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U.S. Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 1995
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from __________ to ___________
Commission file number 0-10627
NORTH COUNTY BANCORP
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(Name of small business issuer in its charter)
California 95-3669135
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
444 S. Escondido Boulevard, Escondido, California 92025
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number (619) 743-2200
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, No Par Value
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(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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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Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B is not contained in this form, and no disclosure will
be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-KSB or any amendment to this Form 10-KSB [ X ]
State issuer's revenues for its most recent fiscal year. $22,898,000
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As of March 8, 1996, the aggregate market value of the voting stock held
by non-affiliates of the registrant was approximately $10,252,000.
Shares of Common Stock held by each officer and director and each person
owning more than five percent of the outstanding Common Stock have been
excluded in that such persons may be deemed to be affiliates. This
determination of the affiliate status is not necessarily a conclusive
determination for other purposes.
The number of shares of Common Stock of the registrant outstanding as of
March 8, 1996 was 1,791,433.
Part of Form 10-KSB
Documents Incorporated by Reference: into which incorporated
- ----------------------------------- -----------------------
Proxy Statement for the Company's Annual Meeting of Shareholders
to be held May 22, 1996 Part III
Transitional Small Business Disclosure Format (check one):
Yes No X
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PART I
ITEM 1. DESCRIPTION OF BUSINESS.
THE COMPANY
North County Bancorp (the "Company") is a California corporation
registered as a bank holding company under the Bank Holding Company Act of
1956, as amended (the "BHC Act"), and is headquartered in Escondido,
California. The Company was incorporated in October, 1981 and acquired all
of the outstanding shares of North County Bank (the "Bank") in July, 1982.
The Company's only subsidiary and principal asset is the Bank. The Company
exists primarily for the purpose of holding the stock of its subsidiary, the
Bank, and of such other subsidiaries as it may acquire or establish.
The Company's principal sources of income are dividends from the Bank.
The expenditures of the Company, including (but not limited to) the payment
of dividends to stockholders, if and when declared by the Board of Directors,
and the cost of servicing debt will generally be paid from such payments made
to the Company by the Bank. (For a description on the restrictions on such
dividends see "Legal Proceedings.") At December 31, 1995, the Company had
consolidated assets of $237.0 million, deposits of $213.8 million and
stockholders' equity of $17.2 million.
The Company's Administrative Offices are located at 444 South Escondido
Boulevard, Escondido, California and its telephone number is (619) 743-2200.
References herein to the "Company" include the Company and the Bank, unless
the context indicates otherwise.
THE BANK
The Bank is a California state-chartered bank that commenced operations
in June, 1974 and the deposits of each of the Bank's depositors are insured
up to $100,000 by the Federal Deposit Insurance Corporation ("FDIC"). The
Bank conducts its business through eight full-service branches, four of which
are located in San Diego County in the cities of Escondido, San Marcos and
San Diego, and four of which are in Riverside County in the cities of
Temecula, Murrieta, Beaumont and Banning.
The Bank provides a wide range of banking services to small and
medium-sized businesses, real estate construction and development companies,
professionals and individuals located in San Diego and Riverside counties.
The Bank holds no material patents, trademarks, licenses (other than
licenses obtained from bank regulatory authorities), franchises or
concessions, and did not spend any amounts on research and development
activities in either of the Company's last two fiscal years. The Bank owns
two subsidiaries; NCB Joint Venture-1, Inc., which participated in a real
estate development, and NCB Mortgage, an inactive corporation.
On April 20, 1994, the Bank reached an informal agreement with the FDIC
and the California Superintendent of Banks (the "Superintendent") to take
certain actions to improve its financial position, including among other
things maintaining a ratio of Tier 1 leverage capital to adjusted total
assets of at least 6.75% (See "Description of the Business -- Regulation and
Supervision -- Regulatory Capital Requirements" herein for a definition of
Tier 1 capital) and refraining from the payment of cash dividends unless,
after the payment of such dividends, its Tier 1 leverage capital ratio would
be at least 6.75%. (See "Legal Proceedings.")
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On May 6, 1995 the Bank agreed to an Order to Cease and Desist with FDIC
(the " Order"), a formal enforcement action pursuant to Section 8(b) of the
Federal Deposit Insurance Act, as amended (the "FDI Act"). The primary
provisions of the Order are substantially similar to those of the informal
agreement. The FDIC and the Bank entered into the Order to correct certain
unsatisfactory conditions disclosed in the FDIC's Report of Examination of
the Bank as of October 5, 1994 (the "1994 Examination"). The 1994 Examination
determined that the Bank had inadequate capital, had continued high asset
classifications, had an inadequate allowance for loan losses, had experienced
continued deterioration of earnings, failed to comply fully with the
informal agreement and required improvements in certain internal routines and
controls. The provisions of the Order are intended to address certain
criticisms cited in the examination as well as certain other matters. The
Order replaces the informal agreement with respect to the FDIC. The informal
agreement continues in effect with respect to the Superintendent who was not
a party to the Order. (See "Legal Proceedings.")
Pursuant to the results of examinations by the Superintendent and the
FDIC as of December 4, 1995 (the "1995 Examination") received by the Bank
during the first quarter of 1996, the Superintendent has terminated the
informal agreement and the FDIC has indicated its preliminary intent to
terminate the Order and may proposed that the Bank enter into a new informal
enforcement action. (See "Legal Proceedings.")
RETAIL BANKING SERVICES
DEPOSITS ACCOUNTS
The Bank offers a wide variety of deposit products for the retail banking
market including checking, interest-bearing checking, savings, certificates
of deposit and retirement accounts. As of December 31, 1995, the Bank had
approximately 20,460 retail deposit accounts with a balance of $109.8 million
as compared to 20,300 retail deposit accounts with a balance of $111.7
million at December 31, 1994. The Bank attempts to attract deposits through
its product mix, pricing, convenient locations, extended hours, and efforts
to provide the highest level of customer service. At December 31, 1995, the
Bank's retail deposits consisted of $17.4 million or 15.8% in
non-interest-bearing demand deposits, $15.7 million or 14.3% in
interest-bearing demand deposits, $47.8 million or 43.6% in savings and
money market deposits, $4.7 million or 4.3% in individual retirement
accounts and, $24.2 million or 22.0% in time certificates of deposit. (See
"Management's Discussion and Analysis or Plan of Operation -- Financial
Condition -- Deposits.")
LOANS
The Bank also offers many types of consumer loans to its customers.
These include new and used automobile, home improvement, home equity,
personal lines of credit, overdraft protection, credit cards and other
secured and unsecured installment and consumer loans. The Bank's consumer
loans totaled approximately $46.7 million and $45.0 million at December 31,
1995 and 1994, respectively. Prior to 1995 the Bank offered a variety of
single family mortgage loan programs through its Real Estate Division. These
mortgage loans were most often sold in the secondary market to FNMA, FHLMC or
other investors, with the Bank retaining servicing rights to the loans. In
early 1995 this operation was closed by the Bank. The Bank originated
approximately $11.3 million in mortgage loans in 1994. At December 31, 1995
and 1994, the Bank's mortgage loan servicing portfolio totaled approximately
$58.9 million and $64.1 million respectively. The Bank also makes
construction loans for custom built, owner-occupied homes.
During 1992, the Bank opened its Equity Services Department. This
department primarily offers FHA Title I home improvement loans ("Title I
loans"). These loans are secured by junior liens on residential real estate,
are insured up to 90% by an agency of the U.S. Government, and may be made
to qualified home owners
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with little or no equity in the property. In addition to offering these
loans to its customers, the Bank also purchases Title I loans from other
Title I lenders. The Bank then sells these loans in the secondary market,
sometimes retaining the servicing rights. The Bank has also sold
certificates of participation in the 90% guaranteed portion, retaining the
serving rights. The Bank has been very successful in this market, generating
$34.5 million and $37.3 million of Title I loans in 1995 and 1994,
respectively, becoming one of the largest Title I lenders in the country.
The Bank's Title I loan servicing portfolio totaled $11.9 million and $13.4
million at December 31, 1995 and 1994 respectively. (See "Management's
Discussion and Analysis or Plan of Operation -- Financial Condition --
Loans.")
OTHER RETAIL PRODUCTS AND SERVICES
The Bank offers other products and services to its retail customers which
compliment its deposit and loan products. These include life insurance
products, including annuities, investments, travelers' checks, safe deposit
boxes, escrow, notary, and collection services. The Bank also has
drive-through facilities with extended hours for customers' convenience and
participates in several shared ATM and point-of-sale ("POS") networks
providing its customers with access to ATMs and POS terminals throughout the
world. The Bank also offers a telephone voice response service which gives
customers access to account information 24 hours a day. This service allows
customers to do loan and deposit account balance inquiries, make loan
payments, transfer funds between accounts, and verify the posting of recent
transactions to their account.
Although Management believes there is a demand for trust services in the
Bank's market area the Bank does not operate or have any present intention to
seek authority to operate a trust department, since Management believes that
the costs of establishing and operating such a department would not be
justified by the potential income to be gained therefrom at this time.
BUSINESS BANKING SERVICES
DEPOSIT ACCOUNTS
The Bank offers interest-bearing and non-interest-bearing deposit
accounts designed for small to medium-sized business customers. The
services offered in conjunction with these accounts may include providing
currency and coin, armored car pick-up, courier services, payroll services,
credit card merchant services, document collection and wire transfers. The
fees charged for a business account typically vary with the amount of
services provided and the level of balances the customer keeps on deposit.
The Bank relies on marketing and promotional activities and personal contact
by its officers, directors and employees to develop these customer
relationships, emphasizing the Bank's local ownership and decision making,
personal service, community ties and financial strength. At December 31,
1995 the Bank had approximately 6,246 business deposit accounts totaling
$104.0 million as compared to approximately 6,800 business deposit accounts
totaling $113.4 million at December 31, 1994. (See "Management's Discussion
and Analysis or Plan of Operation -- Financial Condition -- Deposits.")
LOANS
The Bank provides secured and unsecured loans and lines of credit for the
operating and expansion needs of businesses, ranging from inventory and
accounts receivable financing to equipment financing and letters of credit.
These loans are generally for terms of one year or less. Significant
emphasis is placed on the borrower's earnings history, capitalization,
secondary sources of repayment (such as accounts receivable) or highly liquid
collateral (such as certificates of deposit or publicly traded stocks or
bonds). The Bank also makes
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loans to local real estate developers for the construction of entry level to
middle income single family residences and fixed and variable rate loans on
commercial real estate with terms of up to ten years. For customers whose
loan demands exceed the Bank's legal lending limits, the Bank attempts to
arrange for such loans on a participation basis with correspondent banks.
The Bank also assists customers requiring other services not offered by the
Bank in obtaining such services from its correspondent banks. Commercial
loans (including commercial real estate loans) totaled approximately $97.9
million and $99.2 million at December 31, 1995 and 1994, respectively.
Since 1991, the Bank has been active in originating loans partially
guaranteed by the U.S. Small Business Administration ("SBA"). These loans
have maturities ranging from seven to 25 years and are guaranteed up to 90%
by the SBA. The Bank usually sells the guaranteed portion of the loan for a
premium, retaining the unguaranteed portion and the servicing of the loans
for which it is paid a servicing fee. The Bank originated approximately
$21.7 million and $20.4 million in SBA loans in 1995 and 1994, respectively.
The Bank's SBA loan servicing portfolio totaled approximately $51.2 million
and $41.8 million at December 31, 1995 and 1994, respectively. (See
"Management's Discussion and Analysis or Plan of Operation -- Financial
Condition -- Loans.")
REAL ESTATE INVESTMENTS
The Company has engaged in direct and indirect real estate development
activities on a selective basis. At December 31, 1995, the Company remained
involved in one development project. The Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA") prohibits all insured state
banks from engaging in activities which are not permitted for national banks,
such as real estate development activities. Accordingly, the Bank will be
divesting of this project over the next several years and will not be
participating in additional real estate development activities. (See
"Management's Discussion and Analysis or Plan of Operations -- Financial
Condition -- Real Estate Investments," and "Description of Business --
Regulation and Supervision -- Recent Legislation and Other Matters.")
COMPETITION
The banking business in Southern California generally is highly
competitive with respect to both loans and deposits and is dominated by a
number of major banks which have offices operating throughout the state and
in the Company's market area. The Company actively competes for all types of
deposits and loans with other banks and financial institutions located in its
service area.
Several mergers of large regional banks and large failed savings and loan
associations with major banks, acquisitions of independent banks by major
banks, and the failures of several independent banks in the Company's market
area have significantly increased the presence of large regional banks and
have reduced the number of independent banks competing in the Company's
market area. Additionally, recent legislation has allowed out-of-state banks
to operate in California, further increasing competition in the Bank's market
area. (See "Description of Business -- Regulation and Supervision -- Recent
Legislation and Other Matters.") Although major banks have some competitive
advantages over small independent banks, the Bank has actively tried to make
the loss of local independent banks a competitive advantage by soliciting
customers who prefer the personal service offered by the Bank.
Among the advantages which the major banks have over the Company are
their ability to finance extensive advertising campaigns and to allocate
their investment assets to regions of highest yield and demand, and over a
more diverse geographic area. Many of the major commercial banks operating
in the Company's service area offer certain services, such as trust and
international banking services, which are not offered directly
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by the Company and, by virtue of their greater total capitalization, such
banks have substantially higher lending limits than the Company. The Company
also competes for loans and deposits from non-bank financial institutions and
intermediaries including savings and loan associations, thrift and loan
associations, finance companies, credit unions, mortgage companies, insurance
companies and other lending institutions.
In order to compete with the other financial institutions in its primary
service area, the Company relies principally upon local promotional
activities and personal contact by its officers, directors, and employees and
by providing services such as payroll, messenger, escrow accounting, and
other services. The Company's promotional activities emphasize the advantages
of dealing with a local bank attuned to the particular needs of the
community.
REGULATION AND SUPERVISION
The following discussion of statutes and regulations is only a summary
and does not purport to be complete. This discussion is qualified in its
entirety by reference to such statutes and regulations. No assurance can be
given that such statutes or regulations will not change in the future.
THE COMPANY
The Company is subject to the periodic reporting requirements of Section
13 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"),
which requires the Company to file annual, quarterly and other current
reports with the Securities and Exchange Commission (the "Commission"). The
Company is currently deemed to be a "small business issuer" as defined in the
regulations and files these reports pursuant to Regulation S-B. The Company
is also subject to additional regulations including, but not limited to, the
proxy and tender offer rules promulgated by the Commission under Sections 13
and 14 of the Exchange Act; the reporting requirements of directors,
executive officers and principal stockholders regarding transactions in the
Company's Common Stock and short- swing profits rules promulgated by the
Commission under Section 16 of the Exchange Act; and certain additional
reporting requirements by principal stockholders of the Company promulgated
by the Commission under Section 13 of the Exchange Act.
The Company is a bank holding company within the meaning of the BHC Act
and is registered as such with the Board of Governors of the Federal Reserve
System (the "FRB"). A bank holding company is required to file with the FRB
annual reports and other information regarding its business operations and
those of its subsidiaries. It is also subject to examination by the FRB and
is required to obtain FRB approval before acquiring, directly or indirectly,
ownership or control of any voting shares of any bank if, after such
acquisition, it would directly or indirectly own or control more than 5% of
the voting stock of that bank, unless it already owns a majority of the
voting stock of that bank. The BHC Act further provides that the FRB shall
not approve any such acquisition that would result in or further the creation
of a monopoly, or the effect of which may be substantially to lessen
competition, unless the anticompetitive effects of the proposed transaction
are clearly outweighed by the probable effect in meeting the convenience and
needs of the community to be served.
Furthermore, under the BHC Act, a bank holding company is, with limited
exceptions, prohibited from acquiring direct or indirect ownership or
control of more than 5% of the voting shares of any company which is not a
bank or engaging in any activity other than managing or controlling banks.
With the prior approval of the FRB, however, a bank holding company may own
shares of a company engaged in activities which the FRB determines to be so
closely related to banking or managing or controlling banks as to be a proper
incident thereto.
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The FRB has by regulation determined that certain activities are so
closely related to banking as to be a proper incident thereto within the
meaning of the BHC Act. These activities include, but are not limited to:
operating an industrial loan company, industrial bank, Morris Plan Bank,
mortgage company, finance company, credit card company or factoring company;
performing certain data processing operations; providing investment and
financial advice; operating as a trust company in certain instances; selling
travelers' checks, U.S. savings bonds and certain money orders; providing
certain courier services; performing real estate appraisals; providing
management consulting advice to nonaffiliated depository institutions in some
instances; acting as an insurance agent for certain types of credit-related
insurance and underwriting certain types of credit-related insurance; leasing
property or acting as agent, broker or advisor for leasing property on a
"full pay-out basis;" acting as a consumer financial counselor, including tax
planning and return preparation; performing futures and options advisory
services, check guarantee services and discount brokerage activities;
operating a collection or credit bureau; or performing personal property
appraisals.
The FRB also has determined that certain other activities are not so
closely related to banking as to be a proper incident thereto within the
meaning of the BHC Act. Such activities include: real estate brokerage and
syndication; real estate development; property management; underwriting of
life insurance not related to credit transactions; and, with certain
exceptions, securities underwriting and equity funding. In the future, the
FRB may add to or delete from the list of activities permissible for bank
holding companies.
THE BANK
As the Bank's deposits are insured to a maximum of $100,000 per
depositor by the FDIC, the Bank pays a quarterly assessment to the FDIC and
is subject to the rules and regulations of the FDIC pertaining to deposit
insurance and other matters. The Bank is also subject to examination by the
FDIC. (See "Description of Business -- Regulation and Supervision -- Recent
Legislation and Other Matters.") Like most state-chartered banks of its size
in California, the Bank has chosen not to become a member of the Federal
Reserve System.
As a California state-chartered bank the Bank is also subject to
regulation, supervision and regular examination by the California State
Banking Department. In addition, while the Bank is not be a member of the
Federal Reserve System, it is subject to certain regulations of the FRB. The
regulations of these agencies govern most aspects of the Bank's business,
including the making of periodic reports by the Bank, and the Bank's
activities relating to dividends, investments, loans, borrowings, capital
requirements, certain check-clearing activities, branching, mergers and
acquisitions, reserves against deposits and numerous other areas.
The assets of a commercial banking institution consist largely of
interest-earning assets, including loans and investment securities. The
liabilities of a commercial banking institution consist largely of
interest-bearing liabilities, including time deposits, money market accounts
and other bank borrowings. The values and yields of these assets and rates
paid on these liabilities are sensitive to changes in prevailing market rates
of interest. The earnings and growth of the Bank are largely dependent upon
the Bank's ability to increase the amount and net yield of its
interest-earning assets (as well as to control operating expenses and avoid
or minimize loan and investment losses), which in turn depend upon deposit
growth and the ability of the Bank to maintain a favorable differential or
"spread" between the yield on interest-earning assets and the rate paid on
deposits and other interest-bearing liabilities.
Thus, the earnings and growth of the Bank are influenced by general
economic conditions, both domestic and foreign, the monetary and fiscal
policies of the federal government, and the policies of the regulatory
agencies, particularly the FRB. The FRB implements national monetary policies
(such as seeking to
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curb inflation and combat recession) by its open-market operations in United
States Government securities, by adjusting the required level of reserves for
financial institutions subject to its reserve requirements and by varying the
discount rate applicable to borrowings by banks which are members of the
Federal Reserve System. The actions of the FRB in these areas influence the
growth of bank loans, investments and deposits and also affect interest rates
charged on loans and deposits. The nature and impact of any future changes in
monetary policies cannot be predicted.
REGULATORY CAPITAL REQUIREMENTS
The FRB and the FDIC have adopted substantially similar risk-based
capital ratio guidelines to which the Company and the Bank, respectively, are
subject. Those guidelines establish a systematic analytical framework that
makes regulatory capital requirements more sensitive to differences in risk
profiles among banking organizations. Risk based capital ratios are
determined by allocating assets and specified off-balance sheet commitments
to four risk-weighted categories, with higher levels of capital being
required for the categories perceived as representing greater risk.
These regulatory guidelines divide a financial institution's capital
into two tiers. The first tier ("Tier 1") includes common stockholders'
equity, certain non-cumulative perpetual preferred stock, minority interests
in equity accounts of consolidated subsidiaries, less goodwill and certain
other intangible assets. Supplementary ("Tier 2") capital includes, among
other items, cumulative perpetual and long-term limited-life preferred stock,
mandatory convertible securities, certain hybrid capital instruments, term
subordinated debt and the allowance for loan and lease losses, subject to
certain limitations, less required deductions. Financial institutions are
required to maintain a minimum total risk-based capital ratio of 8.0%, of
which one-half of the total capital must be in the form of Tier 1 capital.
The regulators may, however, set higher capital requirements when an
institution's particular circumstances warrant. Institutions experiencing or
anticipating significant growth and institutions subject to supervisory
orders and directives are expected to maintain capital ratios, including
tangible capital positions, well above minimum levels.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") required each federal banking agency to revise its risk-based
capital standards within 18 months of enactment of the statute to ensure that
those standards take adequate account of interest rate risk, concentration of
credit risk and the risk of non-traditional activities as well as reflect the
actual performance and expected risk of loss on multifamily mortgages. In
August, 1992, the FRB, FDIC and the Office of the Comptroller of the Currency
(the "OCC") requested comments on how the risk-based capital guidelines of
each agency may be revised to take account of concentration of credit risk
and the risk of nontraditional activities. The agencies indicated in
September, 1993, that separate rulemaking proposals on those areas would be
forthcoming. After issuing proposed rules in 1993 implementing those
revisions with respect to interest rate risk the regulatory agencies
indicated in June 1995 that they were amending the risk-based capital
standards to state simply that bank examiners must consider interest rate
risk as part of their examinations. In August, 1995, the three federal
agencies proposed a joint agency policy statement which seeks to establish a
uniform framework to use in measuring and assessing interest rate risk
exposure in financial institutions. The measurement process described in the
policy statement in intended to facilitate the banking agencies assessment of
an institution's interest rate exposure and its capital adequacy. In
assessing the sensitivity of an institution's economic value to changes in
interest rates, the agencies are proposing to use the results of a
supervisory model and for those electing to provide such analysis, the
results of the institution's own internal models. These assessments will rely
on data reported in regulatory Call Reports. Although still required to
assess its degree of interest rate risk, institutions with (i) assets under
$300 million; (ii) composite supervisory CAMEL ratings of 1 or 2; and (iii)
moderate or limited holding of assets with intermediate and long-term
maturity or repricing characteristics would be exempt from the new Call
Report information. Call Report schedules and instructions included in the
proposed policy statement will be effective March 31, 1996 for institutions
required to report. An effective date of December 31, 1996 is proposed for
the
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full implementation of this policy statement. The period for providing
comments on the proposed policy statement expired October 2, 1995; however,
no final action has yet been taken.
As of December 31, 1995, the Company's total risk-based capital and Tier
1 risk-based capital ratios were 11.21% and 9.06%, respectively. As of
December 31, 1995, the Bank's total risk-based capital and Tier 1 risk-based
capital ratios were 11.65% and 10.40%, respectively.
The FRB and FDIC also require the maintenance of a leverage capital
ratio designed to supplement the risk-based capital guidelines. This ratio is
computed by dividing Tier 1 capital, net of all intangibles, by the quarterly
average of total assets. The minimum leverage ratio is 3.0% for the most
highly rated institutions, and at least 100 to 200 basis points higher for
institutions not meeting those standards. Pursuant to federal regulations,
institutions must maintain capital levels commensurate with the level of
risk, including the volume and severity of problem loans, to which they are
exposed.
As of December 31, 1995 the Company's Tier 1 leverage capital ratio was
7.17%. The Bank is currently operating under an Order to Cease and Desist
with the FDIC under which it has agreed to maintain a Tier 1 leverage
capital ratio of at least 7.50%, a level which is higher than the minimum
required ratio. As of December 31, 1995 the Bank's Tier 1 leverage capital
ratio was 8.20%. (See "Legal Proceedings.")
RECENT LEGISLATION AND OTHER MATTERS
From time to time, legislation is proposed or enacted which has the
effect of increasing the cost of doing business, limiting or expanding
permissible activities, or affecting the competitive balance between banks
and other financial and non-financial institutions. Proposals to change the
laws and regulations governing the operations and taxation of banks, bank
holding companies and other financial institutions are frequently made in
Congress, in the California legislature and before various bank regulatory
agencies. Generally speaking, many recent laws have had the effect of
altering competitive relationships existing among financial institutions,
reducing the historical distinctions between the services offered by banks,
savings and loan associations and other financial institutions, and
increasing the cost of funds to banks and other depository institutions.
Certain of the potentially significant laws or regulations which have been
enacted recently and others which are currently under consideration by
Congress or various regulatory or professional authorities are discussed
below.
FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991.
