<PAGE>
OFFICE OF THE COMPTROLLER OF THE CURRENCY
WASHINGTON, D.C. 20219
FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 [FEE
REQUIRED] FOR THE FISCAL YEAR ENDED
DECEMBER 31, 1998
VALLE DE ORO BANK, NATIONAL ASSOCIATION
---------------------------------------
(Name of small business issuer in its charter)
IRS EMPLOYER ID. NO. 95-3746429
1234 EAST MAIN STREET, EL CAJON, CALIFORNIA 92021
-------------------------------------------------
(Address of principal executive office) (Zip Code)
ISSUER'S TELEPHONE NUMBER INCLUDING AREA CODE: (619) 593-3330
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK
------------
(Title of class)
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months and (2) has
been subject to such filing requirements for the past 90 days. Yes X No
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. X
The issuer's revenues for its most recent fiscal year were $21,033,000.
The aggregate market value of the voting stock held by nonaffiliates of the
Registrant as of the close of business on March 25, 1999 was $35,962,471 based
on the quoted Nasdaq closing price on such date.
The number of shares of Common Stock outstanding as of the close of business on
March 25, 1999: 1,325,231.
<PAGE>
DOCUMENTS INCORPORATED BY REFERENCE
Items 10 (as to directors), 11 and 12 of Part III incorporate by reference
information from the registrant's Proxy Statement to be filed with the
Securities and Exchange Commission in connection with the solicitation of
proxies for the registrant's 1999 Annual Meeting of Shareholders to be held on
May 25, 1999.
Transitional Small Business Disclosure Format: Yes No X
2
<PAGE>
1998 10-KSB ANNUAL REPORT
TABLE OF CONTENTS
PART I
ITEM 1. BUSINESS
ITEM 2. DESCRIPTION OF PROPERTIES
ITEM 3. LEGAL PROCEEDINGS
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
PART II
ITEM 5. MARKET FOR THE BANK'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE BANK; COMPLIANCE WITH SECTION
16(a) OF THE EXCHANGE ACT.
ITEM 10. EXECUTIVE COMPENSATION
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
3
<PAGE>
ITEM 1. BUSINESS
GENERAL
On February 18, 1999, Valle de Oro Bank, N.A. (the "Bank") mailed to
stockholders a proxy statement-prospectus regarding a proposal to form a bank
holding company called Valley National Corporation, which will own Valle de Oro
Bank, N.A. A special meeting of stockholders was held on March 23, 1999 to
consider and vote for this proposal.
This reorganization will permit Valley National Corporation and the Bank
greater financial and corporate flexibility in the areas of acquisitions and
debt financing. The reorganization will also allow us to offer new services,
enjoy access to new markets, and participate in activities that are not
permissible for the Bank to engage in directly. As part of the reorganization
proposal, each stockholder will receive two shares of Valley National
Corporation for each share of the Bank. Stockholders approved this proposal, and
the reorganization will occur on March 31, 1999.
Valle de Oro Bank conducts substantially the same business operations as a
typical independent, commercial bank including accepting demand, savings and
time deposits and making commercial, real estate and consumer loans, including
credit card and home equity credit lines. The Bank also offers mortgage
brokerage services including a variety of conventional and FHA/VA residential
real estate loan products, and commercial loan products. The Bank also offers
mutual funds, fixed and variable annuities, stocks, bonds and other nondeposit
investment products through a third party broker/dealer.
The Bank has six offices located in East San Diego County. Since its
inception on March 7, 1983, the Bank has emphasized consumer and small business
banking. The Bank's lending and deposit-taking activities are concentrated in
San Diego County. The Bank does not obtain a material portion of its deposits
from a single person or few persons, nor is a material portion of the Bank's
loans concentrated within a single industry or group of related industries. The
Bank does not attract deposits from and has not made loans to foreign
governments or foreigners. The Bank's business is not seasonal. There has been
no material effect upon the Bank's capital expenditures, earnings, or
competitive position as a result of federal, state or local environmental
regulations.
The Bank holds no patents, registered trademarks, licenses (other than
licenses required to
4
<PAGE>
be obtained from appropriate bank regulatory agencies), franchises or
concessions.
COMPETITION
The banking business in California generally, and specifically in the
Bank's primary service area, is highly competitive with respect to both loans
and deposits and is dominated by a relatively small number of major banks which
have many offices operating over wide geographic areas. The Bank competes for
deposits and loans principally with these major banks, but also with small
independent banks and credit unions located in its service area. Among the
advantages that the major banks have over the Bank is their ability to finance
extensive advertising campaigns and to allocate their investment assets to
regions of highest yield and demand. Many of the major commercial banks
operating in the Bank's service area offer certain services (such as trust and
international banking services) which are not offered directly by the Bank and,
by virtue of their greater total capitalization, such banks have substantially
higher lending limits than the Bank.
Moreover, banks generally, and the Bank in particular, face increasing
competition for loans and deposits from non-bank financial intermediaries
including credit unions, savings and loan associations, brokerage firms,
insurance companies, thrift and loan companies, mortgage companies, and other
financial and non-financial institutions.
The recent trend has been for other institutions, such as brokerage firms,
credit card companies, and even retail establishments, to offer banking services
to consumers, such as money market funds with check access and cash advances on
credit card accounts. In addition, other entities (both public and private)
seeking to raise capital through the issuance and sale of debt or equity
securities compete with banks in the acquisition of deposits. While the
direction of recent legislation and economic developments seems to favor
increased competition between different types of financial institutions for both
deposits and loans, resulting in increased cost of funds to banks generally, and
the Bank in particular, it is not possible to predict the full impact these
developments will have on commercial banking or the Bank.
In order to compete with other financial institutions in its service area,
the Bank relies principally upon local promotional activity including direct
mail and advertising in the local media; personal contacts by its directors,
officers, employees and stockholders; and specialized services. The Bank's
promotional activities emphasize the advantages of dealing with a locally owned
and
5
<PAGE>
headquartered institution attuned to the particular needs of the community.
For customers whose loan demands exceed the Bank's lending limits, the Bank
attempts to arrange for such loans on a participation basis with other financial
institutions. The Bank also assists customers requiring services not offered by
the Bank to obtain these services from its correspondent banks.
EMPLOYEES
As of December 31, 1998 the Bank employed 115 full-time and 13 part-time
employees, including 34 officers. Bank employees are not represented by a union
and the Bank does not participate in any collective bargaining agreement.
SUPERVISION AND REGULATION
The Bank is subject to the periodic reporting requirements of the
Securities and Exchange Act of 1934, as amended (the "Exchange Act"), which
include, but are not limited to, the filing of annual, quarterly and other
reports with the Comptroller of the Currency (the "Comptroller").
As a national bank, the Bank is subject to regulation, supervision and
regular examination by the Office of the Comptroller of the Currency. Generally,
a national bank is required to obtain the approval of the Comptroller before it
may merge or consolidate with another bank.
The Bank is required to file reports with the Comptroller and provide such
additional information as the Comptroller may require. The Comptroller also has
the authority to examine the Bank, with the cost of any such examination to be
borne by the Bank.
Each depositor's account with the Bank is insured by the Federal Deposit
Insurance Corporation (the "FDIC") to the maximum amount permitted by law, which
is currently $100,000 for each insured deposit. The Bank is also subject to
certain regulations promulgated by the Comptroller and applicable provisions of
California law, insofar as they do not conflict with or are not preempted by
Federal banking law. The Comptroller regulates the number of locations of branch
offices of a national bank, but may only permit a national bank to maintain
branches in locations and under the same conditions that state banks are
permitted to maintain by state law. California law presently permits a bank to
locate a branch office in any locality in the state
The regulations of the FDIC and the Comptroller govern most aspects of the
Bank's business, including deposit reserve requirements, investments, loans,
certain check clearing activities, issuance of securities, payment of dividends,
branching, deposit interest and numerous other matters. As a
6
<PAGE>
consequence of the extensive regulation of commercial banking activities in the
United States, the Bank's business is particularly susceptible to changes in the
state and Federal legislation and regulations, which may have the effect of
increasing the cost of doing business, limiting permissible activities or
increasing competition.
GOVERNMENTAL POLICIES AND LEGISLATION. Banking is a business that depends
primarily on rate differentials. In general, the difference between the interest
rates paid by the Bank on its deposits and its other borrowings, and the
interest rates received by the Bank on loans extended to its customers and
securities held in its portfolio, comprise the major portion of the Bank's net
revenues. These rates are highly sensitive to many factors that are beyond the
Bank's control. Accordingly, the Bank's growth and earnings are subject to the
influence of domestic and foreign economic conditions, including inflation,
recession and unemployment.
The commercial banking business is affected not only by general economic
conditions, but is also influenced by the monetary and fiscal policies of the
Federal government and the policies of regulatory agencies, particularly the
Federal Reserve Bank ("FRB"). The FRB implements national monetary policies
(with objectives such as curbing inflation and combating recession) by its
open-market operations in U.S. Government securities, by adjusting the required
level of reserves for financial institutions subject to its reserve requirements
and by varying the discount rates applicable to borrowings by depository
institutions. The actions of the FRB in these areas influence the growth of bank
loans, investments and deposits, and also affect interest rates charged on loans
and paid on deposits. The nature and impact of any future changes in monetary
policies cannot be predicted.
From time to time, legislation is enacted which has the effect of
increasing the cost of doing business, limiting or expanding permissible
activities or affecting the competitive balance between banks and other
financial institutions. Proposals to change the laws and regulations governing
the operations and taxation of bank holding companies, banks and other financial
institutions are frequently made in Congress, in the California Legislature and
before various bank holding company and bank regulatory agencies. The likelihood
of any major changes and the impact such changes might have are impossible to
predict. Certain of the potentially significant changes, which have been enacted
recently by Congress or various regulatory or professional agencies, are
discussed below.
CAPITAL REQUIREMENTS. The Comptroller has adopted risk-based capital
adequacy guidelines
7
<PAGE>
for banks. The risk-based capital adequacy guidelines establish a risk-based
capital ratio based on the overall risk of the entity determined by (i)
assigning weighted risks to each balance sheet asset and certain off-balance
sheet commitments and (ii) adding up all of the weighted risks of all assets and
includable off-balance sheet commitments to obtain the total risk. The
guidelines generally require national banks to maintain a total qualifying
capital to weighted risk assets level of 8% (the "Risk-based Capital Ratio"). Of
the total 8%, at least 4% of the total qualifying capital to weighted risk
assets (the "Tier 1 Risk-based Capital Ratio") must be Tier 1 or core capital
consisting primarily of equity stock. Tier 2 capital, which is to make up the
remainder of total capital, consists of (I) loan loss allowance, up to 1.25% of
weighted risk assets (ii) mandatory convertible debentures and (iii) other forms
of capital. Qualified preferred capital stock may be considered core capital up
to 25% of all core capital elements.
The Comptroller has adopted leverage requirements that apply in addition to
the risk-based capital requirements. Under these requirements, national banks
are required to maintain core capital of at least 3% of their assets (the
"Leverage Ratio"). However, an institution may be required to maintain core
capital of at least 4% or 5%, or possibly higher, depending upon the activities,
risks, rate of growth, and other factors deemed material by regulatory
authorities. As of December 31, 1998 the Bank met all applicable capital
requirements imposed by regulations. See "Item 6. Management's Discussion and
Analysis -- Capital."
DIVIDENDS. There are regulatory restrictions on dividend payments by the
Bank that may affect the Bank's ability to pay dividends on its common stock.
See "Item 5. Market for Common Equity and Related Stockholder Matters."
On December 19, 1991, President Bush signed into law the Federal Deposit
Insurance Corporation Improvement Act of 1991 ("FDICIA"). FDICIA is an omnibus
banking reform bill that added new regulation and made changes in existing
regulation of the operations, procedures and regulatory reporting of insured
institutions, bank holding companies and affiliates. Among other things, FDICIA
establishes five capital categories applicable to insured institutions, each
with specific regulatory consequences. If the appropriate Federal banking agency
determines, after notice and an opportunity for hearing, that an insured
institution is in an unsafe or unsound condition, it
8
<PAGE>
may reclassify the institution to the next lower capital category (other than
critically undercapitalized) and require the submission of a plan to correct the
unsafe or unsound condition. The Comptroller has issued regulations (the "Prompt
Corrective Action Regulations") to implement these provisions. Under the
regulations, the categories are:
a. Well Capitalized -- The institution exceeds the required minimum
level for each relevant capital measure. A well capitalized
institution is one (I) having a Risk-based Capital Ratio of 10% or
greater, (ii) having a Tier 1 Risk-based Capital Ratio of 6% or
greater, (iii) having a Leverage Ratio of 5% or greater and (iv) not
being subject to any order or written directive to meet and maintain a
specific capital level for any capital measure.
b. Adequately Capitalized -- The institution meets the required
minimum level for each relevant capital measure. No capital
distribution may be made that would result in the institution becoming
undercapitalized. An adequately capitalized institution is one (I)
having a Risk-based Capital Ratio of 8% or greater, (ii) having a Tier
1 Risk-based Capital Ratio of 4% or greater and (iii) having a
Leverage Ratio of 4% or greater or a Leverage Ratio of 3% or greater
if the institution is rated composite 1 under the CAMEL rating system.
c. Undercapitalized -- The institution fails to meet the required
minimum level for any relevant capital measure. An undercapitalized
institution is one (I) having a Risk-based Capital Ratio of less than
8% or (ii) having a Tier 1 Risk-based Capital Ratio of less than 4% or
(iii) having a Leverage Ratio of less than 4%, or if the institution
is rated a composite 1 under the CAMEL rating system, a Leverage Ratio
of less than 3%.
The appropriate Federal banking agency must closely monitor an
undercapitalized institution and the institution must submit an
acceptable capital restoration plan. Each company having control over
the undercapitalized institution must provide a limited guarantee that
the institution will comply with its capital restoration plan. Except
under limited circumstances consistent with an accepted capital
restoration plan, an undercapitalized institution may not grow. An
undercapitalized institution may not acquire
9
<PAGE>
another institution, establish additional branch offices or engage in
any new line of business unless determined by the appropriate Federal
banking agency to be consistent with an accepted capital restoration
plan or the FDIC determines that the proposed action will further the
purpose of prompt corrective action. The appropriate Federal banking
agency may take any action authorized for a significantly
undercapitalized institution if an undercapitalized institution fails
to submit an acceptable capital restoration plan or fails in any
material respect to implement a plan accepted by the agency.
d. Significantly Undercapitalized -- The institution is significantly
below the required minimum level for any relevant capital measure. A
significantly undercapitalized institution is one (I) having a
Risk-based Capital Ratio of less than 6% or (ii) having a Tier 1
Risk-based Capital Ratio of less than 3% or (iii) having a Leverage
Ratio of less than 3%.
e. Critically Undercapitalized -- The institution fails to meet a
critical capital level set by the appropriate Federal banking agency.
A critically undercapitalized institution is one having a ratio of
tangible equity to total assets that is equal to or less than 2%.
As of December 31, 1998 the Bank was considered "well capitalized." See
"Item 6. Management's Discussion and Analysis -- Capital."
An institution, which is classified as adequately capitalized or higher,
may not make capital distributions, which would cause it to be less than
adequately capitalized. An institution which is less than adequately capitalized
must adopt an acceptable capital restoration plan, is subject to increased
regulatory oversight, and is increasingly restricted in the scope of its
permissible activities. A critically undercapitalized institution is subject to
having a receiver or conservator appointed to manage its affairs and for loss of
its charter to conduct banking activities.
ITEM 2. DESCRIPTION OF PROPERTIES
The Bank owns approximately 28,000 square feet of commercial space for its
Casa de Oro Office located at 9832 Campo Road, Spring Valley, California 91977.
In August 1990, the Bank exercised its option to purchase property on which
its head office
10
<PAGE>
is located. The Bank took out a $240,000 mortgage for ten years at 8.5% interest
with monthly payments of principal and interest of $3,100. The balance on the
mortgage was $52,000 at December 31, 1998.
