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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
For the fiscal year ended December 31, 1996
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to ___________
Commission file number 0-10627
NORTH COUNTY BANCORP
(Name of small business issuer in its charter)
California 95-3669135
- ------------------------------------- ---------------------------
(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 (760) 743-2200
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
--------------------------
(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
----- -----
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. $26,815,000
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As of March 13, 1997, the aggregate market value of the voting stock held
by non-affiliates of the registrant was approximately $31,318,000.
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 13, 1997 was 2,005,956.
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 21, 1997 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, 1996, the Company had consolidated
assets of $257.3 million, deposits of $229.3 million and stockholders' equity of
$20.2 million.
The Company's Administrative Offices are located at 444 South Escondido
Boulevard, Escondido, California and its telephone number is (760) 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 and one loan
production office. Four of the branches are located in San Diego County in the
cities of Escondido, San Marcos and San Diego, with the remaining in Riverside
County in the cities of Temecula, Murrieta, Beaumont and Banning. The Bank's
loan production office is in Orange County.
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 recently extended its service area with the opening of its SBA (Small
Business Administration) loan office in Orange County to expand its SBA lending
activities in Orange and Los Angeles 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 three subsidiaries; NCB
Joint Venture-1, Inc. and GWB Development, which participated in real estate
development, and NCB Mortgage, all of which are inactive corporations.
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
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among other things maintaining a ratio of Tier 1 leverage capital to adjusted
total assets of at least 6.75% (See "Description of Business -- Regulation and
Supervision -- Capital Adequacy 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.")
On May 6, 1995 the Bank agreed to an Order to Cease and Desist with the
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 were 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 and lease 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 were intended to address certain
criticisms cited in the examination as well as certain other matters. The Order
replaced the informal agreement with respect to the FDIC and not the
Superintendent. Pursuant to the results of examinations by the Superintendent
and the FDIC as of December 4, 1995 (the "1995 Examination") the Superintendent
terminated the informal agreement in February of 1996, and the FDIC terminated
the Order in May of 1996. (See "Legal Proceedings.")
Pursuant to the Federal Reserve Board's (the "FRB") request based on
examinations by the FRB and the FDIC, the Board of Directors of the Company
passed a resolution in April 1994 resolving to take certain actions, including
among other things refraining from the payment of cash dividends without prior
approval of the FRB. In October 1995, an additional resolution was passed in
response to an FRB examination resolving among other things to refrain from the
payment of cash dividends without the advanced written consent of the FRB,
refrain from increasing its borrowings, incurring any additional debt or
purchasing or redeeming any stock without prior written approval of the FRB, not
make any cash expenditure in excess of $20,000 to any individual or entity
during any calendar month without advanced written approval of the FRB. (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, 1996, the Bank had
approximately 21,122 retail deposit accounts with a balance of $106.6 million as
compared to 20,460 retail deposit accounts with a balance of $109.8 million at
December 31, 1995. 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, 1996, the Bank's retail
deposits consisted of $20.6 million or 19.3% in noninterest-bearing demand
deposits, $16.6 million or 15.6% in interest-bearing demand deposits, $45.2
million or 42.4% in savings and money market deposits, $4.5 million or 4.2% in
individual retirement accounts and, $19.7 million or 18.5% 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
$53.8 million and $46.7 million at December 31, 1996 and 1995, respectively.
Prior to 1995 the Bank offered
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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. At December 31,
1996 and 1995, the Bank's mortgage loan servicing portfolio totaled
approximately $51.6 million and $58.9 million respectively. The Bank also makes
construction loans for custom built, owner-occupied homes.
During 1992, the Bank opened its Correspondent Lending Department.
Originally, this department primarily offered 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 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 generated $18.0 million and $34.5 million in Title I
loans in 1996 and 1995, respectively. The Bank's Title I loan servicing
portfolio totaled $9.3 million and $11.6 million at December 31, 1996 and 1995,
respectively. During 1996, the Correspondent Lending Department significantly
increased its volume of other equity loan products. The Bank originates and
purchases these loans, which are also secured by junior liens on residential
real estate, for immediate sale into the secondary market. Other equity loans
generated in 1996 totaled $13.5 million compared to $915,000 in 1995. (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, 1996 the Bank had approximately 7,296 business deposit accounts
totaling $122.7 million as compared to approximately 6,246 business deposit
accounts totaling
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$104.0 million at December 31, 1995. (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 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 $116.8 million and $97.9 million at
December 31, 1996 and 1995, 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. Prior to 1996, the Bank usually sold 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. Management's decision in 1996 to
reduce the volume of SBA loan sales and retain these loans in the portfolio was
based on the low level of demand for other types of commercial loans. The Bank
originated approximately $15.4 million and $21.7 million in SBA loans in 1996
and 1995, respectively. The Bank's SBA loan servicing portfolio totaled
approximately $55.2 million and $51.2 million at December 31, 1996 and 1995,
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, 1996, the Company was involved
in one development project that originated in 1989. The project held one
remaining lot for sale at December 31, 1996, which was sold in January of 1997.
Future involvement in real estate development projects is precluded by the
Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") which
prohibits all insured state banks from engaging in activities which are not
permitted for national banks, such as real estate development activities.
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 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
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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 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, courier, 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. That small business issuer
status will end for fiscal years beginning January 1, 1997. At that time the
Company will commence filing more detailed reports pursuant to Regulation S-K.
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,
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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.
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 a California state-chartered bank whose accounts are insured by the FDIC
up to a maximum of $100,000 per depositor, the Bank is subject to regulation,
supervision and regular examination by the California State Banking Department
(the "Department") and by the FDIC. In addition, while the Bank is not a member
of the Federal Reserve System, it will be subject to certain regulations of the
Board of Governors of the Federal Reserve System (the "FRB"). The regulations
of those 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, the issuance of securities and numerous other areas. The Bank is also
subject to requirements and restrictions of various consumer laws and
regulations. Supervision, legal action and examination of the Bank by the
regulatory agencies are generally intended to protect depositors and are not
intended for the protection of shareholders.
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
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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 will be 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 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.
CAPITAL ADEQUACY REQUIREMENTS
The Bank is subject to the regulations of the FDIC governing capital
adequacy. Those regulations incorporate both risk-based and leverage capital
requirements. As noted below, the federal banking agencies have proposed
regulations which would impose additional capital requirements on banks and bank
holding companies based on the market risk in the trading of debt and equity
investments.
Each of the federal regulators has established risk-based and leverage
capital guidelines for the banks or bank holding companies it regulates, which
set total capital requirements and define capital in terms of "core capital
elements," or Tier 1 capital and "supplemental capital elements," or Tier 2
capital. Tier 1 capital is generally defined as the sum of the core capital
elements less goodwill and certain intangibles. The following items are defined
as core capital elements: (I) common stockholders' equity; (ii) qualifying
noncumulative perpetual preferred stock and related surplus; and (iii) minority
interests in the equity accounts of consolidated subsidiaries. Supplementary
capital elements include: (I) allowance for loan and lease losses (but not more
than 1.25% of an institution's risk-weighted assets); (ii) perpetual preferred
stock and related surplus not qualifying as core capital; (iii) hybrid capital
instruments, perpetual debt and mandatory convertible debt instruments; and (iv)
term subordinated debt and intermediate-term preferred stock and related
surplus. The maximum amount of supplemental capital elements which qualifies as
Tier 2 capital is limited to 100% of Tier 1 capital, net of goodwill.
The Bank is required to maintain a minimum ratio of qualifying total
capital to total risk-weighted assets of 8.0% ("Total Risk-Based Capital
Ratio"), at least one-half of which must be in the form of Tier 1 capital ("Tier
1 Risk-Based Capital Ratio"). Risk-based capital ratios are calculated to
provide a measure of capital that reflects the degree of risk associated with a
banking organization's operations for both transactions reported on the balance
sheet as assets, and transactions, such as letters of credit and recourse
arrangements, which are recorded as off-balance sheet items. Under the
risk-based capital guidelines, the nominal dollar amounts of assets and
credit-equivalent amounts of off-balance sheet items are multiplied by one of
several risk adjustment percentages, which range from 0% for assets with low
credit risk, such as certain U.S. Treasury securities, to 100% for assets with
relatively high credit risk, such as business loans.