On December 19, 1991, the Federal Deposit Insurance Corporation
Improvement Act of 1991 ("FDICIA") was signed into law. The many areas
addressed by FDICIA include, among others, capital standards, enhanced
enforcement powers for the federal regulatory agencies, bank examinations and
assessments, federally prescribed standards for management compensation,
audit standards and procedures, insider lending, BIF recapitalization,
reduction of costs to the insurance fund in the event of bank failures, use
of brokered deposits, risk-based insurance premiums, deposit insurance
coverage for certain accounts, and mandatory FDIC approval for all new
deposit insurance. The potential regulatory burden which could be imposed
upon banks by various provisions of FDICIA is considerable, and it is likely
that this legislation will have a substantial effect on the operations of all
banks. Certain of the most potentially significant changes which have been
enacted or promulgated and proposals which have been made recently are
discussed below.
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PROMPT CORRECTIVE ACTION. Among the most significant aspects of FDICIA
are the prompt corrective action requirements codified in Section 38 of the
Federal Deposit Insurance Act ("Section 38"). Under Section 38, the federal
bank regulatory agencies are required to establish five capital categories
for all depository institutions, based on leverage limit and risk-based
capital requirements established by those agencies. Section 38 established a
framework of supervisory actions indexed to the capital category of each
depository institution. Thus, as a bank's capital ratios fall, it becomes
subject to a series of increasingly restrictive actions. Those five capital
categories are termed "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized" and "critically
undercapitalized."
The FDIC's implementing regulations under Section 38 are set forth in 12
CFR Part 325, Subpart B ("Subpart B") of the FDIC's Regulations. The
principal focus of Subpart B (substantially similar versions of which have
been promulgated by the other federal banking agencies) was to define each of
the five capital categories established by FDICIA. The "well capitalized"
category is defined as including any institution with a ratio of Tier 1
capital to adjusted total assets ("leverage capital ratio") of 5.0% or
greater; a ratio of Tier 1 capital to total risk-weighted assets ("Tier 1
risk-based capital ratio") of 6.0% or greater; and a ratio of total capital
to total risk-weighted assets ("Total risk-based capital ratio") of 10.0% or
greater, provided that such institution is not subject to a regulatory order,
agreement or directive to meet and maintain a specified capital level.
An institution is deemed to be adequately capitalized if it has a
leverage capital ratio of 4.0% or greater, a Tier 1 risk-based capital ratio
of 4.0% or greater and a total risk-based capital ratio of 8.0% or greater.
If a bank's leverage capital ratio or Tier 1 risk-based capital ratio were to
fall below 4.0% or if its total risk-based capital ratio were to fall below
8.0%, it would be deemed to be "undercapitalized" under Section 38 and
Subpart B. State banks which fall within the "undercapitalized" capital
category are subject to certain mandatory restrictions and directives imposed
by the FDIC under FDICIA. Those restrictions and directives include, among
others, the following: (i) submission of a written capital restoration plan
which specifies (a) the steps the bank will take to become adequately
capitalized, (b) the levels of capital to be obtained during each year in
which the plan will be in effect, -C- how the bank will comply with all of
the mandatory restrictions described in this paragraph, and (d) the types and
levels of activities in which the bank will engage; (ii) a restriction upon
the growth of a bank's average total assets during any calendar quarter in
excess of its average total assets during the preceding calendar quarter
(unless specific certain conditions are met); (iii) a prohibition against
making any acquisition, opening any new branch offices or engaging in any new
line of business without prior FDIC approval; (iv) a restriction upon the
payment of cash dividends if, after payment of such dividend, the bank would
be undercapitalized; and (v) a prohibition upon the payment of any management
fee to any person having control of that bank if, after making the payment,
the bank would be undercapitalized.
Additionally, the FDIC has discretionary authority to take further
supervisory actions against an "undercapitalized" bank if it determines that
those actions are necessary to carry out the purpose of the prompt corrective
action provisions of FDICIA. Furthermore, a bank's capital category could be
further downgraded (but not below "significantly undercapitalized") if the
FDIC determines, based on other factors such as safety and soundness
concerns, that a lower capital category is more appropriate.
If at any time a bank's total risk-based capital ratio falls below 6.0%,
or if either its Tier 1 risk-based capital ratio or its leverage capital
ratio falls below 3.0%, the bank would be deemed to be "significantly
undercapitalized" as defined in Subpart B. Banks which fall within the
"significantly undercapitalized" category, or banks which fall within the
"undercapitalized" category and which are subject to the FDIC's discretionary
authority as discussed above, will be subject to, among other things, one or
more of the following actions: (i) a directive that the bank raise adequate
capital to meet minimum capital requirements by selling voting shares; (ii) a
requirement that the bank be merged with or acquired by another institution
if one or more grounds exist for the appointment of a receiver; (iii)
restrictions on transactions with affiliates; (iv) restrictions on interest
rates
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on deposits to "prevailing rates" on deposits of comparable amounts and
maturities in the area (on a prospective basis only); (v) restrictions on
asset growth which are more stringent than the mandatory restrictions imposed
upon "undercapitalized" banks, or directives requiring the reduction of a
bank's total assets; (vi) restrictions on activities by the bank which the
FDIC believes pose excessive risk; (vii) directives regarding the election of
a new board of directors, dismissal of specified directors or senior
executive officers, and/or the employment of qualified senior executive
officers; (viii) prohibitions upon the bank from accepting deposits from
correspondent banks; and (ix) prohibitions upon the payment of any bonus to a
senior executive officer or increasing such officer's compensation above the
average rate of compensation paid to him during the past 12 months without
prior FDIC approval.
If a Bank's ratio of tangible equity capital to adjusted total assets
(essentially the same as the leverage capital ratio for purposes of the Bank)
were to equal or fall below 2%, the bank would be deemed to be "critically
undercapitalized" as defined in Subpart B. Within 90 days after a state bank
becomes critically undercapitalized, the FDIC must either appoint a receiver
or conservator or take such other actions which the FDIC determines would
better achieve the purpose of the prompt corrective action provisions of
FDICIA, after documenting why the alternative action would better achieve
that purpose.
Periodic re-determinations are required every 90 days, and in any event
a receiver must be appointed (with exceptions under certain circumstances)
after 270 days, if the bank's average capital during such period is below the
critical level. A limited exception exists for banks which the FDIC
determines have positive net worth, have been in substantial compliance with
an approved capital restoration plan, are profitable or have an upward trend
in earnings, and are reducing the ratio of non-performing loans to total
loans, provided the Chairman of the FDIC's Board of Directors certifies in
writing that the bank is viable and not expected to fail.
Critically undercapitalized state nonmember banks must also comply with
restrictions on activities to be prescribed by the FDIC in each individual
case, which restrictions will consist at a minimum of prohibitions on (i)
entering into material transactions other than in the ordinary course of
business, including certain investments, sales of assets, acquisitions or
similar actions; (ii) extending credit for highly leveraged transactions;
(iii) amending a bank's charter or bylaws (except to the extent necessary to
carry out the requirement of any law, regulation or order); (iv) making any
material change in accounting methods; (v) engaging in transactions with
affiliates; (vi) paying excessive compensation or bonuses; (vii) paying
interest on new or renewed liabilities above a specified rate; or (viii)
within 60 days of becoming critically undercapitalized, making any payment of
principal or interest on any of a bank's subordinated debt (with limited
exceptions).
IMPROVED EXAMINATIONS. All insured depository institutions must undergo
a full-scope, on-site examination by their appropriate federal banking agency
at least once every 12 months. The cost of examinations of insured depository
institutions and any affiliates may be assessed by the appropriate federal
banking agency against each institution or affiliate as it deems necessary or
appropriate.
STANDARDS FOR SAFETY AND SOUNDNESS. FDICIA requires the federal banking
agencies to prescribe, by regulation, standards for all insured depository
institutions and depository institution holding companies relating to
internal controls, loan documentation, credit underwriting, asset quality,
interest rate exposure, asset growth and employee compensation. Standards
must also be prescribed for classified loans, earnings and the minimum ratio
of market value to book value for publicly traded shares. FDICIA also
requires the federal banking agencies to issue uniform regulations
prescribing standards for real estate lending that are to consider such
factors as the risk to the deposit insurance fund, the need for safe and
sound operation of insured depository institutions and the availability of
credit. Furthermore, FDICIA requires the federal banking agencies to
establish standards prohibiting compensation, fees and benefit arrangements
that are excessive or could lead to financial
11
<PAGE>
loss. Effective August 9, 1995, the FDIC and the other federal banking
agencies issued final regulations concerning the safety and soundness
standards required to be prescribed by FDICIA.
The FDIC and the other federal banking agencies have also issued final
regulations prescribing uniform guidelines for real estate lending, which
require insured depository institutions to adopt written policies
establishing standards, consistent with such guidelines, for extensions of
credit secured by real estate. The policies must address loan portfolio
management, underwriting standards and loan-to-value limits that do not
exceed the supervisory limits prescribed by the regulations.
RISK-BASED PREMIUMS. Under the FDIC's final regulations implementing the
risk-based premium system mandated by FDICIA, which regulations became
effective January 1, 1994, insured depository institutions are now required
to pay insurance premiums depending on their risk classification. Those
regulations were amended effective September 15, 1995 to lower the annual
assessments of commercial banks within a range of four cents per $100 of
deposits to 31 cents per $100 of deposits from the current range of 23 cents
to 31 cents per $100 of deposits. To determine the risk-based assessment for
each institution, the FDIC will categorize an institution as well
capitalized, adequately capitalized or undercapitalized based on its capital
ratios. A well capitalized institution is one that has at least a 10% total
risk-based capital ratio, a 6% Tier 1 risk-based capital ratio and a 5%
leverage capital ratio. An adequately capitalized institution will have at
least an 8% total risk-based capital ratio, a 4% Tier 1 risk-based capital
ratio and a 4% leverage capital ratio. An undercapitalized institution will
be one that does not meet either of the above definitions. The FDIC will also
assign each institution to one of three subgroups based upon reviews by the
institution's primary federal or state regulator, statistical analysis of
financial statements and other information relevant to evaluating the risk
posed by the institution. As a result, and as the designated ratio of the
FDIC's reserves to total insured deposits of 1.25% has been achieved, the
annual assessment rates within each of three capital categories are currently
as follows (expressed as cents per $100 of deposits):
<TABLE>
<CAPTION>
SUPERVISORY SUBGROUP
--------------------
<S> <C> <C> <C>
A B C
--- --- ---
Well capitalized . . . . . . 0 3 17
Adequately capitalized . . . 3 10 24
Undercapitalized . . . . . . 10 24 27
</TABLE>
PROHIBITED ACTIVITIES. FDICIA prohibits insured state-chartered banks
and their majority-owned subsidiaries from conducting activities "as
principal" of a type or amount not permitted for national banks, including
real estate developments and investments in certain equity securities, and
mandates divestiture of these investments by December 19, 1996. A bank,
however, may engage in an otherwise prohibited activity if it meets its
minimum capital requirements and the FDIC determines that the activity does
not present a significant risk to the deposit insurance funds. Activities
defined by the FRB as "closely related to banking," securities activities
conducted in a subsidiary, and certain stock holdings by a majority-owned
subsidiary are permissible. (See "Description of Business -- Regulation and
Supervision -- The Company.") Banks holding prohibited equity investments
are required to submit a plan of divestiture to the FDIC. The law does
provide a partial exception for certain stock and mutual fund ownership,
allowing a bank to retain or acquire new qualifying equity investments upon
approval. The Bank has filed divestiture plans with the FDIC for the
divestiture of such investments. (See "Management's Discussion and Analysis
or Plan of Operation -- Financial Condition -- Real Estate Investments" and
"Management's Discussion and Analysis or Plan of Operation -- Financial
Condition -- Investments.")
The impact of FDICIA on the Bank is uncertain, especially as many of the
regulations promulgated thereunder have only been recently adopted and
certain of the law's provisions still need to be defined through
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<PAGE>
future regulatory action. Certain provisions, such as the recently adopted
real estate lending standards and the operational and managerial standards
governing, among other things, employee compensation, fees, asset quality,
earnings and stock valuation may affect the way in which the Bank conducts
its business, and other provisions, such as those relating to interest rate
risk and the establishment of a risk-based premium system, may adversely
affect the Bank's results of operations.
THE RIEGLE-NEAL INTERSTATE BANKING AND BRANCHING EFFICIENCY ACT OF 1994.
On September 29, 1994, President Clinton signed into law the Riegle-Neal
Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate
Banking Act"). The Interstate Banking Act regulates the interstate activities
of banks and bank holding companies and establishes a framework for
nationwide interstate banking and branching. The most salient features of the
Interstate Banking Act are set forth below.
INTERSTATE BANK MERGERS. Commencing June 1, 1997, a bank in one state
generally will be permitted to merge with a bank located in another state
without the need for explicit state law authorization. However, states can
prohibit interstate mergers involving state banks they have chartered, or
national banks having a main office in such state, if they "opt-out" of this
portion of the federal legislation (i.e., enact state legislation that
prohibits merger transactions involving out-of-state banks) prior to June 1,
1997. Such state legislation must apply equally to all out-of-state banks.
Alternatively, interstate bank mergers can be approved under the Interstate
Banking Act prior to June 1, 1997, if the home state of each bank involved in
the subject transaction has enacted legislation prior to the time of such
approval that expressly permits the interstate merger and such legislation
applies equally to all out-of-state banks.
BANK HOLDING COMPANY ACQUISITIONS. As of September 29, 1995, bank
holding companies are permitted to acquire banks located in any state,
provided that the bank holding company is both adequately capitalized and
adequately managed. This new law is subject to two exceptions: first, any
state may still prohibit bank holding companies from acquiring a bank which
is less than five years old; and second, no interstate acquisition can be
consummated by a bank holding company if the acquiror would control more then
10 percent of the deposits held by insured depository institutions nationwide
or 30 percent or more of the deposits held by insured depository institutions
in any state in which the target bank has branches.
DE NOVO BRANCHING. A bank may establish and operate DE NOVO branches in
any state in which the bank does not maintain a branch if that state has
enacted legislation to expressly permit all out-of-state banks to establish
branches in that state.
OTHER PROVISIONS. Among other things, the Interstate Banking Act amends
the Community Reinvestment Act to require that in the event a bank has
interstate branches, the appropriate federal banking regulatory agency must
prepare for such institution a written evaluation of the bank's record of
performance and the bank's performance in each applicable state. Commencing
June 1, 1997, interstate branches will be prohibited from being used as
deposit production offices; foreign banks will be permitted to establish
branches in any state other than its home state to the same extent that a
bank chartered by the foreign bank's home state may establish such branches;
and certain procedural safeguards have been imposed upon the Comptroller of
the Currency prior to preempting state laws regarding community reinvestment,
consumer production, fair lending and establishment of interstate branches,
whether or not related to interstate branching. It is impossible to ascertain
at this time with any degree of certainty what impact the Interstate Banking
Act will have on the banking industry in general and the Bank in particular.
13
<PAGE>
RIEGLE COMMUNITY DEVELOPMENT AND REGULATORY IMPROVEMENT ACT OF 1994.
On September 23, 1994, President Clinton signed into law the Riegle
Community Development and Regulatory Improvement Act of 1994 (the "Regulatory
Improvement Act"). The Regulatory Improvement Act provides regulatory relief
for both large and small banks by, among other things, reducing the burden of
regulatory examinations, streamlining bank holding company procedures and
establishing a formal regulatory appeals process. The Regulatory Improvement
Act also addresses a variety of other topics, including, but not limited to,
RESPA, call reports, insider lending, money laundering, currency transaction
reports, management interlocks, foreign accounts, mortgage servicing and
credit card receivables. The most salient provisions of the Regulatory
Improvement Act are set forth below.
REGULATORY EXAMINATIONS. The Regulatory Improvement Act greatly expands
the number of small banks eligible for extended examination cycles.
Currently, all banks must be examined annually, with only well-capitalized
and well-managed CAMEL 1 rated banks under $100 million in assets granted an
18-month cycle. The Regulatory Improvement Act (i) permits CAMEL 1 rated
banks with under $250 million in assets to be examined every 18 months; (ii)
with certain eligibility requirements, allows well-managed and
well-capitalized CAMEL 2 rated institutions with no more than $100 million in
assets to be examined every 18 months; and (iii) grants federal bank
regulatory agencies the authority, two years from the date of enactment of
this legislation, to permit well-managed and well-capitalized CAMEL 2 rated
banks with $175 million in assets or less that 18-month examination cycle if
consistent with safety and soundness principles.
BANK HOLDING COMPANY PROCEDURES. The Regulatory Improvement Act provides
new procedures for forming a bank holding company. Although the information
required to be provided in a bank holding company application remains
essentially the same, the formal review process now involves only a 30-day
processing period. This streamlined procedure is available only for entities
where the shareholder interests before and after the reorganization remain
essentially the same, the bank is either well-capitalized or
adequately-capitalized after the reorganization, the bank holding company
meets all of the capital and other requirements of the FRB, and the bank
holding company does not engage in any activities other than managing or
controlling a subsidiary bank(s). Additionally, the Regulatory Improvement
Act formally amends the Securities Act of 1933 to provide that securities
issued by a bank holding company in its initial reorganization are securities
exempt from federal registration requirements and, therefore, no registration
statement is required to be filed with the SEC in connection with the
reorganization. To qualify for such an exemption, (i) the bank holding
company must have no significant assets other than the securities of the
bank, (ii) the shareholders must maintain the same proportional interest
before and after the reorganization, and (iii) the bank holding company must
have the same assets and liabilities on a consolidated basis as the bank
prior to the reorganization. This securities exemption is not available for
future offerings of securities of the reorganized holding company.
REGULATORY APPEALS. The establishment by each of the federal bank
regulatory agencies of an internal regulatory appeals process for all insured
depository institutions is required by the Regulatory Improvement Act within
six months of the legislation's enactment. The appeals process must include
appropriate safeguards to protect an institution from retaliation by
examiners. Each such agency is also required to appoint an ombudsman to
facilitate this process.
OTHER PROVISIONS. In addition to the provisions described above, the
Regulatory Improvement Act, among other things, (i) allows regulators to
issue guidelines instead of regulations on asset quality, earnings and stock
valuation standards, and to exclude bank holding companies from such
requirements; (ii) provides an exemption from RESPA requirements for certain
business and agricultural transactions; (iii) repeals the requirement that
call report data be published in local newspapers; (iv) eliminates the
requirement that prior approval of the board of directors be granted before
an institution may make a loan to an executive officer that
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<PAGE>
is secured by a first lien on that officer's residence; (v) reduces the
geographic residency requirements for national bank boards of directors; (vi)
reduces the waiting period before effecting a merger after receipt of all
regulatory approvals from 30 to 15 days in certain circumstances; (vii)
streamlines the current money laundering laws and currency transaction
reporting requirements; (viii) provides relief in the collateralization of
public deposits in order to provide banks and public entities with greater
comfort with respect to the risk of loss of such deposits; (ix) amends the
Depository Institution Management Interlocks Act by adding certain conditions
to management interlocks and extending the grandfathering authority for
otherwise prohibited management interlocks for an additional five years; (x)
clarifies the potential contractual liability of banks for foreign accounts;
(xi) reduces calculation and disclosure requirements under the mortgage
servicing transfer rules; and (xii) grants the FDIC the authority to waive
its right of repudiation on sales of credit card receivables.
Although the above-described provisions as well as numerous other
provisions of the Regulatory Improvement Act should reduce the regulatory
burden currently imposed on banks, it is not possible to ascertain the
precise effect such provisions will have on the Bank.
OMNIBUS BUDGET RECONCILIATION ACT OF 1993.
In August, 1993, President Clinton signed into law the Omnibus Budget
Reconciliation Act of 1993 (the "Budget Reconciliation Act"). Major
provisions of the Budget Reconciliation Act that have had an effect on the
Bank or will most likely have an effect on the Bank in the future include the
following: (i) the corporate income tax rate was increased from 34% to 35%
for certain levels of taxable income; (ii) new mark-to-market rules for tax
purposes with regard to securities held for sale by the Bank; (iii) since the
beginning of 1994, the amount of business meals and entertainment expenses
that are disallowed has increased to 50% disallowance; (iv) club dues and
lobbying expenses are no longer deductible; and (v) certain intangible
assets, including goodwill, are now amortized over a period of 15 years. The
Bank does not expect the provisions of the Budget Reconciliation Act to have
a material effect on its financial condition or results of operations.
CALDERA, WEGGELAND, AND KILLEA CALIFORNIA INTERSTATE BANKING AND
BRANCHING ACT OF 1995.
On September 28, 1995, California Governor Pete Wilson signed into law
the Caldera, Weggeland, and Killea California Interstate Banking and
Branching Act of 1995 (the "Caldera Weggeland Act"). The Caldera Weggeland
Act, which became effective on October 2, 1995, is designed to implement
important provisions of the Interstate Banking Act (See "Description of
Business --Regulation and Supervision -- Recent Legislation and Other Matters
- -- The Riegle Neal Interstate Banking and Branching Efficiency Act of 1994"
herein) and repeal or modify provisions of the California Financial Code
which are obsolete or impose undue regulatory burdens. A summary of the most
significant provisions of the Caldera Weggeland Act is set forth below.
REPEAL OF THE CALIFORNIA BANKING ACT OF 1986. The California Interstate
(National) Banking Act of 1986 (the "1986 Act"), which was adopted to permit
and regulate interstate banking in California, was largely preempted by the
Interstate Banking Act. Consequently, the Caldera Weggeland Act repealed the
1986 Act in its entirety. Under the 1986 Act, among other things, an
out-of-state bank holding company was not permitted to establish a DE NOVO
California bank except for the purpose of taking over the deposits of a
closed bank. The repeal of the 1986 Act eliminates this restriction.
INTERSTATE BANKING. The Interstate Banking Act provides that bank
holding companies are permitted to acquire banks located in any state so long
as the bank holding company is both adequately capitalized and
15
<PAGE>
adequately managed (subject to certain minimum age requirements of the target
bank) and, provided that, if the acquisition would result in a deposit
concentration in excess of 30 percent in the state in which the target bank
has branches, the responsible federal banking agency may not approve such
acquisition unless, among other alternatives, the acquisition is approved by
the state bank supervisor of that state. The Caldera Weggeland Act
authorizes the California Superintendent of Banks (the "Superintendent") to
approve such an interstate acquisition if the Superintendent finds that the
transaction is consistent with public convenience and advantage in California.
INTERSTATE BRANCHING. Effective June 1, 1997, the Interstate Banking Act
permits a bank, which is located in one state (the "home state") and which
does not already have a branch office in a second state (the "host state"),
to establish a branch office in the host state through acquisition by merging
with a bank located in the host state. The Interstate Banking Act also
permits each state to either "opt-out" from this legislation, i.e., prohibit
all interstate mergers, or "opt-in-early," i.e., enact a law authorizing
interstate branching in advance of the June 1, 1997 effective date of the
Interstate Banking Act. Additionally, the Interstate Banking Act permits a
host state to authorize interstate entry by acquisition of a branch office of
a host state bank or by establishment of a DE NOVO branch office in the host
state.
By means of the Caldera Weggeland Act, the State of California has
elected to "opt-in-early" to interstate branching by permitting a foreign
(other state) bank to acquire an entire California bank by merger or purchase
and thereby establish one or more California branch offices. The Caldera
Weggeland Act expressly prohibits a foreign (other state) bank which does not
already have a California branch office from (i) purchasing a branch office
of a California bank (as opposed to the entire bank) and thereby establishing
a California branch office or (ii) establishing a California branch office on
a DE NOVO basis.
AGENCY. The Caldera Weggeland Act permits California state banks, with
the approval of the Superintendent, to establish agency relationships with
FDIC-insured banks and savings associations. While the Interstate Banking Act
authorizes agency relationships only between subsidiaries of a bank holding
company, the Caldera Weggeland Act is more expansive in that it permits
California state banks to establish agency relationships with both affiliated
and unaffiliated depository institutions. Additionally, the list of
authorized agency activities was expanded by this California statute to
include, in addition to the activities listed in the Interstate Banking Act,
evaluating loan applications and disbursing loan funds. The general law on
agency applies to these relationships and the Superintendent is authorized to
promulgate regulations for the supervision of such activities.
REGULATORY RELIEF. In addition to many provisions enacted to implement
the Interstate Banking Act, the Caldera Weggeland Act provides for regulatory
relief, including (i) authorization for the Superintendent to exempt banks
from the requirement of obtaining approval prior to establishing or
relocating a branch office or place of business; (ii) repeal of the
requirement of directors' oaths; (iii) repeal of the aggregate limit on the
amount a California bank may lend on the security of real property; and (iv)
elimination of the requirement that a California state bank publish in a
newspaper its condensed statement of condition on a quarterly basis.
As the Caldera Weggeland Act has only recently been enacted, it is
impossible to predict with any degree of certainty what impact it will have
on the banking industry in general and the Bank in particular.