On August 30, 1985, the Bank purchased from Bank of America, the building
in which its Sweetwater Office is located at 491 Sweetwater Road, Spring Valley,
California. The purchase price for the 10,000 square foot branch including
fixtures was $400,000. The Bank assumed a ground lease, which runs until
September 2001 with an option extending the term for an additional period of ten
years. The current monthly ground lease payment is $2,745, including common area
charges.
On November 15, 1987, the Bank entered into a lease for a 4,000 square foot
building to house its Rancho San Diego Office. The Bank's lease runs until
November 2003 with two consecutive five year options to extend the lease. The
current monthly lease payment is $9,854, including common area charges.
On January 29, 1993, the Bank entered into a lease for an 8,000 square foot
building to house its Grossmont Center Office. The lease expires in 2015. The
Bank sublets approximately 3,600 square feet of the building. The current
monthly lease payment is $17,154, including common area expenses. The Bank
currently receives sublease rental income of approximately $4,652 per month.
On December 30, 1995, the Grossmont Center Office was entirely destroyed by
fire. The cause of the fire was arson. On January 6, 1997 the Bank completed
re-construction and re-opened the office. The Bank received a total of
$1,854,000 in insurance proceeds, $700,000 in 1996 and $1,154,000 in 1997, which
represent a full settlement of its loss.
On September 7, 1994, the Bank entered into a lease for a 13,000 square
foot building located at 1234 East Main Street, El Cajon, California to house
its El Cajon Office. This lease expires on November 30, 1999, and the Bank is
planning to renew the lease. It has a current monthly rental payment of $12,220.
On December 2, 1996 the Bank purchased a former banking office of Wells
Fargo Bank, N.A. for its Santee Office for $630,000. The building has 3,000
square feet of space and a three lane drive-up facility.
As of December 31, 1998 the Bank had three properties classified other real
estate owned with a carrying value of $1.1 million. These properties are
comprised of two parcels of unimproved
11
<PAGE>
land and a single-family residence. The unimproved land parcels are located in
the Otay Mesa area of San Diego County. The single-family residence was sold in
January 1999. The Bank maintains an active sales program for the unimproved
land.
ITEM 3. LEGAL PROCEEDINGS
The Bank is only involved in routine litigation that is incidental to its
business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the
fourth quarter of 1998.
ITEM 5. MARKET FOR THE BANK'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
The authorized capital stock of the Bank consists of 10,000,000 shares of
common stock, par value $3.33 per share. As of December 31, 1998 there were
1,323,031 shares issued and outstanding.
The Bank's common stock began trading on the Nasdaq Stock Market under the
trading symbol "VADO" on November 17, 1998. Currently, four independent
brokerage firms are registered as market makers for the Bank's common stock.
The following sets forth the high and low trading prices of the Bank's
common stock for the years indicated. Since November 17, 1998 trading prices are
based on the records of the Nasdaq Stock Market. Prior to that, trading prices
are based on transactions of which management is aware:
<TABLE>
<CAPTION>
TRADING PRICES(1)
---------------------
1997 HIGH LOW
------------- ------ ------
<S> <C> <C>
First Quarter $16.32 $14.29
Second Quarter $22.14 $17.14
Third Quarter $23.10 $22.14
Fourth Quarter $25.24 $24.11
</TABLE>
12
<PAGE>
<TABLE>
<CAPTION>
1998 HIGH LOW
---------------- ------ ------
<S> <C> <C>
First Quarter $30.48 $24.29
Second Quarter $34.25 $27.00
Third Quarter $34.75 $29.00
Fourth Quarter $35.88 $28.00
</TABLE>
(1) Prices have been adjusted for each of the 5% common stock dividends
declared and paid by the Bank in 1998 and 1997.
There were approximately 1,255 stockholders of record of the Bank's common
stock on December 31, 1998. The Bank paid a quarterly cash dividend of $0.07 per
share in the third and fourth quarters of 1998 and a quarterly cash dividend of
$0.06 per share in the first two quarters of 1998 and in each quarter of 1997.
The Bank has paid a 5% stock dividend to stockholders in each year since 1988.
Cash was paid in lieu of fractional shares.
The power of the Board of Directors of a national bank, such as the Bank,
to declare a cash dividend is subject to statutory and regulatory restrictions
which limit the amount available for cash dividends depending upon the earnings,
financial condition and cash needs of the bank, as well as general business
conditions. A national bank is prohibited from paying dividends out of common
capital. Dividends must be paid out of undivided profits. If losses have, at any
time, been sustained equal to or exceeding a bank's undivided profits then on
hand, no dividend may be paid. Moreover, even if a national bank's surplus
exceeded its common capital and its undivided profits exceed its losses, the
approval of the Comptroller is required for the payment of dividends if the
total of all dividends declared by a national bank in any calendar year would
exceed the total of its net profits of that year combined with its net profits
of the two preceding years, less any required transfers to surplus.
13
<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF
OPERATION
Statements made in this report looking forward in time are considered
"forward-looking statements" within the meaning of Federal and state securities
laws. Such statements are subject to a number of uncertainties that could cause
the actual results to differ materially from those expected, including but not
limited to the risks associated with the effect of changing economic conditions,
variations in the Bank's cash flow, market acceptance risks, seasonally and
other risks described in the Bank's Office of the Comptroller of the Currency
and Securities and Exchange Commission filings.
OVERVIEW
In 1998 net earnings increased to $2,400,000, a 30% increase over 1997.
This compares to net earnings of $1,852,000 in 1997, which was a 32% increase
over 1996 net earnings of $1,403,000. The 1998 results represent the 15th
consecutive year of increased earnings. Over the past three years, the Bank's
growth has been a major contributor to the increases in net earnings. Total
assets at December 31, 1998 were $236.8 million, a 15% increase over 1997. Net
loans increased 11% to $149.7 million, and deposits increased 15% to $216.4
million. By comparison, total assets grew 12% and 17% in 1997 and 1996,
respectively. Net loans increased 14% in both 1997 and 1996. Deposits increased
13% and 18% in 1997 and 1996, respectively.
Basic and diluted earnings per share in 1998 were $1.83 and $1.69,
respectively. This compares to 1997 basic and diluted earnings per share of
$1.43 and $1.33, respectively. In terms of diluted earnings per share, 1998
represented a 27% increase, compared to a 25% increase in 1997 and 20% increase
in 1996. Cash dividends paid in 1998 were increased to $0.26 per share as
compared to $0.24 per share in 1997 and 1996, respectively.
EARNING ASSETS AND INTEREST INCOME
Average earning assets grew to $204.0 million in 1998, an increase of $26.4
million or 15% over 1997. Average loans increased $18.4 million or 15%. Average
securities, both taxable and tax-exempt, increased $2.2 million or 6% primarily
in tax-exempt securities. Average federal funds sold grew $5.1 million or 31%,
and interest-earning deposits with other banks increased $747,000 or
14
<PAGE>
17%.
In 1998 the Bank increased its efforts to generate loans by focusing on
small business, real estate, and consumer lending. In addition, the local
economy has been good. Low interest rates, low unemployment and rising real
estate values are some of the factors that helped the local economy and
contributed to the Bank's operating results in 1998.
The following table shows the Bank's year-to-date average assets and
liabilities; the interest earned or paid; and the yields for the past three
years.
<TABLE>
<CAPTION>
($ in thousands)
1998 1997 1996
----------------------------- ----------------------------- ------------------------------
Average Int Earned/ Average Int Earned/ Average Int Earned/
Amount Paid Yield Amount Paid Yield Amount Paid Yield
----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Loans, net (1) $ 139,001 $14,456 10.40% $ 120,592 $13,053 10.82% $ 110,342 $12,292 11.14%
Securities
Taxable 23,744 1,429 6.02% 24,565 1,524 6.20% 20,137 1,236 6.14%
Exempt from federal
income taxes (2) 14,591 1,173 8.04% 11,605 930 8.01% 7,646 603 7.89%
Federal funds sold 21,568 1,141 5.29% 16,479 877 5.32% 15,098 774 5.13%
Interest-earning deposits 5,049 296 5.86% 4,302 258 6.00% 3,425 201 5.88%
------------------------------ ----------------------------- -----------------------------
Total earning assets 203,953 $18,495 9.07% 177,543 $16,642 9.37% 156,648 $15,106 9.65%
Non-earning assets 21,699 21,069 19,482
---------- --------- ---------
Total assets $ 225,652 $ 198,612 $ 176,130
---------- --------- ---------
---------- --------- ---------
Time deposits of $100,000 or more $ 15,376 $ 815 5.30% $ 14,620 $ 799 5.47% $ 14,981 $ 815 5.44%
All other interest-bearing
deposits 149,569 5,482 3.67% 131,788 5,141 3.90% 117,403 4,501 3.83%
----------------------------- ----------------------------- -----------------------------
Total interest-bearing
liabilities 164,945 $ 6,297 3.82% 146,408 $ 5,940 4.06% 132,385 $ 5,316 4.02%
Noninterest-bearing deposits 41,506 34,955 28,128
Other liabilities 1,001 1,139 943
Stockholders' equity 18,200 16,110 14,674
---------- --------- ---------
Total liabilities and
stockholders' equity $ 225,652 $ 198,612 $ 176,130
---------- --------- ---------
---------- --------- ---------
Interest income/earning assets $18,495 9.07% $16,642 9.37% $15,106 9.65%
Interest expense/earning assets 6,297 3.09% 5,940 3.35% 5,316 3.39%
----------------- ----------------- -----------------
Net interest income and margin $12,198 5.98% $10,702 6.03% $9,790 6.25%
----------------- ----------------- -----------------
----------------- ----------------- -----------------
</TABLE>
(1) Nonaccrual loans are included in net loans above and in the table of
Changes Due to Volume and Rate below.
(2) Income and yields on securities have been adjusted to a fully
tax-equivalent basis using a rate of 40%.
In recent years, fierce competition for loans has caused loan yields to
decline. In addition, the Federal Reserve Bank lowered short-term interest rates
in the fourth quarter of 1998, which
15
<PAGE>
affected most of the Bank's earning assets as well as interest-bearing
liabilities. This decline in interest rates, however, was offset by the
growth of earning assets. The following table shows the changes in interest
income and expense over the past three years as a result of changes due to
volume and rate.
<TABLE>
<CAPTION>
Changes Due to Volume and Rate (in thousands)
1998 Changes due to 1997 Changes due to 1996 Changes due to
------------------- ------------------- -------------------
Volume Rate Total Volume Rate Total Volume Rate Total
----------------------- ----------------------- -----------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Loans, net $1,915 $ (512) $ 1,403 $1,110 $(349) $ 761 $1,290 $ (933) $ 357
Securities
Taxable (49) (46) (95) 275 13 288 637 5 642
Exempt from federal income 240 3 243 318 9 327 289 (5) 284
taxes
Federal funds sold 269 (5) 264 74 29 103 134 (64) 70
Deposits with financial 44 (6) 38 52 5 57 59 (7) 52
institutions
----------------------- --------------------- ------------------------
Total $2,419 $ (566) $ 1,853 $1,829 $(293) $1,536 $2,409 $(1,004) $1,405
Time deposits of $100,000 or
more $ 41 $ (25) $ 16 $ (20) $ 4 $ (16) $ 185 $ (71) $ 114
All other interest-bearing
deposits 652 (311) 341 561 79 640 877 (4) 873
----------------------- --------------------- ------------------------
Total $ 693 $ (336) $ 357 $ 541 $ 83 $ 624 $1,062 $ (75) $ 987
----------------------- --------------------- ------------------------
Net interest income $1,726 $ (230) $ 1,496 $1,288 $(376) $ 912 $1,347 $(929) $ 418
----------------------- --------------------- ------------------------
----------------------- --------------------- ------------------------
</TABLE>
Changes due to both rate and volume are allocated to volume.
In 1998 average earning assets increased $26.4 million or 15% to $204.0
million. Average loans and federal funds sold accounted for the largest
growth in earning assets in 1998 increasing 15% and 31%, respectively. In
1998 average federal funds sold increased as a result of increases in
deposits. Average taxable securities and interest-earning deposits grew in
1998, but at a lesser rate. Securities exempt from federal income taxes
increased both in yield and in volume. In 1998 the returns on tax-exempt
securities were more attractive to the Bank than what was available on fully
taxable securities.
Average earning assets grew to $177.5 million in 1997, an increase of $21.0
million or 13% over 1996. This increase in earning assets was primarily in loans
and securities. In 1997 average net loans grew $10.3 million or 9% over 1996.
Loan demand in 1997 continued at a somewhat
16
<PAGE>
moderate rate. In 1997 average securities increased $8.4 million or 30% over
1996, a majority of which was divided somewhat evenly between taxable and
tax-exempt securities, although tax-equivalent yields were better for tax-exempt
securities. In 1997 average federal funds sold and average interest-earning
deposits with other financial institutions grew, but at a lesser rate than loans
or securities. Yields on these short-term assets increased in 1997 in line with
other short-term interest rates.
In 1996 average-earning assets increased $29.2 million or 23% over 1995.
Due to moderate loan demand, the growth of average securities of $14.1 million
exceeded the $11.6 million growth in net loans. Yields on loans also declined in
1996. Yields were slightly higher for securities.
The Bank's loan portfolio, classified by type, as of December 31 for each
of the last five years is:
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
<S> <C> <C> <C> <C> <C>
Commercial and industrial $ 62,341 $ 56,477 $ 51,183 $ 50,390 $ 41,695
Real estate-construction 7,960 5,899 5,560 2,830 7,633
Real estate-mortgage 66,850 61,070 52,349 33,710 37,515
Consumer loans 15,062 13,449 10,983 18,654 9,867
----------- ---------- ---------- ---------- ---------
Total $ 152,213 $ 136,895 $ 120,075 $ 105,584 $ 96,710
----------- ---------- ---------- ---------- ---------
----------- ---------- ---------- ---------- ---------
</TABLE>
The analysis of selected loan maturities at December 31, 1998 is:
<TABLE>
<CAPTION>
One Year Year Through Over Five
(In thousands) or Less Five Years Years Total
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Commercial and industrial $ 21,617 $ 22,201 $ 18,523 $ 62,341
Real estate-construction
7,738 222 - 7,960
---------------------------------------------------------
Total $ 29,355 $ 22,423 $ 18,523 $ 70,301
---------------------------------------------------------
---------------------------------------------------------
</TABLE>
Note: Scheduled repayments are reported in the maturity category in which
the payments are due based on the terms of the loan agreements.
17
<PAGE>
The rate structure of selected loans, in thousands, due after one year as of
December 31, 1998 is:
<TABLE>
<CAPTION>
With Pre- With
determined Floating
Rates Rates Total
-------------------------------------------
<S> <C> <C> <C>
Commercial and industrial $ 8,198 $ 32,526 $ 40,724
Real estate-construction
- 222 222
-------------------------------------------
Total $ 8,198 $ 32,748 $ 40,946
-------------------------------------------
-------------------------------------------
</TABLE>
The book value of the Bank's securities for each of the past three years is as
follows: Securities (in thousands)
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
U.S. Treasury and government agencies $ 22,254 $ 19,825 $ 19,248
States and political subdivisions 23,542 16,962 11,362
Other 766 477 485
----------- ----------- -----------
$ 46,562 $ 37,264 $ 31,095
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The maturities at book value, in thousands, and weighted average yields of
securities at December 31, 1998 are:
<TABLE>
<CAPTION>
After One but After Five but
Within One Year Within Five Years Within Ten Years After Ten Years Total
----------------- -------------------- ------------------- ---------------- ----------------
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
-------- ----- -------- ----- ------- ------ -------- ----- -------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury and
government agencies $ 2,757 5.92% $ 14,725 5.89% $ 3,093 6.04% $ 1,679 5.70% $ 22,254 5.90%
States and political
subdivisions 347 5.82% 8,628 5.11% 11,913 4.87% 2,654 5.29% 23,542 5.22%
Other 468 6.04% 298 5.56% -- 0.00% -- 0.00% 766 5.85%
----------------- ------------------- ------------------ ----------------- -----------------
$ 3,572 5.93% $ 23,651 5.60% $ 15,006 5.11% $ 4,333 5.45% $ 46,562 5.46%
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
</TABLE>
Yields are not stated on a tax-equivalent basis.
