-------- -------- ------- ------- --------
Total interest-bearing liabilities........ $136,797 $ 32,549 $ 2,346 $ -- $171,692
Net (interest-bearing
liabilities)/interest-earning assets.... $ (3,460) $(26,699) $38,187 $29,605 $ 37,633
Cumulative net (interest-bearing
liabilities)/ interest-earning assets... $ (3,460) $(30,159) $ 8,028 $37,633
Cumulative GAP as a percentage of total
interest-earning assets................. (1.65)% (14.41)% 3.84% 17.98%
</TABLE>
105
<PAGE>
DECEMBER 31, 1999:
<TABLE>
<CAPTION>
NEXT DAY TO OVER 3 THRU OVER 1 YR OVER 5
3 MONTHS 12 MONTHS THRU 5 YRS YEARS TOTAL
(DOLLARS IN THOUSANDS) ----------- ----------- ---------- -------- --------
<S> <C> <C> <C> <C> <C>
Assets:
Federal funds sold...................... $ 7,800 $ -- $ -- $ -- $ 7,800
Investment securities................... -- 1,216 15,318 28,095 44,629
Loans................................... 104,803 5,395 17,995 1,186 129,379
FHLB Stock.............................. -- -- -- 1,316 1,316
-------- -------- ------- ------- --------
Total interest-earning assets............. $112,603 $ 6,611 $33,313 $30,597 $183,124
Liabilities:
Money market and savings deposits....... $ 89,954 $ -- $ -- $ -- $ 89,954
Time deposits........................... 26,502 20,609 3,968 -- 51,079
-------- -------- ------- ------- --------
Total interest-bearing liabilities........ $116,456 $ 20,609 $ 3,968 $ -- $141,033
Net (interest-bearing
liabilities)/interest-earning assets.... $ (3,853) $(13,998) $29,345 $30,597 $ 42,091
Cumulative net (interest-bearing
liabilities)/ interest-earning assets... $ (3,853) $(17,851) $11,494 $42,091
Cumulative GAP as a percentage of total
interest-earning assets................. (2.10)% (9.75)% 6.28% 22.98%
</TABLE>
Western Holdings' interest rate risk model projects changes in net interest
income that would occur based on forecasted changes in the interest rate
environment. The model compares net interest margin in a flat interest rate
scenario to forecasted financial results based on interest rates with an
increase of 200 basis points and a decrease of 200 basis points over a 12 month
forecast period. The model shows that net interest income would benefit from a
2% increase interest rates by $775,000 over a 12-month forecast period, while a
2% decrease in interest rates would have an adverse impact on earnings of
$968,000.
Western Holdings analyzes its position to be able to maintain its net
interest margin while ensuring adequate liquidity in times of both rising and
falling interest rates. In adjusting the Bank's asset/liability position,
management monitors its interest rate risk while striving to enhance net
interest margins. Depending on the level of interest rates, the relationship
between long- and short-term interest rates, market conditions and competitive
factors, management may increase the interest rate risk position in order to
increase its net interest margin. Its results of operations and net portfolio
values remain vulnerable to increases in the interest rate environment and to
fluctuations in the margin between long and short term interest rates.
106
<PAGE>
SELECTED QUARTERLY FINANCIAL INFORMATION
The following tables disclose selected quarterly financial information for
Western Holdings.
<TABLE>
<CAPTION>
FOR THE QUARTER ENDED
---------------------------------------------------------------
MARCH 31, DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
2000 1999 1999 1999 1999
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) --------- ------------ ------------- -------- ---------
<S> <C> <C> <C> <C> <C>
Interest income............................. $4,110 $3,931 $3,816 $3,276 $3,208
Interest expense............................ 1,426 1,316 1,291 1,181 1,166
------ ------ ------ ------ ------
Net interest income......................... 2,684 2,615 2,525 2,095 2,042
Provision for loan losses................... 80 -- 75 132 80
------ ------ ------ ------ ------
Net interest income after provision......... 2,604 2,615 2,450 1,963 1,962
Noninterest income.......................... 239 298 211 239 285
Noninterest expense......................... 2,057 1,995 1,881 1,689 1,759
------ ------ ------ ------ ------
Net income before taxes..................... 786 918 780 513 488
Provision for income taxes.................. 307 359 305 201 191
------ ------ ------ ------ ------
Net income.................................. $ 479 $ 559 $ 475 $ 312 $ 297
====== ====== ====== ====== ======
Net income per share basic.................. $ 0.18 $ 0.20 $ 0.18 $ 0.11 $ 0.11
Net income per share diluted................ $ 0.17 $ 0.19 $ 0.16 $ 0.11 $ 0.10
</TABLE>
<TABLE>
<CAPTION>
FOR THE QUARTER ENDED
---------------------------------------------------
DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
1998 1998 1998 1998
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) ------------ ------------- -------- ---------
<S> <C> <C> <C> <C>
Interest income................................... $3,112 $3,004 $2,784 $2,630
Interest expense.................................. 1,173 1,020 958 961
------ ------ ------ ------
Net interest income............................... 1,939 1,984 1,826 1,669
Provision for loan losses......................... 15 77 15 123
------ ------ ------ ------
Net interest income after provision............... 1,924 1,907 1,811 1,546
Noninterest income................................ 387 340 250 272
Noninterest expense............................... 1,503 1,668 1,614 1,354
------ ------ ------ ------
Net income before taxes........................... 808 579 447 464
Provision for income taxes........................ 331 238 182 191
------ ------ ------ ------
Net income........................................ $ 477 $ 341 $ 268 $ 273
====== ====== ====== ======
Net income per share basic........................ $ 0.18 $ 0.13 $ 0.10 $ 0.11
Net income per share diluted...................... $ 0.17 $ 0.12 $ 0.09 $ 0.10
</TABLE>
107
<PAGE>
MARKET PRICE AND DIVIDEND INFORMATION
MARKET QUOTATIONS
Heritage's common stock is listed on the Nasdaq National Market under the
symbol "HTBK." Everen Securities, Hoefer & Arnett, Incorporated, Sutro & Co.,
Incorporated and Van Kasper First Security have acted as market makers for the
common stock. These market makers have committed to make a market for Heritage'
common stock, although they may discontinue making a market at any time. No
assurance can be given that an active trading market will be sustained for the
common stock at any time in the future. Western Holdings common stock is closely
held by fewer than 100 shareholders with trades effected occasionally between
individuals or through a brokerage firm with an office in Los Altos.
The following table provides for Heritage common stock the sale prices and
for Western Holdings the sales prices as reported to Western Holdings by brokers
handling trades in its common stock. The Heritage information is based on
information provided by the Nasdaq National Market since fourth quarter in 1998
and on information provided by the market makers for earlier periods. These
quotations reflect inter-dealer prices, without retail mark-up, markdown, or
commission, do not reflect actual transactions, and do not include nominal
amounts traded directly by shareholders or through other dealers who are not
market makers.
<TABLE>
<CAPTION>
HERITAGE WESTERN HOLDINGS
COMMON STOCK COMMON STOCK
------------------- -------------------
HIGH LOW HIGH LOW
-------- -------- -------- --------
<S> <C> <C> <C> <C>
1998
First Quarter............................... $10.30 $ 9.09 $ 5.79 $ 5.37
Second Quarter.............................. 10.30 8.79 9.09 5.79
Third Quarter............................... 12.73 8.79 10.00 9.09
Fourth Quarter.............................. 13.34 10.30 10.00 10.00
1999
First Quarter............................... 20.68 12.12 11.00 10.00
Second Quarter.............................. 18.86 8.75 11.00 10.00
Third Quarter............................... 14.77 12.05 11.00 10.00
Fourth Quarter.............................. 15.46 12.61 11.00 10.00
2000
First Quarter............................... 14.55 10.75 11.00 11.00
Second Quarter.............................. 11.38 9.50 12.25 11.00
Third Quarter (through July 13)............. 11.00 10.00 -- --
</TABLE>
Listed prices for Heritage are adjusted to reflect a 3-for-2 stock split
February 1999 and a 10% stock dividend in February 2000.
Effective February 17, 1998, and following the formation of Heritage as the
bank holding company for Heritage Bank of Commerce, Heritage Bank of Commerce's
stock was exchanged on a share for share basis with the stock of Heritage. As of
February 15, 2000, there were approximately 1,200 holders of shares of
Heritage's common stock.
Listed prices for Western Holding are adjusted to reflect a 10% stock
dividend in February 1998, a two-for-one stock split in July 1998, and a 10%
stock dividend in February 1999.
DIVIDENDS
DIVIDEND RESTRICTIONS
Under California Law, the directors of a California corporation may declare
and pay dividends upon the shares of its capital stock either (i) out of its
retained earnings, or (ii) out of capital, provided
108
<PAGE>
the company would, after making the distribution, meet two conditions, which
generally stated are as follows: (i) the corporation's assets must equal at
least 125% of its liabilities; and (ii) the corporation's current assets must
equal at least its current liabilities or, if the average of the corporation's
earnings before taxes on income and before interest expense for the two
preceding fiscal years was less than the average of the corporation's interest
expense for such fiscal years, then the corporation's current assets must equal
at least 125% of its current liabilities.
A California bank is subject to different dividend restrictions. Under
California law, the holders of common stock of a bank are entitled to receive
dividends when and as declared by the board of directors, out of funds legally
available therefor. The California Banking Law provides that a state-licensed
bank may not make a cash distribution to its shareholders in excess of the
lesser of the following: (i) the bank's retained earnings, or (ii) the bank's
net income for its last three fiscal years, less the amount of any distributions
made by the bank to its shareholders during such period. However, a bank, with
the prior approval of the Commissioner, may make a distribution to its
shareholders of an amount not to exceed the greater of (i) a bank's retained
earnings, (ii) its net income for its last fiscal year, or (iii) its net income
for the current fiscal year. In the event that the Commissioner determines that
the shareholders' equity of a bank is inadequate or that the making of a
distribution by a bank would be unsafe or unsound, the Commissioner may order a
bank to refrain from making such a proposed distribution.
The FDIC and the Commissioner have authority to prohibit a bank from
engaging in business practices that are considered to be unsafe or unsound.
Depending upon the financial condition of a bank and upon other factors, the
FDIC or the Commissioner could assert that payments of dividends or other
payments by a bank might be such an unsafe or unsound practice. The FRB has
similar authority with respect to a bank holding company.
DIVIDEND POLICY
To date, Heritage has not paid cash dividends. It is the current policy of
Heritage to retain earnings to increase its capital to support growth. Payment
of cash dividends in the future will depend upon Heritage's earnings and
financial condition and other factors deemed relevant by management.
Accordingly, it is likely that no cash dividends from Heritage will be declared
in the foreseeable future.
Western Holdings has never paid a cash dividend to its shareholders.
DESCRIPTION OF HERITAGE COMMON STOCK
The authorized capital stock of Heritage consists of 30,000,000 shares of
common stock, no par value, and 10,000,000 shares of preferred stock. As of
June 30, 2000, there were 7,179,676 shares of common stock outstanding and no
shares of preferred stock outstanding. In addition, options to acquire an
additional 1,414,044 shares of Heritage common stock were issued and
outstanding.
COMMON STOCK
Holders of Heritage common stock are entitled to one vote for each share
held of record on all matters submitted to a vote of shareholders, except that,
upon giving the notice required by the Heritage bylaws, shareholders may
cumulate their votes for the election of directors. Shareholders are entitled to
receive ratably such dividends as may be legally declared by Heritage's board of
directors. There are legal and regulatory restrictions on the ability of
Heritage to declare and pay dividends. See "Market Price and Dividend
Information--Dividends and dividend policy" on page 107. In the event of a
liquidation, common shareholders are entitled to share ratably in all assets
remaining after payment of liabilities and liquidation preference for securities
with a priority over the Heritage common stock. Shareholders of Heritage common
stock have no preemptive or conversion rights. Heritage common
109
<PAGE>
stock is not subject to calls or assessments. The transfer agent and registrar
for Heritage common stock is Gemisys Corporation.
PREFERRED STOCK
The Heritage board of directors is authorized to fix the rights,
preferences, privileges and restrictions of the preferred stock and may
establish series of such stock and determine the variations between series. If
and when any preferred stock is issued, the holders of preferred stock may have
a preference over holders of Heritage common stock upon the payment of
dividends, upon liquidation of Heritage, in respect of voting rights and in the
redemption of the capital stock of Heritage. The issuance of any preferred stock
may have the effect of delaying, deferring or preventing a change in control of
Heritage without further action of its shareholders. The issuance of such stock
with voting and conversion rights may adversely affect the voting power of the
holders of Heritage common stock. Heritage has no present plans to issue any
shares of preferred stock.
TRUST PREFERRED SECURITIES
Heritage Capital Trust I is a Delaware business trust wholly owned by
Heritage and formed for the purpose of issuing mandatorily redeemable cumulative
trust preferred securities of the trust holding solely junior subordinated
debentures. During the first quarter of 2000, Heritage Capital Trust I issued
7,000 trust preferred securities with a liquidation value of $1,000 per security
to Heritage for gross proceeds of $7,000,000. The entire proceeds of the
issuance were invested by Heritage Capital Trust I in $7,000,000 aggregate
principal amount of 10 7/8% subordinated debentures due 2030 (the subordinated
debentures) issued by Heritage. The subordinated debentures represent the sole
assets of Heritage Capital Trust I. The subordinated debentures mature on
March 8, 2030, bear interest at the rate of 10 7/8%, payable semi-annually, and
are redeemable by Heritage at a premium beginning on or after March 8, 2010
based on a percentage of the principal amount of the subordinated debentures as
stipulated in the related indenture agreement, plus any accrued and unpaid
interest to the redemption date. The subordinated debentures are redeemable at
100 percent of the principal amount plus any accrued and unpaid interest to the
redemption date at any time on or after March 8, 2020. The trust preferred
securities are subject to mandatory redemption to the extent of any early
redemption of the subordinated debentures and upon maturity of the subordinated
debentures on March 8, 2030.
Holders of the trust preferred securities are entitled to cumulative cash
distributions at an annual rate of 10 7/8% of the liquidation amount of $1,000
per security. Heritage has the option to defer payment of the distributions for
a period of up to five years, as long as Heritage is not in default in the
payment of interest on the subordinated debentures. Heritage has guaranteed, on
a subordinated basis, distributions and other payments due on the trust
preferred securities. The guarantee, when taken together with Heritage's
obligations under the subordinated debentures, the Indenture Agreement pursuant
to which the subordinated debentures were issued and Heritage's obligations
under the Trust Agreement governing the subsidiary trust, provide a full and
unconditional guarantee of amounts due on the trust preferred securities.
The subordinated debentures and related trust investment in the subordinated
debentures have been eliminated in consolidation and the trust preferred
securities reflected as outstanding in the consolidated financial statements of
Heritage included in and incorporated in this document.
DESCRIPTION OF WESTERN HOLDINGS COMMON STOCK
The authorized capital stock of Western Holdings consists of 10,000,000
shares of common stock, no par value. As of June 30, 2000, there were 2,759,676
shares of common stock outstanding and no shares of preferred stock outstanding.
In addition, options to acquire an additional 306,267 shares of Western Holdings
common stock were issued and outstanding.
110
<PAGE>
COMMON STOCK
Holders of Western Holdings common stock are entitled to one vote for each
share held of record on all matters submitted to a vote of shareholders, except
that, upon giving the notice required by the Western Holdings bylaws,
shareholders may cumulate their votes for the election of directors.
Shareholders are entitled to receive ratably such dividends as may be legally
declared by Western Holdings board of directors. There are legal and regulatory
restrictions on the ability of Western Holdings to declare and pay dividends.
See "Market Price and Dividend Information--Dividends and dividend policy" on
page 107. In the event of a liquidation, common shareholders are entitled to
share ratably in all assets after payment of creditors. Shareholders of Western
Holdings common stock have no preemptive or conversion rights. Western Holdings
common stock is not subject to calls or assessments. The transfer agent and
registrar for Western Holdings common stock is U.S. Stock Transfer Corporation.
CERTAIN DIFFERENCES IN RIGHTS OF SHAREHOLDERS
The following is a general discussion of the material differences between
the rights of Heritage shareholders under the Heritage articles and bylaws and
the rights of Western Holdings shareholders under the Western Holdings articles
and bylaws and applicable California law.
CUMULATIVE VOTING
Shareholders of both Heritage and Western Holdings are entitled to cumulate
their votes for the election of directors. Cumulative voting allows a
shareholder to cast a number of votes equal to the number of directors to be
elected multiplied by the number of shares held in the shareholder's name on the
record date. This total number of votes may be cast for one nominee or may be
distributed among as many candidates as the shareholder desires. The candidates
(up to the number of directors to be elected) receiving the highest number of
votes are elected.
A California corporation that is a "listed corporation" may, by amending its
articles or bylaws, eliminate cumulative voting for directors. Because
Heritage's common stock is quoted on the Nasdaq National Market, it qualifies as
a listed corporation. Such an amendment requires the approval of holders of a
majority of the outstanding shares of Heritage common stock. Heritage has no
present plan to propose an amendment to eliminate cumulative voting.
CLASSIFIED BOARD OF DIRECTORS
At present, the Heritage bylaws and the Western Holdings bylaws provide
directors will be elected for a one-year term at each special meeting of
shareholders. A California corporation that is a "listed corporation" may, by
amending its articles or bylaws, provide for a staggered or classified board of
directors. Such an amendment requires the approval of holders of a majority of
the outstanding shares of Heritage common stock. Because Heritage common stock
is quoted on the Nasdaq National Market, it qualifies as a listed corporation.
Heritage has no present plan to propose an amendment to provide for a classified
board of directors.
DISSENTERS' RIGHTS IN MERGERS AND OTHER REORGANIZATIONS
Under California Corporation Law, a dissenting shareholder of a corporation
participating in certain business combinations may, under varying circumstances,
receive cash in the amount of the fair market value of his or her shares in lieu
of the consideration he or she would otherwise receive under the terms of the
transaction. The California General Corporation Law generally does not require
dissenters' rights of appraisal with respect to shares which, immediately prior
to the merger, are listed on any national securities exchange certified by the
Commissioner of Corporations or on the Nasdaq Stock Market unless at least the
holders of five percent or more of the company's common stock make a written
demand for the purchase of dissenting shares. Heritage common stock is listed on
the Nasdaq
111
<PAGE>
National Market. Western Holdings stock is not listed on Nasdaq. Accordingly,
Heritage shareholders generally have somewhat more limited dissenters' rights in
connection with business combinations than do Western Holdings shareholders.
Dissenters' rights are not available to the shareholders of a corporation
surviving a merger if no vote of the shareholders of the surviving corporation
is required.
OTHER MATTERS
Proxy holders will vote all shares represented by duly executed proxies in
accordance with the instructions in the proxies. The boards of directors of
Western Holdings and Heritage know of no other matters which will be brought
before the meetings. If any new matters are properly presented, the proxy
holders will vote all proxies solicited relating to the meeting in accordance
with their judgment.
EXPERTS
The consolidated financial statements of Heritage Commerce Corp as of
December 31, 1999 and 1998 and for each of the years in the three-year period
ended December 31, 1999, included or incorporated by reference in this document
have been audited by Deloitte & Touche LLP, independent auditors, as stated in
their report which is included and incorporated by reference in this document.
Those statements have been included and incorporated by reference in reliance
upon the report of Deloitte & Touche LLP given upon their authority as experts
in accounting and auditing.
The consolidated financial statements of Western Holdings as of
December 31, 1999 and for the year then ended, included in this document, have
been audited by Arthur Andersen LLP, independent public accountants, as stated
in their report with respect thereto, and are included in this document in
reliance upon the authority of said firm as experts in accounting and auditing
in giving said reports.
The consolidated financial statements of Western Holdings as of
December 31, 1998 and for the year then ended, included in this document, have
been audited by PricewaterhouseCoopers LLP, independent accountants, as stated
in its report with respect thereto, and are included in this document in
reliance on the report of such firm, given upon its authority as experts in
accounting and auditing.
LEGAL MATTERS
Certain legal matters with respect to Heritage, including the validity of
the Heritage common stock to be issued in connection with the merger, will be
passed upon for Heritage by McCutchen, Doyle, Brown & Enersen LLP, San
Francisco, California. Certain legal matters with respect to Western Holdings
will be passed upon by Sheppard, Mullin Richter & Hampton, LLP, San Francisco,
California.
INFORMATION CONCERNING HERITAGE MANAGEMENT
Information concerning:
- directors and executive officers,
- executive compensation,
- principal shareholders,
- certain relationships and related transactions, and
- other related matters concerning Heritage
is incorporated by reference in its annual report on Form 10-K for the year
ended December 31, 1999. Heritage's annual report on Form 10-K is incorporated
by reference into this document.
112
<PAGE>
WHERE YOU CAN FIND ADDITIONAL INFORMATION
Heritage files annual, quarterly and current reports, proxy statements and
other information with the Securities and Exchange Commission. You may read and
copy any reports, statements or other information that Heritage files at the
Commission's public reference rooms in Washington, D.C., New York, New York and
Chicago, Illinois. You may also obtain copies of this information by mail from
the Public Reference Section of the Commission, 450 5th Street, N.W., Room 1024,
Washington, DC 20545 at prescribed rates. Please call the Commission at
(800) SEC-0330 for further information on the public reference rooms. The
Commission also maintains an Internet World Wide Web site at
"http://www.sec.gov" at which reports, proxy and information statements and
other information regarding Heritage are available. Reports, proxy statements
and other information concerning Heritage may be inspected at the offices of the
Nasdaq Stock Market, 1735 K Street, Washington, DC 20006.
Heritage has filed with the Securities and Exchange Commission a
registration statement on Form S-4 under the Securities Act relating to the
shares of Heritage common stock to be issued in connection with the merger. This
document also constitutes the prospectus of Heritage filed as part of the
registration statement and does not contain all the information included in the
registration statement and related exhibits. You may copy and read the
registration statement and its exhibits at the public reference facilities
maintained by the Securities and Exchange Commission at the address stated
above.
The Commission allows Heritage to "incorporate by reference" information
into this document, which means that Heritage can disclose important information
to you by referring you to another document filed separately with the
Commission. The information incorporated by reference is deemed to be part of
this document, except for any information superseded by information contained
directly in this document. This document incorporates by reference the documents
listed below that Heritage has previously filed with the Commission. These
documents contain important information about Heritage and its financial
condition.
<TABLE>
<CAPTION>
HERITAGE COMMISSION FILINGS (FILE NO. 001-09383) PERIOD
------------------------------------------------ -------------------------------------
<S> <C>
Annual Report on Form 10-K................ Year ended December 31, 1999
Current Reports on Form 8-K............... Dated January 5, January 20, January
26, April 14, May 11, and June 19,
2000
Quarterly Report on form 10-Q............. Quarter Ended March 31, 2000
</TABLE>
Heritage incorporates by reference any additional documents that it may file
with the Commission between the date of this document and the date of the
shareholder meetings. These include periodic reports, such as annual reports on
Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, as
well as proxy statements. Heritage has supplied all information contained or
incorporated by reference in the document relating to Heritage and Western
Holdings has supplied all such information relating to Western Holdings.
In deciding how to vote on the merger, you should rely only on the
information contained or incorporated by reference in this document. Neither
Heritage nor Western Holdings has authorized any person to provide you with any
information that is different from what is contained in this document. This
document is dated July 14, 2000. You should not assume that the information
contained in this document is accurate as of any date other than such date, and
neither the mailing to you of this document nor the issuance to you of shares of
Heritage common stock will create any implication to the contrary. This document
does not constitute an offer to sell or a solicitation of any offer to buy any
securities, or the solicitation of a proxy in any jurisdiction in which, or to
any person to whom, it is unlawful.
113
<PAGE>
HERITAGE COMMERCE CORP
INDEX TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
Independent Auditors' Report................................ F-2
Consolidated Balance Sheets as of December 31, 1999 and
1998...................................................... F-3
Consolidated Income Statements for the years ended
December 31, 1999, 1998 and 1997.......................... F-4
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 1999, 1998 and 1997.............. F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1999, 1998 and 1997.......................... F-6
Notes to Consolidated Financial Statements.................. F-7
MARCH 31, 2000
(UNAUDITED)
Condensed Consolidated Statements of Financial Condition as
of March 31, 2000 and December 31, 1999................... F-29
Condensed Consolidated Income Statements for the three
months ended March 31, 2000
and 1999.................................................. F-30
Condensed Consolidated Statements of Cash Flows for the
three months ended March 31, 2000 and 1999................ F-31
Notes to Condensed Consolidated Financial Statements........ F-32
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
Heritage Commerce Corp:
We have audited the accompanying consolidated balance sheets of Heritage
Commerce Corp and subsidiaries (the "Company") as of December 31, 1999 and 1998,
and the related consolidated statements of income, shareholders' equity, and
cash flows in each of the three years in the period ended December 31, 1999.
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, such consolidated financial statements present fairly, in
all material respects, the financial position of Heritage Commerce Corp and
subsidiaries as of December 31, 1999 and 1998, and the results of their
operations and their cash flows for each of the three years for the period ended
December 31, 1999 in conformity with generally accepted accounting principles.
/s/ Deloitte & Touche LLP
San Jose, California
January 21, 2000
F-2
<PAGE>
HERITAGE COMMERCE CORP
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------
1999 1998
------------ ------------
<S> <C> <C>
ASSETS
Cash and due from banks..................................... $ 10,049,000 $ 18,039,000
Federal funds sold.......................................... 128,100,000 28,600,000
------------ ------------
Total cash and cash equivalents....................... 138,149,000 46,639,000
Securities available-for-sale, at fair value................ 17,430,000 50,249,000
Securities held-to-maturity, at amortized cost (fair value
of $13,614,000 and $27,240,000, respectively)............. 13,834,000 26,544,000
Loans held-for-sale, at fair value.......................... 22,243,000 33,079,000
Loans, net of deferred fees of $76,000 and $95,000 for 1999
and 1998.................................................. 271,855,000 236,307,000
Allowance for probable loan losses.......................... (5,003,000) (3,825,000)
------------ ------------
Loans, net............................................ 266,852,000 232,482,000
Premises and equipment, net................................. 3,459,000 3,238,000
Accrued interest receivable and other assets................ 5,211,000 7,240,000
Other investments........................................... 9,486,000 5,460,000
------------ ------------
TOTAL............................................... $476,664,000 $404,931,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits
Demand, noninterest bearing............................. $109,432,000 $120,854,000
Demand, interest bearing................................ 9,898,000 9,035,000
Savings and money market................................ 164,060,000 131,518,000
Time deposits, under $100,000........................... 47,355,000 29,793,000
Time deposits, $100,000 and over........................ 87,795,000 58,847,000
------------ ------------
Total deposits............................................ 418,540,000 $350,047,000
Deposits held-for-sale.................................... -- 18,911,000
Accrued interest payable and other liabilities............ 13,593,000 5,276,000
------------ ------------
Total liabilities..................................... 432,133,000 374,234,000
------------ ------------
Commitments and contingencies
Shareholders' equity:
Preferred Stock, no par value; 10,000,000 shares
authorized: none outstanding............................ -- --
Common Stock, no par value; 30,000,000 shares authorized;
shares issued and outstanding: 6,392,342 in 1999 and
5,554,552 in 1998....................................... 41,021,000 29,418,000
Accumulated other comprehensive (loss) income, net of
taxes................................................... (137,000) 658,000
Retained earnings......................................... 3,647,000 621,000
------------ ------------
Total shareholders' equity............................ 44,531,000 30,697,000
------------ ------------
TOTAL............................................... $476,664,000 $404,931,000
============ ============
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE>
HERITAGE COMMERCE CORP
CONSOLIDATED INCOME STATEMENTS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Interest income:
Loans, including fees............................... $25,727,000 $19,777,000 $10,376,000
Securities, taxable................................. 1,764,000 4,915,000 5,188,000
Securities, non-taxable............................. 606,000 679,000 87,000
Federal funds sold.................................. 3,124,000 1,307,000 552,000
----------- ----------- -----------
Total interest income................................. 31,221,000 26,678,000 16,203,000
----------- ----------- -----------
Interest expense:
Deposits............................................ 10,409,000 7,933,000 4,187,000
Other............................................... 35,000 3,000 17,000
----------- ----------- -----------
Total interest expense................................ 10,444,000 7,936,000 4,204,000
----------- ----------- -----------
Net interest income before provision for probable loan
losses.............................................. 20,777,000 18,742,000 11,999,000
Provision for probable loan losses.................... 1,911,000 1,576,000 1,060,000
----------- ----------- -----------
Net interest income after provision for probable loan
losses.............................................. 18,866,000 17,166,000 10,939,000
----------- ----------- -----------
Noninterest income:
Servicing income.................................... 1,576,000 -- --
Gain on sales of securities available-for-sale...... 1,004,000 790,000 164,000
Gain on sale of shares of demutualized life
insurance company................................. 530,000 -- --
Service charges and other fees...................... 343,000 229,000 173,000
Gain on sale of Internet credit card................ 289,000 -- --
Other investments................................... 274,000 226,000 48,000
Gain on sale of deposits............................ 240,000 -- --
Gain on sale of loans............................... 143,000 332,000 205,000
Other income........................................ 585,000 337,000 48,000
----------- ----------- -----------
Total other income.................................... 4,984,000 1,914,000 638,000
----------- ----------- -----------
Noninterest expenses:
Salaries and employee benefits...................... 10,587,000 7,722,000 4,933,000
Client services..................................... 1,527,000 2,426,000 1,169,000
Professional fees................................... 1,217,000 718,000 372,000
Furniture and equipment............................. 1,191,000 828,000 542,000
Occupancy........................................... 1,168,000 792,000 440,000
Advertising and promotion........................... 826,000 786,000 450,000
Loan origination costs.............................. 539,000 449,000 326,000
Stationery & supplies............................... 300,000 247,000 144,000
Telephone........................................... 208,000 172,000 95,000
Other............................................... 1,711,000 1,465,000 697,000
----------- ----------- -----------
Total other expenses.................................. 19,274,000 15,605,000 9,168,000
----------- ----------- -----------
Income before income taxes............................ 4,576,000 3,475,000 2,409,000
Provision for income taxes............................ 1,550,000 1,325,000 844,000
----------- ----------- -----------
Net income............................................ $ 3,026,000 $ 2,150,000 $ 1,565,000
=========== =========== ===========
Earnings per share:
Basic............................................... $ 0.51 $ 0.41 $ 0.32
Diluted............................................. $ 0.45 $ 0.37 $ 0.30
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE>
HERITAGE COMMERCE CORP
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997
<TABLE>
<CAPTION>
ACCUMULATED
OTHER
COMMON STOCK COMPREHENSIVE RETAINED TOTAL OTHER
----------------------- INCOME (NET EARNING/ SHAREHOLDERS' COMPREHENSIVE
SHARES AMOUNT OF TAXES) (DEFICIT) EQUITY INCOME
--------- ----------- ------------- ----------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, JANUARY 1, 1997............. 4,696,049 $22,093,000 $ 221,000 $(1,790,000) $20,524,000
Net income........................... -- -- -- 1,565,000 1,565,000 $ 1,565,000
Net change in unrealized gain (loss)
on securities available-for-sale,
net of reclassification adjustment
and taxes.......................... -- -- 197,000 -- 197,000 197,000
-----------
Total comprehensive income......... $ 1,762,000
===========
Stock dividend....................... 234,523 1,304,000 -- (1,304,000) --
Cash paid for fractional shares...... (291) (2,000) -- (2,000)
Stock options exercised.............. 13,567 52,000 -- -- 52,000
--------- ----------- --------- ----------- -----------
BALANCES, DECEMBER 31, 1997.......... 4,943,848 $23,447,000 $ 418,000 $(1,529,000) $22,336,000
Net income........................... -- -- -- 2,150,000 2,150,000 $ 2,150,000
Net change in unrealized gain on
securities available-for-sale, net
of reclassification adjustment and
taxes.............................. -- -- 240,000 -- 240,000 240,000
-----------
Total comprehensive income......... $ 2,390,000
===========
Common Stock issued pursuant to July
1998 offering (net of issuance
costs of $154,000)................. 580,644 5,846,000 -- -- 5,846,000
Stock options exercised.............. 30,060 125,000 -- -- 125,000
--------- ----------- --------- ----------- -----------
BALANCES, DECEMBER 31, 1998.......... 5,554,552 $29,418,000 $ 658,000 $ 621,000 $30,697,000
Net income........................... -- -- -- 3,026,000 3,026,000 $ 3,026,000
Net change in unrealized gain (loss)
on securities available-for-sale,
net of reclassification adjustment
and taxes.......................... -- -- (795,000) -- (795,000) (795,000)
-----------
Total comprehensive income......... $ 2,231,000
===========
Common Stock issued pursuant to July
1999 offering (net of issuance
costs of $172,000)................. 758,138 11,200,000 -- -- 11,200,000
Cash paid for fractional shares...... (199) (4,000) (4,000)
Stock options exercised.............. 79,851 407,000 -- -- 407,000
--------- ----------- --------- ----------- -----------
BALANCES, DECEMBER 31, 1999.......... 6,392,342 $41,021,000 $(137,000) $ 3,647,000 $44,531,000
========= =========== ========= =========== ===========
</TABLE>
See notes to consolidated financial statements
F-5
<PAGE>
HERITAGE COMMERCE CORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------------
1999 1998 1997
------------ ------------- ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.................................................. $ 3,026,000 $ 2,150,000 $ 1,565,000
Adjustments to reconcile net income to net cash used in
operating activities:
(Loss) in disposals of property and equipment............. (283,000) -- --
Depreciation and amortization............................. 827,000 639,000 388,000
Provision for probable loan losses........................ 1,911,000 1,576,000 1,060,000
Gain on sales of securities available-for-sale............ (1,004,000) (790,000) (164,000)
Deferred income taxes..................................... (709,000) (1,016,000) (448,000)
Amortization/accretion of discounts and premiums on
securities.............................................. (239,000) 242,000 56,000
Proceeds from sales of loans held for sale................ 4,317,000 3,932,000 4,198,000
Originations of loans held for sale....................... (17,941,000) (5,674,000) (4,626,000)
Maturities of loans held for sale......................... 7,839,000 694,000 45,000
Effect of changes in:
Accrued interest receivable and other assets............ (801,000) (2,461,000) (952,000)
Accrued interest payable and other liabilities.......... 11,156,000 2,869,000 605,000
------------ ------------- ------------
Net cash provided by operating activities................... 8,099,000 2,161,000 1,727,000
------------ ------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase in loans....................................... (19,660,000) (139,604,000) (45,650,000)
Purchases of securities available-for-sale.................. (26,334,000) (25,481,000) (49,116,000)
Maturities of securities available-for-sale................. 22,232,000 18,407,000 16,588,000
Proceeds from sales of securities available-for-sale........ 49,512,000 19,046,000 21,955,000
Purchases of securities held-to-maturity.................... -- (8,855,000) (7,659,000)
Proceeds from maturities or calls of securities
held-to-maturity.......................................... 1,115,000 8,722,000 6,388,000
Purchase of corporate-owned life insurance.................. (3,874,000) (987,000) (4,473,000)
Purchases of property and equipment......................... (765,000) (1,906,000) (829,000)
------------ ------------- ------------
Net cash provided by (used in) investing activities......... 22,226,000 (130,658,000) (62,796,000)
------------ ------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits.................................... 49,582,000 125,981,000 96,599,000
Proceeds from sale of securities under agreements to
repurchase................................................ -- -- (5,010,000)
Net proceeds from issuance of common stock.................. 11,603,000 5,970,000 50,000
------------ ------------- ------------
Net cash provided by financing activities................... 61,185,000 131,951,000 91,639,000
------------ ------------- ------------
Net increase in cash and cash equivalents................... 91,510,000 3,454,000 30,570,000
Cash and cash equivalents, beginning of year................ 46,639,000 43,185,000 12,615,000
------------ ------------- ------------
Cash and cash equivalents, end of year...................... $138,149,000 $ 46,639,000 $ 43,185,000
============ ============= ============
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest................................................ $ 10,171,000 $ 7,198,000 $ 4,477,000
Income taxes............................................ $ 2,083,000 $ 1,684,000 $ 1,536,000
Supplemental schedule of non-cash investing and financing
activity:
Transfer from accumulated deficit to common stock due to
stock dividend............................................ -- $ -- $ 1,304,000
Transfer of investment securities from HTM to AFS........... $ 11,669,000 $ -- $ --
</TABLE>
See notes to consolidated financial statements.
F-6
<PAGE>
HERITAGE
COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
Heritage Commerce Corp (the "Company") operates as the bank holding company
for three subsidiary banks: Heritage Bank of Commerce ("HBC"), Heritage Bank
East Bay ("HBEB"), and Heritage Bank South Valley ("HBSV")(collectively the
"Banks"). All are California state chartered banks which offer a full range of
commercial and personal banking services to residents and the
business/professional community in Santa Clara and Alameda Counties, California.
HBC was incorporated on November 23, 1993 and commenced operations on June 8,
1994. HBEB was incorporated on October 21, 1998 and commenced operations on
December 7, 1998. HBSV was incorporated on December 1, 1999 and commenced
operations on January 18, 2000. The accounting and reporting policies of the
Company and its subsidiary banks conform to generally accepted accounting
principles and prevailing practices within the banking industry.
On January 27, 1999, the Company's Board of Directors announced the
declaration of a 3-for-2 stock split effective for shareholder of record on
February 5, 1999. Accordingly, all historical financial information has been
restated as if the stock split had been in effect for all periods presented.
USE OF ESTIMATES
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 and
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.
CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its subsidiary banks. All material intercompany accounts and transactions
have been eliminated.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid debt instruments purchased with
remaining terms to maturity of three months or less from the date of acquisition
to be cash equivalents. Cash and cash equivalents include cash on hand, amounts
due from banks, and federal funds sold. Generally, federal funds are sold and
purchased for one-day periods.
SECURITIES
The Company classifies its securities into two categories,
available-for-sale and held-to-maturity, at the time of purchase. Securities
available-for-sale are measured at fair value with a corresponding recognition
of the net unrealized holding gain or loss, net of income taxes, as a net amount
within accumulated other comprehensive income, which is a separate component of
shareholders' equity, until realized. Securities held-to-maturity are measured
at amortized cost, based on the Company's positive intent and ability to hold
the securities to maturity.
F-7
<PAGE>
HERITAGE
COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
A decline in the market value of any available-for-sale or held-to-maturity
security below cost that is deemed other than temporary results in a charge to
earnings and the corresponding establishment of a new cost basis for the
security.
Premiums and discounts are amortized, or accreted, over the life of the
related investment security as an adjustment to income using a method that
approximates the interest method. Interest income is recognized when earned.
Realized gains and losses for securities classified as available-for-sale are
included in earnings and are derived using the specific identification method
for determining the cost of securities sold.
LOANS HELD FOR SALE
The Company holds for sale the guaranteed portion of certain Small Business
Administration (SBA) loans. These loans are carried at the lower of cost or
market, determined in the aggregate.
Gains or losses on SBA loans held for sale are recognized upon completion of
the sale, and are based on the difference between the net sales proceeds and the
relative fair value of the guaranteed portion of the loan sold compared to the
relative fair value of the unguaranteed portion.
The servicing assets that result from the sale of SBA loans, sold with
servicing rights retained, are amortized over the lives of the loans using a
method approximating the interest method.
The Company accounts for the transfer and servicing of financial assets
based on the financial and servicing assets it controls and liabilities it has
incurred, derecognizes financial assets when control has been surrendered, and
derecognizes liabilities when extinguished. Servicing assets are measured at
their fair value and are amortized in proportion to and over the period of net
servicing income and are assessed for impairment on an ongoing basis. Impairment
is determined by stratifying the servicing rights based on interest rates and
terms. Fair value is determined using prices for similar assets with similar
characteristics, when available, or based upon discounted cash flows using
market-based assumptions. Impairment is recognized through a valuation
allowance. Any servicing assets in excess of the contractually specified
servicing fees have been reclassified at fair value as an interest-only (I/O)
strip receivable and treated like an available for sale security. The servicing
asset, net of any required valuation allowance, and I/O strip receivable are
included in other assets.
LOANS
Loans are stated at the principal amount outstanding. The majority of the
Company's loans are at variable interest rates. Interest on loans is credited to
income when earned.
Generally, if a loan is classified as non-accrual, the accrual of interest
is discontinued, any accrued and unpaid interest is reversed, and the
amortization of deferred loan fees and costs is discontinued, when the payment
of principal or interest is 90 days past due, unless the amount is well secured
and in the process of collection. Any interest or principal payments received on
non-accrual loans are applied toward reduction of principal. Non-accrual loans
generally are not returned to performing status until the obligation is brought
current, has performed in accordance with the contract terms for a reasonable
period of time, and the ultimate collectability of the total contractual
principal and interest is no longer in doubt.
F-8
<PAGE>
HERITAGE
COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Renegotiated loans are those in which the Company has formally restructured
a significant portion of the loan. The remaining portion is charged off, with a
concession either in the form of below market rate financing, or debt
forgiveness on the charged off portion. Loans that have been renegotiated and
have not met specific performance standards for payment are classified as
renegotiated loans within the classification of nonperforming assets. Upon
payment performance, such loans may be transferred from nonperforming status to
accrual status. At December 31, 1999 and 1998 the Company did not have any
renegotiated loans outstanding.
Non-refundable loan fees and direct origination costs are deferred and
recognized over the expected lives of the related loans using the effective
yield interest method.
ALLOWANCE FOR LOAN LOSSES
The Company maintains an allowance for loan losses to absorb probable losses
inherent in the loan portfolio. The allowance is based on ongoing, monthly
assessments of the probable estimated losses. Loans are charged against the
allowance when management believes that the collectability of the principal is
doubtful. The allowance is increased by the provision for loan losses, which is
charged against current period operating results and decreased by the amount of
charge-offs, net of recoveries. The Company's methodology for assessing the
appropriateness of the allowance consists of several key elements, which include
the formula allowance, specific allowances and the unallocated allowance.
The allowance is calculated by applying loss factors to outstanding loans
and certain unused commitments. Loss factors are based on the Company's
historical loss experience and may be adjusted for significant factors that, in
management's judgement, affect the collectibility of the portfolio as of the
evaluation date. Until additional historical data is available, management has
derived a matrix, based on management's prior experience, to determine the loss
factor for each category of loan.
Allowances can apply to some loans but not all loans. Specific allowances
are established in cases where management has identified significant conditions
or circumstances related to a credit that management believes indicate the
probability that a loss has been incurred in excess of the amount determined by
the application of the formula allowance. The allowance also incorporates the
results of measuring impaired loans. Management considers a loan to be impaired
when it is probable that the Company will be unable to collect all amounts due
according to the contractual terms of the note agreement. When a loan is
considered to be impaired, the amount of impairment is measured based on the
present value of expected future cash flows discounted at the note's effective
interest rate, or the fair value of the collateral if the loan is secured by
real estate.
The unallocated allowance is based upon management's evaluation of various
conditions that are not directly measured in the determination of the formula
and specific allowances. The conditions evaluated in connection with the
unallocated allowance may include existing general economic and business
conditions affecting the key lending areas of the Company, credit quality
trends, collateral values, loan volumes and concentrations, seasoning of the
loan portfolio, specific industry conditions within portfolio segments, recent
loss experience in particular segments of the portfolio, duration of the current
business cycle, and bank regulatory examination results.
F-9
<PAGE>
HERITAGE
COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost. Depreciation and amortization are
computed on a straight-line basis over the lesser of the lease terms or
estimated useful lives of five to fifteen years, if appropriate. The Company
evaluates the recoverability of long-lived assets on an on-going basis.
OTHER INVESTMENTS
Other investments consist of cash surrender value of life insurance policies
for certain officers and directors of the Company and its subsidiary banks.
INCOME TAXES
The Company files consolidated federal and combined state income tax
returns. Amounts provided for income tax expense are based on income reported
for financial statement purposes and do not necessarily represent amounts
currently payable under tax laws. Deferred taxes, which arise principally from
temporary differences between the period in which certain income and expenses
are recognized for financial accounting purposes and the period in which they
affect taxable income, are included in the amounts provided for income taxes.
Under this method, the computation of the net deferred tax liability or asset
gives current recognition to changes in the tax laws.
STOCK-BASED COMPENSATION
The Company accounts for stock-based awards to employees using the intrinsic
value method in accordance with Accounting Principles Board (APB) Opinion
No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES. The Company presents the
required proforma disclosures of the effect of stock-based compensation on net
income and earnings per share using the fair value method in accordance with
SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION.
COMPREHENSIVE INCOME
In 1998, the Company adopted SFAS No. 130, "REPORTING COMPREHENSIVE INCOME,"
which requires that an enterprise report and display, by major components and as
a single total, the change in its net assets during the period from non-owner
sources.
F-10
<PAGE>
HERITAGE
COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The following is a summary of the components of other comprehensive income.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
------------------------------------
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Net Income............................................... $3,026,000 $2,150,000 $1,565,000
---------- ---------- ----------
Other comprehensive income, net of tax:
Net unrealized holding gain (loss) on
available-for-sale securities during the year........ (130,000) 729,000 303,000
Less: reclassification adjustment for realized gains on
available-for-sale securities included in net income
during the year...................................... (665,000) (489,000) (106,000)
---------- ---------- ----------
Other comprehensive income............................... (795,000) 240,000 197,000
---------- ---------- ----------
Comprehensive income..................................... $2,231,000 $2,390,000 $1,762,000
========== ========== ==========
</TABLE>
SEGMENT REPORTING
HBC, HBEB, and HBSV are commercial banks, which offer similar products to
customers located in Santa Clara and Alameda counties of California. No customer
accounts for more than 10 percent of revenue for HBC, HBEB, HBSV or the Company.
Management evaluates the Company's performance as a whole and does not allocate
resources based on the performance of different lending or transaction
activities. Accordingly, the Company and its subsidiary banks all operate as one
business segment.
EARNINGS PER SHARE
Basic earnings per share is computed by dividing net income by the weighted
average common shares outstanding. Diluted earnings per share reflects potential
dilution from outstanding stock options, using the treasury stock method. For
each of the years presented, net income is the same for basic and diluted
earnings per share. Reconciliation of weighted average shares used in computing
basic and diluted earnings per share is as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Weighted average common shares outstanding--used in
computing basic earnings per share........................ 5,950,339 5,242,516 4,937,533
Dilutive effect of stock options outstanding, using the
treasury stock method..................................... 756,387 601,522 284,324
--------- --------- ---------
Shares used in computing diluted earnings per share......... 6,706,726 5,844,038 5,221,857
========= ========= =========
</TABLE>
RECLASSIFICATIONS
Certain amounts in the 1998 and 1997 financial statements have been
reclassified to conform to the 1999 presentation. These reclassifications had no
impact on shareholders' equity and net income.
F-11
<PAGE>
HERITAGE
COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, "ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES". The Statement will require the Company to
recognize all derivatives on the balance sheet at fair value. SFAS No. 133
requires that derivative instruments used to hedge be identified specifically to
assets, liabilities, firm commitments or anticipated transactions and measured
as effective and ineffective when hedging changes in fair value or cash flows.