Other legislative and regulatory initiatives which could affect the Bank
and the banking industry in general are pending, and additional initiatives
may be proposed or introduced, before the United States Congress, the
California legislature and other governmental bodies in the future. These
proposals, if enacted, may further alter the structure, regulation and
competitive relationship among financial institutions, and
16
<PAGE>
may subject the Bank to increased regulation, disclosure and reporting
requirements. In addition, the various banking regulatory agencies may
propose rules and regulations to implement and to enforce existing
legislation. It cannot be predicted whether, or in what form, any such
legislation or regulations will be enacted or the extent to which the
business of the Bank would be affected thereby.
ACCOUNTING CHANGES
In October 1995, the Financial Accounting Standards Board (the "FASB")
issued Statement of Financial Accounting Standard ("SFAS") No. 123,
"Accounting for Stock Based Compensation". SFAS No. 123 establishes a fair
value-based method of accounting for stock options and other equity
instruments. Fair value is determined based on the stock price at the date
the options are granted. The fair value method of accounting for stock
options and other instruments involves measuring and recording compensation
costs as the excess of the fair value of the equity instrument over the
amount paid by the grantee. It requires the use of that method for
transactions with other than employees and encourages its use for
transactions with employees. It permits entities to elect to continue to use
the intrinsic value method included in Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees" (APBO No. 25), which
generally results in no compensation cost for most stock option plans.
Entities choosing this option would, however, have to disclose in the notes
to the financial statements pro forma net income and earnings per share as if
the had elected to implement SFAS No. 123.
The recognition requirements for transactions with other than employees
applies for transactions entered into after December 15, 1995. The
recognition alternative of the fair value -based method for transactions with
employees may be implemented immediately upon issuance of SFAS No. 123. The
disclosure requirements, which apply regardless of the recognition method
chosen, are applicable for financial statements for fiscal years beginning
after December 15, 1995. The Company intends to elect to continue to account
for stock options issued to employees in accordance with APBO No. 25. The
Company has not, and does not intend to issue stock based compensation to
non-employees and therefore Management does not expect this change in
accounting principle to have a material effect on the Company's results of
operations.
In May 1995, the FASB issued SFAS No. 122, "Accounting for Mortgage
Servicing Rights", an amendment of SFAS No. 65, "Accounting for Certain
Mortgage Banking Activities." SFAS No. 122 modifies the treatment of the
capitalization of servicing rights by mortgage banking enterprises,
eliminating the differing accounting treatments for servicing rights acquired
through loan origination and those acquired through purchase transactions.
SFAS No. 122 requires that mortgage servicing rights, whether acquired
through loan origination or through purchase transactions be capitalized and
amortized in proportion to and over the period of estimated net servicing
income and should be evaluated for impairment based on their fair value.
Although it has been in the past, the Company is not currently involved in
mortgage banking activities and Management does not expect this change in
accounting principle to have a material effect on the Company's results of
operations. SFAS No. 122 is applicable for financial statements for fiscal
years beginning after December 15, 1995.
In March 1995, the FASB issued SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of."
SFAS No. 121 requires the separation of long-lived assets and certain
identifiable intangible assets into two categories for purposes of accounting
for impairment of assets: those to be held and used and those to be disposed
of. The assets to be held and used must be reviewed whenever events and
circumstances indicate the carrying value may not be recoverable. An
impairment loss is indicated if the sum of the expected future cash flows,
undiscounted and without interest charges, is less than the carrying amount
of the asset. An impairment loss shall be recognized as the amount by which
the carrying amount of the asset exceeds the fair value of the asset.
Generally, assets to be disposed of are to be carried at the lower of
amortized cost or net realizable value. SFAS No. 121 is applicable for
financial statements for fiscal years
17
<PAGE>
beginning after December 15, 1995 Management does not believe that this
change in accounting principle will have a material effect on the Company's
results of operations.
In May, 1993, the FASB issued SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities," which addresses the accounting
and reporting for investments in equity securities that have readily
determinable fair values and for all investments in debt securities. Those
investments would be classified in three categories and accounted for as
follows: (i) debt and equity securities where the entity has the positive
intent and ability to hold to maturity would be classified as
"held-to-maturity" and reported at amortized cost; (ii) debt and equity
securities that are held for current resale would be classified as "trading
securities" and reported at fair value, with unrealized gain and losses
included in earnings; and (iii) debt and equity securities not classified as
either securities "held-to-maturity" or "trading securities" would be
classified as securities "available-for-sale," and reported at fair value,
excluded from earnings and the valuation adjustment, net of tax, reported as
a separate component of stockholders' equity. The rule applies to financial
statements for fiscal years beginning in 1994. Securities classified as
"available-for-sale" are reported at their fair value at the end of each
fiscal quarter. Accordingly, the value of such securities fluctuates based on
changes in interest rates. Generally, an increase in interest rates will
result in a decline in the value of investment securities available-for-sale,
while a decline in interest rates will result in an increase in the value of
such securities. Therefore, to the extent that the Company has any investment
securities classified as available-for-sale, the value of those investment
securities and the Company's stockholders' equity would be subject to
fluctuation based on changes in interest rates. As a consequence, the
Company's capital levels (except those for regulatory capital purposes) could
change based solely on fluctuations in interest rates and fluctuations in the
value of investment securities available-for-sale. The Company adopted SFAS
No. 115 effective January 1, 1994. As the Company did not hold any securities
classified, at that time or during 1995 or 1994 as "trading securities", the
adoption of SFAS No. 115 did not impact the earnings of the Company for the
years ended December 31, 1995 or 1994 As of December 31, 1995 and 1994, the
Company reported, as a separate component of retained earnings, an increase
of $163,000 and a reduction of $210,000 for securities classified as
"available-for-sale", respectively.
In May 1993, the FASB issued SFAS No. 114, "Accounting by Creditors for
Impairment of a Loan" which requires the Company to record a valuation
allowance and recognize a loss when it becomes probable that a creditor will
be unable to collect all amounts due according to the contractual terms of
the loan agreement. The amount of the loss is to be calculated based upon one
of three methods depending on the characteristics of the loan: (i) the
present value of the expected future cash flows discounted at the loans
effective interest rate, (ii) the loan's observable market value, if one
exists or (iii) the fair value of the collateral if the loan is collateral
dependent. If the measure of the impaired loan is less than the recorded
investment in the loan, a creditor shall recognize an impairment by creating
a valuation allowance with a corresponding charge to bad debt expense. This
statement also applies to restructured loans and eliminates the requirement
to account for loans that are in-substance foreclosures as foreclosed assets.
In October 1994, the FASB issued SFAS No. 118, "Accounting by Creditors for
Impairment of a Loan - Income Recognition and Disclosures", an amendment of
SFAS No. 114. SFAS 118 eliminated certain provisions of SFAS No. 114
regarding how a creditor should report income on an impaired loan and
clarified SFAS No. 114's disclosure requirements SFAS No. 114 and 118 are
effective for financial statements issued for fiscal years beginning after
December 15, 1994. Management does not believe that the implementation of
this change in accounting principle has had a material effect upon the
Company's results of operation.
18
<PAGE>
EMPLOYEES
As of December 31, 1995, the Company had 156 full-time employees and 65
part-time employees. The Company's Management believes that its employee
relations are satisfactory.
SELECTED STATISTICAL INFORMATION
Selected statistical information relating to the Company has been
included in Management's Discussion and Analysis or Plan of Operations.
19
<PAGE>
ITEM 2. DESCRIPTION OF PROPERTY.
The following properties (real properties and/or improvements thereon)
are owned by the Company or the Bank and are unencumbered. In the opinion of
Management all properties are adequately covered by insurance.
<TABLE>
<CAPTION>
SQUARE FEET OF
LOCATION USE OF FACILITIES OFFICE SPACE
-------- ----------------- --------------
<S> <C> <C>
2025 Vineyard Avenue Branch Office 6,100
Escondido, California
1000 West San Marcos Blvd Branch Office 6,100
San Marcos, California
27425 Ynez Road Branch Office 4,200
Temecula, California
568 North Tulip Street Data Processing, Operations 11,500
Escondido, California Center, Records and Purchasing Departments
499 East Sixth Street Branch Office 9,700
Beaumont, California
1735 West Ramsey Street Branch Office and Leasable 14,939
Banning, California Retail Space
41500 Ivy Street Branch Office (Temporary 2,160
Murrieta, California Facility)
</TABLE>
The following facilities are leased by the Company or the Bank:
<TABLE>
<CAPTION>
SQUARE FEET OF MONTHLY RENT TERM OF
LOCATION USE OF FACILITIES OFFICE SPACE AS OF 12/31/95 LEASE
-------- ----------------- -------------- -------------- ------------
<S> <C> <C> <C> <C>
444 S. Escondido Boulevard Main Banking Office, 26,100 $30,612 March 31, 2006
Escondido, California Administrative Offices (2 5-year exten-
sion options)
8085 Clairemont Mesa Branch Office 5,200 $12,910 September 30, 2003
Boulevard (3 10-year exten-
San Diego, California sion options)
27403 Ynez Road Loan Production Office 1,090 $745 October 31, 1997
Temecula, California
</TABLE>
20
<PAGE>
ITEM 3. LEGAL PROCEEDINGS
On April 20, 1994, the Bank reached an informal agreement with the FDIC
and the California Superintendent of Banks (the "Superintendent") to take or
refrain from taking certain actions, including among other things: (i)
maintaining a ratio of Tier 1 leverage capital to adjusted total assets of at
least 6.75% (See "Description of the Business -- Regulation and Supervision
- --Regulatory Capital Requirements" herein for a definition of Tier 1
capital), (ii) maintaining an adequate allowance for loan losses, (iii)
reducing classified assets to certain specified levels within prescribed time
parameters, and (iv) not paying cash dividends unless, after the payment of
such dividends, its Tier 1 leverage capital ratio would be at least 6.75%.
This informal agreement superseded a similar informal agreement entered into
in March 1993.
On May 6, 1995 the Bank entered into an Order to Cease and Desist with
FDIC (the "Order"), a formal enforcement action pursuant to Section 8(b) of
the Federal Deposit Insurance Act, as amended (the "FDI Act"). The
provisions of the Order are substantially similar to those under the informal
agreement. The FDIC requested the Bank enter into the Order to correct
certain unsatisfactory conditions disclosed in the FDIC's Report of
Examination of the Bank as of October 5, 1994 (the "1994 Examination"). The
1994 Examination determined that the Bank had inadequate capital, had
continued high asset classifications, had an inadequate allowance for loan
losses, had experienced continued deterioration of earnings, failed to
comply fully with the informal agreement and required improvements in certain
internal routines and controls. The provisions of the Order are intended to
address certain criticisms cited in the 1994 Examination as well as certain
other matters. The Order replaced the informal agreement with respect to the
FDIC. The informal agreement continues in effect with respect to the
Superintendent who was not a party to the Order.
The Order required, among other things, that the Bank; (i) by June 30,
1995 increase its ratio of Tier 1 capital to adjusted total assets to at
least seven and one-quarter percent (7.25%) and by September 30, 1995,
achieve and thereafter maintain a ratio of Tier 1 capital to adjusted total
assets of at least seven and one-half percent (7.50%); (ii) shall not pay
cash dividends without the prior written consent of the FDIC; (iii) by
September 30, 1995 submit a revised strategic plan to the FDIC; (iv) within
60 days of the effective date of the Order, submit a plan to the FDIC to
control overhead; (v) reduce the level of the Bank's classified assets to
agreed upon levels within certain time frames; and (vi) improve certain other
internal routines and controls . Throughout 1995 the Company devoted
significant resources to assure its compliance with the requirements of the
Order, including the completion, in August 1995, of a private placement of
228,194 shares common stock for $1.7 million, $1 million of which was
contributed to the Bank as additional Tier 1 capital.
In December 1995 the Bank was again examined by the FDIC and the
Superintendent. The Bank received the results of its examination by the
Superintendent on February 28, 1996. The examination report concluded that
the Bank had made significant progress in correcting the deficiencies
addressed in the informal agreement and that the Superintendent was
terminating the informal agreement effective February 26, 1996. The Bank
received the results of its examination by the FDIC on March 7, 1996. The
FDIC Safety and Soundness examination report concluded that the Bank had
achieved full compliance with the Order and had made notable improvements in
its operations since the last Safety and Soundness examination although the
FDIC has lingering concerns resulting from the exceptions noted in FDIC
Compliance and Electronic Data Processing ("EDP") reports of examination.
Based upon this examination the FDIC has informally indicated its preliminary
intent to terminate the Order and, pending Management's written response to
the Safety and Soundness examination report as well as its responses to both
the Compliance and EDP reports of examination, may propose that the Bank
enter into a new informal enforcement action the terms of which are currently
unknown. Additionally, the FDIC has stated that the Bank should: (i)
maintain an adequate level of capital, (ii) continue to reduce its overall
level of classified assets, (iii) strengthen certain credit review
procedures, (iv) increase and stabilize its earnings, and (v) correct certain
deficiencies in its internal audit and regulatory compliance programs.
21
<PAGE>
As a bank holding company without significant assets other than its
equity interest in the Bank, the Company's ability to service its debt
obligations depends upon the dividends it receives from the Bank. Under the
Order the Bank has agreed not to pay cash dividends without the prior consent
of the FDIC. Management expects that under the informal agreement to be
proposed by the FDIC a certain level of Tier 1 capital will be required to be
maintained. It is uncertain what restrictions, if any, on the payment of cash
dividends will be agreed to. The Company's private placement of common stock
in 1995 generated sufficient cash to allow the Company to meet its debt
obligations for approximately 18 months without reliance on dividends from
the Bank. (See "Management's Discussion and Analysis or Plan of Operations
- -- Capital Resources.")
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
22
<PAGE>
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
(a) MARKET INFORMATION
The Company's Common Stock is traded in the over-the-counter market, but
is not included for quotation on the National Association of Securities
Dealers Automated Quotation System ("NASDAQ"), nor is it listed on any
exchange. Trading in the Company's Common Stock has been infrequent, and
such trades cannot be characterized as constituting an active trading
market. Based on information provided by the Company's transfer agent,
Management believes that approximately 38,000 and 171,000 shares were traded
in each of 1995 and 1994, respectively. Management is aware of twelve
securities dealers that make a market for the Company's Common Stock. As
reported by the National Daily Quotation Service, bid prices for the Common
Stock ranged from a low of $5.00 to a high of $8.50 during 1995 and from a
low of $3.50 to a high of $7.75 during 1994. These quotes reflect
inter-dealer prices without retail mark-ups, mark-downs or commissions and
may not necessarily have represented actual transactions. There may have
been transactions at other prices during that time. At March 8, 1996 the bid
price was $8.75. The following table provides information with respect to
the range of high and low bid prices for the Company's stock for each
quarterly period for 1995 and 1994:
1995 1994
---------------------- ----------------------
High Low High Low
---- --- ---- ---
First Quarter $6.50 $5.00 $5.25 $3.50
Second Quarter 7.25 5.50 6.75 5.00
Third Quarter 8.00 5.50 7.75 6.125
Fourth Quarter 8.50 7.00 7.75 6.25
(b) HOLDERS
On March 8, 1996 there were approximately 1,100 stockholders of record of
the Common Stock.
(c) DIVIDENDS
As a bank holding company without significant assets other than its
equity interest in the Bank, the Company's ability to pay dividends primarily
depends upon the dividends it receives from the Bank. The Bank currently has
outstanding 75,000 shares of noncumulative preferred stock with a $2.00 per
share annual dividend and 166,677 shares of noncumulative preferred stock
with a $0.72 per share annual dividend. The Bank has no present intention to
pay dividends to the Company other than in amounts sufficient to cover the
Company's interest and operating expenses. (See "Description of the Business
- --Supervision and Regulation -- The Bank" and "Legal Proceedings"). As with
the Company, any change in the Bank's dividend practices will depend upon the
Bank's earnings, financial position, current and anticipated cash
requirements and other factors deemed relevant by the Bank's Board of
Directors at that time. There are also legal limitations on the amounts of
loans
23
<PAGE>
and other advances that can be made by the Bank to the Company. (See
"Business -- Regulation and Supervision -- The Bank.")
Furthermore, under the terms of the Order entered into with the FDIC in
May 1995, the Bank has agreed not to pay a cash dividend to the Company
unless the payment of such dividend is approved in advance by the FDIC.
Based upon the results of the Bank's most recent FDIC examination, the FDIC
informally indicated its preliminary intent to release the Bank from the Order
and may proposed that the Bank agree to a new informal agreement. It is
currently unknown at this time what restrictions, if any, on the payment of
cash dividends will be agreed to. (See "Legal Proceedings" and "Management's
Discussion and Analysis or Plan of Operation -- Capital Resources.")
The Company's ability to pay dividends is also limited by state
corporation law. The California General Corporation Law prohibits the
Company from paying dividends on the Common Stock unless: (1) its retained
earnings, immediately prior to the dividend payment, equals or exceeds the
amount of the dividend or (2) immediately after giving effect to the dividend
the sum of the Company's assets (exclusive of goodwill and deferred charges)
would be at least equal to 125% of its liabilities (not including deferred
taxes, deferred income and other deferred liabilities) and the current assets
of the Company would be at least equal to its current liabilities, or, if the
average of its earnings before taxes on income and before interest expense
for the two preceding fiscal years was less than the average of its interest
expense for the two preceding fiscal years, at least equal to 125% of the
current liabilities.
The Company's practice has been to retain earnings to provide funds for
the operation and expansion of its business. Accordingly, the Company has
not paid any cash dividends on its Common Stock since 1984. Management has
no current plans to pay cash dividends in the foreseeable future. However,
the Board's practice is to review annually the advisability of paying cash
dividends based upon the Company's earnings, financial position, current and
anticipated cash requirements and other factors deemed relevant by the Board
of Directors at that time.
24
<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS.
The following analysis of the Company's financial condition and results
of operations for the years ended December 31, 1995 and 1994 should be read
in conjunction with the consolidated financial statements and the notes
related thereto, and with reference to the discussion of the operations and
other financial information presented elsewhere in this report. For purposes
of calculating the financial ratios, average balances are comprised of both
average Company and Bank balances. Bank average balances are based upon
daily average balances, and Company average balances are based upon month end
balances.
FINANCIAL CONDITION
SUMMARY
Total assets of the Company decreased 4.0%, or $9.9 million, to $237.0
million at December 31, 1995 from $246.8 million at December 31, 1994. This
decrease is largely due to Management's efforts to control the growth of the
Company, thereby helping maintain a Tier 1 capital ratio which complies with
the Order. A large volume of the decrease is due to Management's decision to
stop offering special services to title and escrow company depositors,
resulting in the loss of approximately $13 million in noninterest-bearing
deposit accounts. Total gross loans decreased 2.8% or $4.6 million to $162.0
million at December 31, 1995 from $166.6 million at December 31, 1994. In
addition to Management's efforts to control the Company's growth, the decline
in loans also reflects the continued low level of economic activity and loan
demand among qualified borrowers in the Company's market area. (See
"Management's Discussion and Analysis or Plan of Operation -- Financial
Condition -- Loans".) Total average deposits declined 5.5% or $12.3 million
to $210.3 million at December 31, 1995 from $222.6 million at December 31,
1994. The loss of title and escrow company deposits noted above resulted in
total noninterest-bearing demand deposits to decline 11.2% or $8.9 million to
$70.7 million at December 31, 1995 from $79.7 million at December 31, 1994.
Total interest-bearing deposits declined as well, falling 2.3% or $3.3
million to $143.1 million at December 31, 1995 from $146.5 million at
December 31, 1994. (See "Management's Discussion and Analysis or Plan of
Operation -- Financial Condition -- Deposits".) Net income of the Company
increased to $1.5 million for 1995 as compared to $85,000 for 1994. This
increase was primarily due to an increase in net interest income of $1.0
million and a decrease in other expenses of $1.2 million, offset by an
increase in provision for loan and lease losses of $171,000.
Total assets of the Company increased 2.9%, or $6.9 million, to $246.8
million at December 31, 1994 from $239.9 million at December 31, 1993. This
increase is primarily attributable to an increase in investment securities of
$13.9 million or 104.7%, reflecting the generally slow loan demand the
Company experienced in 1994. (See "Management's Discussion and Analysis or
Plan of Operation -- Financial Condition -- Investment Portfolio".) Total
loans were $166.6 million at December 31, 1994, an increase of $1.2 million
from $165.4 million at the end of 1993. (See "Management's Discussion and
Analysis or Plan of Operation -- Financial Condition -- Loans".) Total
deposits increased $6.8 million, or 3.1% to $226.1 million at December 31,
1994 from $219.3 million at December 31, 1993. This increase was primarily
in money market deposit accounts. Total average deposits for 1994 increased
$11.7 million, or 5.5% to $222.6 million as compared to $210.9 million for
1993 (See "Management's Discussion and Analysis or Plan of Operation --
Financial Condition -- Deposits.") The Company's earnings for 1994 were
$85,000 as compared to $1.3 million for 1993. This decrease was primarily
due to a $3.1 million provision for loan and lease loss and $1.0 million in
writedowns and expenses related to other real estate owned (OREO). (See
"Management's Discussion and Analysis or Plan of Operation -- Financial
Condition -- Loans; and Allowance for Loan Losses" and "Management's
Discussion and Analysis or Plan of Operation -- Results of Operations --
Provision for Loan and Lease Losses".)
25
<PAGE>
Total stockholders' equity at December 31, 1995 was $17.2 million as
compared to $13.8 million at December 31, 1994. This increase was due to net
income of $1.5 million, the sale of common stock totaling $1.8 million, and a
decrease in the unrealized loss on securities classified "available for sale"
of $163,000. The Company's Tier 1 risk-based capital, total risk-based
capital and Tier 1 leverage capital ratios were 9.06%,11.21% and 7.17%,
respectively at December 31, 1995, as compared to 6.99%, 9.10% and 5.47%
respectively at December 31, 1994. (See "Management's Discussion and
Analysis or Plan of Operation -- Financial Condition -- Capital Resources.")
Despite some indications of improvements in the economy of Southern
California, the recovery in general, and the real estate market in
particular, in the Company's service area are still experiencing adverse
effects of the recent protracted recession that has negatively impacted the
ability of certain of the Bank's customers to perform under the terms of
their loan agreements and has eroded the value of the Bank's real estate
collateral and holdings. The effects of these economic conditions may
continue to have an adverse effect on the Bank's business in the near future,
including the level of nonperforming assets, the level of loan charge-offs,
the value of real estate collateral and OREO, the demand for new loan
originations and the ability of borrowers to meet their loan obligations.
LOANS
Gross loans totaled $162.0 million at December 31, 1995 as compared to
$166.6 million at December 31, 1994, a decrease of $4.6 million or 2.8%, and
as of December 31, 1994 had increased $1.2 million or 0.7% from $165.4
million at December 31, 1993. At year-end 1995, loans comprised 68.4% of
total assets as compared to 67.5% at year-end 1994. The ratio of total
average loans to total average deposits was 78.6% and 75.5% for the years
ended December 31, 1995 and 1994 respectively.
Real estate construction loans totaled $9.2 million at December 31, 1995
as compared to $14.2 million at December 31, 1994, a decrease of $5.0 million
or 35.2%, and as of December 31, 1994 had decreased $5.3 million or 27.2%
from $19.5 million at December 31, 1993. Real estate construction loans
comprised 5.7% and 8.5% of total loans at December 31, 1995 and 1994,
respectively. As more fully discussed below, these decreases are due to a
low level of demand for construction loans in the Company's market area as
well as Management's desire to reduce its concentration in real estate
construction lending.
The Company's market area includes San Diego County, Riverside County,
and the southern portion of San Bernardino County. Most of the areas served
by the Company are within commuting distance of major employment centers in
Southern California. Housing prices in Southern California escalated rapidly
in the late 1980's creating demand for affordable new home construction in
these market areas. Beginning in 1991, however, the demand for real estate
declined in Southern California, resulting in significant declines in real
estate values. Consequently the Company's real estate construction lending
activities have slowed and its underwriting standards have been tightened,
although the Company remains active in the marketplace primarily in entry
level single family residences. The ability of the Bank to maintain a high
level of construction lending, and the desirability and profitability of such
lending activities depends on, among other matters, interest rates, real
estate prices, housing market conditions in the Bank's service area,
continued demand for the properties being constructed and the availability of
conventional real estate financing to repay the Company's construction loans
since the Bank does not generally require take-out commitments. Although
some improvement in the economy of Southern California has been noted during
the second half of 1995, Management believes it is unlikely that demand for
real estate in Southern California will improve significantly in 1996,
although the Company intends to remain in the real estate construction
lending market. Management does not believe that its level of real estate
construction lending in 1996 will expand significantly over that of 1995.
The Company's real estate construction loans are primarily for single
family residences located within San Diego and Riverside counties to
developers with a history of successfully developing projects in the
Company's market area. The homes are generally designed for first time and
middle income buyers and
26
<PAGE>
generally have a completed value of between $100,000 and $400,000. The
Company requires that all projects use experienced and licensed contractors.