18
<PAGE>
INTEREST-BEARING LIABILITIES AND INTEREST EXPENSE
In each of the past three years, deposits have increased as a result of an
improving local economy, and such other factors as the Bank's reputation for
customer service, its local decision-making, and its involvement in local
communities. Interest expense during this period has increased as a result of
the growth of interest-bearing deposits.
The following table shows the average amount of (in thousands) and average
rate paid on selected deposit categories as of December 31 for each of the past
three years:
<TABLE>
<CAPTION>
1998 1997 1996
---------------- ----------------- ------------------
Amount Rate Amount Rate Amount Rate
-----------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Noninterest-bearing demand deposits $ 41,506 $ 34,955 $ 28,128
Interest-bearing demand deposits 26,745 1.02% 21,145 1.00% 17,935 1.00%
Savings deposits 84,794 3.84% 74,108 4.07% 65,956 3.89%
Time deposits under $100,000 38,030 5.13% 36,535 5.24% 33,513 5.22%
Time deposits over $100,000 15,376 5.30% 14,620 5.47% 14,981 5.44%
-------- -------- --------
Total $206,451 $181,363 $160,513
-------- -------- --------
-------- -------- --------
</TABLE>
In 1998 interest rates declined. Savings deposits, which include money
market deposit accounts, are the Bank's most rate-sensitive deposit category. In
1998 savings deposits decreased to an average rate of 3.84% after increasing in
1997. The average rate on time deposits also declined in 1998 after increasing
slightly in 1997.
The decline in deposit rates in 1998, however, was not as steep as the
decline in earning asset yields. This resulted in a decrease in the Bank's net
margin to 5.98% from 6.03% in 1997 and 6.25% in 1996. However, the growth in
deposits and earning assets offset this decline in rates.
PROVISION FOR LOAN LOSSES
The provision for loan losses is based on management's assessment of
various factors affecting the allowance for loan losses including, but not
limited to, current and future economic trends, historical loan losses,
delinquencies, underlying collateral values, as well as current and potential
risks identified in the loan portfolio.
Steadily improving local economic conditions and disciplined underwriting
have resulted in lower loan delinquencies over the past several years.
19
<PAGE>
The following table shows the amount of non-performing loans and other real
estate as of December 31, for each of the past five years.
<TABLE>
<CAPTION>
Nonperforming Assets (in thousands)
<S>
Loans: 1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Nonaccrual $ 92 $ 350 $ 619 $ 1,292 $ 1,167
Renegotiated -- -- 1,158 1,174 --
Past due 90 days or more and still
accruing 437 544 12 23 159
-----------------------------------------------------
Total non-performing loans 529 894 1,789 2,489 1,326
Other real estate owned 1,103 1,249 2,561 2,266 2,692
-----------------------------------------------------
-----------------------------------------------------
Total non-performing assets $ 1,632 $ 2,143 $ 4,350 $ 4,755 $ 4,018
-----------------------------------------------------
-----------------------------------------------------
</TABLE>
Note: 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 against current
period interest income. Income on nonaccrual loans is subsequently
recognized only to the extent cash is received and the loan's principal
balance is deemed collectible. Loans are restored to accrual status when the
loans become both well secured and are in process of collection.
Interest income of $43,000, $45,000 and $66,000 would have been recorded for
the years ended December 31, 1998, 1997 and 1996, respectively, if
nonaccrual loans had been on a current basis, in accordance with their
original terms. Interest income of $20,000, $17,000 and $15,000 was
recognized on loans subsequently transferred to nonaccrual status as of
December 31, 1998, 1997 and 1996, respectively.
As a result of declining loan delinquencies, the Bank's net loan
charge-offs decreased to $282,000 in 1998 compared to $344,000 and $1,071,000 in
1997 and 1996, respectively. The provision for loan losses increased in 1998 to
keep pace with the growth in loans.
In 1997 the provision for loan losses was decreased to $497,000 from $1.1
million in 1996 as a result of the decline in net loan charge-offs in 1997.
In 1996 loan charge-offs increased to $1.2 million and recoveries were
lower compared to 1995. Higher loan charge-offs and fewer recoveries prompted
the increase in the provision for loan losses.
20
<PAGE>
The Bank's loan loss experience as of December 31 for each of the past five
years is:
<TABLE>
<CAPTION>
Analysis of the Allowance for Loan Losses (in thousands)
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Balance at beginning of year $ 1,342 $ 1,189 $ 1,198 $ 1,161 $ 1,276
Charge-offs:
Commercial and industrial (97) (211) (923) (627) (906)
Real estate-construction -- -- -- -- --
Real estate-mortgage (103) (129) (64) (129) --
Consumer loans (168) (109) (179) (331) (317)
----------------------------------------------------------------
Total (368) (449) (1,166) (1,087) (1,223)
----------------------------------------------------------------
Recoveries:
Commercial and industrial 71 40 52 217 231
Real estate-construction -- -- -- -- --
Real estate-mortgage -- 57 21 -- --
Consumer loans 15 8 22 45 40
----------------------------------------------------------------
Total 86 105 95 262 271
----------------------------------------------------------------
Net charge-offs (282) (344) (1,071) (825) (952)
Provision for loan losses 627 497 1,062 862 837
----------------------------------------------------------------
Balance at end of year $ 1,687 $ 1,342 $ 1,189 $ 1,198 $ 1,161
----------------------------------------------------------------
----------------------------------------------------------------
Ratio of net charge-offs during the year to
average loans outstanding 0.2% 0.3% 1.0% 0.8% 1.1%
</TABLE>
The Bank's allocation of the allowance for loan losses as of December 31 for
each of the past five years is:
<TABLE>
<CAPTION>
Allocation of the Allowance for Loan Losses ($ in thousands)
1998 1997 1996 1995 1994
------------- ------------- ------------- -------------- -------------
Amount % Amount % Amount % Amount % Amount %
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial and industrial $ 483 29% $ 485 36% $ 464 39% $ 656 55% $ 642 55%
Real estate-construction 11 1% 11 1% 14 1% 11 1% 24 2%
Real estate-mortgage 464 27% 252 19% 203 17% 243 20% 225 20%
Consumer loans 325 19% 265 20% 289 24% 230 19% 176 15%
Unallocated 404 24% 329 24% 219 19% 58 5% 94 8%
--------------------------------------------------------------------------------
Total $1,687 100% $1,342 100% $1,189 100% $1,198 100% $1,161 100%
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
</TABLE>
OTHER INCOME
Service charges on deposit accounts declined slightly in 1998 because the
Bank did not raise service charge fees in 1998 and depositors, especially small
businesses maintained higher account balances, which resulted in fewer account
charges. Merchant processing fees were higher as a result of an increase in
merchant accounts. Mortgage banking fees increased 32% due to an increase in
mortgage refinancing activities. Other income includes commissions on the sale
of nondeposit
21
<PAGE>
investment products, transaction fees on credit and debit card processing, and
other miscellaneous items.
OTHER EXPENSES
Compensation and employee benefits increased in each of the past three
years as a result of an increase in the number of employees, and salary
increases for promotions and cost of living adjustments. In 1998 this expense
increased 6% compared to 14% in 1997. The Bank did not open any new facilities
or engage in any new lines of business in 1998. In 1997 staffing levels
increased to accommodate the opening of a sixth banking office in Santee
California, and to engage in the sale of non-deposit investment products. In
1996 staffing levels remained fairly constant rising at a rate of approximately
6%.
In 1998 occupancy costs rose 4% compared to 26% in 1997. In 1997 occupancy
expense increased due to the opening of the Santee Office and the completion of
the Grossmont Center Office, which was completely destroyed by fire in late
1995. The new facility is larger and contains more amenities designed to support
the future growth of the Bank in the La Mesa area. Insurance proceeds due from
the loss of property were fully collected in 1997.
In 1996 occupancy expense decreased due to the lower cost of temporary
facilities for the Grossmont Center Office.
Furniture and equipment expense increased 10% in 1998 compared to 24% in
1997. In 1998 the Bank spent approximately $171,000 on software upgrades and
other equipment, which would not have otherwise been spent, except for the Year
2000 issue. In 1997 furniture and equipment expense increased as a result of
higher depreciation expense for the Santee and Grossmont Center Offices. By
comparison, furniture and equipment expense increased 4% in 1996, which was
largely the result of higher equipment maintenance and upgrade costs.
22
<PAGE>
The following table sets forth the major categories of other expenses for the
past three years:
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ -------------
<S> <C> <C> <C>
Stationery and supplies $ 245,000 $ 243,000 $ 240,000
Telephone, courier and postage 358,000 336,000 319,000
Data processing 569,000 480,000 428,000
Merchant processing expense 394,000 360,000 285,000
Promotional expenses 391,000 350,000 282,000
Professional services 215,000 149,000 80,000
Insurance 180,000 169,000 137,000
FDIC and regulatory assessments 85,000 77,000 54,000
Other real estate owned expenses 52,000 77,000 201,000
Other 1,012,000 773,000 782,000
------------ ------------ ------------
$ 3,501,000 $ 3,014,000 $ 2,808,000
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
In 1998 other operating expenses increased 16% compared to 7% in 1997 as a
result of the general growth of the Bank and some modest price increases. In
1998 data processing expense increased 19% due to the growth in the number of
accounts, plus the initial cost of the Bank's "PC Banking & Bill Pay" product.
Professional services increased, in part, as a result of consulting fees for
Year 2000. Merchant processing expense, like merchant processing fees, was
higher due to an increase in merchant accounts. Also, other expenses include
$142,000 of organizational costs for Valley National Corporation, the proposed
holding company for the Bank.
In 1997 other expenses increased 7% over 1996 as a result of the growth of
Bank operations. Other real estate owned expense, however, decreased 62% in 1997
due to a reduction in other real estate owned properties and their related
holding costs.
In 1996 the decline in other expenses was attributable to a significant
reduction in FDIC deposit insurance costs. Stationery and supplies declined
because of improved cost controls and data processing costs were lower due to
greater system utilization. Professional services declined in 1996 as a result
of converting item processing from an outside vendor to Bank personnel in
mid-1995.
Income taxes have increased in each of the last three years as a result of
higher pre-tax earnings. The Bank has reduced its effective tax rate in each of
the past three years by increasing its investment in tax-exempt securities. In
1998 the Bank also made an adjustment of $107,000 to reduce its tax liability
that was no longer needed. (See Notes 2, 3 and 9 to the Financial Statements
23
<PAGE>
under Item 7).
LIQUIDITY MANAGEMENT
Liquidity management seeks to ensure that the Bank's cash flows are
adequate to meet the deposit withdrawal and credit needs of its customers, as
well as the Bank's other commitments. Through its branch offices, the Bank has
developed a core retail deposit base that funds the Bank's liquidity needs.
Since the Bank's customers are primarily consumer and small businesses, its
deposit base is considered less sensitive to changes in interest rates or
business and economic cycles.
Funds are held in cash and cash equivalents, which are comprised of cash
and due from banks plus federal funds, sold. Cash and cash equivalents increased
to $23.6 million at December 31, 1998 compared to $19.3 million and $18.8
million at December 31, 1997 and 1996, respectively largely through increased
demand deposits. The only restriction on the Bank's cash and cash equivalents is
a $350,000 compensating balance arrangement with the Federal Reserve Bank.
Short-term securities classified as available-for-sale also provide a
secondary source of liquidity because these securities can be sold at any time,
if necessary. The fair value of available-for-sale securities maturing in one
year or less at December 31, 1998 totaled $3.1 million (see Note 2 to the
Financial Statements under Item 7).
As an additional source of liquidity, the Bank maintains lines of credit
for $11.5 million with correspondent banks for the purchase of overnight funds.
These lines are subject to availability of funds. The Bank also has the
capability of borrowing overnight funds from the Federal Reserve's discount
window. Historically, the Bank has used its borrowing capabilities infrequently.
CAPITAL
Under the federal banking agencies' regulatory requirements, the Bank is
"well" capitalized. The following table shows the regulatory minimum ratios for
a well-capitalized bank compared to the Bank's Tier 1 risk-based capital and
total risk-based capital ratios for the past three years.
<TABLE>
<CAPTION>
Risk-based Capital Ratios
Regulatory Actual Bank Capital Ratios
Minimum 1998 1997 1996
------------- -------- -------- --------
<S> <C> <C> <C> <C>
Tier 1 capital 6.00% 11.47% 11.72% 11.93%
Total capital 10.00% 12.47% 12.65% 12.85%
</TABLE>
24
<PAGE>
Over the last three years, the Bank has increased its capital mainly
through the generation of net earnings. The Bank's record of 15 consecutive
years of increased net earnings demonstrates its ability to provide a steadily
increasing source of capital for growth. As illustrated in the following table,
return on assets and equity continue to increase.
<TABLE>
<CAPTION>
1998 1997 1996
------ ------ ----
<S> <C> <C> <C>
Return on average assets 1.06% 0.93% 0.80%
Return on average equity 13.19% 11.50% 9.56%
Dividend pay-out ratio 14.13% 15.76% 19.83%
Equity to assets 8.07% 8.11% 8.33%
</TABLE>
However, the dividend pay-out ratio declined because net earnings increased
faster, over the past three years, than the amount of cash dividends paid. In
1998 the Bank increased its annual cash dividend from $0.24 per share to $0.26
per share and continues its annual 5% stock dividend. The ratio of equity to
assets declined because asset growth has exceeded retained earnings growth.
RISK MANAGEMENT
Risk management is an important part of the Bank's operations and a key
element of its overall financial results. The Comptroller, in recent years, has
emphasized appropriate risk management, prompting banks to have adequate systems
to identify, monitor and manage risks. The Bank monitors its business activities
and applies various strategies to manage the risks to which it is exposed.
Credit and interest rate risks are two areas of particular concern.
CREDIT RISK
Credit risk arises as a result of the Bank's lending activities. To manage
this risk, the Bank practices sound, conservative lending, employs frequent
monitoring procedures, and takes prompt corrective action when necessary. The
Bank conducts frequent credit reviews using both internal and external,
independent personnel. The Bank employs a risk rating system that identifies the
overall potential amount of risk inherent in the loan portfolio. This monitoring
and rating system is designed to help management determine current and potential
problems so that corrective actions can be taken promptly.
The amount of loans on nonaccrual status at the end of each of the past
three years has
25
<PAGE>
declined. Loans contractually past due greater than 90 days and still accruing
interest decreased in 1998 compared to 1997, but increased in 1997 over 1996.
The Bank's impaired loans have also decreased over the past three years,
especially from 1996 to 1997. A loan is considered impaired when it is probable
that the Bank will be unable to collect all amounts due according to the
original contractual terms of the loan agreement.
The amount of the Bank's other real estate owned (`OREO') generally
reflects several factors including local economic conditions, its real estate
secured loan delinquency rates, foreclosure rates, and its ability to sell
properties without significant losses. Due to improvement in all of these
factors, the Bank's OREO portfolio declined in 1998 to $1.1 million compared to
$1.2 million in 1997 and $2.6 million in 1996. The Bank continues to actively
market its existing properties.
INTEREST RATE RISK
The Bank monitors and evaluates its interest rate risk position on a
quarterly basis using traditional gap analysis. Gap analysis calculates the
mismatches, over certain time periods, between assets and liabilities whose
interest rates are subject to repricing at their contractual maturity date or
repricing period.
26
<PAGE>
The following table shows the maturity and repricing of assets, liabilities and
stockholders' equity at December 31, 1998.