Derivative instruments that do not qualify as either a fair value or cash flow
hedge will be valued at fair value with the resultant gain or loss recognized in
current earnings. Changes in the effective portion of fair value hedges will be
recognized in current earnings along with the change in fair value of the hedged
item. Changes in the effective portion of the fair value of cash flow hedges
will be recognized in other comprehensive income until realization of the cash
flows of the hedged through current earnings. Any ineffective portion of hedges
will be recognized in current earnings. The Company adopted the provisions of
SFAS No. 133 in 1999. The adoption of SFAS No. 133 did not significantly impact
the Company's earnings or financial position.
(2) SECURITIES
The amortized cost and estimated fair value of securities as of December 31,
1999 were as follows:
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
Securities available-for-sale:
U.S. Treasury................................ $11,113,000 $ -- $110,000 $11,003,000
Municipals................................... 5,444,000 -- 91,000 5,353,000
FHLB Stock................................... 1,074,000 -- -- 1,074,000
----------- ------ -------- -----------
Total securities available-for-sale............ $17,631,000 $ -- $201,000 $17,430,000
=========== ====== ======== ===========
Securities held-to-maturity:
Municipals................................... $13,834,000 $ -- $220,000 $13,614,000
----------- ------ -------- -----------
Total securities held-to-maturity.............. $13,834,000 $ -- $220,000 $13,614,000
=========== ====== ======== ===========
</TABLE>
F-12
<PAGE>
HERITAGE
COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) SECURITIES (CONTINUED)
The amortized cost and estimated fair value of securities as of December 31,
1998 were as follows:
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
Securities available-for-sale:
U.S. Treasury............................... $39,254,000 $ 869,000 $ -- $40,123,000
U.S. Government Agencies.................... 3,007,000 44,000 -- 3,051,000
Municipals.................................. 2,595,000 113,000 -- 2,708,000
Preferred Stock............................. 2,015,000 57,000 -- 2,072,000
Commercial Paper............................ 2,259,000 36,000 -- 2,295,000
----------- ---------- --------- -----------
Total securities available-for-sale........... $49,130,000 $1,119,000 $ -- $50,249,000
=========== ========== ========= ===========
Securities held-to-maturity:
Municipals.................................. $23,001,000 $ 650,000 $ -- $23,651,000
U.S. Government Agencies.................... 1,509,000 7,000 -- 1,516,000
U.S. Treasury............................... 2,034,000 39,000 -- 2,073,000
----------- ---------- --------- -----------
Total securities held-to-maturity............. $26,544,000 $ 696,000 $ -- $27,240,000
=========== ========== ========= ===========
</TABLE>
The Company transferred $11,669,000 of certain securities from the
held-to-maturity to available-for-sale classification as allowed by SFAS No. 133
"ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES". The gross
realized and gross unrealized gains or losses on the securities transferred were
not significant to the Company.
The amortized cost and estimated fair values of securities as of December
31, 1999 by contractual maturity, are shown below. Expected maturities will
differ from contractual maturities because borrowers may have the right to call
or pre-pay obligations with or without call or pre-payment penalties.
<TABLE>
<CAPTION>
SECURITIES HELD-TO-MATURITY SECURITIES AVAILABLE-FOR-SALE
----------------------------- ------------------------------
AMORTIZED ESTIMATED FAIR AMORTIZED ESTIMATED FAIR
COST VALUE COST VALUE
------------ -------------- ------------- --------------
<S> <C> <C> <C> <C>
Due within one year...................... $ 1,880,000 $ 1,878,000 $ 3,012,000 $ 2,992,000
Due after one through five years......... 4,482,000 4,461,000 8,481,000 8,389,000
Due after five through ten years......... 6,861,000 6,696,000 5,310,000 5,255,000
Due after ten years...................... 611,000 579,000 828,000 794,000
----------- ----------- ----------- -----------
Total.................................... $13,834,000 $13,614,000 $17,631,000 $17,430,000
=========== =========== =========== ===========
</TABLE>
Sales of securities available-for-sale resulted in gross realized gains of
$1,004,000, $670,000, and $170,000 during the years ended December 31, 1999,
1998, and 1997, respectively.
Sales of securities available-for-sale resulted in gross realized losses of
nil, $5,000, and $6,000, during the years ended December 31, 1999, 1998, and
1997, respectively.
Securities with amortized cost of $11,100,000 and $43,296,000 as of
December 31, 1999 and 1998 were pledged to secure public and certain other
deposits as required by law or contract.
F-13
<PAGE>
HERITAGE
COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) LOANS
Loans as of December 31 were as follows:
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
Loans held-for-sale......................................... $ 22,243,000 $ 33,079,000
============ ============
Loans held-for-investment:
Commercial................................................ 117,918,000 79,566,000
Real estate--mortgage..................................... 83,698,000 57,216,000
Real estate--land and construction........................ 68,152,000 49,270,000
Consumer.................................................. 2,163,000 50,350,000
------------ ------------
Total loans................................................. 271,931,000 236,402,000
Deferred loan fees.......................................... (76,000) (95,000)
Allowance for loan losses................................... (5,003,000) (3,825,000)
------------ ------------
Loans, net.................................................. $266,852,000 $232,482,000
============ ============
</TABLE>
Changes in the allowance for loan losses were as follows:
<TABLE>
<CAPTION>
AT OR FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Balance, beginning of year............................... $3,825,000 $2,285,000 $1,402,000
Loan charge-offs......................................... 806,000 173,000 224,000
Recoveries............................................... (73,000) (137,000) (47,000)
---------- ---------- ----------
Net loan charge-offs..................................... 733,000 36,000 177,000
Provision for loan losses................................ 1,911,000 1,576,000 1,060,000
---------- ---------- ----------
Balance, end of year..................................... $5,003,000 $3,825,000 $2,285,000
========== ========== ==========
</TABLE>
As of December 31, 1999, the Company had $1,396,000 in loans for which
interest is no longer being accrued, no loans past due 90 days or more and still
accruing interest, and no impaired loans. As of December 31, 1998, the Company
had $1,288,000 in loans for which interest is no longer being accrued, no
significant loans past due 90 days or more and still accruing interest, and no
impaired loans. For the year ended December 31, 1999, 1998 and 1997, the Company
had foregone $63,000 of interest income as a result of non-accrual loans. For
the year ended December 31, 1998, the Company had foregone $35,000 of interest
income as a result of non-accrual loans. For the years ended December 31, 1997,
the Company had recognized $17,000 of interest income when it was received from
non-accrual loans.
HBC's SBA loans serviced for others are not included in the accompanying
balance sheets. The unpaid principal balances of these loans as of December 31,
1999 and 1998 were approximately $8,435,000 and $9,130,000, respectively.
Concentrations of credit risk arise when a number of clients are engaged in
similar business activities, or activities in the same geographic region, or
have similar features that would cause their ability to meet contractual
obligations to be similarly affected by changes in economic conditions. The
Company's loan portfolio is concentrated in commercial (primarily manufacturing,
wholesale, and
F-14
<PAGE>
HERITAGE
COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) LOANS (CONTINUED)
service) and real estate lending, with the balance in consumer loans. While no
specific industry concentration is considered significant, the Company's lending
operations are located in the Company's market areas that are dependent on the
technology and real estate industries and their supporting companies. Thus, the
Company's borrowers could be adversely impacted by a downturn in these sectors
of the economy which could reduce the demand for loans and adversely impact the
borrowers' abilities to repay their loans.
During 1999 HBC sold the credit card portfolio established through its
contract with Internet Access Financial Corporation to that corporation. As a
result of the sale of the portfolio the Company removed the credit card loans
from its portfolio of consumer loans and recognized a gain of $289,000. The
Company continues to provide Internet Access Financial Corporation certain
administrative services related to the issuance of credit cards on a fee basis.
HBC and HBEB make loans to executive officers, directors, and their
affiliates in the ordinary course of business. These transactions were on
substantially the same terms as those prevailing at the time for comparable
transactions with unrelated parties and do not involve more than normal risk or
unfavorable terms for the Bank. During 1999, advances on loans were
approximately $437,000. During 1998, new loans to related parties totaled
$188,000. During 1999 and 1998, $530,000 and $1,340,000, respectively, were
repaid to the Banks. As of December 31, 1999, and 1998 the Bank had $900,000 and
$993,000 in loans outstanding to related parties.
(4) PREMISES AND EQUIPMENT
Premises and equipment as of December 31 were as follows:
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Furniture and equipment............................ $ 3,044,000 $ 2,677,000
Leasehold improvements............................. 1,775,000 1,368,000
Software........................................... 669,000 678,000
----------- -----------
5,488,000 4,723,000
Accumulated depreciation and amortization.......... (2,029,000) (1,485,000)
----------- -----------
Premises and equipment, net........................ $ 3,459,000 $ 3,238,000
=========== ===========
</TABLE>
Depreciation expense was $828,000, $639,000, and $388,000 for the years
ended December 31, 1999, 1998, and 1997, respectively.
F-15
<PAGE>
HERITAGE
COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(5) DEPOSITS
At December 31, 1999, the scheduled maturities of time deposits was as
follows:
<TABLE>
<CAPTION>
YEAR
----
<S> <C>
2000........................................................ $125,683,000
2001........................................................ 7,643,000
2002 and after.............................................. 1,824,000
------------
Total time deposits......................................... $135,150,000
============
</TABLE>
Deposits totaling $18,911,000 at December 31, 1998 representing a portion of
HBC's bankruptcy portfolio were held for sale. There were no deposits held of
sale at December 31, 1999.
(6) BORROWING ARRANGEMENTS
AVAILABLE LINES OF CREDIT
The Company has federal funds purchase lines and lines of credit of totaling
$35,000,000. As of December 31, 1999, the Company borrowed $7,000,000 from FHLB
and $2,000,000 from a correspondent bank.
Information concerning borrowings under the above arrangements is as
follows:
<TABLE>
<CAPTION>
1999 1998 1997
---------- -------- --------
<S> <C> <C> <C>
Average balance during the year.............. $ 458,000 $41,000 $297,000
Average interest rate during the year........ 7.64% 7.32% 5.72%
Maximum month-end balance during the year.... $9,000,000 $ -- --
Average rate at December 31.................. 11.98% -- --
</TABLE>
(7) INCOME TAXES
The provision for income taxes for the years ended December 31, consisted of
the following:
<TABLE>
<CAPTION>
1999 1998 1997
---------- ----------- ----------
<S> <C> <C> <C>
Current:
Federal................................ $1,703,000 $ 1,734,000 $ 939,000
State.................................. 556,000 607,000 353,000
---------- ----------- ----------
Total current............................ 2,259,000 2,341,000 1,292,000
---------- ----------- ----------
Deferred:
Federal................................ (578,000) (814,000) (372,000)
State.................................. (131,000) (202,000) (76,000)
---------- ----------- ----------
Total deferred........................... (709,000) (1,016,000) (448,000)
---------- ----------- ----------
Provision for income taxes............... $1,550,000 $ 1,325,000 $ 844,000
========== =========== ==========
</TABLE>
F-16
<PAGE>
HERITAGE
COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(7) INCOME TAXES (CONTINUED)
The effective tax rate differs from the federal statutory rate for the years
ended December 31, as follows:
<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Statutory federal income tax rate.................... 35.0% 35.0% 35.0%
State income taxes, net of federal tax benefit....... 6.0 7.7 7.5
Change in valuation allowance........................ -- -- (8.7)
Non-taxable interest income.......................... (4.6) (5.8) (2.3)
Officers' life insurance............................. (2.1) (2.2) --
Other................................................ (0.5) 3.4 3.5
---- ---- ----
Effective tax rate................................... 33.8% 38.1% 35.0%
==== ==== ====
</TABLE>
Net deferred tax asset as of December 31 consists of the following:
<TABLE>
<CAPTION>
1999 1998
---------- ----------
<S> <C> <C>
Deferred tax assets:
Allowance for loan losses.......................... $2,070,000 $1,541,000
Excess servicing rights............................ 86,000 114,000
Deferred rent...................................... 66,000 77,000
Accrued expenses................................... 408,000 237,000
Securities available-for-sale...................... 73,000 --
Other.............................................. -- 31,000
---------- ----------
Total deferred tax assets............................ 2,703,000 2,000,000
---------- ----------
Deferred tax liabilities:
Securities available-for-sale...................... -- (448,000)
Accrual to cash adjustment......................... (96,000) (164,000)
Depreciation....................................... (20,000) (76,000)
State income taxes................................. (208,000) (163,000)
---------- ----------
Total deferred tax liabilities....................... (324,000) (851,000)
---------- ----------
Net deferred tax assets.............................. $2,379,000 $1,149,000
========== ==========
</TABLE>
The Company believes that it is more likely than not that it will realize
the above deferred tax assets in future periods; therefore, no valuation
allowance has been provided against its deferred tax assets.
(8) STOCK BASED COMPENSATION
The Company has a stock option plan (the Plan) for directors, officers, and
key employees. The Plan provides for the grant of incentive and non-qualified
stock options. The Plan provides that the option price for both incentive and
non-qualified stock options will be determined by the Board of Directors at no
less than the fair value at the date of grant. Options granted vest on a
schedule determined by the Board of Directors at the time of grant. Generally,
options vest over four years. All
F-17
<PAGE>
HERITAGE
COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) STOCK BASED COMPENSATION (CONTINUED)
options expire no later than ten years from the date of grant. As of
December 31, 1999, 94,501 shares are available for future grants under the Plan.
Option activity under the Plan is as follows:
<TABLE>
<CAPTION>
NUMBER WEIGHTED AVERAGE
OF SHARES EXERCISE PRICE
--------- ----------------
<S> <C> <C>
Options Outstanding at January 1, 1997
(413,223 exercisable at a weighted average exercise price
of $3.89)................................................. 861,720 $ 4.01
--------- ------
Granted (weighted average fair value of $2.95).............. 120,928 6.48
Exercised................................................... (13,567) 3.87
Cancelled................................................... (10,298) 4.37
--------- ------
Options Outstanding at December 31, 1997
(652,924 exercisable at a weighted average exercise price
of $4.09)................................................. 958,783 4.32
--------- ------
Granted (weighted average fair value of $4.92).............. 425,400 11.54
Exercised................................................... (30,060) 4.15
Cancelled................................................... (12,009) 5.79
--------- ------
Options Outstanding at December 31, 1998
(902,867 exercisable at a weighted average exercise price
of $5.25)................................................. 1,342,114 6.60
--------- ------
Granted (weighted average fair value of $8.20).............. 155,800 16.00
Exercised................................................... (79,851) 5.10
Cancelled................................................... (11,108) 12.70
--------- ------
Options Outstanding at December 31, 1999
(1,078,928 exercisable at weighted average exercise price
of $6.27)................................................. 1,406,955 $ 7.67
========= ======
</TABLE>
Additional information regarding options outstanding under the Plan as of
December 31, 1999 is as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
-------------------------------------------------
WEIGHTED AVERAGE OPTIONS EXERCISABLE
REMAINING ------------------------------
RANGE OF NUMBER CONTRACTUAL WEIGHTED AVERAGE NUMBER WEIGHTED AVERAGE
EXERCISE PRICES OUTSTANDING LIFE (YRS.) EXERCISE PRICE EXERCISABLE EXERCISE PRICE
--------------- ----------- ---------------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
$ 3.85 - 4.85............ 684,952 4.61 $ 3.89 683,651 $ 3.89
4.86 - 5.85............ 140,834 7.12 5.54 123,061 5.56
5.86 - 10.67............ 193,922 8.36 10.29 79,810 10.26
10.68 - 18.01............ 387,247 9.17 13.82 192,406 13.49
--------- ---- ------ --------- ------
$ 3.85 - 18.01............ 1,406,955 6.64 $ 7.67 1,078,928 $ 6.27
========= ==== ====== ========= ======
</TABLE>
As discussed in Note 1, the Company continues to account for its stock-based
awards using the intrinsic value method in accordance with APB Opinion No. 25,
"ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES", and its related interpretations.
Accordingly, no compensation expense has been recognized in the financial
statements for employee stock option arrangements.
F-18
<PAGE>
HERITAGE
COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) STOCK BASED COMPENSATION (CONTINUED)
SFAS No. 123, "ACCOUNTING FOR STOCK-BASED COMPENSATION", requires the
disclosure of pro forma net income and earnings per share had the Company
adopted the fair value method at the grant date of all stock options. Under SFAS
No. 123, the fair value of stock-based awards to employees is calculated through
the use of option pricing models, even though such models were developed to
estimate the fair value of freely tradable, fully transferable options without
vesting restrictions, which differ significantly from the Company's stock option
awards. Those models also require subjective assumptions, which greatly affect
the calculated values. The Company's calculations were made using the
Black-Scholes option pricing model with the following weighted average
assumptions: expected life, 84 months; risk-free interest rate, 5.5% for 1999,
4.70% for 1998, and 5.75% for 1997; stock volatility of 39% in 1999, and 30% in
1998 and 1997; and no dividends during the expected term. The Company's
calculations are based on a multiple option valuation approach, and forfeitures
are recognized as they occur.
If the computed fair values of the 1999, 1998, and 1997 awards had been
amortized to expense over the vesting periods of the awards, pro forma net
income and earnings per common share would have been as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Net income
As reported............................ $3,026,000 $2,150,000 $1,565,000
Pro forma.............................. $2,326,000 $1,146,000 $1,000,000
Net income per common share--basic
As reported............................ $ 0.51 $ 0.41 $ 0.32
Pro forma.............................. $ 0.39 $ 0.22 $ 0.20
Net income per common share--diluted
As reported............................ $ 0.45 $ 0.37 $ 0.30
Pro forma.............................. $ 0.35 $ 0.20 $ 0.19
</TABLE>
(9) LEASES
The Company leases its premises under non-cancelable operating leases with
terms, including renewal options, ranging from five to fifteen years. Future
minimum payments under the agreements are as follows:
<TABLE>
<S> <C>
Year ending December 31,
2000...................................................... $ 912,000
2001...................................................... 905,000
2002...................................................... 919,000
2003...................................................... 847,000
2004...................................................... 793,000
Thereafter.................................................. 4,493,000
----------
Total....................................................... $8,869,000
==========
</TABLE>
Rent expense under operating leases was $853,000, $613,000, and $314,000,
during the years ended December 31, 1999, 1998, and 1997. Rent expense was
reduced by deferred rent concessions on one of
F-19
<PAGE>
HERITAGE
COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(9) LEASES (CONTINUED)
the Company's locations of $46,000, $47,000, and $50,000, during the years ended
December 31, 1999, 1998, and 1997.
(10) BENEFIT PLANS
The Company offers a 401(k) savings plan. All salaried employees are
eligible to contribute up to 20% of their pre-tax compensation (to a maximum of
$10,500 in 1999) to the plan through salary deductions under Section 401(k) of
the Internal Revenue Code. The Company does not match employee contributions.
The Company also sponsors an employee stock ownership plan. The plan allows
the Company to purchase shares on the open market and award those shares to
certain employees in lieu of paying cash bonuses. To be eligible to receive an
award of shares under this plan, an employee must have worked at least 1,000
hours during the year and must be employed by the Company, or its subsidiaries,
on December 31. Awards under this plan generally vest over four years. During
1999, 1998 and 1997, the Company made contributions of $250,000, $200,000 and
$98,000 into the plan. The amount contributed into this plan was recognized as
salaries and benefits expense in the Company's financial statements. At December
31, 1999, the ESOP owned approximately 26,000 shares of the Company's stock.
The Company also has a nonqualified deferred compensation plan for the
directors ("Deferral Plan"). Under the Deferral Plan, a participating director
may defer up to 100% of his monthly board fees into the Deferral Plan for up to
ten years. Amounts deferred earn interest at the rate of 8% per annum. The
director may elect a distribution schedule of up to ten years with interest
accruing (at the same 8%) on the declining balance. The Company's deferred
compensation obligation of $170,000 and $135,000 as of December 31, 1999 and
1998 is included in accrued interest and other payable.
The Company has purchased life insurance policies on the lives of directors
who have agreed to participate in the Deferral Plan. It is expected that the
earnings on these policies will offset the cost of the program. In addition, the
Company will receive death benefit payments upon the death of the director. The
proceeds will permit the Company to "complete" the deferral program as the
director originally intended if he dies prior to the completion of the deferral
program. The disbursement of deferred fees is accelerated at death and commences
one month after the director dies.
In the event of the director's disability prior to attainment of his benefit
eligibility date, the director may request that the Board permit him to receive
an immediate disability benefit equal to the annualized value of the director's
deferral account.
During 1999, The Company converted its existing nonqualified key executive
and director defined contribution retirement and death benefit plan to a defined
benefit plan (Plan). The Plan is unsecured and unfunded and there are no Plan
assets. The Company has purchased insurance on the lives of the directors and
executive officers in the plan and intends to use the cash values of these
policies ($9,273,000 and $5,399,000 at December 31, 1999 and 1998, respectively)
to pay the retirement obligations. The accrued pension obligation was $395,000
and $55,000 as of December 31, 1999 and 1998, respectively. As a result of the
conversion, the Company recognized an additional $95,000 in expense to increase
the level of the accrued liability as a defined benefit plan. During 1999 the
Company contributed $340,000 to the Plan and the participants were not required
to contribute. The net periodic benefits cost of $262,128 was all related to
service cost. The net periodic cost was determined using a discount rate of 7%.
F-20
<PAGE>
HERITAGE
COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(11) DISCLOSURES OF FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value amounts have been determined by using available
market information and appropriate valuation methodologies. However,
considerable judgement is required to interpret market data to develop the
estimates of fair value. Accordingly, the estimates presented are not
necessarily indicative of the amounts that could be realized in a current market
exchange. The use of different market assumptions and/or estimation techniques
may have a material effect on the estimated fair value amounts.
The carrying amounts and estimated fair values of the Company's financial
instruments as of December 31, 1999 and 1998 were as follows:
<TABLE>
<CAPTION>
1999 1998
--------------------------- ---------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNTS FAIR VALUE AMOUNTS FAIR VALUE
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Assets
Cash and cash equivalents........... $138,150,000 $138,150,000 $ 46,639,000 $ 46,639,000
Securities.......................... 31,264,000 31,044,000 76,793,000 77,490,000
Loans, net.......................... 289,094,000 288,526,000 265,561,000 265,513,000
Cash surrender value of life
insurance......................... 9,273,000 9,273,000 5,399,000 5,399,000
Liabilities
Demand deposits, noninterest
bearing........................... $109,432,000 $109,432,000 $124,995,000 $124,995,000
Demand deposits, interest bearing... 9,898,000 9,898,000 9,061,000 9,061,000
Savings and money market............ 164,060,000 164,060,000 143,518,000 143,518,000
Time deposits....................... 135,150,000 135,465,000 91,384,000 91,578,000
</TABLE>
The following methods and assumptions were used to estimate the fair value
in the table, above:
CASH AND CASH EQUIVALENTS
The carrying amount approximates fair value because of the short maturities
of these instruments.
SECURITIES
The fair value of securities is estimated based on bid market prices. The
fair value of certain municipal securities is not readily available through
market sources other than dealer quotations, so fair value estimates are based
on such dealer quotations.
LOANS, NET
Loans with similar financial characteristics are grouped together for
purposes of estimating their fair value. Loans are segregated by type such as
commercial, term real estate, residential construction, and consumer. Each loan
category is further segmented into fixed and adjustable rate interest terms.
F-21
<PAGE>
HERITAGE
COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(11) DISCLOSURES OF FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
The fair value of performing, fixed rate loans is calculated by discounting
scheduled future cash flows using estimated market discount rates that reflect
the credit and interest rate risk inherent in the loan. The fair value of
variable rate loans is the carrying amount as these loans generally reprice
within 90 days. The fair value calculations are adjusted by the allowance for
possible loan losses.
CASH SURRENDER VALUE OF LIFE INSURANCE
The carrying amount represents a reasonable estimate of fair value.
DEPOSITS
The fair value of deposits with no stated maturity, such as non-interest
bearing demand deposits, savings, and money market accounts, approximates the
amount payable on demand. The carrying amount approximates the fair value of
time deposits with a remaining maturity of less than 90 days. The fair value of
all other time deposits is calculated based on discounting the future cash flows
using rates currently offered by the Bank for time deposits with similar
remaining maturities.
LIMITATIONS
Fair value estimates are made at a specific point in time, based on relevant
market information about the financial instrument. These estimates do not
reflect any premium or discount that could result from offering for sale at one
time the Bank's entire holdings of a particular financial instrument. Fair value
estimates are based on judgements regarding future expected loss experience,
current economic conditions, risk characteristics of various financial
instruments, and other factors. These estimates are subjective in nature and
involve uncertainties and matters of significant judgement and therefore cannot
be determined with precision. Changes in assumptions could significantly affect
the estimates.
(12) COMMITMENTS AND CONTINGENT LIABILITIES
FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
Both HBC and HBEB are party to financial instruments with off-balance sheet
risk in the normal course of business to meet the financing needs of its
clients. These financial instruments include commitments to extend credit and
standby letters of credit. Those instruments involve, to varying degrees,
elements of credit and interest rate risk, in excess of the amounts recognized
in the balance sheets.
The Banks' exposure to credit loss in the event of non-performance of the
other party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual notional amount of
those instruments. The Banks use the same credit policies in making commitments
and conditional obligations as it does for on-balance sheet instruments. Credit
risk is the possibility that a loss may occur because a party to a transaction
failed to perform according to the terms of the contract. The Banks control the
credit risk of these transactions through credit approvals, limits, and
monitoring procedures. Management does not anticipate any significant losses as
a result of these transactions.
F-22
<PAGE>
HERITAGE
COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(12) COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED)
Commitments to extend credit as of December 31, were as follows:
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
Commitments to extend credit..................... $480,319,000 $114,816,000
Standby letters of credit........................ 2,845,000 4,619,000
------------ ------------
$483,164,000 $119,435,000
============ ============
</TABLE>
Commitments to extend credit are agreements to lend to a client as long as
there is no violation of conditions established in the contract. Commitments
generally have fixed expiration dates or other termination clauses. Since some
of the commitments are expected to expire without being drawn upon, the total
commitment amount does not necessarily represent future cash requirements. The
Banks evaluate each client's creditworthiness on a case-by-case basis. The
amount of collateral obtained, if deemed necessary by the Banks upon extension
of credit, is based on management's credit evaluation of the borrower.
Collateral held varies but may include cash, marketable securities, accounts
receivable, inventory, property, plant and equipment, income-producing
commercial properties, and/or residential properties. Fair value of these
instruments is not material.
Standby letters of credit are written conditional commitments issued by the
Banks to guaranty the performance of a client to a third party. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan facilities to clients. Fair value of these instruments is not
material.
(13) REGULATORY MATTERS
The Company and its subsidiary banks are subject to various regulatory
capital requirements administered by the federal banking agencies. Failure to
meet minimum capital requirements can initiate certain mandatory--and possibly
additional discretionary--actions by regulators that, if undertaken, could have
a direct material effect on the Company's financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Company and the banks must meet specific capital guidelines that involve
quantitative measures of the Company's and the banks' assets, liabilities, and
certain off-balance-sheet items as calculated under regulatory accounting
practices. The Company's and the banks' capital amounts and classifications are
also subject to qualitative judgements by the regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the banks to maintain minimum amounts and ratios (set
forth in the table below) of total and Tier I capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier I capital (as
defined) to average assets (as defined). Management believes that, as of
December 31, 1999, the Company and the banks meets all capital adequacy
guidelines to which it is subject.
The most recent notification from the FDIC for the banks as of December 31,
1999 categorized HBC and HBEB as well capitalized under the regulatory framework
for prompt corrective action. As of December 31, 1998, FDIC categorized HBC as
adequately capitalized, and HBEB as well capitalized under the regulatory
framework for prompt corrective action. To be categorized as well capitalized
the Company must maintain minimum total risk-based, Tier I risk-based, and
Tier I leverage ratios as set
F-23
<PAGE>
HERITAGE
COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(13) REGULATORY MATTERS (CONTINUED)
forth in the table. There are no conditions or events since that notification
that management believes have changed the bank's category.
The Company's actual capital amounts and ratios are also presented in the
table.
<TABLE>
<CAPTION>
FOR CAPITAL
ACTUAL ADEQUACY PURPOSES:
---------------------- ----------------------
AMOUNT RATIO AMOUNT RATIO
----------- -------- ----------- --------
<S> <C> <C> <C> <C>
As of December 31, 1999
Total Capital
(to risk-weighted assets).......................... $49,176,000 13.2% $29,706,000 > or = to 8.0%
Tier 1 Capital
(to risk-weighted assets).......................... $44,530,000 12.0% $14,853,000 > or = to 4.0%
Tier 1 Capital
(to average assets)................................ $44,530,000 9.4% $19,012,000 > or = to 4.0%
As of December 31, 1998
Total Capital
(to risk-weighted assets).......................... $33,675,000 10.4% $25,880,000 > or = to 8.0%
Tier 1 Capital
(to risk-weighted assets).......................... $29,850,000 9.2% $12,940,000 > or = to 4.0%
Tier 1 Capital
(to average assets)................................ $29,850,000 7.5% $15,971,000 > or = to 4.0%
</TABLE>
HBC's actual capital amounts and ratios are also presented in the table.
<TABLE>
<CAPTION>
TO BE
WELL-CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES: ACTION PROVISIONS:
---------------------- ---------------------- --------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
----------- -------- ----------- -------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1999
Total Capital
(to risk-weighted assets)..... $34,010,000 10.5% $25,558,000 > or = to 8.0% $31,948,000 > or = to 10.0%
Tier 1 Capital
(to risk-weighted assets)..... $29,611,000 9.3% $12,779,000 > or = to 4.0% $19,169,000 > or = to 6.0%
Tier 1 Capital
(to average assets)........... $29,611,000 7.3% $16,187,000 > or = to 4.0% $20,234,000 > or = to 5.0%
</TABLE>
F-24
<PAGE>
HERITAGE
COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(13) REGULATORY MATTERS (CONTINUED)
<TABLE>
<CAPTION>
TO BE
ADEQUATELY-CAPITALIZED
FOR CAPITAL UNDER PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES: ACTION PROVISIONS:
---------------------- ---------------------- --------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
----------- -------- ----------- -------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1998
Total Capital
(to risk-weighted assets)..... $27,697,000 9.3% $23,837,000 > or = to 8.0% $23,837,000 > or = to 8.0%
Tier 1 Capital
(to risk-weighted assets)..... $24,172,000 8.1% $11,919,000 > or = to 4.0% $11,919,000 > or = to 4.0%
Tier 1 Capital
(to average assets)........... $24,172,000 6.2% $15,561,000 > or = to 4.0% $15,561,000 > or = to 4.0%
</TABLE>
HBEB's actual capital amounts and ratios are also presented in the table.
<TABLE>
<CAPTION>
TO BE
WELL-CAPITALIZED
FOR CAPITAL UNDER PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES: ACTION PROVISIONS:
--------------------- ---------------------- -------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
---------- -------- ---------- --------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1999
Total Capital
(to risk-weighted assets)....... $6,212,000 11.8% $4,212,000 > or = to 8.0% $5,265,000 > or = to 10.0%
Tier 1 Capital
(to risk-weighted assets)....... $5,608,000 10.7% $2,106,000 > or = to 4.0% $3,159,000 > or = to 6.0%
Tier 1 Capital
(to average assets)............. $5,608,000 8.1% $2,770,000 > or = to 4.0% $3,472,000 > or = to 5.0%
As of December 31, 1998
Total Capital
(to risk-weighted assets)....... $5,402,000 18.9% $2,286,000 > or = to 8.0% $2,858,000 > or = to 10.0%
Tier 1 Capital
(to risk-weighted assets)....... $5,102,000 17.9% $1,143,000 > or = to 4.0% $1,715,000 > or = to 6.0%
Tier 1 Capital
(to average assets)............. $5,102,000 15.2% $1,342,000 > or = to 4.0% $1,678,000 > or = to 5.0%
</TABLE>
The Company is required to maintain reserves with the Federal Reserve Bank
of San Francisco. Reserve requirements are based on a percentage of certain
deposits. As of December 31, 1999, the Company maintained reserves of $1,152,000
in the form of vault cash and balances at the Federal Reserve Bank of San
Francisco, which satisfied the regulatory requirements.
Under California law, the holders of common stock are entitled to receive
dividends when and as declared by the Board of Directors, out of funds legally
available therefor. The California Banking Law provides that a state-licensed
bank may not make a cash distribution to its shareholders in excess of the
lesser of the following: (i) the bank's retained earnings, or (ii) the bank's
net income for its last three fiscal years, less the amount of any distributions
made by the bank to its shareholders during such period. However, a bank, with
the prior approval of the Commissioner, may make a distribution to its
shareholders of an amount not to exceed the greater of (i) a bank's retained
earnings, (ii) its net
F-25
<PAGE>
HERITAGE
COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(13) REGULATORY MATTERS (CONTINUED)
income for its last fiscal year, or (iii) its net income for the current fiscal
year. In the event that the Commissioner determines that the shareholders'
equity of a bank is inadequate or that the making of a distribution by a bank
would be unsafe or unsound, the Commissioner may order a bank to refrain from
making such a proposed distribution. At December 31, 1999, the amount available
for such dividend without prior written approval was approximately $7,410,000
for HBC and zero for HBEB. Similar restrictions apply to the amounts and sum of
loans advances and other transfers of funds from the banks to the Company.
(14) PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION
As described in Note 1 to the consolidated financial statements, the merger
of Heritage Bank of Commerce with the Company became effective February 17,
1998. The condensed financial statements of Heritage Commerce Corp (parent
company only) follow:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED,
-----------------------------
DECEMBER 31, DECEMBER 31,
1999 1998
------------- -------------
<S> <C> <C>
CONDENSED BALANCE SHEETS
Cash and cash equivalents................................... $11,230,000 $ 467,000
Investment in and advancements to subsidiaries.............. 35,215,000 30,114,000
Other assets................................................ 86,000 116,000
----------- -----------
Total..................................................... $46,531,000 $30,697,000
=========== ===========
Liabilities................................................. $ 2,000,000 $ --
Shareholders' Equity........................................ 44,531,000 30,697,000
----------- -----------
Total..................................................... $46,531,000 $30,697,000
=========== ===========
<CAPTION>
FOR THE YEARS ENDED,
-----------------------------
DECEMBER 31, DECEMBER 31,
1999 1998
------------- -------------
<S> <C> <C>
CONDENSED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
Dividends from Bank subsidiaries............................ $ -- $ 300,000
Interest income............................................. 200,000 16,000
Interest expense............................................ (16,000) --
Other expenses.............................................. (20,000) (618,000)
----------- -----------
Gain/(loss) before equity in net income of subsidiary
banks..................................................... 164,000 (302,000)
Equity in undistributed net income of subsidiaries.......... 2,917,000 2,336,000
Income tax expense (benefit)................................ (55,000) 116,000
----------- -----------
Net Income.................................................. 3,026,000 2,150,000
----------- -----------
Other comprehensive income.................................. (795,000) 240,000
----------- -----------
Comprehensive income........................................ $ 2,231,000 $ 2,390,000
=========== ===========
</TABLE>
F-26
<PAGE>
HERITAGE
COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(14) PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION (CONTINUED)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED,
-----------------------------
DECEMBER 31, DECEMBER 31,
1999 1998
------------- -------------
<S> <C> <C>
CONDENSED STATEMENTS OF CASH FLOWS
Cash flows from operating activities:
Net Income.................................................. $ 3,026,000 $ 2,150,000
Adjustments to reconcile net income to net cash provided
(used) by operations:
Provision for deferred income taxes....................... 55,000 --
Equity in undistributed income (losses) of subsidiaries... (2,917,000) (2,336,000)
Net change in other liabilities........................... (19,000) (116,000)
----------- -----------
Net cash provided by (used in) operating activities......... 145,000 (302,000)
Cash flows from investing activities:
Other (dividends received from Bank subsidiaries)......... -- 300,000
Cash distributed to Bank subsidiaries..................... (2,985,000) --
----------- -----------
Net cash provided by (used in) investing activities......... (2,985,000) 300,000
Cash flows from financing activities:
Proceeds from issuance of common stock.................... 11,603,000 5,969,000
Cash distributed to Bank subsidiaries..................... -- (5,500,000)
Proceeds from other short-term borrowings................. 4,000,000 --
Repayments of other short-term borrowings................. (2,000,000) --
----------- -----------
Net cash provided by financing activities................... 13,603,000 469,000
Net increase in cash and cash equivalents................... 10,763,000 467,000
Cash and cash equivalents, beginning of year................ 467,000 --
----------- -----------
Cash and cash equivalents, end of year...................... $11,230,000 $ 467,000
=========== ===========
</TABLE>
F-27
<PAGE>
HERITAGE COMMERCE CORP
UNAUDITED FINANCIAL STATEMENTS
AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 2000 AND 1999
F-28
<PAGE>
HERITAGE COMMERCE CORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED)
<TABLE>
<CAPTION>
MARCH 31, 2000 DECEMBER 31, 1999
--------------- ------------------
<S> <C> <C>
ASSETS
Cash and due from banks..................................... $ 23,310,000 $ 10,049,000
Federal funds sold.......................................... 82,050,000 128,100,000
------------ ------------
Total cash and cash equivalents....................... 105,360,000 138,149,000
Securities available-for-sale, at fair value................ 33,892,000 16,356,000
Securities held-to-maturity, at amortized cost (fair value
of $13,553,000 and $13,614,000, respectively)............. 13,823,000 13,834,000
Loan held for sale, at fair value........................... 25,960,000 22,243,000
Loans, net of deferred fees................................. 310,005,000 271,855,000
Allowance for probable loan losses.......................... (5,616,000) (5,003,000)
------------ ------------
Loans, net............................................ 304,389,000 266,852,000
Premises and equipment, net................................. 3,351,000 3,459,000
Accrued interest receivable and other assets................ 4,816,000 5,211,000
Other investments........................................... 14,014,000 10,560,000
------------ ------------
TOTAL................................................. $505,605,000 $476,664,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits
Demand, noninterest bearing............................. $140,738,000 $109,432,000
Demand, interest bearing................................ 12,231,000 9,898,000
Savings and money market................................ 157,059,000 164,060,000
Time deposits, under $100,000........................... 46,288,000 47,355,000
Time deposits, $100,000 and over........................ 92,519,000 87,795,000
------------ ------------
Total deposits............................................ 448,835,000 418,540,000
Mandatorily redeemable cumulative trust preferred
securities of Subsidiary Grantor Trust.................. 7,000,000 --
Accrued interest payable and other liabilities............ 4,222,000 13,593,000
------------ ------------
Total liabilities..................................... 460,057,000 432,133,000
------------ ------------
Commitments and contingencies
Shareholders' equity:
Preferred Stock, no par value; 10,000,000 shares
authorized; none outstanding............................ -- --
Common Stock, no par value; 30,000,000 shares authorized;
Shares issued and outstanding: 7,034,882 at March 31,
2000 and 7,031,576 at December 31, 1999................. 41,036,000 41,021,000
Accumulated other comprehensive loss, net of taxes........ (174,000) (137,000)
Retained Earnings......................................... 4,686,000 3,647,000
------------ ------------
Total shareholders' equity............................ 45,548,000 44,531,000
------------ ------------
TOTAL................................................. $505,605,000 $476,664,000
============ ============
</TABLE>
See notes to condensed consolidated financial statements
F-29
<PAGE>
HERITAGE COMMERCE CORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED INCOME STATEMENTS (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-----------------------
2000 1999
---------- ----------
<S> <C> <C>
Interest income:
Loans, including fees..................................... $8,271,000 $6,031,000
Securities, taxable....................................... 488,000 624,000
Securities, non-taxable................................... 146,000 173,000
Federal funds sold........................................ 976,000 336,000
---------- ----------
Total interest income....................................... 9,881,000 7,164,000
---------- ----------
Interest expense:
Deposits.................................................. 3,413,000 2,160,000
Other..................................................... 20,000 11,000
---------- ----------
Total interest expense...................................... 3,433,000 2,171,000
---------- ----------
Net interest income before provision for probable loan
losses.................................................... 6,448,000 4,993,000
Provision for probable loan losses.......................... 600,000 643,000
---------- ----------
Net interest income after provision for probable loan
losses.................................................... 5,848,000 4,350,000
---------- ----------
Noninterest income:
Other investments......................................... 174,000 80,000
Service charges and other fees............................ 102,000 69,000
Gain on sale of loans..................................... 52,000 46,000
Servicing income.......................................... 7,000 --
Gain on sale of securities available-for-sale............. -- 771,000
Other income.............................................. 148,000 258,000
---------- ----------
Total other income.......................................... 483,000 1,224,000
---------- ----------
Noninterest expenses:
Salaries and employee benefits............................ 2,867,000 2,422,000
Client services........................................... 369,000 661,000
Occupancy................................................. 342,000 232,000
Loan origination costs.................................... 206,000 116,000
Furniture and equipment................................... 203,000 297,000
Professional fees......................................... 185,000 170,000
Advertising and promotion................................. 89,000 149,000
Stationery & supplies..................................... 65,000 79,000
Telephone expense......................................... 63,000 50,000
Other..................................................... 344,000 411,000
---------- ----------
Total other expenses........................................ 4,733,000 4,587,000
---------- ----------
Net income before income taxes.............................. 1,598,000 987,000
Provision for income taxes.................................. 560,000 360,000
---------- ----------
Net income.................................................. $1,038,000 $ 627,000
========== ==========
Earnings per share:
Basic..................................................... $ 0.15 $ 0.10
========== ==========
Diluted................................................... $ 0.13 $ 0.09
========== ==========
</TABLE>
See notes to condensed consolidated financial statements
F-30
<PAGE>
HERITAGE COMMERCE CORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
-----------------------------
2000 1999
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net income.................................................. $ 1,038,000 $ 627,000
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation and amortization............................... 209,000 203,000
Provision for probable loan losses.......................... 600,000 643,000
Gain on sale of securities available-for-sale............... -- (771,000)
Net amortization of premiums / accretion of discounts....... 24,000 (34,000)
Proceeds from sales of loans held for sale.................. -- 2,317,000
Originations of loans held for sale......................... (3,730,000) (322,000)
Maturities of loans held for sale........................... 13,000 2,158,000
Effect of changes in:
Accrued interest receivable and other assets.............. 395,000 (4,248,000)
Accrued interest payable and other liabilities............ (9,359,000) 403,000
------------ ------------
Net cash provided by (used in) operating activities......... (10,810,000) 976,000
Cash flows from investing activities:
Net (increase) decrease in loans............................ (38,138,000) 21,462,000
Purchases of securities available-for-sale.................. (17,597,000) (21,252,000)
Maturities of securities available-for-sale................. -- 2,984,000
Proceeds from sales of securities available-for-sale........ -- 27,749,000
Proceeds from maturities or calls of securities
held-to-maturity.......................................... -- 1,115,000
Purchases of corporate owned life insurance................. (2,524,000) (3,480,000)
Purchases of other investments.............................. (930,000) --
Purchases of property and equipment......................... (100,000) (67,000)
------------ ------------
Net cash provided by (used in) investing activities......... (59,289,000) 28,511,000
Cash flows from financing activities:
Net increase (decrease) in deposits......................... 30,295,000 (46,912,000)
Proceeds from issuance of mandatorily redeemable cumulative
trust preferred securities of Subsidiary Grantor Trust.... 7,000,000 --
Proceeds from exercise of stock options..................... 15,000 38,000
------------ ------------
Net cash provided by (used in) financing activities......... 37,310,000 (46,874,000)
------------ ------------
Net decrease in cash and cash equivalents................... (32,789,000) (17,387,000)
Cash and cash equivalents, beginning of period.............. 138,149,000 46,639,000
------------ ------------
Cash and cash equivalents, end of period.................... $105,360,000 $ 29,252,000
============ ============
Supplemental disclosures of cash paid during the period for:
Interest.................................................. $ 3,149,000 $ 2,246,000
Income taxes.............................................. $ 767,000 $ 728,000
Supplemental schedule of non-cash investing and financing
activity:
Transfer of investment securities from HTM to AFS......... -- $ 11,669,000
</TABLE>
See notes to condensed consolidated financial statements
F-31
<PAGE>
HERITAGE COMMERCE CORP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2000
(UNAUDITED)
1) BASIS OF PRESENTATION
The unaudited condensed consolidated financial statements of Heritage
Commerce Corp and its wholly owned subsidiaries, Heritage Bank of Commerce,
Heritage Bank East Bay, and Heritage Bank South Valley, have been prepared
pursuant to the rules and regulations for reporting on Form 10-Q. Accordingly,
certain information and notes required by generally accepted accounting
principles for complete financial statements are not included herein. The
interim statements should be read in conjunction with the financial statements
and notes thereto included in the Company's Form 10-K Annual Report for the year
ended December 31, 1999.
In the Company's opinion, all adjustments necessary for a fair presentation
of these condensed consolidated financial statements have been included and are
of a normal and recurring nature. Certain reclassifications have been made to
prior year amounts to conform to current year presentation.
The results for the three months ended March 31, 2000 are not necessarily
indicative of the results expected for any subsequent period or for the entire
year ending December 31, 2000.
2) EARNINGS PER SHARE
Basic earnings per share is computed by dividing net income by the weighted
average common shares outstanding. Diluted earnings per share reflects potential
dilution from outstanding stock options, using the treasury stock method. For
each of the periods presented, net income is the same for basic and diluted
earnings per share. Reconciliation of weighted average shares used in computing
basic and diluted earnings per share is as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
---------------------
2000 1999
--------- ---------
<S> <C> <C>
Weighted average common shares outstanding--used in
computing basic EPS.................................. 7,034,615 6,112,611
Dilutive effect of stock options outstanding, using the
treasury stock method................................ 668,892 941,027
--------- ---------
Shares used in computing diluted earnings per share.... 7,703,507 7,053,638
========= =========
</TABLE>
3) COMPREHENSIVE INCOME
In 1998, the Company adopted SFAS No. 130 Reporting Comprehensive Income,
which requires that an enterprise report and display, by major components and as
a single total, the change in its net assets during the period from non-owner
sources.
F-32
<PAGE>
HERITAGE COMMERCE CORP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2000
(UNAUDITED)
3) COMPREHENSIVE INCOME (CONTINUED)
The following is a summary of the components of other comprehensive income:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS
ENDED MARCH 31,
----------------------
2000 1999
---------- ---------
<S> <C> <C>
Net Income............................................ $1,038,000 $ 627,000
---------- ---------
Other comprehensive income, net of tax:
Net unrealized holding gain (loss) on
available-for-sale securities during the period... (24,000) 217,000
Less: reclassification adjustment for realized gains
on available-for-sale securities included in net
income during the period............................ -- (770,000)
---------- ---------
Other comprehensive loss.............................. (24,000) (553,000)
---------- ---------
Comprehensive income.................................. $1,014,000 $ 74,000
========== =========
</TABLE>
4) MANDATORILY REDEEMABLE CUMULATIVE TRUST PREFERRED SECURITIES OF SUBSIDIARY
GRANTOR TRUST
Heritage Capital Trust I is a Delaware business trust wholly owned by
Heritage Commerce Corp and formed for the purpose of issuing Company obligated
mandatorily redeemable cumulative trust preferred securities of Subsidiary
Grantor Trust holding solely junior subordinated debentures.