The construction of single family residences financed by the Company includes
custom built owner-occupied homes and non-owner-occupied homes. For custom
built, owner-occupied homes, the borrower's ability to qualify for permanent
financing upon completion is required. Financing for non-owner-occupied
homes is reviewed in consideration of the probable success for their eventual
sale. Considered in this appraisal are the quality of the projects, projected
selling price, and the local market's ability to absorb the project during
the projected marketing time frame. The loan-to-value ratio on each real
estate construction loan required by the Company depends upon the nature of
the property, whether the property is residential or commercial and whether
or not it is owner-occupied. For owner-occupied residential construction
loans, the Company's policy is to require that the loan-to-value ratio be no
more than 80% and that the borrower have no less than 50% equity in the land,
while for nonowner occupied residential construction loans , the Company's
policy is to require that the loan-to-value ratio not exceed 70% and that
either the borrower own clear title to the property or the borrower own at
least a 50% equity interest in the land and all other liens must be
subordinated to the Company's first trust deed. With respect to commercial
construction loans, the Company requires that the loan not exceed the lesser
of (i) 75% of the value of the property based on capitalization of projected
net income, or (ii) 80% of the value based on a discounted cash flow analysis
which takes into account the quantity, variability, timing and duration of
cash flows over the life of the loan. Additionally, the borrower is required
to have at least 25% or more cash equity in the project. These requirements
are subject to revision based upon Management's assessment of current market
conditions. All construction loans are underwritten and documented to make
them readily saleable to other institutions.
The Bank's risk of loss on a construction loan depends largely on the
accuracy of the estimated construction costs, including interest, and the
accuracy of the initial estimate of the value of the completed project. If
the estimated construction costs prove to have been inaccurate or costs
increase as a result of construction delays, the Bank may elect to advance
funds beyond the amount originally permitted to complete the project. If the
estimated value proves to have been inaccurate the Bank may have a loan at
completion of construction with a collateral value insufficient to assure
full payment. The Company's policy is to maintain an interest reserve for
the life of a construction loan and to establish a special disbursement
account for the proceeds of the loan and to control the disbursement of the
construction loan proceeds from this account. To insure proper payment,
vouchers supported by invoices and receipts must be presented by the
contractors prior to payment. Each construction site is inspected not less
than twice monthly by third party inspectors contracted by the Company to
monitor progress and insure completion. The lending officer responsible for
the loan also makes unannounced visits to the site. The Company's
underwriting procedures are designed to identify what it believes to be
acceptable levels of risk, and the Company constantly reviews these
standards, taking current economic conditions into consideration.
Although there has been some improvement in real estate values in
California, it is presently unclear whether or not real estate values will
recover significantly in 1996 and, if so, which markets in California will be
most affected. The Company is subject to the fluctuations in the California
residential and commercial real estate market and in particular to the
markets in San Diego and Riverside counties. General economic conditions and
more specifically real estate market conditions could have a significant
impact on the quality of the Company's real estate and construction loan
portfolio. The decline in real estate values and the demand for residential
and commercial real estate in the San Diego and Riverside County areas has
contributed to the increase in non-performing assets the Company has
experienced since 1991. (See "Management's Discussion and Analysis of
Financial Condition and Plan of Operations -- Financial Condition --
Nonperforming Assets and Restructured Loans.")
Conventional real estate loans totaled $26.9 million at December 31,
1995, an increase of $129,000 from December 31, 1994, and at December 31,
1994 totaled $26.7 million, an increase of $2.8 million as compared to $23.9
million at December 31, 1993. This category of loans includes commercial
loans secured by first trust deeds on commercial real estate of $23.1 million
and $19.3 million at December 31, 1995 and 1994, respectively. Until 1995,
the Company originated conventional long-term residential real estate loans
for sale in the secondary market as well as for its own portfolio. The Bank
faced significant competition in this market from large thrift institutions
and mortgage brokers and was unable to generate a sufficient volume of
residential mortgage loans to develop a profitable operation, resulting in
the closure of this operation in early 1995.
27
<PAGE>
Mortgage loans held for sale totaled $1.8 million at December 31, 1994. Due
to the decrease in the volume of home sales in the Company's market area and
a decline in refinancings due to higher interest rates, the Company had a
significantly lower volume of conventional real estate loans in 1994 as
compared to 1993. For 1994 the Company originated approximately $11.3
million in conventional residential mortgage loans as compared $39.0 million
for 1993. At December 31, 1995 and 1994, the amount of mortgage loans
serviced was $58.9 million and $64.1 million, respectively.
Commercial loans decreased $945,000 or 1.2% to $74.8 million at December
31, 1995 from $75.7 million at December 31, 1994, and increased $692,000 or
0.9% to $75.7 million at December 31, 1994 from $75.0 million at December 31,
1993. Commercial lending is primarily to professionals and companies with
sales from $1 million to $15 million. A few of the Company's lending
relationships involve companies with sales of up to $40 million. In 1991,
the Bank began originating loans guaranteed by the U.S. Small Business
Administration ("SBA"). These loans have maturities ranging from seven to 25
years and are guaranteed up to 90% by the SBA. The Bank sells the guaranteed
portion of these loans for a premium, retaining the unguaranteed portion and
the servicing of the loans for which it is paid a servicing fee. The Bank
originated approximately $21.7 million and $20.4 million in SBA loans in 1995
and 1994, respectively. The Bank intends continue to expand its SBA lending
activities in 1995.
The Company provides lease financing to municipalities and school
districts in its market area. These leases, which are subject to the same
underwriting considerations and criteria as the Bank's commercial loans,
totaled $3.6 million at December 31, 1995, a decrease of $562,000 or 13.6%
from December 31, 1994, and totaled $4.1 million at December 31, 1994, a
decrease of $1.9 million or 30.3% over 1993. These leases are qualified
tax-exempt lease obligations for federal income tax purposes.
Installment and consumer loans increased $1.7 million or 3.8% to $46.7
million at December 31, 1995 from $45.0 million at December 31, 1994, and
increased $4.5 million or 11.1% to $45.0 million at December 31, 1994 from
$40.5 million at December 31, 1993. The increase in 1995 was primarily due
to an increase in the Bank's Title I loans of $1.5 million or 14.3% to $12.0
million at December 31, 1995 from $10.5 million at December 31, 1994. The
increase in 1994 was due primarily to the expansion of the Bank's Title I
loan program and the results of a marketing program undertaken to increase
the Bank's automobile and other consumer loans. Home equity lines of credit,
which are secured primarily by second trust deeds on single family
residences, declined $784,000 to $8.5 million at December 31, 1995 from $9.3
million at December 31, 1994, and at December 31, 1994 declined $1.2 million
from $10.5 million at December 31, 1993. The Company requires a
debt-to-value ratio of not higher than 80% for home equity loans, and the
decline in real estate values has resulted in fewer qualified borrowers.
Automobile loans increased $905,000 or 10.3% to $9.7 million at December 31,
1995 and for 1994, increased $1.2 million or 15.8% to $8.8 million from $7.6
million at December 31, 1993. These increases are due primarily to
significant promotion of automobile and other consumer loans by the Company.
The Company offers a wide range of new and used direct automobile financing.
Automobile loan terms vary widely depending upon the length and amount of the
loan, the value of the automobile, and the creditworthiness of the borrower.
Automobile loans are generally for terms of three to five years. Such loans
may be made for up to 100% of the purchase price for new automobiles and no
more than 100% of the wholesale value for used automobiles. The borrower may
not finance the payment of tax and license fees as part of any automobile
loan. The Company contracts with a third party service to monitor the
insurance coverage of each vehicle. The Company originates and funds all of
its automobile loans directly. The Company does not engage in indirect
automobile financing which involves the purchase of loans from automobile
dealers and other third party sources. Automobile loans represented 20.8%
and 19.6% of installment and consumer loans at December 31, 1995 and December
31, 1994, respectively.
During 1992, the Bank opened its FHA Title I loan department. Title I
loans are secured by junior liens on residential properties, are insured up
to 90% by an agency of the U.S. Government, and may be made to qualified home
owners with little or no equity in the property. The proceeds must be used
for home improvements. In addition to offering these loans to its customers,
the Bank also purchases Title I loans from other Title I lenders. The Bank
originated or purchased approximately $34.5 million and $37.3 million in Title
28
<PAGE>
I loans in 1995 and 1994 respectively. The Bank often sells these loans in
the secondary market, sometimes retaining the serving rights. The Bank has
also sold certificates of participation in the 90% guaranteed portion,
retaining the serving rights. At December 31, 1995 and 1994 Title I loans
totaled $12.0 million and $10.5 million, respectively. At December 31, 1995
and December 31, 1994 the Bank serviced a total of $11.6 million and $13.4
million in Title I loans respectively.
Under laws governing California state-chartered banks, the Bank may lend
up to 15% of its adjusted capital on an unsecured basis and 25% of its
adjusted capital on a secured basis to any one borrower; provided, however,
that the total of such secured and unsecured loans shall not exceed 25% of
the Bank's adjusted capital. As of December 31, 1995, the Bank's loan limits
under these regulations were $3.4 million on an unsecured basis and $5.7
million on a secured basis. (See "Description of the Business -- Regulation
and Supervision -- The Bank.")
The following table sets forth the amount of total loans outstanding in
each category at the dates indicated.
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------------
1995 1994 1993 1992 1991
---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Conventional real estate loans (1). . . $ 26,870 $ 26,741 $ 23,908 $ 21,339 $ 16,568
Lease financing . . . . . . . . . . . . 3,586 4,148 5,950 7,767 7,358
Real estate construction loans. . . . . 9,212 14,211 19,498 21,222 24,402
Commercial, financial and
agricultural loans. . . . . . . . . . 74,755 75,700 75,008 68,229 56,471
Installment and consumer loans. . . . . 46,748 45,022 40,501 44,315 46,510
All other loans (including overdrafts). 779 787 530 259 394
-------- -------- -------- -------- --------
Total gross loans . . . . . . . . . . 161,950 166,609 165,395 163,131 151,703
Less: Allowance for loan losses. . . . 2,916 2,739 2,195 2,134 1,993
-------- -------- -------- -------- --------
Total net loans (2) . . . . . . . . . $159,034 $163,870 $163,200 $160,997 $149,710
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
</TABLE>
The Company had standby letters of credit outstanding aggregating $2.6
million, $1.8 million, $4.4 million, $2.9 million, and $2.2 million at
December 31, 1995, 1994, 1993, 1992, and 1991, respectively. In addition,
the Company had commitments to grant real estate construction loans,
commercial loans and installment and consumer loans of $6.0 million, $24.6
million and $9.1 million at December 31, 1995.
(1) Consists of $3.8 million, $7.4 million, $13.0 million, $12.3 million,
and $7.4 million, of loans secured by single family residences and $23.1
million, $19.3 million, $10.9 million, $9.0 million, and $9.2 million of
loans secured by commercial property as of December 31, 1995, 1994,
1993, 1992, and 1991, respectively.
(2) Net of participation sold of $2.9 million, $4.2 million, $2.2 million,
$2.8 million, and $4.1 million in 1995, 1994, 1993, 1992, and 1991,
respectively. Participations are sold without recourse.
NONPERFORMING ASSETS AND RESTRUCTURED LOANS
The Company considers a loan to be nonperforming when any one of the
following events occurs: (a) any installment of principal or interest is 90
days past due; (b) the full timely collection of interest or principal becomes
uncertain; (c) the loan is classified as "doubtful" by bank examiners; or (d) a
portion of its principal
29
<PAGE>
balance has been charged-off. The Company's policy is to classify loans
which are 90 days past due as nonaccrual loans unless Management determines
that the loan is adequately collateralized and in the process of collection
or other circumstances exist which would justify the treatment of the loan as
fully collectible.
Total nonperforming assets were $7.7 million at December 31, 1995, a
decline of $1.0 million or 11.5%, as compared to $8.7 million at December 31,
1994. This decline is the results of the Company's concerted efforts to
reduce nonperforming assets to a level more consistent with its peers, as
well as some improvement in the economy in the Company's market area.
Nonperforming assets at December 31, 1995 consist of $5.3 in nonaccrual
loans, an increase of $172,000 or 3.3% as compared to $5.1 million at
December 31, 1994, and $2.4 million in OREO, a decline of $1.2 million or
33.3% as compared to $3.6 million at December 31, 1994. Nonaccrual loans of
$1.1 million in the conventional real estate category consist of a loan on a
retail shopping center for $518,000, a loan on a commercial building for
$260,000 and a loan on a single family residence of $316,000. Construction
loans on nonaccrual status totaled $1.5 million and consist of two loans, one
for $844,000 on vacant land zoned for residential use and one loan for
$622,000 on vacant land zoned for commercial use. Commercial loans
classified as nonaccrual totaled $1.6 million at December 31, 1995, a
decline of $215,000 or 12.1%, as compared to $1.8 million at December 31,
1994. Nonaccrual loans in the installment and consumer category totaled $1.1
million at December 31, 1995, as compared to $767,000 at December 31, 1994,
an increase of $362,000 or 47.2%. This increase is due primarily to two
loans in the home equity line of credit category totaling $397,000 which are
in the process of collection.
Total nonperforming assets were $8.7 million at December 31, 1994, a
decline of $1.5 million or 14.7%, as compared to $10.2 million at December
31, 1993. During 1994 the Company continued to be impacted by the poor
economy in Southern California, particularly as it relates to real estate
related assets, resulting in an increase in nonperforming loans
(nonperforming assets less OREO) of $1.7 million or 49.8% to $5.1 million at
December 31, 1994 from $3.4 million at December 31, 1993. Offsetting this
increase, OREO declined $3.2 million during this period. Nonaccrual loans of
$1.2 million in the conventional real estate category consist of one loan for
$622,000 on a 20 unit apartment building and one loan for $565,000 on a small
retail center. Construction loans on nonaccrual status totaled $1.4 million
and consist of two loans, one for $966,000 on vacant land zoned for
residential use and one loan for $424,000 on a completed single family home.
Commercial loans classified as nonaccrual totaled $1.8 million at December
31, 1994, a decline of $512,000 or 22.4%, as compared to $2.3 million at
December 31, 1993. Nonaccrual loans in the installment and consumer category
totaled $767,000 at December 31, 1994 as compared to $547,000 at December 31,
1993, and increase of $220,000 or 40.2%. This increase is due primarily to
the expansion of the Bank's Title I loan program during 1994. Nonaccrual
loans in this category increased to $295,000 from $166,000, an increase of
129,000; however, Management does not expect significant losses in this
category of loans due to the program's 90% government guarantee.
OREO totaled $2.4 million at December 31, 1995, a decline of $1.2 million
or 33.3%, as compared to $3.6 million at December 31, 1994 and for 1994
declined $3.2 million or 47.1%, as compared to $6.8 million at December 31,
1993. OREO is recorded at its net realizable value at the time the asset is
transferred to OREO. Additional writedowns in the value of the properties
may occur depending upon changes in the market, annual appraisals of the
property and the estimated length of time needed to dispose of the property.
As reflected in the declining OREO balances, the Company has experienced some
improvement in its ability to dispose of its OREO over the last several
years, selling 17 properties for a total of $3.0 million during 1995 and
selling 14 properties for a total of $3.9 million during 1994. At December
31, 1995, OREO consisted of three single family residences totaling $625,000,
one multi-family unit totaling $382,000, three commercial properties totaling
$627,000 and five parcels of vacant land zoned for residential use totaling
$551,000. OREO also includes investments in real estate developments of
$215,000 at December 31, 1995. This project consists of 37 acres subdivided
into 15 lots ranging in size from 1.2 acres to 4.1 acres in Bonsall,
California. At December 31, 1995 four lots remained to be sold. As of
March 15, 1996 three additional lots had been sold, leaving one lot unsold
with a balance of $81,000. The Company has established reserves of $819,000
and $734,000 at December 31,
30
<PAGE>
1995 and 1994, respectively, to reduce the value of the project on its books
to the estimated net realizable value. The FDICIA prohibits all insured state
banks from engaging in activities which are not permitted for national banks,
such as real estate development activities. Accordingly, FDICIA requires the
Bank to divest of its real estate developments no later than December 19,
1996. The Bank has filed a plan with the FDIC detailing how the Bank will
divest of its real estate developments prior to that date. (See "Description
of Business -- Regulation and Supervision -- Recent Legislation and Other
Matters.") Management believes that all of the Bank's OREO will ultimately be
sold at prices sufficient to recover all of the values at which they are
currently being carried on the books of the Bank. However, until each of
those properties is actually sold, it is impossible to predict whether such
prices will actually recover such values.
The decrease in nonperforming assets during 1995 and 1994
notwithstanding, the Company continues to be impacted by the general
slowdown in economic activity experienced in the Company's market area,
including a significant increase in business and personal bankruptcies.
Additionally, the decline in demand for real estate in the Company's market
area has decreased the value of real estate collateral often obtained as a
secondary source of repayment on these loans. The Company maintains an
aggressive collection policy with regard to nonperforming commercial and
installment loans and generally attempts to sell foreclosed property quickly.
Continued high levels of nonperforming assets may continue to occur until,
and for a period after, the current economic environment improves.
Interest income included in net interest income relating to nonaccrual
loans was $208,000 and $151,000 for the years ended December 31, 1995 and
1994, respectively. Additional gross interest income of $489,000 on
nonaccrual loans would have been recorded during each of the years 1995 and
1994 if the loans had been paid in accordance with their original terms and
had been outstanding throughout the 12 months then ended or, if not
outstanding throughout the 12 months then ended, since origination.
31
<PAGE>
The following table provides information with respect to the components
of the Company's nonperforming assets at the dates indicated.
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------------
1995 1994 1993 1992 1991
---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Loans 90 days or more past due
and still accruing (as to principal or interest)
Conventional real estate . . . . . . . . . $ -- $ -- $ -- $ -- $ --
Real estate construction . . . . . . . . . -- -- -- -- --
Commercial . . . . . . . . . . . . . . . . -- -- -- -- --
Installment and consumer loans . . . . . . -- 14 54 18 16
Lease financing, net . . . . . . . . . . . -- -- -- -- --
---- ---- ---- ---- ----
Total. . . . . . . . . . . . . . . . . . -- 14 54 18 16
Nonaccrual loans
Conventional real estate . . . . . . . . . 1,095 1,187 -- 297 275
Real estate construction . . . . . . . . . 1,506 1,389 537 2,357 747
Commercial . . . . . . . . . . . . . . . . 1,560 1,775 2,287 1,978 436
Installment and consumer loans . . . . . . 1,129 767 547 575 246
Lease financing net. . . . . . . . . . . . -- -- -- -- --
----- ----- ----- ----- -----
Total. . . . . . . . . . . . . . . . . . 5,290 5,118 3,371 5,207 1,704
----- ----- ----- ----- -----
Total Nonperforming loans. . . . . . . . 5,290 5,132 3,425 5,225 1,720
Other real estate owned. . . . . . . . . . . 2,402 3,607 6,821 5,859 3,186
----- ----- ----- ----- -----
Total Nonperforming assets . . . . . . . $7,692 $8,739 $10,246 $11,084 $4,906
----- ----- ----- ----- -----
----- ----- ----- ----- -----
Nonperforming loans to
total gross loans. . . . . . . . . . . . . 3.27% 3.08% 2.07% 3.20% 1.13%
----- ----- ----- ----- -----
----- ----- ----- ----- -----
Nonperforming assets to
total gross loans plus
other real estate owned. . . . . . . . . . 4.68% 5.13% 5.95% 6.56% 3.17%
----- ----- ----- ----- -----
----- ----- ----- ----- -----
</TABLE>
Other past due loans at December 31, 1995 included $1.5 million of
loans past due more than 30 days but less than 90 days.
Restructured loans consist of loans which are defined as "troubled
debt-restructurings" by SFAS No. 15. These consist of loans whose terms have
been modified to provide some relief from the scheduled interest and principal
payments in light of the customer's financial difficulties, the objective of
which is to maximize the Bank's possibility of collection. Restructured loans
totaled $6.9 million and $6.1 million at December 31, 1995 and 1994,
respectively.
32
<PAGE>
The following table provides information with respect to the
components of the Company's restructured loans at the dates indicated.
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------
1995 1994 1993 1992 1991
---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Restructured loans
Real estate conventional . . . . . . . . . $6,459 $4,777 $ 330 -- --
Commercial . . . . . . . . . . . . . . . . 479 1,354 1,732 -- --
Installment and consumer loans . . . . . . -- -- -- -- --
------ ------ ------ ---- ----
Total. . . . . . . . . . . . . . . . . . $6,938 $6,131 $2,062 -- $112
------ ------ ------ ---- ----
------ ------ ------ ---- ----
</TABLE>
Restructured loans includes $2,024,000 and $169,000 in conventional real
estate loans and commercial loans, respectively, which were accounted for as
nonaccrual loans at December 31, 1995.
Impaired loans totaled $1,270,000 and $2,467,000 for commercial loans
and real estate mortgage loans, respectively, at December 31, 1995. The
recorded investments are stated net of allowance for loan losses of $289,000
and $134,000, for impaired commercial and real estate mortgage loans,
respectively.
A loan is deemed to be impaired when it is probable that a creditor may
not collect amounts due according to the original contractual terms of the
original loan agreement. Impaired loans are measured using one of the
following methods: (i) the present value of expected cash flows discounted at
the loan's effective interest rate; (ii) the observable value of the loan's
market price; or (iii) the fair value of the collateral if the loan is
collateral dependent. All impaired loans at December 31, 1995 were measured
based on the fair value of the loan collateral. Interest income on impaired
loans is recognized on a cash basis.
ALLOWANCE FOR LOAN AND LEASE LOSSES
The allowance for loan and lease losses at December 31, 1995 totaled
$2.9 million or 1.80% of total gross loans as compared to $2.7 million or
1.64% of total gross loans at December 31, 1994 and $2.2 million or 1.33% of
total gross loans at December 31, 1993.
It is the Company's practice to maintain the allowance for loan and
lease losses at a level considered by Management to be adequate. Each month
Management calculates an acceptable allowance for loan and lease losses using
an internal rating system based upon the risk associated with various
categories of loans. A portion of the calculation is based upon the
historical loss experience of the preceding five years and in some risk
categories the degree of collateralization. The risk assigned to each loan is
first determined when the loan is originated. It is then reviewed quarterly
and revised as appropriate. In addition, the Bank maintains a monitoring
system for all credits that have been identified either internally or
externally as warranting additional Management attention. These credits are
formally reported to Management by the lending officers on a quarterly basis
and are subsequently reviewed by the Loan Committee of the Board of
Directors. Reserves against these loans are based on the credit risk assigned
to the loans as described above utilizing a schedule of percentages developed
by Management in accordance with historical loss experience, ranging from
0.5% to 50% of the present loan balances. These percentages may be modified,
based upon current or prospective local economic conditions. The comments of
bank examiners, the Company's independent auditors and a third party loan
review consultant hired by the Bank on a periodic basis are also considered
in revising risk category assignments. In determining the actual allowance
for loan losses to be maintained, Management augments this calculation with
an analysis of the present and prospective financial condition of certain
borrowers, industry concentrations within the portfolio, trends in
delinquent and nonaccrual loans and general economic conditions.
33
<PAGE>
The allowance for loan and lease losses is based upon estimates and
ultimate losses may vary from current estimates. The continuing evaluation of
the loan portfolio and assessment of current economic conditions will dictate
future funding levels. Management believes that the allowance for loan and
lease losses at December 31, 1995 was adequate to absorb the known and
inherent risks in the loan portfolio. However, no assurance can be given that
continued weakness in the economy and real estate market in the Bank's
principal market area or other circumstances will not result in increased
losses in the Bank's loan portfolio in the future.
Net charged-off loans as a percentage of the beginning of the period
allowance for loan losses were 114.2%, 118.0% and 103.3% in 1995, 1994 and
1993, respectively. The increasing level of charge-offs during these periods
reflects the deterioration of the economy and the erosion of real estate
values in Southern California during these years.
The table on the following page summarizes, for the periods indicated,
loan balances at the end of each period and daily averages during the period;
changes in the allowance for loan and lease losses arising from loans charged
off, recoveries on loans previously charged off, and additions to the
allowance which have been charged to operating expense; and certain ratios
relating to the allowance for loan and lease losses.