<TABLE>
<CAPTION>
Contractual Gap Analysis as of December 31, 1998 (in thousands)
Less than 3 months 1 to 5 Over 5 Non-interest
Repricing interval 3 months to 1 year years years earning/bearing Total
-------------- ------------ ----------- ----------- -------------- --------
<S> <C> <C> <C> <C> <C> <C>
Deposits with financial institutions $ 1,397 $ 3,998 $ 1,001 $ -- $ -- $ 6,396
Federal funds sold 11,890 -- -- -- -- 11,890
Investment securities 1,502 2,070 23,651 19,339 -- 46,562
Loans, gross 87,275 10,780 29,756 24,310 92 152,213
All other assets -- -- -- -- 19,739 19,739
-------------- ------------ ----------- ----------- -------------- ---------
Total $ 102,064 $ 16,848 $ 54,408 $ 43,649 $ 19,831 $ 236,800
---------
---------
Non-interest bearing deposits $ -- $ -- $ -- $ -- $ 44,015 $ 44,015
Savings & NOW deposits -- -- -- 45,971 -- 45,971
Money market deposits 69,969 -- -- -- -- 69,969
Time deposits under $100,000 12,619 21,191 3,997 84 -- 37,891
Time deposits of $100,000 or more 9,407 8,129 1,011 -- -- 18,547
All other liabilities 9 25 18 -- 945 997
Stockholders' equity -- -- -- -- 19,410 19,410
-------------- ------------ ----------- ----------- -------------- ---------
Total $ 92,004 $ 29,345 $ 5,026 $ 46,055 $ 64,370 $ 236,800
-------------- ------------ ----------- ----------- -------------- ---------
Period gap $ 10,060 $(12,497) $ 49,382 $ (2,406) $ (44,539) ---------
Cumulative gap $ 10,060 $ (2,437) $ 46,945 $ 44,539
Cumulative gap/total assets 4% -1% 20% 19%
</TABLE>
NOTE: ALL AMOUNTS ARE REPORTED AT THEIR CONTRACTUAL MATURITY OR REPRICING
PERIODS. FOR PURPOSES OF THIS ANALYSIS, THE BANK ASSUMES THAT SAVINGS DEPOSITS,
WHICH HAVE NO STATED MATURITY, ARE NOT RATE-SENSITIVE, MONEY MARKET ACCOUNTS ARE
REPRICED AT THE DISCRETION OF MANAGEMENT AND GENERALLY ARE MORE RATE SENSITIVE.
The Bank has a positive cumulative gap of $10.0 million or 4% of total
assets in the period of less than three months, which reverses to a negative
cumulative gap of $2.4 million or negative 1% of total assets in the three
months to one year period. When rates rise, net interest income will increase in
the first three months, then decline over the remaining nine months as more
interest-bearing liabilities reprice. When rates fall, the opposite is true. The
Bank has a positive cumulative gap beyond one year that is offset by
noninterest-bearing liabilities and stockholders' equity. The Bank normally
evaluates its risk to earnings using interest rate changes of 200 basis points
upon its one year cumulative gap. At December 31, 1998 an adverse change in
interest rates upon the negative one year cumulative gap of $2.4 million would
result in a decrease of approximately $49,000, or less than 1% of net interest
income, which the Bank views as reasonable.
27
<PAGE>
YEAR 2000
The Year 2000 ("Y2K") issue is the result of computer programs being
written using two digits rather than four to define the applicable year. Any of
the Bank's programs that have time-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a variety
of system miscalculations, operating problems and system failures.
The Bank is addressing its year 2000 ("Y2K") issues using a five phase
program. The five phases are awareness, assessment, renovation, validation, and
implementation. A brief description of each phase and the Bank's progress toward
completing each phase follows.
The awareness phase identifies potential Y2K problems, develops an overall
strategy for addressing the issues, obtains support from the board of directors
and management, appoints a project team of employees to direct the Bank's
activities, and implements an internal and external communication program to
raise awareness of the problems and issues. The Bank completed this phase as of
March 31, 1998.
The assessment phase identifies all information technology systems i.e.,
hardware, software, networks, ATMs, etc., and non-information technology systems
such as alarm and security systems, and environmental controls, etc. This phase
also develops a system to evaluate and assess borrower and vendor preparedness,
including a tracking and monitoring system to identify potential problems.
The Bank's program to assess borrower preparedness includes commercial,
real estate and consumer borrowers. The program is designed to evaluate each
borrower's exposure to Y2K issues, the borrower's preparedness in addressing
this exposure, and an assessment of the borrower's ability to meet its
obligations under a worst case Y2K scenario. Based on this assessment,
additional amounts are specifically allocated, as necessary, to cover potential
losses for borrowers considered having a high Y2K risk rating. In addition,
funds have been allocated to cover potential Y2K related losses, in general,
without regard to specific borrowers.
The Bank has completed all of its information and non-information
technology system assessments. In addition, it has communicated with borrowers
and vendors, established a monitoring system, logged responses, and assigned
risk factors. The Bank has begun quantifying the Y2K risk factors associated
with its borrowers and assigned preliminary allocations of the allowance for
loan losses. This allocation process will be reviewed and revised on a quarterly
basis through, at least,
28
<PAGE>
the first quarter of 2000. Accordingly, monitoring and communication with
borrowers and vendors is ongoing.
The Bank has also made initial assessments of its liquidity position in
relation to the Y2K impact on large depositors and the deposit base, in general.
At this time, the Bank does not see a high level of concern by customers
regarding their ability to conduct normal banking activities. However, the Bank
has made an initial assessment of its projected level of cash and
cash-equivalents for the upcoming 1999 year-end, and is taking appropriate steps
to ensure adequate funds will be available to meet customer needs, should the
need arise. The Bank plans to review and appraise this issue on a quarterly
basis and more frequently after June 1999.
The renovation phase involves making the necessary information technology
and non-information technology changes and upgrades necessary to be Y2K
compliant. The Bank has installed new item processing equipment, new voice
response hardware and software, and new local area network servers. It has
upgraded its communication system, purchased new security and alarm systems, and
installed three new automated teller machines. The Bank considers the renovation
phase on all mission critical systems to be complete.
The validation phase is the testing phase. The Bank uses a third party data
processing vendor whose software is Y2K compliant. However, the software is
currently undergoing proxy testing by several of its users and is expected to be
complete by March 31, 1999. With few exceptions, the Bank has finished testing
its other internal specialized systems.
The implementation phase introduces system changes into its operating
environment. Once tested, Y2K compliant systems are ready to be introduced into
the Bank's operating environment. The target date for implementation of all
systems is September 30, 1999.
Contingency planning has begun. The board of directors has appointed a
contingency planning project manager. A workgroup has been established, and an
outside consulting firm engaged to help prepare a Y2K contingency plan. A
contingency planning outline has been developed which provides a guided approach
to assessing possible Y2K disruption risk, determines a logical course of action
to fix the problem, or a plan to implement an alternative procedure. The Bank is
currently in the process of identifying Y2K disruption risks and preparing
written operating procedures. The Bank intends to complete a full business
resumption plan by June 30, 1999.
29
<PAGE>
With respect to the cost of preparing for Y2K, the Bank's use of a
third-party data processor and its policy of periodically upgrading in-house
hardware and software systems have mitigated its direct expenses for Y2K. In
1998 the Bank spent approximately $30,000, not including the cost of a
significant amount of Bank staff time, on assessing, renovating and testing its
various systems. Its 1998 budget for Y2K expenses was approximately $40,000. In
1998 the Bank also spent approximately $171,000 to replace capital equipment,
which would not have been replaced except for Y2K. Its 1998 capital budget was
$155,000.
In 1999, the Bank's operating budget is $50,500 and in 2000 $13,500. In
1999, its capital budget has recently been increased to $100,000.
At this time, management thinks the most likely worst case Y2K scenario
will involve the inability of the Bank's utility and telephone service providers
to furnish consistent, uninterrupted power and telecommunication services to the
Bank in the early weeks of 2000. This view is based solely on a lack of material
disclosure provided to the Bank by these companies. The correspondence the Bank
has received to date has been somewhat general in nature, and lacking the
specific steps they have taken and still need to take to become fully compliant.
Due to the complexity of today's power and telecommunication systems, management
feels that there may be a good chance of occasional power outages, or loss of
telephone service that may last for several hours or even several days.
If the Bank lost telephone service for a few hours, it would be disruptive
and certainly change normal operations but, most likely, the Bank would not
close its doors. The Bank has undertaken a plan to receive and use data in
hardcopy form and use cellular or digital wireless communications in the event
of telephone service disruptions.
Electrical service is a vital part of the Bank's operation. If the Bank
lost power for more than a few hours it, most likely, would have to close its
doors and discontinue normal operations. For this type of contingency, the Bank
will be acquiring a fully installed electrical generator at a cost of
approximately $50,000 to provide power to one of its offices. If a loss of power
occurs for an extended period of time, the Bank would consolidate operations at
this office. The generator has the capacity to provide consistent, uninterrupted
power for 5 days. Management feels this will keep the Bank operating, with
limited services, under a worst-case electrical disruption.
30
<PAGE>
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements and supplementary data required by this item are
set forth at the pages indicated in Item 13 (a).
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE BANK; COMPLIANCE WITH SECTION
16(A) OF THE EXCHANGE ACT.
Set forth below is certain information regarding the Directors and
Executive Officers of the Bank as of December 31, 1998. Each of the Directors
listed below was elected to the Board of Directors at the Bank's Annual
Shareholders' Meeting held on May 5, 1998 to serve until the Bank's next Annual
Meeting of Shareholders and until his successor is elected and qualified.
<TABLE>
<CAPTION>
Year Elected or
Appointed Director or
Name and Title Age Principal Officer (1)
- -------------- ----- ----------------------
<S> <C> <C>
James F Carroll, 69 1983
Chairman of the Board
of Directors
Obert D. `Dale' Conway, 71 1985
Vice Chairman of the
Board of Directors
Paul M. Cable 49 1998
Senior Vice President and
Chief Financial Officer
Samuel M. Ciccati, Ph.D. 62 1995
Director
</TABLE>
31
<PAGE>
<TABLE>
<CAPTION>
Year Elected or
Appointed Director or
Name and Title Age Principal Officer (1)
- -------------- ----- ----------------------
<S> <C> <C>
William V. Ehlen, 51 1983
President, Chief Executive
Officer and Director
Thomas Ferrara, 55 1986
Executive Vice President and
Chief Credit Officer
Myron D. Fessler, M.D. 67 1985
Director
Michael P. Foley 53 1993
Senior Vice President and
Senior Loan Officer
Philip J. Gelber, M.D. 64 1996
Director
Connie Goules 49 1998
Senior Vice President and
Chief Administrative Officer
C. K. Hill, O.D. 80 1984
Secretary and Director
Janet L. Johnson, 64 1983
Director
Lloyd E. Peterson, 72 1983
Director
Joseph G. Vehige, 77 1985
Director
</TABLE>
(1) All Directors and Executive Officers serve for a term of one year.
JAMES F. CARROLL
James F. Carroll is Chairman of the Board of Directors of the Bank. Mr.
Carroll has also been president of Data Disposal, Inc. since 1985. Mr. Carroll
is a member of the Association of Naval Aviation, the Tailhook Association, and
the Retired Officers Association.
32
<PAGE>
OBERT D. `DALE' CONWAY
Mr. Conway is the Vice Chairman of the Board of Directors of the Bank.
Since 1987, Mr. Conway has been the owner of Continental Investors, a firm which
makes investments in dry cleaning establishments.
PAUL M. CABLE
Mr. Cable is Senior Vice President and Chief Financial Officer of the Bank,
a position he has held since July 1998. Prior to that, he was Vice President and
Controller of the Bank since 1995. From 1991 to 1995, Mr. Cable was Senior Vice
President and Chief Financial Officer of First National Bank of North County,
Carlsbad, California.
SAMUEL M. CICCATI, PH.D.
Dr. Ciccati has been an investor in real estate during the past five years.
He was formerly the President of Cuyamaca College, El Cajon, California from
1984 until his retirement in 1993.
WILLIAM V. EHLEN
Mr. Ehlen has been the President and Chief Executive Officer of the Bank
since its inception in 1983.
THOMAS FERRARA
Thomas Ferrara is the Executive Vice President and Chief Credit Officer of
the Bank, a position he has held since joining the Bank in 1986.
MYRON D. FESSLER, M.D.
Myron D. Fessler, M.D. has been a physician with Comp Health/Kron since
1993. Prior to that, Dr. Fessler was in private practice in Jamul, California
from 1988 to 1993.
MICHAEL P. FOLEY
Michael P. Foley is the Senior Vice President and Senior Lending Officer of
the Bank, a position he has held since joining the Bank in 1993.
PHILIP J. GELBER, M.D.
Philip J. Gelber, M.D. is an ophthalmologist in practice since 1969. He was
past president of the San Diego Ophthalmological Society and is a current
medical director of the San Diego Eye Bank.
CONNIE GOULES
Connie Goules is Senior Vice President and Chief Administrative Officer of
the Bank, a position she has held since June, 1998. She joined the Bank in 1991
as Customer Accounting Manager, and from
33
<PAGE>
1992 to 1998 rose from Assistant Vice President and Administrative Officer to
1st Vice President and Administrative Officer.
C.K. HILL, O.D.
C.K. Hill has been the owner of Casa de Oro Travel since 1978 and is active
in the Spring Valley Rotary Club.
JANET L. JOHNSON
Janet L. Johnson is the owner of M.C. Johnson Scraper Rental, a National
City earthmoving business which she has operated since 1975.
LLOYD E. PETERSON
Lloyd E. Peterson has been active in custom home building over the past
five years.
JOSEPH G. VEHIGE
Joseph G. Vehige has been an investor (real estate and securities) for the
past five years.
During 1998 the Board of Directors held 12 regular meetings, and one
organizational meeting. In addition to meeting as an entire Board, members of
the Board of Directors also devote their time and talent to certain standing
committees.
The Audit Committee is comprised of Directors Gelber, Hill, Johnson and
Peterson, and internal auditor Audrey Wilson. Messrs. Ehlen and Cable are ex
officio members. During 1998 the committee met on three occasions.
The Loan and Discount Committee consists of Directors Ciccati, Conway,
Ehlen and Fessler, and executive officers Ferrara and Foley. The committee,
which establishes credit policy and approves loans in excess of management's
internal limits, met 21 times in 1998.
The Executive Committee serves as a planning arm of the Board of Directors
and is charged with general policy recommendations to the entire Board. The
committee consists of Directors Carroll, Conway, Ehlen, Fessler and Hill and met
six times in 1998.
The Compensation and Human Resources Committee is comprised of Directors
Ciccati, Ehlen, Peterson and Vehige, and human resources director Elizabeth I.
Sigal. The committee reviews the compensation plan for the Bank's employees and
makes recommendations to the entire Board with respect to salaries of executive
officers of the Bank. The committee met on six occasions in 1998.
The Investment Committee consists of Directors Ehlen, Gelber, Hill, Johnson
and Vehige, and executive officer Paul M. Cable. The committee reviews
management's adherence to investment and funds
34
<PAGE>
management policy and met on five occasions in 1998.
The Board does not have a standing Nominating Committee.
During 1998 all members of the Board attended at least 75% of the regular
meetings of the Board of Directors and of the committees to which they were
appointed to serve, with the exception of Director Fessler who was absent from
three of six Executive Committee meetings due to scheduling conflicts related to
his profession as a physician with Comp Health/Kron.
Under the securities laws of the United States, the Bank's directors, its
executive officers, and any persons holding more than 10% of the Bank's common
stock are required to report their initial ownership of the Bank's common stock
and any subsequent changes in that ownership to the Comptroller of the Currency.
Specific due dates for these reports have been established and the Bank is
required to identify in this annual report those persons who failed to timely
file these reports. All of the filing requirements were satisfied for 1998.