During the first quarter of 2000, Heritage Capital Trust I issued 7,000
Trust Preferred Securities with a liquidation value of $1,000 per security to
the Company for gross proceeds of $7,000,000. The entire proceeds of the
issuance were invested by Heritage Capital Trust I in $7,000,000 aggregate
principal amount of 10 7/8% subordinated debentures due 2030 (the Subordinated
Debentures) issued by the Company. The Subordinated Debentures represent the
sole assets of Heritage Capital Trust I. The Subordinated Debentures mature on
March 8, 2030, bear interest at the rate of 10 7/8%, payable semi-annually, and
are redeemable by the Company at a premium beginning on or after March 8, 2010
based on a percentage of the principal amount of the Subordinated Debentures as
stipulated in the Indenture Agreement, plus any accrued and unpaid interest to
the redemption date. The Subordinated Debentures are redeemable at 100 percent
of the principal amount plus any accrued and unpaid interest to the redemption
date at any time on or after March 8, 2020. The Trust Preferred Securities are
subject to mandatory redemption to the extent of any early redemption of the
Subordinated Debentures and upon maturity of the Subordinated Debentures on
March 8, 2030.
Holders of the trust preferred securities are entitled to cumulative cash
distributions at an annual rate of 10 7/8% of the liquidation amount of $1,000
per security. The Company has the option to defer payment of the distributions
for a period of up to five years, as long as the Company is not in default in
the payment of interest on the Subordinated Debentures. The Company has
guaranteed, on a subordinated basis, distributions and other payments due on the
trust preferred securities (the Guarantee). The Guarantee, when taken together
with the Company's obligations under the Subordinated Debentures, the Indenture
Agreement pursuant to which the Subordinated Debentures
F-33
<PAGE>
HERITAGE COMMERCE CORP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2000
(UNAUDITED)
4) MANDATORILY REDEEMABLE CUMULATIVE TRUST PREFERRED SECURITIES OF SUBSIDIARY
GRANTOR TRUST (CONTINUED)
were issued and the Company's obligations under the Trust Agreement governing
the subsidiary trust, provide a full and unconditional guarantee of amounts due
on the Trust Preferred Securities.
The Subordinated Debentures and related trust investment in the Subordinated
Debentures have been eliminated in consolidation and the Trust Preferred
Securities reflected as outstanding in the accompanying condensed consolidated
financial statements. Under applicable regulatory guidelines all of the Trust
Preferred Securities will qualify as Tier I capital.
5) RECLASSIFICATIONS
Certain amounts in the December 31, 1999 and March 31, 1999 financial
statements have been reclassified to conform to the March 31, 2000 financial
statement presentation.
F-34
<PAGE>
WESTERN HOLDINGS BANCORP AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 1999 AND 1998
<TABLE>
<S> <C>
Report of Independent Public Accountants.................... F-36
Consolidated Balance Sheets as of December 31, 1999 and
1998...................................................... F-38
Consolidated Statements of Income for the years ended
December 31, 1999 and 1998................................ F-39
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 1999 and 1998.................... F-40
Consolidated Statements of Cash Flows for the years ended
December 31, 1999 and 1998................................ F-41
Notes to Consolidated Financial Statements.................. F-42
</TABLE>
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2000
(UNAUDITED)
<TABLE>
<S> <C>
Condensed Consolidated Statements of Financial Condition as
of March 31, 2000 and December 31, 1999................... F-59
Condensed Consolidated Income Statements for the three
months ended March 31, 2000 and 1999...................... F-60
Condensed Consolidated of Cash Flows for the three months
ended March 31, 2000 and 1999............................. F-61
Notes to Condensed Consolidated Financial Statements........ F-62
</TABLE>
F-35
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of
Western Holdings Bancorp:
We have audited the consolidated balance sheet of Western Holdings Bancorp
(a California corporation) and Subsidiary (the Company) as of December 31, 1999,
and the related consolidated statements of income, shareholders' equity, and
cash flows for the year then ended. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit. The financial
statements of the Company as of December 31, 1998, were audited by other
auditors, whose report dated January 22, 1999, on those statements included an
explanatory paragraph with respect to a litigation matter.
We conducted our audit 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 audit provides 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 Western Holdings Bancorp and
Subsidiary at December 31, 1999, and the results of their operations and their
cash flows for the year then ended in conformity with generally accepted
accounting principles.
/s/ Arthur Andersen LLP
San Francisco, California,
January 21, 2000
F-36
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders
of Western Holdings Bancorp:
In our opinion, the consolidated balance sheet as of December 31, 1998 and
the related consolidated statements of income, of shareholders' equity and of
cash flows for the year then ended present fairly, in all material respects, the
financial position, results of operations and cash flows of Western Holdings
Bancorp at December 31, 1998 and for the year then ended, in conformity with
generally accepted accounting principles. 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 audit. We conducted our audit
of these statements in accordance with generally accepted auditing standards,
which 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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for the opinion expressed above. As discussed in Note 10 to the
financial statements, Western Holdings Bancorp is subject to a litigation claim
for which neither the amount of the loss nor the outcome can be reasonably
assured. We have not audited the consolidated financial statements of Western
Holdings Bancorp for any period subsequent to December 31, 1998.
/s/ PricewaterhouseCoopers LLP
San Francisco, California
January 22, 1999
F-37
<PAGE>
WESTERN HOLDINGS BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
ASSETS
Cash and due from banks..................................... $ 9,275,025 $ 10,061,779
Federal funds sold.......................................... 7,800,000 6,000,000
------------ ------------
Total cash and cash equivalents......................... 17,075,025 16,061,779
Investment securities available-for-sale.................... 35,465,893 36,316,077
Investment securities held-to-maturity...................... 9,163,142 12,007,289
Federal Home Loan Bank stock, at cost....................... 1,316,200 2,100,800
Loans, net.................................................. 127,876,751 100,379,751
Premises and equipment, net................................. 3,267,618 3,464,414
Deferred income taxes....................................... 1,251,000 1,251,000
Accrued interest receivable and other assets................ 5,038,930 4,891,662
------------ ------------
Total assets............................................ $200,454,559 $176,472,772
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits.................................................... $182,879,872 $140,957,539
FHLB borrowings............................................. 5,000,000 22,000,000
Accrued interest payable and other liabilities.............. 561,338 2,221,716
------------ ------------
Total liabilities....................................... 188,441,210 165,179,255
------------ ------------
Commitments and contingencies (Note 14)..................... -- --
Common stock, no par value; authorized, 10,000,000 shares;
shares issued and outstanding, 2,727,819 and 2,710,181
shares at December 31, 1999 and 1998...................... 10,184,916 7,396,929
Retained earnings........................................... 2,945,210 4,012,632
Accumulated other comprehensive income (loss)............... (1,116,777) (116,044)
------------ ------------
Total shareholders' equity.............................. 12,013,349 11,293,517
------------ ------------
Total liabilities and shareholders' equity.............. $200,454,559 $176,472,772
============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
F-38
<PAGE>
WESTERN HOLDINGS BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
----------- ----------
<S> <C> <C>
INTEREST AND FEE INCOME:
Loans..................................................... $11,049,380 $8,863,576
Investment securities..................................... 2,935,038 2,360,028
Federal funds sold........................................ 246,833 306,632
----------- ----------
Total interest income................................... 14,231,251 11,530,236
INTEREST EXPENSE............................................ 4,954,348 4,111,901
----------- ----------
Net interest income before provision for loan losses.... 9,276,903 7,418,335
PROVISION FOR LOAN LOSSES................................... 287,000 229,833
----------- ----------
Net interest income after provision for loan losses..... 8,989,903 7,188,502
----------- ----------
NONINTEREST INCOME:
Operating lease income.................................... -- 308,826
Customer service charges.................................. 216,812 177,608
Gain on sale of SBA loans................................. 119,107 102,750
Brokered loan fees........................................ 326,955 316,188
Other..................................................... 370,455 343,452
----------- ----------
Total noninterest income................................ 1,033,329 1,248,824
----------- ----------
NONINTEREST EXPENSES:
Salaries and employee benefits............................ 3,906,487 3,218,906
Operating lease amortization.............................. -- 33,230
Lease servicing fees...................................... -- 157,420
Occupancy................................................. 865,439 632,054
Professional fees......................................... 442,349 323,339
Furniture, fixtures, and equipment........................ 485,327 355,727
Marketing................................................. 287,000 214,818
Other..................................................... 1,337,669 1,203,838
----------- ----------
Total noninterest expenses.............................. 7,324,271 6,139,332
----------- ----------
Income before provision for income taxes................ 2,698,961 2,297,994
PROVISION FOR INCOME TAXES.................................. 1,056,103 942,178
----------- ----------
Net income.............................................. $ 1,642,858 $1,355,816
=========== ==========
BASIC EARNINGS PER COMMON SHARE............................. $ 0.60 $ 0.52
DILUTED EARNINGS PER COMMON SHARE........................... 0.57 0.47
</TABLE>
The accompanying notes are an integral part of these statements.
F-39
<PAGE>
WESTERN HOLDINGS BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
ACCUMULATED
COMMON STOCK OTHER
----------------------- RETAINED COMPREHENSIVE COMPREHENSIVE
SHARES AMOUNT EARNINGS INCOME (LOSS) TOTAL INCOME
--------- ----------- ----------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1997............... 2,000,000 $ 5,080,806 $ 4,042,928 $ 14,310 $ 9,138,044 $ --
Net income............................. -- -- 1,355,816 -- 1,355,816 1,355,816
Other comprehensive income:
Net unrealized loss on
available-for-sale securities, net
of tax and reclassification
adjustment......................... -- -- -- (130,354) (130,354) (130,354)
-----------
Comprehensive income................... -- -- -- -- -- $ 1,225,462
===========
Repurchase stock....................... (20,000) (130,000) -- -- (130,000)
10% stock dividend..................... 198,016 1,386,112 (1,386,112) -- --
Options exercised...................... 285,776 1,060,011 -- -- 1,060,011
--------- ----------- ----------- ----------- -----------
BALANCE, DECEMBER 31, 1998............... 2,463,792 7,396,929 4,012,632 (116,044) 11,293,517
Net income............................. -- -- 1,642,858 -- 1,642,858 $ 1,642,858
Other comprehensive income:
Net unrealized loss on
available-for-sale securities, net
of tax and reclassification
adjustment......................... -- -- -- (1,000,733) (1,000,733) (1,000,733)
-----------
Comprehensive income................... -- -- -- -- $ 642,125
===========
10% stock dividend..................... 246,389 2,710,280 (2,710,280) -- --
Options exercised...................... 17,638 77,707 -- -- 77,707
--------- ----------- ----------- ----------- -----------
BALANCE, DECEMBER 31, 1999............... 2,727,819 $10,184,916 $ 2,945,210 $(1,116,777) $12,013,349
========= =========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
F-40
<PAGE>
WESTERN HOLDINGS BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 1,642,858 $ 1,355,816
Adjustments to reconcile net income to net cash provided
by operating activities:
Deferred income taxes................................... -- (60,000)
Depreciation and amortization expenses, net............. 592,644 414,068
Net change in deferred loan costs....................... (240,860) (100,591)
Provision for loan losses............................... 287,000 229,833
Net loss (gain) on sales and calls of securities
available for sale.................................... 34,818 (7,029)
Net (gain) loss on sale of leased equipment residuals... -- (50,439)
Change in certain assets and liabilities:
Decrease (increase) in accrued interest receivable and
other assets........................................ 192,734 (925,932)
Increase (decrease) in accrued interest payable and
other liabilities................................... (1,023,159) 1,063,385
------------ ------------
Net cash provided by operating activities........... 1,486,035 1,919,111
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of investment securities available for sale...... (13,215,922) (39,919,753)
Maturities/paydowns of investment securities available for
sale.................................................... 8,419,922 23,031,841
Proceeds from sale of investment securities available for
sale.................................................... 3,962,938 500,000
Purchase of investment securities held to maturity........ -- (11,347,460)
Maturities/paydowns of investment securities held to
maturity................................................ 2,834,052 10,591,645
Redemption (purchase) of FHLB stock....................... 784,600 (1,733,200)
Net change in loans....................................... (27,543,140) (23,586,204)
Purchase of premises and equipment........................ (375,279) (1,763,233)
Purchase of officer life insurance........................ (340,000) (2,470,000)
Proceeds from sale of leased equipment.................... -- 101,056
------------ ------------
Net cash used in investing activities............... (25,472,829) (46,595,308)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in FHLB borrowings............................. (17,000,000) 18,500,000
Net change in deposits.................................... 41,922,333 28,207,087
Stock repurchased......................................... -- (130,000)
Options exercised......................................... 77,707 1,060,011
------------ ------------
Net cash provided by financing activities........... 25,000,040 47,637,098
------------ ------------
INCREASE IN CASH AND CASH EQUIVALENTS....................... 1,013,246 2,960,901
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR.............. 16,061,779 13,100,878
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF YEAR.................... $ 17,075,025 $ 16,061,779
============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest................................................ $ 4,212,247 $ 4,029,711
Income taxes............................................ 1,359,843 111,169
</TABLE>
The accompanying notes are an integral part of these statements.
F-41
<PAGE>
WESTERN HOLDINGS BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
1. BASIS OF PRESENTATION:
On December 8, 1997, Western Holdings Bancorp (the Company) was formed. On
December 8, 1997, the shareholders of the Bank of Los Altos (the Bank), a state
chartered bank located in Los Altos, California, exchanged all of their
outstanding common shares for an equal number of common shares in the Company
and the Company acquired 100% of the outstanding common shares in the Bank.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
NATURE OF OPERATIONS
The Company, through its subsidiary, the Bank, operates two branches in Los
Altos and one in Mountain View. The Company has two primary sources of revenue:
commercial, construction, and real estate loans to customers who are
predominantly small and middle-market businesses and local individuals, owners
or investors; and investment securities. The cost of funds relates to various
deposit products offered to these same businesses and individuals, and Federal
Home Loan Bank borrowings.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements of the Company include the accounts of
its wholly owned subsidiary, the Bank. All material intercompany accounts and
transactions have been eliminated in consolidation.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of certain assets and liabilities,
the disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of certain revenues and expenses during the
reporting period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
For the purposes of reporting cash flows, cash and cash equivalents include
cash on hand, amounts due from banks, and federal funds sold.
The Bank is required by federal regulations to maintain certain minimum
average balances with the Federal Reserve Bank, based primarily on the Bank's
daily demand deposit balances. Required deposits held with the Federal Reserve
Bank averaged approximately $1,741,000 for the year ended December 31, 1999.
INVESTMENT SECURITIES
Securities in the investment portfolio for which the Company has the ability
and intent to hold to maturity are classified as held to maturity and are stated
at cost, net of any unamortized premiums or discounts. Premiums and discounts
are amortized on these securities over the expected life of the underlying
assets using methods approximating the interest method. All other securities are
considered
F-42
<PAGE>
WESTERN HOLDINGS BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999 AND 1998
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
available for sale and are stated at fair market value, with any net unrealized
holding gain or loss, net of any income tax effect, recorded as a separate
component of shareholders' equity.
Security transactions are accounted for on the date the securities are
purchased or sold (trade date). Any realized gains or losses on sales are
determined using the specific identification method.
LOANS RECEIVABLE
Loans are reported at the principal amount outstanding, net of unearned
income and allowance for loan losses. The Company's loan portfolio consists
primarily of construction, commercial, and real estate loans generally
collateralized by first and second deeds of trust on real estate, as well as
business assets and personal property.
Interest income is accrued daily on the outstanding loan balances using the
simple-interest method. Loans are generally placed on nonaccrual status when the
borrowers are past-due 90 days and when payment in full of principal or interest
is not expected. At the time a loan is placed on nonaccrual status, any interest
income previously accrued but not collected is reversed out of income. Interest
accruals are resumed on such loans only when they are brought fully current with
respect to interest and principal and when, in the judgment of management, the
loans are estimated to be fully collectible as to both principal and interest.
The Company charges loan origination and commitment fees. Net loan
origination fees are deferred and amortized to interest income over the life of
the loan. Commitment fees are deferred and amortized over the term of
commitment.
SALES AND SERVICING OF SMALL BUSINESS ADMINISTRATION (SBA) LOANS
In 1998, the Company began originating loans to customers under SBA programs
that generally provide for SBA guarantees of 70% to 90% of each loan. The
Company has the option to sell the guaranteed portion of each loan to an
investor and retain the unguaranteed portion in its own portfolio. Funding for
the SBA programs depend on annual appropriations by the U.S. Congress.
To determine the gain (loss) on sale and to record originated
mortgage-servicing rights as assets, the Company allocates the total carrying
value of the loan prior to sale against the portion of the loan sold, the
portion retained, and the servicing rights based on their relative fair values
at the time of sale.
Mortgage servicing rights are amortized in proportion to, and over the
period of, estimated net servicing revenues. The Company assesses capitalized
mortgage servicing rights for impairment based upon the fair value of those
rights at each reporting date. For purposes of measuring impairment, the rights
are stratified based upon the product type, term, and interest rates. Fair value
is determined by discounting estimated net future cash flows from mortgage
servicing activities using discount rates that approximate current market rates
and estimated prepayment rates, among other assumptions. The amount of
impairment recognized, if any, is the amount by which the capitalized mortgage
servicing rights for a stratum exceeds their fair value. Impairment, if any, is
recognized through a valuation allowance for each individual stratum.
F-43
<PAGE>
WESTERN HOLDINGS BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999 AND 1998
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
ALLOWANCE FOR LOAN LOSSES
The Company considers a loan to be impaired if it is probable that the
Company will be unable to collect the scheduled payments of principal or
interest when due according to the contractual terms of the loan agreement.
Allowances for losses on impaired loans are to be measured under one of three
methods. Because almost all of the Company's loans are collateral dependent, the
calculation of the allowance on impaired loans is generally based on the fair
value of the collateral. Income recognition on impaired loans conforms to the
method the Company uses for income recognition on nonaccrual loans.
An allowance for loan losses is maintained at a level deemed appropriate by
management to provide for known losses as well as unidentified losses in the
loan portfolio. The allowance is based upon management's assessment of various
factors affecting the collectibility of the loans, including current and
projected economic conditions, past credit experience, delinquency status, the
value of the underlying collateral, if any, and continuing review of the
portfolio of loans. The allowance is increased by provisions charged to
operations and reduced by net charge-offs.
The allowance for loan losses is based on estimates, and ultimate losses may
vary from current estimates. These estimates are reviewed periodically, and as
adjustments become necessary, they are reported in earnings in the periods in
which they become known.
OTHER REAL ESTATE OWNED
Other real estate owned (OREO) consists of properties acquired through
foreclosure and is stated at the lower of cost or fair market value less
estimated costs to sell. Development and improvement costs relating to the
properties are capitalized. Estimated losses that result from the ongoing
periodic valuation of these properties are charged to current earnings with a
provision for losses on foreclosed property in the period in which they are
identified. Operating expenses of such properties are included in other
expenses. The Company did not have any OREO as of December 31, 1999 and 1998.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation and
amortization. Depreciation and amortization are computed on the straight-line
basis over the estimated useful lives of the assets.
INCOME TAXES
The Company's accounting for income taxes is based on an asset and liability
approach. The Company recognizes the amount of taxes payable or refundable for
the current year, as well as deferred tax assets and liabilities for the future
tax consequences that have been recognized in its financial statements or tax
returns. The measurement of tax assets and liabilities is based on the
provisions of enacted tax laws.
F-44
<PAGE>
WESTERN HOLDINGS BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999 AND 1998
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
FEDERAL HOME LOAN BANK SYSTEM
As a member of the Federal Home Loan Bank of San Francisco (the FHLB), the
Company is required to maintain an investment in the capital stock of the FHLB.
The investment is carried at cost.
STOCK-BASED COMPENSATION
The Company uses the intrinsic-value method to account for its stock option
plans (in accordance with the provisions of Accounting Principles Board (APB)
Opinion No. 25). Under this method, compensation expense is recognized for
awards of options to purchase shares of common stock to employees under
compensatory plans only if the fair market value of the stock at the option
grant date (or other measurement date, if later) is greater than the amount the
employee must pay to acquire the stock. SFAS No. 123, ACCOUNTING FOR STOCK-BASED
COMPENSATION, permits companies to continue using the intrinsic-value method or
to adopt a fair-value-based method to account for stock option plans. The
fair-value-based method results in recognizing as expense over the vesting
period the fair value of all stock-based awards on the date of grant. The
Company has elected to continue to use the intrinsic-value method, and the pro
forma disclosures required by SFAS No. 123 are included in Note 10.
COMPREHENSIVE INCOME
As of January 1, 1998, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 130, REPORTING COMPREHENSIVE INCOME. This statement
establishes standards for the reporting and display of comprehensive income and
its components in the financial statements. For the Company, comprehensive
income includes net income reported on the statements of income and changes in
the fair value of its available for sale investments reported as other
comprehensive income.
RECLASSIFICATIONS
Certain reclassifications were made in the prior year's financial statements
to conform to the current year's presentation.
F-45
<PAGE>
WESTERN HOLDINGS BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999 AND 1998
3. INVESTMENT SECURITIES:
The amortized cost and estimated fair values of investment securities were
as follows at December 31, 1999:
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED ESTIMATED FAIR
AMORTIZED COST GAINS LOSSES VALUE
-------------- ---------- ----------- --------------
<S> <C> <C> <C> <C>
Held to maturity:
U.S. treasury and agency securities...... $ -- $-- $ -- $ --
FHLMC mortgage-backed securities......... 4,365,046 -- (220,592) 4,144,454
GNMA mortgage-backed securities.......... 2,394,746 -- (130,030) 2,264,716
CMOs..................................... 2,403,350 -- (163,222) 2,240,128
----------- --- ----------- -----------
$ 9,163,142 $-- $ (513,844) $ 8,649,298
=========== === =========== ===========
Available for sale:
U.S. treasury and agency securities...... $22,991,260 $36 $(1,026,721) $21,964,575
FHLMC mortgage-backed securities......... 1,622,525 -- (89,178) 1,533,347
GNMA mortgage-backed securities.......... 8,970,614 -- (504,362) 8,466,252
Municipal and corporate securities....... 3,716,185 -- (214,466) 3,501,719
----------- --- ----------- -----------
$37,300,584 $36 $(1,834,727) $35,465,893
=========== === =========== ===========
</TABLE>
The amortized cost and estimated fair values of investment securities were
as follows at December 31, 1998:
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
Held to maturity:
U.S. treasury and agency securities......... $ 1,504,361 $ 7,827 $ -- $ 1,512,188
FHLMC mortgage-backed securities............ 5,039,851 2,483 (8,341) 5,033,993
GNMA mortgage-backed securities............. 2,576,474 22,680 -- 2,599,154
CMOs........................................ 2,886,603 16,764 (2,416) 2,900,951
----------- ------- --------- -----------
$12,007,289 $49,754 $ (10,757) $12,046,286
=========== ======= ========= ===========
Available for sale:
U.S. treasury and agency securities......... $29,654,176 $58,450 $(175,731) $29,536,895
FHLMC mortgage-backed securities............ 1,864,894 1,386 (12,011) 1,854,269
GNMA mortgage-backed securities............. 4,993,743 -- (68,830) 4,924,913
Municipal and corporate securities.......... -- -- -- --
----------- ------- --------- -----------
$36,512,813 $59,836 $(256,572) $36,316,077
=========== ======= ========= ===========
</TABLE>
Investment securities with book values totaling $2,443,872 and $1,935,544
were pledged as collateral to secure borrowings and public deposits at
December 31, 1999 and 1998, respectively.
At December 31, 1999 and 1998, the Company had borrowings from the FHLB in
the amounts of $5,000,000 and $22,000,000, respectively (see Note 7 for
details). The amounts advanced by the FHLB
F-46
<PAGE>
WESTERN HOLDINGS BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999 AND 1998
3. INVESTMENT SECURITIES: (CONTINUED)
are under a line of credit collateralized by investment securities with book
values of $29,253,554 at December 31, 1999, and $22,956,807 at December 31,
1998.
During 1999 and 1998, there were sales of investment securities available
for sale that had amortized costs of $4,001,329 and $500,000, respectively. A
net loss of $38,392 and a net gain of $7,029 were recognized on the sale of
these securities in 1999 and 1998, respectively, and reported in other income.
Maturities of investments in debt securities at December 31, 1999, are shown
below:
<TABLE>
<CAPTION>
AMORTIZED
COST FAIR VALUE
----------- -----------
<S> <C> <C>
Held to maturity:
Due in less than one year........................ $ -- $ --
Due after one year through five years............ -- --
Due after five years through ten years........... -- --
Due after ten years.............................. 9,163,142 8,649,298
----------- -----------
$ 9,163,142 $ 8,649,298
=========== ===========
Available for sale:
Due in less than one year........................ $ 1,226,679 $ 1,216,314
Due after one year through five years............ 21,491,206 20,514,960
Due after five years through ten years........... 3,472,939 3,297,549
Due after ten years.............................. 11,109,760 10,437,070
----------- -----------
$37,300,584 $35,465,893
=========== ===========
</TABLE>
4. LOANS AND THE ALLOWANCE FOR LOAN LOSSES:
Loans consisted of the following at December 31, 1999 and 1998:
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
Loans:
Construction.............................................. $ 28,715,779 $ 36,832,482
Real estate............................................... 69,820,054 43,653,597
Commercial................................................ 23,182,784 16,020,287
Installment............................................... 4,698,085 3,707,005
SBA....................................................... 3,186,663 1,585,987
Other..................................................... -- 13,759
Deferred loan origination fees, net....................... (218,748) (189,043)
------------ ------------
129,384,617 101,624,074
------------ ------------
Allowance for loan losses................................... (1,507,866) (1,244,323)
------------ ------------
Loans, net............................................ $127,876,751 $100,379,751
============ ============
</TABLE>
F-47
<PAGE>
WESTERN HOLDINGS BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999 AND 1998
4. LOANS AND THE ALLOWANCE FOR LOAN LOSSES: (CONTINUED)
The Company's lending activities are concentrated primarily in the
California counties of Santa Clara and San Mateo. There were no significant
industry or borrower group concentrations at December 31, 1999 or 1998.
A summary of activity in the allowance for loan losses is as follows:
<TABLE>
<CAPTION>
1999 1998
---------- ----------
<S> <C> <C>
Balance, beginning of the year....................... $1,244,323 $ 985,073
Provision.......................................... 287,000 229,833
Charge-offs........................................ (26,434) (6,012)
Recoveries......................................... 2,977 35,429
---------- ----------
Balance, end of the year............................. $1,507,866 $1,244,323
========== ==========
</TABLE>
As of December 31, 1999 and 1998, loans on nonaccrual status totaled $6,183
and $66,607, respectively. Interest income foregone on such loans for the years
ended December 31, 1999 and 1998, was not significant.
At December 31, 1999 and 1998, the recorded investment in loans for which
impairment has been recognized in accordance with SFAS No. 114, ACCOUNTING BY
CREDITORS FOR IMPAIRMENT OF A LOAN, totaled $6,183 and $66,607, respectively.
The average recorded investment in impaired loans in 1999 and 1998, was $41,600
and $63,721, respectively. Interest income recognized on impaired loans in 1999
and 1998, was $34,606 and $0, respectively.
The Company, through its subsidiary Bank, serviced loans and loan
participations for others totaling $10,409,657 and $3,764,141 as of
December 31, 1999 and 1998, respectively.
5. PREMISES AND EQUIPMENT:
Premises and equipment consisted of the following at December 31, 1999 and
1998:
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Building and leasehold improvements................ $ 2,030,393 $ 2,057,585
Furniture and equipment............................ 2,472,956 2,351,218
Land............................................... 265,000 265,000
----------- -----------
4,768,349 4,673,803
Less: Accumulated depreciation and amortization.... (1,500,731) (1,209,389)
----------- -----------
$ 3,267,618 $ 3,464,414
=========== ===========
</TABLE>
Depreciation and amortization expense for the years ended December 31, 1999
and 1998, was $572,075 and $392,679, respectively.
F-48
<PAGE>
WESTERN HOLDINGS BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999 AND 1998
6. DEPOSITS:
Deposits consisted of the following at December 31, 1999 and 1998:
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
Deposits:
Noninterest-bearing............................ $ 41,847,131 $ 31,044,698
Interest-bearing:
Money market................................. 46,894,008 45,101,842
Savings...................................... 43,059,743 30,097,998
Certificates of deposit issued in amounts
less than $100,000......................... 21,327,256 17,936,547
Certificates of deposit issued in amounts of
$100,000 or more........................... 29,751,734 16,776,454
------------ ------------
$182,879,872 $140,957,539
============ ============
</TABLE>
Certificates of deposit have remaining maturities at December 31, 1999, as
follows:
<TABLE>
<S> <C>
Three months or less........................................ $26,502,407
Three through six months.................................... 9,432,392
Six through twelve months................................... 11,176,529
Over twelve months.......................................... 3,967,662
-----------
Total certificates of deposit....................... $51,078,990
===========
</TABLE>
7. FHLB BORROWINGS:
The Company maintains a collateralized line of credit with the Federal Home
Loan Bank (the FHLB) of San Francisco. Under this line, the Company can borrow
from the FHLB on a short-term (typically overnight) or long-term (over one year)
basis. Borrowings from the FHLB are as follows:
<TABLE>
<CAPTION>
DECEMBER 31
------------------------
1999 1998
---------- -----------
<S> <C> <C>
Long-term borrowings:
FHLB loan, fixed rate of 5.84%, payable on
June 4, 2001.................................... $2,000,000 $ --
FHLB loan, fixed rate of 6.29%, payable on
June 3, 2004.................................... 3,000,000 --
---------- -----------
Total long-term borrowings...................... 5,000,000 --
Short-term borrowings............................. -- 22,000,000
---------- -----------
Total FHLB borrowings........................... $5,000,000 $22,000,000
========== ===========
</TABLE>
Based on FHLB stock requirements at December 31, 1999, this line provided
for maximum borrowings of $39,427,400, of which the $5,000,000 noted above was
outstanding, leaving $34,427,400 available.
F-49
<PAGE>
WESTERN HOLDINGS BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999 AND 1998
8. INCOME TAXES:
The components of the provision (benefit) for federal and state income taxes
at December 31, 1999 and 1998, are as follows:
<TABLE>
<CAPTION>
1999 1998
---------- ----------
<S> <C> <C>
Current tax provision:
Federal................................................... $ 809,000 $ 861,000
State..................................................... 247,103 141,178
---------- ----------
Total current........................................... 1,056,103 1,002,178
---------- ----------
Deferred tax provision:
Federal................................................... (161,000) (170,000)
State..................................................... 62,000 11,000
Utilization of net operating loss carryforwards........... 99,000 99,000
---------- ----------
Total deferred........................................ -- (60,000)
---------- ----------
Total income taxes.................................... $1,056,103 $ 942,178
========== ==========
</TABLE>
Reconciliations of the statutory tax rates to the effective tax rates at
December 31, 1999 and 1998, are as follows:
<TABLE>
<CAPTION>
1999 1998
-------- --------
<S> <C> <C>
Statutory federal tax rate.................................. 34.0% 34.0%
State tax, net of federal income tax effect................. 7.2 7.2
Reduction in deferred tax asset valuation allowance and
other, net................................................ (2.1) (0.2)
---- ----
39.1% 41.0%
==== ====
</TABLE>
Deferred income taxes reflect the estimated future tax effect of temporary
differences between assets and liabilities for financial reporting purposes and
such amounts as measured by tax laws and regulations. The components of deferred
income tax assets and liabilities at December 31, 1999 and 1998, are as follows:
<TABLE>
<CAPTION>
1999 1998
---------- ----------
<S> <C> <C>
Other....................................................... $ (30,000) $ (72,000)
---------- ----------
Total deferred tax liabilities.......................... (30,000) (72,000)
---------- ----------
Allowance for loan losses................................... 138,000 243,000
State tax, net of federal income tax effect................. 160,000 147,000
Net operating loss carryforward............................. 788,000 890,000
Other....................................................... 195,000 43,000
---------- ----------
Total deferred tax assets............................... 1,281,000 1,323,000
---------- ----------
Net deferred tax asset.................................. $1,251,000 $1,251,000
========== ==========
</TABLE>
F-50
<PAGE>
WESTERN HOLDINGS BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999 AND 1998
8. INCOME TAXES: (CONTINUED)
The Company will file its federal tax return on a consolidated basis. As of
December 31, 1999, the Company has federal net operating loss carryforwards
available to reduce future taxable income of approximately $2,300,000. These net
operating loss carryforwards expire in 2007. In 1995, 100% of the Bank's issued
and outstanding stock was purchased by an investor group, which resulted in an
ownership change as defined in Internal Revenue Code Section 382. Accordingly,
the utilization of the net operating loss will be subject to the limitations
prescribed in Section 382.
9. RETIREMENT PLANS:
The Bank has a 401(k) Retirement Savings Plan. Under the plan, employees are
eligible for participation immediately upon hire. Each eligible employee may
make a voluntary election to have a portion of his or her salary contributed to
the plan in lieu of receiving it currently. The Bank makes a matching
contribution to each such employee's account in the plan at rates established
annually by the Board of Directors. The Bank's matching contributions amounted
to approximately $59,470 in 1999 and $43,904 in 1998.
During 1998, the Bank implemented a Salary Continuation Plan (SCP) for
select officers of the Bank. The plans are nonqualified. Select officers
designated by the Board of Directors of the Bank are covered by these plans. At
December 31, 1999, the Bank recorded an accrued liability of $115,249 for the
SCP. The plans are unfunded; however, the Bank has purchased insurance on the
lives of the participants and intends to use the cash values of these policies
($2,946,423 at December 31, 1999) to pay the retirement obligations. The value
of these policies increased by $136,423 for the year ended December 31, 1999.
10. STOCK OPTION PLAN:
In connection with the exchange of the Bank's common shares for the
Company's common shares in December 1997, as described in Note 1, the Company
adopted the Bank's fixed stock option plan (the Plan). Under the Plan, the
Company may grant options to its employees and nonemployee directors for up to
726,000 shares of common stock. Under the Plan, the exercise price of each
option is fixed by the Board of Directors, but shall be at least 100% of the
fair market value of the Company's common stock on the date of the grant, and an
option's maximum term is ten years. Options to directors vest at either the time
of grant or over four years from the date of grant, and options to employees
vest over four years from the date of grant.
In accordance with SFAS No. 123, ACCOUNTING FOR STOCK BASED COMPENSATION,
the fair value of each option grant has been estimated on the date of the grant
using the minimum-value method. Minimum value is determined by a discounted
present value calculation, taking the fair market value of the stock at the
grant date and reducing it by the present value of the exercise price. The
following assumptions were used in the estimation of the fair value of the
options granted in 1999 and 1998, respectively: risk-free rate of 6.75% and
6.00%; expected dividend yield of 0 % and 0%; expected lives of 7 years and 10
years; and volatility of 0% and 0%.
F-51
<PAGE>
WESTERN HOLDINGS BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999 AND 1998
10. STOCK OPTION PLAN: (CONTINUED)
As permitted by SFAS No. 123, the Company has chosen to apply APB Opinion
No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related interpretations in
accounting for its Plan. Accordingly, no compensation cost has been recognized
for options granted under the Plan. Had compensation cost for the Company's Plan
been determined based on the fair value at the grant dates for awards under the
Plan consistent with the method of SFAS No. 123, the Company's net income would
have been reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1999 1998
------------------------ ------------------------
AS REPORTED PRO FORMA AS REPORTED PRO FORMA
----------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Net income.................... $1,642,858 $1,597,858 $1,355,816 $1,309,816
</TABLE>
A summary of the status of the Plan as of December 31, 1999 and 1998, and
changes during the years ending on those dates is presented below:
<TABLE>
<CAPTION>
1999 1998
--------------------------- ----------------------------
WEIGHTED-AVERAGE WEIGHTED-AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE
-------- ---------------- --------- ----------------
<S> <C> <C> <C> <C>
Outstanding at beginning of year.......... 292,076 $ 2.50 586,850 $1.94
Granted................................. 68,700 10.88 22,000 9.32
Exercised............................... (17,638) 2.18 (314,354) 1.75
Forfeited............................... (9,982) 5.37 (2,420) 5.37
-------- ---------
Outstanding at end of year................ 333,156 $ 4.32 292,076 $2.50
======== =========
Options exercisable at year-end........... 235,257 164,808
======== =========
Weighted-average fair value of options
granted during the year................. $ 3.99 $ 4.42
======== =========
</TABLE>
The following table summarizes information about the Plan's stock options at
December 31, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------- ------------------------------
NUMBER WEIGHTED-AVERAGE NUMBER
EXERCISE OUTSTANDING REMAINING WEIGHTED-AVERAGE EXERCISABLE WEIGHTED-AVERAGE
PRICES AT 12/31/99 CONTRACTUAL LIFE EXERCISE PRICE AT 12/31/99 EXERCISE PRICE
-------- ----------- ---------------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
$ 1.74 195,570 5.6 years $ 1.74 195,570 $ 1.74
$ 2.27 16,940 6.5 years $ 2.27 12,707 $ 2.27
$ 3.22 23,896 7.0 years $ 3.22 17,546 $ 3.22
$ 5.37 6,050 7.9 years $ 5.37 3,934 $ 5.37
$ 9.09 16,500 8.5 years $ 9.09 4,125 $ 9.09
$10.00 13,700 9.3 years $10.00 1,375 $10.00
$11.00 60,500 9.6 years $11.00 -- --
------- -------
333,156 6.8 years $ 4.32 235,257 $ 2.12
======= =======
</TABLE>
F-52
<PAGE>
WESTERN HOLDINGS BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999 AND 1998
11. DIVIDEND RESTRICTIONS:
The Bank is regulated by the Federal Deposit Insurance Corporation (FDIC)
and the State of California Department of Financial Institutions. California
banking laws limit the Bank's ability to pay dividends to the Company of the
lesser of (1) retained earnings or (2) net income for the last three fiscal
years, less cash distributions paid during such period. Under this regulation,
at December 31, 1999, the Bank may pay dividends of $4,132,119.
12. RELATED-PARTY TRANSACTIONS:
At December 31, 1999 and 1998, certain officers and directors were indebted
to the Bank in the aggregate amount of $556,157 and $374,730, respectively. At
December 31, 1999, the Bank had $443,715 of commitments to extend credit to
these related parties. In the opinion of management, all such loans were made in
the ordinary course of business.
13. EARNINGS PER SHARE:
Basic earnings per share are computed by dividing net income, less dividends
on preferred stock, by the weighted average common shares outstanding. Diluted
earnings per share are computed by dividing net income, less dividends on
preferred stock, by the weighted average common shares outstanding, including
the dilutive effects of potential common shares (e.g., stock options). The
Company's basic and diluted earnings per share are as follows (in thousands,
except per share data):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1999
---------------------------------------
WEIGHTED PER-SHARE
INCOME AVERAGE SHARES AMOUNT
---------- -------------- ---------
<S> <C> <C> <C>
Basic earnings per share: net income available to common
shareholders............................................ $1,642,858 2,723,143 $0.60
Common stock options outstanding.......................... -- 177,929
---------- ---------
Diluted earnings per share: net income available to common
shareholders............................................ $1,642,858 2,901,072 $0.57
========== =========
<CAPTION>
YEAR ENDED DECEMBER 31, 1998
---------------------------------------
WEIGHTED PER-SHARE
INCOME AVERAGE SHARES AMOUNT
---------- -------------- ---------
<S> <C> <C> <C>
Basic earnings per share: net income available to common
shareholders............................................ $1,355,816 2,628,833 $0.52
Common stock options outstanding.......................... -- 195,398
---------- ---------
Diluted earnings per share: net income available to common
shareholders............................................ $1,355,816 2,824,231 $0.47
========== =========
</TABLE>
F-53
<PAGE>
WESTERN HOLDINGS BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999 AND 1998
14. COMMITMENTS AND CONTINGENCIES:
LEASE COMMITMENTS
The Company's subsidiary Bank leases branch facilities under operating
leases with original terms of five to ten years. The leases include provisions
for annual adjustments based on the Consumer Price Index. The future minimum
noncancelable rental payments under these leases as of December 31, 1999, are as
follows:
<TABLE>
<S> <C>
2000........................................................ $ 489,231
2001........................................................ 503,556
2002........................................................ 518,334
2003........................................................ 533,580
2004........................................................ 549,311
Beyond...................................................... 1,411,626
----------
$4,005,638
==========
</TABLE>
Total rental expense for the years ended December 31, 1999 and 1998, was
$505,803 and $380,699, respectively.
CLAIMS
In 1992 and for a period prior thereto, a former officer and director of the
Bank served as a director of Pacific National Financial Company (PNFC), a
Canadian corporation, when a PNFC subsidiary was the Bank's parent company. In
December 1998, the Bank received a request for indemnity from the former officer
under an indemnity agreement entered into by the Bank in December 1992. The
request for indemnity relates to three complaints naming the former officer and
seven other former directors of PNFC and seeks damages of $166 million
($Canadian 240 million) arising from their role as PNFC directors. The largest
of the three actions alleges that the defendants breached their fiduciary duties
to PNFC, resulting in its 1992 bankruptcy. The former officer has requested that
the Bank pay for his defense and indemnify him in connection with such actions.
Although the Bank has reserved its rights under the indemnity agreement, it has
conditionally agreed to be responsible for payment of the former officer's
defense costs. The Bank is not aware of any material activity in any of these
actions since they were served. Based on the representations of the former
officer and discussions with legal counsel, management and the Board of
Directors have no reason to believe that the indemnification will result in any
material adverse impact on the Bank, but cannot presently state the likelihood
of a favorable or unfavorable outcome or estimate any ultimate loss or costs for
which it could be responsible.
15. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK:
The Company is a party to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of its customers.
To date, these financial instruments are limited to commitments to extend credit
that involve elements of credit risk in excess of the amount recognized in the
statement of financial position.
F-54
<PAGE>
WESTERN HOLDINGS BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999 AND 1998
15. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK: (CONTINUED)
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each customer's
creditworthiness on a case-by-case basis. The Company generally requires
collateral or other security to support commitments to extend credit.
Standby letters of credit represent an obligation on the part of the Company
to a designated third party (the beneficiary) contingent upon the failure of the
Company's customer to perform under the terms of the underlying contract with
the beneficiary.
The following table summarizes these financial instruments at December 31,
1999 and 1998:
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Commitments to extend credit....................... $65,617,350 $55,703,202
Standby letters of credit.......................... 1,618,327 1,864,002
----------- -----------
$67,235,677 $57,567,204
=========== ===========
</TABLE>
16. REGULATORY CAPITAL REQUIREMENTS:
The Company and its subsidiary, the Bank, are subject to various regulatory
capital requirements as established by the applicable federal agencies. Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, the Company and subsidiary Bank must meet specific capital guidelines
that involve quantitative measures of the subsidiary Bank's assets, liabilities
and certain off-balance-sheet items. The quantitative measures for capital
adequacy require the Company and subsidiary Bank to maintain minimum amounts and
ratios of total and Tier 1 (core) capital to risk-weighted assets and of Tier 1
capital to average assets (leverage). The Company's and subsidiary Bank's
capital components, classification, risk weightings and other factors are also
subject to qualitative judgments by regulators. Failure to meet minimum capital
requirements can initiate certain actions by regulators that, if undertaken,
could have a material effect on the Company's financial statements. Management
believes that as of December 31, 1999, the Company and subsidiary Bank meet all
minimum capital adequacy requirements to which they are subject. The most recent
notification from the Federal Deposit Insurance Corporation categorized the Bank
as adequately capitalized under the regulatory framework for prompt corrective
action, as the Bank's total risk-based capital ratio was below 10%.
Subsequently, and at December 31, 1999, the Bank's capital ratios increased and
were considered well capitalized.
F-55
<PAGE>
WESTERN HOLDINGS BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999 AND 1998
16. REGULATORY CAPITAL REQUIREMENTS: (CONTINUED)
The following table presents selected capital information for the Company
and subsidiary Bank as of December 31, 1999 and 1998:
<TABLE>
<CAPTION>
TO BE WELL-
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSE ACTION PROVISIONS
------------------------- ------------------------- -------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
-------------- -------- -------------- -------- -------------- --------
(IN THOUSANDS) (IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1999:
Total risk-based capital:
Consolidated............. $14,588 10.5% $10,967 8.0% $13,707 10.0%
Bank..................... 13,852 10.0 10,960 8.0 13,700 10.0
Tier 1 risk-based capital:
Consolidated............. 13,080 9.5 5,512 4.0 8,284 6.0
Bank..................... 12,344 8.9 5,513 4.0 8,274 6.0
Tier 1 (leverage) capital:
Consolidated............. 13,080 6.6 7,767 4.0 9,780 5.0
Bank..................... 12,344 6.1 7,988 4.0 10,089 5.0
As of December 31, 1998:
Total risk-based capital:
Consolidated............. 12,446 10.9 9,146 8.0 11,426 10.0
Bank..................... 11,581 10.1 9,141 8.0 11,431 10.0
Tier 1 risk-based capital:
Consolidated............. 11,201 9.8 4,571 4.0 6,851 6.0
Bank..................... 10,337 9.1 4,572 4.0 6,857 6.0
Tier 1 (leverage) capital:
Consolidated............. 11,201 6.7 6,471 4.0 8,161 5.0
Bank..................... 10,337 6.2 6,557 4.0 8,277 5.0
</TABLE>
17. FAIR VALUES OF FINANCIAL INSTRUMENTS:
According to SFAS No. 107, DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL
INSTRUMENTS, fair value estimates are determined as of a specific date in time
utilizing quoted market prices, where available, or various assumptions and
estimates. Additionally, the Company has not disclosed highly subjective values
of other nonfinancial instruments. Accordingly, the aggregate fair value amounts
presented do not represent and should not be construed to represent the full
underlying value of the Company.
The methods and assumptions used to estimate the fair values of each class
of financial instruments that were not cash and cash equivalents or investments
utilizing quoted market prices are as follows:
LOANS RECEIVABLE
In order to determine the fair values for loans, the loan portfolio was
segmented based on loan type, credit quality, and repricing characteristics. For
certain variable rate loans with no significant
F-56
<PAGE>
WESTERN HOLDINGS BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999 AND 1998
17. FAIR VALUES OF FINANCIAL INSTRUMENTS: (CONTINUED)
credit concerns and frequent repricings, estimated fair values are generally
based on the carrying values. The fair values of other loans are generally
estimated using discounted cash flow analyses. The discount rates used in these
analyses are generally based on origination rates for similar loans of
comparable credit quality. The allowance for loan losses is a reasonable
estimate of the valuation allowance needed to adjust computed fair values for
credit quality of certain loans in the portfolio.
SECURITIES
For all securities, fair values are based on quoted market prices or dealer
quotes. See Note 3 for further details.
DEPOSITS AND FHLB BORROWINGS
The fair values for deposits subject to immediate withdrawal, such as
interest and noninterest-bearing demand and savings accounts, are equal to the
amount payable on demand at the reporting date (i.e., their carrying amount on
the balance sheets). Fair values for fixed-rate certificates of deposits are
estimated by discounting future cash flows using interest rates currently
offered on time deposits with similar remaining maturities.
ACCRUED INTEREST PAYABLE AND RECEIVABLE
The fair values for accrued interest receivable and payable approximate
their carrying amount due to the short-term nature of these instruments.
