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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1994
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 0-10198
THE SAN FRANCISCO COMPANY
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(Exact name of Registrant as specified in its charter)
Delaware 94-3071255
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
550 Montgomery Street, 10th Floor
San Francisco, California 94111
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(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (415) 781-7810
Securities registered pursuant to Section 12(b) of the Act:
Title of Class Name of Each Exchange on Which
Registered
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Class A Common Stock, $0.01 Par Value American Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K / X /.
The aggregate market value of the voting stock held by non-affiliates of the
Registrant on April 12, 1995, was $25,946,901 computed by reference to the
closing sales price of the Class A Common Stock as reported by the American
Stock Exchange.
The Registrant had 5,765,978 shares of Class A Common Stock outstanding on April
12, 1995.
Documents Incorporated by Reference
The definitive Proxy Statement for the Registrant's 1995 Annual Meeting of
Shareholders Part III
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THE SAN FRANCISCO COMPANY
1994 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENT
PART I
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Page
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Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
The Company and the Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Private and Business Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Trust Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Escrow Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Stock Option Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Association Bank Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Real Estate Investment and Development Activities . . . . . . . . . . . . . . . . . . . . 5
Lending Activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Problem Asset Portfolio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Correspondent Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Employees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Competition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Regulatory Agreement and Orders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Regulation and Supervision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . . . . . . 24
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters . . . . . . . . . . . 25
Item 6. Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations . . . . . 27
Item 8. Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . . . . . 47
Item 9. Changes in and disagreements on Accounting and Financial Disclosures . . . . . . . . . . . . . 80
PART III
Item 10. Directors and Executive Officers of the Registrant . . . . . . . . . . . . . . . . . . . . . . 80
Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80
Item 12. Security Ownership of Certain Beneficial Owners and Management . . . . . . . . . . . . . . . . 80
Item 13. Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . . . . . 80
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K . . . . . . . . . . . . . . . . 80
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PART I
ITEM 1 - BUSINESS
THE COMPANY AND THE BANK
The San Francisco Company (the "Company"), formerly the Bank of San
Francisco Company Holding Company, a Delaware corporation, is a one-bank holding
company, registered under the Bank Holding Company Act of 1956, for Bank of San
Francisco (the "Bank"), a California state chartered bank organized in 1978
whose deposits are insured by the Federal Deposit Insurance Corporation (the
"FDIC"), subject to applicable limits. The Company was organized in California
in 1981 and reincorporated in Delaware in 1988. The Bank, which the Company
acquired through a reorganization in 1982, is the only direct subsidiary of the
Company and accounts for over 99% of the consolidated assets of the Company. The
Bank delivers its services from its headquarters building, Bank of San Francisco
Building, at 550 Montgomery Street (at Clay Street), San Francisco, California
94111, and its phone number is (415) 781-7810.
The Company's Class A Common Stock, par value $0.01 per share (the
"Class A Common Stock"), is listed on the American Stock Exchange (the "AMEX").
The closing price for the Class A Common Stock on April 12, 1995 was $4.50.
The Bank currently specializes in providing private banking and trust
and investment management services for individuals, as well as business banking
for such individuals, their businesses and other businesses, primarily in the
San Francisco banking market. See "-- Private and Business Banking." In
addition, the Bank provides specialized services related to homeowners
associations (see "-- Association Bank Services") and brokerage services (see
"-- Stock Option Services"). In the future, the Bank intends to establish
specialized banking services for the Asian private banking market for
individuals who require private banking services both in Asia and the United
States.
In October 1994, James E. Gilleran was appointed Chairman and Chief
Executive Officer of the Company and the Bank. Mr. Gilleran had been serving as
the California Superintendent of Banks since 1989 and was the Managing Partner
for the San Francisco office of KPMG Peat Marwick LLP from 1977 to 1987.
During the period from 1991 through 1994, the Company suffered an
aggregate of $74.6 million in losses, primarily as a result of defaulted loans
secured by real estate and losses on direct real estate development activities.
The Company and the Bank succeeded in avoiding insolvency during this period
only through the injection of a total of $52.0 million of new capital by the
Company's controlling stockholder, Mr. Putra Masagung. These losses nevertheless
caused impairments of capital and the breach of various regulatory requirements
that have led to the issuance of orders by both state and federal bank
regulatory authorities imposing restrictions and requirements on both the Bank's
(the "Orders") and the Company's (the "Agreement") business activities and
requiring the timely resolution of problem assets. See "-- Regulatory Agreements
and Orders."
In response to continuing operating losses and regulatory oversight,
the Company has revised its business strategy to return the Company and Bank to
profitability. The Company's goal for 1995 is to return to profitability within
the current fiscal year. The following are actions the Company is taking to
achieve its objective:
- Capital On April 20, 1995, Mr. Masagung committed to contribute an
additional $3.8 million to the Company, expected by April 24, 1995.
The Company intends to contribute $4.2 million to the Bank upon
receipt of Mr. Masagung's investment. The Company is attempting to
raise a minimum of $6.3 million of additional capital.
- Non-performing assets The Company intends to reduce non-performing
assets to no more than 50% of capital (after capital restoration plans)
by the end of 1995.
- Deposit and Loan Growth The Company has initiated a core deposit
incentive program, selective marketing programs, and is identifying and
pursuing new sources of core deposits. The funds, if any,
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provided by core deposit growth will be used to fund loan growth. The
concentration risks in the existing loan portfolio are expected to be
reduced through selective renewals and new loan fundings.
- Cost Reductions In addition to the actions mentioned previously, the
Company's actions include staff reductions, reduced occupancy expense
through the leasing of unoccupied space, settlement of litigation
matters to reduce professional fees, and re-engineering operations to
improve efficiency and effectiveness. The Company and Bank will
continue to consider the purchase of limited partnership interests in
the Bank of San Francisco Building Company (BSFBC) as a means of
reducing future occupancy costs.
The Company's objectives involve two simple goals; returning the
Company and the Bank to profitability and increasing shareholder value.
Considerable progress has been made in improving operational routines and
controls. However, given the Bank's financial condition, its ability to achieve
profitability and improve its regulatory ratios in 1995 is dependent on the
Company raising additional capital and executing the sale of a majority of the
Bank's non-performing assets.
PRIVATE AND BUSINESS BANKING
Private and Business Banking at the Bank combines highly personalized
service with an array of products to meet the complex needs of its primary
clients -- executives, professionals and high net worth or high income
individuals and the private and closely held businesses with which such
individuals are associated. The Bank has specialized in private banking since it
began operations in 1979. In the San Francisco area, the Bank's focus on serving
the needs of its clients has led it to offer a range of services, including
general credit and depository services and specialized corporate escrow services
and, to a lesser extent, asset management and trust services.
The Bank seeks to concentrate on establishing relationships with
private and closely held businesses and their owners and operators. In
particular, the Bank seeks relationships with individuals whose financial needs
require customized banking programs. At December 31, 1994 and 1993, Private and
Business Banking managed approximately $67.0 million and $80.4 million in
deposits, representing approximately 45.5% and 38.3% of the Bank's total
deposits, respectively. At December 31, 1994 and 1993, Private and Business
Banking managed approximately $72.7 million and $108.0 million in loans,
representing approximately 67.5% and 72.4% of the Bank's total loans,
respectively.
The Bank places a high degree of importance on providing exceptional
client service. To facilitate providing such a high degree of service, the Bank
has recruited highly experienced banking professionals who understand and can
meet the needs of the Bank's target market. The Bank assigns its professionals
to serve small groups of personal clients rather than periodically reassigning
such professionals to different areas or shifting them into administrative
positions. The Bank seeks to enable its clients to have confidence that their
private bankers understand their financial situations and are accessible when
needed.
The Bank also places a high degree of importance on responding quickly
to its clients' needs. Each client relationship is supported, not only by an
individual banking officer, but also by a team familiar with each client's needs
and situation, so that the client is aware that another Bank employee other than
the primary banking officer is familiar with and is able to respond to such
client's needs.
The Company's primary goals and related action steps for the Private and
Business Banking Department over the next year involve:
- Deposit growth Private Banking will concentrate on deposit growth in
the Bank's "primary" marketing area and aggressively increase new
relationships through selling quality service. The focus will be small
privately held companies and their owners, and professionals. Every
effort will be made to promote merchant and transaction services to
those prospects. The initial focus will be calling on existing clients,
and the identification and calling on prospective clients.
- Loan concentrations One overall goal in 1995 is to improve the risk
ratings and industry concentrations of the portfolio. Private Banking
will focus on a broader diversification and reduce real estate related
loans. Also, the Bank will selectively concentrate on investment
management, law and accounting firms, and other professional companies
as well as the personal accounts of the owners and senior partners
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associated with these organizations. The Bank will strive to obtain the
customer's entire banking relationship rather than being a transaction
bank.
Northern California has a highly diversified economic base, including
high technology electronic manufacturing, scientific research, real estate
construction, retail and wholesale trade and transportation. Much of the
diversity in the economic base is attributable to the service sector, including
finance, accounting, insurance, communications, law, consulting and tourism.
While many of the Bank's loans have been and continue to be collateralized by
real estate, and a significant portion of the Bank's clients' net worth has
historically consisted of real estate holdings, the Bank's deposit and lending
relationships have not been concentrated among borrowers within a specific
trade, service or industrial activity.
TRUST SERVICES
The Bank was granted trust powers in late 1989, and beginning in 1990,
began to combine the personalized services of private banking with comprehensive
investment management services. In addition to acting as investment advisor, the
Bank offers its clients individual securities management, cash management,
trustee services, including bill paying and budget evaluation, and employee
benefits services including Individual Retirement Accounts (IRAs). The Bank can
handle the administration of probates and trusts, and cash management for
foundations. At December 31, 1994 and 1993, trust services were being provided
on assets totaling $26.5 million and $25.7 million, respectively. Trust has
never achieved the size (and, therefore, fee income) necessary to cover its
direct costs. As a result, for 1995, the Company has elected to scale back the
Trust business. During 1995, a concerted effort will be made to increase the
profitability of existing relationships and to re-engineer internal processes
and work flows.
ESCROW SERVICES
Begun in 1989, the Corporate Escrow Services Department ("Escrow")
provides a service for all non-real estate escrows, including the temporary
deposit and investment of funds, deposit of securities, personal property and
other assets by attorneys, business brokers and clients for business
transactions, disputes, life care facilities, and court actions. Escrow has
always made a modest contribution to operating profit and provides a modest
amount of deposits to fund other business activities. At December 31, 1994 and
1993, Escrow managed approximately $6.6 million and $9.2 million in deposits,
representing approximately 4.5% and 4.4% of the Bank's total deposits,
respectively. Escrow's primary goals and related action steps over the next year
involve:
- Increasing fee income and deposits by increasing business development
calls, mailings, and advertisements to targeted markets, companies and
individuals.
- Better integrating with the Bank's other business units by
participating in joint marketing calls with other Bank staff and
identification of joint target clients.
- Cross sell the Bank's other businesses by participating in a
cross-referral program with Trust, Private and Business Banking,
Association Bank Services, and Stock Option Lending.
STOCK OPTION SERVICES
Begun in 1984, Stock Option Services provides a range of brokerage
services combined with a program to facilitate the exercise of stock options by
employees of publicly held companies. The stock option exercise program offers
employees the means to exercise, hold or sell their option shares at a minimum
cost.
In this program, the Bank makes loans to holders of stock options of
publicly traded companies for the purpose of enabling them to exercise their
options and sell the stock thus acquired. The Bank works with stock transfer and
employee benefits officers to coordinate the payment of the option exercise
price to the company granting such options, the provision for the payment of
taxes related to the exercise of such options, the issuance and subsequent sale
of the underlying stock and the distribution of the net sale proceeds. At
December 31, 1994 and 1993, the total amount of the Bank's stock option loans
outstanding was $2.1 million and $1.7 million,
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respectively. Such amounts can vary substantially based upon the timing of the
exercise of stock options as well as market conditions.
Historically, approximately 35% of Stock Option Services' clients have
generated over 90% of the fee income of Stock Option Services. These clients are
the focus of Stock Option Services' customer service activities; however, this
concentration of fee income and service activities exposes the Bank to the
possibility of losing certain important clients. For example, certain clients
moved their accounts to a competitor in late 1993 after the Bank employees
responsible for those accounts were hired by that competitor. This concentration
of accounts also leaves the Bank vulnerable to losing a large source of fee
income with the departure of a few clients. Management considers the fee income
produced by this activity to be highly volatile, and there can be no guarantee
that income levels from the activity can be maintained at current levels.
Stock Option Services is a substantially self-funding activity with
associated deposit balances closely tracking outstanding loan balances. Because
Stock Option Services' deposits are primarily non-interest bearing demand
deposit accounts, the Bank benefits from them by reducing its cost of funds.
Management believes that most of these clients are in industries that continue
to present growth opportunities. Accordingly, stock option programs should
represent a continuing component of such clients' overall compensation programs.
In addition, management believes that the current client base should represent
referral sources for future business development activities for other Bank
products and services. As the Bank and the Company expand the Private Banking
business, the executives who utilize their company's stock option program with
the Bank are natural prospects for other services.
Stock Option Services initiatives include:
- Expanding services to existing clients Through focused calling programs
on each client and by maintaining service quality.
- Develop new company relationships The development of a prospect
database, an action plan for initial contact and follow-up contacts,
and sales and marketing literature are primary action steps completed
by a newly hired manager. The Plan includes the development of a
marketing program for discount brokerage services.
- Improving systems Review stock option reporting systems and interactive
voice response products for possible purchase and linkage with client
company relationships.
- Cross sell the Bank's other businesses Participate in a cross-referral
program with Private and Business Banking. Determine feasibility of
"discount brokerage" concept for Private Banking customers and
prospects.
ASSOCIATION BANK SERVICES
Established in 1987, Association Bank Services operates throughout
California and is a major provider of deposit and financial management services
to homeowner and community associations in the State. The Bank offers deposit
accounts for operating funds and reserves, loans, assessment collection services
and investment services to homeowner and community associations. In addition,
the Bank offers lockbox and courier services, expedited deposit processing and
special handling of accounts to simplify banking operations. Deposits from
homeowner and community associations are a key component of the Bank's core
deposit base. At December 31, 1994 and 1993, the Association Bank Services
Division accounted for approximately $3.1 million and $848,000 in loans,
representing approximately 2.9% and .6% of the Bank's total loans, respectively.
At December 31, 1994 and 1993, the Association Bank Services accounted
for approximately $41.6 million and $45.1 million in deposits, representing
approximately 28.3% and 21.5% of the Bank's total deposits, respectively. A
substantial portion of the Association Bank Services deposits are held in
individual accounts that are 100% covered by FDIC insurance. The Bank also
offers a certificate of deposit placement service (CD Placement) designed to
invest a customer's funds in other insured financial institutions up to a
maximum of
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$100,000 per institution (for which the Bank is paid a fee based on the average
CD Placement investments outstanding).
Although a substantial portion of the individual Association Bank
Services deposit accounts are fully insured, a small number of "account
managers" control significant numbers of such individual accounts, thus
concentrating control of such deposits in the discretionary authority of a few
individuals. Accordingly, a decision by several such account managers to
withdraw their business from the Bank could have a significant impact on the
Bank's core deposits, and thus on the Bank's liquidity. Association Banking
Services' primary goals and related action steps over the next year involve:
- Maintain existing clients by continuing to provide the service level
and specialized services in addition to new products.
- Evaluate the profitability of existing products by working with clients
to ensure that they understand the cost of the services that they
receive, and by cross-selling other Bank services to increase the
service value that they receive.
- Expand market share by increasing in state and out of state business.
Presently, the Bank's primary market of Association Bank Service
deposits are in California. Through direct marketing, Association Bank
Services is targeting a significant increase in market share within the
state. Selective marketing tests in Colorado in 1994 have provided new
clients and broadened the Bank's exposure for prospective clients in
the Colorado market.
- Loan growth by continuing direct marketing to attorneys, CPA's, and
management companies that specialize in the association industry. These
provide an excellent source of prospective lending clients and,
potentially, deposit customers.
- Expand the automation of services by automating the lockbox processing
and integrating ACH services, the Bank will be able to provide a more
cost effective product. A new product that will be introduced in 1995
is for associations to collect assessment dues by credit card.
REAL ESTATE INVESTMENT AND DEVELOPMENT ACTIVITIES
Management has withdrawn the Bank from all real estate development
activities. From 1985 through 1992, the Bank was engaged in commercial and
residential real estate development through Bank of San Francisco Real Estate
Investors ("BSFRI"), a wholly-owned subsidiary of the Bank. Then-applicable
regulations and practices of the FDIC and the Federal Reserve Board permitted
state-chartered bank subsidiaries of bank holding companies to engage in real
estate investment activities if such activities were permitted under state law
(as was the case in California). The Bank's approval for engaging in real estate
investment and development activities was suspended after November 1991 pursuant
to the terms of a Memorandum of Understanding with the FDIC and the State
Banking Department (the "MOU"), and the Bank agreed to discontinue its real
estate investment activities not later than December 1993. In addition, under
FDICIA (see "--Regulation and Supervision -- Federal Deposit Insurance
Corporation Improvement Act of 1991"), the Bank is no longer permitted to engage
in real estate development activities and must dispose of assets acquired for
such purposes by December 19, 1996. See "-- Regulation and Supervision." As
required by FDICIA, the Bank has filed an application to continue the orderly
divestiture of its real estate investments until December 19, 1996. The Bank was
granted until December 31, 1994 to effect an orderly divestiture of its real
estate investments. Although complete divesture was not achieved, the FDIC has
not taken enforcement actions against the Bank (see "PROBLEM ASSET PORTFOLIO").
The Bank intends to file another application with the FDIC to allow for an
orderly liquidation by December 31, 1995.
BSFRI's activities were substantially cut back after 1989. During 1994,
BSFRI sold one property. BSFRI sold no properties in 1993. At December 31, 1994
and 1993, real estate investment totaled $682,000 and $1.5 million, or
approximately 0.4% and 0.6%, respectively, of the Company's total assets,
excluding real estate accounted for as Bank premises (which totaled at such
dates $1.7 million and $2.2 million, respectively).
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LENDING ACTIVITIES
Historically, the Bank concentrated its lending activities in
commercial and financial loans, in real estate construction and development
loans and real estate mortgage loans made primarily to individuals and
businesses in the San Francisco area and, for a brief period, in the Sacramento
area. The Bank also provides financing for the exercise of employee stock
options. The Bank has offered credit for private or closely held businesses
ranging from $250,000 to $2.5 million and credit to high net worth and high
income individuals ranging from $150,000 to $1.5 million. In conjunction with
the Bank's Plan to reduce concentration risks in the loan portfolio, the Bank
has elected to reduce the loans it offers to no more than $1.0 million. The Bank
has no foreign loans. Renewal of existing loans in excess of $500,000 requires
the approval of the Loan and Investment Committee of the Board.
At December 31, 1994 and 1993, the Bank had net loans outstanding of
$99.5 million and $141.1 million, respectively, which represented approximately
67.6% and 67.2% of the Bank's total deposits at those dates and approximately
63.5% and 61.1% of the total assets of the Company. During 1994, the Bank
originated $30.5 million of new loans, compared with $87.8 million of new loans
during 1993. The interest rates charged on the Bank's loans have varied with the
degree of risk, maturity and amount of the loans and have been subject to
competitive pressures, money market rates, funds availability and governmental
regulations. Approximately 93.2% of the Bank's loans have interest rates that
either adjust with the Bank's prime rate or mature within 90 days.
As of December 31, 1994 and 1993, approximately 70.9% and 66.7%,
respectively, of the Bank's loans were secured by real estate. While these
percentages indicate an increase, total loans secured by real estate actually
declined to $75.5 million as of December 31, 1994 from $99.9 million as of
December 31, 1993. A loan may be secured by real estate even though the purpose
of the loan is not to facilitate the purchase or development of real estate and
even though the principal source of repayment is not the sale of the real estate
serving as collateral. However, in accordance with the terms of the Orders the
Bank has agreed to diversify its risk by reducing the Bank's exposure to real
estate lending and investment. See "-- Regulation and Supervision."
LENDING POLICIES AND PROCEDURES
The Bank's lending policies are established by the Bank's senior
management and approved by the Board of Directors of the Bank and its Loan
Committee. The Bank is required by regulation to limit its maximum outstanding
balance to any one borrower to 25% of capital on secured loans and to 15% of
capital on unsecured loans. Secured loans are defined as loans secured by a
first deed of trust or possessory collateral. The Bank has established its own
internal limits on the outstanding balance of loans to a maximum of $1.0
million. Any renewal of existing loans for over $1.0 million requires the
approval of the Loan and Investment Committee of the Board. All loans require
the approval of two officers. All loans in excess of $100,000 must be approved
by the Bank's Loan Committee, chaired by the Chief Credit Officer and comprised
of the Bank's Chief Executive Officer and other senior officers not related to
the lending function. The Loan and Investment Committee also must review all
extensions of credit in which the Bank's total lending exposure equals or
exceeds $500,000.
The Bank assesses the lending risks, economic conditions and other
relevant factors related to the quality of the Bank's loan portfolio in order to
identify possible credit quality risks. The Bank relies primarily on its own
internal credit review staff, which is independent of the lending divisions, to
evaluate the loan portfolio. The Credit Administration Department reviews all
new and renewed credits in excess of $250,000 on a continuous basis and reports
the results of its findings to the Audit Committee of the Bank's Board of
Directors. Results of reviews by the Credit Administration Department as well as
examination of the loan portfolio by state and federal regulators are also
considered by management in determining the level of the allowance for loan
losses. In addition, the allowance for loan losses is reviewed and measured
against the analysis of individual credits when the potential for loss exceeds
amounts assigned to assets of similar risk classifications because of collateral
values, payment history or economic conditions.
When a borrower fails to make a required payment on a loan, the loan is
classified as delinquent. If the delinquency is not cured, workout procedures
are generally commenced. If workout proceedings are not successful, collection
procedures, which may include collection demands, negotiated restructures,
foreclosures and suits for collection, are initiated. In general, loans are
placed on non-accrual status after being contractually delinquent for more than
90 days, or earlier, if management believes full collection of future principal
and interest on a timely
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basis is unlikely. When a loan is placed on non-accrual status, all interest
accrued but not received is charged against interest income. During the period
in which a loan is on non-accrual status, any payment received may be used to
reduce the outstanding loan balance. A non-accrual loan is restored to an
accrual basis when principal and interest payments are being paid currently and
full payment of principal and interest is expected. Loans that are well secured
and in the process of collection remain on accrual status.
The Bank may restructure loans as a result of a borrower's inability to
service the obligation under the original terms of the loan agreement.
Restructures are executed only when the Bank expects to realize more from a
restructured loan than from allowing the loan to be foreclosed or seeking other
forms of collection.
CREDIT QUALITY
In its lending operations, the Bank continues to take steps to
strengthen its credit management practices and to improve the overall quality of
the loan portfolio. Such steps include instituting more stringent underwriting
standards and restricting lending to small businesses, corporations and
individuals for cash flow, inventory funding and other investments. As a result
of the decline in California real property values and the desire to reduce
concentrations of real estate loans, the Bank has substantially eliminated its
origination of land acquisition and development loans other than lending to
community redevelopment projects and funding outstanding commitments. See
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -- Valuation Allowances."
COMPOSITION OF LOAN PORTFOLIO
The composition of the Bank's loan portfolio at December 31 is
summarized as follows:
<TABLE>
<CAPTION>
At December 31,
---------------------------------------------------------------
(Dollars in Thousands) 1994 1993 1992 1991 1990
---------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Commercial and financial $ 83,141 $109,008 $166,364 $183,858 $160,321
Real estate construction 9,004 14,023 37,659 61,756 86,587
Real estate mortgage 14,276 26,479 31,690 35,749 32,729
Net lease financing 31 230 363 490 522
---------------------------------------------------------------
106,452 149,740 236,076 281,853 280,159
Deferred fees and discounts, net (388) (550) (863) (1,162) (1,257)
Allowance for possible loan losses (6,576) (8,050) (8,400) (8,411) (5,052)
---------------------------------------------------------------
Total loans, net $ 99,488 $141,140 $226,813 $272,280 $273,850
===============================================================
</TABLE>
The following table presents the loan portfolio at December 31, 1994
based upon various contractually scheduled principal payments allocated to
maturity categories. This table does not reflect anticipated prepayment of
loans.
<TABLE>
<CAPTION>
One to After
Within Five Five
(Dollars in Thousands) One Year Years Years Total
------------------------------------------------
<S> <C> <C> <C> <C>
Commercial and financial $51,064 $28,951 $ 3,126 $ 83,141
Real estate construction 7,444 1,560 -- 9,004
Real estate mortgage 2,134 4,132 8,010 14,276
Net lease financing 31 -- -- 31
------------------------------------------------
Total loans $60,673 $34,643 $11,136 $106,452
================================================
</TABLE>
Loans due in one year or more include $8.6 million with fixed interest
rates and $37.2 million with floating or adjustable rates based on prime rate.
Commercial and Financial Loans. The Bank offers a variety of
commercial and financial lending services, including revolving lines of credit,
working capital loans, letters of credit and loans to facilitate the exercise of
stock
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<PAGE> 10
options. These loans are typically secured by cash deposits, accounts
receivable, equipment, inventories, investments, real estate and securities. The
Bank's commercial and financial loans typically bear a floating rate of interest
based on the prime rate. The Bank's commercial and financial loans are primarily
in principal amounts of at least $100,000 and generally have terms of one year
or less. As of December 31, 1994 and 1993, the Bank had commercial and financial
loans outstanding of $83.1 million and $109.0 million constituting approximately
78.1% and 77.2% of the Bank's gross loans, respectively. As of December 31,
1994, approximately 61.0% of the Bank's gross commercial and financial loans
were scheduled to mature within one year. During 1994, no single commercial
client accounted for more than 4.3% of the Bank's outstanding loan financings.
In underwriting commercial and financial loans, the Bank focuses on the
net worth, income, liquidity and cash flows of the borrower or borrowers and, in
the case of secured loans, the value of the collateral. The Bank's borrowers who
secure their loans typically use personal or business real estate in the San
Francisco area as collateral. As of December 31, 1994 and 1993, approximately
50.0% and 49.2%, respectively, of the Bank's total commercial and financial
loans were secured by real estate.
At December 31, 1994 and 1993, the total amount of the Bank's stock
option loans outstanding was $2.1 million and $1.7 million, respectively. See
"-- Stock Option Services."
Construction Lending and Real Estate Mortgage Lending. Historically,
the Bank has made loans to finance the construction of commercial, industrial
and residential properties and to finance land development. The Bank's real
estate construction loans typically have had maturities of less than two years,
have had a floating rate of interest based on the Bank's prime lending rate,
have been secured by deeds of trust and usually have not exceeded 70% of the
appraised value of the property at origination. Bank policy generally limits
real estate construction loans to 75% of the appraised value of the property
after development. From time to time, the Bank sought participants to share in
the funding of real estate construction loans. At December 31, 1994 and 1993,
real estate construction and mortgage loans constituted approximately 21.9% and
27.1%, respectively, of the Bank's gross loans outstanding. In 1993, management
decided to reduce the Bank's real estate construction lending activities in
order to help further diversify the Bank's loan portfolio. Accordingly, gross
real estate construction loans outstanding as a percentage of gross loans
outstanding fell to 8.5% at December 31, 1994 from 9.4% at December 31, 1993.
The Bank's real estate mortgage loans typically are secured by first or
second deeds of trust on either commercial or residential property, and have
original maturities of three years or more. Such loans have been non-revolving
and generally have had maturities that do not exceed ten years. Repayment terms
generally include principal amortization over a negotiated term, with balloon
principal payments due upon maturity of the loans. The typical purpose of these
loans is the acquisition of real property securing the loan. The primary sources
of repayment have been the properties' cash flow in the case of commercial real
estate loans and the borrower's cash flow in the case of residential real
estate. The secondary source of repayment is the sale of the real property
securing the loan. Real estate mortgage loans accounted for approximately 13.4%
and 17.7% of the Bank's gross loans outstanding as of December 31, 1994 and
1993, respectively.
From 1990 through 1991, the Bank had a Residential Lending Division
whose objective was to originate residential and multi-family mortgage loans
through a network of retail, wholesale and correspondent sources for resale in
the secondary market for residential loans. During the third quarter of 1991, as
a result of the Division's marginally profitable operations, management decided
to substantially reduce the Bank's residential lending activities and began
winding down the operations of the Residential Lending Division. In the fourth
quarter of 1991, the Bank sold its mortgage servicing portfolio of approximately
$21.0 million at a profit. The Bank has retained $5.5 million in residential
loans in its portfolio, which it has determined will be held to maturity. At
December 31, 1994 and 1993, residential mortgage loans accounted for $4.2
million and $5.5 million, or 4.0% and 3.8% of gross loans outstanding,
respectively.
PROBLEM ASSET PORTFOLIO
The Bank's problem assets portfolio consists of non-performing loans,
real estate held after foreclosure or in substance foreclosure on assets
securing loans ("other real estate owned" or "OREO"), real estate with an
impaired value that was originally acquired by the Bank for its own development
and loans that are performing but otherwise have undesirable characteristics (as
a result, for instance, of impaired collateral or adverse developments
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<PAGE> 11
with respect to the borrower's ability to service the loan out of the cash flow
of the securing property). As a result of the Bank's real estate lending and the
deteriorated economic condition of the California real estate markets, a
significant number of loans and investments made by the Bank from 1985 through
1992 have subsequently proven difficult or impossible to recover without
incurring losses. As of December 31, 1994, the Bank had $9.4 million in problem
loans and $10.7 million in other problem assets (OREO and real estate
investments).
In 1994, the Bank reduced its problem asset portfolio by $36.7 million,
from $56.8 million to $20.1 million, in accordance with the requirements of the
Orders (See "-- Regulatory Agreement and Orders"), through resolutions, charge
offs and improvements in loan quality. Of the $20.1 million of problem assets in
the Bank's portfolio at December 31, 1994, loans and properties classified by
the Bank as other real estate owned comprised 49.8% of the total value of the
problem asset portfolio and 46.8% was held on a non-accrual basis. Based upon
information currently available, Management believes that the Bank has made
sufficient provision to its allowance for possible loan losses and specific
reserves to absorb expected losses that might result from the Bank's current
strategies to resolve the problem assets.
Presently, the Bank's strategy includes the reduction of problem
assets through individual workout plans. Management expects that such sales
would not be likely to entail further write downs of the problem assets sold.
There can be no assurance, however, that the Bank or the Company will be able to
liquidate, resolve or otherwise dispose of any problem assets, or that any
liquidation, resolution or disposal of such assets will be made at acceptable
values or without the incurrence of additional losses to the Bank or the
Company.
The Bank maintains a Special Assets Department to monitor and attempt
to resolve the problem asset portfolio with the objective of maximizing value.
The Special Assets Department is currently staffed with four
full-time-equivalency positions. As a result of the reduction in the number of
problem assets, the staffing level for the management of problem assets can be
reduced and the Special Assets Department will be absorbed into the Credit
Administration Department. Individual workout plans have been developed for
certain assets managed by the Special Assets Department, and a tracking system
to monitor compliance with these plans has also been established.
CORRESPONDENT BANKS
The Bank has correspondent relationships with twelve banks for the
purpose of check clearing, selling federal funds, buying and selling investment
securities, the safekeeping of investment portfolio and related record keeping,
stock registration and stock transfer services, credit card issuance and
servicing, and issuance of letters of credit.
EMPLOYEES
At December 31, 1994 the Company, primarily through the Bank, employed
83 persons, consisting of 76 full-time and 7 part-time employees.
COMPETITION
The banking business in California, and specifically the market area
served by the Bank, is highly competitive. The Bank competes for loans and
deposits with other commercial banks, including some of the country's and the
world's largest banks, savings and loan associations, finance companies, money
market funds, brokerage houses, credit unions and non-financial institutions. By
virtue of their larger amounts of capital, many of the financial institutions
with which the Bank competes have significantly greater lending limits than the
Bank and perform certain functions, including corporate trust services and
international banking services, which are not presently offered directly by the
Bank although such functions may be offered indirectly by the Bank through
correspondent institutions. In addition, certain regulatory restrictions which
have been imposed on the Bank by
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<PAGE> 12
federal and state regulators may prohibit the Bank from engaging in certain
activities and place the Bank at a competitive disadvantage to other financial
institutions.
The Bank's strategy for meeting its competition has been to concentrate
on discrete segments of the market for financial services, particularly small to
medium-sized businesses and their owners, professionals, corporate executives,
affluent individuals, and homeowners and community associations, by offering
specialized and personalized banking services to such clients. In addition, the
Bank offers a range of brokerage services to employees of publicly held
companies and Private and Business Banking clients where it competes with other
brokerage firms, including some of the country's largest brokerage firms.
From time to time, legislation has been and continues to be proposed or
enacted which has the effect of increasing the cost of doing business for banks,
limiting the permissible activities of banks, or affecting the competitive
balance between banks and other financial institutions or between large banks
and small banks. It is difficult to predict the competitive impact that these
and other changes in legislation may have in the future on commercial banking in
general or on the business of the Bank in particular.
REGULATORY AGREEMENT AND ORDERS
CAPITAL ORDERS
On March 24, 1995, the SBD issued an order for the Bank to increase its
capital. The capital order requires that the Bank increase its capital by $4.2
million on or before April 10, 1995 and by a minimum of $10.5 million (including
the first installment of $4.2 million) on or before June 30, 1995. The second
installment must be at least equal to the amount of capital necessary to
increase the shareholder's equity to not less than 7.0% of total tangible assets
as of February 28, 1995. No assurances were given that the SBD would refrain
from taking action against the Bank until the deadlines specified have passed.
On April 20, 1995, the Company received a commitment from its major
shareholder to contribute an additional $3.8 million in capital, expected by
April 24, 1995. The Company intends to contribute $4.2 million in capital to
the Bank upon receipt of Mr. Masagung's investment to meet the first
installment required by the SBD Capital order.
On March 28, 1995, the FDIC issued a Notification of Capital Category
("Notification") in accordance with its Prompt Corrective Action regulations.
The FDIC has determined that the Bank is Critically Undercapitalized. On the
date of the Notification the Bank became subject to certain mandatory
requirements including submission of a capital restoration plan and restrictions
on asset growth, acquisitions, new activities, new branches, payment of
dividends or making any other capital distribution, management fees, and senior
executive compensation. Prior to the Notification, the Bank was subject to the
Orders which included these limitations. In addition, immediately upon receiving
notice, the Bank must obtain FDIC's prior written approval before entering into
any material transaction other than in the usual course of business, extending
any credit for any highly leveraged transactions, as defined by regulation,
amending the Bank's charter or bylaws, except to the extent necessary to carry
out any other requirement of any law, regulation, or order, making any change in
accounting methods, engaging in any covered transaction as defined in section
23A(b) of the Federal Reserve Act, paying excessive compensation or bonuses,
paying interest on new or renewed liabilities at a rate that would increase the
Bank's weighted average cost of funds to a level significantly exceeding the
prevailing rates of interest on insured deposits in the Bank's normal market
area, and making any principal or interest payment on subordinated debt.