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As of December 31, 1996, the Company's total risk-based capital and Tier 1
risk-based capital ratios were 11.96% and 9.94%, respectively. As of December
31, 1996, the Bank's total risk-based capital and Tier 1 risk-based capital
ratios were 12.53% and 11.28%, respectively.
Recently adopted regulations by the federal banking agencies have revised
the risk-based capital standards to take adequate account of concentrations of
credit and the risks of non-traditional activities. Concentrations of credit
refers to situations where a lender has a relatively large proportion of loans
involving one borrower, industry, location, collateral or loan type.
Non-traditional activities are considered those that have not customarily been
part of the banking business but that start to be conducted as a result of
developments in, for example, technology or financial markets. The regulations
require institutions with high or inordinate levels of risk to operate with
higher minimum capital standards. The federal banking agencies also are
authorized to review an institution's management of concentrations of credit
risk for adequacy and consistency with safety and soundness standards regarding
internal controls, credit underwriting or other operational and managerial
areas.
Further, the banking agencies recently have adopted modifications to the
risk-based capital regulations to include standards for interest rate risk
exposures. Interest rate risk is the exposure of a bank's current and future
earnings and equity capital arising from adverse movements in interest rates.
While interest risk is inherent in a bank's role as financial intermediary, it
introduces volatility to bank earnings and to the economic value of the bank.
The banking agencies have addressed this problem by implementing changes to the
capital standards to include a bank's exposure to declines in the economic value
of its capital due to changes in interest rates as a factor that the banking
agencies will consider in evaluating an institution's capital adequacy. Bank
examiners will consider a bank's historical financial performance and its
earnings exposure to interest rate movements as well as qualitative factors such
as the adequacy of a bank's internal interest rate risk management. The federal
banking agencies recently considered adopting a uniform supervisory framework
for all institutions to measure and assess each bank's exposure to interest rate
risk and establish an explicit capital charge based on the assessed risk, but
ultimately elected not to adopt such a uniform framework. Even without such a
uniform framework, however, each bank's interest rate risk exposure is assessed
by its primary federal regulator on an individualized basis, and it may be
required by the regulator to hold additional capital for interest rate risk if
it has a significant exposure to interest rate risk or a weak interest rate risk
management process.
The federal bank regulatory agencies also require the maintenance of a
leverage capital ratio designed to supplement the risk-based capital guidelines.
Banks that have received the highest composite regulatory CAMEL rating and are
not anticipating or experiencing any significant growth must maintain a ratio of
Tier 1 capital (net of all intangibles) to adjusted total assets ("Leverage
Capital Ratio") of at least 3.0%. All other institutions are required to
maintain a leverage ratio of at least 100 to 200 basis points above the 3.0%
minimum, for a minimum of 4.0% to 5.0%. Pursuant to federal regulations, banks
must maintain capital levels commensurate with the level of risk to which they
are exposed, including the volume and severity of problem loans, and federal
regulators may, however, set higher capital requirements when a bank's
particular circumstances warrant. As of December 31, 1996, the Company's and
the Bank's Tier 1 leverage capital ratios were 7.70% and 8.74%, respectively.
PROMPT CORRECTIVE ACTION PROVISIONS
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") amended the Federal Deposit Insurance Act ("FDIA") to, among other
things, establish a framework for closer monitoring of insured depository
institutions and to enable prompt corrective action by regulators when an
institution begins to experience difficulty. Those prompt corrective action
requirements are codified in Section 38 of the FDIA. 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
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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 leverage capital ratio of 5.0% or
greater; a Tier 1 risk-based capital ratio of 6.0% or greater; 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," the
second category under this framework, 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. As of December 31, 1996, the Bank
was categorized as "well capitalized."
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 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
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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).
SAFETY AND SOUNDNESS STANDARDS
In February 1995, the federal banking agencies adopted final safety and
soundness standards for all insured depository institutions. Those standards,
which were issued in the form of guidelines rather than regulations, relate to
internal controls, information systems, internal audit systems, loan
underwriting and documentation, compensation and interest rate exposure. In
general, the standards are designed to assist the federal banking agencies in
identifying and addressing problems at insured depository institutions before
capital becomes impaired. If an institution fails to meet these standards, the
appropriate federal banking agency may require the institution to submit a
compliance plan. Failure to submit an acceptable compliance plan may result in
enforcement proceedings. In addition, the agencies have reissued asset quality
and earnings standards for public comment, as the Riegle Community Development
and Regulatory Improvement Act of 1994 gave the agencies flexibility to issue
broader standards and the agencies determined that the ratios previously
proposed were too restrictive. (See "Description of Business -- Regulation and
Supervision -- Recent and Proposed Legislation -- Riegle Community Development
and Regulatory Improvement Act of 1994" herein.)
LIMITATIONS ON DEPOSIT TAKING
FDICIA provides that a bank may not accept, renew or roll over brokered
deposits unless (I) it is "well capitalized," or (ii) it is adequately
capitalized and receives a waiver from the FDIC permitting it to accept
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brokered deposits paying an interest rate not in excess of 75 basis points over
certain prevailing market rates. FDIC regulations define brokered deposits to
include any deposit obtained, directly or indirectly, from any person engaged in
the business of placing deposits with, or selling interests in deposits of, an
insured depository institution, as well as any deposit obtained by a depository
institution that is not "well capitalized" for regulatory purposes by offering
rates significantly higher (generally more than 75 basis points) than the
prevailing interest rates offered by depository institutions in such
institution's normal market area. In addition, FDICIA provides that
institutions which are ineligible to accept brokered deposits are also
ineligible for pass-through deposit insurance or employee benefit plan deposits.
PREMIUMS FOR DEPOSIT INSURANCE
The FDIC has adopted final regulations implementing a risk-based premium
system, as required by federal law. Under the regulations, insured depository
institutions are required to pay insurance premiums depending on their risk
classification. Under the FDIC's risk-based insurance system, institutions such
as the Bank which are insured by the Bank Insurance Fund ("BIF"), are currently
subject to premiums of between 0 to 27 cents per $100 of deposits.
To arrive at a risk-based assessment for each depository institution, the
FDIC places it in one of nine risk categories using a two-step process based
first on capital ratios and then on relevant supervisory information. Each
institution is assigned to one of three capital categories: "well capitalized,"
"adequately capitalized," or "undercapitalized." A well capitalized institution
is one that has a Total Risk-Based Capital Ratio of at least 10.0%, a Tier 1
Risk-Based Capital Ratio of at least 6.0% and a Leverage Capital Ratio of at
least 5.0%. An adequately capitalized institution has at least an Total
Risk-Based Capital Ratio of at least 8.0%, a Tier 1 Risk-Based Capital Ratio of
at least 4.0% and a Leverage Capital Ratio of at least 4.0%. An
undercapitalized institution is one that does not meet either of the above
definitions. The FDIC also assigns each institution to one of three supervisory
subgroups based on an evaluation of the risk posed by the institution (group "A"
institutions being perceived to present the least risk and group "C"
institutions being perceived to present the greatest risk). The FDIC makes this
evaluation based on reviews by the institution's primary federal or state
regulator, statistical analyses of financial statements, and other information
relevant to gauging the risk posed by the institution. Those supervisory
evaluations modify premium rates within each of the three capital groups,
resulting in a matrix of nine separate assessment categories.
CONSUMER PROTECTION LAWS AND REGULATIONS
The bank regulatory agencies are focusing greater attention on compliance
with consumer protection laws and their implementing regulations. Examination
and enforcement have become more intense in nature, and insured institutions
have been advised to monitor carefully compliance with various consumer
protection laws and their implementing regulations. The Bank is subject to many
federal consumer protection statutes and regulations including, but not limited
to, the Community Reinvestment Act (the "CRA"), the Truth in Lending Act (the
"TILA"), the Fair Housing Act (the "FH Act"), the Equal Credit Opportunity Act
(the "ECOA"), the Real Estate Settlement Procedures Act ("RESPA"), and the Home
Mortgage Disclosure Act (the "HMDA"). Due to heightened regulatory concern
related to compliance with the CRA, TILA, FH Act, ECOA and HMDA generally, the
Bank may incur additional compliance costs or be required to expend additional
funds for investments in its local community.