The estimated fair value of the Company's financial assets is as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1999
---------------------------
CARRYING FAIR
AMOUNT VALUE
------------ ------------
<S> <C> <C>
Financial assets:
Cash and cash equivalents...................... $ 17,075,025 $ 17,075,025
Investment securities.......................... 44,629,035 44,115,191
Federal Home Loan Bank stock, at cost.......... 1,316,200 1,316,200
Loans receivable, net.......................... 127,876,751 130,645,000
Accrued interest receivable.................... 1,038,074 1,038,074
Financial liabilities:
Time deposits.................................. 51,078,990 50,487,000
Other deposits................................. 131,800,882 131,800,882
Accrued interest payable....................... 702,082 702,082
Long-term FHLB borrowings...................... 5,000,000 4,927,000
</TABLE>
F-57
<PAGE>
WESTERN HOLDINGS BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999 AND 1998
17. FAIR VALUES OF FINANCIAL INSTRUMENTS: (CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31, 1998
---------------------------
CARRYING FAIR
AMOUNT VALUE
------------ ------------
<S> <C> <C>
Financial assets:
Cash and cash equivalents...................... $ 16,061,779 $ 16,061,779
Investment securities.......................... 48,323,366 48,362,363
Federal Home Loan Bank stock, at cost.......... 2,100,800 2,100,800
Loans receivable, net.......................... 100,379,751 101,231,130
Accrued interest receivable.................... 918,496 918,496
Financial liabilities:
Time deposits.................................. 34,713,001 34,630,174
Other deposits................................. 106,244,538 106,244,538
Accrued interest payable....................... 786,973 786,973
</TABLE>
18. COMPREHENSIVE INCOME:
The changes in the components of other comprehensive income for the years
ended December 31, 1999 and 1998, are reported as follows:
<TABLE>
<CAPTION>
1999 1998
----------- ---------
<S> <C> <C>
Unrealized losses arising during the period, net of taxes of
$(656,941) and $(87,703), respectively.................... $(1,021,927) $(126,207)
Less: Reclassification adjustment for net realized gains
(losses) on securities available for sale included in
net income during the year, net of taxes of $(13,624)
and $2,882, respectively................................ 21,194 (4,147)
----------- ---------
Net unrealized losses included in other comprehensive
income.................................................... $(1,000,733) $(130,354)
=========== =========
</TABLE>
F-58
<PAGE>
WESTERN HOLDINGS BANCORP
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
2000 1999
------------ -------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Cash and due from banks..................................... $ 12,078,000 $ 9,275,000
Federal funds sold.......................................... 21,645,000 7,800,000
------------ ------------
Total cash and cash equivalents......................... 33,723,000 17,075,000
Securities available-for-sale, at fair value................ 45,530,000 36,782,000
Securities held-to-maturity, at amortized cost (fair value
of $8,211,000 and $8,649,000, respectively)............... 8,751,000 9,163,000
Loans held for sale, at fair value.......................... -- --
Loans, net of deferred fees................................. 133,402,000 129,385,000
Allowance for probable loan losses.......................... (1,588,000) (1,508,000)
------------ ------------
Loans, net.............................................. 131,814,000 127,877,000
Premises and equipment, net................................. 3,165,000 3,268,000
Accrued interest receivable and other assets................ 3,524,000 3,344,000
Other investments........................................... 2,984,000 2,946,000
------------ ------------
TOTAL ASSETS............................................ $229,491,000 $200,455,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits
Demand, noninterest bearing............................... $ 44,144,000 $ 41,847,000
Demand, interest bearing.................................. 40,799,000 37,072,000
Savings and money market.................................. 68,909,000 52,882,000
Time deposits, under $100,000............................. 20,891,000 21,066,000
Time deposits, $100,000 and over.......................... 41,094,000 30,013,000
------------ ------------
Total deposits.......................................... 215,837,000 182,880,000
Other borrowed funds........................................ -- 5,000,000
Accrued interest payable and other liabilities.............. 1,290,000 562,000
------------ ------------
TOTAL LIABILITIES....................................... 217,127,000 188,442,000
SHAREHOLDERS' EQUITY
Preferred Stock............................................. -- --
Common Stock, no par value; 10,000,000 shares authorized;
Shares issued and outstanding: 2,732,752 at March 31, 2000
and 2,727,819 at December 31, 1999........................ 10,326,000 10,315,000
Accumulated other comprehensive loss, net of taxes.......... (1,256,000) (1,117,000)
Retained earnings........................................... 3,424,000 2,945,000
Less: treasury stock........................................ (130,000) (130,000)
------------ ------------
TOTAL SHAREHOLDERS' EQUITY.............................. 12,364,000 12,013,000
------------ ------------
TOTAL LIABILITIES & SHAREHOLDERS' EQUITY................ $229,491,000 $200,455,000
============ ============
</TABLE>
F-59
<PAGE>
WESTERN HOLDINGS BANCORP
CONDENSED CONSOLIDATED INCOME STATEMENTS (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-----------------------
2000 1999
---------- ----------
<S> <C> <C>
INTEREST INCOME:
Loans, including fees....................................... $3,110,000 $2,379,000
Securities, taxable......................................... 693,000 737,000
Securities, non-taxable..................................... 31,000 2,000
Federal funds sold.......................................... 276,000 90,000
---------- ----------
Total interest income................................... 4,110,000 3,208,000
---------- ----------
INTEREST EXPENSE:
Deposits.................................................... 1,386,000 923,000
Other....................................................... 40,000 243,000
---------- ----------
Total interest expense.................................. 1,426,000 1,166,000
---------- ----------
Net interest income before provision for probable loan
losses.................................................... 2,684,000 2,042,000
Provision for probable loan losses.......................... 80,000 80,000
---------- ----------
Net interest income after provision for probable loan
losses.................................................... 2,604,000 1,962,000
Noninterest income:
Other investments......................................... 40,000 36,000
Service charges and other fees............................ 190,000 159,000
Gain on sale of loans..................................... -- 67,000
Servicing income.......................................... -- --
Gain on sale of securities available-for-sale............. -- 3,000
Other income.............................................. 9,000 20,000
---------- ----------
Total noninterest income................................ 239,000 285,000
Noninterest expenses:
Salaries and employee benefits............................ 1,227,000 1,074,000
Client services........................................... 313,000 229,000
Occupancy................................................. 201,000 227,000
Loan origination costs.................................... (79,000) (92,000)
Furniture and equipment................................... 128,000 111,000
Professional fees......................................... 121,000 91,000
Advertising fees.......................................... 90,000 60,000
Stationery & supplies..................................... 33,000 38,000
Telephone expense......................................... 23,000 21,000
---------- ----------
Total noninterest expense............................... 2,057,000 1,759,000
Net income before income taxes.............................. 786,000 488,000
Provision for income taxes.................................. 307,000 191,000
---------- ----------
Net income.................................................. $ 479,000 $ 297,000
========== ==========
Earnings per share:
Basic..................................................... $ 0.18 $ 0.11
========== ==========
Diluted................................................... $ 0.17 $ 0.10
========== ==========
</TABLE>
F-60
<PAGE>
WESTERN HOLDINGS BANCORP
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
------------------------------
2000 1999
-------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net income.................................................. $ 479,000 297,000
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization............................... 143,000 135,000
Provision for probable loan losses.......................... 80,000 80,000
Gain on sale of securities available-for-sale............... -- (3,000)
Net amortization of premiums/accretion of discounts......... 1,000 6,000
Increase in cash surrender value of life insurance.......... (38,000) (31,000)
Effect of changes in:
Accrued interest receivable and other assets.............. (180,000) 113,000
Accrued interest payable and other liabilities............ 728,000 (360,000)
------------ -----------
Net cash provided by operating activities................... 1,213,000 237,000
Cash flows from investing activities:
Net increase in loans....................................... (4,017,000) (7,120,000)
Purchases of securities available-for-sale.................. (9,688,000) (6,766,000)
Maturities of securities available-for-sale................. 176,000 5,585,000
Proceeds from maturities or calls of securities
held-to-maturity.......................................... 410,000 882,000
Purchases of corporate owned life insurance................. -- (340,000)
Redemption (purchase) of Other Investments (FHLB stock)..... 626,000 (24,000)
Purchases of property and equipment......................... (40,000) (227,000)
------------ -----------
Net cash used in investing activities....................... (12,533,000) (8,010,000)
Cash flows from financing activities:
Net increase in deposits.................................... 32,957,000 10,688,000
Paydown of other borrowed funds............................. (5,000,000) (2,500,000)
Proceeds from exercise of stock options..................... 11,000 10,000
------------ -----------
Net cash provided by financing activities................... 27,968,000 8,198,000
Net increase in cash and cash equivalents................... 16,648,000 425,000
Cash and cash equivalents, beginning of period.............. 17,075,000 16,062,000
------------ -----------
Cash and cash equivalents, end of period.................... $ 33,723,000 $16,487,000
============ ===========
Supplemental disclosures of cash paid during the period for:
Interest.................................................. $ 1,122,000 $ 994,000
Income taxes.............................................. 7,000 225,000
</TABLE>
F-61
<PAGE>
WESTERN HOLDINGS BANCORP
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2000
(UNAUDITED)
1) BASIS OF PRESENTATION
The unaudited condensed consolidated financial statements of Western
Holdings Bancorp and its wholly owned subsidiary, Bank of Los Altos, have been
prepared in accordance with generally accepted accounting principles. The
interim statements should be read in conjunction with the financial statements
and notes thereto, as of December 31, 1999 and for the year then ended, audited
by Arthur Andersen LLP, independent public accountants, and included in this
document.
In the Company's opinion, all adjustments necessary for a fair presentation
of these condensed consolidated financial statements have been included and are
of a normal and recurring nature. Certain reclassifications have been made to
prior year amounts to conform to current year presentation.
The results for the three months ended March 31, 2000 are not necessarily
indicative of the results expected for any subsequent period or for the entire
year ending December 31, 2000.
2) EARNINGS PER SHARE
Basic earnings per share is computed by dividing net income by the weighted
average common shares outstanding. Diluted earnings per share reflects potential
dilution from outstanding stock options, using the treasury stock method. For
each of the periods presented, net income is the same for the basic and diluted
earnings per share. Reconciliation of weighted average shares used in computing
basic and diluted earnings per share is as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
---------------------
2000 1999
--------- ---------
<S> <C> <C>
Weighted average common shares outstanding--used in
computing basic EPS.................................. 2,732,752 2,713,789
Dilutive effect of stock options outstanding, using the
treasury stock method................................ 170,465 189,773
--------- ---------
Shares used in computing diluted earnings per share.... 2,903,217 2,903,562
========= =========
</TABLE>
3) COMPREHENSIVE INCOME
In 1998, the Company adopted SFAS No. 130 Reporting Comprehensive Income,
which requires that an enterprise report and display, by major components and as
a single total, the change in its net assets during the period from non-owner
sources.
F-62
<PAGE>
WESTERN HOLDINGS BANCORP
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2000
(UNAUDITED)
3) COMPREHENSIVE INCOME (CONTINUED)
The following is a summary of the components of other comprehensive income:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS
ENDED MARCH 31,
---------------------
2000 1999
--------- ---------
<S> <C> <C>
Net Income.............................................. $479,000 $297,000
-------- --------
Other comprehensive income, net of tax: net unrealized
holding gain (loss) on available-for-sale securities
during the period..................................... (139,000) (244,000)
Less: reclassification adjustment for realized gains on
available-for-sale securities included in net income
during the period..................................... -- --
-------- --------
Other comprehensive loss................................ (139,000) (244,000)
-------- --------
Comprehensive income.................................... $340,000 $ 53,000
======== ========
</TABLE>
4) RECLASSIFICATIONS
Certain amounts in the December 31, 1999 and March 31, 1999 financial
statements have been reclassified to conform to the March 31, 2000 financial
statement presentation.
F-63
<PAGE>
APPENDIX A
AGREEMENT AND PLAN OF MERGER
<PAGE>
<TABLE>
<C> <S> <C>
ARTICLE I THE MERGER AND RELATED MATTERS.............................. A-1
1.1 Merger; Surviving Corporations and Resulting Institution.... A-1
1.2 Effective Time of the Merger................................ A-1
1.3 The Merger.................................................. A-2
(a) Conversion of WHB Common Stock......................... A-2
(b) Adjustment to Exchange Ratio........................... A-2
(c) Reservation of Shares.................................. A-2
(d) Dissenting Shares...................................... A-2
(e) Exchange of WHB Common Stock........................... A-2
(f) No Fractional Shares................................... A-4
(g) Stock Options.......................................... A-4
(h) Articles of Incorporation and Bylaws of the Surviving
Corporation............................................ A-4
(i) Directors and Officers of the Surviving Corporation.... A-4
(j) Principal Office....................................... A-5
1.4 Closing..................................................... A-5
1.5 Reservation of Right to Revise Transaction.................. A-5
1.6 Additional Actions.......................................... A-5
ARTICLE II REPRESENTATIONS AND WARRANTIES OF HCC....................... A-5
2.1 Organization................................................ A-5
2.2 Authorization............................................... A-6
2.3 Conflicts................................................... A-6
2.4 Capitalization.............................................. A-6
2.5 HCC Financial Statements, Material Changes.................. A-7
2.6 HCC Subsidiaries............................................ A-7
2.7 HCC Filings................................................. A-8
2.8 HCC Reports................................................. A-8
2.9 Compliance with Laws........................................ A-8
2.10 Registration Statement; Joint Proxy Statement............... A-9
2.11 Litigation.................................................. A-9
2.12 Licenses.................................................... A-9
2.13 Taxes....................................................... A-9
2.14 Insurance................................................... A-10
2.15 Allowance for Loan Losses................................... A-10
2.16 Compliance With Environmental Laws.......................... A-11
2.17 Defaults.................................................... A-11
2.18 Indemnification............................................. A-12
2.19 Accuracy of Information..................................... A-12
2.20 Governmental Approvals and Other Conditions................. A-12
2.21 Fairness Opinion............................................ A-12
2.22 Year 2000 Compliant......................................... A-12
</TABLE>
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<PAGE>
<TABLE>
<C> <S> <C>
ARTICLE III REPRESENTATIONS AND WARRANTIES OF WHB....................... A-12
3.1 Organization................................................ A-12
3.2 Authorization............................................... A-13
3.3 Conflicts................................................... A-13
3.4 Capitalization and Stockholders............................. A-13
3.5 WHB Financial Statements; Material Changes.................. A-14
3.6 WHB Subsidiaries............................................ A-14
3.7 WHB Filings................................................. A-15
3.8 WHB Reports................................................. A-15
3.9 Compliance With Laws........................................ A-15
3.10 Registration Statement; Joint Proxy Statement............... A-16
3.11 Litigation.................................................. A-16
3.12 Licenses.................................................... A-17
3.13 Taxes....................................................... A-17
3.14 Insurance................................................... A-17
3.15 Loans; Investments.......................................... A-18
3.16 Allowance for Loan Losses................................... A-19
3.17 WHB Benefit Plans........................................... A-19
3.18 Compliance with Environmental Laws.......................... A-21
3.19 Contracts and Commitments................................... A-22
3.20 Defaults.................................................... A-24
3.21 Operations Since December 31, 1999.......................... A-24
3.22 Corporate Records........................................... A-26
3.23 Undisclosed Liabilities..................................... A-26
3.24 Assets...................................................... A-26
3.25 Indemnification............................................. A-26
3.26 Insider Interests........................................... A-27
3.27 Registration Obligations.................................... A-27
3.28 Regulatory, Tax and Accounting Matters...................... A-27
3.29 Brokers and Finders......................................... A-27
3.30 Accuracy of Information..................................... A-27
3.31 Fairness Opinion............................................ A-27
3.32 Governmental Approvals and Other Conditions................. A-27
3.33 Year 2000 Compliant......................................... A-27
ARTICLE IV COVENANTS................................................... A-28
4.1 Business in Ordinary Course................................. A-28
4.2 Conforming Accounting and Reserve Policies; Restructuring
Expenses.................................................. A-30
4.3 Certain Actions............................................. A-30
</TABLE>
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<PAGE>
<TABLE>
<C> <S> <C>
ARTICLE V ADDITIONAL AGREEMENTS....................................... A-31
5.1 Inspection of Records; Confidentiality...................... A-31
5.2 Registration Statement; Stockholder Approval................ A-32
5.3 Agreements of Affiliates.................................... A-32
5.4 Expenses.................................................... A-32
5.5 Cooperation................................................. A-33
5.6 Regulatory Applications..................................... A-33
5.7 Financial Statements and Reports............................ A-33
5.8 Notice...................................................... A-33
5.9 Press Release............................................... A-34
5.10 Delivery of Supplements to Disclosure Schedules............. A-34
5.11 Litigation Matters.......................................... A-34
5.12 Written Agreements with Employees; Benefits and Related
Matters................................................... A-34
(a) New Employee Agreements................................ A-34
(b) Employee Benefits...................................... A-34
5.13 Directors' and Officers' Indemnification Insurance.......... A-34
5.14 Best Efforts to Insure Pooling.............................. A-35
5.15 Trade Name Rights........................................... A-35
5.16 Environmental Reports....................................... A-35
5.17 Stock Option Agreements..................................... A-35
ARTICLE VI CONDITIONS.................................................. A-36
6.1 Conditions to the Obligations of HCC........................ A-36
6.2 Conditions to the Obligations of WHB........................ A-37
6.3 Conditions to the Obligations of the Parties................ A-37
ARTICLE VII TERMINATION; AMENDMENT; WAIVER.............................. A-38
7.1 Termination................................................. A-38
7.2 Liabilities and Remedies Liquidated Damages................. A-39
7.3 Survival of Agreements...................................... A-40
7.4 Amendment................................................... A-40
7.5 Waiver...................................................... A-40
ARTICLE VIII GENERAL PROVISIONS.......................................... A-41
8.1 Survival.................................................... A-41
8.2 Notices..................................................... A-41
8.3 Applicable Law.............................................. A-41
8.4 Headings, Etc............................................... A-41
8.5 Severability................................................ A-41
8.6 Entire Agreement; Binding Effect; Non-Assignment;
Counterparts.............................................. A-42
</TABLE>
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<PAGE>
AGREEMENT AND PLAN OF MERGER AND REORGANIZATION
THIS AGREEMENT AND PLAN OF MERGER AND REORGANIZATION (this "Agreement")
dated May 9, 2000, is by and among Heritage Commerce Corp, a California
corporation and a registered bank holding company under the Federal Bank Holding
Company Act ("HCC"), Western Holdings Bancorp, a California corporation, a
registered bank holding company under the Federal Bank Holding Company Act
("WHB"), and the owner of all of the outstanding shares of Bank of Los Altos, a
California banking corporation ("Bank of Los Altos").
A. HCC and WHB wish to provide for the terms and conditions of a business
combination in which WHB will be merged (the "Merger") with and into HCC.
B. For federal income tax purposes, it is intended that the Merger shall
qualify as a reorganization within the meaning of Section 368(a) of the Internal
Revenue Code of 1986, as amended ("Code"), and this Agreement shall constitute a
plan of reorganization pursuant to Section 368 of the Code.
C. For accounting purposes, it is intended that the Merger shall be
accounted for as a pooling of interests.
D. The parties hereto desire to make certain representations, warranties,
covenants and agreements in connection with the Merger and also to prescribe
various conditions to the Merger.
Accordingly, and in consideration of the representations, warranties,
covenants, agreements and conditions herein contained, the parties hereto agree
as follows:
ARTICLE I
THE MERGER AND RELATED MATTERS
1.1 MERGER; SURVIVING CORPORATIONS AND RESULTING INSTITUTION. Subject to
the terms and conditions of this Agreement, and pursuant to the provisions of
the California General Corporation Law ("CGCL") and the rules and regulations
promulgated by the Board of Governors of the Federal Reserve under the Federal
Reserve Act and the Bank Holding Company Act (collectively "Bank Regulations"),
at the Effective Time (as defined in Section 1.2 hereof), WHB shall be merged
with and into HCC pursuant to the terms and conditions set forth herein. Upon
the consummation of the Merger, the separate corporate existence of WHB shall
cease and HCC shall continue as the surviving corporation under the laws of the
State of California. The name of HCC as the surviving corporation of the Merger
shall remain "Heritage Commerce Corp." From and after the Effective Time, HCC,
as the surviving corporation of the Merger, shall possess all of the properties
and rights and be subject to all of the liabilities and obligations of HCC and
WHB, all as more fully described in the CGCL.
1.2 EFFECTIVE TIME OF THE MERGER. As soon as practicable after each of the
conditions set forth in Article VI hereof have been satisfied or waived, the
parties will file, or cause to be filed, with the California Secretary of State,
the Merger Agreement (the "Merger Agreement") in the form attached hereto as
Exhibit A, and such certificates and other documents as HCC may deem necessary
or appropriate for the Merger, which Merger Agreement and certificates and other
documents shall in each case be in the form required by and executed in
accordance with the applicable provisions of the CGCL. The Merger shall become
effective at the time the certificate of merger for such merger is filed with
the California Secretary of State ("Effective Time"). The parties shall use
their commercially reasonable efforts to cause the Effective Time to be not
later than 30 days following receipt of all required regulatory approvals. The
filing of the Merger Agreement shall take place on such date as HCC shall notify
WHB in writing.
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1.3 THE MERGER.
(a) CONVERSION OF WHB COMMON STOCK. At the Effective Time:
(i) Each share of common stock of WHB, no par value ("WHB Common
Stock"), issued and outstanding immediately prior thereto (except for
Dissenting Shares, if applicable, as defined in Section 1.3(d) hereof)
shall, by virtue of the Merger and without any action on the part of the
holder thereof, but subject to Sections 1.3(b) and(f) hereof, be converted
into the right to receive 3,760,000 divided by the sum of the total
outstanding shares of WHB plus all of WHB's outstanding stock options (the
"Exchange Ratio") of a share of common stock of HCC ("HCC Common Stock")
(the "Per Share Stock Consideration").
(ii) The holders of certificates formerly representing shares of WHB
Common Stock shall cease to have any rights as stockholders of WHB, except
such rights, if any, as they may have pursuant to the CGCL. Except as
provided above, until certificates representing shares of WHB Common Stock
are surrendered for exchange, the certificates of each holder shall, after
the Effective Time, represent for all purposes only the right to receive the
Per Share Stock Consideration and the right to receive the cash value of any
fraction of a share of HCC Common Stock as provided below (collectively, the
"Merger Consideration").
(iii) The Exchange Ratio may be adjusted by HCC pursuant to the
provisions of Section 7.1(g) hereof, in which case the Per Share Stock
Consideration shall be recalculated.
(b) ADJUSTMENT TO EXCHANGE RATIO. If, subsequent to the date of this
Agreement but prior to the Effective Time, the outstanding shares of HCC Common
Stock shall, through a reclassification, recapitalization, stock dividend, stock
split or reverse stock split have been increased, decreased, changed into or
exchanged for a different number or kind of shares or securities, appropriate
adjustment will be made to the Exchange Ratio.
(c) RESERVATION OF SHARES. Prior to the Effective Time, the Board of
Directors of HCC shall reserve for issuance a sufficient number of shares of HCC
Common Stock for the purpose of issuing its shares to the stockholders of WHB in
accordance herewith.
(d) DISSENTING SHARES. Any shares of WHB Common Stock held by a holder who
dissents from the Merger in accordance with Section 1300 of the CGCL shall be
herein called "Dissenting Shares." Notwithstanding any other provision of this
Agreement, any Dissenting Shares shall not, after the Effective Time, be
entitled to vote for any purpose or receive any dividends or other distributions
and shall be entitled only to such rights as are afforded in respect of
Dissenting Shares pursuant to the CGCL.
(e) EXCHANGE OF WHB COMMON STOCK.
(i) As soon as reasonably practicable after the Effective Time, holders
of record of certificates formerly representing shares of WHB Common Stock
("Certificates") shall be instructed to tender such Certificates to an
independent exchange agent to be selected by HCC (the "Exchange Agent")
pursuant to a letter of transmittal that HCC shall deliver or cause to be
delivered to such holders. Such letter of transmittal shall specify that
risk of loss and title to Certificates shall pass only upon acceptance of
such Certificates by HCC or the Exchange Agent.
(ii) After the Effective Time, each holder of a Certificate that
surrenders such Certificate to HCC or the Exchange Agent will, upon
acceptance thereof by HCC or the Exchange Agent, be entitled to the Merger
Consideration payable in respect of the shares represented thereby.
(iii) HCC or the Exchange Agent shall accept Certificates upon compliance
with such reasonable terms and conditions as HCC or the Exchange Agent may
impose to effect an orderly exchange thereof in accordance with customary
exchange practices. Certificates shall be
A-2
<PAGE>
appropriately endorsed or accompanied by such instruments of transfer as HCC
or the Exchange Agent may reasonably require.
(iv) Each outstanding Certificate, other than those representing
Dissenting Shares, shall until duly surrendered to HCC or the Exchange Agent
be deemed to evidence the right to receive the Merger Consideration.
(v) After the Effective Time, holders of Certificates shall cease to
have rights with respect to the WHB Common Stock previously represented by
such Certificates, and their sole rights (other than the holders of
Certificates representing Dissenting Shares) shall be to exchange such
Certificates for the Merger Consideration. At the Effective Time, WHB shall
deliver a certified copy of a list of its stockholders to HCC or the
Exchange Agent. After the Effective Time, there shall be no further transfer
on the records of WHB of Certificates, and if such Certificates are
presented to WHB for transfer, they shall be canceled against delivery of
the Merger Consideration. HCC shall not be obligated to deliver the Merger
Consideration to any holder of WHB Common Stock until such holder surrenders
the Certificates as provided herein. No dividends declared will be remitted,
nor any voting rights granted, to any person entitled to receive HCC Common
Stock under this Agreement until such person surrenders the Certificate
representing the right to receive such HCC Common Stock, at which time such
dividends on whole shares of HCC Common Stock with a record date on or after
the Effective Time shall be remitted to such person, without interest and
less any taxes that may have been imposed thereon, and voting rights will be
restored. Certificates surrendered for exchange by any person constituting
an "affiliate" of WHB for purposes of Rule 145 under the Securities Act of
1933 and the rules and regulations thereunder (the "Securities Act") or
pooling of interests accounting shall not be exchanged for certificates
representing HCC Common Stock until HCC has received a written agreement
from such person as specified in Section 5.3. Neither the Exchange Agent nor
any party to this Agreement nor any affiliate thereof shall be liable to any
holder of WHB Common Stock represented by any Certificate for any
consideration paid to a public official pursuant to applicable abandoned
property, escheat or similar laws. HCC and the Exchange Agent shall be
entitled to rely upon the stock transfer books of WHB to establish the
identity of those persons entitled to receive consideration specified in
this Agreement, which books shall be conclusive with respect thereto. In the
event of a dispute with respect to ownership of stock represented by any
Certificate, HCC or the Exchange Agent shall be entitled to deposit any
consideration in respect thereof in escrow with an independent third party
and thereafter be relieved with respect to any claims thereto.
(vi) If the Merger Consideration is to be issued to a person other than
a person in whose name a surrendered Certificate is registered, it shall be
a condition of issuance that the surrendered Certificate shall be properly
endorsed or otherwise in proper form for transfer and that the person
requesting such issuance shall pay to HCC or the Exchange Agent any required
transfer or other taxes or establish to the satisfaction of HCC or the
Exchange Agent that such tax has been paid or is not applicable.
(vii) In the event any Certificate shall have been lost, stolen or
destroyed, the owner of such lost, stolen or destroyed Certificate shall
deliver to HCC or the Exchange Agent an affidavit stating such fact, in form
satisfactory to HCC, and, at HCC's discretion, an indemnity agreement in
such form as HCC or the Exchange Agent may direct as indemnity against any
claim that may be made against HCC or WHB or its successor or any other
party with respect to the Certificate alleged to have been lost, stolen or
destroyed. Upon such delivery, the owner shall have the right to receive the
Merger Consideration with respect to the shares represented by the lost,
stolen or destroyed Certificate.
A-3
<PAGE>
(f) NO FRACTIONAL SHARES. Notwithstanding any other provision of this
Agreement, neither certificates nor scrip for fractional shares of HCC Common
Stock shall be issued in the Merger. Each holder who otherwise would have been
entitled to a fraction of a share of HCC Common Stock (after taking into account
all Certificates of such holder) shall receive in lieu thereof cash (without
interest) in an amount determined by multiplying the fractional share interest
to which such holder would otherwise be entitled by the average of the bid and
ask price quoted on NASDAQ National Market System for HCC common stock at the
close of the trading day immediately prior the Effective Time. No such holder
shall be entitled to dividends, voting rights or any other rights in respect of
any fractional share interest.
(g) STOCK OPTIONS. At the Effective Time, each option outstanding under
WHB's Stock Option Plan (the "WHB Stock Option Plan"), whether or not then
exercisable, shall continue outstanding as an option to purchase, in place of
WHB Common Stock, the number of shares (rounded down to the nearest whole share)
of HCC Common Stock that would have been received by the optionee in the Merger
had the option been exercised in full (without regard to any limitations
contained therein on exercise) for shares of WHB Common Stock immediately prior
to the Merger upon the same terms and conditions under the relevant option as
were applicable immediately prior to the Effective Time, except for appropriate
pro rata adjustments as to the relevant option price for shares of HCC Common
Stock substituted therefor so that the aggregate option exercise price of shares
subject to an option immediately following the assumption and substitution shall
be the same as the aggregate option exercise price for such shares immediately
prior to such assumption and substitution. HCC shall assume at the Effective
Time each such option and the WHB Stock Option Plan. It is intended that the
foregoing assumption shall be undertaken consistent with and in a manner that
will not constitute a "modification" under Section 424 of the Code as to any
stock option which is an "incentive stock option." HCC and WHB agree to take
such actions as shall be necessary to give effect to the foregoing. WHB shall
not authorize the payment of cash pursuant to the WHB Stock Option Plan. As of
the date of this Agreement there are duly issued and outstanding 335,798 options
to acquire WHB Common Stock under the WHB Stock Option Plan.
At all times after the Effective Time, HCC shall reserve for issuance such
number of shares of HCC Common Stock as are necessary so as to permit the
exercise of options granted under the WHB Option Plan in the manner contemplated
by this Agreement and the instruments pursuant to which such options were
granted. HCC shall make all filings required under federal and state securities
laws so as to permit the exercise of such options and the sale of the shares
received by the option holder upon such exercise.
(h) ARTICLES OF INCORPORATION AND BYLAWS OF THE SURVIVING CORPORATION. The
Articles of Incorporation and Bylaws of HCC, as in effect immediately prior to
the Effective Time, shall be the Articles of Incorporation and Bylaws of HCC, as
the surviving corporation of the Merger, until either is thereafter amended in
accordance with applicable law.
(i) DIRECTORS AND OFFICERS OF THE SURVIVING CORPORATION. The board of
directors of HCC following the Effective Time shall be set by the HCC board of
directors within its variable range at 15 directors, 11 of which shall have been
directors of HCC immediately prior to the Effective Time and 4 of which shall
have been directors of WHB immediately prior to the Effective Time. The board of
directors of HCC as comprised prior to the Effective Time shall select the
individuals who will comprise its 11 directors and the remaining HCC directors
shall resign from the HCC board of directors effective at the Effective Time.
The board of directors of WHB as comprised prior to the Effective Time shall
select the individuals who will comprise its 4 directors and, subject to
approval of the directors so selected by HCC, those individuals will be added to
HCC's board of directors as of the Effective Time.
A-4
<PAGE>
(j) PRINCIPAL OFFICE. The location of the principal office of HCC, as the
surviving corporation of the Merger, shall be 150 Almaden Boulevard, San Jose,
California 95113.
1.4 CLOSING. Subject to the provisions of Article VI hereof, the Closing
shall be at such date, time and location as HCC shall notify WHB in writing. The
date on which the Closing actually occurs is herein referred to as the "Closing
Date."
1.5 RESERVATION OF RIGHT TO REVISE TRANSACTION. After consultation with
WHB, HCC shall have the unilateral right to change the method of effecting the
Merger (including without limitation the provisions of this Article 1), to the
extent permitted by applicable law and to the extent it deems such change to be
desirable, provided, however, that no such change shall (a) alter or change the
amount or kind of the Merger Consideration, (b) diminish the benefits to be
received by the directors, officers or employees of WHB as set forth in this
Agreement, (c) materially impede or delay the consummation of the Merger or (d)
adversely affect the tax treatment of WHB stockholders as a result of receiving
the Merger Consideration. HCC may exercise this right of revision by giving
written notice thereof in the manner provided in Section 8.2 of this Agreement.
1.6 ADDITIONAL ACTIONS. If, at any time after the Effective Time, HCC
shall consider or be advised that any further deeds, assignments or assurances
or any other acts are necessary or desirable to (a) vest, perfect or confirm, of
record or otherwise, in HCC its right, title or interest in, to or under any of
the rights, properties or assets of WHB or Bank of Los Altos, as the case may
be, or (b) otherwise carry out the purposes of this Agreement, WHB shall be
deemed to have granted to HCC an irrevocable power of attorney to execute and
deliver all such deeds, assignments or assurances and to do all acts necessary
or desirable to vest, perfect or confirm title and possession to such rights,
properties or assets in HCC, as the case may be, and otherwise carry out the
purposes of this Agreement, an the officers and directors of HCC are authorized
in the name of WHB to take any and all such action.
ARTICLE II
REPRESENTATIONS AND WARRANTIES OF HCC
HCC represents and warrants to WHB, except as disclosed in writing on the
HCC Disclosure Schedule, that:
2.1 ORGANIZATION.
(a) HCC is a corporation duly organized, validly existing and in good
standing under the laws of the State of California and has all requisite power
and authority, corporate and otherwise, to own, operate and lease its assets and
properties and to carry on its business substantially as it has been and is now
being conducted. HCC is duly qualified to do business and is in good standing in
each jurisdiction where the character of the assets or properties owned or
leased by it or the nature of the business transacted by it requires that it be
so qualified, except where the failure to so qualify would not have a Material
Adverse Effect (as defined in Section 2.1 (b) hereof) on HCC or materially
adversely affect its ability to consummate the transactions contemplated herein.
HCC has all requisite corporate power and authority to enter into this Agreement
and, subject to the receipt of all requisite regulatory approvals and the
expiration of applicable waiting periods, to consummate the transactions
contemplated hereby. HCC is duly registered as a federal bank holding company
under BHCA.
(b) As used in this Agreement, the term "Material Adverse Effect" with
respect to HCC or WHB means any condition, event, change or occurrence that has
or may reasonably be expected to have a material adverse effect on the condition
(financial or otherwise), properties, business, operations, assets or deposit
liabilities of such entity taken together with its affiliated entities on a
consolidated basis; it being understood that a Material Adverse Effect shall not
include: (i) a change with respect to, or effect on, such entity and its
Subsidiaries resulting from a change in law, rule, regulation, generally
A-5
<PAGE>
accepted accounting principles or regulatory accounting principles, as such
would apply to the financial statements of such entity on a consolidated basis;
(ii) a change with respect to, or effect on, such entity and its Subsidiaries
resulting from expenses (such as legal, accounting and investment bankers' fees)
incurred in connection with this Agreement; (iii) a change with respect to, or
effect on, such entity and its Subsidiaries resulting from any other matter
affecting depository institutions generally including, without limitation,
changes in general economic conditions and changes in prevailing interest and
deposit rates; or (iv) in the case of WHB, any financial change resulting from
adjustments taken pursuant to Section 4.2 hereof.
2.2 AUTHORIZATION. The execution, delivery and performance of this
Agreement and the consummation of the transactions contemplated hereby have been
duly approved and authorized by the Boards of Directors of HCC, and no other
corporate action on their part is required to be taken, subject to the approval
of this Agreement and the Merger by the affirmative vote (the "HCC Required
Vote") of a majority of the outstanding shares of HCC Common Stock. This
Agreement has been duly executed and delivered by HCC and constitutes the valid
and binding obligation of each of them and is enforceable against each of them,
except to the extent that enforceability thereof may be limited by applicable
bankruptcy, insolvency, reorganization, moratorium or similar laws or equitable
principles or doctrines.
2.3 CONFLICTS. Subject to the second sentence of this Section 2.3, the
execution and delivery of this Agreement does not, and the consummation of the
transactions contemplated hereby will not, conflict with or result in any
violation, breach or termination of, or default or loss of a material benefit
under, or permit the acceleration of any obligation under, or result in the
creation of any material lien, charge or encumbrance on any of the property or
assets under, any provision of the Certificate of Incorporation or Bylaws of HCC
or similar documents of any HCC Subsidiary or any mortgage, indenture, lease,
agreement or other instrument, permit, concession, grant, franchise, license,
judgment, order, decree, statute, law, ordinance, rule or regulation applicable
to HCC or any HCC Subsidiary or their respective properties, other than any such
conflicts, violations or defaults which (i) will be cured or waived prior to the
Effective Time; (ii) are not material to the conduct of business or operations
of HCC or any HCC Subsidiary; or (iii) are disclosed in Section 2.3 of that
certain confidential writing delivered by HCC to WHB not less than two business
days prior to the date hereof (the "HCC Disclosure Schedule"). No consent,
approval, order or authorization of, or registration, declaration or filing
with, any federal or state governmental authority is required by or with respect
to HCC, in connection with the execution and delivery of this Agreement or the
consummation by them of the transactions contemplated hereby except for: (a) the
filing of all required regulatory applications or notifications by HCC, WHB
and/or their respective Subsidiaries for approval of the transactions
contemplated by this Agreement; (b) the filing by HCC of the registration
statement relating to the HCC Common Stock to be issued pursuant to this
Agreement ("Registration Statement") with the United States Securities and
Exchange Commission ("SEC") and various blue sky authorities, which Registration
Statement shall include the prospectus/joint proxy statement ("Joint Proxy
Statement") for use in connection with the HCC and WHB stockholders' meetings to
approve the Merger ("Stockholders' Meetings"); (c) the filing of certificates of
merger with respect to the Merger with the California and California Secretaries
of State; (d) the filing of the articles of combination with the FDIC relating
to the Bank Merger; (e) any filings, approvals or no-action letters with or from
state securities authorities; and (f) any anti-trust filings, consents, waivers
or approvals.
2.4 CAPITALIZATION.
(a) As of the date hereof, the authorized capital stock of HCC consists of
(i) 30,000,000 shares of HCC Common Stock, of which, as of April 2, 2000,
7,034,557 shares were issued and outstanding and (ii) 10,000,000 shares of
preferred stock, no par value per share ("HCC Preferred Stock"), of which none
are issued and outstanding. All of the issued and outstanding shares of HCC
Common Stock have been, and all of the shares of HCC Common Stock to be issued
in the Merger will be, at the Effective
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<PAGE>
Time, duly and validly authorized and issued, and are or will be, as the case
may be, fully paid and non-assessable. None of the outstanding shares of HCC
Common Stock has been issued in violation of any preemptive rights of the
current or past stockholders of HCC and none of the outstanding shares of HCC
Common Stock is or will be entitled to any preemptive rights in respect of the
Merger or any of the other transactions contemplated by this Agreement.
(b) As of the date hereof, HCC does not have outstanding any securities or
rights convertible into or exchangeable for HCC Common Stock or any commitments,
contracts, understandings or arrangements by which HCC is or may be bound to
issue additional shares of HCC Common Stock, except pursuant to employee and
director stock options, or as otherwise set forth in Section 2.5 of the HCC
Disclosure Schedule.
2.5 HCC FINANCIAL STATEMENTS, MATERIAL CHANGES. HCC has heretofore made
available to WHB its audited consolidated financial statements for the years
ended December 31, 1999 and December 31, 1998 (collectively, the "HCC Financial
Statements"). The HCC Financial Statements (x) are true and correct in all
material respects; (y) have been prepared in accordance with generally accepted
accounting principles applied on a consistent basis during the periods involved
(except as may be indicated in the notes thereto); and (z) fairly present the
consolidated financial position of HCC as of the dates thereof and the
consolidated results of its operations, shareholders' equity, cash flows and
changes in financial position for the periods then ended. Since December 31,
1999, HCC and the HCC Subsidiaries have not undergone or suffered any changes in
their respective condition (financial or otherwise), properties, business or
operations which have been, in any case or in the aggregate, materially adverse
to HCC on a consolidated basis except as disclosed in Section 2.6 of the HCC
Disclosure Schedule. No facts or circumstances have been discovered from which
it reasonably appears that there is a significant risk and reasonable
probability that HCC will suffer or experience a Material Adverse Effect.
2.6 HCC SUBSIDIARIES.
(a) HCC owns directly or indirectly all of the issued and outstanding shares
of capital stock of the HCC Subsidiaries. No capital stock of any of the HCC
Subsidiaries is, or may become required to be, issued (other than to HCC or
another HCC Subsidiary) by reason of any options, warrants, scrip, right to
subscribe to, calls, or commitments of any character whatsoever relating to, or
securities or rights convertible into or exchangeable for, shares of the capital
stock of any HCC Subsidiary. All of the shares of capital stock of each HCC
Subsidiary held by HCC or a HCC Subsidiary are fully paid and non-assessable and
are owned free and clear of any claim, lien or encumbrance, except as disclosed
in Section 2.6 of the HCC Disclosure Schedule.
(b) Each HCC Subsidiary is either a California banking corporation or a
corporation and is duly organized, validly existing and in good standing under
the laws of the jurisdiction in which it is incorporated or organized, and is
duly qualified to do business and in good standing in each jurisdiction where
the character of the assets or properties owned or leased by it or the nature of
the business transacted by it requires it to be so qualified, except where the
failure to so qualify, either individually or in the aggregate, would not have a
Material Adverse Effect on HCC and would not materially adversely effect the
ability of HCC to consummate the transactions contemplated herein. Each HCC
Subsidiary has the corporate power and authority necessary for it to own,
operate or lease its assets and properties and to carry on its business as it
has been and is now being conducted.
(c) For purposes of this Agreement, a "HCC Subsidiary" or a "Subsidiary" of
HCC shall mean each corporation, financial institution or other entity in which
HCC owns or controls directly or indirectly 10% or more of the outstanding
equity securities; provided, however, there shall not be included any such
entity acquired in good faith through foreclosure, or any such entity to the
extent that the equity securities of such entity are owned or controlled in a
bona fide fiduciary capacity.
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(d) Each subsidiary bank of HCC is a California banking corporation. The
deposits of each subsidiary bank of HCC are insured by the Federal Deposit
Insurance Corporation ("FDIC") to the full extent permitted under applicable
law.
2.7 HCC FILINGS. HCC has previously made available, or will make available
prior to the Effective Time, to WHB true and correct copies of (i) its proxy
statements relating to all meetings of its stockholders (whether special or
annual) during calendar years 1998, and 1999; and (ii) all other reports, as
amended, or filings, as amended, required to be filed under the Securities
Exchange Act of 1934, as amended (the "Exchange Act") by HCC with the SEC since
December 31, 1998 including without limitation on Forms 10-K, 10-Q and 8-K.
2.8 HCC REPORTS. Each of HCC and the HCC Subsidiaries has filed, and will
continue to file, all reports and statements, together with any amendment
required to be made with respect thereto, that it was, or will be required to
file with the SEC, the FDIC, the California State Department of Financial
Institutions ("DFI"), the Federal Reserve Board (the "FRB"), the National
Association of Securities Dealers ("NASD") and other applicable bank, securities
and other regulatory authorities (except filings which are not material). As of
their respective dates (and without giving effect to any amendments or
modifications filed after the date of this Agreement with respect to reports and
documents filed before the date of this Agreement), each of such reports and
documents, including the financial statements, exhibits, and schedules thereto,
complied in all material respects with all of the statutes, rules and
regulations enforced or promulgated by the authority with which they were filed
and did not contain any untrue statement of a material fact or omit to state any
material fact necessary in order to make the statements made therein, in light
of the circumstances under which they were made, not misleading. Other than
normal examinations conducted by the Internal Revenue Service (the "IRS"), state
and local taxing authorities, the FDIC or the DFI in the regular course of the
business of HCC or the HCC Subsidiaries, no federal, state or local governmental
agency, commission or other entity has initiated any proceeding or, to the best
knowledge of HCC, investigation into the business or operations of HCC or the
HCC Subsidiaries since December 31, 1998 except as set forth in Section 2.8 of
the HCC Disclosure Schedule. There is no unresolved violation, criticism or
exception by the SEC, DFI, FDIC or other agency, commission or entity with
respect to any report or statement referred to herein that is material to HCC or
any HCC Subsidiary on a consolidated basis.
2.9 COMPLIANCE WITH LAWS.
(a) Except as disclosed in Section 2.9 of the HCC Disclosure Schedule, the
businesses of HCC and the HCC Subsidiaries are not being conducted in violation
of any law, ordinance or regulation of any governmental entity, including,
without limitation, any laws affecting financial institutions (including those
pertaining to the Bank Secrecy Act, the investment of funds, the lending of
money, the collection of interest and the extension of credit), federal and
state securities laws, laws and regulations relating to financial statements and
reports, truth-in-lending, truth-in-savings, usury, fair credit reporting,
consumer protection, occupational safety, fair employment practices, fair labor
standards and laws and regulations relating to employees and employee benefits,
and any statutes or ordinances relating to the properties occupied or used by
HCC or any HCC Subsidiary, except for possible violations which either singly or
in the aggregate do not and, insofar as reasonably can be foreseen in the
future, will not have a Material Adverse Effect on HCC.
(b) Except as disclosed in Section 2.9 of the HCC Disclosure Schedule, no
investigation or review by any governmental entity with respect to HCC or any
HCC Subsidiary is pending or, to the best knowledge of HCC, threatened, nor has
any governmental entity indicated to HCC or any HCC Subsidiary an intention to
conduct the same, other than normal bank regulatory examinations and those the
outcome of which will not have a Material Adverse Effect on HCC.
(c) HCC and each of the HCC Subsidiaries, where applicable, is in
substantial compliance with the applicable provisions of the Community
Reinvestment Act of 1977 (the "CRA") and the regulations
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promulgated thereunder. As of the date of this Agreement, HCC has not been
advised of the existence of any fact or circumstance or set of facts or
circumstances which, if true, would cause HCC or any of the HCC Subsidiaries to
fail to be in substantial compliance with such provisions. No HCC Subsidiary
that is a financial institution has received a composite rating from an
applicable regulatory authority which is less than "satisfactory."
2.10 REGISTRATION STATEMENT; JOINT PROXY STATEMENT. The information to be
supplied by HCC for inclusion in the Registration Statement will not, at the
time the Registration Statement is declared effective and at the Effective Time,
contain any untrue statement of a material fact or omit to state any material
fact required to be stated therein or necessary in order to make the statements
therein not misleading. The information to be supplied by HCC for inclusion in
the Joint Proxy Statement will not, on the date the Joint Proxy Statement (or
any amendment thereof or supplement thereto) is first mailed to HCC's or WHB's
stockholders, at the time of the Stockholders' Meetings, and at the Effective
Time, contain any statement that, in light of the circumstances under which it
is made, is false or misleading with respect to any material fact, omits to
state any material fact necessary in order to make the statements made therein
not false or misleading, or omits to state any material fact necessary to
correct any statement in any earlier communication with respect to the
solicitation of proxies for the Stockholders' Meetings that has become false or
misleading. If, at any time prior to the Effective Time, any event relating to
HCC or any of its affiliates, officers, or directors is discovered by HCC that
should be set forth in an amendment to the Registration Statement or a
supplement to the Joint Proxy Statement, HCC will promptly inform WHB and such
amendment or supplement will be promptly filed with the SEC and, as required by
law, disseminated to the stockholders of WHB. Notwithstanding the foregoing, HCC
makes no representation or warranty with respect to any information supplied by
WHB that is contained in any of the Registration Statement or the Joint Proxy
Statement. The Joint Proxy Statement and the Registration Statement will (with
respect to HCC) comply in all material respects as to form and substance with
the requirements of the Exchange Act, the Securities Act, and the rules and
regulations thereunder.