ITEM 10. EXECUTIVE COMPENSATION
Information required by this item regarding executive compensation has been
set forth in the Proxy Statement for Valley National Corporation to be filed
with the Securities and Exchange Commission in connection with the 1999 Annual
Meeting of Shareholders (the "Proxy Statement") under the caption `Compensation
of Executive Officers and Directors,' and is incorporated herein by reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required by this item regarding security ownership of certain
beneficial owners and management has been set forth in the Proxy Statement for
Valley National Corporation under the caption `Stock Ownership of Management and
Certain Beneficial Owners,' and is incorporated herein by reference.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this item regarding certain relationships and
related transactions has been set forth in the Proxy Statement for Valley
National Corporation under the caption `Certain Other Transactions,' and is
incorporated herein by reference.
35
<PAGE>
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) (1) Financial Statements
The financial statements of the Bank are included herein as required under
Item 7 of this annual report on Form 10-KSB. See Index to Financial
Statements.
(2) Financial Statement Schedules
All financial statement schedules have been omitted since the information
is either not applicable or required, or is included in the financial
statements or notes thereof.
(3) Exhibits
The exhibits listed below are required by Item 601 of Regulation S-K.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ------ ------------------------
<S> <C>
3(i)(1) Articles of Association of the Bank.
3(ii)(2) Restated By-Laws of the Bank.
4.1 Reference is made to Exhibits 3(i) and 3(ii).
10.1 401(k) Plan.
10.2(3) Valle de Oro Bank, N.A. 1994 Stock Option Plan and forms of
agreements.
10.3 Employment Agreement dated July 1, 1995 between the Bank and
William V. Ehlen.
10.4 Salary Continuation Agreement dated January 10, 1996 between
the Bank and William V. Ehlen.
</TABLE>
(1) Incorporated by reference to Exhibit 4.1 to the Bank's Registration
Statement On Form S-8, filed March 4, 1996.
(2) Incorporated by reference to Exhibit 4.2 to the Bank's Registration
Statement On Form S-8, filed March 4, 1996.
(3) Incorporated by reference to Exhibit 10.1 to the Bank's Registration
Statement on Form S-8, filed March 4, 1996.
36
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ------ -----------------------
<S> <C>
10.5 Note secured by deed of trust dated April 11, 1990, in the
amount of $250,000 payable to Crest Rentals, Inc., a California
corporation, in equal monthly installments of $3,100, principal
and interest at the rate of 8.5% per annum, beginning May 1,
1990 until June 1, 2005.
10.6 Ground lease dated November 9, 1960, by and between Alcott
Estates, a California limited partnership and Bank of America,
N.T.S.A., assigned to the Bank on August 1, 1985 for an initial
term of 30 years with options to renew for two additional terms
of ten years each.
10.7 Lease dated November 15, 1987, by and between Reseda Investors,
a California general partnership, and the Bank for a term of 15
years with options to renew for two additional terms of five
years each.
10.8 Lease dated August 6, 1982, by and between BSD Service
Corporation, a California corporation, and Grossmont Center
Land Company, a California limited partnership, amended and
assigned to the Bank as of January 29, 1993, with a termination
date of January 10, 2015.
10.9 Lease dated September 7, 1994, by and between Wellesley Company
N.V., a Netherlands Antilles corporation, and the Bank for an
initial term of five years and three months with options to
renew for three additional terms of five years each.
10.10(4) Valle de Oro Bank, N.A. Employee Stock Ownership Plan
23.1 Consent of Independent Auditors
</TABLE>
(4) Valle de Oro Bank N.A. Employee Stock Ownership Plan, filed as
Exhibit 10.9 to the Company's registration statement on Form S-4
(Registration No. 333-67661) is incorporated herein by reference.
Amendment to Valle de Oro Bank, N.A. Employee Stock Ownership Plan,
filed as Exhibit 99.2 to the Company's registration statement on
Form S-8 as filed with the SEC on March 31, 1999 is incorporated
herein by reference.
37
<PAGE>
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K (Continued)
(b) Reports on Form 8-K
On November 30, 1998 the Bank filed a report on Form 8-K, Item 5,
with the Office of the Comptroller of the Currency stating that
on November 23, 1998 the Bank filed a registration statement
with the Securities and Exchange Commission on Form S-4 to form
a bank holding company called Valley National Corporation. As
part of the reorganization, shares of Valle de Oro Bank would
be exchanged for shares of Valley National Corporation on the
basis of two-for-one.
On November 5, 1998 the Bank filed a report on Form 8-K, Item 5,
with the Office of the Comptroller of the Currency stating that
the Bank was approved to list its shares on the Nasdaq National
Market System effective November 17, 1998.
38
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
Valle de Oro Bank, N.A.
/s/ William V. Ehlen Date: 3-17-99
- -------------------------- ------------
William V. Ehlen,
President and Chief Executive Officer
/s/ Paul M. Cable Date: 3-17-99
- -------------------------- ------------
Paul M. Cable,
Senior Vice President and
Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
/s/ James F. Carroll Date: 3-17-99
- -------------------------- ------------
James F. Carroll,
Chairman of the Board of Directors
/s/ Obert D. Conway Date: 3-17-99
- -------------------------- ------------
Obert D. Conway,
Vice Chairman of the Board of Directors
/s/ Samuel M. Ciccati Date: 3-17-99
- -------------------------- ------------
Samuel M. Ciccati,
Director
/s/ Myron D. Fessler Date: 3-17-99
- -------------------------- ------------
Myron D. Fessler,
Director
/s/ Philip J. Gelber Date: 3-17-99
- -------------------------- ------------
Philip J. Gelber,
Director
/s/ C.K. Hill Date: 3-17-99
- -------------------------- ------------
C.K. Hill,
Director
/s/ Janet L. Johnson Date: 3-17-99
- -------------------------- ------------
Janet L. Johnson,
Director
/s/ Lloyd E. Peterson Date: 3-17-99
- -------------------------- ------------
Lloyd E. Peterson,
Director
Date:
- -------------------------- ------------
Joseph G. Vehige,
Director
<PAGE>
VALLE DE ORO BANK, N.A.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
-------
<S> <C>
Report of KPMG LLP,
Independent Auditors......................................................... F-1
Report of PricewaterhouseCoopers, LLP,
Independent Accountants...................................................... F-2
Balance Sheets - December 31, 1998 and 1997................................... F-3
Statements of Earnings - Years Ended
December 31, 1998, 1997 and 1996............................................. F-4
Statements of Changes in Stockholders' Equity and Comprehensive Income
Years Ended December 31, 1998, 1997 and 1996 ................................ F-5
Statements of Cash Flows - Years Ended
December 31, 1998, 1997 and 1996 ............................................ F-6 - F-7
Notes to Financial Statements................................................. F-8 - F-28
</TABLE>
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Valle de Oro Bank, N.A.:
We have audited the accompanying balance sheets of Valle de Oro Bank, N.A. as of
December 31, 1998 and 1997 and the related statements of earnings, changes in
stockholders' equity and comprehensive income, and cash flows for the years then
ended. These financial statements are the responsibility of the Bank's
management. Our responsibility is to express an opinion on these financial
statements based on our audits. The accompanying financial statements of the
Bank for the year ended December 31, 1996 were audited by other auditors whose
report thereon, dated January 17, 1997, expressed an unqualified opinion on
those statements.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Valle de Oro Bank, N.A. as of
December 31, 1998 and 1997 and the results of its operations and its cash flows
for the years then ended, in conformity with generally accepted accounting
principles.
KPMG LLP
San Diego, California
January 20, 1999
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of
Valle de Oro Bank, N.A.
In our opinion, the accompanying statements of earnings, changes in equity
and comprehensive income and cash flows present fairly, in all material
respects, the results of operations and cash flows of Valle de Oro Bank, N.A.
for the year ended December 31, 1996, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of
the Bank's management. Our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits 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 an
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 audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers, LLP
San Diego, California
January 17, 1997
F-2
<PAGE>
VALLE DE ORO BANK, N.A.
Balance Sheets
December 31, 1998 and 1997
<TABLE>
<CAPTION>
ASSETS 1998 1997
---------------- ---------------
<S> <C> <C>
Cash and due from banks $ 11,704,000 $ 10,562,000
Federal funds sold 11,890,000 8,731,000
Interest-earning deposits 6,396,000 4,499,000
Securities:
Available-for-sale 23,609,000 21,209,000
Held-to-maturity 22,953,000 16,055,000
Federal Reserve Bank stock 445,000 384,000
Loans, net 149,708,000 134,837,000
Bank premises and equipment, net 4,978,000 5,220,000
Other real estate owned, net 1,103,000 1,249,000
Accrued interest receivable 1,617,000 1,600,000
Other assets 2,397,000 1,737,000
-------------- -------------
Total assets $ 236,800,000 $ 206,083,000
-------------- -------------
-------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Non-interest bearing $ 44,015,000 35,110,000
Savings 115,940,000 100,873,000
Time deposits under $100,000 37,891,000 36,021,000
Time deposits of $100,000 or more 18,547,000 16,143,000
-------------- -------------
Total deposits 216,393,000 188,147,000
Long-term debt 52,000 83,000
Accrued expenses and other liabilities 945,000 827,000
------------- -------------
Total liabilities 217,390,000 189,057,000
------------- -------------
Stockholders' equity:
Common stock, $3.33 par value; authorized 10,000,000 shares; issued and
outstanding 1,323,000 and 1,234,000 shares in
1998 and 1997, respectively 4,407,000 4,110,000
Additional paid-in capital 10,467,000 8,698,000
Accumulated other comprehensive income-unrealized gains on
securities available-for-sale, net 142,000 76,000
Retained earnings 4,394,000 4,142,000
------------- -------------
Total stockholders' equity 19,410,000 17,026,000
------------- -------------
Total liabilities and stockholders' equity $ 236,800,000 $ 206,083,000
------------- -------------
------------- -------------
</TABLE>
See accompanying notes to financial statements.
F-3
<PAGE>
VALLE DE ORO BANK, N.A.
Statements of Earnings
Years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
------------------- ------------------- ------------------
<S> <C> <C> <C>
Interest income:
Interest and fees on loans $ 14,456,000 $ 13,053,000 $ 12,292,000
Interest on securities:
Taxable 1,429,000 1,524,000 1,236,000
Exempt from federal income taxes 704,000 558,000 362,000
Interest on federal funds sold 1,141,000 877,000 774,000
Interest on interest-earning deposits 296,000 258,000 201,000
------------------- ------------------- ------------------
18,026,000 16,270,000 14,865,000
------------------- ------------------- ------------------
Interest expense:
Time deposits of $100,000 or more 815,000 799,000 815,000
Other deposits 5,482,000 5,141,000 4,501,000
------------------- ------------------- ------------------
6,297,000 5,940,000 5,316,000
------------------- ------------------- ------------------
Net interest income before provision
for loan losses 11,729,000 10,330,000 9,549,000
Provision for loan losses 627,000 497,000 1,062,000
------------------- ------------------- ------------------
Net interest income after
provision for loan losses 11,102,000 9,833,000 8,487,000
------------------- ------------------- ------------------
Other operating income:
Service charges on deposit accounts 1,614,000 1,642,000 1,495,000
Merchant processing fees 546,000 514,000 418,000
Mortgage brokerage fees 254,000 192,000 63,000
Gain on sale of loans 81,000 48,000 --
Other 512,000 348,000 273,000
------------------- ------------------- ------------------
3,007,000 2,744,000 2,249,000
------------------- ------------------- ------------------
Other operating expenses:
Compensation and employee benefits 5,236,000 4,951,000 4,359,000
Occupancy expense 1,142,000 1,101,000 872,000
Furniture and equipment 683,000 622,000 503,000
Other 3,501,000 3,014,000 2,808,000
------------------- ------------------- ------------------
10,562,000 9,688,000 8,542,000
------------------- ------------------- ------------------
Earnings before income taxes 3,547,000 2,889,000 2,194,000
Income tax expense 1,147,000 1,037,000 791,000
------------------- ------------------- ------------------
Net earnings $ 2,400,000 $ 1,852,000 $ 1,403,000
------------------- ------------------- ------------------
------------------- ------------------- ------------------
Basic earnings per share $ 1.83 $ 1.43 $ 1.09
------------------- ------------------- ------------------
------------------- ------------------- ------------------
Diluted earnings per share $ 1.69 $ 1.33 $ 1.06
------------------- ------------------- ------------------
------------------- ------------------- ------------------
</TABLE>
See accompanying notes to financial statements.
F-4
<PAGE>
VALLE DE ORO BANK, N.A.
Statements of Changes in Stockholders' Equity and Comprehensive Income
Years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER
---------------------------------------- PAID-IN COMPREHENSIVE
SHARES AMOUNT CAPITAL INCOME
------------------- ------------------ ------------------- --------------------
<S> <C> <C> <C> <C>
Balance at January 1, 1996 1,108,000 $ 3,690,000 $ 7,282,000 $ 128,000
5% stock dividend 55,000 183,000 586,000 --
Cash issued in lieu of fractional
shares in 5% stock dividend -- -- -- --
Stock options exercised 13,000 43,000 61,000 --
Cash dividends at $0.24 per share -- -- -- --
Comprehensive income:
Net unrealized change in securities
available-for-sale, net of taxes
of $68,000 -- -- -- (128,000)
Net earnings -- -- -- --
Total comprehensive income
------------------- ------------------ ------------------- --------------------
Balance at December 31, 1996 1,176,000 3,916,000 7,929,000 --
5% stock dividend 58,000 194,000 769,000 --
Cash issued in lieu of fractional
shares in 5% stock dividend -- -- -- --
Cash dividends at $0.24 per share -- -- -- --
Comprehensive income:
Net unrealized change in securities
available-for-sale, net of taxes
of $48,000 -- -- -- 76,000
Net earnings -- -- -- --
Total comprehensive income
------------------- ------------------ ------------------- --------------------
Balance at December 31, 1997 1,234,000 4,110,000 8,698,000 76,000
5% stock dividend 62,000 207,000 1,587,000 --
Cash issued in lieu of fractional
shares in 5% stock dividend -- -- -- --
Stock options exercised 27,000 90,000 182,000 --
Cash dividends at $0.26 per share -- -- -- --
Comprehensive income:
Net unrealized change in securities
available-for-sale, net of taxes
of $46,000 -- -- -- 66,000
Net earnings -- -- -- --
Total comprehensive income
------------------- ------------------ ------------------- --------------------
Balance at December 31, 1998 1,323,000 $ 4,407,000 $ 10,467,000 $ 142,000
------------------- ------------------ ------------------- --------------------
------------------- ------------------ ------------------- --------------------
</TABLE>
<TABLE>
<CAPTION>
RETAINED
EARNINGS TOTAL
------------------ ------------------
<S> <C> <C>
Balance at January 1, 1996 $ 3,203,000 $ 14,303,000
5% stock dividend (769,000) --
Cash issued in lieu of fractional
shares in 5% stock dividend (6,000) (6,000)
Stock options exercised -- 104,000
Cash dividends at $0.24 per share (279,000) (279,000)
Comprehensive income:
Net unrealized change in securities
available-for-sale, net of taxes
of $68,000 -- (128,000)
Net earnings 1,403,000 1,403,000
------------------
Total comprehensive income 1,275,000
------------------ ------------------
Balance at December 31, 1996 3,552,000 15,397,000
5% stock dividend (963,000) --
Cash issued in lieu of fractional
shares in 5% stock dividend (7,000) (7,000)
Cash dividends at $0.24 per share (292,000) (292,000)
Comprehensive income:
Net unrealized change in securities
available-for-sale, net of taxes
of $48,000 -- 76,000
Net earnings 1,852,000 1,852,000
------------------
Total comprehensive income 1,928,000
------------------ ------------------
Balance at December 31, 1997 4,142,000 17,026,000
5% stock dividend (1,794,000) --
Cash issued in lieu of fractional
shares in 5% stock dividend (15,000) (15,000)
Stock options exercised -- 272,000
Cash dividends at $0.26 per share (339,000) (339,000)
Comprehensive income:
Net unrealized change in securities
available-for-sale, net of taxes
of $46,000 -- 66,000
Net earnings 2,400,000 2,400,000
------------------
Total comprehensive income 2,466,000
------------------ ------------------
Balance at December 31, 1998 $ 4,394,000 $ 19,410,000
------------------ ------------------
------------------ ------------------
</TABLE>
See accompanying notes to financial statements.