THE COMMUNITY REINVESTMENT ACT. The CRA, enacted into law in 1977, is
intended to encourage insured depository institutions, while operating safely
and soundly, to help meet the credit needs of their communities. The CRA
specifically directs the federal regulatory agencies, in examining insured
depository
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institutions, to assess their record of helping to meet the credit needs of
their entire community, including low- and moderate-income neighborhoods,
consistent with safe and sound banking practices. The CRA further requires the
agencies to take a financial institution's record of meeting its community
credit needs into account when evaluating applications for, among other things,
domestic branches, consummating mergers or acquisitions, or holding company
formations.
In April 1995, the agencies adopted new, interagency regulations
implementing CRA. The 1995 final rule changed the objective criteria for
evaluation. The final rule seeks to take into account the unique
characteristics and needs of each institution's community, as well as the
capacity and relevant constraints upon institutions for meeting the credit needs
of the assessment area. The evaluations can be completed under a small
institution performance standard for those institutions whose total assets are
$250 million or under. Large institution performance criteria covers all
institutions with assets of $250 million or more and for multiple-bank holding
companies with total bank and thrift assets in excess of $1 billion. There are
also performance criteria for wholesale, limited purpose institutions.
The agencies use the CRA assessment factors in order to provide a rating to
the financial institution. The ratings range from a high of "outstanding" to a
low of "substantial noncompliance". The Bank was last examined for CRA
compliance by the FDIC in 1996 and received a "satisfactory" CRA Assessment
Rating.
THE EQUAL CREDIT OPPORTUNITY ACT. The ECOA, enacted into law in 1974,
prohibits discrimination in any credit transaction, whether for consumer or
business purposes, on the basis of race, color, religion, national origin, sex,
marital status, age (except in limited circumstances), receipt of income from
public assistance programs, or good faith exercise of any rights under the
Consumer Credit Protection Act. In addition to prohibiting outright
discrimination on any of the impermissible bases listed above, an effects test
has been applied to determine whether a violation of the ECOA has occurred.
This means that if a creditor's actions have had the effect of discriminating,
the creditor may be held liable -- even when there is no intent to discriminate.
In addition to actual damages, the ECOA provides for punitive damages of up to
$10,000 in individual lawsuits and up to the lesser of $500,000 or 1.0% of the
creditor's net worth in class action suits. Successful complainants may also be
entitled to an award of court costs and attorneys' fees.
THE FAIR HOUSING ACT. The FH Act, enacted into law in 1968, regulates many
practices, including making it unlawful for any lender to discriminate in its
housing-related lending activities against any person because of race, color,
religion, national origin, sex, handicap, or familial status. The FH Act is
broadly written and has been broadly interpreted by the courts. A number of
lending practices have been found to be, or may be considered, illegal under the
FH Act, including some that are not specifically mentioned in the FH Act itself.
Among those practices that have been found to be, or may be considered, illegal
under the FH Act are: declining a loan for the purposes of racial
discrimination; making excessively low appraisals of property based on racial
considerations; pressuring, discouraging, or denying applications for credit on
a prohibited basis; using excessively burdensome qualifications standards for
the purpose or with the effect of denying housing to minority applicants;
imposing on minority loan applicants more onerous interest rates or other terms,
conditions, or requirements; and racial steering, or deliberately guiding
potential purchasers to or away from certain areas because of race.
The FH Act provides that aggrieved persons may sue anyone who they believe
has discriminated against them. The FH Act provides that the Attorney General
of the United States may sue for an injunction against any pattern or practice
that denies civil rights granted by the FH Act. The FH Act allows a person to
file a discrimination complaint with the Department of Housing and Urban
Development ("HUD"). Penalties for violation of the FH Act include actual
damages suffered by the aggrieved person and injunctive or other equitable
relief. The courts also may assess civil penalties.
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THE TRUTH IN LENDING ACT. The TILA, enacted into law in 1968, is designed
to ensure that credit terms are disclosed in a meaningful way so that consumers
may compare credit terms more readily and knowledgeably. As a result of the
TILA, all creditors must use the same credit terminology and expressions of
rates, the annual percentage rate, the finance charge, the amount financed, the
total of payments and the payment schedule.
Under certain circumstances involving extensions of credit secured by the
borrower's principal dwelling, the TILA and FRB Regulation Z provide a right of
rescission. The consumer cannot be required to pay any amount in the form of
money or property either to the creditor or to a third party as a part of the
transaction in which a consumer exercises the right of rescission. Any amount
of this nature already paid by the consumer must be refunded. Such amounts
include finance charges already accrued and paid, as well as other charges such
as application and commitment fees or fees for a title search or appraisal.
The TILA requirements are complex, however, and even inadvertent
non-compliance could result in civil liability or the extension of the
rescission period for a mortgage loan for up to three years from the date the
loan was made. Recently, a significant number of individual claims and
purported consumer class action claims have been commenced against a number of
financial institutions, their subsidiaries, and other mortgage lending
companies, seeking civil statutory and actual damages and rescission under the
TILA, as well as remedies for alleged violations of various state unfair trade
practices acts and restitution or unjust enrichment with respect to mortgage
loan transactions.
THE HOME MORTGAGE DISCLOSURE ACT. The HMDA, enacted into law in 1975, grew
out of public concern over credit shortages in certain urban neighborhoods. One
purpose of the HMDA is to provide public information that will help show whether
financial institutions are serving the housing credit needs of the neighborhoods
and communities in which they are located. The HMDA also includes a "fair
lending" aspect that requires the collection and disclosure of data about
applicant and borrower characteristics as a way of identifying possible
discriminatory lending patterns and enforcing anti-discrimination statutes. The
HMDA requires institutions to report data regarding applications for one-to-four
family loans, home improvement loans, and multifamily loans, as well as
information concerning originations and purchases of such types of loans.
Federal bank regulators rely, in part, upon data provided under the HMDA to
determine whether depository institutions engage in discriminatory lending
practices.
Compliance with the HMDA and implementing regulations is enforced by the
appropriate federal banking agency, or in some cases, by HUD. Administrative
sanctions, including civil money penalties, may be imposed by supervisory
agencies for violations. The HMDA requires depository institutions to compile
and disclose certain information with respect to mortgage loans, including the
census tract, income level, racial characteristics and gender of the borrower or
potential borrower. In addition, the HMDA data may have a material effect on
the regulators' assessment of an institution, particularly in connection with an
institution's application to enter into a merger or to acquire one or more
branches.
THE REAL ESTATE SETTLEMENT PROCEDURES ACT. RESPA, enacted into law in
1974, requires lenders to provide borrowers with disclosures regarding the
nature and cost of real estate settlements. Also, RESPA prohibits certain
abusive practices, such as kickbacks, and places limitations on the amount of
escrow accounts. Violations of RESPA may result in imposition of the following
penalties: (1) civil liability equal to three times the amount of any charge
paid for the settlement services; (2) the possibility that court costs and
attorneys' fees can be recovered; and (3) a fine of not more than $10,000 or
imprisonment for not more than one year, or both. Recently, a significant
number of individual claims and purported consumer class action claims have been
commenced against a number of financial institutions, their subsidiaries, and
other mortgage lending companies alleging violations of RESPA's escrow account
rules and seeking civil damages, court costs, and attorneys' fees.
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CERTAIN OTHER ASPECTS OF FEDERAL AND STATE LAW
The Bank is also subject to federal and state statutory and regulatory
provisions covering, among other things, security procedures, currency and
foreign transactions reporting, insider transactions, management interlocks,
loan interest rate limitations, electronic funds transfers, funds availability,
and truth-in-savings disclosures.
RECENT AND PROPOSED LEGISLATION
Federal and state laws applicable to financial institutions have undergone
significant changes in recent years. The most significant recent federal
legislative enactments are the Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 and the Riegle Community Development and Regulatory
Improvement Act of 1994, which are discussed below. The most significant
California enactment was the Caldera, Weggeland and Killea California Interstate
Banking and Branching Act of 1995, which is also discussed below. Other
legislation which has been or may be proposed to the Congress or the California
Legislature and regulations which may be proposed by the FRB, the FDIC and the
State Banking Department may also affect the business of the Bank.
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. Commencing September 29, 1995, bank
holding companies were 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 10.0% of the deposits
held by insured depository institutions nationwide or 30.0% 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.
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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 (I) the bank's record of
performance; and (ii) 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 OCC 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 or the Bank in particular.
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 and Proposed Legislation -- Riegle Community Development
and Regulatory Improvement 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 INTERSTATE 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 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
30.0% 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.
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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.