2.11 LITIGATION. Except as disclosed in Section 2.11 of the HCC Disclosure
Schedule, there is no suit, action, investigation or proceeding, legal,
quasi-judicial, administrative or otherwise, pending or, to the best knowledge
of HCC threatened, against or affecting HCC or any HCC Subsidiary, or any of
their respective officers, directors, employees or agents, in their capacities
as such, which if adversely determined, would have a Material Adverse Effect on
HCC or which would materially affect the ability of HCC to consummate the
transactions contemplated herein or which is seeking to enjoin consummation of
the transactions provided for herein or to obtain other relief in connection
with this Agreement or the transactions contemplated hereby, nor is there any
judgment, decree, injunction, rule or order of any court, governmental
department, commission agency, instrumentality or arbitrator outstanding against
HCC or any HCC Subsidiary or any of their respective officers, directors,
employees or agents, in their capacities as such, having, or which, insofar as
reasonably can be foreseen in the future, would have any such effect.
2.12 LICENSES. HCC and the HCC Subsidiaries hold all licenses,
certificates, permits, franchises and all patents, trademarks, service marks,
trade names, copyrights or rights thereto, and required authorizations,
approvals, consents, licenses, clearances and orders or registrations with all
appropriate federal, state or other authorities that are material to the conduct
of their respective businesses as now conducted and as presently proposed to be
conducted.
2.13 TAXES.
(a) Except as disclosed in Section 2.13 of the HCC Disclosure Schedule, HCC
and the HCC Subsidiaries have each timely filed all tax and information returns
required to be filed and have paid (or HCC has paid on behalf of its
Subsidiaries), or have accrued on their respective books and set up an adequate
reserve for the payment of, all taxes reflected on such returns or required to
be paid in
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respect of the periods covered by such returns and have accrued on their
respective books and set up an adequate reserve for the payment of all income
and other taxes anticipated to be payable in respect of periods through the end
of the calendar month next preceding the date hereof. Neither HCC nor any HCC
Subsidiary is delinquent in the payment of any tax, assessment or governmental
charge. No deficiencies for any taxes have been proposed, asserted or assessed
against HCC or any HCC Subsidiary that have not been resolved or settled, and no
requests for waivers of the time to assess any such tax are pending or have been
agreed to. Except as set forth in Section 2.13 of the HCC Disclosure Schedule,
neither HCC nor any HCC Subsidiary is currently subject to audit or examination
of any of its income tax returns by the Internal Revenue Service or any state,
municipal or other taxing authority. Neither HCC nor any HCC Subsidiary is a
party to any action or proceeding by any governmental authority for the
assessment or the collection of taxes. Deferred taxes of HCC and the HCC
Subsidiaries have been accounted for in accordance with generally accepted
accounting principles.
(b) HCC has not filed any consolidated federal income tax return with an
"affiliated group" (within the meaning of Section 1504 of the Code), where HCC
was not the common parent of the group. Neither HCC nor any HCC Subsidiary is,
or has been, a party to any tax allocation agreement or arrangement pursuant to
which it has any contingent or outstanding liability to anyone other than HCC or
a HCC Subsidiary.
(c) HCC and the HCC Subsidiaries have each withheld amounts from its
employees, stockholders or holders of public deposit accounts in compliance with
the tax withholding provisions of applicable federal, state and local laws, have
filed all federal, state and local returns and reports for all periods for which
such returns or reports would be due with respect to income tax withholding,
social security, unemployment taxes, income and other taxes and all payments or
deposits with respect to such taxes have been timely made.
(d) For the purposes of this Agreement, the terms "tax" and "taxes" include
without limitation, any federal, state, local or foreign income, leasing,
franchise, excise, gross receipts, sales, use, occupational, employment, real
property, ad valorem, tangible and intangible personal property and state taxes,
payments in lieu of taxes, levies, duties, imposts, business, operations or
financial condition, assessments, fees, charges and withholdings of any nature
whatsoever, together with any related penalties, fines, additions to tax or
interest thereon.
2.14 INSURANCE. HCC and the HCC Subsidiaries maintain insurance with
insurers which in the best judgment of management of HCC are sound and reputable
on their respective assets and upon their respective businesses and operations
against loss or damage, risks, hazards and liabilities as in their judgment they
deem appropriate. HCC and the HCC Subsidiaries maintain in effect all insurance
required to be carried by law or by any agreement by which they are bound. All
material claims under all policies of insurance maintained by HCC and the HCC
Subsidiaries have been filed in due and timely fashion.
2.15 ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses shown on the
HCC Financial Statements as of December 31, 1999 (and as shown on any financial
statements to be delivered by HCC to WHB pursuant to Section 5.7 hereof), to the
best knowledge of HCC, as of such date was (and will be as of subsequent HCC
Financial Statements) adequate in all respects to provide for losses, net of
recoveries relating to loans previously charged off, on loans outstanding, and
contained (or will contain) an additional amount of unallocated reserves at a
level considered adequate under the standards applied by applicable federal
regulatory authorities and based upon generally accepted accounting principles.
To the best knowledge of HCC, the aggregate principal amount of loans contained
(or that will be contained) in the loan portfolio of HCC and the HCC
Subsidiaries as of December 31, 1999 (and as of the dates of any financial
statements to be delivered by HCC to WHB pursuant to Section 5.7 hereof), in
excess of such reserve, was (and will be) fully collectible.
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2.16 COMPLIANCE WITH ENVIRONMENTAL LAWS.
(a) Except as set forth in Section 2.16 of the HCC Disclosure Schedule:
(i) to the best knowledge of HCC, the operations of HCC and each of the HCC
Subsidiaries comply in all material respects with all applicable past and
present Environmental Laws (as defined below); (ii) to the best knowledge of
HCC, none of the operations of HCC or any HCC Subsidiary, no assets presently or
formerly owned or leased by HCC or any HCC Subsidiary and no Mortgaged Premises
or a Participating Facility (as defined below) are subject to any judicial or
administrative proceedings alleging the violation of any past or present
Environmental Law, nor are they the subject of any claims alleging damages to
health or property, pursuant to which HCC, any HCC Subsidiary or any owner of a
Mortgaged Premises or a Participating Facility would be liable in law or equity;
(iii) none of the operations of HCC or any HCC Subsidiary, no assets presently
owned or, to the best knowledge of HCC, formerly owned by HCC or any HCC
Subsidiary, and, to the best knowledge of HCC, no Mortgaged Premises or
Participating Facility are the subject of any federal, state or local
investigation evaluating whether any remedial action is needed to respond to a
release or threatened release of any Hazardous Substance (as defined below), or
any other substance into the environment, nor has HCC or any HCC Subsidiary, or,
to the best knowledge of HCC, any owner of a Mortgaged Premises or Participating
Facility been directed to conduct such investigation, formally or informally, by
any governmental agency, nor have any of them agreed with any governmental
agency or private person to conduct any such investigation; and (iv) neither HCC
or any HCC Subsidiary, nor, to the best knowledge of HCC, any owner of a
Mortgaged Premises or a Participating Facility has filed any notice under any
Environmental Law indicating past or present treatment, storage or disposal of a
Hazardous Substance' or reporting a spill or release of a Hazardous Substance,
or any other substance into the environment.
(b) For purposes of this Agreement, "Mortgaged Premises" shall mean each
(1) real property interest (including without limitation any fee or leasehold
interest) which is encumbered or affected by any mortgage, deed of trust, deed
to secure debt or other similar document or instrument granting to any party
hereto or any of its Subsidiaries a lien on or security interest in such real
property interest and (ii) any other real property interest upon which is
situated assets or other property affected or encumbered by any document or
instrument granting to any party hereto or any of its Subsidiaries a lien
thereon or security interest therein; provided, however, that the term
"Mortgaged Premises" shall not include one- to four-unit, single-family
residences, and in the case of HCC and the HCC Subsidiaries, any real property
interest securing a loan with a principal balance of less than one million
dollars. For purposes of this Agreement, "Participating Facility" means any
property in which any party hereto or any of its Subsidiaries participates in
the management of such property and, where the context requires, includes the
owner or operator of such property. For purposes of this Agreement, "Hazardous
Substance" has the meaning set forth in Section 9601 of the Comprehensive
Environmental Response Compensation and Liability Act of 1980, 42 U.S.C.A.,
Section 9601 et seq., and also includes any substance now or hereafter regulated
by or subject to any Environmental Laws (as defined below) and any other
pollutant, contaminant, or waste, including without limitation, petroleum,
asbestos, fiberglass, radon, and polychlorinated biphenyls. For purposes of this
Agreement, "Environmental Laws" means all laws (civil or common), ordinances,
rules, regulations, guidelines, and orders that: (i) regulate air, water, soil,
and solid waste management, including the generation, release, containment,
storage, handling, transportation, disposition, or management of any Hazardous
Substance; (ii) regulate or prescribe requirements for air, water, or soil
quality; (iii) are intended to protect public health or the environment; or
(iv) establish liability for the investigation, removal, or cleanup of, or
damage caused by, any Hazardous Substance.
2.17 DEFAULTS. There has not been any default in any material obligation
to be performed by HCC or any HCC Subsidiary under any material contract or
commitment, and neither HCC nor any HCC Subsidiary has waived any material right
under any material contract or commitment. To the best
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knowledge of HCC, no other party to any material contract or commitment is in
default in any material obligation to be performed by such party.
2.18 INDEMNIFICATION. To the best knowledge of HCC, except as set forth in
Section 2.18 of the HCC Disclosure Schedule, no action or failure to take action
by any director, officer, employee or agent of HCC or any HCC Subsidiary has
occurred which would give rise to a claim by any such person for indemnification
from HCC or any HCC Subsidiary under the corporate indemnification provisions of
such entity in effect on the date of this Agreement.
2.19 ACCURACY OF INFORMATION. The statements of HCC contained in this
Agreement, the Schedules hereto and in any other written document executed and
delivered by or on behalf of HCC pursuant to the terms of this Agreement are
true and correct in all material respects.
2.20 GOVERNMENTAL APPROVALS AND OTHER CONDITIONS. To the best knowledge of
HCC, there is no reason relating specifically to HCC or any HCC Subsidiary why
(a) the approvals that are required to be obtained from regulatory authorities
having approval authority in connection with the transactions contemplated
hereby should not be granted, (b) such regulatory approvals should be subject to
a condition which would differ from conditions customarily imposed by such
regulatory authorities in orders approving acquisitions of the type contemplated
hereby or (c) any of the conditions precedent as specified in Article VI hereof
to the obligations of any of the parties hereto to consummate the transactions
contemplated hereby are unlikely to be fulfilled within the applicable time
period or periods required for satisfaction of such condition or conditions.
2.21 FAIRNESS OPINION. HCC has received from Hoefer & Arnett, Inc. a
fairness opinion, dated as of the date of this Agreement, to the effect that the
Exchange Ratio is fair to the holders of HCC Common Stock from a financial point
of view.
2.22 YEAR 2000 COMPLIANT. All computer software and hardware utilized by
HCC or any HCC Subsidiary is Year 2000 compliant, which, for purposes of this
Agreement, shall mean that the data outside the range 1900-1999 will be
correctly processed in any level of computer hardware or software including, but
not limited to, microcode, firmware, applications programs, files and data
bases. All computer software is designed to be used prior to, during, and after
the calendar year 2000 A.D., and such software will operate during each such
time period without error relating to date data, specifically including any
error relating to, or the product of, date data that represents or referenced
different centuries or more than one century.
ARTICLE III
REPRESENTATIONS AND WARRANTIES OF WHB
WHB represents and warrants to HCC, except as disclosed in writing on the
WHB Disclosure Schedule, that:
3.1 ORGANIZATION. WHB is a corporation duly organized, validly existing
and in good standing under the laws of the State of California and has all
requisite power and authority, corporate and otherwise, to own, operate and
lease its assets and properties and to carry on its business substantially as it
has been and is now being conducted. WHB is duly qualified to do business and is
in good standing in each jurisdiction where the character of the assets or
properties owned or leased by it or the nature of the business transacted by it
requires that it be so qualified, except where the failure to so qualify would
not have a Material Adverse Effect on WHB or materially adversely affect its
ability to consummate the transactions contemplated herein. WHB has all
requisite corporate power and authority to enter into this Agreement and,
subject to the approval of this Agreement by its stockholders and the receipt of
all requisite regulatory approvals and the expiration of any applicable waiting
periods, to consummate the transactions contemplated hereby. WHB is duly
registered as a federal bank holding company under the BHCA.
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3.2 AUTHORIZATION. The execution, delivery and performance of this
Agreement and the consummation of the transactions contemplated hereby and
thereby have been duly approved and authorized by the Boards of Directors of
WHB, and all necessary corporate action on the part of WHB has been taken,
subject to the approval of this Agreement and the Merger by the affirmative vote
(the "WHB Required Vote") of a majority of the outstanding shares of WHB Common
Stock. This Agreement has been duly executed and delivered by WHB and
constitutes the valid and binding obligation of each of them and is enforceable
against each of them, except to the extent that enforceability thereof may be
limited by applicable bankruptcy, insolvency, reorganization, moratorium,
receivership, conservatorship or similar laws or equitable principles or
doctrines.
3.3 CONFLICTS. Subject to the second sentence of this Section 3.3, the
execution and delivery of this Agreement does not, and the consummation of the
transactions contemplated hereby and thereby will not, conflict with or result
in any violation, breach or termination of, or default or loss of a material
benefit under, permit the acceleration of any obligation under, require the
giving of notice or obtaining consent under, or result in the creation of any
material lien, charge or encumbrance on any property or assets under, any
provision of the Articles of Incorporation or Bylaws of WHB or similar documents
of any WHB Subsidiary (as defined in Section 3.6 hereof), or any mortgage,
indenture, lease, agreement or other instrument, permit, concession, grant,
franchise, license, judgment, order, decree, statute, law, ordinance, rule or
regulation applicable to WHB or any WHB Subsidiary or their respective
properties, other than any such conflicts, violations or defaults which
(i) will be cured or waived prior to the Effective Time or (ii) are disclosed in
Section 3.3 of the WHB Disclosure Schedule. No consent, approval, order or
authorization of, or registration, declaration or filing with, any federal or
state governmental authority is required by or with respect to WHB or Bank of
Los Altos in connection with the execution and delivery of this Agreement or the
consummation by WHB or Bank of Los Altos of the transactions contemplated hereby
or thereby except for: (a) the filing of all required regulatory applications or
notifications by HCC, WHB and/or their respective Subsidiaries for approval of
the transactions contemplated by this Agreement; (b) the filing by HCC of the
Registration Statement with the SEC and various blue sky authorities, which
Registration Statement shall include the Joint Proxy Statement for use in
connection with the Stockholders' Meetings; (c) the filing of certificates of
merger with respect to the Merger with the California and California Secretaries
of State; (d) the filing of the articles of combination with the FDIC relating
to the Bank Merger; (e) any filings, approvals or no-action letters with or from
state securities authorities; and (f) any anti-trust filings, consents, waivers
or approvals.
3.4 CAPITALIZATION AND STOCKHOLDERS.
(a) As of the date hereof, the authorized capital stock of WHB consists of
10,000,000 shares of WHB Common Stock, of which 2,750,600 shares are issued and
outstanding. All of the issued and outstanding shares of WHB Common Stock have
been duly and validly authorized and issued, and are fully paid and
non-assessable. None of the outstanding shares of WHB Common Stock has been
issued in violation of any preemptive rights of current or past stockholders or
are subject to any preemptive rights of the current or past stockholders of WHB.
All of the issued and outstanding shares of WHB Common Stock will be entitled to
vote to approve this Agreement and the Merger. Except as disclosed in
Section 3.4 of the WHB Disclosure Schedule, neither WHB nor Bank of Los Altos is
aware of any event or circumstance which could disqualify the Merger from being
accounted for as a pooling of interests.
(b) As of the date hereof, WHB had shares of WHB Common Stock reserved for
issuance under the WHB Stock Option Plan for the benefit of employees and
directors of WHB and the WHB Subsidiaries, pursuant to which options covering
shares of WHB Common Stock are outstanding (the "WHB Stock Options"). Except as
set forth in this Section, there are no shares of capital stock or other equity
securities of WHB outstanding and no outstanding options warrants, scrip, rights
to subscribe to, calls or commitments of any character whatsoever relating to,
or securities or rights
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convertible into or exchangeable for, shares of the capital stock of WHB, or
contracts, commitments, understandings, or arrangements by which WHB is or may
be bound to issue additional shares of its capital stock or options, warrants,
or rights to purchase or acquire any additional shares of its capital stock.
There are no outstanding phantom stock rights or awards. Section 3.4 of the WHB
Disclosure Schedule sets forth the name of the holder of each WHB Stock Option
and the date of grant of, number of shares represented by, exercise price,
vesting schedule, and expiration of, each WHB Stock Option.
3.5 WHB FINANCIAL STATEMENTS; MATERIAL CHANGES. WHB has heretofore
delivered to HCC its audited consolidated financial statements for the years
ended December 31, 1999 and December 31, 1998 and its unaudited financial
statements for the quarter ended March 31, 2000 (collectively, the "WHB
Financial Statements"). The WHB Financial Statements (x) are true and correct in
all material respects; (y) have been prepared in accordance with generally
accepted accounting principles applied on a consistent basis during the periods
involved (except as may be indicated in the notes thereto); and (z) fairly
present the consolidated financial position of WHB as of the dates thereof and
the consolidated results of its operations, stockholders' equity, cash flows and
changes in financial position for the periods then ended. Since December 31,
1999 to the date hereof, WHB and the WHB Subsidiaries have not undergone or
suffered any changes in their respective condition (financial or otherwise),
properties, business or operations which have been, in any case or in the
aggregate, materially adverse to WHB on a consolidated basis except as disclosed
in Section 3.5 of the WHB Disclosure Schedule. No facts or circumstances have
been discovered from which it reasonably appears that there is a significant
risk and reasonable probability that WHB will suffer or experience a Material
Adverse Effect.
3.6 WHB SUBSIDIARIES.
(a) All of the WHB Subsidiaries are listed in Section 3.6 of the WHB
Disclosure Schedule. Except as set forth in Section 3.6 of the WHB Disclosure
Schedule, WHB owns directly or indirectly all of the issued and outstanding
shares of capital stock of the WHB Subsidiaries. Section 3.6 of the WHB
Disclosure Schedule sets forth the number of shares of authorized and
outstanding capital stock of the WHB Subsidiaries. Except for equity securities
of the Federal Reserve Bank of San Francisco or as set forth in Section 3.6 of
the WHB Disclosure Schedule, neither WHB nor the WHB Subsidiaries own directly
or indirectly any debt or equity securities, or other proprietary interest in
any other corporation, limited liability company, joint venture, partnership,
entity, association or other business. No capital stock of any of the WHB
Subsidiaries is or may become required to be issued (other than to WHB) by
reason of any options, warrants, scrip, rights to subscribe to, calls, or
commitments of any character whatsoever relating to, or securities or rights
convertible into or exchangeable for, shares of the capital stock of any WHB
Subsidiary. Other than as set forth in Section 3.6 of the WHB Disclosure
Schedule there are no contracts, commitments, understandings or arrangements
relating to the rights of WHB to vote or to dispose of shares of the capital
stock of any WHB Subsidiary. All of the shares of capital stock of each WHB
Subsidiary are fully paid and non-assessable and are owned by WHB or another WHB
Subsidiary free and clear of any claim, lien or encumbrance, except as disclosed
in Section 3.6 of the WHB Disclosure Schedule.
(b) Each WHB Subsidiary is either a California banking corporation or a
corporation and is duly organized, validly existing and in good standing under
the laws of the jurisdiction in which it is incorporated or organized, and is
duly qualified to do business and in good standing in each jurisdiction where
the character of the assets or properties owned or leased by it or the nature of
the business transacted by it requires it to be so qualified, except where the
failure to so qualify, either individually or in the aggregate, would not have a
Material Adverse Effect on WHB and would not materially adversely affect the
ability of WHB or Bank of Los Altos to consummate the transactions contemplated
herein. Each WHB Subsidiary has the corporate power and authority necessary for
it to own, operate
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or lease its assets and properties and to carry on its business substantially as
it has been and is now being conducted.
(c) For purposes of this Agreement, a "WHB Subsidiary" or a "Subsidiary" of
WHB shall mean each corporation, financial institution, or other entity in which
WHB owns or controls directly or indirectly 10% or more of the outstanding
equity securities; provided, however, there shall not be included any such
entity acquired in good faith through foreclosure, or any such entity to the
extent that the equity securities of such entity are owned or controlled in a
bona fide fiduciary capacity,
(d) Bank of Los Altos is a California banking corporation organized under
the California Financial Code and subject to the supervision of the DFI and
FDIC. All eligible deposit accounts issued by WHB's banking subsidiary are
insured by the FDIC to the full extent permitted under applicable law.
3.7 WHB FILINGS. WHB has previously made available to HCC true and correct
copies of (i) its proxy statements relating to all meetings of stockholders
(whether special or annual) of WHB during calendar years 1998, 1999 and 2000 and
(ii) all other reports, as amended, or filings, as amended, required to be filed
with the California Department of Corporations or any banking or other
regulatory agency.
3.8 WHB REPORTS. Except as disclosed in Section 3.8 of the WHB Disclosure
Schedule, each of WHB and the WHB Subsidiaries has filed, and will continue to
file, all reports and statements, together with any amendment required to be
made with respect thereto, that it has, or will be, required to file with the
SEC, the FDIC, the DFI, FRB and other applicable bank, securities and other
regulatory authorities (except filings which are not material). As of their
respective dates (and without giving effect to any amendments or modifications
filed after the date of this Agreement with respect to reports and documents
filed before the date of this Agreement), each of such reports and documents,
including the financial statements, exhibits, and schedules thereto, complied in
all material respects with all of the statutes, rules and regulations enforced
or promulgated by the authority with which they were filed and did not contain
any untrue statement of a material fact or omit to state any material fact
necessary in order to make the statements made therein, in light of the
circumstances under which they were made, not misleading. Other than normal
examinations conducted by the IRS, state and local taxing authorities, the DFI,
the FRB or the FDIC in the regular course of the business of WHB or the WHB
Subsidiaries, no federal, state or local governmental agency, commission or
other entity has initiated any proceeding or, to the best knowledge of WHB,
investigation into the business or operations of WHB or the WHB Subsidiaries
since December 31, 1998 except as set forth in Section 3.8 of the WHB Disclosure
Schedule. There is no unresolved violation, criticism or exception by the SEC,
DFI, FRB, FDIC or other agency, commission or entity with respect to any report
or statement referred to herein that is material to WHB or any WHB Subsidiary.
WHB has previously made available to HCC true and correct copies of all DFI and
FRB filings made during calendar years 1998, 1999 and 2000.
3.9 COMPLIANCE WITH LAWS.
(a) Except as disclosed in Section 3.9 of the WHB Disclosure Schedule, and
for violations which are not material to WHB or any WHB Subsidiary, the
businesses of WHB and the WHB Subsidiaries are being conducted, in all material
respects, in compliance with all laws, ordinances or regulations of governmental
authorities, including without limitation, laws affecting financial institutions
(including those pertaining to the Bank Secrecy Act, the investment of funds,
the lending of money, the collection of interest and the extension of credit),
federal and state securities laws, laws and regulations relating to financial
statements and reports, truth-in-lending, truth-in-savings, usury, fair credit
reporting, consumer protection, occupational safety, fair employment practices,
fair labor standards and all other laws and regulations relating to employees
and employee benefits, and any statutes or ordinances relating to the properties
occupied or used by WHB or any WHB Subsidiary except for possible
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violations which either singly or in the aggregate do not and, insofar as
reasonably can be foreseen in the future, will not have a Material Adverse
Effect on WHB.
(b) Except as disclosed in Section 3.9 of the WHB Disclosure Schedule, no
investigation or review by any governmental entity with respect to WHB or any
WHB Subsidiary is pending or, to the best knowledge of WHB, threatened, nor has
any governmental entity indicated to WHB or any WHB Subsidiary an intention to
conduct the same, other than normal bank regulatory examinations.
(c) WHB and each of the WHB Subsidiaries, where applicable, is in
substantial compliance with the applicable provisions of the CRA and the
regulations promulgated thereunder. As of the date of this Agreement, neither
WHB nor Bank of Los Altos has been advised of the existence of any fact or
circumstance or set of facts or circumstances which, if true, would cause WHB or
any of the WHB Subsidiaries to fail to be in substantial compliance with such
provisions. Bank of Los Altos has not received since December 31, 1998 a
composite rating from an applicable regulatory authority which is less than
"satisfactory."
3.10 REGISTRATION STATEMENT; JOINT PROXY STATEMENT. The information to be
supplied by WHB for inclusion in the Registration Statement will not, at the
time the Registration Statement is declared effective and at the Effective Time,
contain any untrue statement of a material fact or omit to state any material
fact required to be stated therein or necessary in order to make the statements
therein not misleading. The information to be supplied by WHB for inclusion in
the Joint Proxy Statement will not, on the date the Joint Proxy Statement (or
any amendment thereof or supplement thereto) is first mailed to HCC's and WHB's
stockholders, at the time of the Stockholders' Meetings, and at the Effective
Time, contain any statement that, in light of the circumstances under which it
is made, is false or misleading with respect to any material fact, omits to
state any material fact necessary in order to make the statements made therein
not false or misleading, or omits to state any material fact necessary to
correct any statement in any earlier communication with respect to the
solicitation of proxies for the Stockholders' Meetings that has become false or
misleading. If at any time prior to the Effective Time, any event relating to
WHB or any of its affiliates, officers or directors is discovered by WHB that
should be set forth in an amendment to the Registration Statement or a
supplement to the Joint Proxy Statement, WHB will promptly inform HCC, and such
amendment or supplement will be promptly filed with the SEC and, as required by
law, disseminated to the stockholders of WHB. Notwithstanding the foregoing, WHB
makes no representation or warranty with respect to any information supplied by
HCC that is contained in the Registration Statement or the Joint Proxy
Statement. The Joint Proxy Statement will (with respect to WHB) comply in all
material respects as to form and substance with the requirements of the Exchange
Act and the rules and regulations thereunder.
3.11 LITIGATION. Except as disclosed in Section 3.11 of the WHB Disclosure
Schedule, there is no suit, action, investigation or proceeding, legal,
quasi-judicial, administrative or otherwise, pending or, to the best knowledge
of WHB threatened, against or affecting WHB or any WHB Subsidiary, or any of
their respective current or former officers, directors, employees or agents, in
their capacities as such, which is seeking equitable relief or damages against
WHB, any WHB Subsidiary, or any of their respective officers, directors,
employees or agents, in their capacities as such, in excess of $10,000, or which
would materially affect the ability of WHB or Bank of Los Altos to consummate
the transactions contemplated herein or which is seeking to enjoin consummation
of the transactions provided for herein or to obtain other relief in connection
with this Agreement or the transactions contemplated hereby, nor is there any
judgment, decree, injunction, rule or order of any court, governmental
department, commission, agency, instrumentality or arbitrator outstanding
against WHB or any WHB Subsidiary or any of their respective officers,
directors, employees or agents, in their capacities as such, having, or which,
insofar as reasonably can be foreseen in the future, would have any such effect,
nor is there any pending or threatened civil or criminal investigation by any
agency of the United States government in which WHB, any WHB Subsidiary or any
officer or director of WHB is a target or subject of such investigation.
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3.12 LICENSES. WHB and the WHB Subsidiaries hold all licenses,
certificates, permits, franchises and all patents, trademarks, service marks,
trade names, copyrights or right thereto, and required authorizations,
approvals, consents, licenses, clearances and orders or registrations with all
appropriate federal, state or other authorities that are material to the conduct
of their respective businesses as now conducted and as presently proposed to be
conducted.
3.13 TAXES.
(a) Except as disclosed in Section 3.13 of the WHB Disclosure Schedule, WHB
and the WHB Subsidiaries have each timely filed all tax and information returns
required to be filed and have paid (or WHB has paid on behalf of its
Subsidiaries), or have accrued on their respective books and set up an adequate
reserve for the payment of, all taxes reflected on such returns as required to
be paid in respect of the periods covered by such returns and have accrued on
their respective books and set up an adequate reserve for the payment of all
income and other taxes anticipated to be payable in respect of periods through
the end of the calendar month next preceding the date hereof. Neither WHB nor
any WHB Subsidiary is delinquent in the payment of any tax, assessment or
governmental charge. No deficiencies for any taxes have been proposed, asserted
or assessed against WHB or any WHB Subsidiary that have not been resolved or
settled and no requests for waivers of the time to assess any such tax are
pending or have been agreed to. The income tax returns of WHB and WHB
Subsidiaries have not been audited by the IRS, state, municipal or other taxing
authority after the 1995 tax year. Neither WHB nor any WHB Subsidiary is a party
to any action or proceeding by any governmental authority for the assessment or
the collection of taxes. Deferred taxes of WHB and the WHB Subsidiaries have
been accounted for in accordance with generally accepted accounting principles.
(b) WHB has not filed any consolidated federal income tax return with an
"affiliated group" (within the meaning of Section 1504 of the Code) where WHB
was not the common parent of the group. Neither WHB nor any WHB Subsidiary is,
or has been, a party to any tax allocation agreement or arrangement pursuant to
which it has any contingent or outstanding liability to anyone other than WHB or
any WHB Subsidiary. Neither WHB nor any WHB Subsidiary is required to include in
income any adjustment pursuant to Section 481 (a) of the Code and no such
adjustment has been proposed by the IRS. Neither WHB nor any WHB Subsidiary has
filed a consent pursuant to Section 341(f) of the Code or agreed to have Section
341(f)(2) of the Code apply.
(c) WHB and the WHB Subsidiaries have each withheld amounts from its
employees, stockholders, or holders of public deposit accounts in compliance
with the tax withholding provisions of applicable federal, state and local laws,
have filed all federal, state and local returns and reports for all periods for
which such returns or reports would be due with respect to income tax
withholding, social security, unemployment taxes, income and other taxes and all
payments or deposits with respect to such taxes have been timely made.
3.14 INSURANCE. WHB and the WHB Subsidiaries maintain insurance with
insurers which in the best judgment of management of WHB are sound and reputable
on their respective assets and upon their respective businesses and operations
against loss or damage, risks, hazards and liabilities as in their judgment they
deem appropriate. WHB and the WHB Subsidiaries maintain in effect all insurance
required to be carried by law or by any agreement by which they are bound. All
material claims under all policies of insurance maintained by WHB and the WHB
Subsidiaries have been filed in due and timely fashion. Each of WHB and the WHB
Subsidiaries has taken or will timely take all requisite action (including
without limitation the making of claims and the giving of notices) pursuant to
its directors' and officers' liability insurance policy or policies in order to
preserve all rights thereunder with respect to all matters (other than matters
arising in connection with this Agreement and the transactions contemplated
hereby) occurring prior to the Effective Time. Neither WHB nor any of the WHB
Subsidiaries has, since December 31, 1998, had an insurance policy canceled or
been denied insurance coverage for which any of such companies has applied.
Section 3.14 of the WHB
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Disclosure Schedule includes a complete list of each policy of insurance
maintained by WHB or any WHB Subsidiary.
3.15 LOANS; INVESTMENTS. To the best knowledge of WHB and all WHB
Subsidiaries:
(a) Except as otherwise disclosed in Section 3.15 of the WHB Disclosure
Schedule, each loan reflected as an asset on the WHB Financial Statements dated
as of March 31, 2000, and each loan originated or acquired after such date, is
evidenced by appropriate and sufficient documentation and constitutes the legal,
valid and binding obligation of the obligor named therein, enforceable in
accordance with its terms, except to the extent that the enforceability thereof
may be limited by bankruptcy, insolvency, reorganization, moratorium or similar
laws or equitable principles or doctrines. Except as set forth in Section 3.15
of the WHB Disclosure Schedule, all such loans are, and at the Effective Time
will be, free and clear of any security interest, lien, encumbrance or other
charge and do not, and will not at the Effective Time, include any provision for
prepayment penalties in violation of any law or regulation. Except as set forth
in Section 3.15 of the WHB Disclosure Schedule, there is no loan or other asset
of WHB or of any WHB Subsidiary that has been classified by examiners or others
as "Other Loans of Concern," "Substandard," "Doubtful" or "Loss". Set forth in
Section 3.15 of the WHB Disclosure Schedule is a complete list of the real
estate acquired through foreclosure, repossession or deed in lieu thereof
("REO") of WHB and the WHB Subsidiaries as of March 31, 2000.
(b) All guarantees of indebtedness owed to WHB or any WHB Subsidiary,
including but not limited to those of the Federal Housing Administration, the
Small Business Administration, and other state and federal agencies, are, to the
best knowledge of WHB, valid and enforceable, except to the extent
enforceability thereof may be limited by applicable bankruptcy, insolvency,
reorganization, moratorium or similar laws or equitable principles or doctrines.
(c) All interest rate swaps, caps, floors and option agreements and other
interest rate risk management arrangements to which WHB or any WHB Subsidiary is
a party or by which any of their properties or assets may be bound were entered
into in the ordinary course of business and, to the best knowledge of WHB, in
accordance with then-customary practice and applicable rules, regulations and
policies of bank regulatory authorities and with counterparties believed to be
financially responsible at the time and are legal, valid and binding obligations
and are in full force and effect. WHB and the WHB Subsidiaries have duly
performed in all material respects all of their respective obligations
thereunder to the extent that such obligations to perform have accrued, and to
the best knowledge of WHB, there are no material breaches, violations or
defaults or allegations or assertions of such by any party thereunder. None of
the transactions contemplated by this Agreement would permit: (i) a counterparty
under any interest rate swap, cap, floor and option agreement or any other
interest rate risk management agreement or (ii) any party to any mortgage-backed
security financing arrangement, to accelerate, discontinue, terminate or
otherwise modify any such agreement or arrangement or would require WHB or any
WHB Subsidiary to recognize any gain or loss with respect to such arrangement.
(d) Except as set forth in Section 3.15 of the WHB Disclosure Schedule and
except for pledges to secure public and trust deposits, none of the investments
reflected in the WHB Financial Statements dated as of December 31, 1999 under
the heading "Investment Securities," and none of the investments made by WHB and
the WHB Subsidiaries since December 31, 1999, is subject to any restriction,
whether contractual or statutory, which materially impairs the ability of WHB or
any WHB Subsidiary to freely dispose of such investment at any time, other than
those restrictions imposed on securities held for investment under generally
accepted accounting principles. With respect to all material repurchase
agreements to which WHB or any WHB Subsidiary is a party, WHB or such Subsidiary
has a valid, perfected first lien or security interest in the government
securities or other collateral securing each such repurchase agreement, and the
value of the collateral securing each such repurchase agreement equals or
exceeds the amount of the debt secured by such collateral under such agreement.
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Except as set forth in Section 3.15 of the WHB Disclosure Schedule and except
for a transaction involving less than $50,000, neither WHB nor any WHB
Subsidiary has sold or otherwise disposed of any assets in a transaction in
which the acquiror of such assets or other person has the right, either
conditionally or absolutely, to require WHB or any WHB Subsidiary to repurchase
or otherwise reacquire any such assets. Set forth in Section 3.15 of the WHB
Disclosure Schedule is a complete and accurate list of each investment and debt
security, mortgage-backed and related securities, marketable equity securities
and securities purchased under agreements to resell owned by WHB or any WHB
Subsidiary showing as of March 31, 2000 the carrying values and estimated fair
values of investment and debt securities, the gross carrying value and estimated
fair value of the mortgage-backed and related securities and the estimated cost
and estimated fair value of the marketable equity securities.
(e) All United States Treasury securities, obligations of other United
States Government agencies and corporations, obligations of States of United
States and their political subdivisions, and other investment securities
classified as "held to maturity" and "available for sale" held by WHB and the
WHB Subsidiaries, as reflected in the WHB Financial Statements dated March 31,
2000 were classified and accounted for in accordance with F.A.S.B.115 and the
intentions of management.
3.16 ALLOWANCE FOR LOAN LOSSES.
(a) The allowance for loan losses shown on the WHB Financial Statements as
of March 31, 2000 (and as shown on any financial statements to be delivered by
WHB to HCC pursuant to Section 5.7 hereof), to the best knowledge of WHB and all
WHB Subsidiaries, as of such date was (and will be as of such subsequent WHB
Financial Statements) adequate in all respects to provide for losses, net of
recoveries relating to loans previously charged off, on loans outstanding, and
contained (or will contain) an additional amount of unallocated reserves for
unanticipated future losses at a level considered adequate under the standards
applied by applicable federal regulatory authorities and based upon generally
accepted practices. To the best knowledge of WHB, the aggregate principal amount
of loans contained (or that will be contained) in the loan portfolio of WHB and
the WHB Subsidiaries as of March 31, 2000 (and as of the dates of any financial
statements to be delivered by WHB to HCC pursuant to Section 5.7 hereof), in
excess of such reserve, was (and will be) fully collectible.
(b) The sum of the aggregate amount of all Nonperforming Assets (as defined
below) and all troubled debt restructurings (as defined under generally accepted
accounting principles) on the books of WHB and the WHB Subsidiaries does not
exceed 1% of total loans at the date hereof. "Nonperforming Assets" shall mean
(i) all loans and leases (A) that are contractually past due 90 days or more in
the payment of principal and/or interest, (B) that are on nonaccrual status, (C)
where a reasonable doubt exists, in the reasonable judgment of Bank of Los
Altos, as to the timely future collectibility of principal and/or interest,
whether or not interest is still accruing or the loan is less than 90 days past
due, (D) where the interest rate terms have been reduced and/or the maturity
dates have been extended subsequent to the agreement under which the loan was
originally created due to concerns regarding the borrower's ability to pay in
accordance with such initial terms, (E) where a specific reserve allocation
exists in connection therewith, or (F) that have been classified "Doubtful,"
"Loss" or the equivalent thereof by any regulatory authority, and (ii) all
assets classified as REO and other assets acquired through foreclosure or
repossession. Other than as set forth in Section 3.16(b) of the WHB Disclosure
Schedule, WHB and the WHB Subsidiaries have no Nonperforming Assets as defined
herein.
3.17 WHB BENEFIT PLANS.
(a) Section 3.17 of the WHB Disclosure Schedule contains a list of each
compensation, consulting, employment, termination or collective bargaining
agreement, and each stock option, stock purchase, stock appreciation right,
restricted stock, life, health, accident or other insurance, bonus, deferred or
incentive compensation, severance or separation agreement or any agreement
providing any payment or benefit resulting from a change in control, profit
sharing, retirement, or other employee benefit plan,
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practice, policy or arrangement of any kind, oral or written, covering any
employee, former employee, director or former director of WHB or any WHB
Subsidiary or his or her beneficiaries, including, but not limited to, any
employee benefit plans within the meaning of Section 3(3) of ERISA, which WHB or
any WHB Subsidiary maintains, to which WHB or any WHB Subsidiary contributes, or
under which any employee, former employee, director or former director of WHB or
any WHB Subsidiary is covered or has benefit rights and pursuant to which any
liability of WHB or any WHB Subsidiary exists or is reasonably likely to occur
(the "WHB Benefit Plans"). WHB has previously delivered to HCC copies of each
WHB Benefit Plan. Except as set forth in Section 3.17 of the WHB Disclosure
Schedule, WHB and the WHB Subsidiaries neither maintain nor have entered into
any WHB Benefit Plan or other document, plan or agreement which contains any
change in control provisions which would cause an increase or acceleration of
benefits or benefit entitlements to employees or former employees of WHB or any
WHB Subsidiary or their respective beneficiaries, or other provisions, which
would cause an increase in the liability of WHB or any WHB Subsidiary or to HCC
or any HCC Subsidiary as a result of the transactions contemplated by this
Agreement or any related action thereafter (a "Change in Control Benefit"). The
term "WHB Benefit Plans" as used herein refers to all plans contemplated under
the preceding sentences of this Section 3.17, provided that the term "Plan" or
"Plans" is used in this Agreement for convenience only and does not constitute
an acknowledgment that a particular arrangement is an employee benefit plan
within the meaning of Section 3(3) of ERISA. Except as disclosed in Section 3.17
of the WHB Disclosure Schedule, no WHB Benefit Plan is a multiemployer plan
within the meaning of ERISA.
(b) Each of the WHB Benefit Plans that is intended to be a pension, profit
sharing, stock bonus, bank or savings plan that is qualified under Section
401(a) of the Code ("WHB Qualified Plans") has been determined by the IRS to
qualify under Section 401(a) of the Code, or an application for determination of
such qualification has been timely made to the IRS prior to the end of the
applicable remedial amendment period under Section 401(b) of the Code (a copy of
each such determination letter or pending application is included in Section
3.17 of the WHB Disclosure Schedule) and, to the best of WHB's knowledge, there
exist no circumstances likely to adversely affect the qualified status of any
such WHB Qualified Plan. All such WHB Qualified Plans established or maintained
by WHB or any of the WHB Subsidiaries or to which WHB or any of the WHB
Subsidiaries contribute are in compliance in all material respects with all
applicable requirements of ERISA, and are in compliance in all material respects
with all applicable requirements (including qualification and non-discrimination
requirements of the Code for obtaining the tax benefits the Code thereupon
permits with respect to such WHB Qualified Plans. Neither WHB nor any WHB
Subsidiary maintains, sponsors or contributes to a Qualified Plan that is a
defined benefit pension plan subject to Title IV of ERISA. All accrued
contributions and other payments required to be made by WHB or any WHB
Subsidiary to any WHB Benefit Plan through March 31, 2000, have been made or
reserves adequate for such purposes as of March 31, 2000, have been set aside
therefor and are reflected in the WHB Financial Statements dated as of March 31,
2000. Neither WHB nor any WHB Subsidiary is in material default in performing
any of its respective contractual obligations under any of the WHB Benefit Plans
or any related trust agreement or insurance contract, and there are no material
outstanding liabilities of any such Plan other than liabilities for benefits to
be paid to participants in such Plan and their beneficiaries in accordance with
the terms of such Plan.
(c) There is no pending or, to the best knowledge of WHB, threatened
litigation or pending claim (other than routine benefit claims made in the
ordinary course) by or on behalf of or against any of the WHB Benefit Plans (or
with respect to the administration of any such Plans) now or heretofore
maintained by WHB or any WHB Subsidiary which allege violations of applicable
state or federal law which are reasonably likely to result in a liability on the
part of WHB or any WHB Subsidiary or any such Plan.
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(d) WHB and the WHB Subsidiaries and all other persons having fiduciary or
other responsibilities or duties with respect to any WHB Benefit Plan are and
have since the inception of each such Plan been in substantial compliance with,
and each such Plan is and has been operated in substantial accordance with, its
provisions and in substantial compliance with the applicable laws, rules and
regulations governing such Plan, including, without limitation, the rules and
regulations promulgated by the Department of Labor, the PBGC and the IRS under
ERISA, the Code or any other applicable law. Notwithstanding the foregoing, no
representation is made with respect to compliance by a third party insurance
company. No "reportable event" (as defined in Section 4043(b) of ERISA) has
occurred with respect to any WHB Qualified Plan. Except as disclosed in
Section 3.17 of the WHB Disclosure Schedule, neither WHB, any WHB Subsidiary nor
any WHB Benefit Plan has incurred or is reasonably likely to incur any liability
for any "prohibited transactions" (as defined in Section 406 of ERISA or
Section 4975 of the Code), or any material liability under Section 601 of ERISA
or Section 4980 of the Code. All WHB Benefit Plans that are group health plans
have been operated in substantial compliance with the group health plan
continuation requirements of Section 4980B of the Code and Section 601 of ERISA.
(e) Except as set forth in Section 3.17 of the WHB Disclosure Schedule,
neither WHB nor any WHB Subsidiary has made any payments, or is or has been a
party to any agreement or any WHB Benefit Plan, that under any circumstances
could obligate it or its successor to make payments that are not or will not be
deductible because of Sections 162(m) or 280G of the Code.
(f) Section 3.17 of the WHB Disclosure Schedule describes any obligation
that WHB or any WHB Subsidiary has to provide health or welfare benefits to
present or future retirees or other former employees, directors or their
dependents (other than rights under Section 4980B of the Code or Section 601 of
ERISA), including information as to the number of current and vested future
retirees, other former employees or directors and dependents entitled to such
coverage and their ages, and the present value of any benefits to be provided
thereto.
(g) Section 3.17 of the WHB Disclosure Schedule lists: (1) each officer,
employee and director of WHB and any WHB Subsidiary who is eligible to receive a
Change in Control Benefit, showing the amount of each such Change in Control
Benefit, the individual's participation in any bonus or other employee benefit
plan, and such individual's compensation from WHB and each WHB Subsidiary for
each of the calendar years 1995 through 1999 as reported by WHB and a WHB
Subsidiary on Form W-2 or Form 1099; and (ii) each option agreement relating to
WHB Stock Options.
(h) To the best knowledge of WHB, WHB and the WHB Subsidiaries have filed or
caused to be filed, and will continue to file or cause to be filed, in a timely
manner all filings pertaining to each WHB Benefit Plan with the IRS, the
Department of Labor and the PBGC, as prescribed by the Code or ERISA, or
regulations issued thereunder. To the best knowledge of WHB, all such filings,
as amended, were complete and accurate in all material respects as of the dates
of such filings. Notwithstanding the foregoing, no representation is made with
respect to filings by a third party insurance company.
3.18 COMPLIANCE WITH ENVIRONMENTAL LAWS.
(a) Except as set forth in Section 3.18 of the WHB Disclosure Schedule:
(i) the operations of WHB and each of the WHB Subsidiaries comply in all
material respects with all applicable past and present Environmental Laws;
(ii) to the best knowledge of WHB, none of the operations of WHB or any WHB
Subsidiary, no assets presently or formerly owned or leased by WHB or any WHB
Subsidiary and no Mortgaged Premises or Participating Facility are subject to
any judicial or administrative proceedings alleging the violation of any past or
present Environmental Law, nor are they the subject of any claims alleging
damages to health or property, pursuant to which WHB, any WHB Subsidiary or any
owner of a Mortgaged Premises or a Participating Facility would be liable in law
or equity;
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(iii) none of the operations of WHB or any WHB Subsidiary, no assets presently
owned or, to the best knowledge of WHB, formerly owned by WHB or any WHB
Subsidiary, and to the best knowledge of WHB, no Mortgaged Premises or a
Participating Facility are the subject of any federal, state or local
investigation evaluating whether any remedial action is needed to respond to a
release or threatened release of any Hazardous Substance, or any other substance
into the environment, nor has WHB or any WHB Subsidiary, or, to the best
knowledge of WHB, any owner of a Mortgaged Premises or a Participating Facility
been directed to conduct such investigation, formally or informally, by any
governmental agency, nor have any of them agreed with any governmental agency or
private person to conduct any such investigation; and (iv) neither WHB nor any
WHB Subsidiary, nor, to the best knowledge of WHB, any owner of a Mortgaged
Premises or a Participating Facility has filed any notice under any
Environmental Law indicating past or present treatment, storage or disposal of a
Hazardous Substance or reporting a spill or release of a Hazardous Substance, or
any other substance into the environment.