FEDERAL RESERVE BOARD WRITTEN AGREEMENT
As a result of the Federal Reserve Bank of San Francisco's (the "FRB")
examination of the Company as of June 30, 1991, the FRB on April 20, 1992 issued
a letter (the "Directive") prohibiting the Company, without the FRB's prior
approval, from (i) paying any cash dividends to its stockholders, (ii) incurring
any new debt or increasing existing debt, (iii) repurchasing any outstanding
stock of the Company or (iv) acquiring or entering into an agreement to acquire
any entities or portfolios. The Company has been notified that it is in a
"troubled condition" for purposes of Section 914 of the Financial Institutions
Recovery, Reform and Enforcement Act ("FIRREA").
On December 16, 1994, the Company and the FRB entered into a Written
Agreement (the "Agreement") that supersedes the previous directive dated April
20, 1992. The Agreement prohibits the Company, without prior approval of the
FRB, from: (a) paying any cash dividends to its shareholders; (b) directly or
indirectly, acquiring or selling any interest in any entity, line of business,
problem or other assets; (c) executing any new employment,
-10-
<PAGE> 13
service, or severance contracts, or renewing or modifying any existing contracts
with any executive officer; (d) engaging in any transactions with the Bank that
exceeds an aggregate of $20,000 per month; (e) engaging in any cash expenditures
with any individual or entity that exceeds $25,000 per month; (f) increasing
fees paid to any directors for attendance at board or committee meetings, or
paying any bonuses to any executive officers; (g) incurring any new debt or
increasing existing debt; and (h) repurchasing any outstanding stock of the
Company. The Company is required to submit a progress report to the FRB on a
quarterly basis.
The Company was also required to submit to the FRB an acceptable written
plan to improve and maintain an adequate capital position, a comprehensive
business plan concerning current and proposed business activities, a
comprehensive operating budget for the Bank and the consolidated Company. In
addition, the Board of Directors was required to submit an acceptable written
plan designed to enhance their supervision of the operations and management of
the consolidated organization. The Company has filed all of the required
submissions with the FRB in accordance with the Agreement.
CEASE AND DESIST ORDERS
On August 18, 1993, the Bank, without admitting or denying any alleged
charges, stipulated to Cease and Desist Orders (the "Orders") issued by the FDIC
and the California State Banking Department (the "SBD") that became effective
August 29, 1993 (the "Orders Effective Date"). The Orders directed, among other
things, that the Bank: (a) achieve and maintain a 7% leverage capital ratio on
and after September 30, 1993; (b) pay no dividends without the prior written
consent of the FDIC and the California Superintendent of Banks (the
"Superintendent"); (c) reduce the $88.6 million in assets classified
"Substandard" or "Doubtful" as of November 30, 1992 (the date of the most recent
full-scope FDIC and SBD Report of Examination of the Bank), to no more than
$40.0 million by September 30, 1994; (d) have and retain management whose
qualifications and experience are commensurate with their duties and
responsibilities to operate the Bank in a safe and sound manner, notify the FDIC
and the Superintendent at least 30 days prior to adding or replacing any new
director or senior executive officer and comply with certain restrictions in
compensation of senior executive officers; (e) maintain an adequate reserve for
loan losses; (f) not extend additional credit to, or for the benefit of, any
borrower who had a previous loan from the Bank that was charged off or
classified "Loss" in whole or in part; (g) develop and implement a plan to
reduce its concentrations of construction and development loans; (h) not
increase the amount of its brokered deposits above the amount outstanding on the
Orders Effective Date ($20.0 million) and submit a written plan for eliminating
reliance on brokered deposits; (i) revise or adopt, and implement, certain plans
and policies to reduce the Bank's concentration of construction and land
development loans, reduce the Bank's dependency on brokered deposits and out of
area deposits, and to improve internal routines and controls; (j) reduce the
Bank's volatile liability dependency ratio to not more than 15% by March 31,
1994; (k) eliminate or correct all violations of law set out in the most recent
Report of Examination, and take all necessary steps to ensure future compliance
with all applicable laws and regulations; and (l) establish a committee of three
independent directors to monitor compliance with the Orders and report to the
FDIC and the Superintendent on a quarterly basis.
As of December 31, 1994, the Bank failed to meet the capital
requirements of the Orders and other industry wide requirements (see "--
Regulation and Supervision -- Federal Deposit Insurance Corporation Improvement
Act -- Prompt Corrective Action") including the failure to meet the 7% leverage
capital ratio imposed by the Orders. This failure occurred because the continued
operating losses primarily related to problem assets.
On April 20,1995, the Company received a commitment from its major
shareholder to contribute an additional $3.8 million in capital, expected by
April 24, 1995. The Company intends to contribute $4.2 million in capital to
the Bank upon receipt of Mr. Masagung's investment. Giving effect to the
April 1995 capital commitments as of December 31, 1994, the Company and the
Bank would not have been in compliance with all regulatory capital requirements
including the Impaired Capital. The Company is attempting to raise a minimum
of $6.3 million of additional capital in order to comply with all regulatory
capital requirements except the Impaired Capital as discussed under "-- Capital
Impairment Orders".
The Bank believes that the findings of the FDIC and SBD at their recent
examination which began January 30, 1995 will be that the Bank is not in
compliance with substantial requirements of the Orders. However, no Report of
Examination has been received from the FDIC and the SBD as a result of their
recent examination of the Bank. Management believes that the FDIC and SBD will
find that the Bank is not in compliance with: (a) having and maintaining
management whose qualifications and experience are commensurate with their
duties and
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<PAGE> 14
responsibilities to operate the Bank in a safe and sound manner; (b) the
implementation of a plan to reduce concentrations; (c) the submission of an
acceptable plan for the elimination of the reliance on brokered deposits; (d)
the reduction of the volatile liabilities dependency ratio to at or below 15%,
and; (e) the correction of all violations of law as set out in the previous
examination. In addition, because of its asset quality, operating losses,
volatile liability dependency and liquidity constraints, the Bank is potentially
subject to further regulatory sanctions that are generally applicable to banks
that are critically undercapitalized.
In response to the Orders and the failure of the Bank to meet industry
wide capital requirements, management submitted a 1995 Business and Profit Plan
(Plan) on February 14, 1995 to the FDIC and the SBD for approval. It is expected
that the Plan will be have to be updated to give effect for the delay in
capital. Management believes that the Bank will be able to take the actions
contemplated by such Plan, subject to the general requirement that the Bank
return to profitability and be operated safely and soundly. A number of the
restrictions imposed by the Orders will remain in effect until the Orders can
be officially lifted. Although management anticipates the FDIC and the SBD will
lift the Orders once the Bank demonstrates full compliance with the Orders, and
the Bank's problem assets are resolved and it is deemed to be operating is a
safe and sound manner, no assurance can be given as to when all conditions
precedent to the lifting of the Orders will be fulfilled. The Company also is
subject to certain restrictions imposed by the FRB pursuant to the Agreement
that may prevent the Company from taking steps to establish new businesses (or
new subsidiaries) at the Company level until similar conditions precedent are
fulfilled.
CAPITAL IMPAIRMENT ORDERS
The California Financial Code (the "Financial Code") requires the
Superintendent to order any bank whose contributed capital is impaired to
correct such impairment within 60 days of the date of his or her order. Under
Section 134(b) of the Financial Code, the "contributed capital," defined as all
shareholders' equity other than retained earnings, of a bank is deemed to be
impaired whenever such bank has deficit retained earnings in an amount exceeding
40% of such contributed capital. Under Section 662 of the Financial Code, the
Superintendent has the authority, in his or her discretion, to take certain
appropriate regulatory action with respect to a bank having impaired contributed
capital, including possible seizure of such bank's assets. A bank that has
deficit retained earnings may, subject to the approval of its shareholders and
of the Superintendent, readjust its accounts in a quasi-reorganization, which
may include eliminating its deficit retained earnings, under Section 663 of the
Financial Code. However, a bank that is not able to effect such a
quasi-reorganization or otherwise to correct an impairment of its contributed
capital within 60 days of an order to do so from the Superintendent must levy
and collect an assessment on its common shares pursuant to Section 423 of the
California Corporations Code.
A bank must levy such an assessment within 60 days of the
Superintendent's order; the assessment becomes a lien upon the shares assessed
from the time of service or publication of such notice of assessment. Within 60
days of the date on which the assessment becomes delinquent, a bank subject to
the Superintendent's order must sell or cause to be sold to the highest bidder
for cash as many shares of each delinquent holder of the assessed shares as may
be necessary to pay the assessment and charges thereon.
As of December 31, 1994, the Bank had contributed capital of $66.2
million and deficit retained earnings of $64.6 million, or approximately 97.6%
of contributed capital, within the meaning of Section 134(b) of the Financial
Code. Thus, under Section 134(b) of the Financial Code, the Bank's contributed
capital was impaired as of that date in the approximate amount of $38.1 million.
The Superintendent issued orders, most recently on February 1, 1995, to the Bank
to correct the impairment of its contributed capital within 60 days. The Bank
has not complied with these orders. As the sole shareholder of the Bank, the
Company (not the Company's shareholders) will receive any notices of assessment
issued by the Bank. The Bank is in violation of this California law requiring it
to assess the shares of the Bank (which are all held by the Company) in order to
correct the impairment of the bank's capital.
The Bank's capital impairment may be corrected through earnings, by
raising additional capital or by a quasireorganization, subject to the approval
of the SBD, in which the Bank's deficit retained earnings would be reduced or
eliminated by a corresponding reduction in the Bank's contributed capital. The
Bank is addressing the possibility of obtaining approval of a
quasi-reorganization with the SBD. If the SBD refuses to grant permission for
such a quasi-reorganization, as of December 31, 1994, the Bank would have been
required to raise $95.2 million in new capital in order to correct its impaired
contributed capital (because the ratio of deficit retained earnings to
contributed capital may not exceed 40%, $2.50 of new capital must be raised for
every dollar of
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<PAGE> 15
impairment). In response to the February 1, 1995 order requiring the Bank to
correct its impaired capital within 60 days, the Bank notified the SBD in
writing that it did not believe it will be in a position to comply with the
order within 60 days, and requested the SBD's cooperation as the Company
implements its Plan, and as the Company continues to consider the requirements
for a quasireorganization. It is the policy of the Superintendent not to grant a
quasi-reorganization unless a Bank can establish that (a) it has adequate
capital, (b) the problems that created past losses and the impairment of capital
have been corrected and (c) it is currently operating on a profitable basis and
will continue to do so in the future.
No assurance can be given that the Bank's capital condition will not
deteriorate further as a result of operating losses prior to a
quasi-reorganization. In addition, because a quasi-reorganization requires that
the Bank reflect its assets and liabilities at market value at the time of the
reorganization, the Bank's capital could be further impacted from its present
level as a result of such an adjustment in the market value of the Bank's assets
and liabilities. Finally, there can be no assurance that, following a correction
of the Bank's capital impairment, whether through a quasi-reorganization or an
infusion of sufficient capital, the Bank's capital position will not continue to
erode through future operating losses. As long as the Bank's contributed capital
is impaired, the Superintendent is authorized to take possession of the property
and business of the Bank, or to order the Bank to comply with the legal
requirement and levy an assessment on the shares of the Bank held by the Company
sufficient to correct the impairment. As the Company is the sole shareholder of
the Bank, the assessment would be made on the Company. The Company does not have
the funds to satisfy such an assessment. Management believes, however, that the
Superintendent has never exercised his bank takeover powers under Section 134
solely on the basis that a bank's capital is impaired under the standards set
forth in Section 134.
In order to permit a quasi-reorganization of a bank's capital, the SBD
requires, among other things, that a bank demonstrate that it is adequately
capitalized and that it is capable of operating profitably. Management believes,
although it cannot assure, that the Bank will be able to so demonstrate at such
time as the Bank's problem assets are substantially resolved and additional
capital is received, that it will then be possible for the Bank to effect a
quasi-reorganization. Management also believes that the Bank will have high
leverage and risk-based capital ratios if current capital raising efforts are
successful, it is unlikely that the Superintendent would seek to take action
solely on the basis of impaired capital under the Section 134 definition. There
can be no assurance, however, that other circumstances such as insufficient
liquidity (See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - Liquidity") or further operating issues will not arise
that would provide incentive to the Superintendent to utilize the powers granted
by Section 134.
REGULATION AND SUPERVISION
Bank holding companies and banks are subject to extensive supervision
and regulation. The following summaries of certain statutes and regulations
affecting banks and bank holding companies do not purport to be complete. Such
summaries are qualified in their entirety by reference to such statutes and
regulations.
THE COMPANY
The Company, as a bank holding company, is subject to regulation under
the Bank Holding Company Act of 1956, as amended (the "Holding Company Act"),
and is registered with and subject to the supervision of the FRB. It is the
policy of the FRB that each bank holding company serve as a source of financial
and managerial strength to its subsidiary banks and not conduct its operations
in an unsafe or unsound manner.
The Holding Company Act generally restricts the Company from engaging
in any business other than managing or controlling banks or furnishing services
to its subsidiaries. Among the exceptions to such restrictions are certain
activities which, in the opinion of the FRB, are so closely related to banking
or to managing or controlling banks as to be a proper incident to banking. The
Company also is generally prohibited from acquiring direct or indirect ownership
or control of more than 5% of any class of voting shares of any company unless
that company is engaged in activities permissible for bank holding companies and
the Company receives the prior approval of the FRB.
The Company and its subsidiaries are prohibited from engaging in
certain tie-in arrangements in connection with any extension of credit, sale or
lease of property or provision of services. For example, with certain
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<PAGE> 16
exceptions, the Bank is not permitted to condition an extension of credit on a
customer obtaining other services provided by it or the Company, or on a promise
by the customer not to obtain other services from a competitor. In addition,
applicable federal law imposes certain restrictions on transactions between the
Bank and its affiliates. As an affiliate of the Bank, the Company is subject,
with certain exceptions, to the provisions of federal law imposing limitations
on, and requiring collateral for, loans by the Bank to any affiliate.
The Holding Company Act also requires the Company to obtain the prior
approval of the FRB before acquiring all or substantially all of the assets of
any bank or ownership or control of the voting shares of any bank if, after
giving effect to such acquisition, the Company would own or control, directly or
indirectly, more than 5% of any class of voting shares of such bank.
Finally, the Company is subject to restrictions on its operations
imposed by the Agreement. See "-- Regulatory Agreement and Orders -- Federal
Reserve Board Written Agreement."
THE BANK
The Bank is a California state-chartered bank and is subject to
regulation, supervision and periodic examination by the SBD and the FDIC. The
Bank is not a member of the Federal Reserve System, but is nevertheless subject
to certain regulations of the FRB. The Bank's deposits are insured by the FDIC
to the maximum amount permitted by law, which is currently $100,000 per
depositor in most cases.
The regulations of state and federal bank regulatory agencies govern
most aspects of the Bank's business and operations, including but not limited
to, the scope of its business, its investments, its reserves against deposits,
the timing of the availability of deposited funds, the payment of dividends,
potential expansion, including real estate development activities, and the
maximum rates of interest allowed on certain deposits.
The Bank is subject to regulatory and operating restrictions pursuant
to several orders and a notification issued by the FDIC and SBD. These orders
and restrictions are discussed in full in "Regulatory Agreement and Orders".
CHANGE IN BANK CONTROL
The Holding Company Act and the Change in Bank Control Act of 1978, as
amended (the "Change in Control Act"), together with regulations of the FRB,
require that, depending on the particular circumstances, either FRB approval
must be obtained or notice must be furnished to the FRB and not disapproved
prior to any person or company acquiring "control" of a bank holding company,
such as the Company, subject to exemptions for certain transactions. Control is
conclusively presumed to exist if an individual or company acquires 25% or more
of any class of voting securities of the bank holding company. Control is
rebuttably presumed to exist if a person acquires 10% or more but less than 25%
of any class of voting securities and either the company has registered
securities under Section 12 of the Securities Exchange Act of 1934, as amended
(the "Exchange Act"), or no other person will own a greater percentage of that
class of voting securities immediately after the transaction. Generally, similar
rules on the acquisition of control apply to the Bank under California banking
law and the Change in Control Act. Finally, the Hart-Scott-Rodino Antitrust
Improvements Act of 1976, as amended (the "Hart-Scott Act"), together with
regulations of the Federal Trade Commission, may require certain filings to be
made with the Federal Trade Commission and the United States Department of
Justice, and certain waiting periods to expire, prior to consummation of an
acquisition of a bank holding company's voting securities.
CAPITAL ADEQUACY REQUIREMENTS
The Company is subject to the FRB's capital guidelines for bank holding
companies while the Bank is subject to the FDIC's regulations governing capital
adequacy for nonmember banks and to similar rules under California banking law.
As noted below, the Federal banking agencies have solicited comments on a
proposed regulation which would impose additional capital requirements on banks
based on the interest rate risk inherent in a bank's portfolio.
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The FRB has established a minimum leverage ratio of 3% Tier 1 capital1/
to total assets for bank holding companies that have received the highest
composite regulatory rating (a regulatory measurement of capital, assets,
management, earnings and liquidity) and that are not anticipating or
experiencing any significant growth. All other institutions will be required to
maintain a leverage ratio of at least 100 to 200 basis points above the 3%
minimum.
FRB regulations require bank holding companies to maintain a minimum
ratio of qualifying total capital to risk-weighted assets of 8.00%. Risk-based
capital ratios are calculated with reference to risk-weighted assets, including
both on and off-balance sheet exposures, which are multiplied by certain risk
weights assigned by the FRB to those assets. At least one-half of the qualifying
capital must be in the form of Tier 1 capital.
In certain circumstances, the FRB may determine that the capital ratios
for a bank holding company must be maintained at levels which are higher than
the minimum levels required by the guidelines. A bank holding company which does
not achieve and maintain the required capital levels may be issued a capital
directive by the FRB to ensure the maintenance of required capital levels.
The Bank failed to meet its regulatory capital requirements at March
31, 1993 and December 31, 1994 and, therefore, was required to file a Capital
Restoration Plan pursuant to the "prompt corrective action" system imposed by
the FDIC under FDICIA. The Bank failed to comply with the Capital Restoration
Plan filed in 1993. A revised Capital Restoration Plan, the Plan, was filed on
March 15, 1995 and has yet to be approved by the FDIC. As a condition of FDIC
approval of the Bank's previous Capital Restoration Plan, the Company agreed to
guarantee that the Bank will comply with the Capital Restoration Plan. The
Company guaranteed that the Bank would comply with the Capital Restoration Plan
until the Bank met its minimum capital requirements on average during each of
four consecutive calendar quarters. The Company's liability under the guarantee
is limited to the lesser of 5% of the Bank's total assets at the time it became
under capitalized or an amount which is necessary (or would have been necessary)
to bring the Bank into compliance with all of its capital requirements as of the
time it fails to comply with its capital restoration plan. The Bank's capital is
also impaired under California law, permitting the Superintendent to take
possession of the Bank unless its capital impairment is cured through
contribution of additional capital by the Company to the Bank or through a
quasi-reorganization of the Bank. See "-- Regulatory Agreement and Orders --
Capital Impairment Order."
The FDIC has established risk-based and leverage capital regulations
for state nonmember banks which are similar to the FRB's capital guidelines for
bank holding companies. In addition to these capital requirements, the Orders
require the Bank to meet an individual minimum capital requirement after
September 30, 1993 of 7% for Tier 1 capital to total average assets (leverage
ratio). The Bank's leverage capital ratio was 0.9% as of December 31, 1994.
See "-- Regulatory Agreement and Orders."
On April 20, 1995, the Company's major shareholder committed to
contribute $3.8 million in capital, expected by April 24, 1995. The Company
intends to contribute $4.2 million in capital to the Bank upon receipt of Mr.
Masagung's investment. Giving effect to the April 1995 capital commitment as of
December 31, 1994, the Company and the Bank would not have been in compliance
with all regulatory capital requirements including the Impaired Capital. The
Company is attempting to raise a minimum of $6.3 million of additional capital
in order to comply with all regulatory capital requirements except the Impaired
Capital as discussed under "-- Capital Impairment Orders". See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Capital".
- - ---------------------------------
1/ Tier 1 capital is generally defined as the sum of the core capital elements
less goodwill and certain intangibles. The following items are defined as core
capital elements: (i) common stockholders' equity; (ii) qualifying noncumulative
perpetual preferred stock; and (iii) minority interests in the equity accounts
of consolidated subsidiaries.
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<PAGE> 18
PAYMENT OF DIVIDENDS
Since April 20, 1992, the FRB has prohibited the Company from paying
any cash dividends to its shareholders without prior FRB approval. The ability
of the Company to pay dividends in the future will depend in large part on the
Company's ability to satisfy the concerns of the FRB as set forth in the
Agreement regarding the financial performance of the Company, and the ability of
the Bank to make dividend payments to the Company. The Bank's ability to make
dividend payments is dependent upon the ability of the Bank to return to
profitability, to satisfy the regulatory concerns expressed in the Orders, and
the ability of the Bank to cure its capital impairment or obtain approval from
the SBD to conduct a quasi-reorganization to reduce or eliminate the Bank's
deficit retained earnings. See "-- Regulatory Agreement and Orders -- Capital
Impairment Order."
In addition, any future payment of dividends by the Bank is subject to
meeting the state law requirement that amount of funds available for a cash
dividend shall be the lesser of retained earnings of the bank or the bank's net
income for its last three fiscal years (less the amount of any distributions to
shareholders made during such period). If the above test is not met, cash
dividends may be paid with the prior approval of the SBD, in an amount not
exceeding greatest of the bank's retained earnings, net income for its last
fiscal year, or the amount of its net income for its current fiscal year. The
Bank is not presently permitted to pay any dividends to the Company because it
has sustained net losses throughout the period 1991 through 1994. As a result of
these losses, the Bank had deficit retained earnings of $64.6 million as of
December 31, 1994 and currently the Bank's capital is impaired in the amount of
$38.1 million, giving the Superintendent the power to take possession of the
Bank in the event its capital impairment is not cured. See "-- Regulatory
Agreement and Orders -- Capital Impairment Orders."
Accordingly, any future payment of cash dividends will depend upon the
Bank correcting its capital impairment, meeting applicable capital requirements,
maintaining an adequate allowance for loan and lease losses, satisfying the
terms of the Orders outstanding against it, its ability to conduct profitable
operations and other factors.
FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991
General
FDICIA primarily addresses the safety and soundness of the deposit
insurance fund, supervision of and accounting by insured depository institutions
and prompt corrective action by the federal bank regulatory agencies for
troubled institutions. FDICIA gives the FDIC, in its capacity as federal insurer
of deposits, broad authority to promulgate regulations to assure the viability
of the deposit insurance fund including regulations concerning safety and
soundness standards. FDICIA also places restrictions on the activities of
state-chartered institutions and on institutions failing to meet minimum capital
standards and provides enhanced enforcement authority for the federal banking
agencies. FDICIA has strengthened FRB regulations regarding insider
transactions.
Prompt Corrective Action
FDICIA amended the Federal Deposit Insurance Act (the "FDIA") to
establish a format for closer monitoring of insured depository institutions and
to enable prompt corrective action by regulators when an institution begins to
experience difficulty. The general thrust of these provisions is to impose
greater scrutiny and more restrictions on institutions as their requirements for
additional capitalization increases.
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<PAGE> 19
FDICIA establishes five capital categories for insured depository
institutions: (a) Well Capitalized;2/ (b) Adequately Capitalized;3/ (c)
Undercapitalized;4/ (d) Significantly Undercapitalized;5/ and (e) Critically
Undercapitalized.6/ All insured institutions (i.e., the Bank) are barred from
making capital distributions or paying management fees to a controlling person
(i.e., the Company) if to do so would cause the institution to fall into any of
the three undercapitalized categories.
Undercapitalized institutions are subject to several mandatory
supervisory actions, including increased monitoring and periodic review of the
institution's efforts to restore its capital, submitting an acceptable capital
restoration plan, restricted asset growth, and limits on acquisitions, new
branches or new lines of business. A parent holding company of an
undercapitalized bank is expected to guarantee that the bank will comply with
the bank's capital restoration plan until the bank has been adequately
capitalized, on the average, for four (4) consecutive quarters. Such guarantee
is limited to the lesser of 5% of the bank's total assets at the time it became
undercapitalized or the amount necessary to bring the bank into full capital
compliance.
Significantly undercapitalized institutions and undercapitalized
institutions that fail to submit and implement adequate capital restoration
plans are subject to the mandatory provisions applicable to undercapitalized
institutions and, in addition, may be required to: sell additional capital,
including voting shares; restrict transactions with affiliates; restrict
interest rates paid on deposits; restrict asset growth or reduce total assets;
terminate, reduce or alter any risky activities; elect new directors and install
new management; cease accepting deposits from correspondent depository
institutions; or divest or liquidate certain subsidiaries. A bank holding
company may be required to divest itself of any affiliate of the institution
(other than another insured depository institution) under certain conditions.
Critically undercapitalized institutions face even more severe restrictions. See
"-- Regulatory Agreement and Orders -- Capital Orders."
In addition, significantly undercapitalized institutions will be
prohibited from paying any bonus or raise to a senior executive officer without
prior agency approval. No such approval will be granted to an institution which
is required to but has failed to submit an acceptable capital restoration plan.
Critically undercapitalized institutions are required to enter into a
written agreement with the SBD with the FDIC as a party to the agreement to
increase Tier I leverage capital to such level as the FDIC deems appropriate or
the institution may be subject to termination of insurance action by the FDIC.
The written agreement would require the immediate efforts by the institution to
acquire the required capital.
FDICIA also provides that if a well or adequately capitalized or
undercapitalized institution is in an unsafe or unsound condition or is engaging
in an unsafe or unsound practice, its capital category may be downgraded to
achieve a higher level of regulatory scrutiny and prompt corrective action.
FDICIA restricts the solicitation and acceptance of and interest rates payable
on brokered deposits by insured depository institutions that are not well
capitalized and has added new bases for which a conservator or receiver may be
appointed for undercapitalized and
- - -----------------------------
2/ Well Capitalized means a financial institution with a total risk-based ratio
of 10% or more, a Tier 1 risk-based ratio of 6% or more and a leverage ratio of
5% or more, so long as the institution is not subject to an order, written
agreement, capital directive or prompt corrective action directive to meet and
maintain a specific capital level for any capital measure.
3/ Adequately Capitalized means a total risk-based ratio of 8% or more, a Tier 1
risk-based ratio of 4% or more and a leverage ratio of 4% or more (3% or more if
the institution has received the highest composite rating in its most recent
report of examination) and does not meet the definition of a Well Capitalized
institution.
4/ Undercapitalized means a financial institution with a total risk-based ratio
of less than 8%, a Tier 1 risk-based ratio of less than 4% or a leverage ratio
of less than 4%.
5/ Significantly Undercapitalized means a financial institution with a total
risk-based ratio of less than 6%, a Tier 1 risk-based ratio of less than 3% or a
leverage ratio of less than 3%.
6/ Critically Undercapitalized means a financial institution with a ratio of
tangible equity to total assets that is equal to or less than 2%.
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<PAGE> 20
critically undercapitalized institutions and under certain other circumstances
not relating to capital levels. Finally, FDICIA establishes a risk-based
assessment system for calculating a depository institution's semiannual deposit
insurance premium under which institutions pay premiums based upon their capital
classification and supervisory risk.
Brokered Deposits
FDICIA restricts the acceptance of brokered deposits by insured
depository institutions that are not well capitalized. It also places
restrictions on the interest rate payable on brokered deposits and the
solicitation of such deposits. An undercapitalized institution will not be
allowed to solicit brokered deposits by offering rates of interest that are
significantly higher than the prevailing rates of interest on insured deposits
in the particular institution's normal market areas or in the market area in
which such deposits would otherwise be accepted.
The FDIC has promulgated final regulations with respect to the ability
of insured depository institutions in each of the new capitalization categories
to accept brokered deposits. Under the regulations, undercapitalized
institutions are prohibited from accepting funds obtained directly or indirectly
though a deposit broker. Adequately capitalized institutions may accept brokered
deposits only if a waiver is first obtained from the FDIC. Well capitalized
institutions are permitted by the regulations to accept brokered funds without
restriction. For purposes of the brokered deposit regulation the FDIC has stated
that the term "well capitalized" means an institution whose leverage and
risk-based capital ratios are at least one to two percentage points higher than
those currently required by applicable regulations, and which has not been
notified that it is in a troubled condition.
In addition to the above restrictions on acceptance of brokered
deposits, FDICIA provides that no pass-through deposit insurance will be
provided to employee benefit plan deposits accepted by an institution which is
ineligible to accept brokered deposits under applicable law and regulations.
Under the Order, the Bank is required to submit a written plan to the
FDIC for eliminating its reliance on brokered deposits, and to provide the
Regional Director of the FDIC and the SBD with monthly written reports outlining
the Bank's progress under the plan. The FDIC had granted the Bank permission to
renew brokered deposits through September 1995, provided that the Bank continued
to meet the definition of an adequately capitalized institution. At December 31,
1994, the Bank did not meet the definition of an adequately capitalized
institution. The brokered deposit waiver was suspended on January 30, 1995. At
December 31, 1994, the Bank had brokered deposits of $19.7 million. These
brokered deposits have various maturity dates. However, they cannot be extended
without further regulatory approval which cannot be granted if the Bank's
capital ratios remain below the minimum requirements.
Conservatorship and Receivership
FDICIA adds grounds to the previously existing list of reasons for
appointing a conservator or receiver for an insured depository institution
including: (a) substantial dissipation of assets or earnings due to an unsafe or
unsound practice or any violation of law or regulation; (b) existence of an
unsafe or unsound condition; (c) any willful violation of a cease and desist
order; (d) any concealment of assets, records, books or papers from any federal
or state bank regulatory agency; (e) likely inability of the institution to meet
obligations in the normal course of business; (f) losses threatening capital;
(g) the institution becomes undercapitalized where certain factors are present
suggesting the institution may not become adequately capitalized; or (h) the
institution is critically undercapitalized or otherwise has substantially
insufficient capital. The FDIC's March 28, 1995 Notification of Capital Category
included a determination that the Bank is critically under capitalized thus
making the Bank eligible for conservatorship or receivership.
FIRREA provides other grounds upon which a receiver or conservator may
be appointed for a state bank. These other grounds include "having substantially
insufficient capital," incurrence or likely incurrence of losses that will
deplete all or substantially all of a bank's capital with no reasonable prospect
for that capital to be replenished without federal assistance, or a violation of
law or regulation which is likely to weaken the condition of the institution.
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<PAGE> 21
Deposit Insurance Premiums
As of January 1, 1993, the FDIC charges higher deposit insurance
premiums on banks which pose greater risks to the deposit insurance fund. Under
the rule, a bank is required to pay an annual insurance premium ranging from
0.23% to 0.31% for domestic deposits, depending upon the bank's risk
classification. A bank's risk classification is determined by the FDIC according
to the bank's capital ratios and the FDIC's evaluation of the bank based upon
federal and state supervisory examinations and other relevant information. Under
the classification system, the FDIC has assigned the Bank its highest risk
classification and set the Bank's deposit insurance premium at 0.31%.
Restrictions on Insured State Bank Activities and Investments
Recently enacted FDIC regulations generally prohibit an insured state
bank from directly engaging as principal in any activity that is not permissible
for a national bank, and also prohibit majority-owned subsidiaries of an insured
state bank from engaging in any activity that is not permissible for a
subsidiary of a national bank, unless the bank meets and continues to meet
applicable minimum capital standards and the FDIC determines that the conduct of
the activity by the bank and/or its majority-owned subsidiary will not pose a
significant risk to the deposit insurance funds.
If consent to engage in the activity is denied, the bank is required to
cease the activity not later than one year from the denial. However, the FDIC
may condition or restrict the conduct of any impermissible activity during this
phase-out period. If the activities of a subsidiary are denied consent by the
FDIC, the bank is required to divest its interest in the subsidiary as quickly
as prudently possible, but in no event later than December 19, 1996.
Alternatively, the bank may discontinue the impermissible activity, but this
must be effected within one year of the date of denial.
These new regulations also impose new restrictions on real estate
investments, requiring that undercapitalized banks with subsidiaries holding
impermissible equity investments in real estate cease the activity as soon as
practicable, but no later than June 8, 1994, and divest the subsidiary or the
real estate investments owned by the subsidiary as soon as practicable, but in
no event later than December 19, 1996. State banks also must obtain the prior
consent of the FDIC before making real estate loans other than in compliance
with guidelines established for national banks. The Bank has conducted real
estate investment activities through its subsidiary BSFRI. As required by
FDICIA, the Bank has filed an application to continue the orderly divestiture of
its real estate investments until December 19, 1996. The Bank was granted until
December 31, 1994 to effect on orderly divestiture of its real estate
investments. The FDIC has not taken enforcement action against the Bank with
respect to such divestiture. The Bank intends to file another application to
continue the orderly divestiture by December 31, 1995.
Proposed Standards on Safety and Soundness
Pursuant to the requirements of FDICIA, recently proposed FDIC and FRB
regulations provide new standards for safety and soundness applicable to banks
and bank holding companies. The proposed regulations establish managerial,
operational, asset quality and earnings standards for state nonmember banks as
well as bank holding companies, i.e., requiring banks and bank holding companies
to maintain a ratio of classified assets to total capital and ineligible
allowances no greater than 1.25% of risk weighted assets, and to maintain
minimum earnings sufficient to absorb losses without impairing capital. A bank's
"minimum earnings" are deemed sufficient if the bank's earnings during its last
four quarters would be sufficient for the bank to maintain compliance with its
minimum capital requirements for the next four quarters. Due to the Bank's
operating losses during each quarter of 1994, the Bank will not be in compliance
with this regulation if adopted. In addition, the proposed safety and soundness
standards would prohibit excessive compensation or compensation which could lead
to material financial loss for the bank or bank holding company.
These regulations are subject to change; therefore, the ultimate impact
on the Company and the Bank of final regulation in this area cannot be predicted
at this time.
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<PAGE> 22
Extensions of Credit to Insiders and Transactions with Affiliates
The Federal Reserve Act and FRB regulations, which are applicable to
state nonmember banks under regulations of the FDIC, place limitations and
conditions on loans or extensions of credit to: a bank's or bank holding
company's executive officers, directors and principal shareholders (i.e., in
most cases, those persons who own, control or have power to vote more than 10%
of any class of voting securities); any company controlled by any such executive
officer, director or shareholder; or any political or campaign committee
controlled by such executive officer, director or principal shareholder.