The changes effected by Interstate Banking Act and Caldera Weggeland Act
may increase the competitive environment in which the Bank operates in the event
that out-of-state financial institutions directly or indirectly enter the Bank's
market areas. It is expected that the Interstate Banking Act will accelerate
the consolidation of the banking industry as a number of the largest bank
holding companies attempt to expand into different parts of the country that
were previously restricted. However, at this time, it is not possible to
predict what specific impact, if any, the Interstate Banking Act and the Caldera
Weggeland Act will have on the Bank, the competitive environment in which it
operates, or the impact on it of any regulations to be proposed under the
Interstate Banking Act and Caldera Weggeland Act.
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 $250 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. Under the new procedures, a
one-bank holding company may be formed 30
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days after filing a notification with the appropriate Federal Reserve bank,
containing information similar to that previously required in the then
applicable bank holding company application. 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, to review material supervisory
determinations at insured institutions. 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 act as a liaison to
facilitate this process. The Comptroller of the Currency already has an
ombudsman in place and both the Comptroller of the Currency and the FDIC have
internal appeals processes in place although they may have to be modified to
conform to the requirements of the Regulatory Improvement Act.
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 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.
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
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<PAGE>
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
non-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 they had elected to implement SFAS No. 123.
The recognition requirements for transactions with non-employees apply 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 elected 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 this
change in accounting principle did not 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," which was applicable for financial statements for fiscal
years beginning after December 15, 1995. 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 subsequently, this change in accounting principle did not have a material
effect on the Company's results of operations.
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, which was applicable for financial statements for fiscal years beginning
after December 15, 1995, did not have a material effect on the Company's results
of operations.
In June 1996, the FASB issued FASB No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities." SFAS No. 125
requires that a liability be derecognized if and only if (a) the debtor pays the
creditor and is relieved of its obligation for the liability or (b) the debtor
is legally released from being the primary obligor under the liability either
judicially or by the creditor. A transfer of financial assets, or any portion
thereof, in which the transferor surrenders control over those financial assets
shall be accounted for as a sale to the extent that consideration other than
beneficial interests in the transferred assets is received in exchange. Each
time an entity undertakes an obligation to service financial assets it shall
recognize either a servicing asset or a servicing liability for that servicing
contract, unless it securitizes the assets, retains
19
<PAGE>
all of the resulting securities, and classifies them as held to maturity debt
securities in accordance with SFAS No. 115, "Accounting for Certain Investments
in Debt and Equity Securities." If the servicing asset or liability was
purchased or assumed rather than undertaken in a sale or securitization of the
financial assets being serviced, it shall be measured initially at its fair
value, presumptively the price paid. A servicing asset or liability shall be
amortized in proportion to and over the period of estimated net servicing income
or net servicing loss. A servicing asset or liability shall be assessed for
impairment or increased obligation based on its fair value. SFAS No. 125 is
effective for transfers and servicing of financial assets and extinguishments of
liabilities occurring after December 31, 1996, and shall be applied
prospectively. Management does not expect this change in accounting principle
to have a material effect on the Company's results of operations.
EMPLOYEES
As of December 31, 1996, the Company had 101 full-time employees and 95
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.
20
<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.
SQUARE FEET OF
LOCATION USE OF FACILITIES OFFICE SPACE
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)
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 12/31/96 LEASE
-------- ----------------- -------------- --------------- -----
<S> <C> <C> <C> <C>
444 S. Escondido Boulevard Main Banking Office, 26,100 $30,340 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 $800 October 31, 1997
Temecula, California
</TABLE>
21
<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 Business -- Regulation and Supervision -- Capital Adequacy
Requirements" herein for a definition of Tier 1 capital), (ii) maintaining an
adequate allowance for loan and lease 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 were 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 and lease 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 were 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, while the informal agreement
continued 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 CONDLUDED 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 imporvements in
its operations since the last Safety and Soundness examination although the
FDIC had lingering concerns resulting from the exceptions noted in FDIC
Compliance and Electronic Data Processing ("EDP") reports of examination.
BASED UPON THIS EXAMINATION THE FDIC TERMINATED THE ORDER EFFECTIVE MAY 10,
1996. At the request of the FDIC, however, the Board passed a resolution in
May 1996 stating that the Bank would: (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 deficiences in its internal
audit and regulatory compliance programs.
22
<PAGE>
In December 1996, the Bank was again examined by the FDIC and the
Superintendent. The Safety and Soundness portion of the examination report noted
the Bank's return to satisfactory condition, made only minor recommendations
which will be corrected in the normal course of business and terminated all of
the protions of the resolution concerning safety and soundness issues, including
requiring the advanced approval of the FDIC for the payment of dividends to the
Company. The Compliance portion of the report noted continued weaknesses in the
areas of the Bank's internal audit and regulatory compliance programs and
requested that the Bank continue to report its progress on these areas pursuant
to the May 1996 resolution. (See "Market for Common Equity and Related
Stockholder Matters -- Dividends").
In September 1993, the Company was examined by the FRB and received the
report of Holding Company Inspection in March 1994. This report, which relied
significantly on the reports of examination of the FDIC and the Superintendent,
noted the weakened financial condition of the Bank, and pursuant to the FRB's
request, the Board of Directors of the Company passed a resolution in April 1994
resolving to take certain actions, including among other things: (I) submit a
plan to the FRB as to the actions being taken to comply with the informal
agreement and improve the Bank's financial condition, (ii) refrain from the
payment of cash dividends without prior approval of the FRB and (iii) provide
quarterly written progress reports to the FRB detailing the Company's progress
in restoring the Bank's financial condition.
In October 1995, the Company was again examined by the FRB. Pursuant to
the results of this examination, the Board of Directors of the Company was
asked to pass an additional resolution addressing the FRB's concerns over the
financial condition of the Bank. This resolution was passed in October 1995
resolving to take certain actions, including among other things: (I) to
refrain from the payment of cash dividends without the advanced written
consent of the FRB, (ii) ensure compliance with the capital requirements of
the Order, (iii) submit to the FRB a plan to enhance the Board's supervision
of the operations and management of the consolidated Company, (iv) refrain
from increasing its borrowing, incur any additional debt or purchase or
redeem any stock without prior written approval of the FRB, and (v) not make
any cash expenditure in excess of $20,000 to any individual or entity during
any calendar month without advanced written approval of the FRB.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
23
<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 and is
included for quotation on the National Association of Securities Dealers
Automated Quotation System ("NASDAQ"). Although trading in the Company's Common
Stock has increased since the stock was registered on NASDAQ in July of 1996,
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 110,000 and 38,000 shares were traded in each of
1996 and 1995, respectively. Management is aware of eight 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
$8.00 to a high of $17.125 during 1996 and from a low of $5.00 to a high of
$8.50 during 1995. 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 13, 1997 the bid price was $22.75. 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 1996 and 1995:
1996 1995
------------------ ------------------
High Low High Low
---- --- ---- ---
First Quarter $9.50 $8.00 $6.50 $5.00
Second Quarter 11.00 9.50 7.25 5.50
Third Quarter 10.75 10.25 8.00 5.50
Fourth Quarter 17.125 10.75 8.50 7.00
(b) HOLDERS
On March 13, 1997 there were approximately 1,200 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
- -- Regulation and Supervision -- 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
24
<PAGE>
and other advances that can be made by the Bank to the Company. (See
"Description of Business -- Regulation and Supervision -- The Bank.")
The dividends on the Bank's preferred stock have not been paid since 1994,
pursuant to the formal and informal agreements with the Bank's regulators and a
Board resolution adopted in May of 1996 the last of which was terminated in
March 1997. (See "Description of Business -- Regulation and Supervision -- The
Bank" and "Legal Proceedings").
Pursuant to a Board resolution passed in October 1995 the Company has
agreed to refrain from the payment of cash dividends without the advanced
written consent of the FRB. (See "Description of Business -- Regulation and
Supervision -- The Bank" and "Legal Proceedings").
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.
25
<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, 1996 and 1995 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.
Statements contained in this Report on Form 10K-SB that are not purely
historical are forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934, including statements regarding the Company's expectations, intentions,
beliefs or strategies regarding the future. All forward-looking statements
included in this document are based on information available to the Company on
the date thereof, and the Company assumes no obligation to update any such
forward-looking statements. It is important to note that the Company's actual
results could differ materially from those in such forward-looking statements.
Factors that could cause actual results to differ materially from those in such
forward-looking statements are discussed below.