(b) With respect to the real property currently owned or, to the best
knowledge of WHB, formerly owned or currently leased by WHB or any WHB
Subsidiary ("WHB Premises"): (x) no part of the WHB Premises has been used for
the generation, manufacture, handling, storage, or disposal of Hazardous
Substances; (y) except as disclosed in Section 3.18 of the WHB Disclosure
Schedule, the WHB Premises do not contain, and have never contained, an
underground storage tank; and (z) the WHB Premises do not contain and are not
contaminated by any quantity of a Hazardous Substance from any source. With
respect to any underground storage tank listed in Section 3.18 of the WHB
Disclosure Statement as an exception to the foregoing, such underground storage
tank has been removed in compliance with the Environmental Laws, and has not
been the source of any release of a Hazardous Substance into the environment,
unless otherwise set forth in Section 3.18 of the WHB Disclosure Schedule.
3.19 CONTRACTS AND COMMITMENTS. Section 3.19 of the WHB Disclosure
Schedule contains, and shall be supplemented by WHB, as required by
Section 5.10 hereof, so as to contain at the Closing Date copies of each of the
following documents:
(a) a list and description of each outstanding loan agreement, mortgage,
pledge agreement or other similar document or commitment to extend credit to any
officer or director of WHB or any WHB Subsidiary, as well as a listing of all
deposits or deposit surrogates, including the amount, type and interest being
paid thereon, to which WHB or any WHB Subsidiary is a party under which it may
(contingently or otherwise) have any liability involving any officer or director
of WHB or any WHB Subsidiary;
(b) a list and description of each outstanding letter of credit and each
commitment to issue a letter of credit in excess of $25,000 to which WHB or any
WHB Subsidiary is a party and/or under which it may (contingently or otherwise)
have any liability;
(c) a list and description of each contract or agreement (not otherwise
included in the WHB Disclosure Schedule or specifically excluded therefrom in
accordance with the terms of this Agreement) involving goods, services or
occupancy and which (i) has a term of more than six months; (ii) cannot be
terminated on 30 days (or less) written notice without penalty; and
(iii) involves an annual expenditure by WHB or any WHB Subsidiary in excess of
$25,000;
(d) a list and description of each contract or commitment (other than WHB
Permitted Liens as defined in Section 3.21(c) hereof) affecting ownership of,
title to, use of, or any interest in real property which is currently owned by
WHB or any WHB Subsidiary, and a list and description of all real property
owned, leased or licensed by WHB or any WHB Subsidiary;
(e) a list of all fees, salaries, bonuses and other forms of compensation
including but not limited to, country club memberships, automobiles available
for personal use, and credit cards available for
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personal use, provided by WHB or any WHB Subsidiary to any employee, officer or
director or former employee, officer or director of WHB or any WHB Subsidiary
who is expected to earn in salary and bonus in excess of $75,000 during calendar
year 2000;
(f) a list and description of each commitment made by WHB or any WHB
Subsidiary to or with any of its officers, directors or employees extending for
a period of more than six months from the date hereof or providing for earlier
termination only upon the payment of a penalty or equivalent thereto;
(g) the Articles of Incorporation and Bylaws WHB and each WHB Subsidiary;
(h) a list and description of each, other contract or commitment providing
for payment based in any manner upon outstanding loans or profits of WHB or any
WHB Subsidiary;
(i) a list and description of all powers of attorney granted by WHB or any
WHB Subsidiary which are currently in force;
(j) a list and description of all policies of insurance currently maintained
by WHB or any WHB Subsidiary and a list and description of all unsettled or
outstanding claims of WHB or any WHB Subsidiary which have been, or to the best
knowledge of WHB, will be, filed with the companies providing insurance coverage
for WHB or any WHB Subsidiary (except for routine claims for health benefits);
(k) each collective bargaining agreement to which WHB or any WHB Subsidiary
is a party and all affirmative action plans or programs covering employees of
WHB or any WHB Subsidiary, as well as all employee handbooks, policy manuals,
rules and standards of employment promulgated by WHB or any WHB Subsidiary;
(l) each lease or license with respect to real or personal property, whether
as lessor, lessee, licensor or licensee, with annual rental or other payments
due thereunder in excess of $10,000 to which WHB or any WHB Subsidiary is a
party, which does not expire within six months from the date hereof and cannot
be terminated upon 30 days (or less) written notice without penalty;
(m) all employment, consulting, financial advisory, investment banking, and
professional services contracts to which WHB or any WHB Subsidiary is a party;
(n) all judgments, orders, injunctions, court decrees or settlement
agreements arising out of or relating to the labor and employment practices or
decisions of WHB or any WHB Subsidiary which, by their terms, continue to bind
or affect WHB or any WHB Subsidiary;
(o) all orders, decrees, memorandums, agreements or understandings with
regulatory agencies binding upon or affecting the current operations of WHB or
any WHB Subsidiary or any of their directors or officers in their capacities as
such;
(p) all trademarks, trade names, service marks, patents, or copyrights,
whether registered or the subject of an application for registration, which are
owned by WHB or any WHB Subsidiary or licensed from a third party;
(q) all policies formally adopted by the Board of Directors of WHB or any
WHB Subsidiary as currently in effect with respect to environmental matters and
copies of all policies that have been in effect during the last five years
regarding the performance of environmental investigations of properties accepted
as collateral for loans, including the effective dates of all such policies; and
(r) each other agreement to which WHB or any WHB Subsidiary is a party
(which does not expire within six months from the date hereof and cannot be
terminated upon 30 days (or less) written notice without penalty) which
individually during its term could commit WHB or any WHB Subsidiary to an
expenditure (either individually or through a series of installments) in excess
of $25,000 or which
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creates a material right or benefit to receive payments, goods or services not
referred to elsewhere in this Section 3.19 including without limitation:
(i) each agreement of guaranty or indemnification running to any person;
(ii) each agreement containing any covenant limiting the right of WHB or
any WHB Subsidiary to engage in any line of business or to compete with any
person;
(iii) each agreement with respect to any license, permit and similar
matter that is necessary to the operations of WHB or any WHB Subsidiary;
(iv) each agreement that requires the consent or approval of any other
party in order to consummate the Merger;
(v) each agreement relating to the servicing of loans and each mortgage
forward commitment and similar agreement pursuant to which WHB or any WHB
Subsidiary sells to others mortgages which it originates;
(vi) each contract relating to the purchase or sale of financial or
other futures, or any put or call option relating to cash, securities or
commodities and each interest rate swap agreement or other agreement
relating to the hedging of interest rate risks and each agreement or
arrangement described in Section 3.15(d) hereof, and
(vii) each contract or agreement (with the exception of the Federal
National Mortgage Association or Federal Home Loan Mortgage Corporation
WHB's Guide), including but not limited to each contract or agreement
pursuant to which WHB or any WHB Subsidiary has sold, transferred, assigned
or agreed to service any loan, which provides for any recourse or
indemnification obligation on the part of WHB or any WHB Subsidiary; the
name and address of each person which might or could be entitled to recourse
against or indemnification from WHB or any WHB Subsidiary; and the monetary
amount of each actual or potential recourse or indemnification obligation
under each such contract or agreement.
3.20 DEFAULTS. There has not been any default in any material obligation
to be performed by WHB or any WHB Subsidiary under any contract or commitment,
and neither WHB nor or any WHB Subsidiary has waived, and will not waive prior
to the Effective Time, any material right under any contract or commitment. To
the best knowledge of WHB, no other party to any contract or commitment is in
default in any material obligation to be performed by such party.
3.21 OPERATIONS SINCE DECEMBER 31, 1999. Between December 31, 1999 and the
date hereof, except as set forth in Section 3.21 of the WHB Disclosure Schedule,
there has not been:
(a) any increase in the compensation payable or to become payable by WHB or
any WHB Subsidiary to any employee, officer or director, other than routine
annual increases to rank and file employees consistent with past practices;
(b) any payment of dividends or other distributions by WHB to its
stockholders or any redemption by WHB of its capital stock;
(c) any mortgage, pledge or subjection to lien, charge or encumbrance of any
kind of or on any asset, tangible or intangible, of WHB or any WHB Subsidiary,
except the following (each of which, whether arising before or after the date
hereof, is herein referred to as a "WHB Permitted Lien"): (i) liens arising out
of judgments or awards in respect of which WHB or any WHB Subsidiary is in good
faith prosecuting an appeal or proceeding for review and in respect of which it
has secured a subsisting stay of execution pending such appeal of proceeding;
(ii) liens for taxes, assessments, and other governmental charges or levies, the
payment of which is not past due, or as to which WHB or any WHB Subsidiary is
diligently contesting in good faith and by appropriate proceeding either the
amount thereof or the liability therefor or both; (iii) deposits, liens or
pledges to secure payments of
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worker's compensation, unemployment insurance, pensions, or other social
security obligations, or the performance of bids, tenders, leases, contracts
(other than contracts for the payment of money), public or statutory
obligations, surety, stay or appeal bonds, or similar obligations arising in the
ordinary course of business; (iv) zoning restrictions, easements, licenses and
other restrictions on the use of real property or any interest therein, or minor
irregularities in title thereto, which do not materially impair the use of such
property or the merchantability or the value of such property or interest
therein; (v) purchase money mortgages or other purchase money or vendor's liens
or security interests (including, without limitation, finance leases), provided
that no such mortgage, lien or security interest shall extend to or cover any
other property of WHB or any WHB Subsidiary other than that so purchased; and
(vi) pledges and liens given to secure deposits and other liabilities of WHB or
any WHB Subsidiary arising in the ordinary course of business;
(d) any creation or assumption of indebtedness (including the extension or
renewal of any existing indebtedness, or the increase thereof) by WHB or any WHB
Subsidiary for borrowed money, or otherwise, other than in the ordinary course
of business, none of which is in default;
(e) the establishment of any new, modification of or amendment to, or
increase in the formula for contributions to or benefits under, any WHB Benefit
Plan by WHB or any WHB Subsidiary;
(f) any action by WHB or any WHB Subsidiary seeking any cancellation of, or
decrease in the insured limit under, or increase in the deductible amount or the
insured's retention (whether pursuant to coinsurance or otherwise) of or under,
any policy of insurance maintained directly or indirectly by WHB or any WHB
Subsidiary on any of their respective assets or businesses, including but not by
way of limitation, fire and other hazard insurance on its assets, automobile
liability insurance, general public liability insurance, and directors' and
officers' liability insurance; and if an insurer takes any such action, WHB
shall promptly notify HCC;
(g) any change in WHB's independent auditors, historic methods of accounting
(other than as required by generally accepted accounting principles or
regulatory accounting principles), or in its system for maintaining its
equipment and real estate;
(h) any purchase, whether for cash or secured or unsecured obligations
(including finance leases) by WHB or any WHB Subsidiary of any fixed asset which
either (1) has a purchase price individually or in the aggregate in excess of
$50,000 or (ii) is outside of the ordinary course of business;
(i) any sale or transfer of any asset in excess of $50,000 of WHB or any WHB
Subsidiary or outside of the ordinary course of business with the exception of
loans and marketable securities that are held for sale and sold in the ordinary
course of business at market prices;
(j) any cancellation or compromise of any debt to, claim by or right of, WHB
or any WHB Subsidiary except in the ordinary course of business;
(k) any amendment or termination of any contract or commitment to which WHB
or any WHB Subsidiary is a party, other than in the ordinary course of business;
(l) any material damage or destruction to any assets or property of WHB or
any WHB Subsidiary whether or not covered by insurance;
(m) any change in the loan underwriting policies or practices of any WHB
Subsidiary;
(n) any transaction of business or activity undertaken by WHB or any WHB
Subsidiary outside the ordinary course of business consistent with past
practices;
(o) any agreement or commitment to do any of the foregoing; or
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(p) any event or condition of any character (other than changes in legal,
economic or other conditions which are not specially or uniquely applicable to
WHB or any WHB Subsidiary) adversely affecting the business, operations or
financial condition of WHB on a consolidated basis.
3.22 CORPORATE RECORDS. The corporate record books, transfer books and
stock ledgers of WHB and each WHB Subsidiary are complete and accurate in all
material respects and reflect all meetings, consents and other material actions
of the organizers, incorporators, stockholders, Boards of Directors and
committees of the Boards of Directors of WHB and each such Subsidiary, and all
transactions in their respective capital stocks, since their respective
inceptions.
3.23 UNDISCLOSED LIABILITIES. All of the known Liabilities have, in the
case of WHB and the WHB Subsidiaries, been reflected, disclosed or reserved
against in the WHB Financial Statements as of December 31, 1999 or in the notes
thereto, and WHB and the WHB Subsidiaries have no other Liabilities except
(a) Liabilities incurred since December 31, 1999 in the ordinary course of
business or (b) as disclosed in Section 3.23 of the WHB Disclosure Schedule.
3.24 ASSETS.
(a) WHB and the WHB Subsidiaries have good and marketable title to their
real properties, including any leaseholds and ground leases, and their other
assets and properties, all as reflected as owned or held by WHB or any WHB
Subsidiary in the WHB Financial Statements and those acquired since
December 31, 1999, except for (i) assets and properties since disposed of in the
ordinary course of business and (ii) WHB Permitted Liens none of which, in the
aggregate, except as set forth in the WHB Financial Statements dated
December 31, 1999 or in Section 3.24 of the WHB Disclosure Schedule, are
material to the assets of WHB on a consolidated basis. All buildings,
structures, fixtures and appurtenances comprising part of the real properties of
WHB and the WHB Subsidiaries (whether owned or leased) are, in the opinion of
management of WHB, in good operating condition and have been well maintained,
reasonable wear and tear excepted. Title to all real property owned by WHB and
the WHB Subsidiaries is held in fee simple, except as otherwise noted in the WHB
Financial Statements as of December 31, 1999 or as set forth in Section 3.24 of
the WHB Disclosure Schedule. WHB and the WHB Subsidiaries have title or other
rights to its assets sufficient in all material respects for the conduct, of
their respective businesses as presently conducted, and except as set forth in
the WHB Financial Statements dated as of December 31, 1999 or in Section 3.24 of
the WHB Disclosure Schedule, such assets are free, clear and discharged of and
from any and all liens, charges, encumbrances, security interests and/or
equities which are material to WHB or any WHB Subsidiary.
(b) All leases pursuant to which WHB or any WHB Subsidiary, as lessee,
leases real or personal property are, to the best knowledge of WHB, valid,
effective, and enforceable against the lessor in accordance with their
respective terms. There is not under any of such leases any existing default, or
any event which with notice or lapse of time or both would constitute a default,
with respect to either WHB or any WHB Subsidiary, or to the best knowledge of
WHB, the other party. Except as disclosed in Section 3.24 of the WHB Disclosure
Schedule, none of such leases contains a prohibition against assignment by WHB
or any WHB Subsidiary, by operation of law or otherwise, or any other provision
which would preclude the surviving corporation or resulting institution or any
WHB Subsidiary from possessing and using the leased premises for the same
purposes and upon the same rental and other terms upon the consummation of the
Merger as are applicable to the use by WHB or any WHB Subsidiary as of the date
of this Agreement.
3.25 INDEMNIFICATION. To the best knowledge of WHB, except as set forth in
Section 3.25 of the WHB Disclosure Schedule, no action or failure to take action
by any director, officer, employee or agent of WHB or any WHB Subsidiary has
occurred which would give rise to a claim by any such person for indemnification
from WHB or any WHB Subsidiary under the corporate indemnification provisions of
WHB or any WHB Subsidiary in effect on the date of this Agreement.
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3.26 INSIDER INTERESTS. All outstanding loans and other contractual
arrangements (including deposit relationships) between WHB or any WHB Subsidiary
and any officer, director or employee of WHB or any WHB Subsidiary conform to
the applicable rules and regulations and requirements of all applicable
regulatory agencies which were in effect when such loans and other contractual
arrangements were entered into. Except as set forth in Section 3.26 of the WHB
Disclosure Schedule, no officer, director or employee of WHB or any WHB
Subsidiary has any material interest in any property, real or personal, tangible
or intangible, used in or pertaining to the business of WHB or any WHB
Subsidiary.
3.27 REGISTRATION OBLIGATIONS. Except as set forth in Section 3.27 of the
WHB Disclosure Schedule, neither WHB nor any WHB Subsidiary is under any
obligation, contingent or otherwise, which will survive the Effective Time by
reason of any agreement to register any of its securities under the Securities
Act or other federal or state securities laws or regulations.
3.28 REGULATORY, TAX AND ACCOUNTING MATTERS. WHB has not to its best
knowledge taken nor will it knowingly agree to take any action, nor does it have
knowledge of any fact or circumstance, that would (i) materially impede or delay
the consummation of the transactions contemplated by this Agreement or the
ability of the parties to obtain any approval of any regulatory authority
required for the transactions contemplated by this Agreement or to perform their
covenants and agreements under this Agreement or (ii) prevent the Merger from
qualifying as a pooling of interests for accounting purposes or from qualifying
as a reorganization within the meaning of Section 368(a) of the Code.
3.29 BROKERS AND FINDERS. Except as set forth in the agreement with Baxter
Fentriss and Company (which agreement has not been amended since such date), a
copy of which has previously been provided to HCC, neither WHB nor any WHB
Subsidiary nor any of their respective officers, directors or employees has
employed any broker or finder or incurred any liability for any financial
advisory fees, brokerage fees, commissions or finders' fees, and no other broker
or finder has acted directly or indirectly for WHB or any WHB Subsidiary in
connection with this Agreement or the transactions contemplated hereby.
3.30 ACCURACY OF INFORMATION. The statements of WHB contained in this
Agreement, the Schedules hereto and in any other written document executed and
delivered by or on behalf of WHB or Bank of Los Altos pursuant to the terms of
this Agreement are true and correct in all material respects.
3.31 FAIRNESS OPINION. WHB has received from Baxter Fentriss and Company a
fairness opinion, dated as of the date of this Agreement, to the effect that the
Exchange Ratio is fair to the holders of WHB Common Stock from a financial point
of view.
3.32 GOVERNMENTAL APPROVALS AND OTHER CONDITIONS. To the best knowledge of
WHB, there is no reason relating specifically to WHB or any of its Subsidiaries
why (a) the approvals that are required to be obtained from regulatory
authorities having approval authority in connection with the transactions
contemplated hereby should not be granted, (b) such regulatory approvals should
be subject to a condition which would differ from conditions customarily imposed
by such regulatory authorities in orders approving acquisitions of the type
contemplated hereby or (c) any of the conditions precedent as specified in
Article VI hereof to the obligations of any of the parties hereto to consummate
the transactions contemplated hereby are unlikely to be fulfilled within the
applicable time period or periods required for satisfaction of such condition or
conditions.
3.33 YEAR 2000 COMPLIANT. All computer software and hardware utilized by
WHB or any WHB Subsidiary is Year 2000 compliant, which, for purposes of this
Agreement, shall mean that the data outside the range 1900-1999 will be
correctly processed in any level of computer hardware or software including, but
not limited to, microcode, firmware, applications programs, files and data
bases. All computer software is designed to be used prior to, during, and after
the calendar year 2000 A.D., and
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such software will operate during each such time period without error relating
to date data, specifically including any error relating to, or the product of,
date data that represents or referenced different centuries or more than one
century.
ARTICLE IV
COVENANTS
4.1 BUSINESS IN ORDINARY COURSE.
(a) Without the prior written consent of HCC, WHB shall not declare or pay
any dividend or make any other distribution with respect to its capital stock
whether in cash, stock or other property, after the date of this Agreement.
(b) The parties hereto and their respective subsidiaries shall continue to
carry on, after the date hereof, their respective businesses and the discharge
or incurring of obligations and liabilities, only in the usual, regular and
ordinary course of business, as heretofore conducted, and by way of
amplification and not limitation, will not, without the prior written consent of
the other party hereto:
(i) issue any capital stock or, (A) other than HCC options granted in
the ordinary course or (B) other than options (in each case not to exceed
1,000 options) granted by WHB to newly hired employees, any options,
warrants, or other rights to subscribe for or purchase capital stock or any
securities convertible into or exchangeable for any capital stock, except
pursuant to the WHB Stock Options outstanding on the date hereof,
(ii) directly or indirectly redeem, purchase or otherwise acquire any
capital stock or ownership interests of the parties or their respective
subsidiaries;
(iii) effect a reclassification, recapitalization, split-up, exchange of
shares, readjustment or other similar change in or to any capital stock or
otherwise reorganize or recapitalize;
(iv) change their Articles of Incorporation, or Bylaws;
(v) except in the ordinary course of its business, borrow or agree to
borrow any funds, including but not limited to repurchase transactions, or
indirectly guarantee or agree to guarantee any obligations of others;
(vi) make any material changes in policies concerning loan underwriting
or which persons may approve loans;
(vii) knowingly or willfully commit any act or fail to commit any act
which will cause a material breach of any agreement, contract or commitment;
(viii) engage in any activity or transaction outside the ordinary course
of business;
(ix) enter into or acquire any derivatives contract or structured note;
(x) enter into any new, or modify, amend or extend the terms of any
existing contracts relating to the purchase or sale of financial or other
futures, or any put or call option relating to cash, securities or
commodities or any interest rate swap agreements or other agreements
relating to the hedging of interest rate risk;
(xi) take any action that would (A) materially impede or delay the
consummation of the transactions contemplated by this Agreement or the
ability of the parties hereto to obtain any approval of any regulatory
authority required for the transactions contemplated by this Agreement or to
perform its covenants and agreements under this Agreement or (B) prevent the
Merger from qualifying as a pooling of interests for accounting purposes or
as a reorganization within the meaning of Section 368 of the Code; or
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(xii) agree in writing or otherwise to take any of the foregoing actions
or engage in any of the foregoing activities.
(c) In addition to those obligations set forth in Section 4.1(b), WHB and
WHB's Subsidiaries will not, without the prior written consent of HCC (which
consent in the case of subparts (vii) and (ix) below shall not be unreasonably
withheld or delayed):
(i) enter into or modify any employment agreement, severance agreement,
change of control agreement, or plan relative to the foregoing; or grant any
increase (other than ordinary and normal increases to rank and file
employees consistent with past practices) in the compensation payable or to
become payable to directors, officers or employees except as required by
law, pay or agree to pay or accrue for any bonus, or adopt or make any
change in any bonus, insurance, pension, or other WHB Benefit Plan;
(ii) make or commit to make any new loan or letter of credit, or any new
or additional discretionary advance under any existing loan or line of
credit, or restructure any existing loan or line of credit (A) which, under
the Bank of Los Altos loan policy requires approval by its board of
directors or any committee thereof without the prior written consent of HCC
acting through its Chief Executive Officer or Chief Credit Officer in a
written notice to WHB, which approval or rejection shall be given on a
timely basis after delivery by WHB to such officer of HCC of the complete
loan package, or (B) as to any loans or extensions of credit not by policy
reviewed by the Bank of Los Altos board or a committee thereof (x) in the
case of a consumer loan or extension of credit, in a principal amount in
excess of $350,000 or that would increase the aggregate credit outstanding
in this category to any one borrower (or group of affiliated borrowers), to
more than $350,000, or (y) in the case of a commercial loan or mortgage in a
principal amount in excess of $1,000,000 or that would increase the
aggregate credit outstanding in this category to any one borrower (or group
of affiliated borrowers) to more than $1,000,000, without first having
submitted the credit request to HCC's Chief Credit Officer for review and
comment prior to approval by Bank of Los Altos;
(iii) enter into any securities transaction for its own account or
purchase, or otherwise acquire any investment security for its own account
other than U.S. Treasury obligations with maturities of less than one year
and deposits in an overnight account at the FRB of San Francisco or the
Federal Home Loan Bank of San Francisco, provided HCC's consent shall not be
unreasonably withheld or delayed relating to the purchase of other readily
marketable investment securities;
(iv) increase or decrease the rate of interest paid on time deposits or
on certificates of deposit, except in a manner and pursuant to policies
consistent with past practices;
(v) enter into, modify or extend any agreement, contract or commitment
out of the ordinary course of business or having a term in excess of six
months and involving an expenditure in excess of $10,000, other than letters
of credit, loan agreements, deposit agreements, and other lending, credit
and deposit documents made in the ordinary course of business;
(vi) except in the ordinary course of business, place on any of its
assets or properties any mortgage, pledge, lien, charge, or other
encumbrance;
(vii) sell or otherwise dispose of any real property or any material
amount of tangible or intangible personal property other than (A) properties
acquired in foreclosure or otherwise in the ordinary collection of
indebtedness owed to Bank of Los Altos, or (B) loans which are held for sale
by Bank of Los Altos and are sold in the secondary market within 60 days of
origination or (C) SBA loans sold in a manner consistent with the past
practices of WHB;
(viii) foreclose upon or otherwise take title to or possession or control
of any real property without first obtaining, a phase one environmental
report thereon; provided, however, that Bank of
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Los Altos and its Subsidiaries shall not be required to obtain such a report
with respect to single family, non-agricultural residential property of one
acre or less to be foreclosed upon unless it has reason to believe that such
property might contain Hazardous Substances;
(ix) purchase any real or personal property or make any capital
expenditure where the amount paid or committed therefor is in excess of
$25,000, except for outstanding commitments set forth in Section 3.19 of the
WHB Disclosure Schedule;
(x) in the case of Bank of Los Altos, voluntarily make any material
changes in or to its asset and deposit mix;
(d) Neither HCC nor WHB and the respective subsidiaries shall, without the
prior written consent of the other party, engage in any transaction or take any
action that would render untrue any of their respective representations and
warranties (as to WHB contained in Article III and as to HCC contained in
Article II hereof), if such representations and warranties were given as of the
date of such transaction or action.
(e) HCC and WHB will, and will cause their respective subsidiaries to, use
their best efforts to maintain their respective properties and assets in their
present state of repair, order and condition, reasonable wear and tear excepted,
and to maintain and keep in full force and effect all policies of insurance
presently in effect, including insurance of accounts with the FDIC. WHB will,
and will cause the WHB Subsidiaries to, take all requisite action (including
without limitation the making of claims and the giving of notices) pursuant to
their respective directors' and officers' liability insurance policy or policies
in order to preserve all rights thereunder with respect to all matters which
could reasonably give rise to a claim prior to the Effective Time.
(f) The parties hereto shall promptly notify each other in writing of the
occurrence of any matter or event known to and directly that is reasonably
likely to result in a Material Adverse Effect or impair the ability of a party
or its subsidiaries to consummate the transactions contemplated herein.
(g) The parties hereto shall provide such reports on litigation as
reasonably necessary to understand the nature and materiality of such litigation
as it relates to such party, provided that neither party shall be required to
divulge information to the extent that, in the good faith opinion of its
counsel, by doing so, it would risk waiver of the attorney-client privilege to
its detriment.
(h) WHB shall obtain insurance to provide adequate coverage, to the
satisfaction of HCC, for any matter disclosed in Section 3.11 of the WHB
Disclosure Schedule for which WHB or any WHB Subsidiary has an obligation to
provide indemnity to a current or former officer or director of WHB or any WHB
Subsidiary.
4.2 CONFORMING ACCOUNTING AND RESERVE POLICIES; RESTRUCTURING EXPENSES. At
the request of HCC, Bank of Los Altos agrees immediately prior to Closing and
after satisfaction or waiver of the conditions to Closing set forth in Article
VI hereof, to establish and take such reserves and accruals as HCC reasonably
shall request to conform Bank of Los Altos' loan, accrual, reserve and other
accounting policies to the policies of HCC, provided however, such requested
conforming adjustments shall not be taken into account in determining whether
WHB has experienced a Material Adverse Effect.
4.3 CERTAIN ACTIONS.
(a) Neither WHB nor any WHB Subsidiaries (i) shall solicit, initiate,
participate in discussions of, or encourage or take any other action to
facilitate (including by way of the disclosing or furnishing of any information
that it is not legally obligated to disclose or furnish) any inquiry or the
making of any proposal relating to any Acquisition Proposal (as defined below)
with respect to itself or any of its Subsidiaries or (ii) shall (A) solicit,
initiate, participate in discussions of, or encourage or take any other action
to facilitate any inquiry or proposal, or (B) enter into any agreement,
arrangement, or
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understanding (whether written or oral) regarding any proposal or transaction
providing for or requiring it to abandon, terminate or fail to consummate this
Agreement, or any of its Subsidiaries under any of the instances described in
this clause. WHB shall immediately instruct and otherwise use their best efforts
to cause their directors, officers, employees, agents, advisors (including,
without limitation, any investment banker, attorney, or accountant retained by
it or any of its Subsidiaries), consultants and other representatives to comply
with such prohibitions. WHB shall immediately cease and cause to be terminated
any existing activities, discussions, or negotiations with any parties conducted
heretofore with respect to such activities. Notwithstanding the foregoing, WHB
may provide information at the request of or enter into negotiations with a
third party with respect to an Acquisition Proposal if the Board of Directors of
WHB determines, in good faith after consultation with counsel, that the exercise
of its fiduciary duties to WHB's stockholders under applicable law requires it
to take such action, and, provided further, that WHB may not, in any event,
provide to such third party any information which it has not provided to HCC.
WHB shall promptly notify HCC orally and in writing in the event it receives any
such inquiry or proposal and shall provide reasonable detail of all relevant
facts relating to such inquiries. This Section shall not prohibit accurate
disclosure by WHB in any document (including the Joint Proxy Statement and the
Registration Statement) or other disclosure under applicable law if in the
opinion of the Board of Directors of WHB, disclosure is appropriate under
applicable law.
(b) "Acquisition Proposal" shall mean any of the following (other than the
Merger): (i) a merger or consolidation, or any similar transaction of any
company with either WHB or HCC or any Subsidiary of WHB or HCC, (ii) a purchase
lease or other acquisition of a material portion of all the assets of either WHB
or HCC or any Subsidiary of WHB or HCC, (iii) a purchase or other acquisition of
"beneficial ownership" by any "person" or "group" (as such terms are defined in
Section 13(d)(3) of the Exchange Act) (including by way of merger,
consolidation, share exchange, or otherwise) which would cause such person or
group to become the beneficial owner of securities representing 25% or more of
the voting power of either WHB or HCC or any Subsidiary of WHB or HCC, (iv) a
tender or exchange offer to acquire securities representing 25% or more of the
voting power of WHB or HCC, (v) a public proxy or consent solicitation made to
stockholders of WHB or HCC seeking proxies in opposition to any proposal
relating to any of the transactions contemplated by this Agreement, (vi) the
filing of an application or notice with the DFI or any other federal or state
regulatory authority (which application has been accepted for processing)
seeking approval to engage in one or more of the transactions referenced in
clauses (i) through (iv) above, or (vii) the making of a bona fide offer to the
Board of Directors WHB or Bank of Los Altos or HCC by written communication,
that is or becomes the subject of public disclosure, to engage in one or more of
the transactions referenced in clauses (i) through (v) above.
(c) HCC is not now engaged in, nor will it prior to the termination or
consummation of this Agreement without prior notification to WHB engage in,
activities, discussions, or negotiations with any parties conducted heretofore
with respect to an Acquisition Proposal. Notwithstanding the foregoing, HCC may
provide information at the request of or enter into negotiations with a third
party with respect to an Acquisition Proposal if the Board of Directors of HCC
determines, in good faith after consultation with counsel, that the exercise of
its fiduciary duties to HCC's stockholders under applicable law requires it to
take such action, and, provided further, that HCC may not, in any event, provide
to such third party any information which it has not provided to WHB.
ARTICLE V
ADDITIONAL AGREEMENTS
5.1 INSPECTION OF RECORDS; CONFIDENTIALITY.
(a) HCC and WHB shall each afford to the other and to the other's
accountants, counsel and other representatives (and their Subsidiaries) full
access during normal business hours during the
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period prior to the Effective Time to all of their respective properties, books,
contracts, commitments and records, including all attorneys' responses to
auditors' requests for information, and accountants' work papers, developed by
either of them or their respective Subsidiaries or their respective accountants
or attorneys, and will permit each other and their respective representatives to
discuss such information directly with each other's officers, directors,
employees, attorneys and accountants. HCC and WHB shall each use their best
efforts to furnish to the other all other information concerning its business,
properties and personnel as such other party may reasonably request; however,
such access may be limited by the party from whom access is sought so as to
avoid unreasonable disruption or interference with such party's business
operations, as such party may reasonably determine. Any failure to comply with
this covenant shall be disregarded if promptly corrected without material
adverse consequences to the other party. The availability or actual delivery of
information shall not affect the representations, warranties, covenants, and
agreements of the party providing such information that are contained in this
Agreement or in any certificates or other documents delivered pursuant hereto.
(b) All information disclosed by any party to any other party to this
Agreement, whether prior or subsequent to the date of this Agreement including,
without limitation, any information obtained pursuant to this Section 5.1, shall
be kept confidential by such other party and shall not be used by such other
party otherwise as herein contemplated. In the event that this Agreement is
terminated, each party shall return all documents furnished hereunder, shall
destroy all documents or portions thereof prepared by such other party that
contain information furnished by another party pursuant hereto and, in any
event, shall hold all information confidential unless or until such information
is or becomes a matter of public knowledge.
5.2 REGISTRATION STATEMENT; STOCKHOLDER APPROVAL. As soon as practicable
after the date hereof, HCC shall file the Registration Statement with the SEC,
and WHB and HCC shall use their best efforts to cause the Registration Statement
to become effective under the Securities Act. HCC will take any action required
to be taken under the applicable blue sky or securities laws in connection with
the issuance of the shares of HCC Common Stock in the Merger. Each party shall
furnish all information concerning it and the holders of its capital stock as
the other party may reasonably request in connection with such action. HCC and
WHB shall each call a meeting of their respective stockholders as soon as
reasonably practicable after the date of this Agreement for the purpose of
voting upon this Agreement and the Merger. In connection with the stockholders'
meetings, (i) HCC and WHB shall jointly prepare their proxy statements as part
of the Registration Statement and WHB shall mail their proxy statements to their
respective stockholders, (ii) each of the WHB's and HCC's Board of Directors
shall recommend to their respective stockholders the approval of this Agreement
and the Merger, and (iii) if deemed necessary by the parties, shall retain a
professional proxy solicitation firm to assist in securing the necessary
approval.
5.3 AGREEMENTS OF AFFILIATES. As soon as practicable after the date of
this Agreement, WHB shall deliver to HCC a letter, reviewed by its counsel,
identifying all persons whom WHB believes to be "affiliates" of WHB for purposes
of Rule 145 under the Securities Act or for purposes of qualifying for pooling
of interests accounting treatment for the Merger. WHB shall use its best efforts
to cause each person who is so identified as an "affiliate" to deliver to HCC,
as soon as practicable thereafter, a written agreement, in the form of Exhibit
E, providing that from the date of such agreement each such person will agree
not to sell, pledge, transfer or otherwise dispose of, or reduce risk with
respect to, any shares of stock of WHB held by such person or any shares of HCC
Common Stock to be received by such person in the Merger except in compliance
with the applicable provisions of the Securities Act and other applicable laws
and regulations. Prior to the Effective Time, WHB shall amend and supplement
such letter and use its best efforts to cause each additional person who is
identified as an "affiliate" to execute a written agreement as set forth in this
Section 5.3.
5.4 EXPENSES. Each party hereto shall bear its own expenses incident to
preparing, entering into and carrying out this Agreement and to consummating the
Merger. Notwithstanding the foregoing,
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HCC and WHB will share equally all third party printing costs incurred with
respect to the Registration Statement and Joint Proxy Statement in preliminary
and final form. Further notwithstanding the foregoing and in addition to any
other remedy afforded by this Agreement, in the event that the transactions
contemplated by this Agreement are not consummated, WHB shall be responsible for
reimbursing HCC's legal fees in investigating litigation issues and insurance
coverage for matters disclosed in Section 3.11 of the WHB Disclosure Schedule
and for the cost of binding insurance coverage for insurance that is required
pursuant to Section 4.1(h) hereof; provided, however, the obligation to
reimburse the legal fees and insurance binder shall not exceed in the aggregate
$100,000.
5.5 COOPERATION. Each party covenants that it will use its best efforts to
bring about the transactions contemplated by this Agreement as soon as
practicable, unless this Agreement is terminated as provided herein. Subject to
the terms and conditions herein provided, each of the parties hereto agrees to
use all reasonable efforts to take, or cause to be taken, all action, and to do,
or cause to be done, all things necessary, proper or advisable under applicable
laws and regulations to consummate and make effective the transactions
contemplated by this Agreement at the earliest practicable time. In case at any
time after the Effective Time any further action is necessary or desirable to
carry out the purposes of this Agreement, the proper officers and/or directors
of the parties, shall take all such necessary action. Each party shall use its
reasonable best efforts to preserve for itself and the other parties hereto each
available legal privilege with respect to the confidentiality of their
negotiations and related communications, including the attorney-client
privilege.
5.6 REGULATORY APPLICATIONS. The parties shall, as soon as practicable
after the date of this Agreement, file all necessary applications with all
applicable regulatory authorities and shall use their best efforts to respond as
promptly as practicable to all inquiries received concerning said applications.
In the event the Merger is challenged or opposed by any administrative or legal
proceeding, whether by the United States Department of Justice or otherwise, the
determination of whether and to what extent to seek appeal or review,
administrative or otherwise, or other appropriate remedies shall be made by HCC
after consultation with WHB. The party filing an application shall deliver a
copy thereof to the other parties hereto in advance of filing and copies of all
responses from or written communications from regulatory authorities relating to
the Merger or this Agreement (to the extent permitted by law), and the filing
party shall also deliver a final copy of each regulatory application to the
other parties promptly after it is filed with the appropriate regulatory
authority. Each party shall advise the other parties periodically of the status
of each regulatory application.
5.7 FINANCIAL STATEMENTS AND REPORTS. From the date of this Agreement and
prior to the Effective Time: (a) WHB will deliver to HCC not later than 45 days
after the end of any fiscal quarter, the quarterly report filed by Bank of Los
Altos with the DFI; (b) HCC and WHB shall deliver to each other not later than
45 days after the end of each quarter, its Report on Form 10-Q for such quarter
as filed with the SEC, which shall be prepared in conformity with generally
accepted accounting principles and the rules and regulations of the SEC; and (c)
each party will deliver to the others any and all other material reports filed
with the SEC, the FDIC, the DFI, the FRB, or any other regulatory agency within
five business days of the filing of any such report.
5.8 NOTICE. At all times prior to the Effective Time, each party shall
promptly notify the other in writing of the occurrence of any event known to it
which will or may result in the failure to satisfy any of the conditions
specified in Sections 6.1 or 6.2 hereof. In the event that any party becomes
aware of the occurrence or impending occurrence of any event which would
constitute or cause a breach by it of any of its representations and warranties,
covenants or agreements herein in any material respect, or would have
constituted or caused a breach by it of its representations and warranties,
covenants or agreements herein in any respect, had such an event occurred or
been known prior to the date hereof, said party shall immediately give detailed
and written notice thereof to the other parties, and shall, unless the same has
been waived in writing by the other parties, use its reasonable efforts to
remedy
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the same within 30 days, provided that such efforts, if not successful, shall
not be deemed to satisfy any condition precedent to the Merger.
5.9 PRESS RELEASE. Except as otherwise reasonably determined by a party to
be necessary to comply with its legal obligations, at all times prior to the
Effective Time, the parties shall mutually agree to the issuance of any press
release or other information to the press or any third party for general
circulation with respect to this Agreement or the transactions contemplated
hereby.
5.10 DELIVERY OF SUPPLEMENTS TO DISCLOSURE SCHEDULES. Five business days
prior to the Effective Time, each party will supplement or amend its Disclosure
Schedule with respect to any matter hereafter arising which, if existing or
occurring at or prior to the date of this Agreement, would have been required to
be set forth or described in such Disclosure Schedule or which is necessary to
correct any information in the Disclosure Schedule or in any representation and
warranty made by the disclosing party which has been rendered inaccurate
thereby. For purposes of determining the accuracy of the representations and
warranties of HCC and WHB contained, respectively, in Articles II and III hereof
in order to determine the fulfillment of the conditions set forth in Section
6.1(a) and 6.2(a) hereof as of the date of this Agreement, the Disclosure
Schedule of each party shall be deemed to include only that information
contained therein on the date it is initially delivered to the other party.
5.11 LITIGATION MATTERS. WHB will consult with HCC about any proposed
settlement, or any disposition of, any litigation involving amounts in excess of
$10,000.
5.12 WRITTEN AGREEMENTS WITH EMPLOYEES; BENEFITS AND RELATED MATTERS.
(a) NEW EMPLOYEE AGREEMENTS. Immediately prior to the Effective Time, HCC
shall enter into new agreements with employees identified in Schedule 5.12
hereto, which agreements shall be executed prior to the Effective Time (the "New
Employee Agreements"). Pursuant to the New Employee Agreements, at the Effective
Time, all employment contracts or similar agreements theretofore existing
between WHB or any WHB Subsidiary shall terminate and be replaced by the New
Employee Agreements. At the Effective Time, neither WHB or any WHB Subsidiary
nor HCC or any HCC Subsidiary shall make, and shall not be in any manner
obligated to make, any payment whatsoever to any director or employee of WHB or
any WHB Subsidiary under any circumstance in which such payment is not or will
not be deductible under Section 162(m) or Section 280G of the Code.
(b) EMPLOYEE BENEFITS. The parties agree that the WHB Benefit Plans shall
be terminated, frozen, modified or merged into the employee benefit plans of HCC
on or after the Effective Time in accordance with applicable laws and
regulations and at the Effective Time, WHB employees who become employees of HCC
or HCC Subsidiaries will commence participation in HCC's employee benefit plans
in accordance with the terms and conditions provided under such plans (i) with
full credit for prior service with WHB or any of the WHB Subsidiaries for all
purposes other than determining the amount of benefit accruals under any defined
benefit plan, (ii) without any waiting periods, evidence of insurability, or
application of any pre-existing condition limitations, and (iii) with full
credit for claims arising prior to the Effective Time for purposes of
deductibles, out of pocket maximums, benefit maximums, and all other similar
limitations for the applicable plan year during which the Merger is consummated.
Each of HCC and WHB shall use all reasonable efforts to insure that no amounts
paid or payable by WHB, the WHB Subsidiaries, or HCC with respect to any
employee or former employee of WHB or any WHB Subsidiary will fail to be
deductible for federal income tax purposes by reason of Section 162(m) or 280G
of the Code. WHB shall vigorously enforce all "cutback" provisions related to
any contract that could give rise to a payment that would arguably exceed the
limitations of Section 162(m) or 280G.
5.13 DIRECTORS' AND OFFICERS' INDEMNIFICATION INSURANCE. HCC agrees that
the Merger shall not affect or diminish any of WHB's or Bank of Los Altos'
duties and obligations of indemnification existing immediately prior to the
Effective Time in favor of the directors, officers, employees and
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agents of WHB or Bank of Los Altos arising by virtue of the Articles of
Incorporation, Charter or Bylaws of WHB or Bank of Los Altos in the form in
effect at the date of this Agreement or arising by operation of law, and such
duties and obligations shall continue in full force and effect for so long as
they would (but for the Merger) otherwise survive and continue in full force and
effect. All provisions for indemnification and limitation of liability now
existing in favor of the employees, agents, directors or officers of WHB, Bank
of Los Altos or WHB Subsidiaries, as provided by law or regulation or in their
respective Articles of Incorporation or Bylaws shall survive the Merger, shall
be assumed by HCC and shall continue in full force and, effect with respect to
acts or omissions occurring prior to the Effective Time for a period of three
years thereafter or in the case of matters occurring prior to the Effective Time
which have not been resolved prior to the third anniversary of the Effective
Time, until such matters are finally resolved. HCC, respectively, shall also
purchase and keep in force for such three year period director's and officer's
liability insurance and fiduciary liability insurance to provide coverage for
acts or omissions of the type and in the amount currently covered by WHB's
existing directors and officers liability insurance and fiduciary liability
insurance for acts or omissions occurring prior to the Effective Time, provided
that the cost of such coverage does not exceed 150% of WHB's present annual
premium cost, and further provided that HCC may substitute or cause WHB to
substitute therefor single premium tail coverage with policy limits equal to
Bank of Los Altos' existing annual coverage limits. The obligations of HCC
hereunder shall be conditioned on the performance by WHB of its obligations
pursuant to Section 4.1(h) hereof.
5.14 BEST EFFORTS TO INSURE POOLING. Each of HCC, WHB and Bank of Los
Altos undertakes and agrees to use its best efforts to cause the Merger to
qualify for pooling of interests accounting treatment.
5.15 TRADE NAME RIGHTS. From and after the Effective Time, HCC shall
possess all rights with respect to any and all trade names used by WHB or any
WHB Subsidiary including, without limitation, "Bank of Los Altos" or any variant
thereof.
5.16 ENVIRONMENTAL REPORTS. WHB shall cooperate with HCC so that HCC may
as soon as reasonably practicable obtain, at HCC's expense, a report of a phase
one environmental investigation on all real property owned, leased or operated
by WHB or any of the WHB Subsidiaries as of the date hereof (but excluding
property held in trust or in a fiduciary capacity and space in retail or similar
establishments leased by WHB or any of the WHB Subsidiaries for automatic teller
machines or bank branch facilities where the space leased comprises less than
20% of the total space leased to all tenants of such property) and within ten
days after the acquisition or lease of any real property acquired or leased by
WHB or any of the WHB Subsidiaries after the date hereof (but excluding space in
retail and similar establishments leased by WHB or any of the WHB Subsidiaries
for automatic teller machines or bank branch facilities where the space leased
comprises less than 20% of the total space leased to all tenants of such
property). If advisable in light of the phase one report with respect to any
parcel of real property referred to above, in the reasonable opinion of HCC, WHB
shall also cooperate with HCC so that HCC may obtain, at HCC's expense, a phase
two investigation report on such designated parcels. HCC shall have 15 business
days from the receipt of any such phase two investigation report to notify WHB
of any dissatisfaction with the contents of such report.
5.17 STOCK OPTION AGREEMENTS.
(a) As a condition and inducement to HCC's willingness to enter into this
Agreement, WHB will simultaneously with execution of this Agreement execute and
deliver to HCC a Stock Option Agreement in the form attached hereto as Exhibit B
by which WHB grants to HCC an option to purchase shares of WHB Common Stock
constituting 19.9% of the presently outstanding shares of WHB Common Stock.
(b) As a condition and inducement to WHB's willingness to enter into this
Agreement, HCC will simultaneously with execution of this Agreement execute and
deliver to WHB a Stock Option
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Agreement in the form attached hereto as Exhibit C by which HCC grants to WHB an
option to purchase shares of HCC Common Stock constituting 19.9% of the
presently outstanding shares of HCC Common Stock.