Loans extended to any of the above persons must comply with
loans-to-one-borrower limits, require prior full board approval when aggregate
extensions of credit to such person exceed specified amounts, must be made on
substantially the same terms (including interest rates and collateral) as, and
following credit-underwriting procedures that are not less stringent than, those
prevailing at the time for comparable transactions with non-insiders, and must
not involve more than the normal risk of repayment or present other unfavorable
features. Regulation O also prohibits a bank from paying an overdraft on an
account of an executive officer or director, except pursuant to a written
pre-authorized interest-bearing extension of credit plan that specifies a method
of repayment or a written pre-authorized transfer of funds from another account
of the officer or director at the bank.
The provisions of Regulation O summarized above reflect substantial
strengthening as a result of the adoption of FDICIA. FDICIA also resulted in an
amendment to Regulation O which provides that the aggregate limit on extensions
of credit to all insiders of a bank as a group cannot exceed the bank's
unimpaired capital and unimpaired surplus. An exception to this limitation is
provided, until February 18, 1994, for banks with less than $100.0 million in
deposits. The aggregate limit applicable to such banks is two times the bank's
unimpaired capital and unimpaired surplus, provided the bank meets or exceeds
all applicable capital requirements.
Government Monetary Policy
The earnings of the Bank and, therefore, the earnings of the Company,
are and will be affected by the policies of regulatory authorities, including
the FRB. An important function of the FRB is to regulate the national supply of
bank credit. Among the instruments used to implement these objectives are open
market operations in U.S. Government securities, changes in reserve requirements
against bank deposits, and changes in the discount rate which banks pay on
advances from the Federal Reserve System. These instruments are used in varying
combinations to influence overall growth and distribution of bank loans,
investments and deposits, and their use may also affect interest rates on loans
or interest rates paid for deposits. The monetary policies of the FRB have had a
significant effect on the operating results of commercial banks in the past and
are expected to continue to do so in the future. The effect, if any, of such
policies upon the future business earnings of the Company and the Bank cannot be
predicted.
RECENT FEDERAL AND STATE LEGISLATION
FEDERAL
In late September 1994, two major pieces of financial services
legislation were signed into law.
The Riegle Community Development and Regulatory Improvement Act of 1994
seeks to facilitate securitization of small business loans, reduce bank's
paperwork and regulatory burden, streamline anti-money laundering rules, and
toughen flood insurance compliance.
Small Business Capital Formation Small business access to
capital is encouraged by Title II of the ACT, which seeks to remove
impediments in existing law to the securitization of small business loans
and leases. The Small Business Loan Securitization and Secondary Market
Enhancement Act of 1994 creates a secondary market framework for small
business related securities, with the goal of stimulating the flow of funds
to small businesses.
Paperwork Reduction and Regulatory Improvement Title III of the Act of
1994 provides a number of initiatives to lessen the regulatory burden placed
upon banks and other depository institutions. Title III also affects a
number of the consumer compliance laws by allowing streamlined disclosures
for radio advertising
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<PAGE> 23
of consumer leases, providing consumers with information necessary to
challenge an "adverse characterization" due to a credit reporting agency
report and by clarifying the disclosure requirements under the Real Estate
Settlement Procedures Act regarding the transfer of serviced mortgaged
loans.
Money Laundering Title IV addressed reform of Currency
Transaction Reports to increase their usefulness to the Federal Government
and to various law enforcement agencies in combating money laundering. The
measure also calls for improvement in the identification of money laundering
schemes, better controls over negotiable instruments drawn on foreign banks
by making them subject to reporting, and uniform licensing and registration
of check cashing and money transmitting businesses, which are often used to
facilitate illegal currency transactions.
Flood Insurance Title V, the "National Flood Insurance Reform
Act of 1994" reforms the financial condition of the National Flood Insurance
Program (NFIP). This legislation requires improved compliance with the
mandatory purchase requirements of the NFIP by bank lenders and secondary
market purchasers.
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
liberalizes both interstate banking by way of bank subsidiaries and provides for
phased-in direct interstate branch banking.
Mergers and Acquisitions Specifically, Title I of the Interstate
Banking Act allows adequately capitalized and managed bank holding companies
to acquire banks in any state starting one year after enactment. Another
important provision allows interstate merger transactions beginning June 1,
1997. States are permitted, however, to pass legislation providing for
either earlier approval of mergers with out-of State banks, or "opting-out"
of interstate mergers entirely. Through interstate merger transactions,
banks will be able to acquire branches of out-of-State banks by converting
their offices into branches of the resulting bank. The Act provides that it
will be the exclusive means for bank holding companies to obtain interstate
branches.
Protecting key provisions of State law, the Act provides that required
conditions and commitments made relating to interstate mergers that predate
the Act's affective date will remain in force. After the Act becomes
effective, State taxation, community reinvestment, antitrust, deposit
concentration caps and minimum age provisions will be honored unless
preempted. In this regard, Congress intended that the Act does not alter
time-tested preemption rules. Moreover, the Act expressly states that
neither current federal law, nor the Act's amendments provide authority to
preempt State law dealing with homestead protection.
Branching and Community Guidelines Banks may establish and operate a
"de novo branch" in any State that "opts-in" to de novo branching. Foreign
banks are allowed to operate branches, either de novo or by merger. These
branches can operate to the same extent that the establishment and operation
of such branches would be permitted if the foreign bank were a national bank
or State bank. Interstate banks proposing to close any branch in low-or
moderate income areas are now required to provide notice to customers of the
proposed closing.
Title I also requires each Federal banking agency to prescribe uniform
regulations including guidelines ensuring that interstate branches operated
by out-of-State banks are reasonably helping to meet the credit need of
communities where they operate. These agencies are required to conduct
evaluations of overall Community Reinvestment Act performance of
institutions with interstate branches. New procedural requirements are also
required of the Federal banking agencies pertaining to agency preemption
opinion letters and interpretive rules in connection with community
reinvestment, consumer protection, fair lending and establishment of
intrastate branches.
Revival of Statute of Limitations Title II, among other things, permits
in certain circumstances, the FDIC or Resolution Trust Corporation, acting
as conservator or receiver of a failed depository institution to "revive"
tort claims that had expired under a State statute of limitations within
five years of the appointment of a receiver or conservator.
State
As a California state-chartered bank, the Bank is subject to the
California banking laws and to regulation, supervision and periodic examination
by the SBD.
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<PAGE> 24
The California banking laws, among other matters, regulate: (a) the
process of issuance of a banking permit, including the application for, term of
and surrender or revocation of the permit; (b) the conduct of the banking
business, including banking days, banking offices, preservation and disposal of
records, borrowing by the bank and pledges of assets; (c) accounts, including
types of deposit accounts and claims made thereon; (d) reserves, including
forms, computations, limitations and exemptions; (e) loans, including
limitations on obligations to the bank by borrowers in general and by the bank's
officers, directors and employees; (e) mergers, consolidations and conversions
of banks, including changes in control of banks; and (f) liquidation and
dissolution of banks.
Other
Various other legislation, including proposals to overhaul the bank
regulatory system and to limit the investments that a depository institution may
make with insured funds, is introduced into Congress from time to time. The
Company cannot determine the ultimate effect that any potential legislation, if
enacted, would have upon the financial condition or operations of the Company or
the Bank.
RECENT REGULATIONS AND GUIDELINES
Interest Rate Risk
As required by FDICIA, the federal banking agencies have solicited
comments on a proposed method of incorporating an interest rate risk component
into the current risk-based capital guidelines, with the goal of ensuring that
institutions with high levels of interest rate risk have sufficient capital to
cover their exposure. Interest rate risk is the risk that changes in market
interest rates might adversely affect a bank's financial condition. Under the
proposal, interest rate risk exposures would be quantified by weighing assets,
liabilities and off-balance sheet items by risk factors which approximate
sensitivity to interest rate fluctuations. Institutions identified as having an
interest rate risk exposure greater than a defined threshold would be required
to allocate additional capital to support this higher risk. Higher individual
capital allocations could be required by the bank regulators based on
supervisory concerns.
As the federal banking agencies have solicited comments on this
proposal but have not yet proposed regulations to implement any interest rate
risk component into the risk-based capital guidelines, the ultimate impact on
the Company and the Bank of final regulation in this area cannot be predicted at
this time.
State Bank Sales of Nondeposit Investments
Securities activities of state non-member banks, as well as their
subsidiaries and affiliates, are governed by FDIC regulations. The FDIC has
taken the position that bank sales of alternative investment products, such as
mutual funds and annuities, raise substantial bank safety and soundness concerns
involving consumer confusion over the nature of the products offered, and the
potential for mismanagement of sales programs for such investments which could
expose a bank to liability under the anti-fraud provisions of federal securities
laws.
Accordingly, the FDIC has issued guidelines to state non-member banks
which recommend, among other things, establishing a compliance and audit program
to monitor the bank's mutual funds sales activities and compliance with
applicable federal securities laws, providing full disclosure to customers about
the risks of such investments (including the possibility of loss of principal
investment), conducting securities activities of bank subsidiaries or affiliates
in separate and distinct locations, and prohibiting bank employees involved in
deposit-taking activities from selling investment products or from giving
investment advice.
Banks are also required to establish qualitative standards for the
selection and marketing of the investments offered by the bank and maintain
appropriate documentation regarding suitability of investments recommended to
bank customers.
TAXATION
The effective tax rates (benefit) for the years ended December 31,
1994, 1993 and 1992, were 0.4%, 1.7% and (1.7)%, respectively. For each of the
years ended December 31, 1994, 1993 and 1992, the federal statutory tax rate
applicable to the Company was 34%. The tax benefits reported in 1992 are
attributable to the Company's
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<PAGE> 25
ability to carryback net operating losses for 1992 against net operating income
from prior periods. Because the Company has utilized all of its ability to
carryback net operating losses, much of the 1994, 1993 and 1992 losses, and
future losses, if any, must be carried forward to offset future net operating
income. In addition, the actual benefit rate may be less than the current
statutory rate due to tax differentials and the alternative minimum tax. As of
December 31, 1994, the Company has net operating loss carryforwards for federal
tax purposes of approximately $39.0 million which expire in 2007 and onwards,
and for California tax purposes of approximately $24.0 million, which expire in
1997, 1998, and 1999. The Company has rehabilitation tax credit carryforwards
for federal tax purposes of approximately $250,000, which expires in 2004 and
2005. In addition, the Company has minimum tax credits of approximately $230,000
which have no expiration. Utilization of the net operating loss carryforwards,
and rehabilitation and minimum tax credit carryforwards may be limited on an
annual basis under current tax law due to the change in ownership in 1992 and a
possible change in ownership in future years.
ITEM 2 - PROPERTIES
The following table sets forth certain information concerning the
Bank's significant real property lease commitments:
<TABLE>
<CAPTION>
Square Expiration of Renewal
Banking Offices Footage Current Lease Period(s)
- - --------------- ---------------------------- ---------
<S> <C> <C> <C>
550 Montgomery Street 75,488 2022 Option for additional
San Francisco, CA 14 years
351 California Street 7,721 1995 N/A
San Francisco, CA
</TABLE>
The Bank has a long term lease on 550 Montgomery Street, an 89,000
square foot, historically significant office building on Clay and Montgomery
Streets in San Francisco's Financial District. The building serves as the
administrative and banking headquarters of the Company and the Bank. The Bank
leases 75,488 square feet and the remainder is subleased to third parties.
During 1994, the Bank began subleasing some of its space. Additional space will
be made available for sublease in 1995.
The lease on 550 Montgomery Street is currently held by Bank of San
Francisco Building Company (BSFBC), a California limited partnership in which
the Bank and BSFRI have 34.5% and 2.5% partnership interests, respectively. At
December 31, 1994, the Bank's and BSFRI's investment in BSFBC totaled $1.6
million and $120,000, respectively. The Bank's lease agreement may be
renegotiated or the Bank may acquire additional shares of BSFBC. The impact of
such activities is not presently determinable.
As a result of moving the Bank's headquarters to 550 Montgomery Street,
the Bank subleased its facilities at 351 California Street to an unrelated third
party who is presently in default with respect to $60,000 in past due rent. The
lease and subleases expire on June 30, 1995.
The net rental expense and occupancy expenses for all leases of
premises were approximately $2.1 million for each of the two years ended
December 31, 1994 and 1993.
ITEM 3 - LEGAL PROCEEDINGS
LITIGATION
Because of the nature of its business, the Company and its
subsidiaries, including the Bank, are from time-to-time, a party to legal
actions. At December 31, 1994, the Company and/or the Bank are defendants in
certain lawsuits for which the damages sought are substantial as described
below.
Presently, the Bank is involved in several lawsuits. In the first lawsuit,
BSFRI is named as a defendant and has been served with a cross-complaint for
indemnity in a deficiency judgement with respect to a first deed of trust on a
property owned by a limited partnership. The plaintiff under the cross compliant
is seeking damages in the amount of $5.0 million, and unspecified punitive
damages. BSFRI was once a limited partner in the partnership
-23-
<PAGE> 26
but became a secured lender of the partnership under a second deed of trust, at
which time BSFRI was given a release from any liability. The Bank believes it
has meritorious defenses to the cross-claim and will contest any allocation of
liability to it if defendants are found liable for any deficiency.
In the second lawsuit, the Bank has been named a defendant in an action
brought in Florida by the institutional purchaser of a block of loans from the
Bank, alleging failure of the Bank to properly perform a credit check for one of
the loans. The plaintiff is seeking approximately $155,000 it allegedly lost
when the loan defaulted. The Bank is defending the matter vigorously and
believes it has meritorious defenses. In addition, the Bank has been threatened
with arbitration proceedings by another institutional purchaser in connection
with a $750,000 principal amount loan purchased from the Bank on the sale of its
former Sacramento branch. The institutional purchaser contends that the Bank
breached the sale agreement by failing to notify the purchaser of the
downgrading of the loan and the release of certain collateral. The Bank denies
that it has breached the sale agreement.
The Bank is currently involved in two lawsuits which were brought by
former employees of the Bank; one former employee has alleged discrimination and
wrongful termination. The other former employee alleges wrongful termination.
The former employees have sought unspecified damages.
The Bank has denied these allegations and is vigorously defending these
proceedings. The disposition of these proceedings could have a material adverse
effect on the Company's financial position or results of operation, however,
management cannot predict the specific outcome of these actions. Accordingly,
the accompanying financial statements do not include any adjustments that might
result from the outcome of the uncertainties.
The Bank has reached settlement or potential settlement in numerous other
litigation or potential litigation matters. In some instances the Bank has
agreed to make certain payments. As a result of the settlement or potential
settlement of certain lawsuits, the Company established a litigation reserve of
$536,500 as of December 31, 1994.
The Company and the Bank intend to pursue their rights under an
indemnification agreement with Mr. Donald R. Stephens, a former Chairman of the
Board and Chief Executive Officer of the Company who resigned in 1993, pursuant
to which Mr. Stephens is required to provide indemnification in respect of
certain expenses related to actions brought by a former employee.
The jury ruled in favor of the Bank on another lawsuit where the plaintiffs
were seeking compensatory damages in an amount of $6.0 million, and unspecified
punitive damages. The plaintiffs were claiming breach of an alleged joint
venture agreement, and of other duties owed to the plaintiffs, arising from the
Bank's foreclosure on a series of loans made to the plaintiffs by the Bank in
connection with the development of an 800 acre parcel of land.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.
-24-
<PAGE> 27
PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED SHAREHOLDER MARKET
MARKET INFORMATION
The Company's Class A Common Stock is listed on the American Stock
Exchange under the symbol "SFH." The closing sale price for the Class A Shares
on the American Stock Exchange on April 12, 1995 was $4.50. The following table
sets forth the high and low closing sale prices for the Class A Shares on the
American Stock Exchange for each calendar quarter during 1993 and 1994.
<TABLE>
<CAPTION>
1994 1993
-------------------- ---------------------
Quarter High Low High Low
-------------------- ---------------------
<S> <C> <C> <C> <C>
First $37.50 $22.50 $70.00 $25.00
Second 31.25 15.00 53.50 22.50
Third 17.00 10.00 32.50 20.00
Fourth 10.00 6.50 26.60 15.00
</TABLE>
The Series B Preferred Shares had been listed on the American Stock
Exchange since their issuance in October 1988. In March 1990, the Company
received approval from the Securities and Exchange Commission to delist the
Series B Preferred Shares, pursuant to Rule 12d2-2(d), under the Securities
Exchange Act of 1934, as amended. The Series A and Series C Preferred Shares
have never been listed on any exchange or traded in any other public market, and
none were outstanding at December 31, 1994.
The closing sales prices for the Class A Common Shares have been
adjusted to reflect the effect of the 1 for 20 reverse stock split that occurred
on May 23, 1994.
HOLDERS
As of December 31, 1994, the number of holders of record of the
Company's Class A Shares and Series B Preferred Shares was 423 and 14,
respectively, which management believes is in each case substantially less than
the number of beneficial owners whose shares are held in nominee names.
DIVIDENDS
The Company is subject to dividend restrictions under the Delaware
General Corporation Law and regulations and policies of the FRB. The Company's
Series B Preferred Shares participate equally, share for share, in cash
dividends paid on the Class A Shares in addition to receiving the cash dividends
to which they are entitled. The Board of Directors suspended the dividend on the
Class A Shares and the Series B Preferred Shares.
The payment of cash dividends by the Bank to the Company is subject to
certain regulatory restrictions set forth in the California Financial Code. The
Bank and the Company have amended the Certificate of Determinations of Rights,
Preferences, Privileges and Restrictions of the 8% Series B Convertible
Preferred Stock issued by the Bank to the Company to provide that dividends on
the Bank's 8% Series B Convertible Preferred Stock shall be cumulative from year
to year. The Bank's Board of Directors has decided to suspend future payment of
dividends on the Preferred Stock to the Company, and the FRB Directive prohibits
the Company from paying any dividends without the prior approval of the FRB. See
"-- Regulatory Directives and Orders" for a discussion of these restrictions.
-25-
<PAGE> 28
ITEM 6 - SELECTED FINANCIAL DATA
The following table sets forth certain selected consolidated financial data
of the Company at and for the years ended December 31:
<TABLE>
<CAPTION>
(Dollars in Thousands) 1994 1993 1992 1991 1990
------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
FINANCIAL CONDITION DATA:
Total assets $156,780 $231,021 $319,155 $402,699 $393,225
Total loans 106,452 149,740 236,076 281,853 280,159
Total mortgage loans held-for-sale -- -- -- 6,826 31.385
Total securities held-to-maturity 9,196 6,351 4,910 3,276 7,122
Total securities available-for-sale 2,211 14,940 -- -- --
Total securities held-for-sale -- -- 18,731 20,457 16,883
Total deposits 147,148 210,111 285,685 373,199 363,577
Other borrowings 4,070 1,303 15,308 10,832 686
Shareholders' equity 2,129 17,455 15,676 16,181 25,579
OPERATING DATA:
Total interest income $12,651 $18,155 $23,885 $36,742 $39,596
Total interest expense 4,863 7,420 11,295 19,226 20,774
------------------------------------------------------------------
Net interest income 7,788 10,735 12,590 17,516 18,822
Provision for loan losses 3,799 3,554 9,828 11,437 1,600
------------------------------------------------------------------
Net interest income after
provision for loan losses 3,989 7,181 2,762 6,079 17,222
Total non-interest income 2,135 4,497 4,368 6,173 5,240
Total non-interest expense 39,018 21,764 29,697 24,276 18,310
------------------------------------------------------------------
Income (loss) before taxes (32,894) (10,086) (22,567) (12,024) 4,152
Provision (benefit) for income taxes 142 169 (390) (2,870) 1,677
------------------------------------------------------------------
Net income (loss) $(33,036) $(10,255) $(22,177) $(9,154) $ 2,475
==================================================================
OTHER DATA:
Return on average assets (16.8)% (3.5)% (6.2)% (2.2)% 0.7%
Return on average equity (183.0) (57.5) (153.0) (39.2) 10.7
Average equity to average assets 9.2 6.1 4.1 5.6 6.4
Equity to assets at period end 1.4 7.6 4.9 4.0 6.5
Interest rate spread for period 5.0 4.4 4.6 4.5 5.4
Net yield on average earning assets 5.1 4.6 4.5 4.8 5.8
Non-performing assets to total assets 12.8 18.8 16.8 13.5 3.4
Average interest-earning assets to
average interest-bearing liabilities 105.1 103.5 96.6 104.7 106.0
Non-interest expenses to average assets 19.8 7.6 8.9 5.9 5.0
Net interest income, after provision for
loan losses, to non-interest expense 10.2 32.4 9.2 25.0 94.1
Net loan charge-offs as a percent of
average loans 4.4 2.0 3.9 2.7 0.3
Allowance for loan losses as a
percent of loans 6.2 5.4 3.6 3.0 1.8
PER SHARE DATA:
Common shares outstanding,
end of period 5,766,008 444,990 445,100 114,134 113,178
Preferred shares outstanding,
end of period 16,291 916,591 316,591 437,500 437,500
Common Shares:
Book value per common share $ 0.37 $(1.60) $21.60 $119.00 $189.40
Income (loss) per weighted average
common share (10.73) (23.00) (83.60) (82.60) 19.40
Cash dividend declared per common share -- -- -- 0.10 0.10
Dividend payout ratio -- -- -- -- 10.3%
</TABLE>
-26-
<PAGE> 29
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company recorded a net loss of $33.0 million for the year ended December
31, 1994, following net losses of $10.3 million and $22.2 million for the years
1993 and 1992, respectively. These net losses were principally due to the high
level of the provision for loan and real estate owned losses, and declines in
net interest income during each of 1994, 1993 and 1992. In addition, the
Company's non-interest expense reached extremely high levels at 263.9%, 96.1%
and 105.0% of total revenues for the years 1994, 1993 and 1992, respectively.
The Company's provision for loan losses and the increase in the loan loss
allowance as a percentage of outstanding loans reflects management's concern
over the decline in the credit quality of the Bank's loan portfolio, regulatory
examinations, and the high level of net loan charge-offs during the period 1992
through 1994. Although the Company's provision for loan losses increased to $3.8
million in 1994, from $3.6 million in 1993 and declined from $9.8 million in
1992, the allowance for loan losses as a percentage of loans grew from 3.6% in
1992 to 6.2% in 1994. The Company's net loan charge-offs, primarily associated
with unsecured commercial loans, loans secured by real estate, and loans to
facilitate the development of real estate, amounted to $5.3 million in 1994 as
compared to $3.9 million in 1993, and $9.8 million in 1992.
The Company's net interest income was reduced to $7.8 million in 1994 from
$10.7 million in 1993, a 27.5% decline, following a 14.7% decline in net
interest income in 1993 from $12.6 million in 1992. These declines in net
interest income were principally due to a reduction in average earning assets
from $286.0 million in 1992 to $234.8 million in 1993, a 17.9% decline, and a
further reduction to $152.9 million in 1994, a decline of 34.9%.
The Company's non-interest expenses were largely driven by expenses
associated with managing its high level of non-earning assets (average
non-earning assets were 22.3% of total average assets in 1994, 19.6% in 1993 and
20.1% in 1992) in addition to litigation settlements and reserve, legal,
accounting and consulting expenses related to the Company's loan collection and
recapitalization efforts. These costs comprised 40.9% of the Company's
non-interest expense in 1992, declining to 29.6% in 1993 and comprised 66.1% of
non-interest expense during 1994. In 1994, the Bank provided an additional
provision for the decline in the fair value of other real estate owned
properties to reflect the fair value less selling expenses.
At December 31, 1994, total assets and deposits of $156.8 million and $147.1
million, respectively, had declined 32.1% and 30.0%, respectively, from amounts
reported at December 31, 1993. Loans, net of deferred loan fees, were $106.1
million, a decrease of 28.9% from the amount reported at December 31, 1993. At
December 31, 1993, total assets, deposits and net loans were $231.0 million,
$210.1 million and $149.2 million, respectively, a decline of 27.6%, 26.5% and
36.6%, respectively, from amounts reported at the close of 1992. The declines in
assets and loans during 1992, 1993 and 1994 reflect the condition of the Bank
and the general economic conditions in Northern California and more particularly
the depressed value of real estate collateral in the San Francisco Bay Area from
which the repayment of a substantial portion of the Company's loans are based.
The declines followed substantial operating losses of the Company, beginning in
1991 and continuing through 1994. These operating losses were the major cause of
the Company's failure to meet its capital adequacy requirements causing it to
reduce its assets in order to meet regulatory capital adequacy requirements and
the resulting Written Agreement, MOU and Orders which generally require the Bank
to reduce its classified assets, concentration of real estate related credits,
volatile liability dependence, and maintain its liquidity and increase its
capital. See "-- Regulatory Written Agreement and Orders" for a full description
of the Written Agreement and the Orders.
In response to the significant problems experienced by the Company during
the period from 1991 through 1994 the Company restructured its management team
and has analyzed several different business strategies. The 1995 Business and
Profit Plan contemplates three specific measures; 1) the raising of an
additional $15.0 million in capital, 2) the sale of the remaining non-performing
assets through several means, and 3) returning the Company to profitability
through focusing on the Private Banking concept. The previous business plan
contemplated several measures, including without limitation, raising additional
capital, eliminating problem assets, commencing new lines of business, hiring
additional personnel for such new lines of business, and establishing a new
relationship with
-27-
<PAGE> 30
Strategic Alliance Partners. Because of the delay in raising enough capital to
significantly reduce problem assets the Company has not been able to execute its
expansion plans involving new lines of business. If the Company is successful in
raising sufficient capital and disposing of a substantial portion of its problem
assets, of which no assurance can be given, implementation of the international
components of the business plan may become feasible in future years. To the
extent that the Company can return to profitability in the future, recent
financial trends experienced by the Company may not be indicative of future
trends; however, due to the numerous factors affecting the successful
implementation of the 1995 Business and Profit Plan, many of which are beyond
the control of the Company, no prediction can be made with respect to the nature
or extent of future financial trends.
RESULTS OF OPERATIONS - YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992
NET INTEREST INCOME
Yields Earned and Rates Paid
One of the fundamental measures of the Bank's results of operations is net
interest income. Net interest income is the difference between the combined
yield earned on interest earning assets and the combined rate paid on interest
bearing liabilities. Net interest income is also dependent on whether the
balance of interest earning assets equals, exceeds or is less than the balance
of interest bearing liabilities. If an excess in the balance of interest bearing
liabilities over interest earning assets exists, then the positive interest rate
spread between yields earned and rates paid may need to be increased in order to
achieve a positive net interest position.
The following table presents the consolidated average balance sheets of the
Company, together with the total dollar amounts of interest income and expense,
and weighted average interest rates for each of the years in the three year
period ended December 31, 1994. Where possible, the average balances are
calculated on a daily average basis. When this information is not available,
average balances are calculated on a monthly basis.
<TABLE>
<CAPTION>
1994 1993 1992
-------------------------- -------------------------- --------------------------
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
(Dollars in Thousands) Balance Expense Rate Balance Expense Rate Balance Expense Rate
-------------------------- -------------------------- --------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Assets
Interest-earning assets:
Federal Funds and deposit $ 17,326 $ 740 4.3% $ 20,237 $ 594 2.9% $ 11,812 $ 428 3.6%
Investment securities 14,539 653 4.5 17,128 902 5.3 25,244 1,750 6.9
Loans, net (1) 120,992 11,258 9.3 197,446 16,659 8.4 248,960 21,707 8.7
-------------------------- -------------------------- --------------------------
Total earning assets 152,857 12,651 8.3 234,811 18,155 7.7 286,016 23,885 8.4
-------------------------- -------------------------- --------------------------
Non-interest earning assets 43,761 57,153 72,078
-------- -------- --------
Total assets $196,618 $291,964 $358,094
-------- -------- --------
Liabilities and Equity
Interest-bearing liabilities:
Interest-bearing deposit $142,775 4,694 3.3 $220,996 6,966 3.2 $283,652 10,746 3.8
Other borrowings 2,710 169 6.5 5,891 454 7.7 12,558 549 4.4
-------------------------- -------------------------- --------------------------
Total interest-bearing liabilities 145,485 4,863 3.3 226,887 7,420 3.3 296,210 11,295 3.8
-------------------------- -------------------------- --------------------------
Non-interest bearing liabilities 33,079 47,271 47,393
Stockholders' equity 18,054 17,806 14,491
-------- -------- --------
Total liabilities and
stockholders' equity $196,618 $291,964 $358,094
-------- -------- --------
Net interest income $ 7,788 $10,735 $12,590
------- ------- -------
Primary interest rate spread 5.0% 4.4% 4.6%
--- --- ---
Margin as a percent of earning assets:
Interest income 8.3% 7.7% 8.4%
Interest expense 3.2 3.1 4.0
--- --- ---
Spread on earning assets 5.1% 4.6% 4.4%
--- --- ---
</TABLE>
- - -----------------
(1) Non-performing loans have been included in the average loan balances.
Interest income is included on non-accrual loans only to the extent to which
cash payments have been received and full principal repayment is probable.
-28-
<PAGE> 31
The dollar amount of interest income and interest expense fluctuates
depending on changes in the respective interest rates and on changes in the
respective amounts (volume) of the Bank's earning assets and interest bearing
liabilities. For each category of interest earning asset and interest bearing
liability, information is provided in the following table for changes
attributable to (i) changes due to volume (change in average balance multiplied
by prior year's rate), and (ii) changes in rate (changes in rates multiplied by
prior year's average balances). Changes attributable to the combined impact of
volumes and rates have been allocated pro-rata to each category.
<TABLE>
<CAPTION>
1994 versus 1993 1993 versus 1992
----------------------------- -----------------------------------
(Dollars in Thousands) Rate Volume Net Rate Volume Net
----------------------------- -----------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Federal funds and time deposits $ 213 $ (67) $ 146 $ (60) $ 227 $ 167
Investment securities (124) (125) (249) (363) (485) (848)
Loans, net 1,953 (7,354) (5,401) (683) (4,366) (5,049)
----------------------------- -----------------------------------
Total interest-earning assets 2,042 (7,546) (5,504) (1,106) (4,624) (5,730)
----------------------------- -----------------------------------
Interest-bearing liabilities:
Interest-bearing deposits 316 (2,587) (2,271) (1,633) (2,147) (3,780)
Other borrowings (76) (210) (286) (312) 217 (95)
----------------------------- -----------------------------------
Total interest bearing liabilities 240 (2,797) (2,557) (1,945) (1,930) (3,875)
----------------------------- -----------------------------------
Change in net interest income $ 1,802 $(4,749) $(2,947) $ 839 $(2,694) $(1,855)
============================= ===================================
</TABLE>
The Company's interest income decreased during the three year period ended
December 31, 1994 due mainly to a 38.7% decrease in average loans. The decrease
in the loan portfolio primarily resulted from a decision to reduce the size of
the Company's assets to comply with regulatory capital requirements, and loan
repayments. The weighted average yield on loans increased in 1994 after declines
since 1991 primarily due to the Bank's prime rate increase from 6.0% at December
31, 1993 to 8.5% at December 31, 1994. During the two year period prior to 1994
the Bank's prime rate declined from an average of 6.3% 1992 and to 6.0% in 1993.
Interest income and dividends on investment securities was $1.4 million in
1994 compared to $1.5 million in 1993. Although average portfolio balances were
$31.9 million in 1994 compared to $37.4 million in 1993, average portfolio
yields were 4.4% in 1994 compared to 4.0% in 1993. Interest income on investment
securities was $1.5 million in 1993 compared to $2.2 million in 1992. Average
portfolio balances were $37.4 million in 1993 compared to $37.1 million in 1992,
and average portfolio yields were 4.0% in 1993 compared to 5.9% in 1992. The
higher average yields in 1994 reflect the overall increase in market interest
rates and higher average yield realized from reinvestment.
Interest expense for 1994 was $4.9 million, a decrease of $2.6 million, or
34.5% during 1994, as compared to 1993. This decrease was primarily attributable
to a decrease in average interest bearing liabilities of $81.4 million to $145.5
million, or 35.9%, as compared to 1993, partially offset by a slight increase in
average interest rates. The average cost of deposits and borrowings for 1994 was
3.3% as compared to 3.3% for 1993. Interest expense for 1993 was $7.4 million, a
decrease of $3.9 million, or 34.3% during 1993, as compared to 1992. This
decrease was primarily attributable to a decrease in average interest bearing
liabilities of $69.3 million to $226.9 million, or 23.4%, as compared to 1992,
and to a decline in average interest rates. The average cost of deposits and
borrowings for 1993 was 3.3% as compared to 3.8% for 1992.
Interest expense for 1992 was $11.3 million, a decrease of $7.9 million, or
41.3% during 1992, as compared to 1991. This decrease was primarily attributable
to a decrease in average interest bearing liabilities of approximately $49.7
million, or a 14.5% decrease, from 1991, and to a decline in short term interest
rates. The average cost of deposits and borrowings for 1992 was 3.8% as compared
to 5.6% for 1991.
-29-
<PAGE> 32
PROVISION FOR LOAN LOSSES
During 1994, 1993, and 1992, the Bank provided $3.8 million, $3.6 million
and $9.8 million, respectively, to its allowance for loan losses. Net charge
offs recorded for 1994, 1993 and 1992 were $5.3 million, $3.9 million, and $9.8
million, respectively. The increase in the loan loss provision in 1994 as a
percentage of average loans to 3.1% from 1.8% in 1993 was required as a result
of the increase in charge offs in 1994 compared to 1993 and reflects
management's assessment that higher loan loss allocation on loans with specific
weaknesses was required. The substantial loan loss provision made in 1992
reflects management's assessment of the decline in the credit quality in the
Bank's loan portfolio and the impact of declining economic conditions in
California and particularly the real estate values which served as collateral
for many of the Bank's loans. The Company's loan loss provisions were largely
loan loss reserves allocated to specific classified and non-performing loans.
See "-- Allowance for Loan Losses" herein.
Summary of Loan Loss Experience
Net loan charge-offs for the years ended December 31, 1994, 1993 and 1992
were $5.3 million, $3.9 million, and $9.8 million, respectively. As a percentage
of average total loans, net loan charge-offs were 4.4%, 2.0% and 3.9% for 1994,
1993, and 1992, respectively.
In 1994, loan losses from the deterioration in borrowers' financial
condition and the value of collateral securing loans occurred as a result of the
recession in California. A summary of significant charge-off activity during
1994 is as follows:
- - - Unsecured loans charged off totaled $306,000 comprised of two loans.