FINANCIAL CONDITION
SUMMARY
Total assets of the Company increased 8.6%, or $20.3 million, to $257.3
million at December 31, 1996 from $237.0 million at December 31, 1995. This
growth was primarily concentrated in the loan and investment portfolios. Gross
loans increased 11.4% or $18.4 million to $180.4 million at year-end 1996 from
$162.0 million at year-end 1995. The increase in loan balances was largely due
to a decrease in the volume of SBA and Title I loans sold into the secondary
market and an increase in commercial real estate lending. (See "Management's
Discussion and Analysis or Plan of Operation -- Financial Condition --Loans".)
Investment securities increased 31.7% or $8.3 million to $34.5 million at
December 31, 1996 from $26.2 million at December 31, 1995. (See "Management's
Discussion and Analysis or Plan of Operation -- Financial Condition --
Investment Securities".) Total deposits increased 7.3% or $15.5 million to
$229.3 million at December 31, 1996 from $213.8 million at December 31, 1995.
Total noninterest-bearing deposits increased $13.2 million or 18.7% to $83.9
million at year-end 1996 from $70.7 million at year-end 1995. Interest-bearing
deposits also increased, growing 1.6% or $2.3 million to $145.4 million at
December 31, 1996 from $143.1 million at December 31, 1995. (See "Management's
Discussion and Analysis or Plan of Operation -- Financial Condition --
Deposits".) Net income of the Company increased to $2.7 million in 1996
compared to $1.5 million in 1995. This increase was primarily due to a decrease
of $2.0 million in the provision for loan and lease losses and an increase in
net interest income of $606,000. (See "Management's Discussion and Analysis or
Plan of Operation -- Results of Operations".)
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 was largely due to Management's efforts to control growth, thereby
helping to maintain a Tier 1 capital ratio in compliance with the Order that was
in effect at that time. A large volume of the decrease was 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 growth, the decline
in loans also reflected the continued low level of economic activity and loan
demand among qualified borrowers in the Company's market area during this time.
(See "Management's Discussion and Analysis or Plan of Operation
26
<PAGE>
- -- 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 for
the period ended December 31, 1994. The loss of title and escrow company
deposits caused 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 stockholders' equity at December 31, 1996 was $20.2 million compared
to $17.2 million at December 31, 1995. The increase was due to net income of
$2.7 million, the sale of common stock totaling $201,000, and a decrease of
$7,000 in unrealized losses on available for sale securities. The Company's
Tier 1 risk-based capital, total risk-based capital and Tier 1 leverage capital
ratios were 9.94%,11.96% and 7.70%, respectively at December 31, 1996, compared
to 9.06%, 11.21% and 7.17% respectively at December 31, 1995. (See
"Management's Discussion and Analysis or Plan of Operation -- Financial
Condition -- Capital Resources.")
Despite recent improvements in the economy of Southern California, and the
real estate market in particular, the Company's market area is still
experiencing adverse effects of the recent protracted recession that negatively
impacted the ability of certain of the Bank's customers to perform under the
terms of their loan agreements and 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 $180.4 million at December 31, 1996 compared with
$162.0 million at December 31, 1995, an increase of $18.4 million or 11.4%. As
of December 31, 1995, gross loans had decreased $4.6 million or 2.8% from $166.6
million at December 31, 1994. Gross loans comprised 70.1% of total assets at
year-end 1996 compared with 68.3% at year-end 1995. The ratio of total average
loans to total average deposits was 77.8% and 78.6% for the years ended
December 31, 1996 and 1995, respectively.
Real estate construction loans totaled $3.5 million at December 31, 1996, a
decrease of $5.7 million or 62.2% from $9.2 million at December 31, 1995. As of
December 31, 1995, these loans had decreased $5.0 million or 35.2% from $14.2
million at December 31, 1994. Real estate construction loans comprised 1.9% and
5.7% of gross loans at December 31, 1996 and 1995, respectively. As more fully
discussed below, the decrease in construction loans over the past two years was
largely due to the low level of demand for these loans in the Company's market
area as well as Management's desire to reduce its volume of real estate
construction lending due to the depressed level of real estate activity in the
Company's market area.
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 slowed
and its underwriting standards were tightened, although the Company remained
active in the marketplace primarily in entry level single family residences.
Notwithstanding the improvement in the economy of Southern California during
1996, Management is uncertain that demand for real estate in this area will
improve significantly in 1997. Management believes that an improvement in
demand would result in an expansion in its level of real estate construction
lending in 1997 over that of 1996.
27
<PAGE>
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
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. Typically,
the borrower is required to have at least 20% or more cash equity in the
project. These requirements are subject to revision based upon Management's
assessment of current market conditions.
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. In order to control the
risk of its real estate construction lending activities, the Company establishes
interest reserves and controls the disbursement of funds by requiring proper
documentation and inspections to monitor the construction progress and insure
completion within estimated costs. 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 improvement in real estate values in California, it
is presently unclear whether or not real estate values will continue to recover
significantly in 1997 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 both real estate values and the demand for residential and commercial
real estate in the San Diego and Riverside County areas has contributed to the
volume of non-performing assets the Company has experienced since 1992. (See
"Management's Discussion and Analysis or Plan of Operations -- Financial
Condition -- Nonperforming Assets and Restructured Loans.")
Conventional real estate loans totaled $38.4 million at December 31, 1996,
an increase of $11.5 million or 42.7% from December 31, 1995. At December 31,
1995, these loans totaled $26.9 million, an increase of $129,000 from $26.7
million at December 31, 1994. This category of loans includes commercial loans
secured by first trust deeds on commercial real estate which increased $12.0
million or 52.1% to $35.1 million from $23.1 million at December 31, 1996 and
1995, respectively. This increase was the result of the Company's promotional
efforts in the commercial real estate market as well as stabilization of
commercial real estate values in Southern California. Residential mortgage
loans, also included in the conventional real estate loan category, decreased
$515,000 or 13.4% to $3.3 million from $3.8 million at year-end 1995. Until
recently, 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. At December 31, 1996 and 1995, the
amount of mortgage loans serviced was $51.6 million and $58.9 million,
respectively.
Commercial loans increased $6.9 million or 9.3% to $81.7 million at
December 31, 1996 from $74.8 million at December 31, 1995. During 1995
commercial loans decreased $945,000 or 1.2% from $75.7 million at December 31,
1994. 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
28
<PAGE>
million. The Bank also originates loans guaranteed by the U.S. Small Business
Administration ("SBA") which are included in the commercial loan category. SBA
loans increased $7.5 million or 34.4% to $29.5 million at year-end 1996 from
$22.0 million at year-end 1995. These loans have maturities ranging from seven
to 25 years and are guaranteed up to 90% by the SBA. The Bank sometimes 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 $15.4 million and $21.7 million in SBA loans
in 1996 and 1995, respectively. During this same time period, the Bank sold
$8.3 million and $14.1 million in SBA loans. Management's decision to reduce
the volume of SBA loan sales and retain these loans in the portfolio was due to
the low level of demand for other types of commercial loans. The Bank intends
to continue expanding its SBA lending activities and market areas in 1997. A
new office for the production of SBA lending located in Orange County,
California was opened in March of 1997.
The Company provides lease financing to municipalities and school districts
in its market area subject to the same underwriting considerations and criteria
as the Bank's commercial loans. These leases totaled $2.3 million at December
31, 1996, a decrease of $1.3 million or 35.1% from $3.6 million at December 31,
1995. Leases decreased during 1995 by $562,000 or 13.6% from $4.1 million at
December 31, 1994. These leases are qualified tax-exempt lease obligations for
federal income tax purposes.