ARTICLE VI
CONDITIONS
6.1 CONDITIONS TO THE OBLIGATIONS OF HCC. Notwithstanding any other
provision of this Agreement, the obligations of HCC to consummate the Merger are
subject to the following conditions precedent (except as to those which HCC may
choose to waive):
(a) all of the representations and warranties made by WHB in this Agreement
and in any documents or certificates provided by WHB shall have been true and
correct in all material respects as of the date of this Agreement and as of the
Effective Time as though made on and as of the Effective Time;
(b) WHB shall have performed in all material respects all obligations and
shall have complied in all material respects with all agreements and covenants
required by this Agreement to be performed or complied with by them prior to or
at the Effective Time;
(c) there shall not have been any action taken or any statute, rule,
regulation or order enacted, promulgated or issued or deemed applicable to the
Merger by any federal or state government or governmental agency or
instrumentality or court, which would prohibit ownership or operation of all or
a material portion of the assets of WHB on a consolidated basis by HCC or would
compel HCC to dispose of all or a material portion of the assets of WHB on a
consolidated basis, as a result of this Agreement, or which would render any
party hereto unable to consummate the transactions contemplated by this
Agreement;
(d) since the date hereof, WHB shall not have suffered a Material Adverse
Effect;
(e) no regulatory authority shall impose any non-standard or unduly
burdensome condition relating to the Merger such that it would substantially
deprive HCC of the economic benefits of the Merger, as determined in the
reasonable judgment of HCC;
(f) HCC shall have received the opinion of Sheppard, Mullin, Richter &
Hampton, LLP, counsel to WHB, in the form of the attached Exhibit F;
(g) HCC shall have received a certificate signed by the President and Chief
Executive Officer of WHB, dated as of the Effective Time, certifying that based
upon his best knowledge, the conditions set forth in Sections 6.1 (a), (b) and
(d) hereof have been satisfied;
(h) simultaneous with the execution and delivery of this Agreement, the
directors of WHB who are stockholders of WHB shall have executed and delivered
to HCC Voting Agreements in the form attached hereto as Exhibit D;
(i) HCC shall have received the written affiliates' agreements described in
Section 5.3 hereof and in the form attached hereto as Exhibit E;
(j) Dissenting Shares shall not exceed 9% of the issued and outstanding WHB
Common Stock;
(k) HCC shall have received as of the Closing Date an opinion of Deloitte &
Touche, LLP, satisfactory in form and substance to HCC, to the effect that the
parties hereto and the Merger will qualify for pooling of interests accounting
treatment, which opinion shall not have been withdrawn and HCC shall have
received as of the Closing Date a copy of an opinion addressed to WHB from
Arthur Andersen, LLP, to the effect that the parties hereto and the Merger will
qualify for pooling of interests accounting treatment;
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(l) WHB shall have obtained the insurance required pursuant to Section
4.1(h) hereof; and
(m) the New Employee Agreements shall have been duly executed by employees
identified in Schedule 5.12.
6.2 CONDITIONS TO THE OBLIGATIONS OF WHB. Notwithstanding any other
provision of this Agreement, the obligations of WHB to consummate the Merger are
subject to the following conditions precedent (except as to those which WHB may
choose to waive):
(a) all of the representations and warranties made by HCC in this Agreement
and in any documents or certificates provided by HCC shall have been true and
correct in all material respects as of the date of this Agreement and as of the
Effective Time as though made on and as of the Effective Time;
(b) HCC shall have performed in all material respects all obligations and
shall have complied in all material respects with all agreements and covenants
required by this Agreement to be performed or complied with by it prior to or at
the Effective Time;
(c) since the date hereof, HCC shall not have suffered a Material Adverse
Effect;
(d) WHB shall have received the opinion of McCutchen Doyle Brown & Enersen,
LLP, counsel to HCC, in the form attached hereto as Exhibit G;
(e) WHB shall have received a certificate signed by the President and Chief
Executive Officer of HCC, dated as of the Effective Time, that based upon his
best knowledge, the conditions set forth in Sections 6.2(a), (b) and (c) have
been satisfied; and
(f) WHB shall have received as of the Closing Date an opinion of Arthur
Andersen, LLP, satisfactory in form and substance to HCC, to the effect that the
parties hereto and the Merger will qualify for pooling of interests accounting
treatment, which opinion shall not have been withdrawn and WHB shall have
received as of the Closing Date a copy of an opinion addressed to HCC from
Deloitte & Touche, LLP to the effect that the parties hereto and the Merger will
qualify for pooling of interests accounting treatment;
6.3 CONDITIONS TO THE OBLIGATIONS OF THE PARTIES. Notwithstanding any
other provision of this Agreement, the obligations of HCC on the one hand, and
WHB on the other hand, to consummate the Merger are subject to the following
conditions precedent (except as to those which HCC and WHB may choose to waive):
(a) no preliminary or permanent injunction or other order by any federal or
state court which prevents the consummation of the Merger shall have been issued
and shall remain in effect; nor shall there be any third party proceeding
pending to prevent the consummation of the Merger;
(b) the parties shall have received all applicable regulatory approvals and
consents (including without limitation, if appropriate, approval by the FRB of
HCC as a "Bank Holding Company" as that term is defined in the BHCA) to
consummate the transactions contemplated in this Agreement, and all required
waiting periods shall have expired;
(c) the Registration Statement shall have been declared effective under the
Securities Act and no stop orders shall be in effect and no proceedings for such
purpose shall be pending or threatened by the SEC and, if the offering for sale
of the HCC Common Stock in the Merger pursuant to this Agreement is subject to
the securities laws of any state, the Registration Statement shall not be
subject to a stop order of any state securities authority;
(d) each of HCC and WHB shall have received from McCutchen Doyle Brown &
Enersen, LLP, an opinion reasonably satisfactory in form and substance to it to
the effect that the Merger will constitute a reorganization within the meaning
of Section 368 or the Code and that no gain or loss will
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be recognized by the stockholders of WHB to the extent that they receive HCC
Common Stock solely in exchange for shares of WHB Common Stock;
(e) the HCC Common Stock to be issued to holders of WHB Common Stock shall
have been approved for listing on the NASDAQ National Market subject to official
notice of issuance; and
(f) the respective shareholders of WHB and HCC shall have approved the
Merger.
ARTICLE VII
TERMINATION; AMENDMENT; WAIVER
7.1 TERMINATION. This Agreement may be terminated at any time prior to the
Effective Time:
(a) By the mutual written consent of the Boards of Directors of HCC and WHB;
(b) By HCC or WHB if there shall have been a final judicial or regulatory
determination (as to which all periods for appeal shall have expired and no
appeal shall be pending) that any material provision of this Agreement is
illegal, invalid or unenforceable (unless the enforcement thereof is waived by
the affected party) or denying any regulatory application the approval of which
is a condition precedent to a party's obligations hereunder;
(c) By HCC or WHB before the date specified in 7.1(f) hereof, in the event
that any of the conditions precedent to the obligations of the other party to
the Merger are rendered impossible to be satisfied or fulfilled by said date
(other than by reason of a breach by the party seeking to terminate);
(d) By HCC or WHB at any time after the stockholders of HCC or WHB fail to
approve this Agreement and the Merger by the Required Vote at the Stockholders'
Meetings;
(e) By HCC or WHB, in the event of a material breach by the other party of
any representation, warranty, covenant or agreement contained herein or in any
schedule or document delivered pursuant hereto, which breach would result in the
failure to satisfy the closing condition set forth in Section 6.1(a) or 6.1(b)
in the case of HCC, or Section 6.2(a) or 6.2(b) in the case of WHB, and which
breach cannot be or is not cured within 30 days after written notice of such
breach is given by the non-breaching party to the party committing such breach;
(f) By HCC or WHB on or after November 30, 2000, in the event the Merger has
not been consummated by such date (provided, however, that the right to
terminate under this Section 7.1(f) shall not be available to any party whose
failure to perform an obligation hereunder has been the cause of, or has
resulted in, the failure of the Merger to occur on or before such date); or
(g) By the Board of Directors of WHB, if the Board of Directors so
determines by a vote of a majority of the members of its entire Board, at any
time during the two-Business Day period commencing on the first Business Day
after the Determination Date (as defined herein) if the Average HCC Closing
Price shall be less than eight dollars ($8.00). If WHB elects to exercise its
termination right pursuant to the immediately preceding sentence, it shall give
prompt written notice to HCC during such two-Business Day period by means of
facsimile transmission (as provided in Section 8.2 hereof); provided that such
notice of election to terminate may be withdrawn at any time within the
aforementioned two-Business Day period. During the five Business-Day period
commencing on the day after receipt of such notice of election to terminate, HCC
shall have the option of adjusting the Per Share Stock Consideration as follows:
(i) multiply 3,760,000 times 8.00 and divide the product by the Average HCC
Closing Price the result of which shall be the "Adjusted HCC Shares" and (ii)
the Exchange Ratio shall then be re-calculated by dividing the Adjusted HCC
Shares by the total outstanding shares of WHB plus all outstanding WHB stock
options. If HCC makes the election contemplated by the preceding sentence,
within such five Business-Day period, it shall give prompt written notice to WHB
of such election and the revised Exchange Ratio, whereupon no termination shall
have occurred pursuant to this paragraph (g) and this Agreement shall remain in
effect in
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accordance with its terms (except as the Exchange Ratio shall have been so
modified), and any references in this Agreement to "Exchange Ratio" shall
thereafter be deemed to refer to the Exchange Ratio as adjusted pursuant to this
paragraph (g).
For purposes hereof, the following terms have the following meanings:
(i) "Average HCC Closing Price" shall mean the average of the closing
prices of HCC Common Stock on NASDAQ National Market for the 20 consecutive
trading days ending on the Determination Date, rounded to four decimal
places, whether or not trades occurred on those days (subject to adjustment
as provided below and provided that if no trades of HCC Common Stock shall
occur on a given trading day the closing price thereof on the next preceding
day when a trade shall have occurred shall be deemed to be the closing price
on such day for the purposes hereof). In the event HCC pays, declares or
otherwise effects a stock split, reverse stock split, reclassification or
stock dividend or stock distribution with respect to HCC Common Stock
between the date of this Agreement and the Effective Time, appropriate
adjustments will be made to the Average HCC Closing Price of HCC Common
Stock.
(ii) "Determination Date" shall mean the date on which HCC gives WHB
notice of the approval by FRB required for consummation of the Merger shall
be received.
(iii) "Trading Day" shall mean day on which trading generally takes place
on NASDAQ National Market and on which trading in HCC Common Stock has not
been halted or suspended.
In the event a party elects to effect any termination pursuant to Section
7.1(b) through 7.1(g) above, it shall give written notice to the other party
hereto specifying the basis for such termination and certifying that such
termination has been approved by the vote of a majority of the members of its
Board of Directors.
7.2 LIABILITIES AND REMEDIES LIQUIDATED DAMAGES.
(a) In the event that this Agreement is terminated by a party (the
"Aggrieved Party") solely by reason of the material breach by the other party
("Breaching Party") of any of its representations, warranties, covenants or
agreements contained herein then the Aggrieved Party shall be entitled to such
remedies and relief against the Breaching Party as are available at law or in
equity. Moreover, the Aggrieved Party without terminating this Agreement shall
be entitled to specifically enforce the terms hereof against the Breaching Party
in order to cause the Merger to be consummated. Each party acknowledges that
there is not an adequate remedy at law to compensate the other parties relating
to the non-consummation of the Merger. To this end, each party, to the extent
permitted by law, irrevocably waives any defense it might have based on the
adequacy of a remedy at law which might be asserted as a bar to specific
performance, injunctive relief or other equitable relief.
(b) In the event that the WHB Stockholders' Meeting does not take place, the
Board of Directors of WHB fails to recommend approval of this Agreement and the
Merger to the stockholders of WHB, or such Board of Directors shall adversely
alter or modify its favorable recommendation of this Agreement and the Merger to
the stockholders of WHB, and this Agreement and the Merger is not approved by
the stockholders of WHB by the WHB Required Vote, and HCC is not, as of the date
of such event, in material breach of this Agreement, then, upon termination of
this Agreement, WHB shall pay HCC in immediately available funds $2,000,000 as
an agreed upon liquidated damages and as the sole and exclusive remedy of HCC.
In order to obtain the benefit of the expense reimbursement and liquidated
damages provided in this Section 7.2(b), HCC shall be required to execute a
waiver of their rights under Section 7.2(a) above, and shall not have taken any
action to enforce any light that they might have under Section 7.2(a) hereof.
(c) In the event that an Acquisition Proposal occurs between the date hereof
and the time of the WHB Stockholders' Meeting and the stockholders of WHB fail
to approve this Agreement and the
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Merger under circumstances where the Board of Directors of WHB continuously
maintained its favorable recommendation of this Agreement and the Merger, and
HCC was not, as of the date of such action, in material breach of this
Agreement, then if a definitive agreement relating to an Acquisition Proposal is
executed by WHB or any WHB Subsidiary, or an Acquisition Proposal is
consummated, in either case within 15 months after the termination of this
Agreement, then upon the happening of such event WHB shall be obligated to pay
HCC a cash amount of $2,000,000 as an agreed upon liquidated damages and as the
sole and exclusive remedy of HCC. There shall be no duplication of remedy under
this Section 7.2(c) and 7.2(b). In order to obtain the benefit of the liquidated
damages provided in this Section 7.2(c), HCC shall be required to execute a
waiver of their rights under Section 7.2(a) above, and shall not have taken any
action to enforce any right that they might have under Section 7.2(a) hereof
(d) In the event that all of the conditions precedent to the consummation of
the Merger in Article VI have been satisfied or would be satisfied by the
delivery of documents which are under the control of HCC and HCC in material
breach of this Agreement refuses to consummate the Merger, or if HCC otherwise
willfully abandons the Merger in material breach of this Agreement, then in
either case, HCC shall pay WHB liquidated damages in the cash amount of
$2,000,000 as their sole and exclusive remedy against HCC. In order to pursue
the liquidated damage remedy provided in this subsection, WHB shall be required
to execute a waiver of their rights under Section 7.2(a) hereof and shall have
not have taken any action to enforce any right that they might have under
Section 7.2(a) hereof.
7.3 SURVIVAL OF AGREEMENTS. In the event of termination of this Agreement
by either HCC or WHB as provided in Section 7.1, this Agreement shall forthwith
become void and have no effect except that the agreements contained in Sections
5.1(b), 5.4 and 7.2 hereof shall survive the termination hereof.
7.4 AMENDMENT. This Agreement may be amended by the parties hereto by
action taken by their respective Boards of Directors at any time before or after
approval hereof by the stockholders of WHB but, after such approval, no
amendment shall be made which changes the form of consideration or the value of
the consideration to be received by the stockholders of WHB without the approval
of the stockholders of WHB. This Agreement may not be amended except by an
instrument in writing signed on behalf of each of the parties hereto. The
parties may, without approval of their respective Boards of Directors, make such
technical changes to this Agreement, not inconsistent with the purposes hereof
as may be required to effect or facilitate any regulatory approval or acceptance
of the Merger or of this Agreement or to effect or facilitate any regulatory or
governmental filing or recording required for the consummation of any of the
transactions contemplated hereby.
7.5 WAIVER. Any term, provision or condition of this Agreement (other than
the requirement of WHB stockholder approval) may be waived in writing at any
time by the party which is entitled to the benefits hereof each and every right
granted to any party hereunder, or under any other document delivered in
connection herewith or therewith, and each and every right allowed it by law or
equity, shall be cumulative and may be exercised from time to time. The failure
of a party at any time or times to require performance of any provision hereof
shall in no manner affect such party's right at a later time to enforce the
same. No waiver by any party of a condition or of the breach of any term,
covenant, representation or warranty contained in this Agreement, whether by
conduct or otherwise, in any one or more instances shall be deemed to be or
construed as a further or continuing waiver of any such condition or breach or a
waiver of any other condition or of the breach of any other term, covenant,
representation or warranty of this Agreement. No investigation, review or audit
by a party of another party prior to or after the date hereof shall stop or
prevent such party from exercising any right hereunder or be deemed to be a
waiver of any such right.
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ARTICLE VIII
GENERAL PROVISIONS
8.1 SURVIVAL. All representations, warranties, covenants and agreements of
the parties in this Agreement or in any instrument delivered by the parties
pursuant to this Agreement (other than the agreements, covenants and obligations
set forth herein which are contemplated to be performed after the Effective
Time) shall not survive the Effective Time.
8.2 NOTICES. All notices and other communications hereunder shall be in
writing and shall be deemed given if delivered personally, by facsimile
transmission or by registered or certified mail to the parties at the following
addresses (or at such other address for a party as shall be specified by like
notice) and shall be deemed to be delivered on the date so delivered:
(a) if to HCC:
Heritage Commerce Corp
150 Almaden Boulevard
San Jose, CA 95113
Attention: John E. Rossell III, President & CEO
Facsimile: (408) 947-1054
copy to:
McCutchen Doyle Brown & Enersen
3 Embarcadero Center
San Francisco, CA 94111
Attention: James M. Rockett
Facsimile: (415) 393-2286
(b) if to WHB:
Western Holdings Bancorp
4546 El Camino Real
Los Altos, CA 94022
Attention: James Wall, President
Facsimile: (650) 941-8739
copy to:
Sheppard Mullin Richter & Hampton, LLP
4 Embarcadero Center
San Francisco, CA 94111
Attention: John Sears
Facsimile: (415) 434-3947
8.3 APPLICABLE LAW. This Agreement shall be construed and interpreted
according to the laws of the State of California without regard to conflicts of
laws principles thereof, except to the extent that the federal laws of the
United States apply.
8.4 HEADINGS, ETC. The article headings and section headings contained in
this Agreement are inserted for convenience only and shall not affect in any way
the meaning or interpretation of this Agreement.
8.5 SEVERABILITY. If any term, provision, covenant, or restriction
contained in this Agreement is held by a final and unappealable order of a court
of competent jurisdiction to be invalid, void, or unenforceable, then the
remainder of the terms, provisions, covenants, and restrictions contained in
this
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Agreement shall remain in full force and effect, and shall in no way be
affected, impaired, or invalidated unless the effect would be to cause this
Agreement to not achieve its essential purposes.
8.6 ENTIRE AGREEMENT; BINDING EFFECT; NON-ASSIGNMENT; COUNTERPARTS. Except
as otherwise expressly provided herein, this Agreement (including the documents
and instruments referred to herein) (a) constitutes the entire agreement between
the parties hereto and supersedes all other prior agreements and undertakings,
both written and oral, between the parties, with respect to the subject matter
hereof; and (b) is not intended to confer upon any other person any rights or
remedies hereunder except as specifically provided herein. This Agreement shall
be binding upon and inure to the benefit of the parties named herein and their
respective successors. Neither this Agreement nor any of the rights, interests
or obligations hereunder shall be assigned by any party hereto without the prior
written consent of the other party hereto. This Agreement may be executed in two
or more counterparts which together shall constitute a single agreement.
The undersigned have caused this Agreement to be executed as of the day and
year first above written.
<TABLE>
<S> <C> <C> <C>
HERITAGE COMMERCE CORP
By
-----------------------------------------
President and Chief Executive Officer
WESTERN HOLDINGS BANCORP BANK OF LOS ALTOS
By By
----------------------------------------- -----------------------------------------
Chairman and Chief Executive Officer President and Chief Executive Officer
</TABLE>
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<PAGE>
APPENDIX B1
May 9, 2000
Members of the Board of Directors
Heritage Commerce Corp.
150 Almaden Boulevard
San Jose, California 95113
Members of the Board:
You have requested our opinion as investment bankers as to the fairness,
from a financial point of view, to the holders of the outstanding shares of
Common Stock, no par value, of Heritage Commerce Corp. ("HTBK") of the Exchange
Ratio, as defined in Section 1.3(a) of the Agreement and Plan of Merger and
Reorganization dated as of May 9, 2000 (the "Agreement"), in the proposed merger
(the "Merger") of Heritage Commerce Corp. ("HTBK") and Western Holdings Bancorp
("Western").
Hoefer & Arnett Incorporated, as part of its investment banking business, is
continually engaged in the valuation of businesses and their securities in
connection with mergers and acquisitions, negotiated underwritings, competitive
biddings, secondary distributions of listed and unlisted securities, private
placements and valuations for estate, corporate and other purposes. Hoefer &
Arnett Incorporated provides a full range of financial advisory and securities
services and, in the course of its normal trading activities, may from time to
time effect transactions and hold securities, of HTBK or Western for its own
account and for the accounts of customers. We are familiar with HTBK having
acted as its financial advisor in connection with the Merger.
In connection with this opinion, we have reviewed, among other things, the
Agreement; the Annual Report to Shareholders of HTBK for the years ended
December 31, 1997 and 1998; the consolidated financial report of Western for the
years ended December 31, 1998 and 1999; Annual Report on Form 10-K of HTBK for
the year ended December 31, 1999; FFIEC Report of Bank of Los Altos for the year
ended December 31, 1999; certain interim reports to shareholders and Quarterly
Report on Form 10-Q of HTBK; certain other communications from HTBK and Western
to the their respective shareholders; and certain internal financial analyses
and forecasts for HTBK and Western prepared by their respective managements
including forecasts for certain costs savings and revenue opportunities (the
"Synergies") expected to be achieved as a result of the Merger. We also have
held discussions with members of the senior management of HTBK and Western
regarding the strategic rationale for, and the potential benefits of, the Merger
and the past and current business operations, regulatory relationships,
financial condition and future prospects of their respective companies. In
addition, we have reviewed the reported price and trading activity for the
shares of HTBK and Western, compared certain financial and stock market
information for HTBK and Western with similar information for certain other
companies the securities of which are publicly traded, reviewed the financial
terms of certain recent business combinations in the commercial banking industry
and performed such other studies and analyses as we considered appropriate.
We have relied upon the accuracy and completeness of all of the financial
and other information reviewed by us and have assumed such accuracy and
completeness for purposes of rendering this opinion. In that regard, we have
assumed, with your consent, that the financial forecasts, including, without
limitation, the Synergies and projections regarding under-performing and
non-performing assets and net charge-offs have been reasonably prepared on a
basis reflecting the best currently available judgments and estimates of HTBK
and Western and that such forecasts will be realized in the amounts and at the
times contemplated thereby. We are not experts in the evaluation of loan and
lease portfolios for purposes of assessing the adequacy of the allowances for
losses with respect thereto and
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<PAGE>
have assumed, with your consent, that such allowances for each of HTBK and
Western are in the aggregate adequate to cover all such losses. In addition, we
have not reviewed individual credit files nor have we made an independent
evaluation or appraisal of the assets and liabilities of HTBK, Western or any of
their subsidiaries and we have not been furnished with any such evaluation or
appraisal. We also have assumed, with your consent, that the Merger will be
accounted for as a pooling of interests under generally accepted accounting
principles and that obtaining any necessary regulatory approvals and third party
consents for the Merger or otherwise will not have a material adverse effect on
HTBK, Western, or the combined company pursuant to the Merger. In addition, our
opinion does not address the relative merits of the Merger as compared to any
alternative business transaction that might be available to HTBK.
Our advisory services and the opinion expressed herein are provided for the
information and assistance of the Board of Directors of HTBK in connection with
its consideration of the Merger and such opinion does not constitute a
recommendation as to how any holder of shares of HTBK should vote with respect
to such transaction.
Based upon and subject to the foregoing and based upon such other matters as
we consider relevant, it is our opinion that as of the date hereof the Exchange
Ratio pursuant to the Agreement is fair from a financial point of view to the
holders of the outstanding shares of Common Stock of Heritage Commerce Corp.
Very truly yours,
HOEFER & ARNETT INCORPORATED
B1-2
<PAGE>
APPENDIX B2
May 9, 2000
The Board of Directors
Western Holdings Bancorp
4546 El Camino Real
Los Altos, CA 94022
Dear Members of the Board:
Western Holdings Bancorp, Los Altos, California, ("WHB") and Heritage
Commerce Corp, San Jose, California, ("HCC") have entered into an agreement
providing for the merger of WHB into HCC through an exchange of shares
("Merger"). The terms of the Merger are set forth in the Agreement and Plan of
Merger and Reorganization ("Agreement") dated May 9, 2000.
The terms of the Merger provide that, with the possible exception of those
shares as to which dissenter's rights may be perfected, each share of WHB common
stock, no par value, will be exchanged for the right to receive shares of HCC
common stock, no par value, equal to 3,760,000 divided by the sum of the total
outstanding shares of WHB plus all of WHB's stock options (the "Exchange
Ratio"), subject to certain adjustments.
You have asked our opinion as to whether the Exchange Ratio is fair to the
respective shareholders of WHB from a financial point of view.
In rendering our opinion, we have evaluated the consolidated financial
statements of WHB and HCC available to us from published sources. In addition,
we have, among other things: (a) to the extent deemed relevant, analyzed
selected public information of certain other financial institutions and compared
WHB and HCC from a financial point of view to the other financial institutions;
(b) compared the terms of the Merger with the terms of certain other comparable
transactions to the extent information concerning such acquisitions was publicly
available; (c) reviewed the Agreement and related documents; (d) reviewed the
historical market price of WHB's common stock and HCC's common stock; and
(e) made such other analyses and examinations as we deemed necessary. We also
met with various senior officers of WHB and HCC to discuss the foregoing as well
as other matters that may be relevant.
We have not independently verified the financial and other information
concerning WHB or HCC, or other data which we have considered in our review. We
have assumed the accuracy and completeness of all such information, however, we
have no reason to believe that such information is not accurate and complete.
Our conclusion is rendered on the basis of securities market conditions
prevailing as of the date hereof and on the conditions and prospects, financial
and otherwise, of WHB and HCC as they exist and are known to us as of March 31,
2000.
We have acted as financial advisor to WHB and in connection with the Merger
and will receive from WHB a fee for our services, a significant portion of which
is contingent upon the consummation of the Merger.
It is understood that this opinion may be included in its entirety in any
communication by WHB or the Board of Directors to the shareholders of WHB. The
opinion may not, however, be summarized, excerpted from or otherwise publicly
referred to without our prior written consent.
Based on the foregoing, and subject to the limitations described above, we
are of the opinion that the Exchange Ratio is fair to the shareholders of WHB
from a financial point of view.
Sincerely,
Baxter Fentriss and Company
B2-1
<PAGE>
APPENDIX C
CHAPTER 13 OF THE CALIFORNIA GENERAL CORPORATION CODE
SECTION 1300. RIGHT TO REQUIRE PURCHASE--"DISSENTING SHARES" AND "DISSENTING
SHAREHOLDER" DEFINED.
(a) If the approval of the outstanding shares (Section 152) of a corporation
is required for a reorganization under subdivisions (a) and (b) or subdivision
(e) or (f) of Section 1201, each shareholder of the corporation entitled to vote
on the transaction and each shareholder of a subsidiary corporation in a
short-form merger may, by complying with this chapter, require the corporation
in which the shareholder holds shares to purchase for cash at their fair market
value the shares owned by the shareholder which are dissenting shares as defined
in subdivision (b). The fair market value shall be determined as of the day
before the first announcement of the terms of the proposed reorganization or
short- form merger, excluding any appreciation or depreciation in consequence of
the proposed action, but adjusted for any stock split, reverse stock split or
share dividend which becomes effective thereafter.
(b) As used in this chapter, "dissenting shares" means shares which come
within all of the following descriptions:
(1) Which were not immediately prior to the reorganization or short-form
merger either (A) listed on any national securities exchange certified by
the Commissioner of Corporations under subdivision (o) of Section 25100 or
(B) listed on the list of National Market System of the NASDAQ Stock Market,
and the notice of meeting of shareholders to act upon the reorganization
summarizes this section and Sections 1301, 1302, 1303 and 1304; provided,
however, that this provisions does not apply to any shares with respect to
which there exists any restriction on transfer imposed by the corporation or
by any law or regulation; and provided, further, that this provision does
not apply to any class of shares described in subparagraph (A) or (B) if
demands for payment are filed with respect to 5 percent or more of the
outstanding shares of that class.
(2) Which were outstanding on the date for the determination of
shareholders entitled to vote on the reorganization and (A) were not voted
in favor of the reorganization or, (B) if described in subparagraph (A) or
(B) of paragraph (1) (without regard to the provisos in that paragraph),
were voted against the reorganization, or which were held of record on the
effective date of a short-form merger; provided, however, that subparagraph
(A) rather than subparagraph (B) of this paragraph applies in any case where
the approval required by Section 1201 is sought by written consent rather
than at a meeting.
(3) Which the dissenting shareholder has demanded that the corporation
purchase at their fair market value, in accordance with Section 1301.
(4) Which the dissenting shareholder has submitted for endorsement, in
accordance with Section 1302.
(c) As used in this chapter, "dissenting shareholder" means the
recordholder of dissenting shares and includes a transferee of record.
SECTION 1301. DEMAND FOR PURCHASE.
(a) If, in the case of a reorganization, any shareholders of a corporation
have a right under Section 1300, subject to compliance with paragraphs (3) and
(4) of subdivision (b) thereof, to require the corporation to purchase their
shares for cash, such corporation shall mail to each such shareholder a notice
of the approval of the reorganization by its outstanding shares (Section 152)
within 10 days after the date of such approval, accompanied by a copy of
Sections 1300, 1302, 1303, 1304 and this
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<PAGE>
section, a statement of the price determined by the corporation to represent the
fair market value of the dissenting shares, and a brief description of the
procedure to be followed if the shareholder desires to exercise the
shareholder's right under such sections. The statement of price constitutes an
offer by the corporation to purchase at the price stated any dissenting shares
as defined in subdivision (b) of Section 1300, unless they lose their status as
dissenting shares under Section 1309.
(b) Any shareholder who has a right to require the corporation to purchase
the shareholder's shares for cash under Section 1300, subject to compliance with
paragraphs (3) and (4) of subdivision (b) thereof, and who desires the
corporation to purchase such shares shall make written demand upon the
corporation for the purchase of such shares and payment to the shareholder in
cash of their fair market value. The demand is not effective for any purpose
unless it is received by the corporation or any transfer agent thereof (1) in
the case of shares described in clause (i) or (ii) of paragraph (1) of
subdivision (b) of Section 1300 (without regard to the provisos in that
paragraph), not later than the date of the shareholders' meeting to vote upon
the reorganization, or (2) in any other case within 30 days after the date on
which the notice of the approval by the outstanding shares pursuant to
subdivision (a) or the notice pursuant to subdivision (i) of Section 1110 was
mailed to the shareholder.
(c) The demand shall state the number and class of the shares held of record
by the shareholder which the shareholder demands that the corporation purchase
and shall contain a statement of what such shareholder claims to be the fair
market value of those shares as of the day before the announcement of the
proposed reorganization or short-form merger. The statement of fair market value
constitutes an offer by the shareholder to sell the shares at such price.
SECTION 1302. ENDORSEMENT OF SHARES.
Within 30 days after the date on which notice of the approval by the
outstanding shares or the notice pursuant to subdivision (i) of Section 1110 was
mailed to the shareholder, the shareholder shall submit to the corporation at
its principal office or at the office of any transfer agent thereof, (a) if the
shares are certificated securities, the shareholder's certificates representing
any shares which the shareholder demands that the corporation purchase, to be
stamped or endorsed with a statement that the shares are dissenting shares or to
be exchanged for certificates of appropriate denomination so stamped or endorsed
or (b) if the shares are uncertificated securities, written notice of the number
of shares which the shareholder demands that the corporation purchase. Upon
subsequent transfers of the dissenting shares on the books of the corporation,
the new certificates, initial transaction statement, and other written
statements issued therefor shall bear a like statement, together with the name
of the original dissenting holder of the shares.
SECTION 1303. AGREED PRICE--TIME FOR PAYMENT.
(a) If the corporation and the shareholder agree that the shares are
dissenting shares and agree upon the price of the shares, the dissenting
shareholder is entitled to the agreed price with interest thereon at the legal
rate on judgments from the date of the agreement. Any agreements fixing the fair
market value of any dissenting shares as between the corporation and the holders
thereof shall be filed with the secretary of the corporation.
(b) Subject to the provisions of Section 1306, payment of the fair market
value of dissenting shares shall be made within 30 days after the amount thereof
has been agreed or within 30 days after any statutory or contractual conditions
to the reorganization are satisfied, whichever is later, and in the case of
certificated securities, subject to surrender of the certificates therefor,
unless provided otherwise by agreement.
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SECTION 1304. DISSENTER'S ACTION TO ENFORCE PAYMENT.
(a) If the corporation denies that the shares are dissenting shares, or the
corporation and the shareholder fail to agree upon the fair market value of the
shares, then the shareholder demanding purchase of such shares as dissenting
shares or any interested corporation, within six months after the date on which
notice of the approval by the outstanding shares (Section 152) or notice
pursuant to subdivision (i) of Section 1110 was mailed to the shareholder, but
not thereafter, may file a complaint in the superior court of the proper county
praying the court to determine whether the shares are dissenting shares or the
fair market value of the dissenting shares or both or may intervene in any
action pending on such a complaint.
(b) Two or more dissenting shareholders may join as plaintiffs or be joined
as defendants in any such action and two or more such actions may be
consolidated.
(c) On the trial of the action, the court shall determine the issues. If the
status of the shares as dissenting shares is in issue, the court shall first
determine that issue. If the fair market value of the dissenting shares is in
issue, the court shall determine, or shall appoint one or more impartial
appraisers to determine the fair market value of the shares.
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<PAGE>
APPENDIX D
STOCK OPTION AGREEMENT
This AGREEMENT is dated as of May 9, 2000, between Heritage Commerce Corp
("HCC"), a California corporation, and Western Holdings Bancorp, a California
corporation ("WHB").
W I T N E S S E T H:
WHEREAS, the Boards of Directors of HCC and WHB have approved an Agreement
and Plan of Merger and Reorganization ("Plan") dated as of the date hereof which
contemplates the acquisition by HCC of WHB by means of the merger of WHB with
and into HCC, with HCC as the entity surviving the merger;
WHEREAS, as a condition to HCC's entry into the Plan and to induce such
entry, WHB has agreed to grant to HCC the option set forth herein to purchase
shares of WHB's authorized but unissued common stock, no par value ("Common
Stock");
Unless otherwise provided in this Agreement, capitalized terms shall have
the meanings ascribed to such terms in the Plan.
NOW, THEREFORE, in consideration of the premises herein contained, the
parties agree as follows:
1. GRANT OF OPTION. Subject to the terms and conditions set forth herein,
WHB hereby grants to HCC an option (the "Option") to purchase up to 543,818
shares of Common Stock (the "Option Shares"), at Eleven Dollars ($11.00) per
share (the "Exercise Price"); provided, however, that in the event WHB issues or
agrees to issue any shares of Common Stock to an Acquiring Person (as that term
is defined in Section 6 herein) at a price less than the Exercise Price, the
Exercise Price shall be equal to such lesser price.
2. EXERCISE OF OPTION.
(a) HCC may exercise the Option, in whole or in part, in accordance with and
to the extent permitted by applicable law at any time or from time to time but
only upon or after the occurrence of a Purchase Event (as that term is defined
in Paragraph (b) below of this section); provided that to the extent the Option
shall not have been exercised, it shall terminate and be of no further force and
effect upon the earliest to occur (such earliest date, the "Expiration Date") of
(i) the termination of the Plan pursuant to Section 7.2 (a) or (g) thereof; (ii)
the date of termination pursuant to Section 7.2 (b), (c) or (d) thereof if such
date is prior to a Purchase Event; (iii) the effective time of the acquisition
of WHB by HCC pursuant to the Plan, or (iv) twelve months following the
occurrence of the earliest to occur of (A) the date of any termination of the
Plan other than as described in (i) or (ii) above or (B) the date of first
occurrence of a Purchase Event. Notwithstanding the foregoing, WHB shall not be
obligated to issue the Option Shares upon exercise of the Option (i) in the
absence of any required governmental or regulatory waiver, consent or approval
necessary for WHB to issue such Option Shares or for HCC or any transferee to
exercise the Option or prior to the expiration or termination of any waiting
period required by law, or (ii) so long as any injunction or other order, decree
or ruling issued by any federal or state court of competent jurisdiction is in
effect which prohibits the sale or delivery of the Option Shares.
(b) As used herein, a "Purchase Event" shall have occurred when: (i) WHB or
any subsidiary of WHB, (without the prior written consent of HCC) enters into an
agreement with any person (other than HCC or any of its subsidiaries) pursuant
to which such person would: (x) merge or consolidate with, or enter into any
similar transaction with WHB or any subsidiary of WHB, (y) purchase, lease or
otherwise acquire all or substantially all of the assets of WHB or (z) purchase
or otherwise acquire (by
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merger, consolidation, share exchange or any similar transaction) securities
representing 10 percent or more of the voting shares of WHB (the transactions
referred to in subparagraph (x), (y) and (z) are referred to as an "Acquisition
Transaction"); (ii) any person or group of persons acting in concert (other than
HCC or any of its subsidiaries) acquires the beneficial ownership or the right
to acquire beneficial ownership of securities representing 24.99 percent or more
of the voting shares of WHB (the term "beneficial ownership" for purposes of
this Agreement shall have the meaning set forth in Section 13(d) of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), and the
regulations promulgated thereunder); (iii) the shareholders of WHB fail to
approve the business combination between WHB and HCC contemplated by the Plan at
any meeting of such shareholders which has been held for that purpose or any
adjournment or postponement thereof, the failure of such a shareholder meeting
to occur prior to termination of the Plan, or the withdrawal or modification (in
a manner adverse to HCC) of the recommendation of WHB's Board of Directors of
the Merger and Plan and that the shareholders of WHB approve the Merger and the
Plan, in each case, after there shall have been a public announcement that any
person (other than HCC or any of its subsidiaries), shall have (A) made, or
publicly disclosed an intention to make, a proposal to engage in an Acquisition
Transaction, (B) commenced a tender offer, as defined herein, or filed a
registration statement under the Securities Act of 1933, as amended (the
"Securities Act"), with respect to an exchange offer, as defined herein, or (C)
filed an application (or given a notice), whether in draft or final form, with
the Department of Financial Institutions of the State of California or other
federal or state bank regulatory authority, which application or notice has been
accepted for processing, for approval to engage in an Acquisition Transaction;
(iv) any person (other than HCC or other than in connection with a transaction
which HCC has given its prior written consent), shall have filed an application
or notice with the Department of Financial Institutions of the State of
California or other federal or state bank regulatory authority, which
application or notice has been accepted for processing, for approval to engage
in an Acquisition Transaction, exchange offer or tender offer; (v) WHB shall
have willfully breached any covenant or obligation contained in the Plan in
anticipation of engaging in a Purchase Event, and following such breach HCC
would be entitled to terminate the Plan (whether immediately or after the giving
of notice or passage of time or both); or (vi) a public announcement by WHB of
the authorization, recommendation or endorsement by WHB of an Acquisition
Transaction, exchange offer or tender offer or a public announcement by WHB of
an intention to authorize, recommend or announce an Acquisition Transaction,
exchange offer or tender offer. If a Purchase Event has occurred, the Option
shall continue to be exercisable until its termination in accordance with
Section 2(a) hereof. WHB shall notify HCC promptly in writing upon learning of
the occurrence of a Purchase Event, it being understood that the giving of such
notice by WHB shall not be a condition to the right of HCC to transfer or
exercise the Option. As used in this Agreement, "person" shall have the same
meaning set forth in the Plan. As used in this paragraph "tender offer" or
"exchange offer" shall mean, respectively, the commencement (as such term is
defined in Rule 14d-2 promulgated under the Exchange Act) by any person (other
than HCC or any subsidiary of HCC) of, or the filing by any person (other than
HCC or any subsidiary of HCC) of a registration statement or a tender offer
schedule under, the Securities Act or the Exchange Act with respect to, a tender
offer or exchange offer, respectively, to purchase shares of WHB Stock such
that, upon consummation of such offer, such person would own or control 10
percent or more of the then-outstanding shares of WHB Stock.
(c) In the event a Purchase Event occurs, HCC may elect to exercise the
Option. If HCC wishes to exercise the Option, it shall send to WHB a written
notice (the date of which shall be referred to herein as the "Notice Date")
which specifies (i) the total number of Option Shares to be purchased, and (ii)
a place and date not earlier than two business days nor later than ten business
days from the Notice Date for the closing (the "Closing") of such purchase (the
"Closing Date"); provided however, that if prior notification to or approval of
the Department of Financial Institutions of the State of California or any other
regulatory agency is required in connection with such purchase, the Holder, as
defined below, shall promptly file the required notice or application for
approval, shall promptly notify
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WHB of such filing, and shall expeditiously process the same and the period of
time that otherwise would run pursuant to this sentence shall run instead from
the date on which any required notification periods have expired or been
terminated or such approvals have been obtained and any requisite waiting period
or periods shall have passed. Any exercise of the Option shall be deemed to
occur on the Notice Date relating thereto, subject to receipt of any required
regulatory approvals.
3. PAYMENT AND DELIVERY OF CERTIFICATES; HCC REPRESENTATION.
(a) If HCC elects to exercise the Option, then at the Closing, HCC shall pay
to WHB the aggregate purchase price for the Option Shares purchased pursuant to
the exercise of the Option in immediately available funds by a wire transfer to
a bank designated by WHB.
(b) At such Closing, simultaneously with the delivery of the purchase price
for the Option Shares as provided in Paragraph (a) hereof, WHB shall deliver to
HCC a certificate or certificates, registered in the name of HCC or its
designee, representing the number of Option Shares purchased by HCC. Such
certificates may be endorsed with any legend required pursuant to any permit or
exemption granted by the Department of Financial Institutions of the State of
California or any other regulatory agency, as well as the following legend:
THE TRANSFER OF THE SHARES REPRESENTED BY THIS CERTIFICATE IS SUBJECT TO
CERTAIN PROVISIONS OF AN AGREEMENT BETWEEN THE REGISTERED HOLDER HEREOF AND THE
ISSUER, A COPY OF WHICH AGREEMENT IS ON FILE AT THE PRINCIPAL OFFICE OF THE
ISSUER. A COPY OF SUCH AGREEMENT WILL BE PROVIDED TO THE HOLDER HEREOF WITHOUT
CHARGE UPON RECEIPT BY THE ISSUER OF A REQUEST THEREFOR.
Any such legend shall be removed by delivery of a substitute certificate without
such legend if HCC shall have delivered to WHB an opinion of counsel, in form
and substance satisfactory to WHB, that such legend is not required for purposes
of assuring compliance with applicable securities or other law or with this
Agreement.
(c) Except as otherwise provided herein, HCC hereby represents and warrants
to WHB that the Option is being, and any Option Shares issued upon exercise of
the Option will be, acquired by HCC for its own account and not with a view to
any distribution thereof, and HCC will not sell any Option Shares purchased
pursuant to exercise of the Option except in compliance with applicable
securities and other laws.
4. REPRESENTATIONS. WHB hereby represents and warrants to HCC as follows:
(a) WHB has all requisite corporate power and authority to enter into and
perform all of its obligations under this Agreement. The execution, delivery and
performance of this Agreement and all of the transactions contemplated hereby
have been duly authorized by all necessary corporate action on the part of WHB.
This Agreement has been duly executed and delivered by WHB and constitutes a
valid and binding agreement of WHB, enforceable against WHB in accordance with
its terms, except as the enforceability hereof may be limited by bankruptcy,
insolvency, moratorium or other similar laws affecting the rights of creditors
generally or by equitable principles, whether such enforcement is sought in law
or equity.
(b) The execution and delivery by WHB of this Agreement and the consummation
of the transactions herein contemplated do not and will not violate or conflict
with WHB's Articles of Incorporation or Bylaws, any statute, regulation,
judgment, order, writ, decree or injunction applicable to WHB (other than as may
be effected by HCC's ownership of Common Stock exceeding certain limits set
forth by statute or regulation) or its properties or assets and do not and will
not violate, conflict with, result in a breach of, constitute a default (or an
event which with due notice and/or lapse of time would constitute a default)
under, result in a termination of, accelerate the performance
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<PAGE>
required by, or result in the creation of any lien, pledge, security interest,
charge or other encumbrance upon any of the properties or assets of WHB under
the terms, conditions or provisions of any note, bond, mortgage, indenture, deed
of trust, or loan agreement or other agreement, instrument or obligation to
which WHB is a party, or by which WHB or any of its properties or assets may be
bound or affected.
(c) WHB has taken all necessary corporate action to authorize and reserve
and to permit it to issue, and at all times from the date hereof through the
termination of this Agreement in accordance with its terms, will have reserved
for issuance upon the exercise of the Option a number of shares of Common Stock
sufficient to satisfy the exercise of the Option in full, all of which Common
Stock, upon issuance pursuant hereto, shall be duly authorized, validly issued,
fully paid and nonassessable, and shall be delivered free and clear of all
claims, liens, encumbrances, security interests and preemptive rights.
5. ADJUSTMENT UPON CHANGES IN CAPITALIZATION.
(a) In the event of any stock dividend, stock split, split-up,
recapitalization, reclassification, combination, exchange of shares or similar
transaction or event with respect to Common Stock, the type and number of shares
or securities subject to the Option and the Exercise Price therefor, shall be
adjusted appropriately, and proper provision shall be made in the agreements
governing such transaction so that HCC shall receive, upon exercise of the
Option, the number and class of shares or other securities or property that HCC
would have received in respect of Common Stock if the Option had been exercised
immediately prior to such event, or the record date thereof, as applicable. If
any shares of Common Stock are issued after the date of this Agreement (other
than pursuant to an event described in the first sentence of this Section 5(a)),
the number of shares of Common Stock subject to the Option shall be adjusted so
that, after such issuance, it, together with any shares of Common Stock
previously issued to HCC pursuant hereto, equals 19.9 percent of the number of
shares of Common Stock then issued and outstanding, without giving effect to any
shares subject to or issued pursuant to this Option.
(b) In the event that WHB, shall, prior to the Expiration Date, enter into
an agreement: (i) to consolidate with or merge into any person, other than HCC
or one of its subsidiaries, and shall not be the continuing or surviving
corporation of such consolidation or merger, (ii) to permit any person, other
than HCC or one of its subsidiaries, to merge into WHB and WHB shall be the
continuing or surviving corporation, but, in connection with such merger, the
then outstanding shares of Common Stock shall be changed into or exchanged for
stock or other securities of WHB or any other person or cash or any other
property or the outstanding shares of Common Stock immediately prior to such
merger shall after such merger represent less than 50 percent of the outstanding
shares and share equivalents of the merged company; or (iii) to sell or
otherwise transfer all or substantially all of its assets to any person, other
than HCC or one of its subsidiaries, then, and in each such case, the agreement
governing such transaction shall make proper provisions so that the Option
shall, upon the consummation of any such transaction and upon the terms and
conditions set forth herein, be converted into, or exchanged for, an option (the
"Substitute Option"), at the election of HCC, of either (x) the Succeeding
Corporation (as defined below), (y) any person that controls the Succeeding
Corporation, or (z) in the case of a merger described in clause (ii), WHB (in
each case, such person being referred to as the "Substitute Option Issuer.")
(c) The Substitute Option shall have the same terms as the Option, provided,
that, if the terms of the Substitute Option cannot, for legal reasons, be the
same as the Option, such terms shall be as similar as possible and in no event
less advantageous to HCC. The Substitute Option Issuer shall also enter into an
agreement with the then-holder or holders of the Substitute Option in
substantially the form as this Agreement, which shall be applicable to the
Substitute Option.
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(d) The Substitute Option shall be exercisable for such number of shares of
the Substitute Common Stock (as hereinafter defined) as is equal to the Assigned
Value (as hereinafter defined) multiplied by the number of shares of Common
Stock for which the Option was theretofore exercisable, divided by the Average
Price (as hereinafter defined). The exercise price of the Substitute Option per
share of the Substitute Common Stock (the "Substitute Option Price") shall then
be equal to the Exercise Price multiplied by a fraction in which the numerator
is the number of shares of the Common Stock for which the Option was theretofore
exercisable and the denominator is the number of shares for which the Substitute
Option is exercisable.