- - - The charge-offs related to commercial and financial loans totaled $3.0
million and were comprised of 14 loans. The single largest charge-off was
$529,000. This loan is secured by a limited partnership interest. The loan
was classified as non-accrual in the first quarter 1994 and a partial
charge-off was recorded in the third quarter of 1994 and the remaining
balance was charged off in the fourth quarter of 1994.
- - - The charge-offs related to real estate construction loans totaled $630,300
and were comprised of two loans. The loans were secured by a first deed of
trust on land under development located in Northern California. The largest
charge-off on these loans related to a restructuring which provided for a
discount for a partial payoff.
- - - The charge-offs related to real estate mortgage loans totaled $2.6 million
and were comprised of 13 loans. The single largest charge-off was $1.0
million. This loan was secured by a first deed of trust on land zoned for
single family development property and the purpose of the loan was for the
purchase of real estate. The loan was a loan to facilitate the sale of real
estate foreclosure which was placed on non-accrual during the third quarter
of 1994 and the charge-off recorded during the fourth quarter reflected a
deterioration in the collateral value based on updated appraisal
information.
In 1993, loan losses from the deterioration in borrowers' financial
condition and the value of collateral securing loans occurred as a result of the
recession in California. A summary of significant charge-off activity during
1993 is as follows:
- - - Unsecured loans charged off totaled $290,200 and was comprised of five
loans. The single largest charge-off was $174,400.
- - - The charge-offs related to commercial and financial loans totaled $2.1
million and were comprised of 19 loans. The single largest charge-off was
$600,000. The purpose of this loan was for working capital and to acquire
partnership interest in two limited partnerships. This loan is secured by
UCC filings and securities agreements on various partnerships and trusts.
The loan was classified as non-accrual in the second quarter 1993 and a
partial charge-off was recorded in the third quarter of 1993.
- - - The charge-offs related to real estate construction loans totaled $137,300
and were comprised of two related loans. The related loans were secured by a
first deed of trust on land under development located in Northern
California. This property was classified as non-accrual during the third
quarter of 1992 and transferred to in-
-30-
<PAGE> 33
substance foreclosure during the fourth quarter of 1993 when an updated
appraisal indicated that the borrower's equity in the property had
deteriorated.
- - - The charge-offs related to real estate mortgage loans totaled $1.1 million
and were comprised of six loans. The single largest charge-off was $761,800.
This loan was secured by a fourth deed of trust on commercial property and
the purpose of the loan was for real estate investment. The loan was
classified as non-accrual during the second quarter of 1993 and the
charge-off recorded during the fourth quarter reflected a deterioration in
the collateral value and a weakness in the guarantors' financial condition.
. The charge-offs related to the sale of the Sacramento Regional Office
totaled $402,000. This charge-off was incurred as a result of selling $28.0
million in loans at the Bank's carrying value, less an allocated allowance.
NON-INTEREST INCOME
Non-interest income decreased $2.3 million or 53.3% in 1994 as compared to
1993, primarily as a result of a decrease in brokerage fee income related to the
exercise of stock options of $1.3 million, a decrease in income from limited
partnership of $527,000 as a result of the decline in the limited partnerships
earnings resulting primarily from deferred maintenance costs, and a decline in
service charge and fee revenue and all other income of $514,000 related to trust
management fees, referral fees on CD Placement, and deposit products and
services because of lower transaction volumes and lower average deposit balance
outstanding, lower levels of assets under management through trust services, and
an increase in the loss on sale of securities.
Non-interest income increased $129,000 or 3.0% in 1993 as compared to 1992,
primarily as a result of an increase in brokerage fee income related to the
exercise of stock options of $586,000 and a decrease in service charges and fee
revenue and all other income of $781,000 related to trust management fees,
escrow fees, referral fee on CD Placement, and deposit products and services
because of lower transaction volumes and lower average deposit balance
outstanding, and lower levels of assets under management through trust services.
The following table provides a detail of non-interest income for the years
ended December 31:
<TABLE>
<CAPTION>
(Dollars in Thousands) 1994 1993 1992
-------------------------------
<S> <C> <C> <C>
Service charges and fees $ 143 $ 173 $ 223
Results of operations from limited partnership (264) 263 202
Loan brokerage and servicing fees 347 324 201
Stock option commissions and fees 1,562 2,906 2,320
Other income, net 604 894 1,633
Loss on sale of assets (257) (63) (211)
-------------------------------
Total non-interest income $2,135 $4,497 $4,368
===============================
</TABLE>
NON-INTEREST EXPENSE
For the year ended December 31, 1994, non-interest expense increased $17.3
million, or 79.3%, from the year ended December 31, 1993. The increase was
attributed primarily to higher a level of costs related to real estate asset, a
higher level of litigation settlement and provision charges, and a higher
professional costs for legal and consulting costs related to the Company's
litigation matters, and the requirement for special services related to
addressing the Company's financial condition.
For the year ended December 31, 1993, non-interest expenses decreased $8.0
million, or 26.5%, from the year ended December 31, 1992. The reduction was
attributed primarily to lower compensation related expenses, a lower level of
costs related to asset and credit quality, and lower level of legal and
consulting costs related to the Company's loan collection and recapitalization
efforts.
-31-
<PAGE> 34
The following table provides a detail of non-interest expense for the years
ended December 31:
<TABLE>
<CAPTION>
(Dollars in Thousands) 1994 1993 1992
--------------------------------
<S> <C> <C> <C>
Salaries and related benefits $ 7,330 $ 8,325 $9,858
Occupancy expense 2,121 2,054 2,061
Professional fees 3,071 2,326 3,426
Litigation settlement and reserve 3,601 -- --
Equipment expense 564 849 938
FDIC insurance premiums 633 849 816
Data processing 439 457 478
Loss on sale of Sacramento Regional Office -- 420 --
Marketing 369 71 314
Telephone 155 314 274
Insurance premiums 189 97 251
Other operating expenses 1,419 1,876 2,560
--------------------------------
Total operating expenses 19,891 17,638 20,976
Net cost of real estate operations 19,127 4,126 8,721
--------------------------------
Total non-interest expense $39,018 $21,764 $29,697
================================
</TABLE>
The decrease in compensation related expenses of $1.0 million in 1994 to
$7.3 million, or 12.0% from the 1993 level, resulted from lower staffing levels,
partially offset by higher incentive compensation paid and severance related
costs. The decrease in compensation related expenses of $1.5 million in 1993 to
$8.3 million, or 15.6% from the 1992 level, resulted from lower staffing levels,
and lower levels of other benefits for executive officers, partially offset by
an increase in incentive compensation primarily related to work performed
related to reductions in problem assets. The compensation expense included
performance-based incentives of $755,000, $526,000, and $920,000 for 1994, 1993
and 1992, respectively.
The Company's expenses for professional services were $3.1 million in 1994
compared to $2.3 million and $3.4 million in 1993 and 1992, respectively. The
Company includes in professional fees the costs of legal, accounting, and
management consulting services. Professional service expenses increased in 1994
as a result of the continuing activities related to recapitalization, consulting
services related to the new lines of business, and the increase in professional
services required to manage the resolution of classified and non-performing
assets during that year. In 1994, the Company incurred additional professions
service costs related to the analysis and preliminary activities required to
establish various international business strategies. Professional service costs
decreased in 1993 by $1.1 million compared to 1992 as a result of lower costs
related to the Company's loan collection and recapitalization efforts.
Professional service expenses were high in 1992 as a result of the substantial
activities undertaken by the Company to complete its 1992 recapitalization, and
the increase in professional services required to manage the resolution of
classified and non-performing assets during that year.
The increase of $15.0 million in net cost of real estate operations related
to asset and credit quality from $4.1 million in 1993 to $19.1 million in 1994
reflects continued deterioration in the value of the real estate collateral.
The decrease of $4.6 million in net cost of real estate operations related to
asset and credit quality from $8.7 million in 1992 to $4.1 million in 1993
reflects lower levels of classified assets and lower levels of loans migrating
to classified or non-performing status because of the stabilization of
borrowers' financial conditions and the quality of the underlying collateral on
loans.
The decline of $463,000 in 1994 other operating costs to $1.4 million from
$1.9 million in 1993 and the $620,000 decrease in 1993 other operating expenses
from $2.5 million in 1992 resulted primarily from cost reduction initiatives in
miscellaneous expenses and customer related service expenses.
In 1994, the Bank recorded loss provisions totaling $16.5 million for 18
other real estate owned assets compared to $3.3 million in 1993 on 15
properties, an increase of 400.0%. In addition to the provisions, the Bank
recognized $73,300 in losses on the sale of two real estate properties acquired
in settlement of loans in 1994 compared to $712,000 on 11 properties in 1993.
The Bank recognized recoveries and gains on sale of other real estate owned
totaling $253,000 million on three properties in 1994 compared to $1.7 million
in 1993 on four properties.
-32-
<PAGE> 35
In 1993, the Bank recorded loss provisions totaling $3.3 million for 15
other real estate owned assets compared to $5.5 million in 1992 on 17
properties, an improvement of 40.0%. In addition to the provisions, the Bank
recognized $712,000 in losses on the sale of 11 real estate properties acquired
in settlement of loans in 1993 compared to $467,000 on five properties in 1992.
The Bank recognized recoveries and gains on sale of other real estate owned
totaling $1.7 million on four properties in 1993 compared to $1.0 million in
1992 on five properties.
The Bank recorded a loss provision of $513,500 for three real estate
investment property compared to $250,000 in 1993 on one property, an increase of
88.0%. The Bank did not recognized a loss on the sale of real estate investment
in 1994 compared to a loss of $54,000 on one real estate investment in 1993. The
Bank recognized gains on sale of real estate investments totaling $10,000 in
1994 on one property. No gains were recognized in 1993.
The Bank recorded a loss provision of $250,000 for one real estate
investment property compared to $662,000 in 1992 on three properties, an
improvement of 62.2%. In addition to the provisions, the Bank recognized a loss
of $54,000 on the sale of one real estate investment in 1992 compared to none in
1993. The Bank recognized gains on sale of real estate investments totaling
$749,000 in 1992 on two properties. No gains were recognized in 1993.
FINANCIAL CONDITION
TOTAL ASSETS
With the recurring operating losses during 1994, 1993 and 1992 and the
failure of the Company and the Bank to consistently meet its regulatory capital
requirements, management of the Company implemented a strategy of reducing the
Company's total assets in order to more easily meet its regulatory capital
ratios and an aggressive loan work-out program to reduce the level of the real
estate related and other problem loans. As a result, the Company's assets
decreased 32.1% in 1994 from $231.0 million at December 31, 1993 to $156.8
million at December 31, 1994.
CASH AND CASH EQUIVALENTS
The Bank maintains cash and cash equivalents, such as federal funds sold, at
levels management believes are sufficient to meet the liquidity needs of its
deposit customers. At December 31, 1994 the Company's cash and cash equivalents
were $28.6 million or 19.5% of total deposits and 94.7% of non-interest bearing
deposits. At December 31, 1993 the Company's cash and cash equivalents were
$25.8 million or 12.3% of total deposits and 74.1% of non-interest bearing
deposits. See also "Liquidity" herein for a further discussion of the Bank's
other sources of liquid assets.
INVESTMENT ACTIVITIES
The Bank maintains a securities portfolio consisting of United States
Government and Federal agency securities, collateralized mortgage obligations,
investments in certificates of deposits at other financial institutions, and
mutual funds. The balance of the investment securities maintained by the Bank in
excess of the requirement of applicable regulations and the Orders reflect
management's objective of ensuring compliance with liquidity requirements. Most
securities are held in safekeeping by an independent custodian.
In May 1993, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt & Equity Securities." The Statement addresses the accounting and reporting
for investments in equity securities that have a readily determinable fair value
and for all investments in debt securities. The Statement requires that all
securities be classified, at acquisition, into one of three categories:
held-to-maturity securities, trading securities, and available-for-sale
securities. Held-to-maturity securities are those securities the Bank has the
intent and ability to hold to maturity and are carried at amortized cost.
Trading securities are those securities that are bought and held principally for
the purpose of selling in the near term and are reported at fair value, with
unrealized gains or losses included in current earnings. Available-for-sale
securities are those securities that do not fall into the other two categories
and are reported at fair value, with unrealized gains or losses reported as a
separate component of shareholders' equity. This Statement is effective for
-33-
<PAGE> 36
fiscal years beginning after December 15, 1993, however, earlier implementation
is permitted. The Bank elected to implement SFAS No. 115 effective as of
December 31, 1993.
The Bank determines the classification of all securities at the time of
acquisition. In classifying securities as being heldto-maturity, trading, or
available-for-sale, the Bank considers its collateral needs, asset/liability
management strategies, liquidity needs, interest rate sensitivity and other
factors in determining its intent and ability to hold the securities to
maturity.
Investment securities held-to-maturity include United States Treasury and
Federal agency securities, investments in certificates of deposit, and an equity
investment in Federal Home Loan Bank of San Francisco (FHLB) membership stock.
The objectives of these investments are to increase portfolio yield, and to
provide collateral to pledge for federal, state and local government deposits
and other borrowing facilities. The investments held-to-maturity have an average
term to maturity of four months and 20 months at December 31, 1994 and 1993,
respectively. The investments held-to-maturity are carried at amortized cost. At
December 31, 1994 and 1993, the investment securities held-to-maturity portfolio
includes $7.9 million and $3.1 million in fixed rate investments, and $1.3 and
$3.3 million in adjustable-rate investments, respectively. During 1994, the Bank
reclassified certain collateralized mortgage obligations to the
available-for-sale category as a result of a change in the strategy regarding
the investment in these types of securities.
Investment securities available-for-sale may include United States Treasury
and Federal agency securities, mutual funds, and collateralized mortgage
obligations. These securities are typically used to supplement the Bank's
liquidity portfolio with the objective of increasing yield. Investment
securities available-for-sale are accounted for at fair value. Unrealized gains
and losses are recorded as an adjustment to equity and are not reflected in the
current earnings of the Bank. If the security is sold any gain or loss is
recorded as a charge to earnings and the equity adjustment is reversed. At
December 31, 1994 and 1993, the Bank held $2.2 million and $14.9 million
classified as investments available-for-sale, respectively. At December 31, 1994
and 1993, $4,000 and $60,000 was charged against equity to reflect the market
value adjustment to the securities available-for-sale, respectively.
The table below sets forth certain information regarding the carrying values
and market values and the weighted average yields of the Bank's investment
securities portfolio by maturity at December 31, 1994:
<TABLE>
<CAPTION>
Within One Year One to Five Years Total Investment Securities
---------------- ----------------- ----------------------------
Carrying Average Carrying Average Carrying Market Average
(Dollars in Thousands) Value Yield Value Yield Value Value Yield
---------------- ----------------- ----------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury and agency securities $ 9,800 4.9% $ 9,800 $ 9,777 4.9%
Collateralized mortgage obligations -- -- $ 270 4.1 270 270 4.1
FHLB stock -- -- -- -- 1,337 1,337 5.7
---------------- ----------------- ----------------------------
Total $ 9,800 4.9% $ 270 4.1% $11,407 $11,384 5.0%
================ ================= ============================
</TABLE>
No investment securities had a maturity of more than five years at December
31, 1994. The FHLB stock have no term to maturity.
In October 1994, Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) no. 119, Disclosure About
Derivative Financial Instruments and Fair Value of Financial Instruments. The
provisions of SFAS No. 119 are effective for the Company and the Bank as of
December 31, 1995. SFAS No. 119 required disclosure about derivative financial
instruments -- futures, forwards, swap and option contracts, and other financial
instruments with similar characteristics. As of December 31, 1994, the Company
and the Bank had no derivative financial instruments that would be subject to
such disclosure.
-34-
<PAGE> 37
LOANS
During 1994, the Company reduced its total loans by $43.3 million from
$149.7 million at December 31, 1993. The reduction in total loans resulted
primarily from a strategic decision to reduce concentrations in real estate
and/or real estate related loans and to reduce the total loan portfolio to
improve the liquidity position of the Bank through loan repayments. In addition,
loans were reduced by charge-offs of $6.6 million.
In addition, the increase in classified loans from $22.9 million at December
31, 1993 to $25.0 million at December 31, 1994 was the result of redefining the
criteria for all classified assets based on comments from the FDIC examiners.
During 1994, there were $14.7 million in newly classified loans, of which $12.2
million were reclassified in the first quarter of 1994 based on FDIC examiners
comments, whereas in 1993, there were $4.4 million in newly classified loans.
For a description of the composition of the loan portfolio and a description
based upon various contractually scheduled repayments, see "BUSINESS -- The
Company and the Bank -Lending Activities -- Composition of Loan Portfolio."
CLASSIFIED ASSETS
Federal regulations require banks to review their assets on a regular basis
and to classify them if any weaknesses are noted. Banks must maintain adequate
allowances for assets classified as "Substandard" or "Doubtful" and to
immediately write off those assets classified as "Loss". The Bank has a
comprehensive process for classifying assets and asset reviews are performed on
a periodic basis. In addition to identifying adversely classified assets, the
Bank identifies certain assets as "Special Mention", which do not currently
expose the Bank to a sufficient degree of risk to warrant a more adverse
classification but do possess credit deficiencies or potential weaknesses
deserving management's close attention. Assets that do not possess credit
deficiencies are not classified and are labeled "Pass". The Bank stratifies its
loan portfolio based on collateral type concentrations and delinquency trends.
The objective of the review process is to identify any trends and determine the
levels of loss exposure to the Bank that would require an adjustment to the
valuation allowance.
Classified assets include non-accrual loans, other real estate owned, real
estate investments and performing loans that exhibit credit quality weaknesses.
Certain loans identified as in-substance foreclosed are included in other real
estate owned. The table below outlines the Bank's classified assets as of
December 31, 1994 and 1993:
<TABLE>
<CAPTION>
(Dollars in Thousands) 1994 1993
-------------------
<S> <C> <C>
Loans - performing $15,580 $11,847
Non-accrual loans 9,377 11,086
Other real estate owned 10,021 32,372
Real estate investments 682 1,468
-------------------
Total classified assets $35,660 $56,773
===================
</TABLE>
-35-
<PAGE> 38
The Bank is required by the Orders to reduce its classified assets, as
defined by the Orders, to no more than $60.0 million by December 31, 1993, no
more than $50.0 million by March 31, 1994 and no more than $40.0 million by
September 30, 1994. At December 31, 1994, the Bank had $20.8 million in such
assets. However, no assurance can be given that the regulatory authorities will
not establish additional requirements on the Bank to reduce its classified
assets.
Further declination in the regional real estate market could increase the
amount of the Bank's non-performing assets and, in addition, could have an
adverse effect on the Bank's efforts to collect its non-performing loans or
otherwise liquidate its non-performing assets on terms favorable to the Bank.
Accordingly, there can be no assurance that the Bank will not experience
additional increases in the amount of its non-performing assets or experience
significant additional losses in attempting to collect the non-performing loans
or otherwise liquidate the non-performing assets which are presently reflected
on the Bank's statement of financial condition. Moreover, the Bank has been
incurring substantial asset-carrying expenses, such as the expenses of
maintaining and operating properties included among the Bank's other real estate
owned classification, and the Bank may continue to incur assetcarrying expenses
in connection with such loans and assets until its non-performing loans and
assets are collected or liquidated.
NON-PERFORMING ASSETS
When a borrower fails to make a required payment on a loan, the loan is
classified as delinquent. If the delinquency is not cured, workout procedures
are generally commenced and the loan is transferred to the Bank's Special Assets
Department. If workout proceedings are not successful, collection procedures,
which may include collection demands, negotiated restructures, foreclosures,
suits for collection and borrower bankruptcy, are initiated. In general, loans
are placed on non-accrual status after being contractually delinquent for more
than 90 days, or earlier if management believes full collection of future
principal and interest on a timely basis is unlikely. When a loan is placed on
non-accrual status, all interest accrued but not received is charged against
interest income. During the period in which a loan is on non-accrual status, any
payment received may be used to reduce the outstanding loan balance. A
non-accrual loan is restored to an accrual basis when principal and interest
payments are paid current and full payment of principal and interest is
expected. Loans that are well secured and in the process of collection remain on
accrual status.
The Bank may restructure loans as a result of a borrower's inability to
service the obligation under the original terms of the loan agreement.
Restructures are executed only when the Bank expects to realize more from a
restructured loan rather than allowing it to go into foreclosure or other form
of collection.
At December 31, 1994 and 1993, other real estate owned, including
in-substance foreclosed loans, were $10.0 million and $32.4 million,
respectively. In-substance foreclosed loans are those in which the borrower has
little or no equity in the collateral based on its fair value, the borrower has
effectively abandoned control of the collateral so that many of the risks and
rewards of ownership have been passed to the lender, and repayment of the loan
can only be expected from the operation or sale of the collateral. At December
31, 1994 and 1993, in-substance foreclosed loans were $4.6 million and $19.1
million, respectively. As of December 31, 1994 and 1993, all other real estate
owned and real estate investments were classified.
Non-performing assets include non-accrual loans, in-substance foreclosed
assets and real estate foreclosures. Non-performing assets were $19.4 million at
the end of 1994, down 55.4% from $43.5 million in 1993. Loans past due 90 days
or more and accruing are included in the schedule of non-performing assets.
-36-
<PAGE> 39
The following table provides information on all non-performing assets at
December 31:
<TABLE>
<CAPTION>
(Dollars in Thousands) 1994 1993 1992 1991 1990
----------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Non-accrual loans $ 9,377 $11,086 $17,811 $ 11.781 $ 8,076
Other real estate owned 10,021 32,372 35,457 39,927 3,915
----------------------------------------------------------
Total non-performing assets $19,398 $43,458 $53,268 $51,708 $ 11,991
==========================================================
Non-performing assets as a percentage
of total loans and OREO outstanding 16.7% 23.9% 19.7% 16.1% 4.2%
Loans past due 90 days or more and accruing $ 940 $ -- $ 182 $ 2,513 $ 1,270
Loans restructured and in compliance
with modified terms 6,317 1,967 -- 3,146 2,560
</TABLE>
In addition to the loans disclosed in the foregoing table, the Bank had
approximately $3.3 million in loans on December 31, 1994 that were between 31
and 89 days delinquent. In the opinion of management, these loans have a greater
than ordinary risk that the borrowers may not be able to perform under the terms
of their contractual arrangements. Approximately $2.7 million of these loans are
secured by first or subordinate deeds of trust on real estate.
At December 31, 1994, the Bank had two loans totaling $22,000 that were less
than 90 days delinquent and on non-accrual status. The performance history of
these loans demonstrated that the borrower may not be able to perform under the
terms of the contractual arrangements. As of December 31, 1994, the Bank had
three loans totaling $940,000 that were more than 90 days delinquent with
accrued interest income that was included in income. These loans were in the
process of renewal, and were renewed and interest and principal were paid
current during the first quarter of 1995.
The following table provides a stratification of non-performing assets,
which includes non-accrual loans and other real estate owned, by collateral type
as of December 31, 1994 and 1993.
<TABLE>
<CAPTION>
(Dollars in Thousands) 1994 1993
-------------------
<S> <C> <C>
Real Estate:
Residential $ 1,403 $ 5,117
Residential development 7,012 12,175
Commercial -- 700
Commercial development 1,309 1,632
Land under development 3,665 748
Raw land 4,494 18,573
Other 1,515 4,513
-------------------
Total non-performing assets $19,398 $43,458
===================
</TABLE>
At December 31, 1994, substantially all of the non-performing assets are
real estate or loans secured by real estate located in Northern California. Raw
land consists of land acquired for the purpose of future residential or
commercial development. The Bank had no non-performing assets secured by
subordinate deeds of trust as of December 31, 1994.
Restructured loans totaled $6.3 million and $2.0 at December 31, 1994 and
1993, respectively. For the years ended December 31, 1994 and 1993, interest
income foregone on restructured loans was $18,000 and $166,000, respectively.
-37-
<PAGE> 40
VALUATION ALLOWANCES
The Bank charges current earnings with provisions for estimated losses on
loans receivable, other real estate owned, and real estate investments. The
provisions take into consideration specifically identified problem loans, the
financial condition of the borrowers, the fair value of the collateral, recourse
to guarantors, and other factors.
In 1993, the FASB issued SFAS No. 114 "Accounting by Creditors for
Impairment of a Loan". This Statement required that impaired loans be measured
based on the present value of expected future cash flows discounted at the
effective rate of the loan's observable market price or the fair market value of
the collateral if the loan is collateral dependent. This Statement applies to
financial statements for fiscal years beginning after December 31, 1994. In
October 1994, the FASB issued SFAS No. 118 "Accounting by Creditors for
Impairment of a Loan-Income Recognition and Disclosures". SFAS No. 118 amends
SFAS No. 114 to allow a creditor to use existing methods for recognizing
interest income on an impaired loan. SFAS No. 118 is effective concurrent with
the effective date of SFAS No. 114. The Company elected not to implement SFAS
No. 114 and 118 for the period ended December 31, 1994. It has been determined
that the effect of SFAS No. 114 and 118 on the Company's financial statements
would not have been material had the Company implemented SFAS No. 114 and 118 as
of December 31, 1994.
Allowance for Loan Losses
Prior to 1991, the Bank's method of analyzing the adequacy of its allowance
for loan losses generally relied on the application of historic loan loss ratios
and specific allocations of loss allowances based on specific credit reviews. In
1991, the Bank revised its methodology because of deterioration in the credit
quality of the loan portfolio, resulting from weakness in the economy and the
oversupply of properties similar to the properties collateralizing many of the
Bank's loans. The Bank has continued to refine the allowance methodology to
ensure that all known risks, trends, and facts are utilized in determining the
adequacy of the allowance for loan losses.
Fair value of the underlying collateral is based on current market
conditions, appraisals, and estimated sales values of similar properties, less
an estimated discount for selling and other expenses. In addition, the Bank
establishes a specific loss allowance based on the asset classification and
credit quality grade. This specific loss allowance is utilized to ensure that
allowances are allocated based on the credit quality grading to capture inherent
risks. In addition, the Bank carries an "unallocated" loan loss allowance to
provide for losses that may occur in the future in loans that are not presently
classified, based on present economic conditions, trends, and related
uncertainties.
-38-
<PAGE> 41
The following table summarizes the loan loss experience of the Bank for the
years ended December 31:
<TABLE>
<CAPTION>
(Dollars in Thousands) 1994 1993 1992 1991 1990
---------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance of allowance for loan
losses at beginning of period $8,050 $8,400 $8,411 $5,052 $4,178
Loans charged off:
Commercial, financial and unsecured (3,888) (2.407) (6,315) (5,653) (634)
Real estate (2,732) (1,254) (3,750) (2,495) (205)
Sale of Sacramento loans -- (402) -- -- --
Net lease financing -- -- -- (24) (190)
---------------------------------------------------------
Subtotal (6,620) (4,063) (10,065) (8,172) (1,029)
Recoveries of previous losses:
Commercial and financial 1,181 148 221 40 237
Real estate construction 166 6 5 16 --
Net lease financing -- 5 -- 38 66
---------------------------------------------------------
Subtotal 1,347 159 226 94 303
---------------------------------------------------------
Net loans charged off (5,273) (3,904) (9,839) (8,078) (726)
Provision for loan losses 3,799 3,554 9,828 11,437 1,600
---------------------------------------------------------
Balance of allowance for loan and
lease losses at end of period $6,576 $8,050 $8,400 $8,411 $5,052
---------------------------------------------------------
Ratio of the allowance to total loans 6.2% 5.4% 3.6% 3.0% 1.8%
Ratio of the allowance to non-performing loans 70.1 72.6 47.2 71.4 62.6
Ratio of net charge-offs to average loans 4.4 2.0 3.9 2.7 0.3
</TABLE>
The following table provides an allocation of the allowance for loan losses
by collateral type at December 31:
<TABLE>
<CAPTION>
1994 1993 1992
-------------------- ------------------- --------------------
(Dollars in Thousands) Balance Percent(1) Balance Percent(1) Balance Percent(1)
-------------------- ------------------- --------------------
<S> <C> <C> <C> <C> <C> <C>
Commercial and financial $4,113 78.1% $3,781 72.8% $5,496 70.5%
Real estate construction 1,208 8.5 635 9.4 1,958 15.9
Real estate mortgage 882 13.4 839 17.7 670 13.4
Lease financing -- -- -- -- 2 0.2
Unallocated 373 -- 2,795 -- 274 --
-------------------- ------------------- --------------------
Total $6,576 100.0% $8,050 100.0% $8,400 100.00%
-------------------- ------------------- --------------------
</TABLE>
<TABLE>
<CAPTION>
1991 1990
------------------- --------------------
Balance Percent(1) Balance Percent(1)
------------------- --------------------
<S> <C> <C> <C> <C>
Commercial and financial $4,260 65.2% $1,723 57.2%
Real estate construction 2,304 21.9 437 30.9
Real estate mortgage 932 12.7 -- 11.7
Lease financing 3 0.2 -- 0.2
Unallocated 912 -- 2,892 --
------------------- --------------------
Total $8,411 100.0% $5,052 100.0%
------------------- --------------------
</TABLE>
(1) Percent refers to the percent of loans in each category to total loans.
-39-
<PAGE> 42
Allowance for Losses on Other Real Estate Owned
Real estate acquired through foreclosure and in-substance foreclosed loans
are recorded at fair value at the time of transfer to OREO. In 1992, the Bank
adopted a policy in which the Bank periodically obtains either an appraisal or
market valuation analysis on all other real estate owned. If the valuation
analysis indicates a decline in the market value of the property, a specific
loss allowance is established. The Bank provides a charge against current
earnings for estimated losses on foreclosed property when the carrying value of
the property exceeds its fair value net of estimated selling expenses. Fair
value is based on current market conditions, appraisals, and estimated sales
values of similar properties, net of an estimated discount for selling and other
expenses.
The following table summarizes the other real estate owned loss experience
of the Bank for the periods shown:
<TABLE>
<CAPTION>
(Dollars in Thousands) 1994 1993 1992
--------------------------------
<S> <C> <C> <C>
--------------------------------
Balance of allowance for losses - beginning $2,986 $6,632 $1,672
Charge-offs (33) (6,982) (531)
Provision 16,451 3,336 5,491
--------------------------------
Balance of allowance for losses - ending $19,404 $2,986 $6,632
--------------------------------
</TABLE>
The Bank recorded gains on sale of other real estate owned totaling $253,000
in 1994 and $1.7 million in 1993. The gains in 1993 were related to four
properties. The Bank recorded losses on sale of other real estate owned totaling
$73,000 in 1994 and $712,000 in 1993. The losses in 1994 were related to two
properties and in 1993 were related to 11 properties. The OREO properties are
shown net of allowance for losses.
During 1993, the Bank transferred a loan with a carrying value of $1.6
million collateralized by commercial real estate to in-substance foreclosure.
The collateral securing this loan requires seismic upgrading and may be located
on property containing hazardous materials. During 1994, the asset was charged
off.
Allowance for Losses on Real Estate Investments
Real estate investments are recorded at the lower of cost or fair value.
Periodically, the Bank obtains either an appraisal or market valuation analysis
on all real estate investments. If the valuation analysis indicates a decline in
the market value of the property subsequent to the date of acquisition, a
specific loss allowance is established. The Bank provides a charge against
current earnings for estimated losses on real estate investments when the
carrying value of the property exceeds its fair value less estimated selling
expenses. Fair value is based on current market conditions, appraisals, and
estimated sales values of similar properties, less an estimated discount for
selling and other expenses.
The following table summarizes the real estate investments loss experience
of the Bank for the years ended December 31:
<TABLE>
<CAPTION>
1994 1993
------------------
<S> <C> <C>
Balance of allowance for losses - beginning $712 $462
Charge-off (167) --
Provision 514 250
------------------
Balance of allowance for losses - ending $1,059 $ 712
------------------
</TABLE>
DEPOSITS
The Bank had total deposits of $147.1 million and $210.1 million at
December 31, 1994 and 1993, respectively. As of December 31, 1994, deposits
consisted of demand deposits totaling $30.3 million, money market accounts
totaling $25.3 million, savings and NOW accounts totaling $43.4 million and time
deposits totaling
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<PAGE> 43
$48.2 million. As of December 31, 1994, the Bank had a total of 4,554 deposit
accounts consisting of 1,132 demand deposit accounts with an average balance of
approximately $27,000 each, 864 money market accounts with an average balance of
approximately $29,000 each, approximately 1,829 savings and NOW accounts with an
average balance of approximately $24,000 each and 729 time accounts with an
average balance of approximately $66,000. The Bank's deposits and,
correspondingly, its liquidity, are largely dependent upon four sources of
funds: deposits acquired through its Association Bank Services function,
brokered placement of certificates of deposit, and deposits solicited through
the Bank's money desk. These sources of deposits comprised 46.8% of the Bank's
total deposits at December 31, 1994.
Certificates of deposit having a balance of at least $100,000
(including brokered placements of certificates of deposit) represented
approximately 7.0% of the Bank's total deposits as of December 31, 1994 compared
to 24.8% as of December 31, 1993. As of December 31, 1994, 68.7% of the Bank's
certificates of deposit of at least $100,000 mature in 90 days or less, 27.4%
between 91 days and one year and 3.9% greater than a year. The aggregate average
maturity of all of the Bank's certificates of deposit of at least $100,000 was
four months as of December 31, 1994, and the aggregate amount of all such
certificates of deposit as of December 31, 1994 was $10.2 million.
Concentrations of large certificates of deposit and certain money market
deposits have been classified by bank regulatory authorities as volatile
liabilities associated with certain risks, including the risks of reduced
liquidity if a bank is unable to retain such deposits and reduced margins if its
interest costs are increased by a bank in order to retain such deposits. See "--
Regulation and Supervision." As a result of the Orders the Bank was required to
submit a plan to the FDIC and SBD to reduce its dependence on volatile
liabilities.
Deposits from homeowner and community associations are a key component
of the Bank's core deposit base. See "Association Bank Services". At December
31, 1994 and 1993, the Association Bank Services function accounted for $34.5
million and $45.1 million in deposits, representing approximately 23.4% and
21.5% of the Bank's total deposits, respectively. During 1994, Association Bank
Service customer deposits declined 23.5% from a year earlier. In August 1993,
the manager and much of the staff of the Association Bank Services function left
the Bank to join a competitor, whose services have been actively marketed to the
Bank's customer base. Since March 31, 1994, there has not been a significant
decline in Association Bank Service customer deposits as a result of the change
in management, but there can be no assurance that the Bank will be able to
continue to stem the loss of such deposits.
At December 31, 1994 and 1993, the Bank had brokered deposits totaling
$19.8 million or 13.5% and $20.0 million or 9.5% of total deposits,
respectively. During 1994, the Bank's agreement with a major retail brokerage
firm for the placement of certificates of deposits was cancelled. The Bank
repaid the $20.0 million in deposits from the major retail brokerage firm in
September 1994 and established other sources of brokered deposits through other
intermediaries. In addition, as a result of a regulatory examination in 1994
certain money market accounts totaling approximately $7.2 million as of December
31, 1994, were reclassified as brokered deposits. Most of these deposits have
been on deposit with the Bank since 1989.