F-5
<PAGE>
VALLE DE ORO BANK, N.A.
Statements of Cash Flows
Years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
------------------ ------------------ ------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings $ 2,400,000 $ 1,852,000 $ 1,403,000
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Gain on sale of loans (81,000) (48,000) --
Depreciation and amortization 955,000 1,010,000 617,000
(Gain) loss on sale of other real estate owned (29,000) (75,000) 26,000
Provision for loan losses 627,000 497,000 1,062,000
Provision for losses on other real estate
owned 60,000 143,000 --
Increase in accrued interest receivable and
other assets (723,000) (498,000) (122,000)
Increase (decrease) in accrued expenses and
other liabilities 118,000 (54,000) 453,000
------------------ ------------------ ------------------
Net cash provided by operating
activities 3,327,000 2,827,000 3,439,000
------------------ ------------------ ------------------
Cash flows from investing activities:
Net increase in securities -- -- (8,293,000)
Maturities of securities held-to-maturity 1,136,000 -- --
Purchases of securities held-to-maturity (8,162,000) (8,954,000) --
Proceeds from sale of securities available-for-sale -- 675,000 --
Maturities of securities available-for-sale 9,485,000 4,732,000 --
Purchases of securities available-for-sale (11,773,000) (2,723,000) --
Net additions to interest-earning deposits (1,897,000) (601,000) (599,000)
Purchases of Federal Reserve Bank stock (61,000) (30,000) (25,000)
Net increase in loans outstanding (16,209,000) (17,891,000) (16,570,000)
Purchases of bank premises and equipment (585,000) (1,496,000) (2,496,000)
Proceeds from insurance -- 1,154,000 --
Proceeds from sale of loans 837,000 745,000 --
Proceeds from sale of other real estate owned 70,000 1,323,000 425,000
------------------ ------------------ ------------------
Net cash used in investing activities (27,159,000) (23,066,000) (27,558,000)
------------------ ------------------ ------------------
Cash flows from financing activities:
Net increase in deposits 28,246,000 21,088,000 25,091,000
Payments on long-term debt (31,000) (29,000) (27,000)
Proceeds from exercise of stock options 272,000 -- 104,000
Cash paid in lieu of fractional shares on 5% stock
dividend (15,000) (7,000) (6,000)
Cash dividends paid (339,000) (292,000) (279,000)
------------------ ------------------ ------------------
Net cash provided by financing
activities 28,133,000 20,760,000 24,883,000
------------------ ------------------ ------------------
Net increase in cash and cash equivalents 4,301,000 521,000 764,000
Cash and cash equivalents at beginning of year 19,293,000 18,772,000 18,008,000
------------------ ------------------ ------------------
Cash and cash equivalents at end of year $ 23,594,000 $ 19,293,000 $ 18,772,000
------------------ ------------------ ------------------
------------------ ------------------ ------------------
</TABLE>
F-6
<PAGE>
VALLE DE ORO BANK, N.A.
Statements of Cash Flows
Years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
---------------- ---------------- ----------------
<S> <C> <C> <C>
Supplemental disclosure of cash flow information:
Cash paid during the year for interest $ 6,336,000 $ 5,916,000 $ 5,299,000
Cash paid during the year for income taxes $ 1,554,000 $ 1,451,000 $ 665,000
Supplemental disclosure of noncash investing and financing activities:
Loans transferred to other real estate owned $ 738,000 $ 79,000 $ 664,000
Deletions of Bank premises and equipment due
to fire $ -- $ 1,679,000 $ --
Loans to facilitate the sale of other real estate
owned $ 783,000 $ -- $ --
</TABLE>
See accompanying notes to financial statements.
F-7
<PAGE>
VALLE DE ORO BANK, N.A.
Financial Statements
December 31, 1998 and 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) NATURE OF OPERATIONS
Valle de Oro Bank, N.A. (the "Bank") operates six offices in San Diego
County, California. The Bank's primary source of revenue is interest
from real estate and commercial loans to individuals and small to
middle-market businesses. The accounting and reporting policies of the
Bank conform to generally accepted accounting principles and to
general practices within the banking industry. The following is a
description of the more significant policies.
(b) CASH AND CASH EQUIVALENTS
For purposes of the statement of cash flows, cash and cash equivalents
consist of cash, due from banks and Federal funds sold. Generally,
Federal funds are sold for one-day periods. The Bank keeps $350,000 on
deposit at the Federal Reserve Bank in accordance with a compensating
balance arrangement.
(c) SECURITIES
Management determines the appropriate classification of securities at
the time of purchase. If management has the intent and the Bank has
the ability at the time of purchase to hold securities until maturity,
they are classified as held-to-maturity. Securities held-to-maturity
are stated at cost, adjusted for amortization of premiums and
accretion of discounts over the period to call or maturity of the
related security using the interest method. Securities to be held for
indefinite periods of time, but not necessarily to be held-to-maturity
or on a long-term basis, are classified as available-for-sale and
carried at fair value with unrealized gains or losses, net of tax,
reported as a separate component of other comprehensive income until
realized. Realized gains or losses on the sale of securities
available-for-sale, if any, are determined using the amortized cost of
the specific securities sold. Securities available-for-sale include
securities that management intends to use as part of its
asset/liability management strategy and that may be sold in response
to changes in interest rates, prepayment risk and other related
factors. Securities are individually evaluated for appropriate
classification, when acquired; consequently, similar types of
securities may be classified differently depending on factors existing
at the time of purchase.
When a security is sold, the realized gain or loss, determined on a
specific-identification basis, is included in earnings. To the extent
a security has a decline in fair value, which is determined by the
Bank as other than temporary, the adjusted cost basis is written down
to fair value and the amount of the write-down is charged to earnings.
F-8
<PAGE>
VALLE DE ORO BANK, N.A.
Financial Statements
December 31, 1998 and 1997
(d) LOANS AND LOAN FEES
Loans are stated at the amount of principal outstanding. 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 against current period interest income.
Income on nonaccrual loans is subsequently recognized only to the
extent cash is received and the loan's principal balance is deemed
collectible. Loans are restored to accrual status when the loans
become both well-secured and are in process of collection.
Nonrefundable fees and related direct costs associated with the
origination of loans are deferred and netted against outstanding loan
balances. Net deferred fees and costs are recognized in interest
income over the terms of the loans using the interest method. The
amortization of loan fees is discontinued on nonaccrual loans.
(e) ALLOWANCE FOR LOAN LOSSES
An allowance for loan losses is maintained at a level deemed
appropriate by management to adequately provide for known and inherent
risks in the loan portfolio and other extensions of credit, including
off-balance sheet credit extensions. The allowance is based upon a
continuing review of the portfolio, past loan loss experience, current
economic conditions which may affect the borrowers' ability to pay,
and the underlying collateral value of the loans. When a loan or
portion of a loan is determined to be uncollectible, the portion
deemed uncollectible is charged off and deducted from the allowance.
The provision for loan losses and recoveries on loans previously
charged off are added to the allowance.
A loan is considered impaired when it is probable that a creditor will
be unable to collect all amounts due according to the original
contractual terms of the loan agreement. If the measure of the
impaired loan is less than the recorded investment in the loan, a
valuation allowance is established with a corresponding charge to the
provision for loan losses. Since substantially all of the Bank's loans
are collateral dependent, the calculation of the allowance for losses
on impaired loans is generally based on the fair value of the
collateral, less estimated costs of disposal.
The allowance for loan losses is subjective and may be adjusted in the
future because of changes in economic conditions and the repayment
abilities of the borrowers. In addition, various regulatory agencies,
as an integral part of their examination process, periodically review
the Bank's allowance. These agencies may require the Bank to recognize
additions to the allowance based on their judgments related to
information available to them at the time of their examinations.
F-9
<PAGE>
VALLE DE ORO BANK, N.A.
Financial Statements
December 31, 1998 and 1997
(f) BANK PREMISES AND EQUIPMENT
Bank premises and equipment are stated at cost, less accumulated
depreciation. Depreciation is charged to operating expense using the
straight-line method over the estimated useful lives of depreciable
assets, which range from 3 to 30 years. Leasehold improvements are
capitalized and amortized to operating expense over the term of the
respective lease or the estimated useful life of the improvement,
whichever is shorter.
(g) OTHER REAL ESTATE OWNED
Real estate properties acquired through loan foreclosure or through
acceptance of a deed-in-lieu of foreclosure are initially recorded at
fair value, less estimated selling costs at the date of foreclosure.
Once real estate properties are acquired, valuations are periodically
obtained by management and an allowance for losses is established by a
charge to operations if the carrying value of a property exceeds its
fair value, less estimated costs of disposal. Real estate properties
held for sale are carried at the lower of cost, including the cost of
improvements and amenities incurred subsequent to acquisition, or fair
value, less estimated selling costs. Costs related to development and
improvement of properties are capitalized, whereas costs relating to
holding the properties are expensed.
(h) INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income
in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in earnings in the
period that includes the enactment date.
(i) STOCK-BASED COMPENSATION
Prior to January 1, 1996, the Bank accounted for its stock option
plans in accordance with the provisions of Accounting Principles Board
("APB") No. 25, "Accounting for Stock Issued to Employees," and
related interpretations. As such, compensation expense would be
recorded on the date of grant only if the current market price of the
underlying stock exceeded the exercise price. On January 1, 1996, the
Bank adopted Statement of Financial Accounting Standards (SFAS) No.
123, "Accounting for Stock-Based Compensation" ("Statement 123"),
which permits entities to recognize as expense over the vesting period
the fair value of all stock-based awards on the date of grant.
Alternatively, Statement 123 also allows entities to continue to apply
the provisions of APB No. 25 and provide pro forma net earnings and
pro forma net earnings per share disclosures for employee stock option
grants made in 1995 and future years as if the fair-value-based method
defined in Statement 123 had been applied. The Bank has elected to
continue to apply the provisions of APB No. 25 and provide the pro
forma disclosure provisions of Statement 123.
F-10
<PAGE>
VALLE DE ORO BANK, N.A.
Financial Statements
December 31, 1998 and 1997
(j) EARNINGS PER SHARE
Basic earnings per share is computed by dividing net earnings by the
weighted-average number of shares of common stock outstanding during
the period. Diluted earnings per share is computed by dividing net
earnings by the weighted-average number of shares of common stock,
common stock equivalents and other potentially dilutive securities
outstanding during the period.
(k) USE OF ESTIMATES
Management of the Bank has made a number of estimates and assumptions
relating to the reporting of assets and liabilities and the disclosure
of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the
reporting period to prepare these financial statements in conformity
with generally accepted accounting principles. Actual results could
differ from those estimates.
(l) COMPREHENSIVE INCOME
On January 1, 1998, the Bank adopted SFAS No. 130, "Reporting
Comprehensive Income" ("Statement 130"). Statement 130 establishes
standards for the reporting and display of comprehensive income and
its components in a full set of general-purpose financial statements;
it does not change the display or components of present-day net
earnings. Comprehensive income consists of net earnings and net
unrealized gains (losses) on available-for-sale securities and is
presented in the statements of stockholders' equity and comprehensive
income. Statement 130 requires only additional disclosures in the
financial statements; it does not affect the Bank's financial position
or results of operations. Prior year financial statements have been
reclassified to conform to the requirements of Statement 130.
(m) YEAR 2000
The Bank has developed a remediation plan and is in the process of
converting computer systems and applications for the Year 2000.
Expenditures related to Year 2000 issues are expensed as incurred.
(n) RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the
current year's presentation.
F-11
<PAGE>
VALLE DE ORO BANK, N.A.
Financial Statements
December 31, 1998 and 1997
(2) SECURITIES AVAILABLE-FOR-SALE
The amortized cost, gross unrealized gains and losses and fair value of
securities available-for-sale as of December 31, 1998 and 1997 are as
follows:
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED FAIR
AMORTIZED COST GAINS LOSSES VALUE
----------------- --------------- --------------- -----------------
<S> <C> <C> <C> <C>
1998:
U.S. Treasury notes and U.S.
agency securities $ 14,655,000 $ 155,000 $ (55,000) $ 14,755,000
Obligations of states and
political subdivisions 8,417,000 162,000 (23,000) 8,556,000
Corporate obligations 301,000 -- (3,000) 298,000
----------------- --------------- --------------- -----------------
$ 23,373,000 $ 317,000 $ (81,000) $ 23,609,000
----------------- --------------- --------------- -----------------
----------------- --------------- --------------- -----------------
1997:
U.S. Treasury notes and U.S.
agency securities $ 16,844,000 $ 69,000 $ (4,000) $ 16,909,000
Obligations of states and
political subdivisions 4,241,000 68,000 (9,000) 4,300,000
----------------- --------------- --------------- -----------------
$ 21,085,000 $ 137,000 $ (13,000) $ 21,209,000
----------------- --------------- --------------- -----------------
----------------- --------------- --------------- -----------------
</TABLE>
The maturity distribution based on amortized cost and fair value as of
December 31, 1998, by contractual maturity, is shown below. Expected
maturities may differ from contractual maturities because borrowers may
have the right to call or prepay obligations with or without call or
prepayment penalties:
<TABLE>
<CAPTION>
AMORTIZED COST FAIR VALUE
------------------ ------------------
<S> <C> <C>
Due in one year or less $ 3,094,000 $ 3,103,000
Due after one year through five years 13,058,000 13,211,000
Due after five years through ten years 5,509,000 5,616,000
Due after ten years 1,712,000 1,679,000
------------------ ------------------
$ 23,373,000 $ 23,609,000
------------------ ------------------
------------------ ------------------
</TABLE>
As of December 31, 1998, securities held-to-maturity with an amortized cost
of $1,910,000 and securities available-for-sale with a fair value of
$2,565,000 totaling $4,475,000 were pledged as security for public deposits
and other purposes as required by various statutes and agreements.
During 1998, 1997 and 1996, all unrealized gains arose during the year and
are included in other comprehensive income. No previous unrealized gains or
losses were realized in earnings for the years
F-12
<PAGE>
VALLE DE ORO BANK, N.A.
Financial Statements
December 31, 1998 and 1997
ended December 31, 1998, 1997 or 1996.
(3) SECURITIES HELD-TO-MATURITY
The amortized cost, gross unrealized gains and losses and fair value of
securities held-to-maturity as of December 31, 1998 and 1997 are as
follows:
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED FAIR
AMORTIZED COST GAINS LOSSES VALUE
----------------- --------------- --------------- -----------------
<S> <C> <C> <C> <C>
1998:
U.S. Treasury notes and U.S.
government agencies $ 7,499,000 $ 85,000 $ (17,000) $ 7,567,000
Obligations of states and
political subdivisions 14,986,000 609,000 -- 15,595,000
Corporate obligations 468,000 2,000 -- 470,000
----------------- --------------- --------------- -----------------
$ 22,953,000 $ 696,000 $ (17,000) $ 23,632,000
----------------- --------------- --------------- -----------------
----------------- --------------- --------------- -----------------
1997:
U.S. Treasury notes and U.S.
government agencies $ 2,916,000 $ 27,000 $ (1,000) $ 2,942,000
Obligations of states and
political subdivisions 12,662,000 255,000 (55,000) 12,862,000
Corporate obligations 477,000 -- -- 477,000
----------------- --------------- --------------- -----------------
$ 16,055,000 $ 282,000 $ (56,000) $ 16,281,000
----------------- --------------- --------------- -----------------
----------------- --------------- --------------- -----------------
</TABLE>
The maturity distribution based on amortized cost and fair value as of
December 31, 1998, by contractual maturity, is shown below. Expected
maturities may differ from contractual maturities because borrowers may
have the right to call or prepay obligations with or without call or
prepayment penalties:
<TABLE>
<CAPTION>
AMORTIZED COST FAIR VALUE
------------------ ------------------
<S> <C> <C>
Due in one year or less $ 468,000 $ 470,000
Due after one year through five years 10,440,000 10,581,000
Due after five years through ten years 9,391,000 9,721,000
Due after ten years 2,654,000 2,860,000
------------------ ------------------
$ 22,953,000 $ 23,632,000
------------------ ------------------
------------------ ------------------
</TABLE>
F-13
<PAGE>
VALLE DE ORO BANK, N.A.