Installment and consumer loans increased $7.1 million or 15.1% to $53.8
million at December 31, 1996. These loans totaled $46.7 million at December
31, 1995, an increase of $1.7 million or 3.8% from $45.0 million at December
31, 1994. These increases were primarily due to growth in the Title I
portfolio of $11.0 million or 91.5% to $23.0 million at December 31, 1996 as
more fully discussed below. At December 31, 1995, Title I loans totaled
$12.0 million, an increase of $1.5 million or 14.3% from $10.5 million at
December 31, 1994. Other equity loans totaled $1.2 million at December 31,
1996, up $541,000 or 84.7% from $639,000 at December 31, 1995. Prior to 1995
the Company was not active in the equity loan market. Home equity lines of
credit, secured primarily by second trust deeds on single family residences,
declined $1.1 million to $7.4 million at December 31, 1996 from $8.5 million
at December 31, 1995. Home equity lines decreased $784,000 in 1995 from $9.3
million at December 31, 1994. The Company requires a debt-to-value ratio of
not higher than 80% for home equity lines, and the decline in real estate
values has resulted in fewer qualified borrowers. Automobile loans decreased
$73,000 or 0.8% to $9.6 million at December 31, 1996 from $9.7 million at
December 31, 1995. In 1995 these loans increased $905,000 or 10.3% from
$8.8 million at December 31, 1994 due primarily to promotion campaigns for
automobile and other consumer loans. 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. Automobile loans represented 17.9% and 20.8% of installment and
consumer loans at December 31, 1996 and December 31, 1995, respectively.
Title I loans are secured by junior liens on residential properties and
insured up to 90% by an agency of the U.S. Government through a reserve
calculated as 10% of the Company's outstanding Title I loan balances reduced by
claims filed (the "HUD reserve"). Title I loans 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 amount of
Title I loans that the Bank originated or purchased declined to approximately
$18.0 million in 1996 from $34.5 million in 1995, due to increased competition
in the Title I market. The Bank often 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 and retained the
servicing rights and some of the liability for claims. Claims on these
certificates of participation, which have reduced the Bank's HUD reserve, were
$916,000 in 1996 and $658,000 in 1995. The Bank has provided $400,000 in loan
loss provision in 1996 to supplement its Title I HUD reserves. During 1996 and
1995, the Bank sold $5.3 million and $32.5 million, respectively, in Title I
loans. The lack of demand in the Company's market areas for installment loans,
increased competition among Title I lenders,
29
<PAGE>
combined with the attractive yield afforded by Title I loans influenced
management's decision to reduce its volume of Title I loan sales and keep these
loans in its portfolio. At December 31, 1996 and 1995, Title I loans totaled
$23.0 million and $12.0 million, respectively. The Bank serviced a total of
$9.3 million and $11.6 million in Title I loans at December 31, 1996 and 1995,
respectively.
As a result of increased competition in the Title I market, as well as
increased demand for other types of equity loans, and to mitigate the impact of
decreased Title I loan sales to current income, the Bank increased its volume in
other equity loans during 1996. These equity loans are secured by junior trust
deeds on residential properties and may be made to home owners with little or no
equity in the property. The loan-to-value ratio for equity loans may go as high
as 125%. While the face amount of the loan can be as high as $100,000, subject
to certain terms, the average loan size approximates $35,000. These loans have
maturities ranging from 15 to 25 years. The proceeds can be used for a variety
of purposes the most common of which are home improvement and debt
consolidation. The Bank purchases and originates equity loans for immediate
sale into the secondary market. During 1996 and 1995, the Bank originated or
purchased $13.5 million and $915,000, respectively, in equity loans which were
sold in the secondary market.
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, 1996, the Bank's loan limits under these
regulations were $3.9 million on an unsecured basis and $6.6 million on a
secured basis. (See "Description of 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,
--------------------------------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Conventional real estate loans (1) . . . . . $ 38,352 $ 26,870 $ 26,741 $ 23,908 $ 21,339
Lease financing. . . . . . . . . . . . . . . 2,329 3,586 4,148 5,950 7,767
Real estate construction loans . . . . . . . 3,481 9,212 14,211 19,498 21,222
Commercial, financial and
agricultural loans . . . . . . . . . . . . 81,692 74,755 75,700 75,008 68,229
Installment and consumer loans . . . . . . . 53,815 46,748 45,022 40,501 44,315
All other loans (including overdrafts) . . . 741 779 787 530 259
-------- -------- -------- -------- --------
Total gross loans. . . . . . . . . . . . 180,410 161,950 166,609 165,395 163,131
Less: Allowance for loan
and lease losses . . . . . . . . . . . . . 3,129 2,916 2,739 2,195 2,134
-------- -------- -------- -------- --------
Total net loans (2). . . . . . . . . . . $177,281 $159,034 $163,870 $163,200 $160,997
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
</TABLE>
The Company had standby letters of credit outstanding aggregating $1.9
million, $2.6 million, $1.8 million, $4.4 million, and $2.9 million at
December 31, 1996, 1995, 1994, 1993, and 1992, respectively. In addition, the
Company had commitments to grant real estate construction loans, commercial
loans, and installment and consumer loans of $3.6 million, $29.7 million and
$9.8 million at December 31, 1996.
- ---------------------------
Footnotes on following page
30
<PAGE>
NONPERFORMING ASSETS AND RESTRUCTURED LOANS
Nonperforming assets consist of nonperforming assets and other real estate
owned ("OREO"). The Company considers a loan to be nonperforming when any one
of the following events occurs: (i) any installment of principal or interest is
90 days past due; (ii) the full timely collection of interest or principal
becomes uncertain; (iii) the loan is classified as "doubtful" by bank examiners;
or (iv) a portion of its principal 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. OREO, which is any real estate
owned other than banking premises, typically consists of foreclosed properties.
Total nonperforming assets were $6.3 million at December 31, 1996, a
decline of $1.4 million or 18.1%, as compared to $7.7 million at December 31,
1995. This decline was the result of the Company's continued efforts to reduce
nonperforming assets, as well as improvement in the Southern California economy.
Nonperforming assets at December 31, 1996 consisted of $3.5 million in
nonaccrual loans, a decrease of $1.8 million or 33.1% as compared to $5.3
million at December 31, 1995, and $2.8 million in OREO, an increase of $354,000
or 14.7% as compared to $2.4 million at December 31, 1995. Nonaccrual loans of
$150,000 in the conventional real estate category consisted of two loans on
single family residences. One construction loan in the amount of $581,000 on
vacant land zoned for residential use was on nonaccrual status. Commercial
loans classified as nonaccrual totaled $1.5 million at December 31, 1996, a
decline of $20,000 or 1.3%. Nonaccrual loans in the installment and consumer
category totaled $1.3 million at December 31, 1996, as compared to $1.1 million
at December 31, 1995, an increase of $141,000 or 12.5%.
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. Nonperforming assets at December 31, 1995 consisted of $5.3 million 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 consisted 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 consisted 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 was due primarily to two loans in the home equity line of credit
category totaling $397,000.
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. The Company has
- ----------------------------
Footnotes from previous page
(1) Consists of $3.3 million, $3.8 million, $7.4 million, $13.0 million, and
$12.3 million, of loans secured by single family residences and $35.1
million, $23.1 million, $19.3 million, $10.9 million, and $9.0 million of
loans secured by commercial property as of December 31, 1996, 1995, 1994,
1993, and 1992, respectively.
(2) Net of participation sold of $2.2 million, $2.9 million, $4.2 million, $2.2
million, and $2.8 million in 1996, 1995, 1994, 1993, and 1992,
respectively. Participations are sold without recourse.
31
<PAGE>
experienced some improvement in its ability to dispose of its OREO over the
last several years, selling 22 properties that totaled $2.8 million during
1996 and 17 properties that totaled $3.3 million during 1995. At December
31, 1996, OREO consisted of four single family residences totaling $510,000,
one multi-family unit totaling $214,000, four commercial properties totaling
$1.4 million, two parcels of vacant land zoned for commercial use totaling
$574,000 and two parcels of vacant land zoned for residential use totaling
$93,000. OREO also included an investment in a real estate development
project that consisted of 37 acres subdivided into 15 lots ranging in size
from 1.2 acres to 4.1 acres in Bonsall, California. At December 31, 1996 one
lot remained which was sold on January 17, 1997 for $62,000. The Bank, as
an insured state bank, is prohibited by FDICIA from engaging in activities
which are not permitted for national banks, such as real estate development
activities. 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 1996 and 1995 and an improving
regional economy notwithstanding, the Company continues to be impacted by the
general slowdown in economic activity experienced in the Company's market area
during the past several years. 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 while, and for a period after, the current economic
environment improves.
Interest income included in net interest income relating to nonaccrual
loans was $84,000 and $208,000 for the years ended December 31, 1996 and 1995,
respectively. Additional interest income of $327,000 and $489,000 on nonaccrual
loans would have been recorded during 1996 and 1995, respectively, 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.
The table on the following page provides information with respect to the
components of the Company's nonperforming assets at the dates indicated.