At December 31, 1994 and 1993, the Bank's brokered deposits were
approximately 12.5% and 8.7% of the Bank's total assets, respectively. During
1994 and 1993 brokered deposits averaged $24.9 million and $36.3 million,
respectively, with high and low balances for 1994 of $27.0 million and $11.1
million, respectively. Such brokered certificates of deposit have a remaining
weighted average term to maturity of approximately six months The Bank's
brokered deposit waiver was suspended on January 30, 1995 by the FDIC. As a
result of the suspension of the brokered deposit waiver the Bank will not be
able to renew these brokered deposits.
In March 1993, the Bank initiated a money desk for the purpose of
attracting additional deposits. These deposits are gathered principally from
other financial institutions and municipalities outside of the Bank's market
area. As of December 31, 1994 and 1993, the Bank had outstanding money desk
deposits of $14.9 million or 9.6% of total Bank's assets and $41.5 million or
19.8% of Bank's total deposits. During 1994, the money desk deposits averaged
$28.4 million, with a high balance of $41.5 million. As of December 31, 1994,
money desk deposits had a remaining weighted average maturity of approximately
seven months. In response to the suspension of the brokered deposit waiver, the
Bank has reactivated its money desk deposit program for the purpose of replacing
the maturing brokered deposits.
The Bank's ability to accept brokered placements of certificates of
deposit was restricted in the first quarter of 1992 under FDICIA and FDIC
regulations that prohibit adequately capitalized banks from accepting or
renewing
-41-
<PAGE> 44
such deposits. As of December 31, 1994, the Bank was accepting brokered deposits
pursuant to a waiver of such prohibition received in September 1994 with a term
of one year. As required by the Orders, the Bank has submitted a plan to the
FDIC and the SBD to eliminate reliance on brokered deposits and to reduce its
dependency on out of area deposits and volatile liabilities. During the first
quarter of 1995, the Bank's risk-based capital ratio declined to below the
minimum regulatory requirement of 8.0% which caused the FDIC to suspend the
Bank's brokered deposit waiver. No assurance can be given that brokered
deposits, in the near future, can be replaced with other core deposits. See --
"Regulatory Agreement and Orders" and "Regulation and Supervision".
The following table sets forth the maturities, as of December
31, 1994, of the Bank's interest-bearing deposits and other interest-bearing
liabilities:
<TABLE>
<CAPTION>
Over 3 Over More Than
3 Months Months to 6 Months 1 Year to
(Dollars in Thousands) or Less 6 Months to 1 Year 5 Years Total
-------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Interest-Bearing Liabilities:
Money market accounts $25,250 -- -- -- $ 25,250
Savings and NOW accounts 43,415 -- -- -- 43,415
Time deposits 18,369 $12,158 $15,394 $ 2,303 48,224
Other borrowings 4,070 -- -- -- 4,070
Total interest-bearing -------------------------------------------------------------
liabilities $91,104 $12,158 $15,394 $ 2,303 $120,959
=============================================================
</TABLE>
OTHER BORROWINGS
The Bank's other borrowings at December 31, 1994 totaled $4.1 million, as
compared to $1.3 million at December 31, 1993. The Bank's other borrowing
facilities include advances from the FHLB and reverse repurchase agreements.
The Bank's short term line of credit with the Federal Reserve Bank of San
Francisco (Federal Reserve Bank) was cancelled effective April 3, 1995. However,
the Bank has an overdraft line with the Federal Reserve Bank of $1.1 million
secured by loans in the Bank's portfolio. The Bank's short term line of credit
with the FHLB of up to $5.5 million is secured by pledged loans. At December 31,
1994 and 1993, the Bank had no borrowings outstanding with the FHLB or Federal
Reserve Bank. During 1994 and 1993, the Bank did not borrow at the discount
window at the Federal Reserve Bank. In the first quarter of 1995, the Bank
activated its FHLB borrowing as a result of liquidity concerns related to the
decline in core deposits since December 31, 1994.
ASSET AND LIABILITY MANAGEMENT
Banking is a business which depends on rate differentials. In general, the
difference between the interest rate paid by the Bank on its deposits and its
other borrowing and the interest rate received by the Bank on loans extended to
its customers and securities held in the Bank's portfolio comprise the major
portion of the Bank's earnings. These rates are highly sensitive to many factors
which are beyond the control of the Bank. Accordingly, the earnings and growth
of the Bank are subject to the influence of domestic economic conditions,
including inflation, recession and unemployment.
The most important component of the Bank's earnings is the difference
between the rates earned on its assets as compared to the rates paid on its
liabilities. The difference between the amount of assets and the amount of
liabilities which are subject to interest rate risk is referred to as the "gap."
The gap represents the risk and the opportunity inherent in mismatching asset
and liability interest rate changes. If more assets than liabilities are
interest rate sensitive at a given time in a rising interest rate environment,
net interest income increases. In a declining interest rate environment with the
same "gap", net interest income decreases. If more liabilities change rates than
assets, the same scenarios produce the opposite effects.
-42-
<PAGE> 45
The Bank's risk management policies are established by the ALCO. The ALCO
meets semi-monthly to formulate the Bank's strategies. The basic
responsibilities of the ALCO include the management of interest rate risk,
liquidity, funding, and asset and liability products. The Bank's approach is to
measure interest rate risk, assess and determine if the risk level is acceptable
and to develop strategies to either reduce excessive risk or recognize the
trade-offs between risk and return.
The following table shows the repricing opportunities for the Bank's
interest-earning assets and interest-bearing liabilities at December 31, 1994:
<TABLE>
<CAPTION>
Over 3 Over More Than
3 Months Months to 6 Months 1 Year to Over
(Dollars in Thousands) or Less 6 Months to 1 Year 5 Years 5 Years Total
------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest-Earning Assets:
Investment securities and
cash equivalents $ 24,482 -- $ 4,872 -- -- $ 29,354
Loans (1) 86,942 -- 1,649 $ 256 $ 8,228 97,075
------------------------------------------------------------------------
Total interest-earning assets 111,424 -- 6,521 256 8,228 126,429
------------------------------------------------------------------------
Interest-Bearing Liabilities:
Interest-bearing deposits 87,035 12,158 15,394 2,303 -- 116,890
Other borrowings 4,070 -- -- -- -- 4,070
------------------------------------------------------------------------
Total interest-bearing abilities 91,105 12,158 15,394 2,303 -- 120,960
------------------------------------------------------------------------
Interest bearing assets over (under)
interest bearing liabilities $ 20,319 $(12,158) $ (8,873) $ (2,047) $ 8,228 $ 5,469
========================================================================
Cumulative primary gap $ 20,319 $ 8,161 $ (712) $ (2,759) $ 5,469
===========================================================
Gap as a percentage of total assets 13.0% 5.2% (0.5)% (1.8)% 3.5%
</TABLE>
(1) Excludes non-accrual loans.
The maturity/rate sensitivity analysis is a static view of the balance sheet
with assets and liabilities grouped into certain defined time periods, and thus
only partially depicts the dynamics of the Bank's sensitivity to interest rate
changes. Such an analysis does not fully describe the complexity of
relationships between product features and pricing, market rates and future
management of the balance sheet mix. As a result, assets and liabilities
indicated as repricing within the same period may in fact reprice at different
times and different rates. The Company's net interest margins on average
earnings assets for the years ended December 31, 1994, 1993 and 1992, were 5.1%,
4.6% and 4.5%, respectively.
LIQUIDITY
In 1994 and 1993, the Company's principal source of liquidity has been
new capital from the issuance of its capital stock. Generally, the Bank has
various sources of liquidity including core deposits, money desk deposits, other
borrowings, loan participations and sales, loan repayments, and the sale of
problem assets. The Bank's access to all of these sources of liquidity is
limited as a result of the failure to meet capital requirements, its level of
classified assets, continued operating losses, and contractual maturities of
performing loans or the inability of borrowers to repay loans according to the
contractual terms. In addition, the Bank's brokered deposit waiver was suspended
on January 30, 1995 disallowing the Bank from renewing existing and accepting
new brokered deposits.
Liquidity is the Bank's ability to meet the present and future needs of
its clients for loans and deposit withdrawals. The Bank's liquidity generally
decreases as a result of increases in the Bank's loans and other assets, and
fluctuations in the maturities of deposits in the Bank can have a significant
effect on the Bank's liquidity. The sources of the Bank's liquidity include
deposits, other liquid assets and short-term borrowings. The most important
source of these assets are core deposits. Core deposits are defined as all
deposits from its customer base except time deposits of $100,000 or greater and
all deposits identified as volatile. At December 31, 1994, the Bank's core
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<PAGE> 46
deposits were $101.2 million, representing a 12.8% decrease from core deposits
of $116.0 million at December 31, 1993, which in turn represents a 49.1%
decrease from core deposits of $228.0 million at December 31, 1992. The Bank's
liquid assets, which includes cash and short term investments, at December 31,
1994 totaled $40.1 million, a decrease of 15.0% from $47.1 million at December
31, 1993. The Bank currently has an overdraft line with the Federal Reserve Bank
of up to $1.1 million secured by loans in the Bank's portfolio. As of December
31, 1994, the Bank had pledged loans and securities enabling the Bank to borrow
up to $5.5 million from the Federal Home Loan Bank of San Francisco, and the
Bank had not drawn on this line of credit.
The Bank's ability to generate liquidity through deposits from
homeowner and community associations, $34.5 million or 23.4% of deposits at
December 31, 1994, had become the subject of intense competition during 1993.
During 1994, these deposits declined $4.9 million or 12.4% from December 31,
1993. In addition, out of area deposits solicited through the Bank's money desk,
$14.9 million or 10.0% of deposits at December 31, 1994 are the subject of an
Order requiring the Bank to reduce its reliance on such deposits. During 1994,
the Bank reduced these deposits by $26.6 million or 64.0% since December 31,
1993.
The Bank's ability to generate liquidity through acceptance of brokered
placements of certificates of deposit was restricted in the first quarter of
1992 under FDICIA and new FDIC regulations that prohibit undercapitalized banks
from accepting or renewing such brokered deposits and prohibit adequately
capitalized institutions from accepting or renewing such deposits unless such
institutions obtain a waiver of such prohibition from the FDIC. Under the
Orders, the Bank was required to submit a written plan to the FDIC and the SBD
for eliminating its reliance on brokered deposits, and to provide the Regional
Director of the FDIC and the Superintendent with monthly reports outlining the
Bank's progress under such plan. The FDIC had granted the Bank a one-year waiver
expiring in September 1995 to permit renewal of brokered deposits, provided that
the Bank continues to meet the definition of an adequately capitalized
institution. If the Bank fails to meet the definition of an adequately
capitalized institution or fails to demonstrate substantial progress towards
elimination of dependency on brokered deposits, the Bank may be unable to obtain
an extension of such waiver. During the first quarter of 1995, the Bank's
brokered deposit waiver was suspended as a result of the failure to meet the
minimum risk-based capital requirement. See "-- Regulation and Supervision."
During 1994, the Bank had a plan to reduce its reliance on volatile
liabilities which included certain actions including the hiring of a liability
manager to work with Private and Business Banking officers in the development
and marketing of core deposit programs, a new local area certificate of deposit
product was rolled-out in early February, 1994, and the Bank's international
strategy with deposits expected to exceed loans by a ratio of 2:1. As a result
of the Bank's capital position, management determined that the implementation of
these measures was not advisable. The Bank's present strategy focuses on the
stabilization of the existing core deposit portfolio and the selective
non-renewal of transaction type loans. The proceeds from loan pay offs will be
used to fund the maturity of volatile liabilities.
Although management believes that the Bank's ability to eliminate its
brokered deposits, and reduce its reliance on out of area and volatile
liabilities can be accomplished through local deposit marketing efforts
following a recapitalization of the Bank, the success of which cannot be
assured, and because brokered deposits and out of area deposits presently
comprise over 23.5% of the Bank's total deposits, it is not expected that, in
the near future, these deposits can be replaced with core deposits. Nor can any
assurance be given that the Bank will be able to successfully implement its
plans, find alternate sources of deposits and avoid violation of the Orders. See
"-- Regulatory Directives and Orders."
CAPITAL
Shareholders' equity totaled $2.1 million at December 31, 1994, a
decrease of $15.4 million from $17.5 million at December 31, 1993. During the
period from 1991 through 1994, the Company suffered an aggregate of $74.6
million in losses, primarily as a result of defaulted loans secured by real
estate and losses on direct real estate development activities. The Company and
the Bank succeeded in avoiding insolvency during this period only through the
injection of a total of $52.0 million in new capital as of December 31, 1994.
The Company's majority shareholder committed to an additional capital
contribution of $3.8 million, expected by April 24, 1995. The Company intends
to raise a minimum of $6.3 million of additional capital in 1995.
-44-
<PAGE> 47
Pursuant to federal law, the Company is subject to the Federal Reserve
Board's capital guidelines of the FRB and the Bank is subject to the FDIC's
regulations governing capital adequacy for banks that are not members
("non-member banks") of the Federal Reserve System. As a result of the Bank's
failure to meet its minimum regulatory and Orders capital requirements at
December 31, 1994, the Bank filed the Plan in compliance with "Prompt Corrective
Action" imposed by FDICIA. It is expected that the Plan will be acceptable to
the FDIC and the SBD after the receipt of additional capital. The Plan
supersedes previously filed plans under the "Prompt Corrective Action"
regulations. In addition, in 1993 the Company agreed to guarantee that the Bank
will comply with the previously filed capital restoration plan until the Bank
has met its minimum capital requirements on average during each of four
consecutive calendar quarters. The Company's liability under the guarantee is
limited to the lesser of 5% of the Bank's total assets at the time it became
undercapitalized, $15.3 million or an amount necessary (or that would have been
necessary) to bring the Bank into compliance with all of its capital
requirements as of the time it fails to comply with the Restoration Plan. The
Company currently does not have sufficient funds to satisfy the guarantee, and
would be in default thereunder if called upon to do so. See "-- Supervision and
Regulation" for further information concerning FDICIA's "Prompt Corrective
Action" system.
Under California law, if a bank's deficit retained earnings exceed 40% of
its contributed capital, its capital is deemed to be impaired, and the bank is
required to levy an assessment on its shares to correct the impairment. The SBD
has issued eight Impairment Orders to the Bank, most recently dated February 1,
1995. At December 31, 1994, the Bank had contributed capital of $66.2 million
and deficit retained earnings of $64.6 million resulting in a $38.1 million
capital impairment. See "-- Regulatory Directives and Orders -- Capital
Impairment Order" for more discussion on the Bank's impairment of capital.
On July 13, 1992, the Company had completed (i) the sale to the Company's
controlling stockholder of 280,000 shares of Class A Common Stock (the "Class A
Shares") at $50.00 per share and warrants which will enable the Company's
controlling stockholder to acquire 1.0408 additional Class A Shares at $50.0 per
share for every Class A Share issued by the Company for an aggregate purchase
price of $14,000,000, under an Amended Stock Purchase Agreement dated April 10,
1992. As a consequence of the acquisition of the 280,000 Class A Shares by the
Company's controlling stockholder on July 13, 1992, a change of control of the
Company was effected.
On October 29, 1992, the Company entered into an agreement which was
subsequently amended on November 20, 1992 (as amended, the "October 29 Letter
Agreement") with the Company's controlling stockholder whereby it was agreed
that the Company's controlling stockholder would purchase up to 600,000 shares
of Series C Preferred Share at a price of $20.00 per share, completed by a
specified date and the Company would grant to the Company's controlling
stockholder an option (the "Series C Preferred Stock Option") to purchase up to
an additional 400,000 Series C Preferred Shares at a price of $20.00 per share,
exercisable in whole or in part at any time before a specified date. The
Company's controlling stockholder acquired 300,000 shares as of December 31,
1992, 300,000 shares on February 26, 1993, 200,000 shares on August 27, and
100,000 shares on September 30, 1993, of Series C Preferred Stock.
On May 23, 1994, the holder of the Company's Series C Preferred Stock
converted each share of his Preferred Stock into 40 shares of Class A Common
Stock and 40 warrants, with each warrant granting the right to purchase an
additional share of Class A Common Stock, exercisable at $0.50 per share (before
the reverse split). The warrants have not been exercised. In addition to the
conversion, the Company effected a 1-for-20 reverse stock split of the Company's
Class A Common Stock and changed the authorized number of shares to 40,000,000.
As a result of the reverse stock split, the Company repurchased the fractional
shares which totaled 119 new shares. No Series C Preferred Shares were
outstanding at December 31, 1994.
On July 25, 1994, the Company issued 3,521,126 shares of Class A Common
Stock, and warrants to purchase an additional 3,521,126 shares with an exercise
price for each share of $10.00 to its principal stockholder in its first closing
of a private stock offering for $20.0 million in capital. The price per unit was
$5.68. Each unit sold under the private placement includes a Risk Protection
Right (RPR). Under the RPR, additional Class A Common Stock will be issued to
the holder of each RPR if a net loss is incurred on certain specified assets or
as the result of losses, incurred related to certain litigation actions. The RPR
will effectuate this risk allocation by compensating the holder with additional
shares of Class A Common Stock (Adjustment Shares) up to a maximum number of
shares per RPR without the payment of additional consideration. This
compensation will be effected through periodic distributions of Adjustment
Shares. Adjustment Shares will be issued to compensate for net losses, net
charge-offs and expenses on certain specified assets (Specified Assets) and the
lawsuit that was settled for $2.0 million during July 1994 up
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<PAGE> 48
to a cumulative amount of $16.0 million. The maximum number of shares to be
issued is 9,723,000. As a result of the losses incurred in 1994, the maximum
number of Adjustment Shares would have been issued at December 31, 1994 as a
result of the losses incurred in 1994.
The total cost of this capital raising was $2.4 million for a net capital
contribution of $17.6 million. On July 27, 1994 and December 31, 1994, the
Company contributed net capital of $13.5 million and $3.5 million, respectively,
to the Bank.
With the conversion and the issuance of the Adjustment Shares, and if the
controlling stockholder exercised all of the Warrants, then the Company's
controlling stockholder would receive an additional 1,800,000 Class A Common
Shares and would own approximately 99.2% of the total number of issued and
outstanding common shares.
Mr. Kaharudin Latief of Jakarta, Indonesia is presently in the process of
providing notice to the FRB and applying to the SBD for approval to acquire
shares of the Class A Common Stock. If and when regulatory clearance is
received, Mr. Latief plans to acquire from the Company's controlling stockholder
600,000 shares of Class A Common Stock and Warrants through cancellation of an
unsecured, personal loan in the amount of $6.0 million which Mr. Latief
previously extended to the Company's controlling stockholder. The Company's
controlling stockholder used the proceeds of this loan to acquire 300,000 shares
of the Series C Preferred Stock from the Company. If Mr. Latief consummates this
transaction, the Company's stockholders, Mr. Latief would hold 600,000 shares of
Class A Common Stock and 600,000 Warrants with an exercise price of $10.00 per
share. Mr. Latief's ownership percentage including Warrants would be 5.8% and
the Company's controlling stockholder's new common ownership would decline to
approximately 93.4%.
The Company and the Bank are subject to general regulations issued by the
FRB, FDIC, and SBD which require maintenance of a certain level of capital and
the Bank is under specific capital requirements as a result of the Orders. As of
December 31, 1994, the Company was not in compliance with all minimum capital
requirements and the Bank was not in compliance with all minimum capital
requirements including the minimum leverage ratio of 7.0% mandated by the
Orders.
The following table reflects both the Company's and the Bank's capital
ratios with respect to minimum capital requirements in effect as of December 31,
1994.
<TABLE>
<CAPTION>
Minimum
Capital
Company Bank Requirement Orders
-----------------------------------------------
<S> <C> <C> <C> <C>
Leverage ratio 1.2% 0.9% 4.0% 7.0%
Tier 1 risk-based capital 1.6 1.2 4.0 N/A
Total risk-based capital 3.0 2.6 8.0 N/A
</TABLE>
On April 20, 1995, the Company's majority shareholder committed to
contributing $3.8 million in capital, expected by April 24, 1995. The Company
intends to contribute $4.2 million of capital to the Bank upon receipt of the
$3.8 million. The following table reflects both the Company's and Bank's
capital ratios with respect to minimum capital requirements in effect as of
December 31, 1994 giving effect to the capital raised in April of 1995.
<TABLE>
<CAPTION>
Minimum
Capital
Company Bank Requirement Orders
-----------------------------------------------
<S> <C> <C> <C> <C>
Leverage ratio 3.4% 3.4% 4.0% 7.0%
Tier 1 risk-based capital 4.5 4.4 4.0 N/A
Total risk-based capital 6.0 5.9 8.0 N/A
</TABLE>
Certain reclassification were made in the prior years' financial statements
to conform to the current year presentation.
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<PAGE> 49
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Accountants . . . . . . . . . . . . . . . . . . . . . . . 48
Consolidated Statements of Financial Condition,
December 31, 1994 and 1993 . . . . . . . . . . . . . . . . . . . . . . . . 49
Consolidated Statements of Operations, . . . . . . . . . . . . . . . . . . . . 50
Years ended December 31, 1994, 1993 and 1992
Consolidated Statements of Changes in Shareholders' Equity, . . . . . . . . . . 51
Years ended December 31, 1994, 1993 and 1992
Consolidated Statements of Cash Flows, . . . . . . . . . . . . . . . . . . . . 52
Years ended December 31, 1994, 1993 and 1992
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . 54
</TABLE>
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<PAGE> 50
REPORT OF INDEPENDENT ACCOUNTANTS
The Board of Directors and Shareholders of
The San Francisco Company:
We have audited the accompanying consolidated statements of financial condition
of The San Francisco Company and subsidiaries (the Company) as of December 31,
1994 and 1993 and the related consolidated statements of operations, changes in
shareholders' equity and cash flows for each of the years in the three-year
period ended December 31, 1994. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to report on
these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated 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 report.
In our opinion, the consolidated financial statements present fairly, in all
material respects, the financial position of the Company and subsidiaries at
December 31, 1994 and 1993 and the results of their operations and their cash
flows for each of the years in the three-year period ended December 31, 1994 in
conformity with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in note 2 to the
consolidated financial statements, the Company's recurring losses from
operations; noncompliance of the Bank of San Francisco (the Bank) with the
Orders to Cease and Desist issued jointly by the Federal Deposit Insurance
Corporation (the FDIC) and the California State Banking Department (the SBD);
the Bank's noncompliance with the Impairment Orders issued by the SBD; the
Bank's designation as a critically undercapitalized institution by the FDIC and
the restrictions imposed by the prompt corrective action provisions of Federal
Deposit Insurance Corporation Improvement Act of 1991; and the uncertainty
relating to the potential unfavorable outcome of pending litigation discussed in
note 17 to the consolidated financial statements, raise substantial doubt about
the Company's ability to continue as a going concern. The ability of the Company
to continue as a going concern is dependent on many factors, including obtaining
additional capital contributions, increasing and maintaining its capital ratios,
achieving profitable operations and obtaining full compliance with the Cease and
Desist and Impairment Orders. Management's plans in regard to these matters are
described in note 2 to the consolidated financial statements. The accompanying
consolidated financial statements do not included any adjustments that might
result from the outcome of these uncertainties.
Because of the significance of the uncertainties discussed above, we are unable
to express, and we do not express, an opinion on the accompanying 1994
consolidated financial statements.
KPMG Peat Marwick LLP
April 4, 1995, except as to note 3,
which is as of April 20, 1995
San Francisco, California
-48-
<PAGE> 51
THE SAN FRANCISCO COMPANY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1994 AND 1993
<TABLE>
<CAPTION>
(Dollars in Thousands Except Per Share Data) Notes 1994 1993
---------------------------------
<S> <C> <C> <C>
ASSETS:
Cash and due from banks $ 11,397 $ 8,333
Federal funds sold 17,250 17,500
-----------------------
Cash and cash equivalents 28,647 25,833
Investment securities held-to-maturity
(Market value: 1994 - $9,173; 1993 - $6,353) 4 9,196 6,351
Investment securities available-for-sale 5 2,211 14,940
Loans 6 106,452 149,740
Deferred loan fees 6 (388) (550)
Allowance for loan losses 7 (6,576) (8,050)
-----------------------
Loans, net 99,488 141,140
Other real estate owned 8 10,021 32,372
Real estate investments 9 2,364 3,643
Premises and equipment, net 10 2,996 3,592
Interest receivable 820 946
Other assets 1,037 2,204
-----------------------
Total assets $156,780 $231,021
=======================
LIABILITIES AND SHAREHOLDERS' EQUITY:
Non-interest bearing deposits $ 30,259 $ 34,859
Interest bearing deposits 116,889 175,252
-----------------------
Total deposits 11 147,148 210,111
Other borrowings 12 4,070 1,303
Other liabilities and interest payable 3,433 2,152
-----------------------
Total liabilities 154,651 213,566
-----------------------
Commitments and contingencies 17
Shareholders' Equity: 14
Preferred Stock (par value $0.01 per share)
Series B - Authorized - 437,500 shares
Issued and outstanding - 16,291 and 16,591 shares, respectively 114 116
Series C - Authorized - 1,800,000 shares
Issued and outstanding - 0 and 900,000 shares, respectively -- 18,000
Common stock (par value $0.01 per share)
Class A - Authorized - 40,000,000 shares
Issued and outstanding - 5,766,008 and 444,990 shares, respectively 58 4
Class B - Authorized - None
Issued and outstanding - None -- --
Additional paid in capital 70,168 34,662
Retained deficit (68,137) (35,101)
Employee purchase and option plans (70) (166)
Unrealized loss on securities available-for-sale (4) (60)
-----------------------
Total shareholders' equity 2,129 17,455
-----------------------
Total liabilities and shareholders' equity $156,780 $231,021
=======================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
-49-
<PAGE> 52
THE SAN FRANCISCO COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992
<TABLE>
<CAPTION>
(Dollars in Thousands Except Per Share Data) Notes 1994 1993 1992
---------------------------------------------------
<S> <C> <C> <C>
Interest income:
Loans $ 11,258 $ 16,659 $ 21,707
Investments 1,329 1,451 2,152
Dividends 64 45 26
------------------------------------
Total interest income 12,651 18,155 23,885
------------------------------------
Interest expense:
Deposits 11 4,694 6,966 10,746
Other borrowings 169 454 549
------------------------------------
Total interest expense 4,863 7,420 11,295
------------------------------------
Net interest income 7,788 10,735 12,590
Provision for loan losses 7 3,799 3,554 9,828
------------------------------------
Net interest income after provision for loan losses 3,989 7,181 2,762
------------------------------------
Non-interest income:
Service charges and fees 143 173 223
Results of operations from limited partnership 9/18 (264) 263 202
Loan brokerage and servicing fees 347 324 201
Stock option commissions and fees 1,562 2,906 2,320
Other income 604 894 1,633
Loss on sale of assets, net (257) (63) (211)
------------------------------------
Total non-interest income 2,135 4,497 4,368
------------------------------------
Non-interest expense:
Salaries and related benefits 7,330 8,325 9,858
Occupancy expense 10 2,121 2,054 2,061
Professional fees 3,071 2,326 3,426
Litigation settlement and reserve 3,601 -- --
Equipment expense 564 849 937
FDIC insurance premiums 633 849 816
Data processing 439 457 478
Loss on sale of Sacramento Branch -- 420 --
Marketing 369 71 379
Insurance premiums 189 97 251
Telephone 155 314 274
Other operating expenses 1,419 1,876 2,496
------------------------------------
Total operating expenses 19,891 17,638 20,976
Net cost of real estate operations 19,127 4,126 8,721
------------------------------------
Total non-interest expense 39,018 21,764 29,697
------------------------------------
Loss before income taxes (32,894) (10,086) (22,567)
Provision (benefit) for income taxes 13 142 169 (390)
------------------------------------
Net loss $(33,036) $(10,255) $ (22,177)
====================================
Loss per share:
Weighted average shares outstanding 3,078,303 445,064 265,718
Net loss $(10.73) $(23.00) $(83.60)
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
-50-
<PAGE> 53
THE SAN FRANCISCO COMPANY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992
<TABLE>
<CAPTION>
Employee Unrealized
Purchase Loss on Total
Additional and Securities Share-
Preferred Common Paid-in Retained Option Available- Holders
(Dollars in Thousands) Stock Stock Capital (Deficit) Plans for-Sale Equity
--------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balances at January 1, 1992 $ 3,000 $ 1 $16,291 $ (2,669) $ (442) $ -- $16,181
Net change in employee stock
ownership plans -- -- (4) -- 176 172
Conversion of stock (2,884) -- 2,884 -- -- --
Net proceeds from sale of stock 6,000 3 14,782 -- -- 20,785
Conversion of subordinated debt -- -- 715 -- -- 715
Net loss -- -- -- (22,177) -- (22,177)
--------------------------------------------------------------------------
Balances at December 31, 1992 6,116 4 34,668 (24,846) (266) -- 15,676
Net change in employee stock
ownership plans -- -- (6) -- 100 94
Net proceeds from sale of stock 12,000 -- -- -- -- 12,000
Unrealized loss on securities
available-for-sale -- -- -- -- -- (60) (60)
Net Loss -- -- -- (10,255) -- -- (10,255)
--------------------------------------------------------------------------
Balances at December 31, 1993 $18,116 4 34,662 (35,101) (166) (60) 17,455
Net change in employee stock
ownership plans -- -- -- -- 96 -- 96
Conversion of preferred stock
to common stock (18,002) 18 17,984 -- -- -- --
Net proceeds from sale of stock -- 36 17,524 -- -- -- 17,560
Redemption of fractional shares -- -- (2) -- -- -- (2)
Appreciation in market value of
securities available-for-sale -- -- -- -- -- 56 56
Net loss -- -- -- (33,036) -- -- (33,036)
--------------------------------------------------------------------------
Balances at December 31, 1994 $114 $ 58 $70,168 $(68,137) $ (70) $ (4) $ 2,129
==========================================================================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
-51-
<PAGE> 54
SAN FRANCISCO COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992
<TABLE>
<CAPTION>
(Dollars in Thousands) 1994 1993 1992
--------------------------------------
<S> <C> <C> <C>
Cash Flows from Operating Activities:
Net loss $(33,036) $(10,255) $(22,177)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Provision for loan losses 3,799 3,554 9,828
Depreciation and amortization expense 660 770 990
Provision for other real estate owned and real estate investment 17,074 2,629 4,917
Loss on investment securities held-for-sale -- 67 235
Loss on sale of investment securities available for sale 265 -- --
Loss on sale of investment securities held-to-maturity prior to maturity 14 -- --
Decrease in mortgage loans held-for-sale -- -- 6,826
Decrease in interest receivable 126 539 1,078
Decrease in interest payable (143) (213) (362)
Decrease in deferred loan fees (162) (313) (299)
Deferred income tax expense (benefit) -- -- 528
--------------------------------------
Net cash flows provided by (used in) operating activities (11,403) (3,222) 1,564
--------------------------------------
Cash Flows from Investing Activities:
Proceeds from maturities of investment securities held-to-maturity 7,516 28,200 1,608
Sale of investment securities held-to-maturity prior to maturity 2,344 -- --
Purchase of investment securities held-to-maturity (12,719) (29,404) (3,242)
Proceeds from sales of investment securities available-for-sale 19,402 24,472 21,533
Purchase of investment securities available-for-sale (8,492) -- --
Purchase of investment securities held-for-sale -- (20,808) (20,042)
Proceeds from maturities of investment securities available-for-sale 1,610 -- --
Capital expenditures for real estate owned (575) (3,790) (1,358)
Net decrease in loans 39,101 51,253 29,745
Loans sold in sale of branch -- 27,934 --
Recoveries of loans previously charged off 1,347 159 226
Purchases of premises and equipment (64) (124) (159)
Premises and equipment sold in sale of branch -- 350 --
Decrease in other assets sold in sale of branch -- 201 --
Proceeds from sales of real estate investments 4,700 7,563 10,500
Net decrease in other assets 1,165 1,152 3,155
--------------------------------------
Net cash provided by investing activities 55,335 87,158 41,966
--------------------------------------
Cash Flows from Financing Activities:
Net decrease in deposits (62,963) (42,459) (87,514)
Net increase (decrease) in other borrowings 2,859 (14,005) 4,640
Deposits sold in sale of branch -- (33,115) --
Net increase (decrease) in other liabilities 1,426 (121) 361
Net proceeds from sale of preferred stock -- 12,000 6,000
Net proceeds from sale of common stock 17,560 -- 14,793
Net proceeds from issuance of subordinated debt -- -- 715
--------------------------------------
Net cash used in financing activities (41,118) (77,700) (61,005)
--------------------------------------
Increase (decrease) in cash and cash equivalents 2,814 6,236 (17,475)
Cash and cash equivalents at beginning of year 25,833 19,597 37,072
--------------------------------------
Cash and cash equivalents at end of year $28,647 $25,833 $19,597
======================================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements. (continued)
-52-
<PAGE> 55
THE SAN FRANCISCO COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992
(continued)
<TABLE>
<CAPTION>
(Dollars in Thousands) 1994 1993 1992
-------------------------------------
<S> <C> <C> <C>
Supplemental Disclosure of Cash Flow Information:
Cash paid during the year for:
Interest $ 5,006 $7,632 $11,666
Income taxes 142 106 65
Supplemental Schedule of Noncash Investing and Financing Activities:
Net transfer of loans to other real estate owned 587 2,943 5,967
Conversion of subordinated debt to common stock -- -- 715
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
-53-
<PAGE> 56
THE SAN FRANCISCO COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1994 AND 1993
Note 1: Statement of Accounting Policies
Organization
The San Francisco Company (Company) formerly the Bank of San Francisco
Company Holding Company is a Delaware corporation and a bank holding company
registered under the Bank Holding Company Act of 1956, as amended. The Company
was organized in 1981 under the laws of the State of California. In July 1988,
the Company changed its state of incorporation from California to Delaware by
means of a merger of the Company into a newly formed wholly owned Delaware
subsidiary. Bank of San Francisco (Bank), a state chartered bank, was organized
as a California banking corporation in 1978 and became a wholly owned subsidiary
of the Company through a reorganization in 1982.
The Bank and Bank of San Francisco Realty Investors (BSFRI) acquired
partnership interests of 34.5% and 2.5%, respectively, in Bank of San Francisco
Building Company (BSFBC), a California limited partnership which holds the
leasehold interest in the Company's headquarters building located at 550
Montgomery Street, San Francisco, California. The Company accounts for its
investment in BSFBC using the equity method.