Financial Statements
December 31, 1998 and 1997
(4) LOANS
The composition of the Bank's loan portfolio is as follows as of December
31:
<TABLE>
<CAPTION>
1998 1997
------------------ ------------------
<S> <C> <C>
Construction $ 7,960,000 $ 5,899,000
Real estate 66,850,000 61,070,000
Commercial and industrial loans 62,341,000 56,477,000
Installment 14,754,000 12,621,000
All other loans (including overdrafts) 308,000 828,000
------------------ ------------------
152,213,000 136,895,000
Less allowance for loan losses (1,687,000) (1,342,000)
Less deferred loan fees (818,000) (716,000)
------------------ ------------------
$ 149,708,000 $ 134,837,000
------------------ ------------------
------------------ ------------------
</TABLE>
Although the Bank seeks to avoid undue concentrations of loans to a single
industry or based upon a single class of collateral, the Bank's loan
portfolio consists primarily of loans to borrowers within San Diego County
and, as a result, the Bank's loan and collateral portfolios are to some
degree concentrated. The portfolio is well diversified in both project type
and area within the San Diego County region. The Bank evaluates each credit
on an individual basis and determines collateral requirements accordingly.
When real estate is taken as collateral, advances are generally limited to
a certain percentage of the appraised value of the collateral at the time
the loan is made, depending on the type of loan, the underlying property
and other factors.
The Bank has established a monitoring system for its loans in order to
identify potential problem loans and to permit the periodic evaluation of
impairment and the adequacy of the allowance for loan losses in a timely
manner. Impaired loans included in the Bank's loan portfolio as of December
31, 1998 and 1997 were $92,000 and $158,000, respectively, which had
aggregate specific related allowance amounts of $9,000 and $61,000,
respectively. During 1998, 1997 and 1996, the average balances of impaired
loans were $302,000, $219,000 and $2,102,000, respectively. During 1998 and
1997, no interest was recognized on these loans during the period of
impairment. During 1996, $75,000 of interest was recognized on these loans
during the period of impairment on a cash basis in accordance with Bank
policy.
F-14
<PAGE>
VALLE DE ORO BANK, N.A.
Financial Statements
December 31, 1998 and 1997
A summary of the activity in the allowance for loan losses is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------------ ------------------ ------------------
<S> <C> <C> <C>
Balance, beginning of year $ 1,342,000 $ 1,189,000 $ 1,198,000
Provision for loan losses 627,000 497,000 1,062,000
Loans charged off (368,000) (449,000) (1,166,000)
Recoveries 86,000 105,000 95,000
------------------ ------------------ ------------------
Balance, end of year $ 1,687,000 $ 1,342,000 $ 1,189,000
------------------ ------------------ ------------------
------------------ ------------------ ------------------
</TABLE>
Loans on nonaccrual amounted to $92,000, $350,000 and $619,000 as of
December 31, 1998, 1997 and 1996, respectively. Interest income of $43,000,
$45,000 and $66,000 would have been recorded for the years ended December
31, 1998, 1997 and 1996, respectively, if nonaccrual loans had been on a
current basis, in accordance with their original terms. Interest income of
$20,000, $17,000 and $15,000 was recognized on loans subsequently
transferred to nonaccrual status as of December 31, 1998, 1997 and 1996,
respectively. Loans contractually past due greater than 90 days and still
accruing interest totaled approximately $437,000, $544,000 and $12,000 as
of December 31, 1998, 1997 and 1996, respectively.
In the normal course of business, the Bank has granted loans to certain
directors and their affiliates under terms which Bank management believes
are consistent with the Bank's general lending policies. An analysis of
this activity is as follows:
<TABLE>
<CAPTION>
1998 1997
------------------ ------------------
<S> <C> <C>
Balance, beginning of year $ 1,041,000 $ 982,000
Loans granted, including renewals 470,000 236,000
Repayments (398,000) (177,000)
------------------ ------------------
Balance, end of year $ 1,113,000 $ 1,041,000
------------------ ------------------
------------------ ------------------
</TABLE>
The Bank had additional commitments for loans of $2,345,000 and $731,000 to
certain directors and their affiliates as of December 31, 1998 and 1997,
respectively.
F-15
<PAGE>
VALLE DE ORO BANK, N.A.
Financial Statements
December 31, 1998 and 1997
(5) BANK PREMISES AND EQUIPMENT
Bank premises and equipment consist of the following as of December 31:
<TABLE>
<CAPTION>
1998 1997
------------------ ------------------
<S> <C> <C>
Land $ 746,000 $ 746,000
Buildings 1,500,000 1,416,000
Leasehold improvements 3,318,000 3,227,000
Furniture, fixtures and equipment 3,888,000 3,478,000
------------------ ------------------
9,452,000 8,867,000
Less accumulated depreciation and amortization (4,474,000) (3,647,000)
------------------ ------------------
$ 4,978,000 $ 5,220,000
------------------ ------------------
------------------ ------------------
</TABLE>
Depreciation expense for the years ended December 31, 1998, 1997 and 1996
totaled $827,000, $788,000 and $617,000, respectively. In December 1995,
the Bank's Grossmont Center Office was destroyed by fire. During 1996 and
1997, the Bank reconstructed the facility. As of December 31, 1997, the
Bank had been fully reimbursed for its loss, less a $1,000 deductible.
(6) OTHER REAL ESTATE OWNED
A summary of the changes in the allowance for possible losses on other real
estate owned is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------------ ------------------ ------------------
<S> <C> <C> <C>
Balance, beginning of year $ 235,000 $ 218,000 $ 140,000
Provision charged to expense 60,000 143,000 93,000
Recoveries (charge-offs), net 5,000 (126,000) (15,000)
------------------ ------------------ ------------------
Balance, end of year $ 300,000 $ 235,000 $ 218,000
------------------ ------------------ ------------------
------------------ ------------------ ------------------
</TABLE>
(7) DEPOSITS
The maturity distribution of time deposits as of December 31, 1998 is as
follows:
<TABLE>
<S> <C>
Three months or less $ 22,026,000
Over three through six months 14,926,000
Over six through twelve months 14,394,000
Over twelve months 5,092,000
-----------------
Total $ 56,438,000
-----------------
-----------------
</TABLE>
F-16
<PAGE>
VALLE DE ORO BANK, N.A.
Financial Statements
December 31, 1998 and 1997
(8) LONG-TERM DEBT
Long-term debt of $52,000 and $83,000 as of December 31, 1998 and 1997,
respectively, consisted of a mortgage note payable in monthly installments
of $3,100 through July 2000, including interest at a fixed rate of 8.5%.
Future maturities of long-term debt are as follows:
<TABLE>
<S> <C>
1999 $ 34,000
2000 18,000
------------
$ 52,000
------------
------------
</TABLE>
(9) INCOME TAXES
The components of income taxes for the years ended December 31 are as
follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------------ ------------------ ------------------
<S> <C> <C> <C>
Federal:
Current $ 1,056,000 $ 858,000 $ 622,000
Deferred (286,000) (157,000) (67,000)
------------------ ------------------ ------------------
770,000 701,000 555,000
------------------ ------------------ ------------------
State:
Current 484,000 351,000 261,000
Deferred (107,000) (15,000) (25,000)
------------------ ------------------ ------------------
377,000 336,000 236,000
------------------ ------------------ ------------------
Total $ 1,147,000 $ 1,037,000 $ 791,000
------------------ ------------------ ------------------
------------------ ------------------ ------------------
</TABLE>
A reconciliation of total income taxes for the years ended December 31,
1998, 1997 and 1996 to the amount computed by applying the applicable
statutory federal income tax rate of 34% to earnings before income taxes
follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------------ ------------------ ------------------
<S> <C> <C> <C>
Computed "expected" income tax $ 1,206,000 $ 982,000 $ 748,000
State tax, net of federal benefit 249,000 222,000 163,000
Tax-exempt interest (267,000) (162,000) (149,000)
Reduction of tax liability (107,000) -- --
Other, net 66,000 (5,000) 29,000
------------------ ------------------ ------------------
$ 1,147,000 $ 1,037,000 $ 791,000
------------------ ------------------ ------------------
------------------ ------------------ ------------------
</TABLE>
F-17
<PAGE>
VALLE DE ORO BANK, N.A.
Financial Statements
December 31, 1998 and 1997
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities as of
December 31 are as follows:
<TABLE>
<CAPTION>
1998 1997
------------------ ------------------
<S> <C> <C>
Deferred tax assets:
Allowance for loan losses $ 292,000 $ 173,000
Deferred compensation 46,000 51,000
Nonaccrual interest 12,000 17,000
State taxes 165,000 133,000
Other real estate owned 100,000 70,000
Organization costs 56,000 --
Depreciation 140,000 --
------------------ ------------------
811,000 444,000
Deferred tax liabilities:
Depreciation -- (26,000)
Unrealized gains on securities available-for-sale (94,000) (48,000)
------------------ ------------------
Net deferred tax assets $ 717,000 $ 370,000
------------------ ------------------
------------------ ------------------
</TABLE>
Based upon the level of historical taxable income and projections for
future taxable income over the periods in which the deferred tax assets are
deductible, management believes it is more likely than not that the Bank
will realize the benefits of these deductible differences.
Income taxes payable at December 31, 1998 and 1997 totaled $174,000 and
$189,000, respectively.
(10) COMMITMENTS AND CONTINGENCIES
As of December 31, 1998, minimum rental payments due under operating leases
having initial or remaining noncancelable lease terms in excess of one year
are as follows:
<TABLE>
<S> <C>
1999 $ 455,000
2000 325,000
2001 329,000
2002 319,000
2003 310,000
Thereafter 2,260,000
Less minimum sublease rentals (484,000)
-------------------
$ 3,514,000
-------------------
-------------------
</TABLE>
F-18
<PAGE>
VALLE DE ORO BANK, N.A.
Financial Statements
December 31, 1998 and 1997
Net rental expense relating to these leases was approximately $462,000,
$503,000 and $356,000 in 1998, 1997 and 1996, respectively, including
sublease rentals of $56,000 in 1998, $42,000 in 1997 and none in 1996.
There are no contingent rental payments applicable to any of the leases.
Most of the leases provide that the Bank pay taxes, maintenance, insurance
and certain other operating expenses applicable to the leased premises in
addition to the monthly minimum payments. Management expects that in the
normal course of business, leases that expire will be renewed or replaced
by other leases.
The Bank has adopted three plans for the benefit of its eligible employees.
In 1998, the Bank adopted an Employee Stock Ownership Plan (the "ESOP") to
replace its profit sharing plan. The Board approved discretionary
contributions to the ESOP of $155,000 for 1998. The Board approved
contributions of $120,000 and $62,000 to the profit sharing plan in 1997
and 1996, respectively. The Bank also has a salary deferral 401(k) plan and
a cash incentive plan. The Board approved contributions to these plans of
$43,000 and $39,000 for 1998 and 1997, respectively.
The Bank 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
and to reduce its own exposure to fluctuations in interest rates. 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 amount recognized in the
balance sheets. The contract or notional amounts of those instruments
reflect the extent of involvement the Bank has in particular classes of
financial instruments.
The Bank's exposure to credit loss in the event of nonperformance by the
counterparty to the financial instrument for commitments to extend credit
and standby letters of credit is represented by the contractual amount of
those instruments. The Bank uses the same credit policies in making
commitments and conditional obligations as it does for on-balance-sheet
instruments.
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. Commitments to
extend credit amounting to $43,138,000 and $30,830,000 were outstanding as
of December 31, 1998 and 1997, respectively. Of these commitments to extend
credit, $7,747,000 and $6,839,000 represent home equity lines of credit as
of December 31, 1998 and 1997, respectively, which will be repaid over a
ten-year period if drawn upon. The Bank evaluates each customer's credit
worthiness on a case-by-case basis. The amount of collateral obtained by
the Bank, if deemed necessary upon extension of credit, is based on
management's credit evaluation of the counterparty. Collateral held varies
but may include certificates of deposit, accounts receivable, inventory,
property, plant and equipment, residential real estate and income-producing
commercial properties.
F-19
<PAGE>
VALLE DE ORO BANK, N.A.
Financial Statements
December 31, 1998 and 1997
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. Those guarantees
are primarily issued to support public and private borrowing arrangements,
including commercial paper, bond financing and similar transactions. The
credit risk involved in issuing letters of credit is essentially the same
as that involved in extending loan facilities to customers. The Bank holds
various types of collateral (primarily certificates of deposit) to support
those commitments for which collateral is deemed necessary. The Bank had
approximately $488,000 and $270,000 in standby letters of credit
outstanding as of December 31, 1998 and 1997, respectively. Most of the
letters of credit expire within twelve months.
Management does not anticipate any material losses will arise from
additional fundings of the aforementioned lines of credit or letters of
credit.
As of December 31, 1998, the Bank guaranteed $240,000 of outstanding debt
of Valley National Corporation, a Delaware corporation formed to become the
holding company for the Bank. The debt will be repaid in March 1999 upon
completion of the reorganization, subject to stockholder approval.
As of December 31, 1998 and 1997, the Bank had lines of credit in the
amount of $11,500,000 from correspondent banks, of which no amounts were
outstanding as of December 31, 1998 or 1997. These lines are renewable
annually. The availability of the lines of credit, as well as adjustments
in deposit programs, provide for liquidity in the event the level of
deposits should fall abnormally low. These sources provide that funding
thereof may be withdrawn depending upon the financial strength of the Bank.
Because of the nature of its activities, the Bank is at all times subject
to pending and threatened legal actions which arise out of the normal
course of its business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on the
Bank's financial position, results of operations or liquidity.
(11) FAIR VALUE OF FINANCIAL INSTRUMENTS
Estimated fair values for the Bank's financial instruments and a
description of the methodologies and assumptions used to determine such
amounts follows:
(a) CASH AND DUE FROM BANKS, INTEREST-EARNING DEPOSITS AND FEDERAL FUNDS
SOLD
The carrying amount is assumed to be the fair value because of the
liquidity of these instruments.
(b) FEDERAL RESERVE BANK STOCK
The carrying value approximates the fair value because the stock can
be redeemed at par.
(c) INVESTMENT SECURITIES
Fair value of investment securities is based on quoted market prices
available as of the balance sheet date. If quoted market prices are
not available, fair value is estimated based on quoted market prices
for similar securities.
F-20
<PAGE>
VALLE DE ORO BANK, N.A.
Financial Statements
December 31, 1998 and 1997
(d) LOANS
Fair values are estimated for portfolios of loans with similar
financial characteristics. Loans are segregated by type and further
segmented into fixed and adjustable rate interest terms and by credit
risk categories.
The fair value of fixed rate loans and nonperforming or adversely
classified adjustable rate loans is calculated by discounting
scheduled cash flows through the estimated maturity using estimated
market discount rates that reflect the credit and interest rate risk
inherent in the loans. The discount rates used for performing fixed
rate loans are the Bank's current offer rates for comparable
instruments with similar terms.
The fair value of performing adjustable rate loans is estimated to be
carrying value. These loans reprice frequently at market rates and the
credit risk is not considered to be greater than normal.
(e) DEPOSITS
The fair value of deposits with no stated maturity, such as
non-interest bearing demand deposits, savings and checking accounts,
is equal to the amount payable on demand as of the balance sheet date.
The fair value of time deposits is based on the discounted value of
contractual cash flows. The discount rate is estimated using the rates
currently offered for deposits of similar remaining maturities. No
value has been assigned to the Bank's long-term relationships with its
deposit customers (core deposit intangible).
(f) LONG-TERM DEBT
The carrying amount is assumed to be the fair value because the rate
is consistent with current market rates for similar instruments.