34
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------------------------
1995 1994 1993 1992 1991
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCES:
Average loans during period . . . . . . . . $165,374 $168,076 $167,402 $159,797 $137,735
Loans at end of period. . . . . . . . . . . 161,950 166,609 165,395 163,131 151,703
ALLOWANCE FOR LOAN AND LEASE LOSSES:
Balance at beginning of period. . . . . . . 2,739 2,195 2,134 1,993 1,547
Actual charge-offs:
Conventional real estate loans . . . . . 183 380 197 -- --
Real estate construction . . . . . . . . 525 71 69 370 --
Commercial, financial and
agricultural loans. . . . . . . . . . 1,514 1,595 1,101 298 203
Installment and consumer loans . . . . . 1,022 804 963 225 204
-------- -------- -------- -------- --------
Total . . . . . . . . . . . . . . . . 3,244 2,850 2,330 893 407
Recoveries on loans previously
charged-off:
Conventional real estate loans. . . . . . . -- -- -- -- --
Real estate construction. . . . . . . . . . -- -- -- -- --
Commercial, financial and
agricultural loans . . . . . . . . . . . 47 184 51 36 5
Installment and consumer loans. . . . . . . 68 75 75 48 14
-------- -------- -------- -------- --------
Total . . . . . . . . . . . . . . . . 115 259 126 84 19
Net loan charge-offs. 3,129 2,591 2,204 809 388
Adjustment due to business
combination. . . . . . . . . . . . . . . . . -- -- -- -- 416
Provision for loan losses . . . . . . . . . . 3,306 3,135 2,265 950 418
-------- -------- -------- -------- --------
Balance at end of period . . . . . . . . . . . $ 2,916 $ 2,739 $ 2,195 $ 2,134 $ 1,993
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
RATIOS:
Net loan charge-offs to
average loans . . . . . . . . . . . . . . 1.89% 1.54% 1.32% 0.51% 0.28%
Allowance for loan losses
to loans at end of period . . . . . . . . 1.80 1.64 1.33 1.31 1.31
Net loan charge-offs to beginning of the
period allowance for loan losses. . . . . 114.2 118.0 103.3 40.6 25.1
Net loan charge-offs to provision
for loan losses . . . . . . . . . . . . . 94.7 82.7 97.3 85.2 92.8
</TABLE>
The primary risk element considered by Management with respect to each
installment and conventional real estate loan is lack of timely payment and
the value of the collateral. The primary risk elements with respect to real
estate construction loans are fluctuations in real estate values in the
Company's market areas, inaccurate estimates of construction costs,
fluctuations in interest rates, the availability of conventional financing,
the demand for housing in the Company's market area and general economic
conditions. (See "Management's Discussion and Analysis or Plan of Operation
- -- Financial Condition -- Loans.") The primary risk elements with respect to
commercial loans are the financial condition of the borrower, general
economic conditions ni the Company's market area, the sufficiency of
collateral, the timeliness of payment and with respect to adjustable rate
loans, interest rate fluctuations. Management has a policy of requesting and
reviewing annual financial statements from its commercial loan customers and
periodically reviews the existence of collateral and its value. Management
also has a reporting system that monitors all past due loans and has adopted
policies to pursue its creditor's rights in order to preserve the Company's
position. As indicated by the table above, commercial loans have been the
largest category of loans charged-off in the last five years.
35
<PAGE>
Loans are charged against the allowance when, in Management's opinion,
they are deemed uncollectible, although the Bank continues to aggressively
pursue collection. Although Management believes that the allowance for loan
losses is adequate to absorb losses as they arise, there can be no assurance
that i) the Company will not sustain losses in any given period which could
be substantial in relation to the size of the allowance for loan losses, ii)
the Company's level of nonperforming loans will not increase, iii) the
Company will not be required to make significant additional provisions to its
allowance for loan losses, or iv) the level of net charge-offs will not
increase and possibly exceed applicable reserves.
The Company anticipates total net charge-offs of approximately $2.2
million during 1996. It is anticipated that net charge-offs by loan category
will be as follows; conventional real estate, $200,000; real estate
construction, $250,000; commercial, financial and agricultural, $1.0 million;
and installment and consumer loans, $750,000. These estimates are based
upon Management's analysis of the loan portfolio and its analysis of the
adequacy of the allowance for loan losses. No assurances can be given that
the net charge-offs anticipated will not be greater than or less than $2.2
million, or that the net charge-offs anticipated will be in the categories
expected.
INVESTMENT PORTFOLIO
The Company's investment portfolio is used primarily for investment
income and secondarily for liquidity purposes. The portfolio includes United
States Treasury and other U.S. government agency instruments, investment
grade municipal obligations, collateralized mortgage obligations, and
government securities bond funds (equity securities). The Company's current
investment policy is to invest in securities that have a maturity or
remaining projected life of not more than seven years and an investment grade
credit rating by one or more nationally recognized rating agencies. The
policy prohibits gains trading, when-issued trading, short sales and
investing in stripped securities, mortgage-backed residuals, derivative
securities and most structured securities.
At December 31, 1995, investment securities totaled $26.2 million or
11.0% of total assets, a decrease of $996,000, or 3.7%, compared to $27.2
million or 11.0% of assets at December 31, 1994 and for 1994 increased $13.9
million, or 104.7%, compared to $13.3 million or 5.5% of assets at December
31, 1993.
In May 1993, the FASB issued SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." This pronouncement requires that
upon acquisition, an investment security be classified as "held to maturity,"
"available for sale," or "trading." Generally, investments classified as
"held to maturity" are carried at amortized cost, investments classified as
"available for sale" are carried at market value, with the unrealized gain
or loss reflected as a separate component of stockholders' equity, and
investments classified as "trading" are carried at market value, with the
unrealized gain or loss reflected in the income statement. Transfers
between the categories are recorded at fair market value. Specific rules
control the treatment of previously recorded gains and losses depending upon
which categories the investments are transferring between. SFAS No. 115
became effective for the Company on January 1, 1994. Securities classified
as "available for sale" totaled $18.3 million, $15.6 million and $9.8 million
at December 31, 1995, December 31, 1994 and January 1, 1994 respectively.
Securities classified as "held to maturity" totaled $7.9 million, $11.6
million and $3.5 million at December 31, 1995, December 31, 1994 and January
1, 1994, respectively. The Company has no investment securities classified
as "trading." An unrealized gain of $163,000 for 1995 and an unrealized
loss of $210,000 for 1994 have been recognized in the "available for sale"
portfolio. (See "Description of Business -- Regulation and Supervision --
Accounting Changes".) During 1995 and 1994 investments totaling $5.2 million
and $3.6 million, respectively, were sold by the Company at a net loss of
$18,000 in 1995 and at a net profit of less than $1,000 in 1994.
36
<PAGE>
The small decline in the Company's investment portfolio is reflective of
the Company's decline in total assets during 1995. The shift in the
portfolio to a greater proportion of "available for sale" securities is to
assure adequate liquidity for the Company's operations. The increase in the
investment portfolio during 1994 is due primarily to the slow loan demand
that the Company experienced during 1994 as well as the Company's practice of
selling the majority of its Title I and SBA loans, creating a high level of
liquidity. The increase in the investment portfolio during 1994 was primarily
in the U.S. Treasury and Government Agency categories which totaled $24.0
million at December 31, 1994, an increase of $13.5 million or 129.2% compared
to $10.5 million at December 31, 1993. The majority of these securities
mature in less than three years, as these securities tend to have relatively
low volatility during times of changing interest rates such as experienced
during 1994, therefore minimizing unrealized losses.
At December 31, 1993, the Company's investment portfolio contained an
investment in a corporate utility stock fund. At December 31, 1993, this
fund had an unrealized loss of approximately $265,000 which Management deemed
to be a permanent decline in value and accordingly reflected this loss in its
statement of income for 1993. Additionally, pursuant to FDIC regulations,
this investment was no longer considered to be a suitable investment for
banks, and under the FDICIA all banks must divest of such investments by
December 19, 1996. During 1994, this security was sold at an additional loss
of $25,000. (See "Description of Business -- Regulation and Supervision --
Recent Legislation and Other Matters.")
The table below summarizes the book value and market value, and the
distribution of the Company's investment securities as of the dates indicated
(dollar amounts are stated in thousands).
<TABLE>
<CAPTION>
DECEMBER 31, 1995
---------------------------------------
HELD TO MATURITY AVAILABLE FOR SALE
------------------ ------------------
AMORTIZED MARKET AMORTIZED MARKET
COST VALUE COST VALUE
--------- ------ --------- -------
<S> <C> <C> <C> <C>
U.S. Treasury securities . . . . . . . . $1,744 $1,763 $ 550 $ 548
Obligations of other U.S.
government agencies. . . . . . . . . . 4,933 4,922 9,997 9,977
Obligations of states and political
sub-divisions. . . . . . . . . . . . . 907 929 1,596 1,599
Mortgage-backed securities . . . . . . . 338 338 3,000 3,014
Equity securities (1). . . . . . . . . . -- -- 3,274 3,112
--------- ------ --------- -------
Total investment securities. . . . . . . $7,922 $7,952 $18,417 $18,250
--------- ------ --------- -------
--------- ------ --------- -------
</TABLE>
37
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31, 1994
---------------------------------------
---------------------------------------
HELD TO MATURITY AVAILABLE FOR SALE
------------------ ------------------
AMORTIZED MARKET AMORTIZED MARKET
COST VALUE COST VALUE
--------- ------ --------- -------
<S> <C> <C> <C> <C>
U.S. Treasury securities . . . . . . . . $ 2,236 $ 2,193 $ 8,817 $ 8,697
Obligations of other U.S.
government agencies. . . . . . . . . . 7,990 7,609 5,278 5,064
Obligations of states and political
sub-divisions. . . . . . . . . . . . . 929 902 824 797
Mortgage-backed securities . . . . . . . 411 402 734 707
Equity securities (1). . . . . . . . . . -- -- 418 337
--------- ------ --------- -------
Total investment securities. . . . . . . $11,566 $11,106 $16,071 $15,602
--------- ------ --------- -------
--------- ------ --------- -------
</TABLE>
The following table summarizes the maturity of the Company's investment
securities and their weighted average yields at December 31, 1995.
Tax-exempt income from investment securities is presented on a tax-equivalent
basis assuming a 34% federal income tax rate for 1995.
<TABLE>
<CAPTION>
AFTER ONE BUT AFTER FIVE BUT
WITHIN WITHIN FIVE WITHIN TEN AFTER TEN
ONE YEAR YEARS YEARS YEARS TOTAL
------------- -------------- -------------- ------------- --------------
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
------ ----- ------- ----- ------ ------ ------ ----- ------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury securities . . . . . . . $1,550 5.67% $ 744 6.43% $ -- -- $ -- -- $ 2,294 5.92%
Obligations of other U.S.
government agencies. . . . . . . . . 1,502 5.34 13,428 5.88 -- -- -- -- 14,930 5.83
Obligations of states and
political subdivisions . . . . . . . 275 5.17 930 6.86 180 6.85 1,118 6.36 2,503 6.45
Mortgage-backed securities . . . . . . -- -- -- -- 828 7.35 2,510 6.66 3,338 6.83
Equity securities (1). . . . . . . . . 3,112 5.75 -- -- -- -- -- -- 3,112 5.75
------ ------- ------ ------ -------
Total investment securities. . . . . $6,439 5.61% $15,102 5.97% $1,008 7.26% $3,628 6.57% $26,177 6.83%
------ ------- ------ ------ -------
------ ------- ------ ------ -------
</TABLE>
(1) Equity securities consist of $356,000 and $337,000 in a government
securities bond fund which invests in GNMA certificates and other
securities guaranteed by the U.S. Government in 1995 and 1994, respectively
and $2.9 million in a government money market fund in 1995. Equity
securities are carried on the books of the Company at the lower of
aggregate cost or market. In 1995 and 1994 stockholders' equity was
reduced by $44,000 and $35,000, respectively to reflect a decline in the
market value of these securities.
DEPOSITS
Total average deposits decreased to $210.3 million for 1995 as compared
to $222.6 million for 1994, a decrease of $12.3 million or 5.5%. All
categories of average deposits decreased during 1995, with the largest
decrease in the non-interest-bearing demand category which decreased to $66.9
million for 1995 from $73.2 million for 1994, a decrease of $6.3 million or
8.6%. Noninterest-bearing demand deposits represent 31.8% and 32.9% of total
average deposits in 1995 and 1994, respectively, reflecting the retail nature
of the Company's deposit base. Approximately 15% of such deposits during
1994 (or approximately 5% of total average deposits) represent deposits of
title and escrow companies. The Company provides these depositors with
certain customer services consisting primarily of data processing and courier
services. The Company controls its customer service expenses by continuously
monitoring the earnings performance of its account relationships and, on that
basis, limiting the amount of services provided. Title and escrow company
deposits are volatile in nature and sensitive to prevailing interest rates
and other general economic factors that affect the demand for real estate.
During 1994, the Company informed these depositors that it intended to stop
offering these services in the future, and the decline in noninterest-bearing
deposits during 1995 is due primarily to the loss of these accounts.
Interest-bearing demand deposits declined $1.3 million or 3.7%, savings
deposits declined $2.8 million or 3.4% and time certificates of deposit
declined $2.1 million or 6.4%. The interest rates paid on these accounts
most closely follow short-term interest
38
<PAGE>
rates, which decreased throughout 1995, prompting depositors to seek higher
yields in other types of accounts or with other institutions.
Total average deposits increased to $222.6 million for 1994 as compared
to $210.9 million for 1993, an increase of $11.7 million or 5.5%. All
categories of average deposits, with the exception of time deposits,
increased during 1994, with the largest increase in the savings category
which increased $19.4 million or 31.1%. This category includes money market
deposit accounts. The interest rates paid on these accounts most closely
follow short-term interest rates, which increased significantly during 1994,
accounting for the large increase in this category. In other categories,
average non-interest-bearing demand deposits increased 5.8% and average
interest-bearing demand deposits increased 14.9%. Total average time deposits
declined 33.2% during 1994 due to Management's efforts to lessen its reliance
on these deposits which tend to carry higher interest rates than other types
of deposits and are generally more sensitive to interest rate changes.
The levels of non-interest-bearing demand deposits (including retail
accounts) are influenced by such factors as customer service, service charges
and the availability of banking services (i.e., extended hours, convenience
of location, availability of ATMs). No assurance can be given that the
Company will be able to maintain its current level of non-interest-bearing
deposits. The Company's percentage of non-interest-bearing deposits remains
high compared to similar sized institutions. Competition from other banks
and thrift institutions as well as money market funds, some of which offer
interest rates substantially higher than the Company, makes it difficult for
the Company to maintain the current level of non-interest-bearing deposits.
Management continually works to implement pricing and marketing strategies
designed to lower the average rate paid on interest-bearing deposits and to
maintain a stable deposit mix.
The table on the following page summarizes the distribution of average
deposits and the average rates paid for the periods indicated.
39
<PAGE>
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------
1995 1994 1993
------------------- ------------------- -------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE RATE BALANCE RATE BALANCE RATE
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Non-interest-bearing
demand deposits. . . . $ 66,910 -- $ 73,165 -- $ 69,195 --
Interest-bearing
demand deposits. . . . 33,744 1.70% 34,977 1.70% 30,428 1.82%
Savings deposits . . . . 79,031 3.42 81,751 3.04 62,353 2.70
Time deposits. . . . . . 30,600 4.76 32,680 3.18 48,948 3.56
-------- -------- --------
Total deposits. . . $210,285 2.25% $222,573 1.85% $210,924 1.89%
-------- -------- --------
-------- -------- --------
</TABLE>
As part of its asset/liability management policy, the Company generally
limits the issuance of time deposits of $100,000 or greater primarily to
customers who have other business relationships with the Company and who
reside within the Company's market area, although the Company may offer such
deposits to others to help it meet its liquidity needs. The Company
generally limits the terms of these deposits to less than one year in order
to allow it to react quickly to changing interest rates. At December 31,
1995, time deposits of $100,000 or more totaled $7.0 million, representing
20.8% and 3.3% of total time deposits and total deposits, respectively. At
December 31, 1994, time deposits of $100,000 or more totaled $4.7 million,
representing 19.0% and 2.1% of total time deposits and total deposits,
respectively. (See "Management's Discussion and Analysis or Plan of
Operation -- Liquidity and Asset Liability Management.")
The scheduled maturity of the Company's time deposits in denominations of
$100,000 or greater as of December 31, 1995 were as follows:
DECEMBER 31, 1995
-----------------
TIME DEPOSITS MATURING IN (Dollars in thousands)
-------------------------
Three months or less . . . . . . . . . . . $4,919
Over three months through six months . . . 658
Over six months through twelve months. . . 1,445
Over twelve months . . . . . . . . . . . . --
------
Total. . . . . . . . . . . . . . . . . . $7,022
------
------
CAPITAL RESOURCES
Stockholders' equity increased $3.4 million or 24.6% to $17.2 million at
December 31, 1995 from $13.8 million at December 31, 1994. This increase was
due to net income of $1.5 million, the sale of common stock totaling $1.8
million, and a decrease in the unrealized loss on securities classified
"available for sale" of $163,000. Stockholders' equity decreased $125,000 or
0.9% to $13.8 million at December 31, 1994 from $13.9 million at December 31,
1993. This decrease was due to net income of $85,000, offset by an increase
in the unrealized loss on securities classified "available for sale" of
$210,000. (See "Management's Discussion and Analysis or Plan of Operation
- --Results of Operations.")
Under the risk-based capital guidelines for banks and bank holding
companies adopted by the FDIC and the FRB in 1988 the Company and the Bank
are required to maintain a minimum a ratio of 8.00% (at least one-half of
which must consist of Tier 1 capital). At December 31, 1995 the Company's
risk-based capital ratios were 9.06 for Tier 1 capital and 11.21% for total
capital
40
<PAGE>
and the Bank's risk-based capital ratios were 10.40% for Tier 1 and 11.65%
for total capital. The Company's risk-based capital ratios at December 31,
1994 were 6.99% for Tier 1 capital and 9.10% for total capital and the Bank's
risk-based capital ratios were 8.35% for Tier 1 capital and 9.60% for total
capital.
Additionally, the FRB and FDIC have adopted minimum Tier 1 leverage
capital ratio requirements in 1990 supplementing the risked-based capital
regulations and replacing minimum leverage ratios used prior to 1990. The
rules require a minimum ratio of Tier 1 capital to total assets of 3.00% for
institutions receiving the highest regulatory rating. All other institutions
are required to meet a minimum ratio of 4.00% to 5.00%. Tier 1 capital
consists of common equity, minority interest in equity of consolidated
subsidiaries, and qualifying perpetual preferred stock. At December 31,
1995 and 1994, the Company's Tier 1 leverage capital ratios were 7.17% and
5.47%, respectively. The Tier 1 leverage capital ratios of the Bank were
8.20% and 6.52% at December 31, 1995 and 1994, respectively. (See
"Description of Business -- Regulatory Capital Requirements -- The Bank, and
Legal Proceedings.").
At December 31, 1995, the Company had $1.7 million in 9 1/4% Convertible
Subordinated Debentures ("Debentures") due May 15, 2002 outstanding. The
debentures are convertible at the option of the holder into common stock of
the Company at a conversion price of $8.23 per share, subject to adjustments
for stock splits, stock dividends or other certain events. The debentures
are redeemable, in whole or in part, at the option of the Company at
declining redemption prices that range from 104.25% at December 31, 1995 to
par on or after May 15, 1999. Under the risk-based capital regulations the
debentures qualify as Tier 2 capital. The Company used a portion of the
proceeds of the debentures to purchase $1.5 million of noncumulative
perpetual preferred stock from the Bank, increasing the Bank's capital
ratios. Additionally, the company had $1.5 million outstanding under two
term notes with directors of the Company as of December 31, 1995. The notes
are unsecured and have an interest rate of 8.0%. The notes have varying
interest and principal payment schedules. One note for $500,000 matures on
July 1, 1998 and one note for $1,000,000 matures on January 1, 1999. The
Company also used the proceeds of these notes to purchase $1.5 million of
noncumulative perpetual preferred stock from the Bank. In December 1994, the
directors holding these notes agreed to a change in terms which deferred the
commencement of the originally scheduled payments by nine months. As a bank
holding company without significant assets other than its equity interest in
the Bank, the Company's ability to service its debt obligations depends upon
the dividends it receives from the Bank. Under the terms of the Order
entered into with the FDIC in May 1995, the Bank has agreed not to pay cash
dividends to the Company without the prior consent of the FDIC. Based upon
the results of the Bank's most recent FDIC examination, the FDIC has
indicated its preliminary intent to release the Bank from the Order and may
proposed that the Bank agree to a new informal agreement. Management expects
that under the informal agreement to be proposed by the FDIC a certain level
of Tier 1 capital will be required to be maintained. It is uncertain what
restrictions, if any, on the payment of cash dividends will be agreed to.
The Company's private placement of common stock in 1995 generated sufficient
cash to allow the Company to meet its debt obligations for approximately 18
months without reliance on dividends from the Bank. (See "Market for Common
Equity and Related Stockholder Matters -- Dividends").
During 1996, Management anticipates no significant capital expenditures
for facilities, furniture, equipment or computer software. For information
regarding legal restrictions upon the ability of the Bank to pay dividends to
the Company see "Description of Business - Regulation and Supervision".
RESULTS OF OPERATIONS
NET INCOME
Net income for the year ended December 31, 1995 increased to $1.5 million
from $85,000 for the year ended December 31, 1994, an increase of $1.4
million. Primary earnings per share increased to $.94 in 1995 from $.05 in
1994. Return on average stockholders' equity was 10.0% for 1995, up from
0.6% for 1994. The primary reasons for this increase are an increase in net
interest
41
<PAGE>
income of $1.0 million and a decrease in other expense of $1.2 million,
offset by an increase in the provision for loan loss of $171,000 and
provision for income taxes of $308,000. (See "Management's Discussion and
Analysis or Plan of Operation -- Results of Operations -- Net Interest
Income; Provision for Loan and Lease Losses, Other Expense and Income
Taxes".)
Net income decreased to $85,000 for the year ended December 31, 1994 from
$1.3 million for the year ended December 31, 1993, a decrease of $1.2
million, reflecting the continued weakness and uncertainty of the Southern
California economy during that period. Primary earnings per share decreased
to $.05 in 1994 from $.82 in 1993. Return on average stockholders' equity was
0.6% for 1994, down from 10.0% for 1993. The primary reason for the decrease
in net income is an increase in the provision for loan loss, increases in
other expenses, primarily in personnel and occupancy expense and a decrease
in fees and premiums on the sale of mortgage loans, offset by an increase in
net interest income and gains on sale of SBA and Title I loans. Increasing
interest rates during 1994 had a generally positive impact on the Company's
net interest income, however, it had a negative impact on its mortgage
lending business which declined significantly. Although, declining in 1994
as compared to 1993, the Company also incurred significant expenses in
maintaining and disposing of other real estate owned. (See "Management's
Discussion and Analysis or Plan of Operation -- Results of Operation --
Provision for Loan and Lease Losses; Net Interest Income; Other Income and
Other Expense".)
NET INTEREST INCOME
Net interest income, which constitutes the principal source of income for
the Company, is the amount by which interest and fees earned on
interest-earning assets exceeds the interest paid on deposits and other
borrowed funds. Changes in net interest income from period to period result
from increases or decreases in the average balances (volume) of
interest-earning assets and interest-bearing liabilities, increases or
decreases in the average rates earned and paid on such assets and
liabilities, the Company's ability to manage its earning asset portfolio and
the availability of particular sources of funds.
Net interest income for the year ended December 31, 1995 increased $1.0
million or 7.6% to $14.1 million from $13.1 million for 1994. This increase
was primarily attributable to an increase in interest income of $1.6 million
for 1995 as compared to 1994. The average yield on interest-earning assets
increased to 9.95% for 1995 as compared to 8.89% for 1994. The average yield
on loans, investment securities and Fed funds sold for 1995 were 10.65%, 6.15%
and 5.56% respectively, compared to 9.79%, 4.26% and 3.91% respectively for
1994. Offsetting the increase in the yield on interest-earning assets was
a decrease in total average interest-earning assets to $194.9 million for
1995 as compared to $200.1 million for 1994, a decrease of $5.2 million or
2.6%. This decrease was primarily in total average loans which decreased to
$165.4 million for 1995 as compared to $168.1 million for 1994, a decrease of
$2.7 million or 1.6%. (See "Management's Discussion and Analysis or Plan of
Operation -- Financial Condition -- Loans.") Average Federal funds sold also
decreased to $7.7 million for 1995 as compared to $9.7 million for 1994, a
decrease of $2.0 million or 20.6%. Offsetting the increase in interest
income, interest expense for 1995 was $5.2 million, an increase of $639,000
or 14.1% as compared to $4.5 million for 1994. This increase was due
primarily to an increase in the average rate paid on interest-bearing
liabilities to 3.48% in 1995 from 2.93% in 1994, offset by a decrease in
average interest-bearing liabilities to $148.5 million at December 31, 1995
from $154.5 million at December 31, 1994, a decrease of $6.0 million or 3.9%.
(See "Managements' Discussion and Analysis or Plan of Operation --
Financial Condition --Deposits".) Recent declines in short-term interest
rates notwithstanding, average short-term rates during 1995 were generally
higher than those in 1994 accounting for the increases in both the average
yield on interest-earning assets and the average rate paid on
interest-bearing liabilities. The Company's net interest spread (the average
taxable equivalent rate earned on interest-earning assets less the average
rate paid on interest-bearing liabilities) increased to 6.47% for 1995 from
5.96% for 1994 and the net interest margin increased to 7.30% for 1995 from
6.63% for 1994.