Principles of Consolidation
The accompanying financial statements include the accounts of the Company,
the Bank, and the Bank's wholly owned subsidiary, BSFRI, formerly BSF Equities.
All material intercompany transactions have been eliminated in consolidation.
Other ventures and partnerships in which the Company or any of its
subsidiaries have a significant ownership interest are accounted for by the
equity method. These investments are recorded as real estate investments, and
gains or losses upon disposition of these investments are recorded in gain/loss
on sale of real estate.
Cash and Cash Equivalents and Statements of Cash Flows
Cash equivalents are defined as short-term, highly liquid investments both
readily convertible to known amounts of cash and so near maturity that there is
insignificant risk of changes in value because of changes in interest rates.
Generally, only investments with maturities of three months or less at the time
of purchase qualify as cash equivalents. Cash and cash equivalents include cash
and due from banks, time deposits with other financial institutions, and Federal
funds sold.
The Bank is required to maintain non-interest bearing cash reserves equal to
a percentage of certain deposits. In 1994 and 1993, the average reserve balances
outstanding were $2.8 million and $5.7 million, respectively. Generally, the
Bank does not maintain compensating balance arrangements.
Investment Securities
At December 31, 1993, the Company adopted Statement of Financial Accounting
Standards "Accounting for Certain Investments in Debt and Equity Securities"
(SFAS No. 115) which requires the classification of debt and equity securities
into one of three categories; held-to-maturity, trading, or available-for-sale.
The investments classified as held-to-maturity are carried at amortized cost
because management has both the intent and ability to hold these investments to
maturity. Investments classified as available-for-sale are carried at fair value
with any unrealized gains and loss included as a separate component of
shareholders' (deficit)/equity.
Investment securities include both debt and equity securities. At December
31, 1994, Bank maintained two securities portfolios; investment securities
held-to-maturity, and debt and equity securities available-for-sale. Investment
securities held-to-maturity are carried at amortized cost and discounts or
premiums are accreted or amortized to income over the expected term of the
investment based on prepayment assumptions. Discounts or
-54-
<PAGE> 57
premiums are adjusted periodically to reflect actual prepayment experience. The
gain or loss on all investment securities sold is determined based on the
specific identification method. The estimated fair value is based on market
price.
Loans Receivable
Loans are stated at the principal amount outstanding, net of the allowance
for loan losses, deferred fees and unearned discount, if any. The Bank holds
loans receivable primarily for investment purposes. A significant portion of the
Bank's loan portfolio is comprised of adjustable rate loans.
Interest on loans is calculated using the simple interest method on the
daily balances of the principal amount outstanding. The accrual of interest is
discontinued and any accrued and unpaid interest is charged against current
income when the payment of principal or interest is 90 days past due, unless the
amount is well-secured and in the process of collection. Subsequent interest
payments on loans in non-accruing status are recorded as a reduction of the loan
balance. Interest payments received on loans for which the future collection of
the recorded principal is probable are recognized as interest income.
Lease financing receivables, net of unearned income, are included in loans.
Unearned income and residual values related to lease financing receivables are
recognized in income over the life of the lease under a method that yields an
approximately level rate of return on the unrecovered lease investment.
Loan Fees
The Bank charges nonrefundable fees for originating loans. Loan origination
fees, net of the direct costs of underwriting and closing the loans, are
deferred and amortized to interest income using the interest method. Unamortized
net fees and costs on loans sold or paid in full are recognized as income. Other
loan fees and charges, which represent income from delinquent payment charges,
and miscellaneous loan services, are recognized as interest income when
collected.
Allowance for Loan Losses
The Company records a provision for estimated losses on loans receivable
considering both specifically identified problem loans and credit risks not
specifically identified in the loan portfolio. The allowance for loan losses
takes into consideration numerous factors including the financial condition of
the borrowers, the fair value of the collateral prior to the anticipated date of
sale, delinquency trends, collateral concentrations and past loss experience.
Losses are recognized as charges to the allowance when the loan is
considered uncollectible or at the time of foreclosure. Recoveries on loans
receivable previously charged off are credited to allowance for loan losses.
Premises and Equipment
Premises and equipment are stated at historical cost less accumulated
depreciation and amortization. Depreciation on furniture, fixtures and equipment
is computed on the straight-line method over the estimated useful life of each
type of asset. Estimated useful lives are from three to seven years. Leasehold
improvements are amortized over the term of the applicable lease or their
estimated useful life, whichever is shorter.
Real Estate Investments
The Company, through BSFRI, has acquired property for development and sale
and has made investments in joint ventures and partnerships. Real estate
acquired for development and sale is recorded at the lower of cost (adjusted for
subsequent development costs) or fair value net of estimated selling costs.
Interest costs are capitalized when properties are in the development stage.
Investments in real estate joint ventures and partnerships are reported using
the equity method of accounting.
-55-
<PAGE> 58
Other Real Estate Owned
Other real estate owned (OREO) includes loans receivable that have either
been repossessed in settlement of debt (foreclosures) or substantially
repossessed ("in-substance foreclosures"). In-substance foreclosures occur when
the market value of the collateral is less than the legal obligation of the
borrower and the Bank expects the payment of the loan to come only from sale of
the collateral. At the date of transfer, OREO is recorded at fair value net of
estimated selling costs.
The Company provides a charge against current earnings for estimated losses
on foreclosed property when the carrying value of the property exceeds its fair
value net of estimated selling expenses. The Bank obtains an appraisal or market
valuation analysis on all other real estate owned periodically. If the periodic
valuation indicates a decline in the fair value below recorded carrying value,
an allowance for OREO losses is established. Fair value is based on current
market conditions, appraisals, and estimated sales values of similar properties,
net of estimated selling and other expenses.
Other Assets
Other assets include equipment owned by the Bank and leased to third
parties under an operating lease which is stated at cost less accumulated
depreciation. Depreciation is computed using a straight-line method over five
years.
Income Taxes
Prior to 1987, the Company filed consolidated Federal income and combined
California franchise tax returns, using the cash method of accounting. Beginning
in 1987, as required by the Tax Reform Act of 1986, the Company filed
consolidated tax returns using the accrual method of accounting.
Effective January 1, 1993, the Company changed its method of accounting for
income taxes to adopt Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes" (SFAS No. 109). Under the asset and liability
method prescribed by SFAS No. 109, deferred tax assets and liabilities are
recognized for the future tax consequences of differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases (temporary differences). 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 rate is recognized in income in the period of enactment.
Under SFAS No. 109, deferred tax assets are recognized for deductible
temporary differences and operating loss and tax credit carryforwards, and then
a valuation allowance is established to reduce that deferred tax asset if it is
"more likely than not" that the related tax benefits will not be realized. The
adoption of SFAS No. 109 did not have a material impact on the Company's January
1, 1993 net deferred tax asset. Additionally, the adoption of this accounting
method did not have a material impact on tax expense and net income for 1994 and
1993.
Non-Interest Income
Fees for other customer services represent fees earned for the brokerage of
certificates of deposit and commissions earned in connection with the Bank's
stock option lending program and other banking services. Fees for services are
recorded as income when the services are performed.
Loss per Share
Loss per share is calculated using the weighted average number of common
shares outstanding divided into net loss. The conversion of the Series C
Preferred Shares and warrants are included in the calculations of loss per share
for 1994 effective from the date of conversion.
-56-
<PAGE> 59
Recent Accounting Pronouncements
In October 1994, Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) no. 119, Disclosure About
Derivative Financial Instruments and Fair Value of Financial Instruments. The
provisions of SFAS No. 119 are effective for the Company and the Bank as of
December 31, 1995. SFAS No. 119 required disclosure about derivative financial
instruments -- futures, forwards, swap and option contracts, and other financial
instruments with similar characteristics. As of December 31, 1994, the Company
and the Bank had no derivative financial instruments that would be subject to
such disclosure.
In 1993, the FASB issued SFAS No. 114 "Accounting by Creditors for
Impairment of a Loan". This Statement required that impaired loans be measured
based on the present value of expected future cash flows discounted at the
effective rate of the loan's observable market price or the fair market value of
the collateral if the loan is collateral dependent. This Statement applies to
financial statements for fiscal years beginning after December 31, 1994. In
October 1994, the FASB issued SFAS No. 118 "Accounting by Creditors for
Impairment of a Loan-Income Recognition and Disclosures". SFAS No. 118 amends
SFAS No. 114 to allow a creditor to use existing methods for recognizing
interest income on an impaired loan. SFAS No. 118 is effective concurrent with
the effective date of SFAS No. 114. The Company elected not to implement SFAS
No. 114 and 118 for the period ended December 31, 1994. It has been determined
that the effect of SFAS No. 114 and 118 on the Company's financial statements
would not have been material had the Company implemented SFAS No. 114 and 118 as
of December 31, 1994.
Reclassifications
Certain reclassifications have been made in the prior years' consolidated
financial statements to conform to current year presentation.
Note 2: Regulatory Orders and Going Concern Considerations
The Company
On December 16, 1994, the Company and the Federal Reserve Bank of San
Francisco (FRB) entered into a Written Agreement (the "Agreement") that
supersedes the previous directive dated April 20, 1992. The Agreement prohibits
the Company, without prior approval of the FRB, from: (a) paying any cash
dividends to its shareholders; (b) directly or indirectly, acquiring or selling
any interest in any entity, line of business, problem or other assets; (c)
executing any new employment, service, or severance contracts, or renewing or
modifying any existing contracts with any executive officer; (d) engaging in any
transactions with the Bank that exceeds an aggregate of $20,000 per month; (e)
engaging in any cash expenditures with any individual or entity that exceeds
$25,000 per month; (f) increasing fees paid to any directors for attendance at
board or committee meetings, or paying any bonuses to any executive officers;
(g) incurring any new debt or increasing existing debt; and (h) repurchasing any
outstanding stock of the Company. The Company is required to submit a progress
report to the FRB on a quarterly basis.
The Company was also required to submit to the FRB an acceptable written
plan to improve and maintain adequate capital position, a comprehensive
business plan concerning current and proposed business activities, a
comprehensive operating budget at the Bank and the consolidated organization.
In addition, the Board of Directors was required to submit an acceptable
written plan designed to enhance their supervision of the operations and
management of the consolidated organization. The Company has filed all of the
required submissions with the FRB in accordance with the Agreement.
-57-
<PAGE> 60
The Bank
Capital Orders
On March 24, 1995, the State Banking Department (SBD) issued an order
for the Bank to increase its level of capital. The capital order requires that
the Bank increase its capital by $4.2 million on or before April 10, 1995 and by
a minimum of $10.5 million (including the first installment of $4.2 million) on
or before June 30, 1995. The second installment must be at least equal to the
amount of capital necessary to increase the shareholder's equity to not less
than 7.0% of total tangible assets as of February 28, 1995. No assurances were
given that the SBD would refrain from taking action against the Bank until the
deadlines specified have passed.
On March 28, 1995, the Federal Deposit Insurance Corporations (FDIC) issued
a Notification of Capital Category ("Notification") in accordance with Prompt
Corrective Action regulations. The FDIC has determined that the Bank is
Critically Undercapitalized. On the date of the Notification the Bank became
subject to certain mandatory requirements including submission of a capital
restorations plan and restrictions on asset growth, acquisitions, new
activities, new branches, payment of dividends or making any other capital
distribution, management fees, and senior executive compensation. Prior to the
Notification, the Bank was subject to the Orders to Cease and Desist (Orders),
as described below, which included these limitations. In addition, immediately
upon receiving notice, the Bank must obtain FDIC's prior written approval before
entering into any material transaction other than in the usual course of
business, extending any credit for any highly leveraged transactions, as defined
by regulation, amending the Bank's charter or bylaws, except to the extent
necessary to carry out any other requirement of any law, regulation, or order,
making any change in accounting methods, engaging in any covered transaction as
defined in section 23A(b) of the Federal Reserve Act, pay excessive compensation
or bonuses, paying interest on new or renewed liabilities at a rate that would
increase the Bank's weighted average cost of funds to a level significantly
exceeding the prevailing rates of interest on insured deposits in the Bank's
normal market area, and making any principal or interest payment on subordinated
debt.
Orders to Cease and Desist
On August 18, 1993, the Bank stipulated to Orders to Cease and Desist
(Orders) issued jointly by the FDIC and the SBD, whereby the Bank agreed to
correct alleged unsafe and unsound practices disclosed in the FDIC and SBD
Reports of Examination as of November 30, 1992. The Orders supersede the
Memorandum of Understanding that the Bank had been operating under since
November 15, 1991. As a result of the Orders, the Bank is classified as a
"troubled institution" by the FDIC.
The Orders, which became effective on August 29, 1993, require that the
Bank: (a) achieve and maintain a 7% leverage capital ratio on and after
September 30, 1993; (b) pay no dividends without the prior written consent of
the FDIC and the California Superintendent of Banks (the "Superintendent"); (c)
reduce the $88.6 million in assets classified "Substandard" or "Doubtful" as of
November 30, 1992 (the date of the most recent full-scope FDIC and SBD Report of
Examination of the Bank), to no more than $40.0 million by August 31, 1994; (d)
have and retain management whose qualifications and experience are commensurate
with their duties and responsibilities to operate the Bank in a safe and sound
manner, notify the FDIC and the Superintendent at least 30 days prior to adding
or replacing any new director or senior executive officer and comply with
certain restrictions in compensation of senior executive officers; (e) maintain
an adequate reserve for loan losses; (f) not extend additional credit to, or for
the benefit of, any borrower who had a previous loan from the Bank that was
charged off or classified "Loss" in whole or in part; (g) develop and implement
a plan to reduce its concentrations of construction and development loans; (h)
not increase the amount of its brokered deposits above the amount outstanding on
the Orders Effective Date ($20.0 million) and submit a written plan for
eliminating reliance on brokered deposits; (i) revise or adopt, and implement,
certain plans and policies to reduce the Bank's concentration of construction
and land development loans, reduce the Bank's dependency on brokered deposits
and out of area deposits, and to improve internal routines and controls; (j)
reduce the Bank's volatile liability dependency ratio to not more than 15% by
March 31, 1994; (k) eliminate or correct all violations of law set out in the
most recent Report of Examination, and take all necessary steps to ensure future
compliance with all applicable laws and regulations; and (l) establish a
committee of three independent directors to monitor compliance with the Orders
and report to the FDIC and the Superintendent on a quarterly basis.
-58-
<PAGE> 61
Failure to comply with the above Orders could result in the termination of
the Bank's federal deposit insurance, imposition of civil money penalties
against the Bank or other responsible parties, or possession of the Bank's
property and business and ultimate liquidation thereof by the SBD.
As of December 31, 1994, the Bank failed to meet industry-wide capital
requirements and to meet the 7% leverage capital ratio imposed by the Orders
primarily because of the continued losses incurred as a result of problem
assets. As to the other requirements of the Orders and the Restoration Plan, the
Bank believes that the findings of the FDIC and SBD at its recent examination
which began January 30, 1995 will be that the Bank is not in compliance with
substantial requirements of the Orders including the SBD's order requiring the
Bank to correct its capital impairment. However, no Report of Examination has
been received from the FDIC and the SBD as a result of their recent examination
of the Bank. In addition, because of its asset quality, continued operating
losses, volatile liability dependency and liquidity problems, the Bank is
potentially subject to further regulatory sanctions that are generally
applicable to banks that are critically undercapitalized.
In response to the Orders and Prompt Correction Action regulations,
management has submitted a 1995 Business and Profit Plan to the FDIC and the SBD
for approval. It is expected that the business plan will be acceptable to the
FDIC and the SBD after the receipt of additional capital. Management believes
that the Bank will be able to take the actions contemplated by such plan without
need for further FDIC approval, subject to the general requirement that the Bank
return to profitability and be operated safely and soundly. A number of the
restrictions imposed by the Orders will remain in effect until the Orders are
officially lifted. Although management anticipates the FDIC and the SBD will
lift the Orders if the Bank's problem assets are fully resolved, no assurance
can be given as to when all conditions precedent to the lifting of the Orders
will be fulfilled. The Company also is subject to certain restrictions imposed
by the FRB pursuant to the Agreement that may prevent the Company from taking
steps to establish new businesses (or new subsidiaries) at the Company level
until similar conditions precedent are fulfilled.
Prompt Corrective Action
The Bank's failure to meet minimum regulatory requirements as of
December 31, 1994, resulted in the imposition of operating restrictions pursuant
to the prompt corrective action provisions of FDIC Improvement Act (FDICIA). In
accordance with FDICIA, the Bank submitted a capital restoration plan (Plan) for
meeting regulatory capital requirements. The Plan has not been approved. In
addition, in 1993 the Company agreed to guarantee that the Bank will comply with
the previously filed capital restoration plan until the Bank has met its minimum
capital requirements on average during each of four consecutive calendar
quarters. The Company agreed to guarantee the Bank's performance under the Plan
for up to five percent (5%) of the Bank's assets or the amount needed to bring
the Bank into compliance. The Company's guarantee will remain in effect until
the Bank maintains compliance with the minimum capital ratio requirements for
four consecutive calendar quarters.
Failure to maintain minimum capital requirements or to implement the Plan
can result in the imposition of additional restrictions upon the Bank's
activities including increased supervision and ultimately regulatory takeover.
Impairment Orders
Under California law, if a bank's deficit retained earnings exceed 40% of
its contributed capital, its capital is deemed to be impaired, and the bank is
required to levy an assessment on its shares to correct the impairment. The SBD
has issued six impairment orders to the Bank, with the most recent dated
February 1, 1995 (the "Impairment Orders"). At December 31, 1994, the Bank had
contributed capital of $66.2 million and deficit retained earnings of $64.6
million.
The Impairment Orders require the Bank to correct the impairment within 60
days by levying an assessment on the Company as the Bank's sole shareholder. The
Bank has not levied an assessment against its shares nor has it otherwise
corrected the impairment, and, therefore, is in violation of this law. In
addition, the SBD has specifically reserved the right to take such other action
as the Superintendent may deem appropriate or necessary, which may include
taking possession of the Bank's property and business, including ultimately
liquidating the business and affairs of the Bank.
-59-
<PAGE> 62
The Company plans to correct the Bank's capital impairment by requesting the
SBD to approve a quasi-reorganization of the Bank. In a quasi-reorganization,
the Bank's retained deficit would be reduced or eliminated by netting
the retained deficit against contributed capital. Management believes that
approval for such a quasi-reorganization would only be granted by the SBD upon
the Bank raising sufficient additional capital for the Bank to sustain
profitable operations and meet all of its regulatory capital requirements in the
future. Should the SBD deny approval for a quasi-reorganization of the Bank, the
Bank would be required to raise additional new capital of $95.2 million, to
cure the capital impairment at December 31, 1994. Any operating losses
thereafter would further impair the Bank's capital and give rise to further
capital assessments.
No assurance can be given that the Bank's capital condition will not
deteriorate further prior to any such quasi-reorganization as a result of
operating losses. In addition, because a quasi-reorganization requires that the
Bank adjust its assets and liabilities to market value at the time of the
reorganization, the Bank's capital could be further reduced from its present
level. Finally, there can be no assurance given that, following a correction of
the Bank's capital impairment, whether through a quasireorganization or an
infusion of sufficient capital, the Bank's capital position will not continue to
erode through future operating losses.
Going Concern Considerations
During the period 1991 through 1994, the Company suffered an aggregate of
$74.6 million in losses, primarily as a result of defaulted loans secured by
real estate and losses on direct real estate development activities. The Company
and the Bank succeeded in avoiding insolvency during this period only through
the injection of a total of $52.0 million of new capital by the Company's
controlling stockholder. The Company's and the Bank's recurring losses from
operations, noncompliance with minimum regulatory capital requirements, the
negative capital position, the Bank's designation as a critically
undercapitalized institution by the FDIC, and the Bank's noncompliance with the
Orders and Impairment Order raise substantial doubt about the Company's ability
to continue as a going concern.
The ability of the Company to continue as a going concern is dependent upon
many factors, including increasing and maintaining its capital ratios, obtaining
additional capital contributions and returning the Company to profitable
operations. In response to these problems, the Company and the Bank have
developed a business strategy and capital plan to raise new capital and return
the Company and the Bank to profitability. The Company intends to raise
additional capital in 1995 and contribute that capital to the Bank. If the
Company does not succeed in raising new capital, termination of the Bank's FDIC
insurance is likely.
Note 3: Subsequent Event -- Capital Contribution
In April 1995, the Company received a commitment from its majority
shareholder for $3.8 million in capital, expected by April 24, 1995. The
Company intends to contribute a total of $4.2 million in capital to the Bank
upon receipt of the $3.8 million. The following table reflects both the
Company's and Bank's capital ratios with respect to minimum capital
requirements in effect as of December 31, 1994 giving effect to the capital
commitment.
<TABLE>
<CAPTION>
Minimum
Capital
Company Bank Requirement Orders
-----------------------------------------------------------
<S> <C> <C> <C> <C>
Leverage ratio 3.4% 3.4% 4.0% 7.0%
Tier 1 risk-based capital 4.5 4.4 4.0 N/A
Total risk-based capital 6.0 5.9 8.0 N/A
</TABLE>
-60-
<PAGE> 63
Note 4: Investment Securities Held-to-Maturity
The carrying and estimated market values of investment securities
held-to-maturity at December 31 are as follows:
<TABLE>
<CAPTION>
Carrying Unrealized Unrealized Market
(Dollars in Thousands) Value Gains Losses Value
----------------------------------------------
<S> <C> <C> <C> <C>
1994:
U.S. Treasury and agency securities $7,859 $ -- $ (23) $7,836
Federal Home Loan Bank stock 1,337 -- -- 1,337
----------------------------------------------
Total $9,196 $ 0 $ (23) $9,173
==============================================
1993:
U.S. Treasury and agency securities $4,082 $ 2 $ (1) $4,083
Collateralized mortgage obligation (CMO) 996 1 -- 997
Federal Home Loan Bank stock 1,273 -- -- 1,273
----------------------------------------------
Total $6,351 $ 3 $ (1) $6,353
==============================================
</TABLE>
At December 31, 1994 and 1993, $2.5 million and $2.1 million, respectively,
of securities were pledged as collateral for treasury, tax, loan deposits,
public agency, bankruptcy and trust deposits. At December 31, 1994 and 1993, the
Company had no securities sold under agreements to repurchase.
The average yield on investments securities was 4.6% and 3.6% at December
31, 1994 and 1993, respectively. U.S. Treasury and agency securities held by the
Company have maturities of less than one year. The FHLB stock has no stated
maturity.
During 1994, the Bank reclassified collateralized mortgage obligations with
an amortized cost of $2.3 million to the availablefor-sale investment category
as a result of a change in the strategy regarding the investment in these types
of securities. The Bank recorded a loss of $14,000 on the transfer of securities
to the available-for-sale category.
Note 5: Investment Securities Available-for-Sale
The carrying and estimated market values of investment securities
available-for-sale at December 31 are as follows:
<TABLE>
<CAPTION>
Original Unrealized Unrealized Market
(Dollars in Thousands) Cost Gains Losses Value
------------------------------------------------
<S> <C> <C> <C> <C>
1994:
U.S. Treasury and agency securities $1,943 $ -- $ (2) $1,941
Collateralized mortgage obligation (CMO) 272 -- (2) 270
------------------------------------------------
Total $2,215 $ -- $ (4) $2,211
================================================
1993:
Mutual funds $15,000 $ -- $ (60) $14,940
================================================
</TABLE>
For 1994 and 1993, the Bank included an unrealized loss of $4,000 and
$60,000 as a separate component of stockholders' equity. U.S. Treasury and
agency securities and CMO held by the Company have maturities of less than one
year. The maturity on the CMO is estimated based on the prepayment experience of
similar investment securities.
The proceeds from sales of securities available for sale were $19.4
million at December 31, 1994. During 1994, the Bank recorded no gains, and
losses of $265,000 were realized.
-61-
<PAGE> 64
Note 6: Loans Receivable
The Bank's loan portfolios at December 31 are summarized as follows:
<TABLE>
<CAPTION>
(Dollars in Thousands) 1994 1993
-------------------------
<S> <C> <C>
Commercial and financial $83,141 $109,008
Real estate construction 9,004 14,023
Real estate mortgage 14,276 26,479
Net lease financing 31 230
-------------------------
Total loans 106,452 149,740
Deferred fees (388) (550)
Allowance for loan losses (6,576) (8,050)
-------------------------
Total loans, net $99,488 $141,140
=========================
</TABLE>
At December 31, 1994 and 1993, non-accrual loans totaled $9.4 million and
$11.1 million, respectively, and loans past due 90 days or more and still
accruing totaled $940,000 and $182,000, respectively. For the years ended
December 31, 1994, 1993 and 1992, interest income foregone on non-accrual loans
was $918,000, $797,000, and $713,000, respectively. Restructured loans totaled
$6.3 million and $2.0 million at December 31, 1994 and 1993, respectively. For
the years ended December 31, 1994, 1993 and 1992, interest income foregone on
restructured loans were $18,000, $166,000 and zero, respectively.
There were $9.4 million of fixed rate loans at December 31, 1994 with a
weighted average yield of 7.1%. Total fixed rate loans, most of which mature in
more than five years, comprised approximately 8.8% of the Bank's loan portfolio
at December 31, 1994.
The Company makes commercial and financial loans secured by real estate,
which are principally located in Northern California. At December 31, 1994 loans
secured by deeds of trust on property located in these areas represented 65.4%
of the Bank's loans. The primary source of repayment of commercial and financial
loans is the borrower's or property's debt service capacity while the secondary
source of repayment is the underlying real estate collateral.
At December 31, 1994, 8.5% of the Bank's loan portfolio was composed of
loans secured by properties that were under construction or contract for
construction.
Note 7. Allowance for Loan Losses
Changes in the Company's allowance for loan losses for the years ended
December 31 were as follows:
<TABLE>
<CAPTION>
(Dollars in Thousands) 1994 1993 1992
-----------------------------------
<S> <C> <C> <C>
Balances at beginning of the year $8,050 $8,400 $8,411
Additions to allowance for loan losses 3,799 3,554 9,828
Loans charged off (6,620) (4,063) (10,065)
Recoveries of loans charged off 1,347 159 226
-----------------------------------
Balances at end of the year $6,576 $8,050 $8,400
===================================
</TABLE>
-62-
<PAGE> 65
Note 8: Other Real Estate Owned
Other real estate owned (including in-substance foreclosures) at December 31
consist of the following:
<TABLE>
<CAPTION>
(Dollars in Thousands) 1994 1993
------------------------
<S> <C> <C>
Real Estate:
Residential $ 2,216 $ 3,695
Residential development 7,127 12,704
Commercial development 1,045 819
Land under development 2,543 1,632
Raw land 16,494 16,508
------------------------
Subtotal 29,425 35,358
Allowance for losses (19,404) (2,986)
------------------------
Total $10,021 $32,372
========================
</TABLE>
At December 31, 1994 and 1993, other real estate owned included $4.6 million
and $19.1 million, respectively, of in-substance foreclosed loans. For both
December 31, 1994 and 1993, other real estate owned was comprised of 18
properties, with the largest single property totaling $3.5 million.
The following table summarizes the other real estate owned loss experience
of the Bank for the periods shown:
<TABLE>
<CAPTION>
(Dollars in Thousands) 1994 1993 1992
-------------------------------------
<S> <C> <C> <C>
Balance of allowance for losses - beginning $2,986 $6,632 $1,672
Charge-offs (33) (6,982) (531)
Provision 16,451 3,336 $5,491
-------------------------------------
Balance of allowance for losses - ending $19,404 $2,986 $6,632
=====================================
</TABLE>
Note 9: Real Estate Investments
Real estate investments at December 31 consist of the following:
<TABLE>
<CAPTION>
(Dollars in Thousands) 1994 1993
----------------------
<S> <C> <C>
Residential development $ 507 $ 954
Commercial development 1,234 1,226
General and limited partnership investment in Bank premises 1,682 2,175
----------------------
Subtotal 3,423 4,355
Allowance for losses (1,059) (712)
----------------------
Total $2,364 $3,643
======================
</TABLE>
At December 31, 1994 and 1993, real estate investments included two
residential development properties, one commercial land available for
development, and the general and limited partnership investments in BSFBC. In
1994 and 1993, the Bank had losses of $264,000 and earnings of $263,000,
respectively from BSFBC.
-63-
<PAGE> 66
Note 10: Premises and Equipment
Premises and equipment at December 31 consist of the following:
<TABLE>
<CAPTION>
(Dollars in Thousands) 1994 1993
----------------------
<S> <C> <C>
Leasehold improvements $3,129 $3,103
Furniture and equipment 5,065 5,073
----------------------
Subtotal 8,194 8,176
Less: Accumulated depreciation and amortization (5,198) (4,584)
----------------------
Total $2,996 $3,592
======================
</TABLE>
The amount of depreciation and amortization included in non-interest expense
was $660,000, $770,000, and $990,000 in 1994, 1993 and 1992, respectively. Total
rental expense net of sublease income and other occupancy expenses for the
Company premises were $2.1 million in 1994, 1993 and 1992.
At December 31, 1994, the approximate future minimum rental payments under
non-cancelable operating leases, with remaining terms ranging from six months to
twenty-three years, for the Company's premises are as follows:
<TABLE>
<CAPTION>
(Dollars in Thousands) Amount
-----------
<S> <C>
1995 $ 1,697
1996 1,625
1997 1,950
1998 1,950
1999 1,950
Thereafter 53,908
-----------
Total $63,080
===========
</TABLE>
Lease payments are subject to rent adjustments every five years to reflect
changes in the consumer price index with a minimum increase of 20%. During 1994,
1993 and 1992, the Company received $169,000, $59,000 and $30,000 of sublease
income, respectively. The total future minimum rent payments to be received
under noncancellable operating subleases at December 31, 1994 were approximately
$354,000. These payments are not reflected in the above table.
Note 11: Deposits
Deposit balances by deposit programs offered by the Bank at December 31 are
as follows:
<TABLE>
<CAPTION>
1994 1993
------------------ --------------------
Average Average
(Dollars in Thousands) Balance Rate Balance Rate
------------------ --------------------
<S> <C> <C> <C> <C>
Demand deposit accounts $30,259 0.0% $ 34,859 0.0%
Savings and NOW accounts 43,415 2.4 35,050 2.5
Money market accounts 25,250 3.2 56,453 2.9
Time accounts 48,224 5.0 83,749 3.8
------------------ --------------------
Total $147,148 2.9% $210,111 2.6%
================== ====================
</TABLE>
Total deposit balances averaged $172.9 million and $264.7 million during
1994 and 1993, respectively, with average interest rates of 2.7% and 2.6%,
respectively. The weighted average stated rates on deposits as of December 31,
1994 and 1993 was 2.9% and 3.0%, respectively.
-64-
<PAGE> 67
Domestic time deposits in amounts of $100,000 or more by time remaining to
maturity at December 31 are as follows:
<TABLE>
<CAPTION>
(Dollars in Thousands) 1994 1993
-------------------
<S> <C> <C>
Three months or less $ 7,028 $27,765
Three months to six months 1,586 1,917
Six months to one year 1,216 1,674
Over one year 405 810
-------------------
Total $10,235 $32,166
===================
</TABLE>
Interest expense on time deposits in amounts of $100,000 or more was
$935,000, $2.0 million and $1.8 million in 1994, 1993, and 1992, respectively.
Time deposit accounts in amounts of $100,000 or more averaged $24.5 million and
$54.7 million during 1994 and 1993, respectively, with weighted average rates of
3.8% and 3.7%, respectively. The weighted average stated interest rate on such
deposits at December 31, 1994 and 1993 was 4.4% and 3.3%, respectively.
Brokered deposits totaled $19.7 million and $20.0 million, and money desk
deposits totaled $15.1 million and $41.5 million at December 31, 1994 and 1993,
respectively.
Note 12: Other Borrowings
Other borrowings at December 31 are as follows:
<TABLE>
<CAPTION>
Maximum
Balance Stated Average Average Balance
(Dollars in Thousands) Outstanding Rate Balance Rate Outstanding
--------------------------------------------------------------
1994:
<S> <C> <C> <C> <C> <C>
Borrowings for employee stock ownership plan $ 70 8.1% $ 83 6.8% $ 163
Mortgage indebtedness -- -- 629 10.0 1,141
Securities sold under agreements to repurchase 4,000 5.8 639 5.3 11,201
Other borrowings - FHLB line of credit -- -- 1,359 5.0 9,800
--------------------------------------------------------------
Total $ 4,070 5.8% $ 2,710 6.4% $22,305
==============================================================
1993:
Borrowings for employee stock ownership plan $ 162 5.7% $ 213 5.7% $ 255
Mortgage indebtedness 1,141 10.0 703 9.5 1,813
Securities sold under agreements to repurchase -- -- 1,917 3.7 11,201
Other borrowings - FHLB line of credit -- -- 3,975 3.4 9,800
--------------------------------------------------------------
Total $ 1,303 9.5% $ 6,808 4.3% $23,069
==============================================================
</TABLE>
The terms of the borrowings outstanding at December 31, 1994 provide for the
repayment of $4.1 million in 1995. The securities pledged under the agreement to
resell are held in safe keeping by an unrelated third party.
The Bank has an approved FHLB line of credit, of which $5.5 million was
available at December 31, 1994, based on the collateral pledged. At December 31,
1994 and 1993, $11.4 million and $6.4 million of loans and securities are
pledged as collateral against other borrowings. The Bank is required to hold
FHLB stock as a condition for maintaining its line of credit.
The Bank's other borrowings included senior liens of other real estate
owned. The rates and terms of these borrowings vary. As of December 31, 1994,
there was no outstanding balance in real estate owned securing the senior liens.
-65-
<PAGE> 68
Note 13: Income Taxes
The provision (benefit) for Federal and state income taxes consists of:
<TABLE>
<CAPTION>
(Dollars in Thousands) 1994 1993 1992
----------------------------------
<S> <C> <C> <C>
Current:
Federal $ -- $ -- $(968)
State 142 169 50
----------------------------------
Total current 142 169 (918)
----------------------------------
Deferred:
Federal -- -- 528
State -- -- --
----------------------------------
Total deferred -- -- 528
----------------------------------
Total provision (benefit) for income taxes $ 142 $ 169 $(390)
==================================
</TABLE>
The provision for state taxes for 1994, 1993 and 1992 consists of the
minimum amount of franchise taxes due.