(g) COMMITMENTS TO EXTEND CREDIT AND STANDBY LETTERS OF CREDIT
The fair value of commitments to extend credit is estimated using the
fees currently charged to enter into similar agreements, taking into
account the remaining terms of the agreements and the present
creditworthiness of the counterparties. The fair value of standby
letters of credit is based on fees currently charged for similar
agreements or on the estimated cost to terminate them or otherwise
settle the obligations with the counterparties.
(h) LIMITATIONS
Fair value estimates are made at a specific point in time and are
based on relevant market information and 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. Because
no market exists for a portion of the Bank's financial instruments,
fair value estimates are based on what management believes to be
conservative judgments regarding expected future cash flows, 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 judgment
and, therefore, cannot be determined with precision. Changes in
assumptions could significantly affect the estimates. Since the fair
value is estimated as of December 31, 1998 and 1997, the amounts that
will actually be realized or paid at settlement or maturity of the
instruments could be significantly different.
F-21
<PAGE>
VALLE DE ORO BANK, N.A.
Financial Statements
December 31, 1998 and 1997
The fair value of the Bank's financial instruments as of December 31,
1998 and 1997 is as follows:
<TABLE>
<CAPTION>
1998
---------------------------------------
CARRYING/ FAIR
CONTRACT AMOUNT VALUE
----------------- ------------------
<S> <C> <C>
Financial assets:
Cash and due from banks $ 11,704,000 $ 11,704,000
Federal funds sold 11,890,000 11,890,000
Interest-earning deposits 6,396,000 6,396,000
Securities available-for-sale 23,609,000 23,609,000
Investment securities held-to-maturity 22,953,000 23,632,000
Federal Reserve Bank stock 445,000 445,000
Loans, net 149,708,000 150,283,000
Financial liabilities:
Deposits 216,393,000 216,635,000
Long-term debt 52,000 52,000
Off-balance sheet financial instruments:
Commitments to extend credit 43,138,000 261,000
Standby letters of credit 488,000 9,000
</TABLE>
<TABLE>
<CAPTION>
1997
---------------------------------------
CARRYING/ FAIR
CONTRACT AMOUNT VALUE
----------------- ------------------
<S> <C> <C>
Financial assets:
Cash and due from banks $ 10,562,000 $ 10,562,000
Federal funds sold 8,731,000 8,731,000
Interest-earning deposits 4,499,000 4,499,000
Securities available-for-sale 21,209,000 21,209,000
Investment securities held-to-maturity 16,055,000 16,281,000
Federal Reserve Bank stock 384,000 384,000
Loans, net 134,837,000 134,537,000
Financial liabilities:
Deposits 188,147,000 188,195,000
Long-term debt 83,000 83,000
Off-balance sheet financial instruments:
Commitments to extend credit 30,830,000 166,000
Standby letters of credit 270,000 5,000
</TABLE>
(12) REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements administered
by the Federal banking agencies. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action,
F-22
<PAGE>
VALLE DE ORO BANK, N.A.
Financial Statements
December 31, 1998 and 1997
the Bank must meet specific capital guidelines that involve quantitative
measures of the Bank's assets, liabilities and certain off-balance sheet
items as calculated under regulatory accounting practices. The Bank's
capital amounts and classification are also subject to qualitative
judgments by the regulators about components, risk weightings and other
factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank 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, as of December 31, 1998,
that the Bank meets all capital adequacy requirements to which it is
subject.
As of December 31, 1998, the most recent notification from the Federal
Deposit Insurance Corporation categorized the Bank as well capitalized
under the regulatory framework for prompt corrective action. To be
categorized as well capitalized, the Bank must maintain minimum total
risk-based, Tier I risk-based and Tier I leverage ratios as set forth in
the table. There are no conditions or events since that notification that
management believes has changed the Bank's category.
The Bank's actual capital amounts and ratios as of December 31, 1998 and
1997 are presented in the following tables:
<TABLE>
<CAPTION>
TO BE WELL
CAPITALIZED
FOR CAPITAL UNDER PROMPT
ADEQUACY CORRECTIVE ACTION
ACTUAL PURPOSES 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) $ 20,955,000 12.47% $ 13,444,000 >8.00% $ 16,805,000 >10.00%
Tier I Capital (to
Risk-Weighted
Assets) 19,268,000 11.47% 6,722,000 >4.00% 10,083,000 >6.00%
Tier I Capital (to
Average Assets) 19,268,000 8.06% 9,563,000 >4.00% 11,954,000 >5.00%
</TABLE>
F-23
<PAGE>
VALLE DE ORO BANK, N.A.
Financial Statements
December 31, 1998 and 1997
<TABLE>
<CAPTION>
TO BE WELL
CAPITALIZED
FOR CAPITAL UNDER PROMPT
ADEQUACY CORRECTIVE ACTION
ACTUAL PURPOSES PROVISIONS
--------------------------- --------------------------- --------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------------- ------------ ------------ ------------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
As of December 31,
1997:
Total Capital (to
Risk-Weighted
Assets) $ 18,294,000 12.65% $ 11,571,000 >8.00% $ 14,463,000 >10.00%
Tier I Capital (to
Risk-Weighted
Assets) 16,952,000 11.72% 5,785,000 >4.00% 8,678,000 >6.00%
Tier I Capital (to
Average Assets) 16,952,000 8.22% 8,252,000 >4.00% 10,315,000 >5.00%
</TABLE>
Under Federal banking law, dividends declared by the Bank in any calendar
year may not, without the approval of the Comptroller of the Currency
(OCC), exceed its net earnings for that year combined with its retained
earnings from the preceding two years. However, the OCC has previously
issued a bulletin to all national banks outlining new guidelines limiting
the circumstances under which national banks may pay dividends even if the
banks are otherwise statutorily authorized to pay dividends. The
limitations impose a requirement or in some cases suggest that prior
approval of the OCC should be obtained before a dividend is paid if a
national bank is the subject of administrative action or if the payment
could be viewed by the OCC as unsafe or unusual.
(13) STOCK OPTIONS
In 1982 and 1994, the stockholders of the Bank approved stock option plans
(the "1982 Plan" and the "1994 Plan") pursuant to which the Bank's Board of
Directors may grant stock options to officers, directors and certain key
employees. The 1982 Plan, which expired in 1992, authorized grants of
options to purchase up to 87,000 shares of common stock after adjustment
for stock dividends (original authorized number of shares was 25,000), and
the 1994 Plan authorizes grants of options to purchase up to 303,000 shares
of common stock after adjustments for stock dividends (original authorized
number of shares was 250,000). Stock options are granted with an exercise
price equal to the stock's fair value at the date of grant. All stock
options have ten-year terms and vest and become fully exercisable at a rate
of 20% per year commencing one year from the grant date.
As of December 31, 1998, there were no additional shares available for
grant under the 1982 Plan and 115,000 shares available for grant under the
1994 Plan. The fair value of each stock option granted has been estimated
on the date of the grant using the Black-Scholes option-pricing model with
the following weighted-average assumptions: 1998 - dividend yield of 1.19%;
volatility of 20.96%; risk-free interest rate of 4.75%; and expected lives
of 6.68 years; 1997 and 1996 - dividend yield of 1.6%; volatility of
25.63%; risk-free interest rate ranging from 6.74% - 7.76%; and expected
lives of 7.35 years.
The per share weighted-average fair value of stock options granted during
1998 was $8.56.
F-24
<PAGE>
VALLE DE ORO BANK, N.A.
Financial Statements
December 31, 1998 and 1997
The Bank applies the provisions of APB No. 25 in accounting for its Plans,
and accordingly, no compensation cost has been recognized for its stock
options in the financial statements. Had the Bank determined compensation
cost based on the fair value at the grant date for its stock options under
Statement 123, the Bank's net earnings and basic and diluted net earnings
per share would have been reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1998 1997 1996
------------------ ------------------ ------------------
<S> <C> <C> <C>
Net earnings, as reported $ 2,400,000 $ 1,852,000 $ 1,403,000
Pro forma net earnings 2,309,000 1,785,000 1,336,000
Basic earnings per share, as reported $ 1.83 $ 1.43 $ 1.09
Pro forma basic earnings per share 1.76 1.38 1.03
Diluted earnings per share, as reported $ 1.69 $ 1.33 $ 1.06
Pro forma diluted earnings per share 1.63 1.28 1.01
</TABLE>
Stock option activity for the years ended December 31, 1998, 1997 and 1996
was as follows:
<TABLE>
<CAPTION>
WEIGHTED-
AVERAGE
EXERCISE
OPTIONS PRICE
------------------ ------------------
<S> <C> <C>
Balance as of January 1, 1996 143,000 $ 10.76
Stock options granted 59,000 15.29
Stock options exercised (13,000) 10.76
Stock options forfeited (5,000) 10.76
5% stock dividend 7,000 10.76
------------------ ------------------
Balance as of December 31, 1996 191,000 12.22
5% stock dividend 9,000 12.22
------------------ ------------------
Balance as of December 31, 1997 200,000 11.57
Stock options granted 33,000 29.59
Stock options exercised (27,000) 10.06
Stock options forfeited (3,000) 10.28
5% stock dividend 9,000 12.22
------------------ ------------------
Balance as of December 31, 1998 212,000 $ 14.09
------------------ ------------------
------------------ ------------------
Exercisable as of December 31, 1998 125,000 $ 10.59
------------------ ------------------
------------------ ------------------
</TABLE>
F-25
<PAGE>
VALLE DE ORO BANK, N.A.
Financial Statements
December 31, 1998 and 1997
As of December 31, 1998, options outstanding have exercise prices between
$8.80 and $30.00 and a weighted-average remaining contractual life of 6
years. As of December 31, 1997, options outstanding had exercise prices
between $9.24 and $14.76 and a weighted-average remaining contractual life
of 6.2 years.
(14) OTHER EXPENSES
Other expenses are as follows for the years ended December 31:
<TABLE>
<CAPTION>
1998 1997 1996
------------------ ------------------ ------------------
<S> <C> <C> <C>
Stationery and supplies $ 245,000 $ 243,000 $ 240,000
Telephone, courier and postage 358,000 336,000 319,000
Data processing 569,000 480,000 428,000
Merchant processing expense 394,000 360,000 285,000
Promotional expenses 391,000 350,000 282,000
Professional services 215,000 149,000 80,000
Insurance 180,000 169,000 137,000
FDIC and regulatory assessments 85,000 77,000 54,000
Other real estate owned expenses 52,000 77,000 201,000
Other 1,012,000 773,000 782,000
------------------ ------------------ ------------------
$ 3,501,000 $ 3,014,000 $ 2,808,000
------------------ ------------------ ------------------
------------------ ------------------ ------------------
</TABLE>
(15) NET EARNINGS PER SHARE
In accordance with SFAS 128, the following is a reconciliation of the
numerators and denominators of the basic and diluted earnings per share.
<TABLE>
<CAPTION>
EARNINGS SHARES PER SHARE AMOUNTS
(NUMERATOR) (DENOMINATOR)
------------------------------------------- ------------------- -------------------- -------------------
<S> <C> <C> <C>
Basic 1998 EPS
Net earnings $ 2,400,000 1,312,000 $ 1.83
Effect of dilutive stock options -- 105,000 (0.14)
-------------------------------------------- -------------------- -------------------- -------------------
Dilutive EPS $ 2,400,000 1,417,000 $ 1.69
-------------------------------------------- -------------------- -------------------- -------------------
Basic 1997 EPS
Net earnings $ 1,852,000 1,296,000 $ 1.43
Effect of dilutive stock options -- 99,000 (0.10)
-------------------------------------------- -------------------- -------------------- -------------------
Dilutive EPS $ 1,852,000 1,395,000 $ 1.33
-------------------------------------------- -------------------- -------------------- -------------------
Basic 1996 EPS
Net earnings $ 1,403,000 1,291,000 $ 1.09
Effect of dilutive stock options -- 37,000 (0.03)
-------------------------------------------- -------------------- -------------------- -------------------
Dilutive EPS $ 1,403,000 1,328,000 $ 1.06
-------------------------------------------- -------------------- -------------------- -------------------
</TABLE>
F-26
<PAGE>
VALLE DE ORO BANK, N.A.
Financial Statements
December 31, 1998 and 1997
(16) QUARTERLY EARNINGS (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED:
1998 DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
---------------------------- ------------------- -------------------- -------------------- -------------------
<S> <C> <C> <C> <C>
Interest income $ 4,657,000 $ 4,646,000 $ 4,428,000 $ 4,295,000
Interest expense 1,525,000 1,650,000 1,565,000 1,557,000
Net interest income before
provision for loan
losses 3,132,000 2,996,000 2,863,000 2,738,000
Provision for loan losses
139,000 139,000 168,000 181,000
Net interest income after
provision for loan
losses 2,993,000 2,857,000 2,695,000 2,557,000
Other operating income
826,000 758,000 773,000 650,000
Other operating expenses
2,858,000 2,642,000 2,535,000 2,527,000
Earnings before income
taxes 961,000 973,000 933,000 680,000
Income taxes 233,000 349,000 333,000 232,000
Net earnings $ 728,000 $ 624,000 $ 600,000 $ 448,000
Basic earnings per share $ 0.55 $ 0.47 $ 0.46 $ 0.35
Diluted earnings per share $ 0.52 $ 0.43 $ 0.42 $ 0.32
</TABLE>
F-27
<PAGE>
VALLE DE ORO BANK, N.A.
Financial Statements
December 31, 1998 and 1997
<TABLE>
<CAPTION>
THREE MONTHS ENDED:
1997 DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
---------------------------- ------------------- -------------------- -------------------- -------------------
<S> <C> <C> <C> <C>
Interest income $ 4,271,000 4,133,000 3,998,000 3,868,000
Interest expense 1,580,000 1,534,000 1,448,000 1,378,000
Net interest income before
provision for loan
losses 2,691,000 2,599,000 2,550,000 2,490,000
Provision for loan losses
76,000 84,000 140,000 197,000
Net interest income after
provision for loan
losses 2,615,000 2,515,000 2,410,000 2,293,000
Other operating income
695,000 816,000 634,000 599,000
Other operating expenses
2,462,000 2,500,000 2,432,000 2,294,000
Earnings before income
taxes 848,000 831,000 612,000 598,000
Income taxes 316,000 298,000 211,000 212,000
Net earnings $ 532,000 $ 533,000 $ 401,000 $ 386,000
Basic earnings per share $ 0.42 $ 0.41 $ 0.30 $ 0.30
Diluted earnings per share $ 0.39 $ 0.38 $ 0.28 $ 0.28
</TABLE>
F-28
<PAGE>
[LETTERHEAD] EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Valle de Oro Bank, N.A.
We consent to incorporation by reference in the registration statement dated
March 1, 1996 on Form S-8 of Valle de Oro Bank, N.A., of our report dated
January 20, 1999, relating to the balance sheets of Valle de Oro Bank, N.A. as
of December 31, 1998 and 1997, and the related statements of earnings, changes
in stockholders' equity and comprehensive income, and cash flows for the years
then ended, which report appears in the December 31, 1998, annual report on Form
10-KSB of Valle de Oro Bank, N.A.
KPMG LLP
San Diego, California
March 30, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 23,594,000
<SECURITIES> 47,007,000
<RECEIVABLES> 149,708,000
<ALLOWANCES> 1,687,000
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 9,452,000
<DEPRECIATION> 4,474,000
<TOTAL-ASSETS> 236,800,000
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 4,407,000
<OTHER-SE> 15,003,000
<TOTAL-LIABILITY-AND-EQUITY> 236,800,000
<SALES> 0
<TOTAL-REVENUES> 21,033,000
<CGS> 0
<TOTAL-COSTS> 6,297,000
<OTHER-EXPENSES> 10,562,000
<LOSS-PROVISION> 627,000
<INTEREST-EXPENSE> 6,297,000
<INCOME-PRETAX> 3,547,000
<INCOME-TAX> 1,147,000
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,400,000
<EPS-PRIMARY> 1.83
<EPS-DILUTED> 1.69
</TABLE>