32
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(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
Lease financing, net . . . . . . . . . . . -- -- -- -- --
------- ------- ------- ------- -------
Total. . . . . . . . . . . . . . . . . . -- -- 14 54 18
Nonaccrual loans
Conventional real estate . . . . . . . . . 150 1,095 1,187 -- 297
Real estate construction . . . . . . . . . 581 1,506 1,389 537 2,357
Commercial . . . . . . . . . . . . . . . . 1,540 1,560 1,775 2,287 1,978
Installment and consumer loans . . . . . . 1,270 1,129 767 547 575
Lease financing net. . . . . . . . . . . . -- -- -- -- --
------- ------- ------- ------- -------
Total. . . . . . . . . . . . . . . . . . 3,541 5,290 5,118 3,371 5,207
------- ------- ------- ------- -------
Total Nonperforming loans. . . . . . . . 3,541 5,290 5,132 3,425 5,225
Other real estate owned. . . . . . . . . . . 2,756 2,402 3,607 6,821 5,859
------- ------- ------- ------- -------
Total Nonperforming assets . . . . . . . $ 6,297 $ 7,692 $ 8,739 $10,246 $11,084
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Nonperforming loans to
total gross loans. . . . . . . . . . . . . 1.96% 3.27% 3.08% 2.07% 3.20%
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Nonperforming assets to
total gross loans plus
other real estate owned. . . . . . . . . . 3.44% 4.68% 5.13% 5.95% 6.56%
------- ------- ------- ------- -------
------- ------- ------- ------- -------
</TABLE>
Other past due loans at December 31, 1996 included $1.1 million of loans
past due more than 30 days but less than 90 days.
Restructured loans 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 $5.4 million
and $6.9 million at December 31, 1996 and 1995, respectively.
The following table provides information with respect to the components of
the Company's restructured loans at the dates indicated.
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Restructured loans
Real estate conventional . . . . . . . . . $4,674 $6,459 $4,777 $ 330 $ --
Commercial . . . . . . . . . . . . . . . . 731 479 1,354 1,732 --
Installment and consumer loans . . . . . . -- -- -- -- --
------ ------ ------ ------ ------
Total. . . . . . . . . . . . . . . . . . $5,405 $6,938 $6,131 $2,062 $ --
------ ------ ------ ------ ------
------ ------ ------ ------ ------
</TABLE>
Restructured loans includes $267,000 and $765,000 in conventional real
estate loans and commercial loans, respectively, which were accounted for as
nonaccrual loans at December 31, 1996.
33
<PAGE>
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, 1996 were measured based on the fair value of the
loan collateral. Interest income on impaired loans is recognized on a cash
basis.
Impaired loans totaled $1.1 million and $846,000 for commercial loans and
real estate mortgage loans, respectively, at December 31, 1996. The recorded
investments are stated net of allowance for loan and lease losses of $274,000
and $68,000, for impaired commercial and real estate mortgage loans,
respectively.
ALLOWANCE FOR LOAN AND LEASE LOSSES
The allowance for loan and lease losses at December 31, 1996 totaled $3.1
million or 1.73% of total gross loans as compared to $2.9 million or 1.80% of
total gross loans at December 31, 1995 and $2.7 million or 1.64% of total gross
loans at December 31, 1994.
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 and lease losses to be maintained, Management augments
this calculation with an analysis of the present and prospective financial
condition of certain borrowers, industry concentrations within the portfolio,
trends in delinquent and nonaccrual loans and general economic conditions.
During 1996, $400,000 of the provision for loan and lease losses was provided to
supplement the Bank's Title I HUD reserve due to potential losses arising from
the Title I participation certificates sold in 1993 and 1994. Additional
reserves for this purpose may be established in the future pursuant to
management's continued analysis.
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, 1996 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 and lease losses were 37.3%, 114.2% and 118.0% in 1996, 1995
and 1994, respectively. The decreased level of charge-offs during 1996 reflects
improvement in the Southern California economy and real estate values, and in
the Company's asset quality.
34
<PAGE>
The following table 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 losses.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCES:
Average loans during period. . . . . . . . $171,906 $165,374 $168,076 $167,402 $159,797
Loans at end of period . . . . . . . . . . 180,410 161,950 166,609 165,395 163,131
ALLOWANCE FOR LOAN AND LEASE LOSSES:
Balance at beginning of period . . . . . . 2,916 2,739 2,195 2,134 1,993
Actual charge-offs:
Conventional real estate loans . . . . . 361 183 380 197 --
Real estate construction . . . . . . . . -- 525 71 69 370
Commercial, financial and
agricultural loans . . . . . . . . . . 450 1,514 1,595 1,101 298
Installment and consumer loans . . . . . 609 1,022 804 963 225
-------- -------- -------- -------- --------
Total. . . . . . . . . . . . . . . . . 1,420 3,244 2,850 2,330 893
Recoveries on loans previously
charged-off:
Conventional real estate loans . . . . . -- -- -- -- --
Real estate construction . . . . . . . . -- -- -- -- --
Commercial, financial and
agricultural loans . . . . . . . . . . 274 47 184 51 36
Installment and consumer loans.. . . . . 59 68 75 75 48
-------- -------- -------- -------- --------
Total. . . . . . . . . . . . . . . . 333 115 259 126 84
Net loan charge-offs . . . . . . . . . . . 1,087 3,129 2,591 2,204 809
Provision for loan and lease losses. . . . 1,300 3,306 3,135 2,265 950
-------- -------- -------- -------- --------
Balance at end of period . . . . . . . . . $ 3,129 $ 2,916 $ 2,739 $ 2,195 $ 2,134
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
RATIOS:
Net loan charge-offs to
average loans. . . . . . . . . . . . . . 0.63% 1.89% 1.54% 1.32% 0.51%
Allowance for loan and lease losses
to loans at end of period. . . . . . . . 1.73 1.80 1.64 1.33 1.31
Net loan charge-offs to beginning
of the period allowance for
for loan and lease losses. . . . . . . . 37.3 114.2 118.0 103.3 40.6
Net loan charge-offs to provision
for loan and lease losses. . . . . . . . 83.6 94.7 82.7 97.3 85.2
</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
in the Company's market area, the sufficiency of collateral, the timeliness of
payment and with respect to adjustable
35
<PAGE>
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.
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 and lease
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 and lease 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 and lease 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 $1.3 million
during 1997 as compared to net charge-offs of $1.0 million in 1996. This
projected increase is due to loan growth combined with a reduction in the level
of loan loss recoveries as compared to 1996. It is anticipated that net charge-
offs by loan category will be as follows; conventional real estate, $173,000;
real estate construction, $167,000; commercial, financial and agricultural,
$523,000; and installment and consumer loans, $478,000. These estimates are
based upon Management's analysis of the loan portfolio and its analysis of the
adequacy of the allowance for loan and lease losses. No assurances can be given
that the net charge-offs anticipated will not be greater than or less than $1.3
million, or that they will occur in the projected categories.
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, 1996, investment securities totaled $34.5 million or 13.4%
of total assets, an increase of $8.3 million, or 31.7%, compared to $26.2
million or 11.0% of assets at December 31, 1995. The increase in the
investment portfolio was primarily funded by a reduction in Federal funds sold
of $8.3 million to $2.2 million at year-end 1996 from $10.5 million at year-end
1995. The majority of the investment portfolio increase was in the mortgage-
backed securities category which grew $7.1 million or 214.3% to $10.5 million at
December 31, 1996 from $3.4 million at the end of 1995. This investment
category is comprised of agency pass-through securities which consists of
selected residential mortgages that are purchased by one of three U.S.
government agencies or government-sponsored enterprises (the Government National
Mortgage Association, the Federal National Mortgage Association or the Federal
Home Loan Mortgage Corporation ) and packaged into securities. Principal and
interest payments on the underlying mortgages are "passed through" to the
security holders. Due to the nature of mortgage loans, which tend to payoff
prior to maturity, agency pass-through securities are calculated to have an
estimated average life based on properties inherent to the underlying mortgages
and the mortgage industry's prepayment history. Generally, pass-through
securities, due to an active secondary market, can offer liquidity similar to
U.S. Treasury securities at yields that are typically higher than comparable
Treasury securities. The mortgage-backed securities purchased in 1996 had an
estimated average life of one to five years. In 1995 investment securities
decreased $996,000, or 3.7%, from $27.2 million or 11.0% of assets at
December 31, 1994. The small decline in the investment portfolio during 1995
was reflective of the Company's decline in total assets.