In 1992, during which period the Company accounted for income taxes under
the deferred method as described in APB Opinion No. 11, deferred taxes arose
from timing differences in the recognition of revenues and expenses for tax and
financial reporting purposes. The tax effects of the principal items resulting
in deferred tax expense (benefit) were the difference between:
<TABLE>
<CAPTION>
(Dollars in Thousands) 1992
-------------
<S> <C>
Accrual and cash basis income $(127)
Book and tax provision for loan losses 648
Book and tax depreciation (111)
Book and tax treatment of leases (13)
Book and tax recognition of rehabilitation tax credit (153)
Book and tax treatment for provision for 351 California lease 47
Book and tax treatment for other real estate owned 243
Other, net (6)
-------------
Total $528
=============
</TABLE>
-66-
<PAGE> 69
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets and deferred tax liabilities at December 31,
1994 and 1993 are presented below:
<TABLE>
<CAPTION>
(Dollars in Thousands) 1994 1993
-------------------------
<S> <C> <C>
Deferred Tax Assets:
Book loan loss reserve in excess of tax $ 2,213 $ 2,348
Other provisions 256 376
Provision for losses for real estate 9,164 2,212
Net operating losses 15,120 9,100
Tax credits 489 489
Difference in recognition of income from partnerships 63 23
Income recognized on leased property 1,832 1,772
Capitalized costs 391 390
Other 131 93
-------------------------
Total deferred tax assets 29,659 16,803
Valuation allowance (27,534) (14,341)
-------------------------
Total deferred tax assets, net 2,125 2,462
-------------------------
Deferred Tax Liabilities:
Net book value of premises and equipment in excess of tax (1,608) (1,751)
Loan origination costs (116) (223)
Difference in recognition of income from partnerships -- (43)
State tax -- (28)
Taxable income in excess of book for rehabilitation credit (401) (417)
-------------------------
Total deferred tax liabilities (2,125) (2,462)
-------------------------
Net deferred taxes $ -- $ --
=========================
</TABLE>
The Bank provided a valuation allowance for deferred tax assets as the
utilization of the net operating loss carryforwards and rehabilitation and
minimum tax credit carryforwards may be limited on an annual basis under current
tax law due to the change in ownership in 1992 and possible changes in ownership
in future years.
The total tax provision (benefit) differs from the statutory Federal rates
for the reasons shown in the following table:
<TABLE>
<CAPTION>
1994 1993 1992
-----------------------------------
<S> <C> <C> <C>
Tax benefit at the statutory federal rate (34.0)% (34.0)% (34.0)%
Limitation on utilization of net operating loss carryback due to
tax rate differential, alternative minimum tax and
utilization of prior taxable income 34.0 34.1 32.0
State income taxes, net of federal tax benefit 0.4 1.7 0.2
Non-deductible expenditures and non-taxable income -- (0.1) 0.1
-----------------------------------
Total effective tax provision (benefit) rate 0.4% 1.7% (1.7)%
===================================
</TABLE>
At December 31, 1994 and 1993, there is no deferred income tax receivable.
The tax benefits reported in 1992 were attributable to the Company's ability
to carryback net operating losses for 1992 against net operating income of prior
periods. Because the Company has utilized all of its ability to carryback net
operating losses, much of the 1994, 1993, and 1992 losses, and future losses, if
any, must be carried forward to offset future net operating income. In addition,
the actual benefit rate may be less than the current statutory rate due to tax
differentials and the alternative minimum tax. As of December 31, 1994, the
Company has net operating loss carryforwards for federal tax purposes of
approximately $39.0 million which expire in 2007 and onwards, and for California
tax purposes of approximately $24.0 million, which expire in 1997, 1998, and
1999. The Company has rehabilitation tax credits carryforwards for federal tax
purposes of approximately $250,000, which expire in 2004 and 2005. In addition,
the Company has minimum tax credits of approximately $230,000 which have no
expiration.
-67-
<PAGE> 70
Note 14: Shareholders' Equity (See Note 2: Impairment Orders)
The capital infusion by the Company's controlling stockholder in 1994, 1993
and 1992 was $20.0 million, $12.0 million and $20.0 million, respectively. The
capital for 1994 was raised from the issuance of 3,521,126 shares of Class A
common stock at $5.68 per share. The capital for 1993 and 1992 was raised from
the issuance of shares of Series C Perpetual Preferred Shares (Series C
Preferred Shares) at twenty dollars ($20.00) per share. The Series C Preferred
Shares were converted in to Class A Common shares in 1994.
Description of Capital Stock
The authorized capital stock of the Company consists of 40,000,000 Class A
Shares, par value $0.01 per share and 2,500,000 shares of preferred stock, par
value $0.01 per share, of which 437,500 are designated as Series B Preferred
Shares. The remainder are not designated.
In accordance with the Agreement and the Orders, the Company and the Bank
are prohibited from paying dividends without the prior written consent or
approval of the FDIC, the Superintendent of Banks and the Federal Reserve Bank
of San Francisco.
On July 25, 1994, the Company issued 3,521,126 shares of Class A Common
Stock, and warrants to purchase an additional 3,521,126 shares with an exercise
price for each share of $10.00 to its principal shareholder in its closing of a
private stock offering for $20.0 million in capital. The price per unit was
$5.68. Each unit sold under the private placement includes a Risk Protection
Right (RPR). Under the RPR, additional Class A Common Stock will be issued to
the holder of each RPR if a net loss is incurred on certain specified assets or
as the result of losses, incurred related to certain litigation actions. The RPR
will effectuate this risk allocation by compensating the holder with additional
shares of Class A Common Stock (Adjustment Shares) up to a maximum number of
shares per RPR without the payment of additional consideration. This
compensation will be effected through periodic distributions of Adjustment
Shares. Adjustment Shares will be issued to compensate for net Losses, net
charge-offs and expenses on certain specified assets (Specified Assets) and the
lawsuit that was settled for $2.0 million during July 1994 up to a cumulative
amount of $16.0 million. The maximum number of Class A Common shares to be
issued is 9,723,000. As a result of the losses incurred in 1994, the maximum
number of Adjustment Shares would have been issued at December 31, 1994 as a
result of the losses incurred in 1994.
Description of Class A Common Stock
As of December 31, 1994 there were 5,766,008 Class A Shares outstanding out
of a total of 40,000,000 shares authorized. During 1994, the Shareholders of
Company approved to reclassification of all Class B Common Stock as and into
class A Common Stock. The Series B Preferred Shares, which were convertible into
shares of the Class B Common Stock at the option of the holders thereof are now
convertible to Class A Common Stock. The reclassification is not deemed by the
Company to alter or change any of the relative powers, preferences or special
rights of the holders of the Class B Preferred Stock.
Dividends
Subject to the rights and preferences of any preferred stock outstanding,
each Class A Share Common Stock is entitled to receive dividends if, as and when
declared by the Board of Directors of the Company. Subject to the rights of the
Series B Preferred Shares and the Series C Preferred Shares, dividends must be
paid on the Class A Shares Common Stock, together with the Series B Preferred
Shares and the Series C Preferred Shares, at any time that dividends are paid on
either. Any dividend so declared and payable in cash, capital stock of the
Company or other property will be paid equally, share for share, on the Class A
Common Stock, Series B Preferred Shares, Series C Preferred Shares and on any
other participating series of preferred stock issued in the future; provided,
however, that the Company may issue dividends consisting solely of its Class A
Shares on the Class A Shares of Common Stock.
Liquidation Rights
In the event of the liquidation, dissolution or winding up of the Company,
holders of the Class A Common Stock are entitled to share equally, share for
share, in the assets available for distribution, subject to the liquidation
-68-
<PAGE> 71
preferences of the Series B Preferred Shares and Series C Preferred Shares and
the rights of any other class or series of preferred stock then outstanding.
Description of Preferred Stock
The Board of Directors of the Company is authorized by the Certificate of
Incorporation to provide for the issuance of one or more series of preferred
stock. The Board of Directors has the power to fix various terms with respect to
each such series, including voting powers, designations, preferences, dividend
rates, conversion and exchange provisions, redemption provisions, and the
amounts which holders are entitled to receive upon any liquidation, dissolution,
or winding up of the Company. To date the Board of Directors has authorized only
the issuance of the Series B Preferred Shares and the Series C Preferred Shares.
Pursuant to the Amended Stock Purchase Agreement, the Company's Certificate of
Incorporation and Bylaws were amended to provide that additional securities,
including additional shares of any class of preferred stock, can be issued only
if unanimously approved by the Board of Directors or by stockholders holding a
majority of the voting power of the Company.
Voting Rights
Holders of Class A Common Stock (when and if issued) are entitled to one
vote per share. Except as described below, holders of Class A vote together
with holders of the Company's Series B Preferred Shares and Series C Preferred
Shares, on all matters including the election of directors. The Board of
Directors is presently authorized to have 14 members. The Board of Directors is
a classified Board with staggered terms providing for a maximum of three classes
of directors, which are as nearly equal in number as possible, and with one
class elected each year for a maximum term of three years. Holders of Class A
Common Stock are not entitled to vote cumulatively for the election of
directors.
The holders of Class A Common Stock are entitled to vote as separate classes
on any modification to the rights of either class of stock and as otherwise
required by law. As part of the transactions contemplated by the Amended Stock
Purchase Agreement, the stockholders of the Company eliminated multiple voting
rights of the Series B Preferred Shares.
Description of Series B Preferred Stock
The Company issued the Series B Preferred Shares during 1988. As of December
31, 1994, there were 16,291 Series B Preferred Shares outstanding.
Dividends
Holders of the Series B Preferred Shares are entitled to receive, when funds
of the Company are legally available for payment, an annual cash dividend of
Fifty-Six Cents ($0.56) per share, payable quarterly in January, April, July and
October of each year. Dividends on the Series B Preferred Shares are cumulative.
Payment of dividends on the Series B Preferred Shares shall be junior to
payment of dividends at the stated rate of all other series of preferred stock
that the Company may issue in the future and that are designated senior to the
Series B Preferred Shares. Dividends on the Series B Preferred Shares will be
declared and paid or set apart for payment in full for all previous dividend
periods (i) before the payment or setting apart of any funds or assets for the
payment of any dividends on the Class A Common Stock or any other class of
stock, except preferred stock ranking on a parity with or senior to the Series B
Preferred Shares, and (ii) before any purchase or other acquisition for value of
any Class A Common Stock or any future class of stock except preferred stock
ranking on a parity with or senior to the Series B Preferred Shares; provided,
however, that the Company may issue dividends consisting of its Class A Shares
on the Class A Shares.
After payment of dividends at the stated rate on all series of preferred
stock that the Company may issue in the future and that are designated senior to
the Series B Preferred Shares and on any other preferred stock of the Company
that is on a parity with the Series B Preferred Shares, and payment of dividends
at the stated rate on the Series B Preferred Shares, holders of the Series B
Preferred Shares will participate pro rata with the holders of Class A Common
Stock and Series C Preferred Shares, on the basis of number of shares owned, in
all other dividends by the Company to its stockholders, except that, as noted
above, the Company may issue dividends consisting solely of its Class A Shares
on the Class A Shares.
-69-
<PAGE> 72
Liquidation Rights
In the event of any liquidation, dissolution, receivership, bankruptcy, or
winding up of the Company, voluntarily or involuntarily, the holders of the
Series B Preferred Shares are entitled to receive the sum of Seven Dollars
($7.00) per share, plus any accrued and unpaid dividends thereon, before any
distributions will be made to the holders of the Class A Common Stock or any
other class of stock junior in preference upon liquidation, but after or
concurrent with distributions to be made at the stated rate on preferred stock
of any series ranking on a parity with or senior in preference upon liquidation
to the Series B Preferred Shares, and will be entitled to no other distribution.
Conversion
The holders of Series B Preferred Shares are entitled at any time to convert
their Series B Preferred Shares into Class A Common Stock of the Company at the
conversion ratio of one Series B Preferred Share convertible into one-tenth of
one share of Class A Common Stock, upon payment of a conversion fee of Seven
Dollars ($7.00) per share, subject to adjustment under certain conditions.
Prior to the reclassification of the Class B Common Stock, the Amended Stock
Purchase Agreement required that at least 90% of the Series B Preferred Shares
be converted into Class A Shares on a share-for-share basis. Holders of 408,865
Series B Preferred Shares so converted on July 13, 1992, and a total of 420,909
Series B Preferred Shares had been so converted as of December 31, 1992. Three
hundred shares converted during 1994. The remaining shares outstanding at
December 31, 1994 are 16,291.
Voting Rights
The holders of the Series B Preferred Shares are entitled to one vote per
Series B Preferred Share on all matters on which shareholders are entitled to
vote. Holders of the Series B Preferred Shares have full voting rights and
powers equal to the voting rights and powers of the holders of the Class A
Common Stock. Holders of the Series B Preferred Shares are entitled to vote
generally for the election of directors and vote with the holders of the Class A
Common Stock and Series C Preferred Shares as a single class, except that the
holders of the Series B Preferred Shares are entitled to vote as a class on any
modification to the rights of the Series B Preferred Shares and otherwise as
required by law.
Description of Stock Option Plans
Prior to 1994, the Company had various stock option plans which provided for
the issuance of up to 20,000 Class A Common Shares. The stock option plans
expired by their terms in January 1992 except that options granted prior to that
date remain in effect and exercisable during the term of the options. Generally,
options were granted at a price not less than the fair market value of the stock
at the date of grant, were exercisable in increments of 40%
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<PAGE> 73
after two years after the date of the grant and 20% each year thereafter, and
expire ten years after the date of the grant.
<TABLE>
<CAPTION>
Shares Options Outstanding
---------------------------
Available Number Price
for Grant of Options Per Share
------------------------------------------------
<S> <C> <C> <C>
Balances at December 31, 1991 935 17,586 $80.0 - $118.2
Options granted (8,674) 8,673 72.5
Options cancelled 7,739 (8,350) 80.0 - 107.5
------------------------------------------------
Balances at December 31, 1992 -- 17,909 72.5 - 107.5
Options cancelled -- (12,999) 72.5 - 107.5
------------------------------------------------
Balances at December 31, 1993 -- 4,910 $72.5 -$107.5
Options cancelled -- (2,837) 72.5 - 107.5
------------------------------------------------
Balances at December 31, 1994 -- 2,073 $72.5- $100.0
================================================
</TABLE>
Outstanding stock options for the purchase of 50 shares exercisable at
$100.00, 1,423 shares exercisable at $80.00 and 600 shares exercisable at $72.50
were outstanding at December 31, 1994.
During 1994, the Company's shareholders approved two new stock option plans;
the 1993 Executive Stock Option Plan ("Executive Plan") and the 1993
Non-employee Directors Stock Option Plan ("Director Plan").
Executive Plan
Options under the Executive Plan may be granted to key employees and
consultants of the Company and its subsidiaries. The Executive Plan will cover a
total of 1,100,000 shares of Class A Common Stock. The number of shares granted
is subject to adjustment to prevent dilution. The exercise price of options must
be at least the fair market value of the shares of the Company's Class A Common
Stock as of the date the option is granted. As of December 31, 1994, shares
granted under the Executive Plan total 188,022 with an average exercise price of
$10.00. None of the options have been exercised.
The executive employment agreement for certain officers provide that certain
officers shall be granted options to acquire shares of Class A Common Stock
under the Executive Plan equal to 8% of the fully-diluted shares of the
Company's Class A Common Stock, with additional shares to be issued in the
future to maintain the 8% ratio. The effective dates of the initial grant of
options for certain officers are September 30, 1993 and October 1, 1994. Based
on the current capitalization of the Company, certain officers received options
to purchase 501,392 shares of the Company, as of December 31, 1994.
Director Plan
Options under the Directors' Plan may be granted to non-executive directors
of the Company and its subsidiaries. The Directors' Plan will cover a total of
50,000 shares of Class A Common Stock. The number of shares granted is subject
to adjustment to prevent dilution. The exercise price of options must be at
least the fair market value of the shares of the Company's Class A Common Stock
as of the date the option is granted. As of April 1, 1994, shares granted under
the Directors' Plan total 12,500 with an average exercise price of $30.00. Each
non-employee director serving on each subsequent April 1 shall automatically be
granted additional options to acquire up to 1,250 shares of Class A Common
Stock. None of the options have been exercised.
Note 15: Regulation
In accordance with FIRREA, the FRB and the FDIC established capital
regulations requiring the Company and Bank to maintain minimum: (i) tier 1
capital equal to 4% of total assets, as defined; (ii) tier 1 capital equal to 4%
of risk-weighted assets; and (iii) total capital, as defined, equal to 8% of
risk-weighted assets, as defined.
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<PAGE> 74
The following table sets forth the Company's and the Bank's capital ratios
compared to minimum capital requirements as of December 31, 1994 and the
requirements contained in the Orders:
<TABLE>
<CAPTION>
Minimum
Capital
Company Bank Requirement Orders
----------------------------------------------------------
<S> <C> <C> <C> <C>
Leverage 1.2% .9% 4.0% 7.0%
Tier 1 risk-based capital 1.6 1.2 4.0 N/A
Total risk-based capital 3.0 2.6 8.0 N/A
</TABLE>
The FDICIA requires each federal banking agency to implement prompt
corrective actions for institutions that it regulates. In response to this
requirement, the FDIC adopted final rules, effective for December 19, 1992,
based upon FDICIA's five capital tiers: well capitalized, adequately
capitalized, undercapitalized, significantly undercapitalized, and critically
undercapitalized. Under FDICIA, the FDIC is required to take supervisory action
against financial institutions that are not deemed either well capitalized or
adequately capitalized. The rules generally provide that a bank is adequately
capitalized if its total risk-based capital ratio is 8% or greater, its Tier 1
capital to risk based assets is 4% or greater, its leverage ratio is 4% or
greater, and the financial institution is not subject to a capital directive.
See "Note 3. Subsequent Event -- Capital Contribution".
The Bank's failure to meet minimum regulatory requirements as of
December 31, 1994, resulted in the imposition of operating restrictions pursuant
to the prompt corrective action provisions of FDIC Improvement Act (FDICIA). See
Note 2: Regulatory Orders and Going Concern Considerations.
Note 16: Employee Benefit Plans
Employee Stock Ownership Plan
The Company has established an Employee Stock Ownership Plan ("ESOP") for
the benefit of its employees. During 1985, the ESOP borrowed $500,000 from a
third party financial institution at a floating rate based upon 90% of the
institution's current prime rate. Repayment of the principal occurred in seven
annual installments of $71,000 through June 30, 1992 and was completed as
scheduled. The proceeds from this borrowing, which was not guaranteed by the
Company, were used to purchase 5,208 Class A Shares at a price of $160.00 per
share. During 1988, the ESOP established a loan for $650,000 from a third party
financial institution at a floating rate based upon 95% of the current prime
rate. At December 31, 1988, the ESOP had drawn $325,000 from this loan.
Repayment of the principal is scheduled in quarterly payments of $23,000 through
March 31, 1995. Payment on this loan started in the fourth quarter of 1988. The
proceeds from the borrowing were used to purchase 1,429 shares of the Company's
Series B Preferred Shares at a price of $140.00 per share, and to purchase the
Company's Class A Shares throughout 1988. The stock purchased is pledged as
collateral for the loan. During 1989, the ESOP drew the remaining $325,000 from
this loan. The proceeds from the borrowing were used to purchase 2,500 shares of
the Company's Class A Shares at a price of $100.00 per share. During 1994 and
1993, the ESOP did not purchase any shares of the Company's stock.
The Company has determined that its contribution to the ESOP will be
sufficient to cover the yearly debt service on the ESOP's borrowings. At
December 31, 1994, the Company had provided a total of approximately $1.9
million in contributions to the ESOP since its inception in 1985. During 1994,
1993 and 1992, the Company contributed $130,000, $120,000, and $240,000,
respectively, to the ESOP.
Employee Stock Purchase Plan
The Company's Board of Directors adopted an Employee Stock Purchase Plan
("ESPP") for the benefit of substantially all employees in March 1990, which was
approved by the Company's stockholders in July 1990.
A total of 1,250 shares of the Company's Class A Shares have been made
available for purchase under the Plan, and a total of 1,250 shares of Class A
Shares have been made available for matching awards under the Plan. The purchase
price of the shares available under the Plan is the lesser of (i) 85% of the
fair market value of such
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<PAGE> 75
shares on the first day of the purchase period, or (ii) 85% of the fair market
value of such shares on the last day of such purchase period.
At December 31, 1994, the Company had outstanding 364 Class A Shares under
the ESPP, approximately 2.0% of which represented matching shares. At December
31, 1993, the Company had outstanding 429 Class A Shares under the ESPP. The
Company's Board of Directors suspended this Plan as of December 31, 1991.
Employee 401K Plan
The Company provides a 401k plan for its employees. The Company provides
matching contributions up to 2% of the employees qualifying earnings. During
1994, 1993, and 1992, the Company included $42,000, $81,000 and $90,000,
respectively in non-interest expense in order to recognize contributions to the
401k Plan.
Note 17: Commitments and Contingencies
Lending and Letter of Credit Commitments
In the normal course of its business, the Bank has entered into various
commitments to extend credit which are not reflected in the consolidated
financial statements. Over 90% of such commitments consist of the undisbursed
balance on personal and commercial lines of credit and of undisbursed funds on
construction and development loans. At December 31, 1994 and 1993, the Bank had
outstanding loan commitments, which are primarily adjustable rates, totaling
approximately $16.3 million and $29.6 million, respectively. In addition, the
Bank had outstanding letters of credit, which represent guarantees of
obligations of Bank customers, totaling $10.4 million and $12.1 million at
December 31, 1994 and 1993, respectively. The actual liquidity needs or the
credit risk that the Company will experience will be lower than the contractual
amount of commitments to extend credit because a significant portion of these
commitments is expected to expire without being drawn upon. The Bank's
outstanding loan commitments are made using the same underwriting standards as
comparable outstanding loans. The credit risk associated with these commitments
is considered in management's determination of the allowance for loan losses.
Litigation
Because of the nature of its business, the Company and its subsidiaries,
including the Bank, are from time-to-time, a party to legal actions. At December
31, 1994, the Company and/or the Bank are defendants in certain lawsuits for
which the damages sought are substantial as described below.
Presently, the Bank is involved in several lawsuits. In the first lawsuit,
BSFRI is named as a defendant and has been served with a cross-complaint for
indemnity in a deficiency judgement with respect to a first deed of trust on a
property owned by a limited partnership. The plaintiff under the cross complaint
is seeking damages in the amount of $5.0 million, and unspecified punitive
damages. BSFRI was once a limited partner in the partnership but became a
secured lender of the partnership under a second deed of trust, at which time
BSFRI was given a release for any liability. The Bank believes it has
meritorious defenses to the cross-claim and will contest any allocation of
liability to it if defendants are found liable for any deficiency.
In the second lawsuit, the Bank has been named a defendant in an action
brought in Florida by the institutional purchaser of a block of loans from the
Bank, alleging failure of the Bank to properly perform a credit check for one of
the loans. The plaintiff is seeking approximately $155,000 it allegedly lost
when the loan defaulted. The Bank is defending the matter vigorously and
believes it has meritorious defenses. In addition, the Bank has been threatened
with arbitration proceedings by another institutional purchaser in connection
with a $750,000 principal amount loan purchased from the Bank on the sale of its
former Sacramento branch. The institutional purchaser contends that the Bank
breached the sale agreement by failing to notify the purchaser of the
downgrading of the loan and the release of certain collateral. The Bank denies
that it has breached the sale agreement.
The Bank is currently involved in two lawsuits which were brought by former
employees of the Bank; one former employee has alleged discrimination and
wrongful termination. The other former employee alleges wrongful termination.
The former employees have sought unspecified damages.
-73-
<PAGE> 76
The Bank has denied these allegations and is vigorously defending these
proceedings. The disposition of these proceedings could have a material adverse
effect on the Company's financial position or results of operation, however,
management cannot predict the specific outcome of these actions. Accordingly,
the accompanying financial statements do not include any adjustments that might
result from the outcome of the uncertainties.
The Bank has reached settlement or potential settlement in numerous other
litigation or potential litigation matters. In some instances the Bank has
agreed to make certain payments. As a result of the settlement or potential
settlement of certain lawsuits, the Company established a litigation reserve of
$536,500 as of December 31, 1994.
The Company and the Bank intend to pursue their rights under an
indemnification agreement with Mr. Donald R. Stephens, a former Chairman of the
Board and Chief Executive Officer of the Company who resigned in 1993, pursuant
to which Mr. Stephens is required to provide indemnification in respect of
certain expenses related to actions brought by a former employee.
The jury ruled in favor of the Bank on another lawsuit where the plaintiffs
were seeking compensatory damages in an amount of $6.0 million, and unspecified
punitive damages. The plaintiffs were claiming breach of an alleged joint
venture agreement, and of other duties owed to the plaintiffs, arising from the
Bank's foreclosure on a series of loans made to the plaintiffs by the Bank in
connection with the development of an 800 acre parcel of land.
Other Contingencies
During 1993, the Bank transferred a loan with a carrying value of $1.6
million collateralized by commercial real estate to in-substance foreclosure.
The collateral securing this loan requires seismic upgrading and may be located
on property containing hazardous materials. During 1994, the asset was charged
off.
Note 18: Related Party Transactions
In the ordinary course of business, the Bank makes loans to directors,
officers, shareholders and their associates on substantially the same terms,
including interest rates and collateral, as in comparable loan transactions with
unaffiliated persons, and such loans do not involve more than the normal risk of
collection. The following table sets forth the activity related to loans to
directors, officers and principal shareholders and their associates for the year
ended December 31, 1994:
<TABLE>
<CAPTION>
(Dollars in Thousands) Amount
-------------
<S> <C>
Balance at December 31, 1993 $ 496
New loans or disbursements 22
Principal reductions (including cash repayments) (280)
-------------
Balance at December 31, 1994 $ 238
=============
</TABLE>
The Company accounts for its investment in BSFBC, a California limited
partnership, using the equity method. Condensed statements of financial
condition and operations of BSFBC at December 31 are as follows:
-74-
<PAGE> 77
CONDENSED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED)
<TABLE>
<CAPTION>
(Dollars in Thousands) 1994 1993
---------------------
<S> <C> <C>
Assets:
Cash $1,271 $1,380
Receivables 43 25
Fixed assets, net 5,707 6.860
---------------------
Total assets $7,021 $8,265
=====================
Liabilities and Partners' Equity:
Notes payable $2,230 $2,297
Other liabilities 239 207
Partners' equity 4,552 5,761
---------------------
Total liabilities and partners' equity $7,021 $8,265
=====================
</TABLE>
CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
(Dollars in Thousands) 1994 1993 1992
----------------------------------
<S> <C> <C> <C>
Rental income $1,834 $1,845 $1,846
Other income 113 101 99
----------------------------------
Total income 1,947 1,946 1,945
Total expense 2,555 1,004 1,456
----------------------------------
Net income of partnership $(608) $ 942 $ 489
==================================
</TABLE>
The Bank's and BSFRI's equity in the operating results of BSFBC in 1994,
1993 and 1992 was approximately a loss of $264,000, and earnings of $263,000,
$202,000, respectively. Such income is included in the Bank's other income in
the Company's Consolidated Financial Statements.
Note 19: Fair Value of Financial Instruments
The following disclosures of the estimated fair value of financial
instruments are made in accordance with the requirements of Statement of
Financial Accounting Standards No. 107 "Disclosures about Fair Value of
Financial Instruments" (SFAS No. 107). The estimated fair value amounts have
been determined by the Company using available market information and
appropriate valuation methodologies. However, considerable judgement is
necessarily required to interpret market data to develop the estimates of fair
value. Accordingly, the estimates presented herein are not necessarily
indicative of the amount the Company could realize in a current market exchange.
The use of different market assumptions and/or estimation methodologies may have
a material effect on the estimated fair value amounts.
-75-
<PAGE> 78
The carrying amount and estimated fair values of the Company's financial
instruments at December 31 are as follows:
<TABLE>
<CAPTION>
1994 1993
--------------------------- ---------------------------
Carrying Fair Carrying Fair
(Dollars in Thousands) Amount Value Amount Value
--------------------------- ---------------------------
<S> <C> <C> <C> <C>
Financial Assets:
Cash and cash equivalents $ 28,647 $ 28,647 $25,833 $ 25,833
Investment securities 11,407 11,384 21,191 21,293
Loans, net 99,488 99,326 141,140 145,350
Financial Liabilities:
Deposits 147,148 147,071 210,111 209,934
Other borrowings 4,070 4,070 1,303 1,361
</TABLE>
The following methods and assumptions were used to estimate the fair value
of each major classification of financial instruments at December 31, 1994 and
1993:
CASH AND CASH EQUIVALENTS: Current carrying amounts approximate estimated fair
value.
TIME DEPOSITS WITH OTHER FINANCIAL INSTITUTIONS: Due to the short term nature of
time deposits with other financial institutions (original maturities of 90 days
or less), current carrying amounts approximate market.
INVESTMENT SECURITIES HELD-TO-MATURITY AND AVAILABLE-FOR-SALE: For securities
held-to-maturity and available-for-sale, current market prices were used to
determine fair value.
LOANS RECEIVABLE: The carrying amount of loans is net of unearned fee income and
the reserve for possible losses. To estimate fair value of the Company's loans,
primarily adjustable rate, commercial and real estate secured loans, each loan
collateral type is segmented into categories based on fixed or adjustable
interest rate terms, maturity, estimated credit risk, and accrual status. The
fair value of loans is calculated by discounting cash flows expected to be
received through the estimated maturity using estimated market discount rates
that reflect the credit and interest rate risk inherent in the loan. The
estimate of maturity is based on the Bank's historical experience with
repayments for each loan classification, modified, as required, by an estimate
of the effect of current economic and lending factors.
DEPOSIT LIABILITIES: The fair value of deposits with no stated maturity, such as
non-interest bearing demand deposits, savings and NOW accounts, and money market
and checking accounts, is equal to the amount payable on demand as of December
31, 1994. 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.
BORROWED FUNDS: Due to the terms of these borrowings, current carrying amounts
approximate estimated fair value. A total of $4.0 million matures in January
1995.
OFF BALANCE SHEET INSTRUMENTS: The estimated fair value of off balance sheet
instruments, principally letters of credit and loan commitments, is
approximately the face value of commitment fees collected.
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<PAGE> 79
Note 20: The San Francisco Company
Condensed statements of financial condition and operations of The San
Francisco Company at December 31 are as follows:
CONDENSED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
(Dollars in Thousands) 1994 1993
-------------------------
<S> <C> <C>
Assets:
Cash and short term investments $ 656 $ 249
Other real estate owned 85 96
Investment in subsidiary 1,592 17,407
Other assets 131 252
-------------------------
Total assets $ 2,464 $ 18,004
=========================
Liabilities:
Borrowings for Employee Stock Ownership Plan $ 70 $ 162
Other liabilities 265 387
-------------------------
Total liabilities 335 549
-------------------------
Stockholders' equity 2,129 17,455
-------------------------
Total liabilities and shareholders' equity $ 2,464 $ 18,004
=========================
</TABLE>
CONDENSED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
(Dollars in Thousands) 1994 1993 1992
---------------------------------------
<S> <C> <C> <C>
Income:
Interest earned $ 51 $ 13 $ 30
Other Income 33 -- --
---------------------------------------
Total income 84 13 30
---------------------------------------
Expense:
Provision for loan losses -- 53 --
Other expense 251 409 53
---------------------------------------
Total expense 251 462 53
---------------------------------------
Income (loss) before equity in undistributed net loss of subsidiary (167) (449) (23)
Equity in undistributed net loss of subsidiary (32,869) (9,806) (22,154)
---------------------------------------
Net loss $(33,036) $(10,255) $(22,177)
=======================================
</TABLE>
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<PAGE> 80
CONDENSED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
(Dollars in Thousands) 1994 1993 1992
--------------------------------------
<S> <C> <C> <C>
Cash Flows from Operating Activities:
Net loss $(33,036) $(10,255) $(22,177)
Adjustments to reconcile net loss to net cash used in
operating activities:
Equity in undistributed net loss of subsidiary 32,869 9,806 22,154
Provision for loan losses -- 53 --
--------------------------------------
Net cash flows used in operating activities (167) (396) (23)
--------------------------------------
Cash Flows used in investing activities:
Principal collected on loans -- -- 10
Investment in Bank (17,000) (11,850) (22,000)
Net decrease (increase) in other assets 136 (246) (2)
--------------------------------------
Net cash used in investing activities (16,864) (12,096) (21,992)
--------------------------------------
Cash Flows provided by financing activities:
Proceeds from sale of Preferred Stock -- 12,000 6,000
Proceeds from sale of Common Stock 17,560 -- 15,500
Net increase (decrease) in other liabilities (122) 390 (3)
Other net -- -- 8
--------------------------------------
Net cash provided by financing activities 17,438 12,390 21,505
--------------------------------------
Increase (decrease) in cash and cash equivalents 407 (102) (510)
Cash and cash equivalents at beginning of year 249 351 861
--------------------------------------
Cash and cash equivalents at end of year $ 656 $ 249 $ 351
======================================
</TABLE>
Note 21: Quarterly Information (Unaudited)
The following table sets forth the condensed operating results of the
Company for each quarter of the two year periods ending December 31, 1994, and
is qualified in its entirety by the more detailed information and financial
statements contained elsewhere in this report:
<TABLE>
<CAPTION>
1994 Quarters Ended
-------------------------------------------------------
(Dollars in Thousands Except Per Share Data) March 31 June 30 Sept. 30 Dec. 31
-------------------------------------------------------
<S> <C> <C> <C> <C>
Interest income $3,263 $3,203 $3,164 $3,021
Interest expense 1,295 1,268 1,172 1,128
-------------------------------------------------------
Net interest income 1,968 1,935 1,992 1,893
Provision for loan losses 141 141 141 3,376
Non-interest income 815 462 235 623
Non-interest expense 5,798 8,253 7,666 17,301
-------------------------------------------------------
Loss before income taxes (3,156) (5,997) (5,580) (18,161)
Provision for taxes 28 39 38 37
-------------------------------------------------------
Net loss $(3,184) $(6,036) $(5,618) $(18,198)
=======================================================
Loss per common share:
Average common shares outstanding 444,990 1,176,718 4,847,501 5,766,008
Net loss $(7.15) $(5.13) $(1.16) $(3.16)
</TABLE>
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<PAGE> 81
<TABLE>
<CAPTION>
1993 Quarters Ended
------------------------------------------------------
(Dollars in Thousands Except Per Share Data) March 31 June 30 Sept. 30 Dec. 31
------------------------------------------------------
<S> <C> <C> <C> <C>
Interest income $4,826 $4,922 $4,445 $3,962
Interest expense 1,947 2,056 1,845 1,572
------------------------------------------------------
Net interest income 2,879 2,866 2,600 2,390
Provision for loan losses 141 2,641 618 154
Non-interest income 1,226 1,249 1,333 1,071
Non-interest expense 6,466 5,465 5,260 4,955
------------------------------------------------------
Loss before income taxes (2,502) (3,991) (1,945) (1,648)
Provision for taxes 68 20 15 66
------------------------------------------------------
Net loss $(2,570) $(4,011) $(1,960) $(1,714)
======================================================
Loss per common share:
Average common shares outstanding 445,100 445,100 445,066 444,991
Net loss $(5.77) $(9.01) $(4.40) $(3.85)
</TABLE>
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<PAGE> 82
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item will be furnished in the
Company's definitive Proxy Statement and is incorporated herein by
reference.