(e) The following terms have the meanings indicated:
(i) "Succeeding Corporation" shall mean (x) the continuing or surviving
corporation of a consolidation or merger with WHB (if other than WHB), (y)
WHB in a merger in which WHB is the continuing or surviving person, and (z)
the transferee of all or any substantial part of WHB assets (or the assets
of its subsidiaries).
(ii) "Substitute Common Stock" shall mean the common stock issued by the
Substitute Option Issuer upon exercise of the Substitute Option.
(iii) "Assigned Value" shall mean the highest of (x) the price per share
of Common Stock at which a tender offer or exchange offer therefor has been
made by any person (other than HCC or its subsidiaries) (y) the price per
share of Common Stock to be paid by any person (other than HCC or any of its
subsidiaries) pursuant to an agreement with WHB, and (z) the highest closing
sales price per share of Common Stock as quoted on the Nasdaq National
Market (or if Common Stock is not quoted on the Nasdaq National Market, the
highest bid price per share on any day as quoted on the principal trading
market or securities exchange on which such shares are traded as reported by
a recognized source chosen by HCC) within the six-month period immediately
preceding the agreement referred to in (y), or if the Common Stock is not
publicly traded, then the price per share as determined by a nationally
recognized investment banking firm mutually selected by HCC and WHB (or if
applicable, the Succeeding Corporation), provided that if a mutual selection
cannot be made as to such investment banking firm, it shall be selected by
HCC; provided, that in the event of a sale of less than all of WHB's assets,
the Assigned Value shall be the sum of the price paid in such sale for such
assets and the current market value of the remaining assets of WHB as
determined by a nationally recognized investment banking firm selected by
HCC and reasonably acceptable to WHB, divided by the number of shares of
Common Stock outstanding at the time of such sale. In the event that an
exchange offer is made for Common Stock or an agreement is entered into for
a merger or consolidation involving consideration other than cash, the value
of the securities or other property issuable or deliverable in exchange for
the Common Stock shall be determined by a nationally recognized investment
banking firm mutually selected by HCC and WHB (or if applicable, the
Succeeding Corporation), provided that if a mutual selection cannot be made
as to such investment banking firm, it shall be selected by HCC.
(iv) "Average Price" shall mean the average closing price of a share of
the Substitute Common Stock for the one year immediately preceding the
consolidation, merger or sale in question, but in no event higher than the
closing price of the shares of the Substitute Common Stock on the day
preceding such consolidation, merger or sale, provided that if WHB is the
issuer of the Substitute Option, the Average Price shall be computed with
respect to a share of common stock issued by WHB, the person merging into
WHB or by any company which controls or is controlled by such merging
person, as HCC may elect.
(f) In no event pursuant to any of foregoing paragraphs shall the Substitute
Option be exercisable for more than 19.9 percent of the aggregate of the shares
of the Substitute Common Stock outstanding immediately prior to exercise of the
Substitute Option. In the event that the Substitute Option would
D-5
<PAGE>
be exercisable for more than 19.9 percent of the aggregate of the shares of
Substitute Common Stock but for this clause (f), the Substitute Option Issuer
shall make a cash payment to HCC equal to the excess of (i) the value of the
Substitute Option without giving effect to the limitation in this clause (f)
over (ii) the value of the Substitute Option after giving effect to the
limitation in this clause (f). This difference in value shall be determined by a
nationally recognized investment banking firm selected by HCC and the Substitute
Option Issuer.
(g) WHB shall not enter into any transaction described in subsection (b) of
this Section 5 unless the Succeeding Corporation and any person that controls
the Succeeding Corporation assume in writing all the obligations of WHB
hereunder and take all other actions that may be necessary so that the
provisions of this Agreement, including but not limited to this Section 5, are
given full force and effect (including, without limitation, any action that may
be necessary so that the shares of Substitute Common Stock are in no way
distinguishable from or have lesser economic value than other shares of common
stock issued by the Substitute Option Issuer).
6. PURCHASE OF OPTION SHARES AND OPTIONS BY WHB.
(a) From and after the first date a transaction specified in Section 5(b)
herein is consummated (the "Repurchase Event"), and subject to applicable
regulatory restrictions, HCC or a holder or former holder of any Options (a
"Holder") who has exercised the Options in whole or in part shall have the right
to require WHB to purchase some or all of the Option Shares at a purchase price
per share (the "Purchase Price") equal to the highest of (i) 100 percent of the
Exercise Price, (ii) the highest price paid or agreed to be paid for shares of
Common Stock by an Acquiring Person (as defined in Paragraph (b) of this
Section) in any tender offer, exchange offer or other transaction or series of
related transactions involving the acquisition of 10 percent or more of the
outstanding shares of Common Stock during the one-year period immediately
preceding the Purchase Date (as defined in Paragraph (d) of this Section) and
(iii) in the event of a sale of all or substantially all of WHB's assets, (x)
the sum of the price paid in such sale for such assets and the current market
value of the remaining assets of WHB as determined by a recognized investment
banking firm jointly selected by such Holder and WHB, each acting in good faith,
divided by (y) the number of shares of Common Stock then outstanding. In the
event that any of the consideration paid or agreed to be paid by an Acquiring
Person for any shares of Common Stock or for any of WHB's assets consists in
whole or in part of securities, the value of such securities for purposes of
determining the Purchase Price shall be determined (i) if there is an existing
public trading market therefor, by the average of the last sales prices for such
securities on the ten trading days ending three trading days prior to the
payment of such consideration (if such consideration has been paid) or prior to
the date of determination (if such consideration has not yet been paid) and (ii)
if there is no existing public trading market for such securities, by a
recognized investment banking firm jointly selected by the Holder and WHB, each
acting in good faith. The Holder's right to require WHB to purchase some or all
of the Option Shares under this Section shall expire on the day which is one
year following the Repurchase Event; provided, that if WHB is prohibited under
applicable regulations from purchasing Common Stock as to which a Holder has
given notice hereunder, then the Holder's right to require WHB to purchase such
shares shall expire on the date which is one year following the date on which
WHB no longer is prohibited from purchasing such shares: provided further, that
WHB shall use its best efforts to obtain any consent or approval and make any
filing required for WHB to consummate as quickly as possible the purchase of the
Common Stock contemplated hereunder.
(b) For purposes of this Agreement, "Acquiring Person" shall mean a person
or group (as such terms are defined in the Exchange Act and the rules and
regulations thereunder) other than HCC or a subsidiary of HCC who on or after
the date of this Agreement engages in a transaction which gives rise to a
Purchase Event.
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(c) Subject to applicable regulatory restrictions, from and after a
Repurchase Event or after HCC receives official notice that an approval of the
Department of Financial Institutions of the State of California, or any other
regulatory authority, required for the exercise of the Option and purchase of
the Option Shares will not be issued or granted, a Holder shall have the right
to require WHB to purchase some or all of the Options held by such Holder at a
price equal to the Purchase Price minus the Exercise Price on the Purchase Date
(as defined in Paragraph (d) of this Section) multiplied by the number of shares
of Common Stock that may be purchased on the Purchase Date upon the exercise of
the Options elected to be purchased. Notwithstanding the termination date of the
Options, the Holder's right to require WHB to purchase some or all of the
Options under this Section shall expire on the day which is one year following
the Repurchase Event; provided, that if WHB is prohibited under applicable
regulations from purchasing the Options as to which an Holder has given notice
hereunder, then the Holder's right to require WHB to purchase such Options shall
expire on the day which is one year following the date on which WHB no longer is
prohibited from purchasing such Options; provided further, that WHB shall use
its best efforts to obtain any consent or approval and make any filing required
for WHB to consummate as quickly as possible the purchase of the Options
contemplated hereunder.
(d) A Holder may exercise its right to require WHB to purchase the Common
Stock or Options (collectively, "Securities") pursuant to this Section by
surrendering for such purpose to WHB, at its principal office or at such other
office or agency maintained by WHB for that purpose, within the period specified
above, the certificates or other instruments representing the Securities to be
purchased accompanied by a written notice stating that it elects to require WHB
to purchase all or a specified number of such Securities. Within five business
days after the surrender of such certificates or instruments and the receipt of
such notice relating thereto, to the extent it is legally permitted to do so,
WHB shall deliver or cause to be delivered to the Securities Holder (i) a bank
cashier's or certified check payable to the Securities Holder in an amount equal
to the applicable purchase price therefor, and (ii) if less than the full number
of Securities evidenced by the surrendered instruments are being purchased, a
new certificate or instrument, for the number of Securities evidenced by such
surrendered certificates or other instruments less the number of Securities
purchased. Such purchases shall be deemed to have been made at the close of
business on the date (the "Purchase Date") of the receipt of such notice and of
such surrender of the certificates or other instruments representing the
Securities to be purchased and the rights of the Securities Holder, except for
the right to receive the applicable purchase price therefor in accordance
herewith, shall cease on the Purchase Date.
7. DEMAND REGISTRATION RIGHTS. As promptly as practicable upon HCC's
request after a Purchase Event, WHB agrees to prepare and file not more than two
registration statements, prospectuses or permit or exemption applications
("Registration Event") as appropriate, under federal and any applicable state
securities laws, with respect to any proposed sale of any warrants, options or
other securities representing any of HCC's rights under this Agreement or
proposed dispositions by HCC of any or all of the Option Shares, if such
registrations or filings are required by law or regulation, and to use its best
efforts to cause any such registration statements or prospectuses to become
effective, or to have any permit or exemption granted, as expeditiously as
possible and to keep such registration statement, prospectus, permit or
exemption effective for a period of not less than 180 days unless, in the
written opinion of counsel to WHB, addressed to HCC and satisfactory in form and
substance to HCC and its counsel, registration (or filing of a prospectus, or
grant of a permit or exemption) is not required for such proposed transactions.
All fees, expenses and charges of any kind or nature whatsoever incurred in
connection with any registration of, or the preparation of any registration
statement, prospectus or permit or exemption application relating to, the
Options or the Option Shares pursuant to this Section 7 shall be borne and paid
by WHB; provided, however, that in no event shall this Section 7 be construed to
require WHB to bear the expense of any change of control notice or similar
regulatory filing made by any purchaser or acquiror of Option Shares issued to
HCC pursuant to this Agreement. In the event HCC exercises its registration
rights under this Section 7, WHB shall
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provide HCC, its affiliates, each of their respective officers and directors and
any underwriters used by HCC, with indemnifications, representations and
warranties and shall cause its attorneys and accountants to deliver to HCC and
any such underwriters attorneys' opinions and "comfort letters", all of a type
customarily provided or delivered in connection with public underwritten
offerings of securities. In the event WHB effects a registration of Common Stock
for its own account or for any other shareholder of WHB, it shall allow HCC to
participate in such registration. Notwithstanding the foregoing, WHB shall have
the right to delay (a "Delay Right") a Registration Event for a period of up to
thirty (30) days, in the event it receives a request from HCC to effect a
Registration Event, if WHB (i) is involved in a material transaction, or (ii)
determines, in the good faith exercise of its reasonable business judgment, that
such registration and offering could adversely effect or interfere with bona
fide material financing plans of WHB or would require disclosure of information,
the premature disclosure of which could materially adversely affect WHB or any
transaction under active consideration by WHB. For purposes of this Agreement,
the term "material transaction" shall mean a transaction which, if WHB were
subject to the reporting requirements under the Exchange Act, would require WHB
to file a current report on Form 8-K with the Securities Exchange Commission.
WHB shall have the right to exercise two Delay Rights in any eighteen (18) month
period.
8. LISTING.
If Common Stock or any other securities to be acquired upon exercise of the
Option are then authorized for quotation or trading or listing on the Nasdaq
National Market or any other securities exchange or automated quotation system,
WHB, or any successor thereto, upon the request of the holder of the Option,
will promptly file an application, if required, to authorize for listing or
trading or quotation the shares of Common Stock or other securities to be
acquired upon exercise of the Option on the Nasdaq National Market or any other
securities exchange or automated quotation system and will use its best efforts
to obtain approval, if required, of such listing or quotation as soon as
possible.
9. MISCELLANEOUS.
(a) EXPENSES. Each of the parties hereto shall bear and pay all costs and
expenses incurred by it or on its behalf in connection with the transactions
contemplated hereunder, including fees and expenses of its own financial
consultants, investment bankers, accountants and counsel.
(b) ENTIRE AGREEMENT. Except as otherwise expressly provided herein, this
Agreement contains the entire agreement between the parties with respect to the
transactions contemplated hereunder and supersedes all prior arrangements or
understandings with respect thereto, written or oral. The terms and conditions
of this Agreement shall inure to the benefit of and be binding upon the parties
hereto and their respective successors and assigns. Nothing in this Agreement,
expressed or implied, is intended to confer upon any party, other than the
parties hereto, and their respective successors and assigns, any rights,
remedies, obligations or liabilities under or by reason of this Agreement,
except as expressly provided herein.
(c) ASSIGNMENT. At any time after a Purchase Event occurs, HCC may sell,
assign or otherwise transfer its rights and obligations hereunder, in whole or
in part, by issuing Options or otherwise, to any person or group of persons,
subject to applicable law, rule or regulation. In order to effectuate the
foregoing, HCC (or any direct or indirect assignee or transferee of HCC) shall
be entitled to surrender this Agreement to WHB in exchange for two or more
Agreements entitling the holders thereof to purchase in the aggregate the same
number of shares of Common Stock as may be purchasable hereunder.
(d) NOTICES. All notices or other communications which are required or
permitted hereunder shall be in writing and sufficient if delivered personally
or by confirmed facsimile transmission or sent
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by registered or certified mail or overnight courier, postage prepaid, with
return receipt requested, addressed as follows:
If to HCC:
Heritage Commerce Corp
150 Almaden Boulevard
San Jose, CA 95113
Attention: John E. Rossell, III
President & CEO
Facsimile Number: (408) 947-1054
With a copy to:
McCutchen, Doyle, Brown & Enersen, LLP
3 Embarcadero Center, #1800
San Francisco, California 94111
Attention: James M. Rockett, Esq.
Facsimile Number: (415) 393-2286
If to WHB:
Western Holdings Bancorp
4546 El Camino Real
Los Altos, CA 94022
Attention: James Wall
President & CEO
Facsimile Number: (650) 941-8739
With a copy to:
Sheppard Mullin Richter & Hampton, LLP
4 Embarcadero Center
San Francisco, CA 94111
Attention: John Sears
Facsimile Number: (415) 434-3947
A party may change its address for notice purposes by written notice to the
other party hereto.
(e) COUNTERPARTS. This Agreement may be executed in any number of
counterparts, and each such counterpart shall be deemed to be an original
instrument, but all such counterparts together shall constitute but one
agreement.
(f) SPECIFIC PERFORMANCE. The parties hereto agree that irreparable harm
would occur in the event that any of the provisions of this Agreement were not
performed by them in accordance with their specific terms or conditions or were
otherwise breached and that money damages are an inadequate remedy for breach of
this Agreement because of the difficulty of ascertaining the amount of damage
that will be suffered by the parties in the event that this Agreement is not
performed in accordance with its terms or conditions or otherwise breached. It
is accordingly agreed that the parties shall be entitled to an injunction or
injunctions to prevent breaches of this Agreement by the parties and to enforce
specifically the terms and provisions hereof in any court of the United States
or any state having jurisdiction, this being in addition to any other remedy to
which it is entitled at law or in equity.
(g) GOVERNING LAW. This Agreement shall be governed by and construed in
accordance with the laws of the State of California.
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(h) BEST EFFORTS. Each of HCC and WHB will use its best efforts to make
all filings with, and to obtain consents of, all third parties and governmental
authorities necessary to the consummation of the transactions contemplated by
this Agreement, including without limitation applying to the Department of
Financial Institutions of the State of California for approval to acquire or
issue the shares issuable hereunder.
(i) DESCRIPTIVE HEADINGS. The descriptive headings herein are inserted for
convenience of reference and are not intended to be part of or to affect the
meaning or interpretation of this Agreement.
IN WITNESS WHEREOF, each of the parties hereto has executed this Agreement,
as of the day and year first written above.
<TABLE>
<S> <C> <C>
HERITAGE COMMERCE CORP
By
------------------------------------------
President and Chief Executive Officer
WESTERN HOLDINGS BANCORP
By
------------------------------------------
President
</TABLE>
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STOCK OPTION AGREEMENT
This AGREEMENT is dated as of May 9, 2000, between Western Holdings Bancorp,
a California corporation ("WHB") and Heritage Commerce Corp ("HCC"), a
California corporation.
W I T N E S S E T H:
WHEREAS, the Boards of Directors of HCC and WHB have approved an Agreement
and Plan of Merger and Reorganization ("Plan") dated as of the date hereof which
contemplates the acquisition by HCC of WHB by means of the merger of WHB with
and into HCC, with HCC as the entity surviving the merger;
WHEREAS, as a condition to WHB's entry into the Plan and to induce such
entry, HCC has agreed to grant to WHB the option set forth herein to purchase
shares of HCC's authorized but unissued common stock, no par value ("Common
Stock");
Unless otherwise provided in this Agreement, capitalized terms shall have
the meanings ascribed to such terms in the Plan.
NOW, THEREFORE, in consideration of the premises herein contained, the
parties agree as follows:
1. GRANT OF OPTION. Subject to the terms and conditions set forth herein,
HCC hereby grants to WHB an option (the "Option") to purchase up to 1,399,877
shares of Common Stock (the "Option Shares"), at a per share price equal to the
average of the bid and ask prices for Common Stock for the five trading days
preceding the execution of the Plan (the "Exercise Price"); PROVIDED, HOWEVER,
that in the event HCC issues or agrees to issue any shares of Common Stock to an
Acquiring Person (as that term is defined in Section 6 herein) at a price less
than the Exercise Price, the Exercise Price shall be equal to such lesser price.
2. EXERCISE OF OPTION.
(a) WHB may exercise the Option, in whole or in part, in accordance with and
to the extent permitted by applicable law at any time or from time to time but
only upon or after the occurrence of a Purchase Event (as that term is defined
in Paragraph (b) below of this section); provided that to the extent the Option
shall not have been exercised, it shall terminate and be of no further force and
effect upon the earliest to occur (such earliest date, the "Expiration Date") of
(i) the termination of the Plan pursuant to Section 7.2 (a) and (g) thereof;
(ii) the date of termination pursuant to Section 7.2 (b), (c) or (d) thereof if
such date is prior to a Purchase Event; (iii) the effective time of the
acquisition of WHB by HCC pursuant to the Plan; or (iv) twelve months following
the occurrence of the earliest to occur of (A) the date of any termination of
the Plan other than as described in (i) or (ii) above or (B) the date of first
occurrence of a Purchase Event. Notwithstanding the foregoing, HCC shall not be
obligated to issue the Option Shares upon exercise of the Option (i) in the
absence of any required governmental or regulatory waiver, consent or approval
necessary for HCC to issue such Option Shares or for WHB or any transferee to
exercise the Option or prior to the expiration or termination of any waiting
period required by law, or (ii) so long as any injunction or other order, decree
or ruling issued by any federal or state court of competent jurisdiction is in
effect which prohibits the sale or delivery of the Option Shares.
(b) As used herein, a "Purchase Event" shall have occurred when: (i) HCC or
any subsidiary of HCC (without the prior written consent of WHB) enters into an
agreement with any person (other than WHB or any of its subsidiaries) pursuant
to which such person would: (x) merge or consolidate with, or enter into any
similar transaction with HCC or any subsidiary of HCC, (y) purchase, lease or
otherwise acquire all or substantially all of the assets of HCC or (z) purchase
or otherwise acquire (by merger, consolidation, share exchange or any similar
transaction) securities representing 10 percent or more of the voting shares of
HCC (the transactions referred to in subparagraph (x), (y) and (z) are
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referred to as an "Acquisition Transaction"); (ii) any person or group of
persons acting in concert (other than WHB or any of its subsidiaries) acquires
the beneficial ownership or the right to acquire beneficial ownership of
securities representing 24.99 percent or more of the voting shares of HCC (the
term "beneficial ownership" for purposes of this Agreement shall have the
meaning set forth in Section 13(d) of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), and the regulations promulgated thereunder); (iii)
the shareholders of HCC fail to approve the business combination between HCC and
WHB contemplated by the Plan at any meeting of such shareholders which has been
held for that purpose or any adjournment or postponement thereof, the failure of
such a shareholder meeting to occur prior to termination of the Plan, or the
withdrawal or modification (in a manner adverse to WHB) of the recommendation of
HCC's Board of Directors of the Merger and Plan and that the shareholders of HCC
approve the Merger and the Plan, in each case, after there shall have been a
public announcement that any person (other than WHB or any of its subsidiaries),
shall have (A) made, or publicly disclosed an intention to make, a proposal to
engage in an Acquisition Transaction, (B) commenced a tender offer, as defined
herein, or filed a registration statement under the Securities Act of 1933, as
amended (the "Securities Act"), with respect to an exchange offer, as defined
herein, or (C) filed an application (or given a notice), whether in draft or
final form, with the Department of Financial Institutions of the State of
California or other federal or state bank regulatory authority, which
application or notice has been accepted for processing, for approval to engage
in an Acquisition Transaction; (iv) any person (other than WHB or other than in
connection with a transaction which WHB has given its prior written consent),
shall have filed an application or notice with the Department of Financial
Institutions of the State of California or other federal or state bank
regulatory authority, which application or notice has been accepted for
processing, for approval to engage in an Acquisition Transaction, exchange offer
or tender offer; (v) HCC shall have willfully breached any covenant or
obligation contained in the Plan in anticipation of engaging in a Purchase
Event, and following such breach WHB would be entitled to terminate the Plan
(whether immediately or after the giving of notice or passage of time or both);
or (vi) a public announcement by HCC of the authorization, recommendation or
endorsement by HCC of an Acquisition Transaction, exchange offer or tender offer
or a public announcement by HCC of an intention to authorize, recommend or
announce an Acquisition Transaction, exchange offer or tender offer; provided
however, that none of the foreging proposed transactions shall be a Purchase
Event if the terms and provisions thereof envision the pursuit and ultimate
consummation of the Plan as a condition to such proposed transaction (each such
excluded transaction an "Excluded Event"). If a Purchase Event has occurred, the
Option shall continue to be exercisable until its termination in accordance with
Section 2(a) hereof. HCC shall notify WHB promptly in writing upon learning of
the occurrence of a Purchase Event, it being understood that the giving of such
notice by HCC shall not be a condition to the right of WHB to transfer or
exercise the Option. As used in this Agreement, "person" shall have the same
meaning set forth in the Plan. As used in this paragraph "tender offer" or
"exchange offer" shall mean, respectively, the commencement (as such term is
defined in Rule 14d-2 promulgated under the Exchange Act) by any person (other
than WHB or any subsidiary of WHB) of, or the filing by any person (other than
WHB or any subsidiary of WHB) of a registration statement or a tender offer
schedule under, the Securities Act or the Exchange Act with respect to, a tender
offer or exchange offer, respectively, to purchase shares of HCC Stock such
that, upon consummation of such offer, such person would own or control 10
percent or more of the then-outstanding shares of HCC Stock.
(c) In the event a Purchase Event occurs, WHB may elect to exercise the
Option. If WHB wishes to exercise the Option, it shall send to HCC a written
notice (the date of which shall be referred to herein as the "Notice Date")
which specifies (i) the total number of Option Shares to be purchased, and (ii)
a place and date not earlier than two business days nor later than ten business
days from the Notice Date for the closing (the "Closing") of such purchase (the
"Closing Date"); provided however, that if prior notification to or approval of
the Department of Financial Institutions of the State of California or any other
regulatory agency is required in connection with such purchase, the Holder, as
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defined below, shall promptly file the required notice or application for
approval, shall promptly notify HCC of such filing, and shall expeditiously
process the same and the period of time that otherwise would run pursuant to
this sentence shall run instead from the date on which any required notification
periods have expired or been terminated or such approvals have been obtained and
any requisite waiting period or periods shall have passed. Any exercise of the
Option shall be deemed to occur on the Notice Date relating thereto, subject to
receipt of any required regulatory approvals.
3. PAYMENT AND DELIVERY OF CERTIFICATES; HCC REPRESENTATION.
(a) If WHB elects to exercise the Option, then at the Closing, WHB shall pay
to HCC the aggregate purchase price for the Option Shares purchased pursuant to
the exercise of the Option in immediately available funds by a wire transfer to
a bank designated by HCC.
(b) At such Closing, simultaneously with the delivery of the purchase price
for the Option Shares as provided in Paragraph (a) hereof, HCC shall deliver to
WHB a certificate or certificates, registered in the name of WHB or its
designee, representing the number of Option Shares purchased by WHB. Such
certificates may be endorsed with any legend required pursuant to any permit or
exemption granted by the Department of Financial Institutions of the State of
California or any other regulatory agency, as well as the following legend:
THE TRANSFER OF THE SHARES REPRESENTED BY THIS CERTIFICATE IS SUBJECT TO
CERTAIN PROVISIONS OF AN AGREEMENT BETWEEN THE REGISTERED HOLDER HEREOF AND THE
ISSUER, A COPY OF WHICH AGREEMENT IS ON FILE AT THE PRINCIPAL OFFICE OF THE
ISSUER. A COPY OF SUCH AGREEMENT WILL BE PROVIDED TO THE HOLDER HEREOF WITHOUT
CHARGE UPON RECEIPT BY THE ISSUER OF A REQUEST THEREFOR.
Any such legend shall be removed by delivery of a substitute certificate without
such legend if WHB shall have delivered to HCC an opinion of counsel, in form
and substance satisfactory to HCC, that such legend is not required for purposes
of assuring compliance with applicable securities or other law or with this
Agreement.
(c) Except as otherwise provided herein, WHB hereby represents and warrants
to HCC that the Option is being, and any Option Shares issued upon exercise of
the Option will be, acquired by WHB for its own account and not with a view to
any distribution thereof, and WHB will not sell any Option Shares purchased
pursuant to exercise of the Option except in compliance with applicable
securities and other laws.
4. REPRESENTATIONS. HCC hereby represents and warrants to WHB as follows:
(a) HCC has all requisite corporate power and authority to enter into and
perform all of its obligations under this Agreement. The execution, delivery and
performance of this Agreement and all of the transactions contemplated hereby
have been duly authorized by all necessary corporate action on the part of HCC.
This Agreement has been duly executed and delivered by HCC and constitutes a
valid and binding agreement of HCC, enforceable against HCC in accordance with
its terms, except as the enforceability hereof may be limited by bankruptcy,
insolvency, moratorium or other similar laws affecting the rights of creditors
generally or by equitable principles, whether such enforcement is sought in law
or equity.
(b) The execution and delivery by HCC of this Agreement and the consummation
of the transactions herein contemplated do not and will not violate or conflict
with HCC's Articles of Incorporation or Bylaws, any statute, regulation,
judgment, order, writ, decree or injunction applicable to HCC (other than as may
be effected by WHB's ownership of Common Stock exceeding certain limits set
forth by statute or regulation) or its properties or assets and do not and will
not violate, conflict with, result in a breach of, constitute a default (or an
event which with due notice and/or lapse
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of time would constitute a default) under, result in a termination of,
accelerate the performance required by, or result in the creation of any lien,
pledge, security interest, charge or other encumbrance upon any of the
properties or assets of HCC under the terms, conditions or provisions of any
note, bond, mortgage, indenture, deed of trust, or loan agreement or other
agreement, instrument or obligation to which HCC is a party, or by which HCC or
any of its properties or assets may be bound or affected.
(c) HCC has taken all necessary corporate action to authorize and reserve
and to permit it to issue, and at all times from the date hereof through the
termination of this Agreement in accordance with its terms, will have reserved
for issuance upon the exercise of the Option a number of shares of Common Stock
sufficient to satisfy the exercise of the Option in full, all of which Common
Stock, upon issuance pursuant hereto, shall be duly authorized, validly issued,
fully paid and nonassessable, and shall be delivered free and clear of all
claims, liens, encumbrances, security interests and preemptive rights.
5. ADJUSTMENT UPON CHANGES IN CAPITALIZATION.
(a) In the event of any stock dividend, stock split, split-up,
recapitalization, reclassification, combination, exchange of shares or similar
transaction or event with respect to Common Stock, the type and number of shares
or securities subject to the Option and the Exercise Price therefor, shall be
adjusted appropriately, and proper provision shall be made in the agreements
governing such transaction so that WHB shall receive, upon exercise of the
Option, the number and class of shares or other securities or property that WHB
would have received in respect of Common Stock if the Option had been exercised
immediately prior to such event, or the record date thereof, as applicable. If
any shares of Common Stock are issued after the date of this Agreement (other
than pursuant to an event described in the first sentence of this Section 5(a)),
the number of shares of Common Stock subject to the Option shall be adjusted so
that, after such issuance, it, together with any shares of Common Stock
previously issued to WHB pursuant hereto, equals 19.9 percent of the number of
shares of Common Stock then issued and outstanding, without giving effect to any
shares subject to or issued pursuant to this Option.
(b) Except in the case of an Excluded Event, in the event that HCC, shall,
prior to the Expiration Date, enter into an agreement: (i) to consolidate with
or merge into any person, other than WHB or one of its subsidiaries, and shall
not be the continuing or surviving corporation of such consolidation or merger,
(ii) to permit any person, other than WHB or one of its subsidiaries, to merge
into HCC and HCC shall be the continuing or surviving corporation, but, in
connection with such merger, the then outstanding shares of Common Stock shall
be changed into or exchanged for stock or other securities of HCC or any other
person or cash or any other property or the outstanding shares of Common Stock
immediately prior to such merger shall after such merger represent less than 50
percent of the outstanding shares and share equivalents of the merged company;
or (iii) to sell or otherwise transfer all or substantially all of its assets to
any person, other than WHB or one of its subsidiaries, then, and in each such
case, the agreement governing such transaction shall make proper provisions so
that the Option shall, upon the consummation of any such transaction and upon
the terms and conditions set forth herein, be converted into, or exchanged for,
an option (the "Substitute Option"), at the election of WHB, of either (x) the
Succeeding Corporation (as defined below), (y) any person that controls the
Succeeding Corporation, or (z) in the case of a merger described in clause (ii),
HCC (in each case, such person being referred to as the "Substitute Option
Issuer.")
(c) The Substitute Option shall have the same terms as the Option, provided,
that, if the terms of the Substitute Option cannot, for legal reasons, be the
same as the Option, such terms shall be as similar as possible and in no event
less advantageous to WHB. The Substitute Option Issuer shall also enter into an
agreement with the then-holder or holders of the Substitute Option in
substantially the form as this Agreement, which shall be applicable to the
Substitute Option.
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(d) The Substitute Option shall be exercisable for such number of shares of
the Substitute Common Stock (as hereinafter defined) as is equal to the Assigned
Value (as hereinafter defined) multiplied by the number of shares of Common
Stock for which the Option was theretofore exercisable, divided by the Average
Price (as hereinafter defined). The exercise price of the Substitute Option per
share of the Substitute Common Stock (the "Substitute Option Price") shall then
be equal to the Exercise Price multiplied by a fraction in which the numerator
is the number of shares of the Common Stock for which the Option was theretofore
exercisable and the denominator is the number of shares for which the Substitute
Option is exercisable.
(e) The following terms have the meanings indicated:
(i) "Succeeding Corporation" shall mean (x) the continuing or surviving
corporation of a consolidation or merger with HCC (if other than HCC), (y)
HCC in a merger in which HCC is the continuing or surviving person, and (z)
the transferee of all or any substantial part of HCC assets (or the assets
of its subsidiaries).
(ii) "Substitute Common Stock" shall mean the common stock issued by the
Substitute Option Issuer upon exercise of the Substitute Option.
(iii) "Assigned Value" shall mean the highest of (x) the price per share
of Common Stock at which a tender offer or exchange offer therefor has been
made by any person (other than WHB or its subsidiaries) (y) the price per
share of Common Stock to be paid by any person (other than WHB or any of its
subsidiaries) pursuant to an agreement with HCC, and (z) the highest closing
sales price per share of Common Stock as quoted on the Nasdaq National
Market (or if Common Stock is not quoted on the Nasdaq National Market, the
highest bid price per share on any day as quoted on the principal trading
market or securities exchange on which such shares are traded as reported by
a recognized source chosen by WHB) within the six-month period immediately
preceding the agreement referred to in (y), or if the Common Stock is not
publicly traded, then the price per share as determined by a nationally
recognized investment banking firm mutually selected by WHB and HCC (or if
applicable, the Succeeding Corporation), provided that if a mutual selection
cannot be made as to such investment banking firm, it shall be selected by
WHB; provided, that in the event of a sale of less than all of HCC's assets,
the Assigned Value shall be the sum of the price paid in such sale for such
assets and the current market value of the remaining assets of HCC as
determined by a nationally recognized investment banking firm selected by
WHB and reasonably acceptable to HCC, divided by the number of shares of
Common Stock outstanding at the time of such sale. In the event that an
exchange offer is made for Common Stock or an agreement is entered into for
a merger or consolidation involving consideration other than cash, the value
of the securities or other property issuable or deliverable in exchange for
the Common Stock shall be determined by a nationally recognized investment
banking firm mutually selected by WHB and HCC (or if applicable, the
Succeeding Corporation), provided that if a mutual selection cannot be made
as to such investment banking firm, it shall be selected by WHB.
(iv) "Average Price" shall mean the average closing price of a share of
the Substitute Common Stock for the one year immediately preceding the
consolidation, merger or sale in question, but in no event higher than the
closing price of the shares of the Substitute Common Stock on the day
preceding such consolidation, merger or sale, provided that if HCC is the
issuer of the Substitute Option, the Average Price shall be computed with
respect to a share of common stock issued by HCC, the person merging into
HCC or by any company which controls or is controlled by such merging
person, as WHB may elect.
(f) In no event pursuant to any of foregoing paragraphs shall the Substitute
Option be exercisable for more than 19.9 percent of the aggregate of the shares
of the Substitute Common Stock outstanding immediately prior to exercise of the
Substitute Option. In the event that the Substitute Option would
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be exercisable for more than 19.9 percent of the aggregate of the shares of
Substitute Common Stock but for this clause (f), the Substitute Option Issuer
shall make a cash payment to WHB equal to the excess of (i) the value of the
Substitute Option without giving effect to the limitation in this clause (f)
over (ii) the value of the Substitute Option after giving effect to the
limitation in this clause (f). This difference in value shall be determined by a
nationally recognized investment banking firm selected by WHB and the Substitute
Option Issuer.
(g) HCC shall not enter into any transaction described in subsection (b) of
this Section 5 unless the Succeeding Corporation and any person that controls
the Succeeding Corporation assume in writing all the obligations of HCC
hereunder and take all other actions that may be necessary so that the
provisions of this Agreement, including but not limited to this Section 5, are
given full force and effect (including, without limitation, any action that may
be necessary so that the shares of Substitute Common Stock are in no way
distinguishable from or have lesser economic value than other shares of common
stock issued by the Substitute Option Issuer).
6. PURCHASE OF OPTION SHARES AND OPTIONS BY HCC.
(a) From and after the first date a transaction specified in Section 5(b)
herein is consummated (the "Repurchase Event"), and subject to applicable
regulatory restrictions, WHB or a holder or former holder of any Options (a
"Holder") who has exercised the Options in whole or in part shall have the right
to require HCC to purchase some or all of the Option Shares at a purchase price
per share (the "Purchase Price") equal to the highest of (i) 100 percent of the
Exercise Price, (ii) the highest price paid or agreed to be paid for shares of
Common Stock by an Acquiring Person (as defined in Paragraph (b) of this
Section) in any tender offer, exchange offer or other transaction or series of
related transactions involving the acquisition of 10 percent or more of the
outstanding shares of Common Stock during the one-year period immediately
preceding the Purchase Date (as defined in Paragraph (d) of this Section) and
(iii) in the event of a sale of all or substantially all of HCC's assets, (x)
the sum of the price paid in such sale for such assets and the current market
value of the remaining assets of HCC as determined by a recognized investment
banking firm jointly selected by such Holder and HCC, each acting in good faith,
divided by (y) the number of shares of Common Stock then outstanding. In the
event that any of the consideration paid or agreed to be paid by an Acquiring
Person for any shares of Common Stock or for any of HCC's assets consists in
whole or in part of securities, the value of such securities for purposes of
determining the Purchase Price shall be determined (i) if there is an existing
public trading market therefor, by the average of the last sales prices for such
securities on the ten trading days ending three trading days prior to the
payment of such consideration (if such consideration has been paid) or prior to
the date of determination (if such consideration has not yet been paid) and (ii)
if there is no existing public trading market for such securities, by a
recognized investment banking firm jointly selected by the Holder and HCC, each
acting in good faith. The Holder's right to require HCC to purchase some or all
of the Option Shares under this Section shall expire on the day which is one
year following the Repurchase Event; provided, that if HCC is prohibited under
applicable regulations from purchasing Common Stock as to which a Holder has
given notice hereunder, then the Holder's right to require HCC to purchase such
shares shall expire on the date which is one year following the date on which
HCC no longer is prohibited from purchasing such shares: provided further, that
HCC shall use its best efforts to obtain any consent or approval and make any
filing required for HCC to consummate as quickly as possible the purchase of the
Common Stock contemplated hereunder.
(b) For purposes of this Agreement, "Acquiring Person" shall mean a person
or group (as such terms are defined in the Exchange Act and the rules and
regulations thereunder) other than WHB or a subsidiary of WHB who on or after
the date of this Agreement engages in a transaction which gives rise to a
Purchase Event.
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<PAGE>
(c) Subject to applicable regulatory restrictions, from and after a
Repurchase Event or after HCC receives official notice that an approval of the
Department of Financial Institutions of the State of California, or any other
regulatory authority, required for the exercise of the Option and purchase of
the Option Shares will not be issued or granted, a Holder shall have the right
to require HCC to purchase some or all of the Options held by such Holder at a
price equal to the Purchase Price minus the Exercise Price on the Purchase Date
(as defined in Paragraph (d) of this Section) multiplied by the number of shares
of Common Stock that may be purchased on the Purchase Date upon the exercise of
the Options elected to be purchased. Notwithstanding the termination date of the
Options, the Holder's right to require HCC to purchase some or all of the
Options under this Section shall expire on the day which is one year following
the Repurchase Event; provided, that if HCC is prohibited under applicable
regulations from purchasing the Options as to which an Holder has given notice
hereunder, then the Holder's right to require HCC to purchase such Options shall
expire on the day which is one year following the date on which HCC no longer is
prohibited from purchasing such Options; provided further, that HCC shall use
its best efforts to obtain any consent or approval and make any filing required
for HCC to consummate as quickly as possible the purchase of the Options
contemplated hereunder.
(d) A Holder may exercise its right to require HCC to purchase the Common
Stock or Options (collectively, "Securities") pursuant to this Section by
surrendering for such purpose to HCC, at its principal office or at such other
office or agency maintained by HCC for that purpose, within the period specified
above, the certificates or other instruments representing the Securities to be
purchased accompanied by a written notice stating that it elects to require HCC
to purchase all or a specified number of such Securities. Within five business
days after the surrender of such certificates or instruments and the receipt of
such notice relating thereto, to the extent it is legally permitted to do so,
HCC shall deliver or cause to be delivered to the Securities Holder (i) a bank
cashier's or certified check payable to the Securities Holder in an amount equal
to the applicable purchase price therefor, and (ii) if less than the full number
of Securities evidenced by the surrendered instruments are being purchased, a
new certificate or instrument, for the number of Securities evidenced by such
surrendered certificates or other instruments less the number of Securities
purchased. Such purchases shall be deemed to have been made at the close of
business on the date (the "Purchase Date") of the receipt of such notice and of
such surrender of the certificates or other instruments representing the
Securities to be purchased and the rights of the Securities Holder, except for
the right to receive the applicable purchase price therefor in accordance
herewith, shall cease on the Purchase Date.
7. DEMAND REGISTRATION RIGHTS. As promptly as practicable upon WHB's
request after a Purchase Event, HCC agrees to prepare and file not more than two
registration statements, prospectuses or permit or exemption applications
("Registration Event") as appropriate, under federal and any applicable state
securities laws, with respect to any proposed sale of any warrants, options or
other securities representing any of WHB's rights under this Agreement or
proposed dispositions by WHB of any or all of the Option Shares, if such
registrations or filings are required by law or regulation, and to use its best
efforts to cause any such registration statements or prospectuses to become
effective, or to have any permit or exemption granted, as expeditiously as
possible and to keep such registration statement, prospectus, permit or
exemption effective for a period of not less than 180 days unless, in the
written opinion of counsel to HCC, addressed to WHB and satisfactory in form and
substance to WHB and its counsel, registration (or filing of a prospectus, or
grant of a permit or exemption) is not required for such proposed transactions.
All fees, expenses and charges of any kind or nature whatsoever incurred in
connection with any registration of, or the preparation of any registration
statement, prospectus or permit or exemption application relating to, the
Options or the Option Shares pursuant to this Section 7 shall be borne and paid
by HCC; provided, however, that in no event shall this Section 7 be construed to
require HCC to bear the expense of any change of control notice or similar
regulatory filing made by any purchaser or acquiror of Option Shares issued to
WHB pursuant to this Agreement. In the event WHB exercises its registration
rights under this Section 7, HCC shall
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provide WHB, its affiliates, each of their respective officers and directors and
any underwriters used by WHB, with indemnifications, representations and
warranties and shall cause its attorneys and accountants to deliver to WHB and
any such underwriters attorneys' opinions and "comfort letters", all of a type
customarily provided or delivered in connection with public underwritten
offerings of securities. In the event HCC effects a registration of Common Stock
for its own account or for any other shareholder of HCC, it shall allow WHB to
participate in such registration. Notwithstanding the foregoing, HCC shall have
the right to delay (a "Delay Right") a Registration Event for a period of up to
thirty (30) days, in the event it receives a request from WHB to effect a
Registration Event, if HCC (i) is involved in a material transaction, or (ii)
determines, in the good faith exercise of its reasonable business judgment, that
such registration and offering could adversely effect or interfere with bona
fide material financing plans of HCC or would require disclosure of information,
the premature disclosure of which could materially adversely affect HCC or any
transaction under active consideration by HCC. For purposes of this Agreement,
the term "material transaction" shall mean a transaction which, if HCC were
subject to the reporting requirements under the Exchange Act, would require HCC
to file a current report on Form 8-K with the Securities Exchange Commission.
HCC shall have the right to exercise two Delay Rights in any eighteen (18) month
period.
8. LISTING.
If Common Stock or any other securities to be acquired upon exercise of the
Option are then authorized for quotation or trading or listing on the Nasdaq
National Market or any other securities exchange or automated quotation system,
HCC, or any successor thereto, upon the request of the holder of the Option,
will promptly file an application, if required, to authorize for listing or
trading or quotation the shares of Common Stock or other securities to be
acquired upon exercise of the Option on the Nasdaq National Market or any other
securities exchange or automated quotation system and will use its best efforts
to obtain approval, if required, of such listing or quotation as soon as
possible.
9. MISCELLANEOUS.
(a) EXPENSES. Each of the parties hereto shall bear and pay all costs and
expenses incurred by it or on its behalf in connection with the transactions
contemplated hereunder, including fees and expenses of its own financial
consultants, investment bankers, accountants and counsel.
(b) ENTIRE AGREEMENT. Except as otherwise expressly provided herein, this
Agreement contains the entire agreement between the parties with respect to the
transactions contemplated hereunder and supersedes all prior arrangements or
understandings with respect thereto, written or oral. The terms and conditions
of this Agreement shall inure to the benefit of and be binding upon the parties
hereto and their respective successors and assigns. Nothing in this Agreement,
expressed or implied, is intended to confer upon any party, other than the
parties hereto, and their respective successors and assigns, any rights,
remedies, obligations or liabilities under or by reason of this Agreement,
except as expressly provided herein.
(c) ASSIGNMENT. At any time after a Purchase Event occurs, WHB may sell,
assign or otherwise transfer its rights and obligations hereunder, in whole or
in part, by issuing Options or otherwise, to any person or group of persons,
subject to applicable law, rule or regulation. In order to effectuate the
foregoing, WHB (or any direct or indirect assignee or transferee of WHB) shall
be entitled to surrender this Agreement to HCC in exchange for two or more
Agreements entitling the holders thereof to purchase in the aggregate the same
number of shares of Common Stock as may be purchasable hereunder.
(d) NOTICES. All notices or other communications which are required or
permitted hereunder shall be in writing and sufficient if delivered personally
or by confirmed facsimile transmission or sent
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by registered or certified mail or overnight courier, postage prepaid, with
return receipt requested, addressed as follows:
If to WHB:
Western Holdings Bancorp
4546 El Camino Real
Los Altos, CA 94022
Attention: James Wall
President
Facsimile Number: (650) 941-8739
With a copy to:
Sheppard Mullin Richter & Hampton, LLP
4 Embarcadero Center
San Francisco, CA 94111
Attention: John Sears
Facsimile Number: (415) 434-3947
If to HCC:
Heritage Commerce Corp
150 Almaden Boulevard
San Jose, CA 95113
Attention: John E. Rossell, III
President & CEO
Facsimile Number: (408) 947-1054
With a copy to:
McCutchen, Doyle, Brown & Enersen, LLP
3 Embarcadero Center, #1800
San Francisco, California 94111
Attention: James M. Rockett, Esq.
Facsimile Number: (415) 393-2286
A party may change its address for notice purposes by written notice to the
other party hereto.
(e) COUNTERPARTS. This Agreement may be executed in any number of
counterparts, and each such counterpart shall be deemed to be an original
instrument, but all such counterparts together shall constitute but one
agreement.
(f) SPECIFIC PERFORMANCE. The parties hereto agree that irreparable harm
would occur in the event that any of the provisions of this Agreement were not
performed by them in accordance with their specific terms or conditions or were
otherwise breached and that money damages are an inadequate remedy for breach of
this Agreement because of the difficulty of ascertaining the amount of damage
that will be suffered by the parties in the event that this Agreement is not
performed in accordance with its terms or conditions or otherwise breached. It
is accordingly agreed that the parties shall be entitled to an injunction or
injunctions to prevent breaches of this Agreement by the parties and to enforce
specifically the terms and provisions hereof in any court of the United States
or any state having jurisdiction, this being in addition to any other remedy to
which it is entitled at law or in equity.
(g) GOVERNING LAW. This Agreement shall be governed by and construed in
accordance with the laws of the State of California.
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(h) BEST EFFORTS. Each of HCC and WHB will use its best efforts to make
all filings with, and to obtain consents of, all third parties and governmental
authorities necessary to the consummation of the transactions contemplated by
this Agreement, including without limitation applying to the Department of
Financial Institutions of the State of California for approval to acquire or
issue the shares issuable hereunder.
(i) DESCRIPTIVE HEADINGS. The descriptive headings herein are inserted for
convenience of reference and are not intended to be part of or to affect the
meaning or interpretation of this Agreement.
IN WITNESS WHEREOF, each of the parties hereto has executed this Agreement,
as of the day and year first written above.
<TABLE>
<S> <C> <C>
WESTERN HOLDINGS BANCORP
By
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President
HERITAGE COMMERCE CORP
By
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President and Chief Executive Officer
</TABLE>
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