Net interest income for the year ended December 31, 1994 increased
$657,000 or 5.3% to $13.1 million from $12.5 million for 1993. This increase
was primarily attributable to an increase in interest income of $875,000 for
1994 as compared to 1993. This increase was primarily due to an increase in
total average interest earning assets of $12.3 million, offset by a decrease
in the average yield on interest-earning assets to 8.89% for 1994 as compared
to 9.06% for 1993. Although interest rates increased during 1994, the
Company's average yield on interest-earning assets decreased as poor loan
demand resulted in an increase in the proportion
42
<PAGE>
of lower yielding interest-earning assets such as investment securities and
Federal funds sold to total average interest-earning assets to 16.0% for 1994
from 10.9% for 1993. Average investment securities and Federal funds sold
increased $11.6 million or 56.7% to $32.0 million for 1994 from $20.4 million
for 1993, accounting for an increase in interest income $486,000. The
average yield on loans increased to 9.79% for 1994 from 9.64% for 1993. This
increase is due primarily to increases in the prime lending rate and the
Bank's base lending rate to 8.50% and 9.75%, respectively at December 31,
1994 from 6.00% and 7.25%, respectively at December 31, 1993. Additional
interest income of $489,000 and $318,000 on nonaccrual loans would have been
recorded during 1994 and 1993, respectively if the loans had been paid in
accordance with their original terms, which reduced the yield on average
loans by approximately 0.29% and 0.19% for 1994 and 1993, respectively. The
yield on approximately 63.6% of the Banks earnings assets at December 31,
1994 were tied to the Bank's base lending rate, national prime rate or mature
within one year, allowing rapid repricing of much of the Company's earning
assets. Also offsetting the impact of the increases in the prime and base
lending rates was the runoff of a large volume of consumer loans made
primarily in 1990 and 1989 at an average rate of approximately 9.75% and the
replacement of these loans at rates ranging generally from 7.75% to 8.75%.
(See "Management's Discussion and Analysis or Plan of Operation -- Financial
Condition -- Loans.") Offsetting the increase in interest income, interest
expense increased $218,000 during 1994. This increase is due primarily to an
increase in average interest-bearing liabilities of $8.5 million during 1994,
primarily in the savings category, offset by a decrease in the average rate
paid on average interest-bearing liabilities to 2.93% for 1994 as compared to
2.95% for 1993, despite generally higher short term interest rates in 1994.
Average savings deposits, which tend to be sensitive to short term interest
rates, increased $19.4 million or 31.1% to $81.8 million for 1994 from $62.4
million for 1993 and the average rate paid on these deposits increased to
3.04% for 1994 from 2.70% for 1993. Offsetting these increases was a decline
in average time deposits and in the rate paid on average time deposits, which
historically have carried the highest interest rates of the Company's
deposits. Average time deposits declined to 21.9% of total average
interest-bearing deposits for 1994 from 34.5% for 1993 and the average rate
paid on time deposits decreased to 3.18% for 1994 as compared to 3.56% for
1993. The Company's net interest spread (the average taxable equivalent
rate earned on interest-earning assets less the average rate paid on
interest-bearing liabilities) decreased to 5.96% for 1994 from 6.11% for 1993
and the net interest margin decreased to 6.63% for 1994 from 6.76% for 1993.
The yield on approximately 53.8% and 58.2% at December 31, 1995 and 1994,
respectively, of the Bank's loan portfolio moves up or down within one year
as the Bank adjusts its base lending rate (generally set at between 1% to 2%
over national prime rate) with changes in the national prime rate, or with
changes in other widely used indices. An additional 8.5% and 7.9% at
December 31, 1995 and 1994, respectively, of the portfolio consists of fixed
rate loans which mature in one year or less. The foregoing enables the Bank
to quickly adjust to a changing interest rate environment. Management
believes that interest rates on each category of loans in the Bank's loan
portfolio are competitively priced for banks in its market area. The yield on
average loans is also dependent on the mix of loans in the loan portfolio.
Real estate construction loans and commercial loans are typically offered at
higher interest rates and fees than conventional real estate loans, lease
financing or automobile and other consumer loans. (See "Management's
Discussion and Analysis or Plan of Operation -- Financial Condition --
Loans.")
The table on the following page shows the Company's consolidated average
balances of assets, liabilities and stockholders' equity, the amount of interest
income or interest expense, the average yield or rate for each category of
interest-earning assets and interest-bearing liabilities, and the net interest
spread and net interest margin for the year indicated. Tax-exempt income from
investment securities and loans is presented on a tax-equivalentbasis assuming
a 34% federal tax rate for 1995, 1994, and 1993.
43
<PAGE>
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------------------------------------------------------------------
1995 1994 1993
-------------------------------------------------------------------------------------------------
INTEREST AVERAGE INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ RATE/ AVERAGE INCOME/ RATE/ AVERAGE INCOME RATE/
BALANCE EXPENSE YIELD BALANCE EXPENSE YIELD BALANCE EXPENSE YIELD
-------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets:
Loans (1) . . . . . . . . . . $165,374 $17,617 10.65% $168,076 $16,459 9.79% $167,402 $16,132 9.64%
Taxable investment
securities . . . . . . . . 20,570 1,294 6.29 21,209 883 4.16 12,300 536 4.36
Tax-exempt investment
securities . . . . . . . . 1,223 47 3.81 1,095 68 6.19 2,934 198 6.74
Interest-bearing deposits . . 44 3 5.60 78 3 3.65 -- -- --
Federal funds sold and
securities purchased
under agreement to resell. 7,708 429 5.56 9,655 378 3.91 5,213 146 2.81
-------- ------- ----- -------- ------- ----- -------- ------- -----
Total earning assets. . . . . 194,919 19,390 9.95 200,113 17,791 8.89 187,849 17,012 9.06
-------- ------- ----- -------- ------- ----- -------- ------- -----
Non-interest-earning assets:
Cash and due from banks . . . 21,070 24,643 21,727
Premises and equipment, net . 10,026 9,664 9,856
Other assets(2) . . . . . . . 9,238 11,040 11,554
-------- -------- --------
Total non-interest-earning
assets . . . . . . . . . . 40,334 45,347 43,137
-------- -------- --------
Less allowance for loan
losses. . . . . . . . . . . . 2,668 2,088 2,363
-------- -------- --------
Total assets. . . . . . . . . $232,585 $243,372 $228,623
-------- -------- --------
-------- -------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Deposits:
Interest-bearing demand. . 33,744 574 1.70 34,977 596 1.70 30,428 555 1.82
Savings. . . . . . . . . . 79,031 2,705 3.42 81,751 2,485 3.04 62,353 1,686 2.70
Time . . . . . . . . . . . 30,600 1,457 4.76 32,680 1,039 3.18 48,948 1,741 3.56
Other short term borrowings . 1,483 84 5.65 1,433 57 4.00 1,607 51 3.18
Capital lease . . . . . . . . 476 721 4.18 495 701 4.14 506 721 4.31
Long term debt. . . . . . . . 3,178 272 8.56 3,178 278 8.73 2,181 202 9.27
-------- ------- ----- -------- ------- ----- -------- ------- -----
Total interest-bearing
liabilities. . . . . . . . 148,512 5,164 3.48 154,514 4,525 2.93 146,023 4,307 2.95
-------- ------- ----- -------- ------- ----- -------- ------- -----
Non-interest-bearing liabilities:
Demand deposits . . . . . . . 66,910 73,165 69,195
Other liabilities . . . . . . 1,799 1,601 670
-------- -------- --------
Total liabilities . . . . . . 217,221 229,280 215,888
Stockholders' equity. . . . . . 15,364 14,092 12,735
-------- -------- --------
Total liabilities and
stockholders' equity . . . $232,585 $243,372 $228,623
-------- -------- --------
-------- -------- --------
Net interest income
(tax equivalent basis). . . . 14,226 13,266 12,705
Reversal of tax equivalent
adjustment. . . . . . . . . . (104) (144) (240)
------- ------- -------
Net interest income . . . . . . $14,122 $13,122 $12,465
------- ------- -------
------- ------- -------
Net interest spread(3). . . . . 6.47% 5.96% 6.11%
----- ----- -----
----- ----- -----
Net interest margin(4). . . . . 7.30% 6.63% 6.76%
----- ----- -----
----- ----- -----
</TABLE>
- -----------------------------
(Footnotes on following page)
44
<PAGE>
The following table sets forth the dollar amount of changes in interest
earned and paid for each major category of interest-earning assets and
interest-bearing liabilities and the amount of change attributable to changes
in average balances (volume) or changes in average interest rates. The variances
attributable to both balance and rate changes have been allocated to volume and
rate changes in proportion to the relationship of the absolute dollar amounts of
the changes in each. Tax-exempt income from investment securities and loans is
not presented on a tax-equivalent basis.
<TABLE>
<CAPTION>
1995 vs. 1994 1994 vs. 1993
----------------------------------------------------------------------
Increase (Decrease) Increase (Decrease)
Due to Changes in Due to Change in
----------------------------------------------------------------------
Volume Rate Total Volume Rate Total
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Earning assets -- Interest income:
Loans $(266) $1,458 $1,192 $ 65 $ 321 $386
Investment securities:
Taxable (27) 438 411 372 (25) 347
Non-taxable 5 (20) (15) (82) (11) (93)
Federal funds sold (87) 138 51 158 74 232
Interest-bearing deposits (1) 1 -- 3 -- 3
----- ------ ------ ----- ----- -----
Total (376) 2,015 1,639 516 359 875
----- ------ ------ ----- ----- -----
Deposits and borrowed funds --
Interest expense:
Interest-bearing demand
deposits (21) (1) (22) 79 (37) 42
Savings deposits (85) 306 221 571 227 798
Time deposits (70) 487 417 (533) (169) (702)
Other short term borrowings 2 25 27 (6) 12 6
Long term debt -- (1) (1) 88 (12) 76
Capital lease (3) -- (3) (1) (1) (2)
----- ------ ------ ----- ----- -----
Total (177) 816 639 198 20 218
----- ------ ------ ----- ----- -----
Change in net interest income $(199) $1,199 $1,000 $ 318 $ 339 $ 657
----- ------ ------ ----- ----- -----
----- ------ ------ ----- ----- -----
</TABLE>
- ------------------------------
(Footnotes from previous page)
(1) For purposes of these computations, nonaccrual loans are included in the
daily average loan amounts outstanding.
(2) Includes average balances of real estate owned other than Company and Bank
premises during 1995 1994, and 1993 of $3.3 million, $4.9 million, and
$7.6 million, respectively.
(3) Represents the average rate earned on interest-earning assets less the
average rate paid on interest-bearing liabilities.
(4) Represents net interest income as a percentage of average interest-earning
assets.
45
<PAGE>
PROVISION FOR LOAN AND LEASE LOSSES
The Company provides for loan and lease losses by a charge to operations
based upon Management's evaluation of the loan portfolio, past loan loss
experience, general economic conditions, and other pertinent factors. For
the year ended December 31, 1995 the provision for loan losses increased
$171,000 or 5.5%, to $3.3 million from $3.1 million for the year ended
December 31, 1994. This increase is due to an increase in net loans charged
off to $3.1 million or 1.89% of average loans outstanding during 1995 from
$2.6 million or 1.54% of average loans outstanding during 1994, as well as
additional provisions for loan and lease loss necessary in Management's
opinion to reflect current weakness in the Southern California economy and
downturn in the real estate market. For the year ended December 31, 1994 the
provision for loan and lease losses increased $870,000 or 38.4%, to $3.1
million from $2.3 million for the year ended December 31, 1993. This
increase is due to an increase in net loans charged off to $2.6 million or
1.54% of average loans outstanding during 1994 from $2.2 million or 1.32% of
average loans outstanding during 1993, and the increase in nonperforming
loans experienced during 1994. As of December 31, 1995 and 1994 the
allowance for loan and lease losses represented 1.80% and 1.64% of total
loans, respectively. (See "Management's Discussion and Analysis or Plan of
Operation -- Financial Condition -- Allowance for Loan and Lease Losses.")
OTHER INCOME
For the year ended December 31, 1995, other income decreased to $6.6
million from $6.9 million for 1994, a decrease of $261,000 or 3.8%. This
decrease was due primarily to a decrease in the premiums on SBA loans sold of
$802,000, offset by an increase in service charges on deposits of $495,000. The
decline in premiums on the sale of SBA loans is due in part to lower premium
levels experienced in 1995 as compared to 1994 as well as Management's decision
to sell fewer loans in an effort to boost the Company's level of earning assets
during a period of low loan demand.
For the year ended December 31, 1994, other income increased to $6.9 million
from $6.5 million for 1993, an increase of $408,000 or 6.3%. This increase was
due to an increase in premiums on the sale of SBA and Title I loans of
$1.1 million and an increase in service charges on deposits of $352,000.
Rising interest rates during 1994 resulted in a significant decrease in the
Company's mortgage lending activities, as the market for refinancing of
mortgages declined significantly from the 1993 and 1992 levels. Fees on
mortgage loans and the gains on sales of mortgage loans decreased $363,000 in
1994 as compared to 1993.
OTHER EXPENSE
Other expense decreased $1.2 million or 7.2% to $15.3 million for 1995 as
compared to $16.5 million for 1994. Decreases of $549,000, $260,000 and
$180,000 in advertising and public relations, salaries and employee benefits,
and professional services respectively were due primarily to Management's
efforts to reduce the Company's overhead costs by discontinuing some marginally
profitable operations, making certain staff reductions and centralizing certain
operational functions. Also contributing to the decrease in other expense was a
decline in the carrying costs of other real estate owned of $256,000 due to the
lower volume of OREO during 1995.
46
<PAGE>
Other expense increased $1.4 million or 9.1% to $16.5 million for 1994 as
compared to $15.1 million for 1993. The largest increases were in salaries and
employee benefits which increased $778,000 and in occupancy expense which
increases $313,000. These increases were primarily due to increases in activity
and volume in the Bank's SBA and Title I loan departments. Additionally,
although decreasing in 1994 as compared to 1993, the Company incurred $1.0
million in expenses related to costs and writedowns related to other real estate
owned, as compared to $1.2 million for 1993.
INCOME TAXES
For 1995, the Company's provision for federal and state income taxes was
$562,000, an effective rate of 26.8%, a decrease from an effective rate of 74.9%
for 1994. This increase is due to a significant increase in pretax income,
offset by a decrease in the amount of valuation provision for deferred tax
debits which represents future tax deductions.
For 1994, the Company's provision for federal and state income taxes was
$254,000, an effective rate of 74.9%, an increase from an effective rate of
33.5% for 1993. This increase is primarily due to an increase of $150,000 in
the valuation allowance for deferred tax debits which represents future tax
deductions.
At December 31, 1995 and 1994 the Company's net deferred tax asset totaled
$1.4 million and $1.3 million, respectively, before application of the valuation
allowance. Management has analyzed the Company's deferred tax asset and
determined that a valuation allowance of $225,000 and $350,000 at December 31,
1995 and 1994, respectively, was appropriate.
LIQUIDITY AND ASSET/LIABILITY MANAGEMENT
The liquidity of a banking institution reflects its ability to provide
funds to meet customer credit needs, to accommodate possible outflows in
deposits, to provide funds for day-to-day operations, and to take advantage of
interest rate market opportunities. Funding of loan requests, providing for
liability outflows, and management of interest rate risk requires continuous
analysis in order to match the maturities of categories of loans and investments
with the maturities of deposits and bank-related borrowings. Bank liquidity is
thus normally considered in terms of the nature and mix of the banking
institution's sources and uses of funds. Asset liquidity is provided by cash,
certificates of deposit with other financial institutions, Federal funds sold,
maturing investments, and loan maturities and repayments. Liquid assets
(consisting of cash, Federal funds sold and investment securities) comprised
25.7% and 24.4% of the Company's total assets at December 31, 1995 and 1994
respectively. Liquidity management also includes the management of unfunded
commitments to make loans and undisbursed amounts under lines of credit. At
December 31, 1995 these commitments totaled $24.6 million in commercial loans,
$2.6 million in letters of credit, $6.0 million in real estate construction
loans, and $9.1 million in consumer and installment loans. At December 31, 1994
these commitments totaled $25.9 million in commercial loans, $1.8 million in
letters of credit, $8.4 million in real estate construction loans, and $9.7
million in consumer and installment loans. The average Federal funds sold was
$7.7 million in 1995 and $9.7 million in 1994.
The Bank also has several secondary sources of liquidity. Many of the
Bank's real estate construction, mortgage, Title I and SBA loans are
originated pursuant to underwriting standards which make them readily marketable
to other financial institutions or investors in the secondary market. In
addition, in order to meet
47
<PAGE>
liquidity needs on a temporary basis, the Bank has unsecured lines of credit in
the amount of $3.0 million for the purchase of Federal funds with other
financial institutions, may borrow funds under reverse repurchase agreements
with other financial institutions and may borrow at the Federal Reserve discount
window subject to the Bank's ability to supply collateral. Average Federal
funds purchased were $506,000 and $134,000 in 1995 and 1994, respectively.
Asset/liability management also involves minimizing the impact of interest
rate changes on the Company's earnings through the management of the amount,
composition and repricing periods of rate-sensitive assets and rate-sensitive
liabilities. Emphasis is placed on maintaining a rate-sensitivity position
within the Company's policy guidelines to avoid wide swings in spreads and to
minimize risk due to changes in interest rates. At December 31, 1995 and 1994
approximately 64.9% and 67.7%, respectively, of the Company's total loans and
61.7% and 63.5%, respectively, of the Company's total interest-earning assets
were tied to the Company's base lending rate, national prime rate, or mature
within one year. Nearly all (96.0% in 1995 and 96.1% in 1994) of the Company's
interest-bearing liabilities are immediately repriceable or mature in one year
or less.
The following table shows the amounts of real estate construction loans,
and commercial financial and agricultural loans outstanding as of December 31,
1995, which, based on remaining scheduled repayments of principal, were due
within one year, after one but within five years, and in more than five years:
<TABLE>
<CAPTION>
MATURING
-----------------------------------------------
AFTER ONE
WITHIN BUT WITHIN MORE THAN
ONE YEAR FIVE YEARS FIVE YEARS TOTAL
-------- ---------- ---------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Real estate construction loans . . $ 8,860 $ 57 $ 295 $ 9,212
Commercial, financial and
agricultural loans. . . . . . 25,749 20,743 28,263 74,755
------- ------- ------- -------
Total. . . . . . . . . . $34,609 $20,800 $28,558 $83,967
------- ------- ------- -------
------- ------- ------- -------
</TABLE>
The following table sets forth the sensitivity of the amounts due after one
year to changes in interest rates.
<TABLE>
<CAPTION>
MATURING
-----------------------------------
AFTER ONE
BUT WITHIN MORE THAN
FIVE YEARS FIVE YEARS TOTAL
---------- ---------- ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Loans:
With fixed rate interest. . . $ 9,188 $ 1,115 $10,303
With floating rate interest . 11,612 27,443 39,055
------- ------- -------
Total. . . . . . . . . . . $20,800 $28,558 $49,358
------- ------- -------
------- ------- -------
</TABLE>
48
<PAGE>
In order to match the rate-sensitivity of its assets, the Company's
policy is to offer a significant number of variable rate deposit products and
limit the level of large dollar time deposits with maturities greater than
one year.
The following table sets forth the rate-sensitivity of the Company's
interest-earning assets and interest-bearing liabilities as of December 31,
1995, the interest rate-sensitivity gap (interest rate-sensitive assets less
interest rate-sensitive liabilities), cumulative interest rate-sensitivity
gap, the Company's interest rate-sensitivity gap ratio (interest rate-sensitive
assets divided by interest rate-sensitive liabilities) and the Company's
cumulative interest rate-sensitivity gap ratio. For the purposes of the
following table, an asset or liability is considered rate-sensitive within a
specified period when it matures or could be repriced within such period in
accordance with its contractual terms.
<TABLE>
<CAPTION>
AFTER THREE AFTER SIX AFTER ONE
WITHIN MONTHS BUT MONTHS BUT YEAR BUT AFTER
THREE WITHIN SIX WITHIN ONE WITHIN FIVE
MONTHS MONTHS YEAR FIVE YEARS YEARS TOTAL
-------- ----------- ---------- ---------- ------ --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
INTEREST-EARNINGS ASSETS:
Loans . . . . . . . . . . . $ 69,906 $28,875 $ 6,329 $49,186 $ 7,654 $161,950
Investment securities . . . 4,098 1,325 1,499 12,832 6,418 26,172
Federal funds sold. . . . . 10,500 -- -- -- -- 10,500
Interest-bearing deposits . -- -- -- -- -- --
-------- ------- ------- ------- ------- --------
Total. . . . . . . . . . 84,504 30,200 7,828 62,018 14,072 198,622
INTEREST-BEARING LIABILITIES:
Interest-bearing demand
deposits . . . . . . . . 35,119 -- -- -- -- 35,119
Savings deposits. . . . . . 74,216 -- -- -- -- 74,216
Time deposits . . . . . . . 19,399 6,851 5,145 2,372 6 33,773
Borrowed funds. . . . . . . 568 43 89 3,021 462 4,183
-------- ------- ------- ------- ------- --------
Total. . . . . . . . . . 129,302 6,894 5,234 5,393 468 147,291
Interest rate-sensitivity gap (44,798) 23,306 2,594 56,625 13,604 $ 51,331
Cumulative interest rate
sensitivity gap . . . . . . $(44,798) $(21,492) $(18,898) $37,727 $51,331
Interest rate-sensitivity
gap ratio . . . . . . . . . .65x 4.38x 1.50x 11.50x 30.07x 1.35x
Cumulative interest rate
sensitivity gap ratio . . . .65x .84x .87x 1.26x 1.35x
</TABLE>
As of December 31, 1995, the Company was liability-sensitive within one
year and asset-sensitive beyond one year. Liability sensitivity means that
rate-sensitive liabilities exceed rate-sensitive assets. This position will
generally result in enhanced earnings in a falling interest rate environment
and declining earnings in a rising interest rate environment. Asset sensitivity
means that rate-sensitive assets exceed rate-sensitive liabilities. This
position will generally result in enhanced earnings in a rising interest rate
environment and declining earnings in a falling interest rate environment
because a larger volume of assets than liabilities will reprice. However, the
foregoing table does not necessarily indicate the impact of general interest
rate movements on the Company's net interest yield, because the repricing of
various categories of assets and liabilities is
49
<PAGE>
discretionary and is subject to competition and other pressures. As a
result, various assets and liabilities indicated as repricing within the same
period may in fact price at different times and at different rate levels.
Management attempts to mitigate the impact of changing interest rates in
several ways, one of which is to manage its interest rate-sensitivity gap.
The use of a base lending rate by the Company for the majority of its
floating rate loans also allows the Company more flexibility than the use of
a national prime rate in matching changes to the yield on floating rate loans
to changes in its funding costs. In addition to managing its assets/liability
position, the Company has taken steps to mitigate the impact of changing
interest rates by generating non-interest income through service charges,
offering products which are not interest rate-sensitive, such as escrow services
and insurance products, and through the sale and servicing of mortgage loans.
EFFECTS OF INFLATION
The impact of inflation on banks differs from its impact on non-financial
institutions. Banks, as financial intermediaries, have assets which are
primarily monetary in nature and which tend to fluctuate with inflation. This
is especially true for banks with a high percentage of rate-sensitive
interest-earning assets and interest-bearing liabilities. A bank can further
reduce the impact of inflation if it can manage its rate-sensitivity gap.
This gap represents the difference between variable rate assets and variable
rate liabilities. The Company attempts to structure its assets and
liabilities and manage its gap accordingly, thus seeking to minimize the
potential effects of inflation. (See "Management's Discussion and Analysis
or Plan of Operations --Liquidity and Asset/Liability Management").
ITEM 7. FINANCIAL STATEMENTS.
North County Bancorp's financial statements begin on page 58 of this report.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
50
<PAGE>
PART III
ITEMS 9, 10, 11 AND 12.
The information required by these items is contained in the Company's
definitive Proxy Statement for the Company's 1996 Annual Meeting of
Shareholders which the Company intends to file with the Commission within 120
days after the close of the Company's 1995 fiscal year in accordance with the
Commission's Regulation 14A under the Securities Exchange Act of 1934. Such
information is incorporated herein by this reference.
51
<PAGE>
PART IV
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT
(1) FINANCIAL STATEMENTS
The following consolidated financial statements and report
of independent accountants of North County Bancorp are
included in this report commencing on page 58
Report of Independent Accountants
Consolidated Statement of Financial Condition - December 31, 1995
and 1994
Consolidated Statement of Income - Years ended December 31, 1995
and 1994
Consolidated Statement of Changes in Stockholders' Equity - Years
ended December 31, 1995 and 1994
Consolidated Statement of Cash Flows - Years ended
December 31, 1995 and 1994
Notes to Consolidated Financial Statements
(2) FINANCIAL STATEMENT SCHEDULES
Schedules to the consolidated financial statements are
omitted because the required information is inapplicable
or the information is presented in North County Bancorp's
consolidated financial statements or related notes.
(3) EXHIBITS
Exhibits required to be filed hereunder are indexed on
sequentially numbered pages 57 through 59 hereof.
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the last quarter of
the Company's fiscal year ended December 31, 1995
52
<PAGE>
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.