ITEM 11 - EXECUTIVE COMPENSATION
The information required by this Item will be furnished in the
Company's definitive Proxy Statement and is incorporated herein by
reference.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item will be furnished in the
Company's definitive Proxy Statement and is incorporated herein by
reference.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item will be furnished in the
Company's definitive Proxy Statement and is incorporated herein by
reference.
PART IV
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. List of documents filed as a part of the report.
The following financial statements are included in Item 8 of this
report:
Report of Independent Public Accountants;
Consolidated Balance Sheets at December 31, 1994 and 1993;
Consolidated Statements of Income for the years ended December 31,
1994, 1993, and 1992;
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 1994, 1993 and 1992;
Consolidated Statements of Cash Flow for the years ended December 31,
1994, 1993 and 1992;
Notes to Consolidated Financial Statements.
2. Financial Statement Schedules
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<PAGE> 83
All financial statement schedules are omitted because they are not
applicable or not required, or because the required information is
included in the Consolidated Financial Statements or the notes thereto.
3. List of Exhibits (numbered in accordance with Item 601 of Regulation
S-K):
Exhibit 3.1 Certificate of Incorporation of Bank of San
Francisco (Delaware) Holding Company, dated June 23,
1988 (1)
Exhibit 3.2 Agreement and Plan of Merger of Bank of San Francisco
(Delaware) Holding Company, a Delaware corporation and
Bank of San Francisco Company Holding Company, a
California Corporation, dated June 24, 1988 (1)
Exhibit 3.3 Certificate of Amendment of the Certificate of
Incorporation of Bank of San Francisco Company Holding
Company, dated May 22, 1989 (1)
Exhibit 3.4 Certificate of Amendment of the Certificate of
Incorporation of Bank of San Francisco Company Holding
Company, dated September 21, 1989 (1)
Exhibit 3.5 Bylaws of Bank of San Francisco (Delaware) Holding
Company, dated June 23, 1988 (1)
Exhibit 3.6 First Amendment to Bylaws of Bank of San Francisco
Company Holding Company, dated July 19, 1989 (1)
Exhibit 3.7 Second Amendment to Bylaws of Bank of San Francisco
Company Holding Company, dated June 6, 1990 (1)
Exhibit 3.8 Certificate of Amendment of the Certificate of
Incorporation of Bank of San Francisco Company Holding
Company, dated May 23, 1994 (10)
Exhibit 3.9 Amended and Restated Certificate of Incorporation of
The San Francisco Company, dated May 23, 1994 (10)
Exhibit 4.1 Certificate of Designations of Rights, Preferences,
Privileges and Restrictions of 8% Series B Convertible
Preferred Stock of Bank of San Francisco Company
Holding Company, dated July 28, 1988 (1)
Exhibit 4.2 Amended Certificate of Designations of Rights,
Preferences, Privileges and Restrictions of 7% Series
B Convertible Preferred Stock of Bank of San Francisco
Company Holding Company, dated October 7, 1988 (1)
Exhibit 4.3 Certificate of Correction of Certificate of
Incorporation, dated June 18, 1990 (1)
Exhibit 10.1 Sales agreement dated October 23, 1986 between Bank of
San Francisco Realty Investors (BSFRI) and Bank of
America with respect to the lease on 550 Montgomery
Street, San Francisco, California (2)
Exhibit 10.2 Lease dated November 1, 1960 between The Lurie Company
and Bank of America, with respect to premises at 550
Montgomery Street (2)
Exhibit 10.3 Consent to Assignment of Lease, dated October 8, 1986,
between The Lurie Company and Bank of San Francisco
and Bank of San Francisco Realty Investors, with
respect to premises at 550 Montgomery Street (2)
Exhibit 10.4 Assignment of Lease, dated October 17, 1986, by Bank
of America to Bank of San Francisco and Bank of San
Francisco Realty Investors, with respect to premises
at 550 Montgomery Street (2)
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<PAGE> 84
Exhibit 10.5 Nominee Agreement between Bank of San Francisco Realty
Investors and 550 Partners, with respect to premises
at 550 Montgomery Street (2)
Exhibit 10.6 Partnership Agreement, dated October 23, 1986, by and
among Bank of San Francisco, Bank of San Francisco
Realty Investors, and D.R. Stephens Separate Property
Trust, with respect to 550 Montgomery Street (2)
Exhibit 10.7 Lease dated May 1, 1987, between Bank of San Francisco
Building Company and Bank of San Francisco with
respect to premises at 550 Montgomery Street, San
Francisco, California (Bank Space and Office Space
Leases) (3)
Exhibit 10.8 Bank of San Francisco Company Holding Company Employee
Stock Ownership Plan, restated and amended as of
January 1, 1989 (1)
Exhibit 10.9 Agreement dated January 17, 1990 between Bank of San
Francisco and Rogers, Casey & Associates, Inc. with
respect to investment consulting services (1)
Exhibit 10.10 Employee Stock Purchase Plan (4)
Exhibit 10.11 Letter Agreement with the Board of Governors of the
Federal Reserve Board, dated April 21, 1989 (1)
Exhibit 10.12 Escrow Agreement dated December 31, 1990 between Bank
of San Francisco Company Holding Company and Bank of
San Francisco with respect to the Employee Stock
Purchase Plan (5)
Exhibit 10.13 Bank of San Francisco Company Holding Company 401(k)
Profit Sharing Plan (5)
Exhibit 10.14 Amended and Restated Indemnification Agreements dated
October 29, 1991 between Bank of San Francisco Company
Holding Company and each director and executive
officer of the Company (7)
Exhibit 10.15 Indemnification Agreement dated November 25, 1991
between Bank of San Francisco and each director and
executive officer of the Bank (8)
Exhibit 10.16 Stock Purchase Agreement dated as of April 10, 1992
between Bank of San Francisco Company Holding and
Peninsula Holdings (9)
Exhibit 10.17 First amendment to Stock Purchase Agreement dated May
14, 1992 between Bank of San Francisco Company Holding
Company and Putra Masagung (9)
Exhibit 10.18 Second amendment to Stock Purchase Agreement dated
June 18, 1992 between Bank of San Francisco Company
Holding Company and Putra Masagung (9)
Exhibit 10.19 Agreement Respecting Assignment, Assumption, Consent
and Amendments dated as of May 8, 1992 among Bank of
San Francisco Company Holding Company, Peninsula
Holdings and Putra Masagung (10)
Exhibit 10.20 Subscription Agreement dated as of October 29, 1992
between Bank of San Francisco Holding Company and
Putra Masagung (10)
Exhibit 10.21 First Amendment of Bank Space and Office Space lease,
dated July 8, 1992 between Bank of San Francisco and
Bank of San Francisco Building Company, with respect
to premises at 550 Montgomery Street, San Francisco,
California (10)
Exhibit 10.22 Employment Agreements dated October 1, 1994 between
Mr. Gilleran and The San Francisco Company and the
Bank of San Francisco. *
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<PAGE> 85
Exhibit 10.23 The San Francisco Company 1993 Executive Stock Option
Plan (11)
Exhibit 10.24 The San Francisco Company 1993 Non-Employee Directors
Stock Option Plan (11)
Exhibit 21 Subsidiaries of registrant (6)
Exhibit 27 Financial Data Schedule *
---------------------------
Footnotes to List of Exhibits:
* Indicates filed herewith.
(1) Incorporated by reference from the exhibits included with the
Registrant's Form S-2 Registration Statement (Registration No.
33-34985), previously filed with the Commission.
(2) Incorporated by reference from exhibits included in the Company's
Annual Report on Form 10-K for the year ended December 31, 1986,
previously filed with the Commission.
(3) Incorporated by reference from exhibits included with the Company's
Annual Report on Form 10-K for the year ended December 31, 1987,
previously filed with the Commission.
(4) Incorporated by reference from exhibits included with the Company's
Form S-8 Registration Statement (Registration No. 33-35649),
previously filed with the Commission.
(5) Incorporated by reference from exhibits included with the Company's
Annual Report on Form 10-K for the year ended December 31, 1990,
previously filed with the Commission.
(6) Incorporated by reference from exhibits included with the Company's
Annual report on Form 10-K for the year ended December 31, 1990,
previously filed with the Commission.
(7) Identical agreements have been signed by each executive officer and
director of the Company.
(8) Identical agreements have been signed by each executive officer and
director of the Bank.
(9) Incorporated by reference from exhibits included with the Company's
Proxy Statement for the Special Meeting of Stockholders' held on
June 25, 1992, previously filed with the Commission.
(10) Incorporated by reference from exhibits included with the
Company's Annual report on Form 10-K for the year ended
December 31, 1992, previously filed with the Commission.
(11) Incorporated by reference from exhibits included with the
Company's Proxy Statement for the Special Meeting of Stockholders'
held on May 23, 1994, previously filed with the Commission.
(b) Reports on Form 8-K filed in the fourth quarter of 1994:
None
-83-
<PAGE> 86
SIGNATURES
Pursuant to the requirements of 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.
THE SAN FRANCISCO COMPANY
By: /s/ James E. Gilleran
----------------------------
James E. Gilleran
Chairman of the Board and
Chief Executive Officer
Date: April 20, 1995
--------------
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 in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ James E. Gilleran Chairman of the Board and April 20, 1995
- - ------------------------- --------------
James E. Gilleran Chief Executive Officer
(Principal Executive Officer)
/s/ Steven R. Champion Director April 20, 1995
- - ------------------------- --------------
Steven R. Champion
/s/ Donna Miller Casey Director April 20, 1995
- - ------------------------- --------------
Donna Miller Casey
/s/ David R. Holbrooke Director April 20, 1995
- - ------------------------- --------------
David R. Holbrooke, M.D.
/s/ Willard D. Sharpe Director April 20, 1995
- - ------------------------- --------------
Willard D. Sharpe
/s/ Gordon B. Swanson Director April 20, 1995
- - ------------------------- --------------
Gordon B. Swanson
/s/ Kent D. Price Director April 20, 1995
- - ------------------------- --------------
Kent D. Price
/s/ Nicholas Unkovic Director April 20, 1995
- - ------------------------- --------------
Nicholas Unkovic
-84-
<PAGE> 87
EXHIBIT INDEX
Exhibit 10.22 Employment Agreement dated October 1, 1994 between Mr.
Gilleran and The San Francisco Company and the Bank of San
Francisco.
Exhibit 27 Financial Data Schedule.
<PAGE> 1
EXHIBIT 10.22
JAMES E. GILLERAN
EMPLOYMENT AGREEMENT
THIS EMPLOYMENT AGREEMENT (the "Agreement") is entered into as of October
1, 1994 by and between The San Francisco Company (the "Company"), Bank of San
Francisco (the "Bank") (collectively, the "Employer"), and JAMES E. GILLERAN
("Executive").
R E C I T A L S:
A. The Employer desires to employ Executive to serve as Chairman of the
Board and Chief Officer of the Company and Chairman of the Board and Chief
Executive Officer of the Bank, and the Boards of Directors of the Company and
the Bank have approved the Employer's employment of Executive.
B. Executive hereby accepts such employment on the terms and conditions
set forth in this Agreement.
A G R E E M E N T:
1. Agreement to Employ. Subject to the terms and conditions contained
herein, the Employer hereby employs Executive and Executive hereby accepts
employment by the Employer.
2. Term of Employment. The term shall be for three (3) years commencing
on October 1, 1994, and ending, unless terminated earlier, September 30, 1997
(the "Expiration Date").
3. Position and Duties/Authority of Executive. During the term of this
Agreement, Executive shall hold the positions of Chairman of the Board and Chief
Executive Officer of the Bank. Executive shall perform such additional duties
and responsibilities, consistent with the foregoing positions as may be assigned
to Executive from time to time by the respective Boards of Directors of the
Employer acting with reasonable discretion and in accord with the scope of this
Agreement.
4. Place of Employment. Executive's principal place of employment shall
be 550 Montgomery Street, San Francisco, California. While discharging his
duties and responsibilities hereunder, Executive may be required to travel from
time to time and, as a result, be temporarily absent from his place of
employment.
5. Devotion of Time to Business. Except as provided below, Executive
shall devote his best efforts and ability, and
1
<PAGE> 2
attention to the business and affairs of the Employer and to performing the
duties and responsibilities set forth herein on behalf of the Employer.
Notwithstanding any language herein to the contrary, Executive shall be entitled
to devote time to charitable, political and civic activities and speaking
engagements, and Executive shall be permitted to serve on the boards of
directors of other companies which do not directly compete with the Employer
provided such activities do not have a material, adverse effect on Executive's
performance hereunder.
6. Confidential Information/Trade Secrets.
a. In performing his duties under this Agreement, Executive will have
access to and become acquainted with information concerning the Employer's
operations, including financial, personnel, marketing, and other information and
customer lists that are owned by the Employer and regularly used in the
Employer's business, and such information is confidential and constitutes trade
secrets of the Employer.
b. Executive will not misuse, misappropriate, or disclose any such trade
secrets, directly or indirectly, to any other person, or use them in any way,
except as required in the course of his employment hereunder.
c. The unauthorized use or disclosure of any of the Employer's
confidential information/trade secrets (including without limitation
information concerning current or future proposed work, services, or products,
the fact that any such work, services, or products are planned, under
consideration, or in use, and any descriptions thereof) constitute unfair
competition.
d. Any violation by Executive of any of the provisions of this paragraph
would result in irreparable injury to the Employer, and the Employer shall be
entitled to injunctive relief to prevent or terminate such violation.
e. This paragraph shall not apply to any information that becomes
generally known to or available for use by the public other than as a result of
Executive's acts.
f. The covenants set forth in this paragraph shall survive termination of
this Agreement for a period of one year; provided, however, that with respect to
the Employer's customer lists and relationships, such period shall be two years.
2
<PAGE> 3
7. Compensation to Executive.
a. Salary and Benefits. Subject to the terms and conditions contained
herein, throughout the term of this Agreement, Executive shall be entitled to
receive the following salary and benefits from the Employer:
i) Annual Base Salary. The Employer shall pay to Executive as
compensation for his services an Annual Base Salary of Two Hundred and
Fifty Thousand Dollars ($250,000) in such intervals as other salaried
executives of the Employer are presently paid (but in no case less
frequently than monthly). The Annual Base Salary shall be paid subject to
all federal, state and local rules for payment, deduction and withholding
of taxes. The Annual Base Salary shall be increased prospectively to Three
Hundred Thousand Dollars ($300,000) upon the conclusion of the Company's
third consecutive profitable quarter after the date of this Agreement.
ii) Annual Performance Bonus. For each calendar year, Executive and
the boards of directors of the Company and the Bank shall establish
reasonable goals for such year which, if met, will result in a bonus
payable to Executive from 0% to 100% of his base salary in cash. With
respect to the Bank, such goals shall be based upon positive performance
criteria which will include asset quality, resolution of problem assets,
core deposit growth, pre-tax earnings (not including any earnings related
to tax loss carry forwards or similar tax attributes), capital adequacy,
liability management, liquidity, and leadership and oversight of the
management of the Company and the Bank.
iii) Special Incentive. The Employer shall pay to Executive a
one-time bonus of $150,000 at such time subsequent to a regulatory
examination that the boards of directors of the Company and the Bank
determine, respectively, that the condition of the Company and the
condition of the Bank (as measured by its capital, assets, management,
earnings and liquidity) are satisfactory.
b. Retirement Plan. The Employer shall provide Executive with retirement
benefits, including any Section 401(k) Plan, under which the Employer provides
retirement or similar benefits to the other Company or Bank Employees. The
Company currently sponsors The San Francisco Company 401(k) Plan. Executive's
participation in the Section 401(k) Plan shall begin as of July 1, 1995.
c. Benefits. The Employer shall, during the term of this Agreement, make
available to Executive the following:
3
<PAGE> 4
i) insurance coverage and benefits according to its existing health
plans;
ii) group term life insurance, accidental death and dismemberment
insurance, and long-term group disability insurance, all in accordance
with the Employer's existing plans; and
iii) vacation of four weeks per year.
d. Expense Account. The Employer will require Executive to incur travel,
lodging, meal, entertainment, and similar expenses. The Employer shall advance
or promptly reimburse Executive for all expenses reasonably incurred by
Executive in the performance of his duties for which Executive furnishes the
Employer with adequate records and other documentary evidence as required by
applicable federal and state laws and regulations.
e. Stock Options.
i) The Board of Directors of the Company has adopted an Executive
Stock Option Plan (the "Stock Plan") under which Executive shall be
eligible to receive options to purchase shares of the Company's Class A
Common Stock, and the Company has reserved shares for issuance under the
Stock Plan and shall grant options under the Stock Plan to Executive to
purchase five percent (5)% of the shares of the Company's Class A Common
Stock. The options shall be granted effective on October 1, 1994, and the
option price shall be $5.68 per share. Thirty-three and one-third (33 1/3)
of such options shall vest on each anniversary of this Agreement until all
such options are vested. Once vested, such options shall be exercisable for
a period of ten (10) years from the date of grant.
ii) Additional options (the "anti-dilution options") shall be granted
to Executive from time to time at the then current fair market value and in
such amounts as to assure that Executive's options and shares previously
issued to Executive upon exercise of options will comprise not less than
five percent (5%) of the fully diluted number of shares of all classes of
the Company's Common Stock (i.e., the sum of the number of shares of all
classes of Common Stock issued and outstanding, plus the number of shares
of all classes of Common Stock subject to options, warrants, conversion
rights and all other outstanding rights to purchase any class of shares of
Common Stock). Such additional options shall be granted at the fair market
value at the date of grant. The antidilution options shall vest on the
schedule set forth above, except that notwithstanding such vesting schedule
options granted on account of options,
4
<PAGE> 5
warrants, conversion rights or other rights to purchase Common Stock shall
not be exercisable unless and until Common Stock is issued upon the
exercise of such rights. The Company shall have no obligation to grant
Executive any antidilution options with respect to any dilutive events
occurring after the completion of the next public offering by the Company
of its Common Stock.
f. Other Benefits. The Employer shall provide Executive with such other
pension, health and welfare benefits as it may from time to time offer to other
senior executives in the ordinary course of its business, or as may be
reasonably required or necessary for him to perform his duties.
8. Termination.
a. Termination by the Employer for Cause. The Employer may terminate
Executive's employment at any time for "cause." For the purpose of the
Employer's termination of this Agreement, the term "cause" shall include any of
the following:
i) Adjudication of Executive's guilt in connection with the
commission of a felony or a misdemeanor involving moral turpitude
(excluding traffic violations);
ii) Good faith finding by the Employer's Boards of Directors of
Executive's theft, conversion, misappropriation, or embezzlement of any
assets of the Employer;
iii) Executive's (A) habitual neglect of his duties, (B) failure to
obey the lawful directions of the Boards of Directors of the Employer that
do not contravene regulations or regulatory policies, guidelines,
agreements or orders, or (C) conduct that has a direct, substantial and
adverse effect on the Employer's reputation, in each case, after written
notice and adequate opportunity to cure any such asserted neglect, failure
or conduct; or
iv) Good faith finding by the Employer's Boards of Directors that
Executive's performance of his duties resulted in a material deterioration
in the condition of the Company or the Bank, provided that such
deterioration is not the result of conditions either existing on the date
of Executive's employment or external to the Company and the Bank and
beyond Executive's control.
b. Termination without Cause.
i) The Employer may terminate Executive's employment without "cause"
or without cause under "Special Circumstances" at any time subject only to
the provisions of
5
<PAGE> 6
paragraph 9.d. In addition, the Employer may allow this Agreement to expire
on the Expiration Date under "Special Circumstances" subject only to the
provisions of paragraph 9.f.
ii) Special Circumstances shall exist where, after a reasonable period of
time from the date hereof, the Boards of Directors of the Employer make a
good faith determination that Executive's actions have directly precluded
the improvement of the Employer's financial condition. The Employer and
Executive acknowledge that (A) the Employer is presently a distressed
institution the survival of which is in question, (B) the resolution of
nonperforming assets and similar remedial action may have a further
negative impact on the Employer's earnings and capital, (C) events and
circumstances beyond the direct control of Executive may also have a
negative impact on the Employer's financial condition, such as the
inability of the Employer to raise additional capital, (D) Executive may
implement or recommend to the Boards of Directors of the Employer courses
of action that will initially have a negative impact on the earnings and
capital of the Employer, such as the resolution of litigation and
employment related settlements and (E) directions and policies of the
Employer's Boards of Directors may negatively impact the Employer's
earnings and capital. The Employer's termination or permitted expiration
of this Agreement as a result of any of the foregoing, any other
circumstances beyond the direct control of Executive, or any action
reasonably undertaken by Executive shall not be under "Special
Circumstances."
c. Termination for Death. Executive's employment shall terminate upon
Executive's death.
d. Termination for Disability. The Employer may terminate Executive's
employment upon the disability of Executive. As used herein, the term
"disability" shall mean sickness or physical or mental disability that renders
Executive unable to perform a substantial portion of more than ninety (90) days
in any twelve (12) month period.
e. Notice of Termination. If the Employer desires to terminate
Executive's employment under this Agreement, whether or
6
<PAGE> 7
not for cause, the Employer shall deliver a notice of termination in writing to
Executive (the "Notice of Termination"). The Notice of Termination shall specify
whether the termination is (A) for cause (in which case the conduct of Executive
or the Employer giving rise to the termination shall be specified), (B) for
death, (C) for disability, (E) without cause, or (F) without cause under Special
Circumstances (in which case the conduct of Executive giving rise to the
termination shall be specified). The Notice of Termination shall specify an
effective date of termination (the "Termination Date") on or after the date
notice is given.
9. Effect of Termination. Upon the termination of this Agreement by
either party, the parties shall comply with the following obligations and
duties:
a. Termination for Cause. If the Employer terminates Executive's
employment for cause:
i) Annnual Base Salary. The Employer shall on the Termination
Date pay Executive Executive's Annual Base Salary through the
Termination Date.
ii) Reimbursement Expenses. The Employer shall, on the
Termination Date, pay Executive all reimbursable expenses for which
expense reports have been provided to the Employer in accordance with
the Employer's policy.
iii) Vesting of Stock Options. All of the stock options granted
to Executive which have vested as of the Termination Date shall be
retained by Executive and shall be exercisable in accordance with the
Stock Plan, and any unvested options shall be forfeited.
b. Termination for Death. If Executive's employment is terminated as
a result of Executive's death:
i) Annual Base Salary. The Employer's obligation to pay
Executive's salary shall terminate upon his death.
ii) Reimbursable Expenses. The Employer shall, within thirty (30)
days following the date of Executive's death, pay Executive's estate all
reimbursable expenses for which expense reports have been provided to
the Employer in accordance with the Employer's policy.
iii) Annual Performance Bonus. The Employer shall, within thirty
(30) days following the date of death, pay Executive's estate
Executive's Annual Performance Bonus at a rate of fifty percent (50%) of
Bonus Plan prorated by
7
<PAGE> 8
the number of full months served during the current Bonus Plan year.
iv) Vesting of Stock Options. All of the stock options granted to
Executive which are vested or are scheduled to vest on the next vesting
date shall be immediately vested and shall be exercisable by Executive's
estate in accordance with paragraph 7.e., and unvested options shall be
forfeited.
c. Termination for Disability.
i) Annual Base Salary. The Employer shall pay Executive
Executive's Annual Base Salary through Termination Date.
ii) Reimbursable Expenses. The Employer shall, within thirty (30)
days following the Termination Day, pay Executive all reimbursable
expenses for which expense reports have been provided to the Employer in
accordance with the Employer's policy.
iii) Annual Performance Bonus. The Employer shall, within thirty
(30) days following the Termination Date, pay Executive Executive's
Annual Performance Bonus at a rate of fifty percent (50%) of Bonus Plan
prorated by the number of full months served during the current Bonus
Plan year.
iv) Vesting of Stock Options. All of the stock options granted to
Executive which are vested or are scheduled to vest on the next vesting
date shall be immediately vested and shall be exercisable in accordance
with paragraph 7.e., and unvested options shall be forfeited.
d. Termination without Cause. If the Employer terminated
Executive's employment without cause:
i) Annual Base Salary. The Employer shall, on the Termination
Date, pay Executive his Annual Base Salary through the Termination
Date. In addition, the Employer shall, on the Termination Date, pay
Executive an additional one (1) year of Annual Base Salary, provided,
however, that (A) if such termination is without cause under Special
Circumstances, such payment shall be of an additional six (6) months
of Annual Base Salary, (B) such payment shall be subject to applicable
statutory or regulatory restrictions, and (C) no such payment shall
be made for so long as the Federal Reserve or the Federal Deposit
Insurance Corporation determines that the Employer is in an unsafe or
unsound financial condition.
8
<PAGE> 9
ii) Reimbursable Expenses. The Employer shall, on the Termination
Day, pay Executive all reimbursable expenses for which expense reports
have been provided to the Employer in accordance with the Employer's
policy.
iii) Annual Performance Bonus. The Employer shall, on the
Termination Date, pay Executive Executive's Annual Performance Bonus at
a rate of fifty percent (50%) of Bonus Plan prorated by the number of
full months served during the current Bonus Plan year. In addition, the
Employer shall, on the Termination Date, pay Executive an additional one
(1) year of Annual Performance Bonus based on achievement of Bonus Plan
at fifty percent (50%), provided, however, that (A) if such termination
is without cause under Special Circumstances, such payment shall be
based on achievement of Bonus Plan at twenty-five (25%), (B) such
payment shall be subject to applicable statutory or regulatory
restrictions, and (C) no such payment shall be made for so long as the
Federal Reserve or the Federal Deposit Insurance Corporation determines
that the Employer is in an unsafe or unsound financial condition.
iv) Vesting of Stock Options. All of the stock options granted to
Executive shall vest immediately, and shall be exercisable in accordance
with paragraph 7.e.
e. Voluntary Termination by Executive. If Executive terminates this
Agreement voluntarily:
i) Annual Base Salary. The Employer shall, within three (3) days
following the Termination Date, pay Executive Executive's Annual Base
Salary through the Termination Date.
ii) Reimbursable Expenses. The Employer shall, within thirty (30)
days following the Termination Date, pay Executive all reimbursable
expenses for which expense reports have been provided to the Employer in
accordance with the Employer's policy.
iii) Vesting of Stock Options. All of the stock options granted
to Executive which have vested as of the Termination Date shall be
retained by Executive and shall be exercisable in accordance with the
Stock Plan, and any unvested options shall be forfeited.
f. Expiration of the Term of the Agreement. If Executive's
employment terminates upon the Expiration Date:
i) Annual Base Salary. The Employer shall on the Expiration Date
pay Executive Executive's Annual Base Salary through the Expiration
Date. In addition, the
9
<PAGE> 10
Employer shall pay Executive an additional one (1) year of Annual Base
Salary, provided, however, that (A) if such expiration is under Special
Circumstances, the Employer shall so notify Executive and such payment
shall be of an additional six (6) months of Annual Base Salary, (B) such
payment shall be subject to applicable statutory or regulatory
restrictions, and (C) no such payment shall be made for so long as the
Federal Reserve or the Federal Deposit Insurance Corporation determines
that the Employer is in an unsafe or unsound financial condition. Such
additional salary shall be payable twice a month in equal installments
over the twelve (12) months commencing as soon as such amount is payable.
The foregoing notwithstanding, no such additional salary whatsoever shall
be paid if either (A) Executive's employment continues past the Expiration
Date on terms and conditions agreed in writing by the Employer and the
Executive, or (B) the Employer offered to extend Executive's employment
under this Agreement for a period of one (1) year on the same terms and
conditions.
ii) Reimbursable Expenses. The Employer shall, within thirty
(30) days following the Expiration Date, pay Executive all reimbursable
expenses for which expense reports have been provided in accordance with
the Employer's policy.
iii) Annual Performance Bonus. The Employer shall, on the
Expiration Date, pay Executive's Annual Performance Bonus for the year
which the Boards determine has been earned through the Expiration Date.
iv) Vesting of Stock Options. All of the stock options granted
to Executive which have vested as of the Expiration Date shall be retained
by Executive and shall be exercisable in accordance with paragraph 7.e.,
and any unvested options shall be forfeited.
v) Other. Executive shall be entitled to no other
compensation or benefits upon expiration of this Agreement.
10. Indemnification of Executive.
a. Pre-Execution Actions and Events. Notwithstanding any other
provision to the contrary contained in this Agreement, the Employer shall
indemnify, defend at its expense, and hold Executive entirely harmless against
and from any claim, demand, cause of action, judgment, loss, liability, damage,
cost or expense whatsoever, including without limitation reasonable attorneys'
fees, which Executive may suffer, sustain, incur or otherwise become subject to
either directly or indirectly as a result of any claim, controversy, dispute,
legal action or
10
<PAGE> 11
proceeding whatsoever arising from actions taken by the Employer or events
relating to the business of the Bank or the Company occurring prior to the
execution of this Agreement.
b. Post-Execution Actions and Events.
Notwithstanding any other provision to the contrary contained in this Agreement,
the Employer shall indemnify, defend at its expense, and hold Executive entirely
harmless against and from any claim, demand, cause of action, judgment, loss,
liability, damage, cost or expense whatsoever, including without limitation
reasonable attorneys' fees, which Executive may suffer, sustain, incur or
otherwise become subject to either directly or indirectly as a result of any
claim, controversy, dispute, legal action or proceeding whatsoever arising from
actions taken by the Employer or events relating to the business of the Bank or
the Company occurring subsequent to the execution of this Agreement, other than
any such claim, demand, cause of action, judgment, loss, liability, damage, cost
or expense whatsoever which is directly and substantially due to Executive's
misconduct or gross negligence. Notwithstanding the foregoing, in any
administrative proceeding or civil action initiated by any federal banking
agency, the Bank or the Company may only reimburse, indemnify or hold harmless
Executive if the Bank is in compliance with any applicable statute, rule,
regulation or policy of the Federal Deposit Insurance Corporation, Federal
Reserve Board, or the California State Banking Department regarding permissible
indemnification payments.
c. Payment of expenses. In the event the Employer is obligated
hereunder to defend and indemnify Executive and in the event Executive is
required to retain independent legal counsel, other experts or professionals or
should incur any cost himself in connection with Paragraph 10.b. above, the
Employer shall promptly pay such expenses as incurred.
d. Survival of Indemnification. The obligations of the Employer
under this paragraph 10 to indemnify Executive shall survive the expiration or
termination of this Agreement.
11. Insurance. The Employer agrees to make reasonable efforts to maintain
director's and officer's liability insurance in an amount of not less than
$2,000,000 for each occurrence for the benefit of Executive. In the event that
the Employer is unable to maintain such insurance and: (i) such event occurs
before Executive commenced his employment hereunder, this Agreement shall not be
effective and neither party shall be obligated hereunder, (ii) such event
occurs after Executive commences his employment hereunder, Executive shall have
the right for a period of thirty (30) days after any such event to treat such
event as termination without cause under Paragraph 9.d. above; provided,
however, that Executive shall not have such
11
<PAGE> 12
right if such event is directly and substantially due to Executive's action or
inaction.
12. General provisions.
a. Binding on Successors. Subject to any restrictions stated in any
other provision of this Agreement, this Agreement shall be binding on and shall
inure to the benefit of the parties and their respective successors and assigns.
b. Partial Invalidity/Severability. Should any of the provisions of
this Agreement be held to be invalid or unenforceable, such invalidity or
unenforceability shall not affect the validity or enforceability of any other
provision of this Agreement.
c. Entire Agreement. This Agreement contains the entire agreement
between the parties with respect to the subject matter of this Agreement and
supersedes all prior oral or written understandings and agreements.
d. Amendments; Waivers. No provision of this Agreement may be
changed, waived, modified, discharged or terminated, except by a written
instrument executed by the parties hereto.
e. Notices. Any notice to be given under this Agreement shall be in
writing and shall be deemed effective only when hand-delivered or when delivered
by overnight courier, or three (3) days after the date postmarked if sent by
certified or registered mail, postage prepaid, return receipt requested,
addressed as follows:
If to the Employer:
The San Francisco Company &
Bank of San Francisco
550 Montgomery Street
San Francisco, California 94111
Attn: Boards of Directors
If to Executive:
James E. Gilleran
947 Lake Street
San Francisco, California 94118
f. Attorney's Fees and Costs. The Employer shall bear all of the
costs and expenses, including attorney's fees, incurred by both parties in the
negotiation and drafting of this Agreement. In the event of a dispute regarding
this Agreement,
12
<PAGE> 13
the prevailing party in any arbitration or litigation shall be entitled to its
reasonable legal fees and costs.
g. Governing Law. This Agreement shall be construed and enforced in
accordance with the laws of the State of California.
h. Title and Headings. Title and heading to paragraphs,
subparagraphs and sub-subparagraphs of this Agreement are for the purpose of
reference only and shall not affect the interpretation of this Agreement.
i. Regulatory Approval. This Agreement is subject to and shall not
become effective until any required approval or non-disapproval of the
employment of Executive by the Federal Reserve Bank, the Federal Deposit
Insurance Corporation and the California State Banking Department has been
obtained.
j. Insolvency. The terms and conditions of the Agreement shall in
no way be binding on the FDIC, or any successor agency, in the event the Bank
is determined to be insolvent and becomes subject to a receiver, conservator or
liquidator.
k. Resolution of disputes. Any and all disputes relating to the
performance of interpretation of this Agreement, or termination of the
employment relationship, shall be resolved exclusively by binding arbitration
before the Judicial Arbitration & Mediation Service ("JAMS") in San Francisco.
l. Conflicts. The Employer and Executive are aware of the Conflict
of Interest provisions of Section 87400 et. seq. of the Government Code. To his
knowledge, with the exception of a proceeding related to a proposed transaction
involving a purchase of interests in the partnership that holds the lease on the
building occupied by the Company and the Bank, Executive has not in the past
participated in any proceeding related to the Employer which is still
outstanding within the meaning of Section 87401(b) of the Government Code. The
Employer's Boards of
13
<PAGE> 14
Directors and Executive will not in the future take any action that would
violate Section 87400 et. seq. of the Government Code.
IN WITNESS WHEREOF, the undersigned have hereunto caused this
Agreement to be executed as of the day and year first above written.
THE SAN FRANCISCO COMPANY
By:
------------------------------
BANK OF SAN FRANCISCO
By:
------------------------------
EXECUTIVE:
--------------------------------
James E. Gilleran
14
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