Dated: March 20, 1996 NORTH COUNTY BANCORP,
a California corporation
By: /s/ Michael J. Gilligan
-----------------------
Michael J. Gilligan
Vice President and Chief
Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
/s/ Alan P. Chamberlain Director March 20, 1996
- ------------------------
Alan P. Chamberlain
/s/ G. Bruce Dunn Director March 20, 1996
- ------------------------
G. Bruce Dunn
/s/ Michael J. Gilligan Vice President and Chief March 20, 1996
- ------------------------
Michael J. Gilligan Financial Officer
/s/ Ronald K. Goode Director March 20, 1996
- ------------------------
Ronald K. Goode
/s/ James M. Gregg Chairman of the Board and March 20, 1996
- ------------------------
James M. Gregg Chief Executive Officer
/s/ Rodney D. Jones President and Director March 20, 1996
- ------------------------
Rodney D. Jones
/s/ Eric D. Kroesche Director March 20, 1996
- ------------------------
Eric D. Kroesche
/s/ Jack Port Director March 20, 1996
- ------------------------
Jack Port
/s/ Clarence R. Smith Director March 20, 1996
- ------------------------
Clarence R. Smith
/s/ Raymond V. Stone Director March 20, 1996
- ------------------------
Raymond V. Stone
/s/ Burnet F. Wohlford Director March 20, 1996
- ------------------------
Burnet F. Wohlford
</TABLE>
53
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
PAGE NUMBER IN
EXHIBIT TABLE SEQUENTIAL
REFERENCE NUMBERING
NUMBER ITEM SYSTEM
- ------------ ---- ---------------
<S> <C> <C>
3.1 Articles of Incorporation of North County Bancorp filed
October 5, 1981 as amended by Certificate of Amendment
of Articles of Incorporation filed July 28, 1988. (3)
3.2 Amended and Restated Bylaws of North County Bancorp as
adopted February 21, 1990. (3)
4.1 Specimen of Common Stock Certificate. (3)
4.2 Form of Indenture between North County Bancorp and
Security Pacific National Bank, as Trustee, for up
to $3,593,000 aggregate principal amount of 9 1/4%
convertible subordinated debentures due May 15, 2002. (4)
4.3 Specimen of Debenture Certificate. (4)
10.1 Lease dated April 23, 1975 by and between Fifth Avenue
Financial Group, a general partnership, and North County
Bank, including an Amendment to Lease, effective May 1,
1980, and Assignment of Lease, effective August 1, 1985,
for a portion of the office space at the Fifth Avenue
Financial Center in Escondido, California. (3)
10.2 Sublease dated September 28, 1989, between FarWest
Savings and Loan Association and North County Bancorp,
including First Amendment to Sublease, dated October 19,
1989, for a portion of the office space at the Fifth Avenue
Financial Center in Escondido, California. (3)
10.3 Lease Agreement dated November 1, 1989, between Ontario
Associates, a general partnership, and North County
Bancorp, for a portion of the office space at the Fifth
Avenue Financial Center in Escondido, California. (3)
10.4 Lease Agreement dated March 1, 1990, between Ontario
Associates, a general partnership, and North County
Bancorp, for a portion of the office space at the Fifth
Avenue Financial Center in Escondido, California. (4)
</TABLE>
____________________________________
(Footnotes on page 57)
54
<PAGE>
<TABLE>
<CAPTION>
PAGE NUMBER IN
EXHIBIT TABLE SEQUENTIAL
REFERENCE NUMBERING
NUMBER ITEM SYSTEM
- ------------ ---- ---------------
<S> <C> <C>
10.5 Lease Agreement dated November 1, 1986, between Ontario
Associates, a general partnership, and North County
Bancorp, relating to a portion of the office space at the
Fifth Avenue Financial Center in Escondido, California. (3)
10.6 Assignment of Lease dated July 1, 1989, between First
National Bank and North County Bancorp, for the premises
located at 8085 Clairemont Mesa Boulevard, San Diego,
California. (3)
10.7 North County Bancorp Incentive Stock Option Plan and
Form of Stock Option Agreement. (1)
10.8 North County Bank Employee Stock Ownership Plan
Restated as of January 1, 1989. (3)
10.9 Employment Contract between James M. Gregg and North
County Bank, dated April 14, 1983. (3)
10.10 Deferred Compensation and Stock Purchase Agreement
between James M. Gregg and North County Bank, dated
February 1, 1986. (3)
10.11 Lease Agreement dated March 1, 1990, between Ontario
Associates, a general partnership, and North County
Bancorp, for a portion of the office space at the
Fifth Avenue Financial Center in Escondido, California. (4)
10.12 Lease Agreement dated July 15, 1991 between Ontario
Associates, a general partnership, and North County
Bancorp, for a portion of the office space at the Fifth
Avenue Financial Center in Escondido, California. (5)
10.13 Adoption agreement between North County Bank and The
Prudential Bank dated August 29, 1991 for the North
County Bancorp and Subsidiaries 401(k) Plan. (5)
</TABLE>
- ----------------------
(Footnotes on page 57)
55
<PAGE>
EXHIBIT TABLE PAGE NUMBER IN
REFERENCE SEQUENTIAL
NUMBER NUMBERING
- ------------- ITEM SYSTEM
---- --------------
10.14 Lease Agreement dated July 23, 1992 between Hagan
Enterprises and North County Bank for a portion of
the premises located at 1735 West Ramsey Street,
Banning, California. (6)
10.15 Lease Agreement dated February 1, 1992 between Son
Corporation and North County Bank for a modular
banking facility located at 41500 Ivy Street,
Murrieta, California. (6)
10.16 Lease Agreement dated August 27, 1993 between Ontario
Associates, a general partnership, and North County
Bancorp, for a portion of the office space at the
Fifth Avenue Financial Center in Escondido,
California. (7)
10.17 Lease Agreement dated January 4, 1994 between the
County of Riverside and North County Bank for a
portion of the premises located at 1735 West Ramsey
Street, Banning, California. (7)
22 Subsidiaries of North County Bancorp
24 Consent of Price Waterhouse.
- ------------------------------
(Footnotes on following page)
56
<PAGE>
- -------------------------------
(Footnotes from previous pages)
(1) Incorporated by reference to the Exhibits to the North County Bancorp
S-8 Registration Statement, Registration No. 2-84173, as filed with
the Commission on May 25, 1983.
(2) Incorporated by reference to the Exhibits to the North County Bancorp
Annual Report on Form 10-K for the fiscal year ended December 31,
1988, File No. 2-75820, as filed with the Commission on March 31,
1989, and amended on April 13, 1989.
(3) Incorporated by reference to the Exhibits to the North County Bancorp
Annual Report on Form 10-K for the fiscal year ended December 31, 1989
File No. 0-10627, as filed with the Commission on March 1, 1990, and
amended on April 30, 1990.
(4) Incorporated by reference to the Exhibits to the North County Bancorp
Annual Report on Form 10-K for the fiscal year ended December 31, 1990
File No. 0-10627, as filed with the Commission on March 31, 1991.
(5) Incorporated by reference to the Exhibits to the North County Bancorp
Annual Report on Form 10-K for the fiscal year ended December 31, 1991
File No. 0-10627, as filed with the Commission on March 30, 1992.
(6) Incorporated by reference to the Exhibits to the North County Bancorp
Annual Report on Form 10-K for the fiscal year ended December 31, 1992
File No. 0-10627, as filed with the Commission on March 30, 1993.
(7) Incorporated by reference to the Exhibits to the North County Bancorp
Annual Report on Form 10-K for the fiscal year ended December 31, 1993
File No. 0-10627, as filed with the Commission on March 30, 1994.
57
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders and Board of Directors
of North County Bancorp
In our opinion, the accompanying consolidated statement of financial condition
and the related consolidated statements of income, of changes in stockholders'
equity and of cash flows present fairly, in all material respects, the financial
position of North County Bancorp and its subsidiary at December 31, 1995 and
1994, and the results of their operations and their cash flows for the years
then ended in conformity with generally accepted accounting principles. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
PRICE WATERHOUSE LLP
San Diego, California
March 4, 1996
58
<PAGE>
NORTH COUNTY BANCORP
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
December 31,
----------------------------
1995 1994
------------ ------------
<S> <C> <C>
ASSETS
Cash and cash equivalents:
Cash and due from banks $ 24,233,000 $ 30,553,000
Federal funds sold 10,500,000 2,500,000
------------ ------------
34,733,000 33,053,000
Investment securities:
Available for sale 18,250,000 15,602,000
Held to maturity 7,922,000 11,566,000
Mortgage loans held for sale --- 1,772,000
Loans 161,950,000 166,609,000
Less: Allowance for loan and lease losses 2,916,000 2,739,000
------------ ------------
159,034,000 163,870,000
Other real estate owned 2,402,000 3,607,000
Premises and equipment, net 9,526,000 10,386,000
Accrued interest receivable and other assets 5,167,000 6,984,000
------------ ------------
$237,034,000 $246,840,000
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Non-interest-bearing $ 70,728,000 $ 79,651,000
Interest-bearing 143,108,000 146,450,000
------------ ------------
213,836,000 226,101,000
Accrued expenses and other liabilities 1,788,000 1,211,000
U. S. Treasury demand note 543,000 2,103,000
Notes payable 1,500,000 1,500,000
Capital lease obligation 462,000 491,000
Convertible subordinated debentures 1,678,000 1,678,000
------------ ------------
Total liabilities 219,807,000 233,084,000
------------ ------------
Stockholders' equity:
Common stock, no par value;
Authorized, 5,000,000 shares;
Outstanding shares 1,789,779 in
1995 and 1,549,709 in 1994 9,156,000 7,380,000
Retained earnings 8,164,000 6,632,000
Unrealized loss on available for
sale securities, net of tax (93,000) (256,000)
------------ ------------
Total stockholders' equity 17,227,000 13,756,000
------------ ------------
Commitments and contingencies (Notes 8 and 16)
$237,034,000 $246,840,000
------------ ------------
------------ ------------
</TABLE>
See accompanying notes to consolidated financial statements
59
<PAGE>
NORTH COUNTY BANCORP
CONSOLIDATED STATEMENT OF INCOME
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------
1995 1994
------------ ------------
<S> <C> <C>
Interest income:
Interest and fees on loans $17,527,000 $16,335,000
Investment securities:
Taxable 1,115,000 847,000
Exempt from Federal income taxes 33,000 48,000
Dividends 179,000 36,000
Federal funds sold 429,000 378,000
Deposits with other financial institutions 3,000 3,000
----------- -----------
Total interest income 19,286,000 17,647,000
----------- -----------
Interest expense:
Deposits 4,736,000 4,120,000
Federal funds purchased 33,000 6,000
U. S. Treasury demand note 51,000 51,000
Notes payable, capital lease obligation
and convertible subordinated debentures 344,000 348,000
----------- -----------
Total interest expense 5,164,000 4,525,000
----------- -----------
Net interest income 14,122,000 13,122,000
Provision for loan and lease losses 3,306,000 3,135,000
----------- -----------
Net interest income after
provision for loan losses 10,816,000 9,987,000
Other income 6,612,000 6,873,000
Other expense 15,334,000 16,521,000
----------- -----------
Income before income taxes 2,094,000 339,000
Provision for income taxes 562,000 254,000
----------- -----------
Net income $ 1,532,000 $ 85,000
----------- -----------
----------- -----------
Earnings per share:
Primary $ .94 $ .05
----------- -----------
----------- -----------
Fully diluted $ .88 $ .05
----------- -----------
----------- -----------
Pro forma earnings per share:
(unaudited) (Notes 1 and 17):
Primary $ .89 $ .05
----------- -----------
----------- -----------
Fully diluted $ .84 $ .05
----------- -----------
----------- -----------
</TABLE>
See accompanying notes to consolidated financial statements.
60
<PAGE>
NORTH COUNTY BANCORP
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Common stock Total
----------------------- Retained Unrealized loss stockholders'
Shares Amount earnings on securities equity
--------- ---------- ---------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1993 1,549,709 $7,380,000 $6,547,000 $ (46,000) $13,881,000
Increase in unrealized loss on
available for sale securities,
net of tax (210,000) (210,000)
Net income 85,000 85,000
--------- ---------- ---------- --------- -----------
Balance at December 31, 1994 1,549,709 7,380,000 6,632,000 (256,000) 13,756,000
Exercise of stock options 11,876 87,000 87,000
Sale of common stock 228,194 1,689,000 1,689,000
Decrease in unrealized loss on
available for sale securities,
net of tax 163,000 163,000
Net income 1,532,000 1,532,000
--------- ---------- ---------- --------- -----------
Balance at December 31, 1995 1,789,779 $9,156,000 $8,164,000$ (93,000) $17,227,000
--------- ---------- ---------- --------- -----------
--------- ---------- ---------- --------- -----------
</TABLE>
See accompanying notes to consolidated financial statements
61
<PAGE>
NORTH COUNTY BANCORP
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
December 31,
------------------------------
1995 1994
------------- ------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,532,000 $ 85,000
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation and amortization of:
Office property and equipment 1,471,000 1,384,000
Deferred loan fees and costs, net (495,000) (443,000)
Investment premiums and discounts, net 50,000 159,000
Loan servicing rights 320,000 341,000
Other 50,000 50,000
Provision for loan loss 3,306,000 3,135,000
Origination and sale of mortgage loans, net --- 1,602,000
Loss on the sale of investment securities 18,000 ---
Decrease (increase) in interest receivable 173,000 (287,000)
Increase (decrease) in taxes payable 136,000 (260,000)
Increase in accrued expenses 251,000 247,000
Increase in interest payable 192,000 86,000
Decrease (increase) in loan sales receivable 1,282,000 (1,282,000)
Other, net 736,000 (575,000)
------------ ------------
Net cash provided by operating
activities 9,022,000 4,242,000
------------ ------------
Cash flows from investing activities:
Proceeds from maturities of
investment securities 12,103,000 3,085,000
Proceeds from sale of available for
sale securities 5,150,000 3,646,000
Purchases of investment securities (16,325,000) (20,784,000)
Net decrease (increase) in loans 1,129,000 (4,277,000)
Purchase of premises and equipment (612,000) (2,382,000)
Proceeds from sale of other real estate owned 3,292,000 3,891,000
------------ ------------
Net cash provided by (used in)
investing activities 4,737,000 (16,821,000)
------------ ------------
Cash flows from financing activities:
Cash payments on capital lease
obligations (29,000) (10,000)
Net (decrease) increase in deposits (12,266,000) 6,835,000
Net (decrease) increase in
U.S. Treasury demand note (1,560,000) 289,000
Net decrease in notes payable --- (139,000)
Cash proceeds from sale of common stock 1,776,000 ---
------------ ------------
Net cash (used in) provided by
financing activities (12,079,000) 6,975,000
------------ ------------
Net increase (decrease) in cash and
cash equivalents 1,680,000 (5,604,000)
Cash and cash equivalents at
beginning of year 33,053,000 38,657,000
------------ ------------
Cash and cash equivalents at
end of year $ 34,733,000 $ 33,053,000
------------ ------------
------------ ------------
Supplemental disclosure of cash flow information:
Total interest paid $ 4,972,000 $ 4,937,000
Total income taxes paid $ 793,000 $ 514,000
Real estate acquired through foreclosure $ 2,668,000 $ 915,000
</TABLE>
See accompanying notes to consolidated financial statements.
62
<PAGE>
NORTH COUNTY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
BASIS OF PRESENTATION The consolidated financial statements include the
accounts of North County Bancorp (the Company) and its wholly owned subsidiary,
North County Bank (the Bank). All significant intercompany accounts and
transactions have been eliminated. The preparation of financial statements in
accordance with generally acceptable accounting principles requires management
to make estimates and assumptions that affect the reported amounts and
disclosures in the financial statements. Actual results could differ from those
estimates.
In the normal course of its business, the Company encounters two significant
types of risk: economic and regulatory. Economic risk is comprised of three
components - interest rate risk, credit risk and market risk. The Company is
subject to interest rate risk to the degree that its interest-bearing
liabilities mature and reprice at different speeds, or on a different basis,
than its interest-earning assets. Credit risk is the risk of default on the
Company's loan portfolio that results from the borrower's inability or
unwillingness to make contractually required payments. Market risk results from
changes in the value of assets and liabilities which may impact, favorably or
unfavorably, the realizability of those assets and liabilities.
The Company is subject to regulations of various governmental agencies. These
regulations can and do change significantly from period to period. The Company
also undergoes periodic examinations by the regulatory agencies, which may
subject it to further changes with respect to asset valuations, amounts of
required loss allowances and operating restrictions resulting from the
regulators' judgments based on information available to them at the time of
their examination. (See "NOTE 2 - REGULATORY MATTERS".)
CASH AND CASH EQUIVALENTS Cash on hand, cash items in the process of
collection, amounts due from correspondent banks and the Federal Reserve Bank
and federal funds sold to other financial institutions are included in cash and
cash equivalents.
INVESTMENT SECURITIES Securities held for investment purposes consist of
debt obligations and marketable equity securities. Investments are classified
into the following two categories: held to maturity or available for sale. Held
to maturity securities are carried at amortized cost while available for sale
securities are carried at market value. Unrealized gains and losses on
available for sale securities are recorded directly to stockholders' equity, net
of tax. Gains or losses on sales are based upon specific identification of
securities sold.
MORTGAGE LOANS HELD FOR SALE Mortgage loans originated and held for sale
are valued in the aggregate at the lower of cost or market. Gain or loss is
recognized upon sale as the difference between the net sales price and the
carrying value at the time of sale. Servicing fee income is recognized as
collected on loans for which servicing rights have been retained.
LOANS Interest on loans is accrued based upon the principal amount
outstanding. The accrual of interest on loans is discontinued when, in
management's judgment, the interest will not be paid in accordance with its
63
<PAGE>
terms. At that time interest previously recorded but not collected is reversed
and charged against current income. Loan origination fees, certain direct loan
origination costs and purchase premiums and discounts on loans are deferred and
amortized over the related life of the loan as an adjustment to the loan's
yield.
The Company sells Small Business Administration (SBA) loans to a variety of
secondary market investors. The Bank sells the guaranteed portions of SBA loans
and retains the unguaranteed portions as well as the rights and obligations to
service the loans. The Company receives an interest rate differential from
payments made by the borrowers which is at least sufficient to provide for the
future servicing costs and an allowance for a reasonable profit. Gains are
recorded upon the sale of the loans based upon premiums paid by the purchasers
and upon the present value of the retained interest rate differential over the
estimated lives of the loans where the differential exceeds the Company's
estimated future servicing costs.
The Company also sells Federal Home Administration Title I loans to secondary
market investors. Gains or losses on the sale of Title I loans are recognized
upon sale as the difference between the net sales price and the carrying value
at the time of sale. Deferred origination fees and expenses are recognized at
the time of sale.
ALLOWANCE FOR LOAN AND LEASE LOSSES The Company provides an allowance for
loan and lease losses by a charge to current operations based on Management's
evaluation of the risks in the loan portfolio, prospective economic conditions,
past loss experience, and other pertinent factors which form a basis for
determining the adequacy of the allowance for loan and lease losses.
During 1995, the Company adopted Statement of Financial Accounting Standard
("SFAS") No. 114, "Accounting by Creditors for Impairment of a Loan" as amended
by SFAS No. 118, "Accounting for Loan Impairment-Income Recognition and
Disclosures." A loan is deemed to be impaired when it is probable that a
creditor may not collect amounts due according to the original contractual terms
of the original loan agreement. Impaired loans are measured using one of the
following methods: (i) the present value of expected cash flows discounted at
the loan's effective interest rate; (ii) the observable value of the loan's
market price; or (iii) the fair value of the collateral if the loan is
collateral dependent. The effect of adoption on the Company's financial
position and results of operations was not material.
OTHER REAL ESTATE OWNED Real estate acquired in satisfaction of loans is
reported as other real estate owned. Other real estate owned is recorded at the
lower of the loan balance at the date of acquisition, the present value of
expected cash flows or the fair value less expected selling costs. Subsequent
operating expenses or income, reductions in estimated value, and gains or losses
upon sale are charged to current operations.
PREMISES AND EQUIPMENT Premises and equipment are stated at cost less
accumulated depreciation and amortization. Depreciation and amortization are
determined by use of the straight-line method over the estimated useful lives of
the assets, primarily 3 to 45 years. Maintenance and repair costs are expensed
as they are incurred, while renewals and betterments are capitalized.
INCOME TAXES The Company files consolidated Federal and combined California
state income tax returns. The Company provides for income taxes under the
liability method. A deferred tax asset and/or liability is computed for both
the expected future impact of differences between the financial statement and
tax basis of assets and liabilities, and for the expected future tax benefit to
be derived from tax loss and tax credit carryforwards. A valuation allowance may
64
<PAGE>
NORTH COUNTY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
be established to reflect the likelihood of realization of deferred tax
assets. The effect of tax rate changes are reflected in income in the period
in which such changes are enacted.
EARNINGS PER SHARE Earnings per share is based upon the weighted average
number of common stock and common stock equivalents (stock options) outstanding.
The weighted average number of shares used for primary earnings per share was
1,637,245 and 1,549,709 in 1995 and 1994, respectively. The calculation of fully
diluted earnings per share assumes the issuance of 203,888 shares of common
stock upon conversion of the Company's convertible subordinated debentures. The
weighted average number of shares used for fully diluted earnings per share was
1,850,859 and 1,549,709 in 1995 and 1994 respectively.
Pro forma earnings per share is based upon the weighted average number of common
stock and common stock equivalents (stock options) outstanding adjusted
retroactively for a stock dividend declared on February 21, 1996. (See "NOTE 17
- - SUBSEQUENT EVENTS".) The weighted average number shares used for primary
earnings per share was 1,722,967 and 1,627,194 in 1995 and 1994, respectively.
The calculation of fully diluted earnings per share assumes the issuance of
214,031 shares of common stock upon conversion of the Company's convertible
subordinated debentures. The weighted average number of shares used for fully
diluted earnings per share was 1,947,210 and 1,627,174 in 1995 and 1994
respectively. The calculation of earnings per share and pro forma earnings
per share upon conversion of the debentures proved to be anti-dilutive at
December 31, 1994 and as such is not reflected in the calculations.
NOTE 2 - REGULATORY MATTERS:
In May 1995, the Bank agreed to an Order to Cease and Desist (the "Order") with
the Federal Deposit Insurance Corporation ("FDIC") pursuant to Section 8(b) of
the Federal Deposit Insurance Act, as amended. The Order required, among other
things, that the Bank; (a) maintain a ratio of Tier I capital to adjusted total
assets of (i) at least seven and one-quarter percent (7.25%) by June 30, 1995
and (ii) at least seven and one-half percent (7.50%) by September 30, 1995, and
(b) shall not pay cash dividends without the prior written consent of the FDIC.
Based upon the results of its examination conducted in December, 1995, the FDIC
has informally indicated its preliminary intent to terminate the Order and,
pending Management's written response to the examination report may propose that
the Bank enter into a new informal enforcement action the terms of which are
currently unknown. Additionally, the FDIC has stated that the Bank should: (i)
maintain an adequate level of capital, (ii) continue to reduce its overall level
of classified assets, (iii) strengthen certain credit review procedures, (iv)
increase and stabilize its earnings, and (v) correct certain deficiencies in its
internal audit and regulatory compliance programs.
As a bank holding company without significant assets other than its equity
interest in the Bank, the Company's ability to service its debt obligations
depends upon the dividends it receives from the Bank. As part of a new informal
enforcement action, the Bank may agree to maintain a specified level of Tier 1
capital, however, it is uncertain what restrictions, if any, on the payment of
cash dividends will be agreed to.
65
<PAGE>
NORTH COUNTY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3 - INVESTMENT SECURITIES:
The amortized cost and market value of investment securities as of December 31,
1995 and 1994 are as follows:
Available for sale:
<TABLE>
<CAPTION>
December 31, 1995
--------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
U. S. Government and
Federal agencies $10,547,000 $20,000 $ (42,000) $10,525,000
States and
municipalities 1,596,000 4,000 (1,000) 1,599,000
Mortgage-backed 3,000,000 15,000 (1,000) 3,014,000
Equity securities 3,274,000 -- (162,000) 3,112,000
----------- ------- --------- -----------
$18,417,000 $39,000 $(206,000) $18,250,000
----------- ------- --------- -----------
----------- ------- --------- -----------
</TABLE>
Held to maturity:
<TABLE>
<CAPTION>
December 31, 1995
------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
U. S. Government and
Federal agencies $6,677,000 $48,000 $(40,000) $6,685,000
States and
municipalities 907,000 22,000 -- 929,000
Mortgage-backed 338,000 -- -- 338,000
---------- ------- -------- ----------
$7,922,000 $70,000 $(40,000) $7,952,000
---------- ------- -------- ----------
---------- ------- -------- ----------
</TABLE>
Available for sale:
<TABLE>
<CAPTION>
December 31, 1995
--------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
U. S. Government and
Federal agencies $14,095,000 $ -- $(334,000) $13,761,000
States and
municipalities 824,000 -- (27,000) 797,000
Mortgage-backed 734,000 -- (27,000) 707,000
Equity securities 418,000 -- (81,000) 337,000
----------- ---------- --------- -----------
$16,071,000 $ -- $(469,000) $15,602,000
----------- ---------- --------- -----------
----------- ---------- --------- -----------
</TABLE>
66
<PAGE>
NORTH COUNTY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Held to maturity:
<TABLE>
<CAPTION>
December 31, 1994
--------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
U. S. Government and
Federal agencies $10,226,000 $ -- $(424,000) $ 9,802,000
States and
municipalities 929,000 -- (27,000) 902,000
Mortgage-backed 411,000 -- (9,000) 402,000
----------- ---------- --------- -----------
$11,566,000 $ -- $(460,000) $11,106,000
----------- ---------- --------- -----------
----------- ---------- --------- -----------
</TABLE>
Investment securities with a carrying value of $6,501,000 and $7,459,000 at
December 31, 1995 and 1994, respectively, were pledged to secure public deposits
as well as for other purposes required by law. Sales of available for sale
securities during 1995 resulted in gross gains and losses of $18,000 and
$36,000, respectively, and resulted in net taxes of $8,000. Sales of available
for sale securities during 1994 resulted in gross gains of $44,000 and gross
losses of $44,000 and resulted in no net tax impact.
The following table summarizes the maturity distribution of debt securities
based on final maturity at December 31, 1995:
<TABLE>
<CAPTION>
Held to Maturity Available for Sale
--------------------------- ---------------------------
Amortized Estimated Amortized Estimated
Cost Market Value Cost Market Value
---------- ------------ --------- ------------
<S> <C> <C> <C> <C>
Within one year $1,250,000 $1,253,000 $ 2,077,000 $ 2,074,000
After one but
within five years 6,258,000 6,284,000 8,845,000 8,825,000
After five but
within ten years 76,000 77,000 103,000 105,000
After ten years -- -- 1,118,000 1,120,000
Mortgage-backed
securities 338,000 338,000 3,000,000 3,014,000
---------- ---------- ----------- -----------
$7,922,000 $7,952,000 $15,143,000 $15,138,000
---------- ---------- ----------- -----------
---------- ---------- ----------- -----------
</TABLE>
67
<PAGE>
NORTH COUNTY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4 - LOANS:
Loans at December 31 are summarized as follows:
<TABLE>
<CAPTION>
1995 1994
------------ ------------
<S> <C> <C>
Commercial, financial and agricultural $ 74,755,000 $ 75,700,000
Installment and consumer 46,748,000 45,022,000
Real estate mortgage 26,870,000 26,741,000
Real estate construction 9,212,000 14,211,000
Lease financing receivables 3,586,000 4,148,000
Other 779,000 787,000
------------ ------------
$161,950,000 $166,609,000
------------ ------------
------------ ------------
</TABLE>
A summary of the changes in the allowance for loan and lease losses is as
follows:
<TABLE>
<CAPTION>
1995 1994
---------- ----------
<S> <C> <C>
Balance at beginning of year $2,739,000 $2,195,000
Provision charged to
operating expense 3,306,000 3,135,000
Recoveries on loans
previously charged off 115,000 259,000
Loans charged off (3,244,000) (2,850,000)
---------- ----------
Balance at end of year $2,916,000 $2,739,000
---------- ----------
---------- ----------
</TABLE>
At December 31, 1995 and 1994 loans on a nonaccrual basis were $5,290,000 and
$5,118,000, respectively. Interest income collected relating to nonaccrual
loans was $208,000 and $151,000 for the years ended December 31, 1995 and 1994.
Additional interest income of $489,000 would have been recorded during both 1995
and 1994 if the loans had been paid in accordance with their original terms.
The Company's recorded investment in impaired loans at December 31, 1995 was
$4,160,000 for which it had established reserves for loan losses of $423,000.
The average recorded investment in impaired loans during 1995 was $4,387,000.
Interest income on impaired loans of $173,000 was recognized for cash payments
received in 1995. The Company is not committed to lend additional funds to
debtors whose loans have been modified.
The Company in the normal course of business to meet the financing needs of its
customers is a party to financial instruments with off-balance sheet risk. The
Company's maximum potential exposure to credit loss in the event of
nonperformance by the other party to the financial instrument for commitments to
extend credit and letters of credit is represented by the contractual amounts of
those instruments.
Commitments to extend credit are agreements to lend to a customer provided there
is no violation of any condition established in the contract. Commitments
68
<PAGE>
NORTH COUNTY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Letters of credit are conditional commitments issued
by the Company to guarantee the performance of a customer to a third party. The
credit risk in issuing letters of credit is essentially the same as that
involved in extending loan facilities to customers. The amount of collateral
obtained if deemed necessary by the Company upon extension of credit is based on
management's credit evaluation of the borrower. Since certain of the
commitments are expected to expire without being drawn upon, they do not
necessarily represent future cash requirements. The Company evaluates each
customer's creditworthiness on a case-by-case basis.
The Company's off-balance sheet credit risk for undisbursed loan commitments and
letters of credit at December 31, was as follows:
<TABLE>
<CAPTION>
1995 1994
----------- -----------
<S> <C> <C>
Commercial loans $24,596,000 $25,926,000
Installment and consumer loans 9,085,000 9,680,000
Real estate construction loans 6,036,000 8,397,000
Letters of credit 2,600,000 1,816,000
----------- -----------
$42,317,000 $45,819,000
----------- -----------
----------- -----------
</TABLE>
Most of the Company's business activity is with customers located within San
Diego and Riverside counties of Southern California. Accordingly, the Company's
financial performance may be significantly impacted by the economic conditions
of the area.
NOTE 5 - PREMISES AND EQUIPMENT:
Premises and equipment at December 31 are as follows:
<TABLE>
<CAPTION>
1995 1994
---------- -----------
<S> <C> <C>
Land $2,068,000 $ 2,068,000
Building and improvements 7,389,000 7,145,000
Furniture, fixtures and
equipment 7,737,000 7,474,000
---------- -----------
17,194,000 16,687,000
Less: Accumulated depreciation
and amortization 7,668,000 6,301,000
---------- -----------
$9,526,000 $10,386,000
---------- -----------
---------- -----------
</TABLE>
Building and improvements include a capitalized lease on the main branch
premises of $580,000, less accumulated amortization of $381,000, as of December
31, 1995 (see Note 8). Amortization on this capital lease was $20,000 in both
1995 and 1994.
69
<PAGE>
NORTH COUNTY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6 - DEPOSITS:
Deposits at December 31 are summarized as follows:
<TABLE>
<CAPTION>
1995 1994
------------ ------------
<S> <C> <C>
Noninterest-bearing demand $ 70,728,000 $ 79,651,000
Interest-bearing demand 35,119,000 33,514,000
Savings 74,216,000 88,045,000
Time deposits of $100,000 or more 7,022,000 4,742,000
Time deposits of less than $100,000 26,751,000 20,149,000
------------ ------------
$213,836,000 $226,101,000
------------ ------------
------------ ------------
</TABLE>
NOTE 7 - NOTES PAYABLE AND CONVERTIBLE SUBORDINATED DEBENTURES:
Notes payable at December 31, 1995, included $1,000,000 and $500,000 outstanding
under two term notes with directors of the Company. Both notes are unsecured
and carry a fixed interest rate of 8.00%. Terms on the $1,000,000 note consist
of quarterly interest payments commencing April 1, 1996, with final payment on
January 1, 1999 for principal and interest in full. Terms for the $500,000 note
call for principal and interest payments beginning October 1, 1995 until paid in
full on July 1, 1998.
In May 1990, the Company issued $1,678,000 in 9 1/4% convertible subordinated
debentures (the "Debentures") which mature on May 15, 2002. Interest is payable
semiannually on May 15 and November 15. The debentures are convertible at the
option of the holder into Common Stock of the Company at a conversion price of
$8.23 per share, subject to adjustment for stock splits, stock dividends or
certain other events. The debentures are redeemable in whole or in part at the
option of the Company at declining redemption prices that range from 104.25% at
December 31, 1995 to par on or after May 15, 1999. Underwriting discounts and
expenses totaling $259,000 associated with the issuance were capitalized and are
being amortized over the life of the debentures. The debentures are
subordinated to deposits and other liabilities incurred by the Company in the
normal course of business. Under current regulatory capital guidelines the
debentures are included as part of regulatory capital. The debentures qualify
as Tier 2 capital under risk-based capital guidelines.
70
<PAGE>
NORTH COUNTY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8 - LEASE OBLIGATIONS:
The Company leases the main office premises under a long-term capital lease
agreement which will expire in 2006 and other office space under various
operating leases. The future minimum lease payments for all lease obligations
consisted of the following at December 31, 1995:
<TABLE>
<CAPTION>
Capital Operating
Lease Leases
---------- ----------
<S> <C> <C>
1996 $ 214,000 $ 317,000
1997 214,000 316,000
1998 214,000 314,000
1999 214,000 320,000
2000 214,000 326,000
Thereafter 1,126,000 1,429,000
---------- ----------
Total minimum lease payments 2,196,000 $3,022,000
----------
----------
Amounts representing interest (422,000)
Cost escalation (1,312,000)
----------
Present value of net minimum
lease payments $ 462,000
----------
----------
</TABLE>
The amount of future lease payments is contingent upon normal cost escalation
clauses. Rent expense on the operating leases was $312,000 in 1995 and $317,000
in 1994.
NOTE 9 - FAIR VALUES OF FINANCIAL INSTRUMENTS:
The carrying amount and estimated fair value of the Company's financial
instruments as of December 31, 1995 are as follows:
<TABLE>
<CAPTION>
Carrying Fair
amount value
------------ ------------
<S> <C> <C>
Financial assets:
Cash and due from banks $ 24,233,000 $ 24,233,000
Federal funds sold 10,500,000 10,500,000
Investment securities 26,172,000 26,202,000
Loans 159,034,000 157,409,000
</TABLE>
71
<PAGE>
NORTH COUNTY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Financial liabilities:
<TABLE>
<S> <C> <C>
Deposits $213,836,000 $209,960,000
U.S. Treasury demand note 543,000 543,000
Note Payable 1,500,000 1,500,000
Convertible subordinated debentures 1,678,000 1,644,000
</TABLE>
The following methods and assumptions were used to estimate the fair value of
each material class of financial instruments at December 31, 1995:
CASH AND DUE FROM BANKS AND FEDERAL FUNDS SOLD The carrying amount of cash and
due from banks and federal funds sold approximates the fair value.
INVESTMENT SECURITIES The fair value of securities held as investments is based
on quoted market prices or dealer quotes.
LOANS The fair value of loans is based upon the aggregate estimated fair values
of homogeneous loan groups, giving effect to credit quality and time to
maturity. The fair value of fixed rate loans is estimated by discounting
estimated future cash flows, using a discount rate adjusted by estimated credit
risk for each loan group. The fair value of variable rate loans is estimated to
approximate carrying value. Where credit deterioration has occurred, management
has reduced estimated cash flows to give effect to estimated future losses.
DEPOSITS The carrying amount of demand and savings deposits is the estimated
fair value, which is the amount payable on demand. The carrying amount for
variable rate, fixed term time deposit accounts approximates fair value. The
fair value of fixed rate time deposits is estimated using a discounted cash flow
calculation. The discount rate on such deposits is based upon rates currently
offered for deposits of similar remaining maturities.
U.S. TREASURY DEMAND NOTE The carrying value of the Company's U.S. Treasury
demand note approximates fair value.
NOTES PAYABLE The fair value of note payable is estimated to approximate
carrying value.
CONVERTIBLE SUBORDINATED DEBENTURES There is no active trading market for the
Company's convertible subordinated debentures (the "debentures"). The fair
value is estimated based upon the most recent bid price of the debentures.
LETTERS OF CREDIT AND UNDISBURSED LOAN FUNDS The fair value of letters of
credit and undisbursed loan funds is estimated to be the cost to terminate or
otherwise settle such obligations with counterparties.
72
<PAGE>
NORTH COUNTY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The fair values of financial instruments may not necessarily be indicative of
the net realizable or liquidation value of these instruments. Furthermore,
management does not intend to dispose of significant portions of all of its
financial instruments and, thus, any aggregate unrealized gain or loss should
not be interpreted as a forecast of future earnings and cash flows.
These fair value disclosures do not include certain financial instruments such
as equity investments in consolidated subsidiaries, obligations for pension and
other post retirement benefits and deferred compensation arrangements. In
addition, fair value estimates do not attempt to estimate the value of
anticipated future business which may result from existing customer
relationships, or the value of assets and liabilities that are not considered
financial instruments, such as deferred tax assets, intangible assets or
property, plant and equipment.
NOTE 10 - OTHER INCOME AND EXPENSE:
Other income consists of:
<TABLE>
<CAPTION>
1995 1994
---------- ----------
<S> <C> <C>
Service charges on deposits $3,078,000 $2,583,000
Gain on sale of loans 2,240,000 3,010,000
Loan servicing fees 497,000 301,000
Fees on sold loans 192,000 323,000
Escrow fees 90,000 171,000
Other 515,000 485,000
---------- ----------
$6,612,000 $6,873,000
---------- ----------
---------- ----------
</TABLE>
Other expense consists of:
<TABLE>
<CAPTION>
1995 1994
----------- -----------
<S> <C> <C>
Salaries and employee benefits $ 7,545,000 $ 7,805,000
Occupancy expense 3,198,000 3,242,000
Other real estate owned 792,000 1,048,000
Regulatory assessments 617,000 598,000
Telephone and postage 582,000 639,000
Advertising and public relations 447,000 996,000
Printing, stationery
and supplies 322,000 319,000
Professional services 270,000 450,000
Other 1,561,000 1,424,000
----------- -----------
$15,334,000 $16,521,000
----------- -----------
----------- -----------
</TABLE>
73
<PAGE>
NORTH COUNTY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11 - INCOME TAXES:
The provision for income taxes consists of the following:
<TABLE>
<CAPTION>
1995 1994
-------- ---------
<S> <C> <C>
Current taxes:
Federal $741,000 $(28,000)
State 202,000 8,000
-------- --------
943,000 (20,000)
Deferred taxes:
Federal (384,000) 155,000
State 3,000 119,000
-------- --------
(381,000) 274,000
-------- --------
$562,000 $254,000
-------- --------
-------- --------
</TABLE>
Deferred tax (assets) liabilities are comprised of the following:
<TABLE>
<CAPTION>
1995 1994
----------- -----------
<S> <C> <C>
Writedown of other real estate owned $ (726,000) $ (545,000)
Provision for loan and lease losses (521,000) (685,000)
Loan fees deferred (387,000) (365,000)
Deferred compensation (141,000) (112,000)
Capital lease amortization (119,000) (124,000)
Securities held for sale (116,000) --
Unrealized loss on securities (76,000) (213,000)
----------- ----------
Gross deferred tax assets (2,086,000) (2,044,000)
----------- ----------
Depreciation 466,000 435,000
Loan origination cost capitalized 80,000 76,000
Loan servicing rights 33,000 41,000
Securities held for sale -- 91,000
Other 84,000 96,000
----------- ----------
Gross deferred tax liabilities 663,000 739,000
----------- ----------
Deferred tax assets
valuation allowance 225,000 350,000
----------- ----------
$(1,198,000) $ (955,000)
----------- ----------
</TABLE>
74
<PAGE>
NORTH COUNTY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
A reconciliation between the provision for income taxes at the statutory Federal
rate and the actual effective provision for income taxes at December 31 is as
follows:
<TABLE>
<CAPTION>
1995 1994
-------- --------
<S> <C> <C>
Federal tax at statutory rates $711,000 $115,000
State tax, net of Federal
tax effect 157,000 46,000
Tax exempt income (83,000) (112,000)
Deferred valuation allowance (125,000) 150,000
Other (98,000) 55,000
-------- --------
$562,000 $254,000
-------- --------
-------- --------
</TABLE>
Tax exempt income consists of income from investment securities and municipal
lease financing.
NOTE 12 - STOCK OPTION PLAN:
The Company has two incentive stock option plans which provide for the granting
of options to purchase up to 268,355 shares of common stock at a price of not
less than 100% of its fair market value at the date of the grant. Options for
22,906, 41,840 and 8,788 shares are exercisable at $6.99, $7.34 and $5.77,
respectively, per share as of December 31, 1995. A summary of transactions
relating to the plan for the two years ended December 31, 1995, is as follows:
<TABLE>
<CAPTION>
Number Per share
of option
shares price
-------- ------------
<S> <C> <C>
Outstanding at December 31, 1993 185,576 $5.37 - 7.34
Expired during 1994 1,630 5.37
------- ------------
Outstanding at December 31, 1994 183,946 5.77 - 7.34
Exercised during 1995 11,876 6.99 - 7.34
------- ------------
Outstanding at December 31, 1995 172,070 $5.77 - 7.34
------- ------------
------- ------------
</TABLE>
75
<PAGE>
NORTH COUNTY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 13 - EMPLOYEE RETIREMENT PLANS:
The Company has established an Employee Stock Ownership Plan (ESOP) to provide
an ownership interest in the Company and retirement benefits to substantially
all full-time employees. The amount of annual contributions is at the
discretion of the Board of Directors, subject to a maximum of 15 percent of the
total annual compensation of all eligible participants. The Company made no
contribution to the ESOP in 1995 and 1994. The ESOP has purchased $585,000 of
the Company's stock in the open market and $280,000 in newly issued common stock
since it was established in 1981.
Additionally, all full-time employees who have at least one year of service are
eligible to contribute up to 15% annually of their pretax compensation to a
retirement account under the North County Bancorp 401(k) Plan. Employees
control the investment of their funds and may elect to invest in the Company's
common stock. The Company matches 50% of an employee's contribution up to 5%
annually of the employee's covered compensation for those who have at least
three months of service and who elect to contribute under the plan. The Company
contributed $89,000 to the plan in 1995 and $85,000 in 1994.
76
<PAGE>
NORTH COUNTY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 14 - NORTH COUNTY BANCORP (PARENT CORPORATION):
Condensed financial statements presented on a parent company only basis are as
follows:
CONDENSED STATEMENT OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
December 31,
---------------------------
1995 1994
----------- -----------
<S> <C> <C>
ASSETS
Cash $ 650,000 $ 79,000
Investment in subsidiary 19,841,000 16,851,000
Premises and equipment, net 199,000 219,000
Other assets 254,000 405,000
----------- -----------
$20,944,000 $17,554,000
----------- -----------
----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Accrued expenses and other liabilities $ 77,000 $ 129,000
Notes payable 1,500,000 1,500,000
Capital lease obligation 462,000 491,000
Convertible subordinated debentures 1,678,000 1,678,000
----------- -----------
3,717,000 3,798,000
----------- -----------
----------- -----------
Stockholders' equity
Common stock, no par value 9,156,000 7,380,000
Retained earnings 8,071,000 6,376,000
----------- -----------
Total stockholders' equity 17,227,000 13,756,000
----------- -----------
$20,944,000 $17,554,000
----------- -----------
----------- -----------
</TABLE>
CONDENSED STATEMENT OF INCOME
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------
1995 1994
----------- ---------
<S> <C> <C>
Dividends from subsidiary $ -- $ 135,000
Other income 247,000 408,000
----------- ---------
Total income 247,000 543,000
Interest expense 344,000 348,000
Other operating expense 439,000 445,000
----------- ---------
Total expenses 783,000 793,000
Loss before income tax (536,000) (250,000)
Applicable income tax benefit 243,000 136,000
Equity in undistributed
income of subsidiary 1,825,000 199,000
----------- ---------
Net income $1,532,000 $ 85,000
----------- ---------
----------- ---------
</TABLE>
77
<PAGE>
NORTH COUNTY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CONDENSED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
December 31,
-------------------------
1995 1994
----------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,532,000 $ 85,000
Adjustments to reconcile net income to net
cash (used in) provided by
operating activities:
Depreciation and amortization 20,000 42,000
Equity in undistributed income
of subsidiary (1,825,000) (199,000)
Increase in accrued expenses 83,000 81,000
Other, net 14,000 76,000
Net cash flows (used in) provided by
operating activities (176,000) 85,000
----------- ---------
Cash flows used in investing activities:
Cash invested in subsidiary (1,000,000) --
----------- ---------
Net cash used in investing activities (1,000,000) --
----------- ---------
Cash flows from financing activities:
Cash payments on capital lease
obligations (29,000) (10,000)
Issuance of common stock 1,776,000 --
----------- ---------
Net cash provided by (used in)
financing activities 1,747,000 (10,000)
----------- ---------
Net increase in cash and
cash equivalents 571,000 75,000
Cash and cash equivalents at
beginning of year 79,000 4,000
----------- ---------
Cash and cash equivalents at
end of year $ 650,000 $ 79,000
----------- ---------
----------- ---------
</TABLE>
78
<PAGE>
NORTH COUNTY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 15 - RELATED PARTY TRANSACTIONS:
Certain directors and executive officers of the Company and their associates are
customers of and have other transactions with the Bank in the ordinary course of
business. Loans and commitments included in such transactions are made on
substantially the same terms as those prevailing at the time for comparable
transactions with other persons. Such loans aggregated $971,000 and $1,253,000
at December 31, 1995 and 1994, respectively. During 1995 new loans (including
drawdowns on revolving lines of credit and loan renewals) aggregated $7,909,000
and repayments (including payments on revolving lines of credit and loan
renewals) aggregated $8,191,000.
NOTE 16 - COMMITMENTS AND CONTINGENCIES:
At December 31, 1995, the Bank was party to certain legal actions. The Company
has reviewed these matters with legal counsel and, in management's opinion, the
ultimate resolution of these actions will not have a material effect on the
Company's financial position.
At December 31, 1995, the Company had unsecured lines of credit totaling
$3,000,000 for the purchase of Federal funds with other financial institutions.
In addition the Company may borrow under reverse repurchase facilities with
other financial institutions and at the Federal Reserve discount window,
subject to the Company's ability to supply collateral.
NOTE 17 - SUBSEQUENT EVENTS (Unaudited):
On February 21, 1996, the Company declared a 5% stock dividend payable on March
29, 1996 to stockholders of record on March 1, 1996. This will result in the
issuance of 89,288 shares of common stock.
79
<PAGE>
EXHIBIT 21
SUBSIDIARIES OF NORTH COUNTY BANCORP
1. North County Bank, a California state chartered bank is a subsidiary of
North County Bancorp.
2. NCB Joint Venture-I, Inc. a California corporation is a subsidiary of
North County Bank, and is a participant in Ledford/NCB-I, a California
joint venture.
3. GWB Development, a California corporation is a subsidiary of North
County Bank, and is a partner in B & G Joint Venture, a California
general partnership.
80
<PAGE>
EXHIBIT 23
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Prospectus
constituting part of the Registration Statement on Form S-8 (No. 2-84173) of
North County Bancorp of our report dated March 4, 1996 appearing on page 58 of
the Annual Report to Shareholders which is incorporated in this Annual Report on
Form 10-KSB.
PRICE WATERHOUSE LLP
San Diego, California
March 25, 1996
81
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF OPERATIONS FOUND ON
PAGES 59 TO 79 OF THE COMPANY'S FORM 10-KSB FOR THE YEAR ENDED DECEMBER 31, 1995
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-START> JAN-01-1995
<PERIOD-END> DEC-31-1995
<CASH> 24,233,000
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 10,500,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 18,250,000
<INVESTMENTS-CARRYING> 7,922,000
<INVESTMENTS-MARKET> 7,952,000
<LOANS> 161,950,000
<ALLOWANCE> 2,916,000
<TOTAL-ASSETS> 237,034,000
<DEPOSITS> 213,836,000
<SHORT-TERM> 543,000
<LIABILITIES-OTHER> 1,788,000
<LONG-TERM> 3,640,000
0
0
<COMMON> 9,156,000
<OTHER-SE> 8,071,000
<TOTAL-LIABILITIES-AND-EQUITY> 237,034,000
<INTEREST-LOAN> 17,527,000
<INTEREST-INVEST> 1,327,000
<INTEREST-OTHER> 432,000
<INTEREST-TOTAL> 19,286,000
<INTEREST-DEPOSIT> 4,736,000
<INTEREST-EXPENSE> 5,164,000
<INTEREST-INCOME-NET> 14,122,000
<LOAN-LOSSES> 3,306,000
<SECURITIES-GAINS> (10,000)
<EXPENSE-OTHER> 15,334,000
<INCOME-PRETAX> 2,094,000
<INCOME-PRE-EXTRAORDINARY> 1,532,000
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,532,000
<EPS-PRIMARY> .94
<EPS-DILUTED> .88
<YIELD-ACTUAL> 6.47
<LOANS-NON> 5,290,000
<LOANS-PAST> 0
<LOANS-TROUBLED> 6,938,000
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 2,739,000
<CHARGE-OFFS> 3,244,000
<RECOVERIES> 115,000
<ALLOWANCE-CLOSE> 2,916,000
<ALLOWANCE-DOMESTIC> 2,916,000
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