36
<PAGE>
Investments are classified into three categories: available for sale, held
to maturity, or trading. 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. Investments classified as held to
maturity are carried at amortized cost. 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.
Available for sale securities totaled $23.1 million and $18.3 million at
December 31, 1996 and 1995, respectively. Held to maturity securities totaled
$11.3 million and $7.9 million at December 31, 1996 and 1995, respectively.
The Company has no investment securities classified as trading. Unrealized
losses of $156,000 and $167,000 for 1996 and 1995, respectively, have been
recognized in the available for sale portfolio. During 1996 and 1995
investments totaling $2.5 million and $5.2 million, respectively, were sold for
a net loss of $24,000 and $18,000, respectively.
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, 1996
------------------------------------------------------
AVAILABLE FOR SALE HELD TO MATURITY
------------------------ ------------------------
AMORTIZED MARKET AMORTIZED MARKET
COST VALUE COST VALUE
--------- ------ --------- ------
<S> <C> <C> <C> <C>
U.S. Treasury securities. . . . . . . . . . $ 500 $ 501 $ 747 $ 751
Obligations of other U.S.
government agencies . . . . . . . . . . . 9,039 9,022 5,674 5,658
Obligations of states and political
sub-divisions . . . . . . . . . . . . . . 2,134 2,142 1,751 1,755
Mortgage-backed securities. . . . . . . . . 7,387 7,362 3,172 3,168
Equity securities (1) . . . . . . . . . . . 4,213 4,090 -- --
------- ------- ------- -------
Total investment securities . . . . . . . . $23,273 $23,117 $11,344 $11,332
------- ------- ------- -------
------- ------- ------- -------
DECEMBER 31, 1995
------------------------------------------------------
AVAILABLE FOR SALE HELD TO MATURITY
------------------------ ------------------------
AMORTIZED MARKET AMORTIZED MARKET
COST VALUE COST VALUE
--------- ------ --------- ------
U.S. Treasury securities. . . . . . . . . . $ 550 $ 548 $ 1,744 $ 1,763
Obligations of other U.S.
government agencies . . . . . . . . . . . 9,997 9,977 4,933 4,922
Obligations of states and political
sub-divisions . . . . . . . . . . . . . . 1,596 1,599 907 929
Mortgage-backed securities. . . . . . . . . 3,000 3,014 338 338
Equity securities (1) . . . . . . . . . . . 3,274 3,112 -- --
------- ------- ------- -------
Total investment securities . . . . . . . . $18,417 $18,250 $ 7,922 $ 7,952
------- ------- ------- -------
------- ------- ------- -------
</TABLE>
The table on the following page summarizes the maturity of the Company's
investment securities and their weighted average yields at December 31, 1996.
Tax-exempt income from investment securities is presented on a tax-equivalent
basis assuming a 34% federal income tax rate for 1996. Mortgage-backed
securities are categorized based on final maturity dates.
37
<PAGE>
<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 . . . $ 1,248 6.15% $ -- --% $ -- --% $ -- --% $ 1,248 6.15%
Obligations of other U.S.
government agencies. . . . . 1,430 5.32 12,973 6.21 293 6.11 -- -- 14,696 6.63
Obligations of states and
political subdivisions . . . 1,094 9.51 2,618 6.61 181 6.85 -- -- 3,893 7.44
Mortgage-backed securities . . 792 6.63 1,956 6.80 1,946 6.81 5,840 7.08 10,534 6.94
Equity securities (1). . . . . 4,090 3.33 -- -- -- -- -- -- 4,090 3.33
------- ------- ------- ------- -------
Total investment securities. $ 8,654 5.10% $17,547 6.30% $ 2,420 6.70% $ 5,840 7.08% $34,461 6.40%
------- ------- ------- ------- -------
------- ------- ------- ------- -------
</TABLE>
DEPOSITS
Total average deposits increased to $220.8 million in 1996 compared to
$210.3 million for 1995, an increase of $10.5 million or 5.0%. Noninterest-
bearing demand accounts provided the largest average dollar increase, growing
$6.4 million or 9.6% to $73.3 million in 1996 from $66.9 million in 1995.
Average noninterest-bearing demand deposits represented 32.0% and 31.3% of total
average deposits in 1996 and 1995, respectively, reflecting the retail nature of
the Company's deposit base. Interest-bearing demand deposits increased $3.0
million or 9.0% to $36.8 million and time deposits grew $4.6 million or 14.9% to
$35.2 million. Savings accounts, the only category to decrease, dropped $3.4
million or 4.4% to $75.6 million in 1996, representing 33.0% of total average
deposits compared to 37% in 1995.
Total average deposits decreased to $210.3 million in 1995 compared to
$222.6 million in 1994, a decrease of $12.3 million or 5.5%. All categories of
average deposits decreased during 1995, with the largest decrease in the
noninterest-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%. Approximately
5% of total average deposits during 1994 (or 15% of average noninterest-bearing
demand) represented deposits of title and escrow companies. The Company provided
these depositors with certain customer services consisting primarily of data
processing and courier services. The Company controlled 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. The decline in
noninterest-bearing deposits during 1995 was 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 rates, which decreased throughout 1995,
prompting depositors to seek higher yields in other types of accounts or with
other institutions.
The levels of noninterest-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 noninterest-bearing deposits. The
Company's percentage of noninterest-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
- --------------------
(1) Equity securities in 1996 and 1995, included $3.4 million and $3.1 million,
respectively, in government securities bond and money market funds which
invest in securities guaranteed by the U.S. Government, and $733,000 in
Federal Home Loan Bank stock in 1996. Equity securities are carried on the
books of the Company at the lower of aggregate cost or market. In 1996 and
1995 stockholders' equity was reduced by $68,000 and $44,000,
respectively to reflect a decline in the market value of these securities.
38
<PAGE>
it difficult for the Company to maintain the current level of noninterest-
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 following table summarizes the distribution of average deposits and the
average rates paid for the periods indicated.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------------------------------------------------
1996 1995 1994
---------------------- ---------------------- ----------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE RATE BALANCE RATE BALANCE RATE
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Noninterest-bearing
demand deposits. . . . . . . . . $ 73,298 -- $ 66,910 -- $ 73,165 --
Interest bearing
demand deposits. . . . . . . . . 36,791 1.44% 33,744 1.70% 34,977 1.70%
Savings deposits . . . . . . . . . 75,583 3.29 79,031 3.42 81,751 3.04
Time deposits. . . . . . . . . . . 35,166 4.77 30,600 4.76 32,680 3.18
-------- -------- --------
Total deposits. . . . . . . . $220,838 2.13% $210,285 2.25% $222,573 1.85%
-------- -------- --------
-------- -------- --------
</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, 1996, time deposits of
$100,000 or more totaled $9.2 million, representing 24.6% and 4.0% of total time
deposits and total deposits, respectively. 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. (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, 1996 were as follows:
DECEMBER 31, 1996
-----------------
TIME DEPOSITS MATURING IN (DOLLARS IN THOUSANDS)
-------------------------
Three months or less. . . . . . . . . . . . . . . $5,076
Over three months through six months. . . . . . . 1,978
Over six months through twelve months . . . . . . 1,973
Over twelve months. . . . . . . . . . . . . . . . 200
------
Total. . . . . . . . . . . . . . . . . . . . . $9,227
------
------
CAPITAL RESOURCES
Stockholders' equity increased $3.0 million or 17.1% to $20.2 million at
December 31, 1996 from $17.2 million at December 31, 1995. This increase was
due to net income of $2.7 million, the sale of common stock totaling $201,000,
and a decrease of $7,000 in unrealized losses on available for sale securities.
Stockholders'
39
<PAGE>
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
$163,000 in unrealized losses on available for sale securities. (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 ratio of 8.00% (at least one-half of which must
consist of Tier 1 capital). Risk-based capital ratios are calculated to provide
a measure of capital that reflects the degree of risk associated with a banking
organization's operations for both transactions reported on the balance sheet as
assets, and transactions, such as letters of credit and recourse arrangements,
which are recorded as off-balance sheet items. At December 31, 1996 the
Company's risk-based capital ratios were 9.94% for Tier 1 capital and 11.96% for
total capital and the Bank's risk-based capital ratios were 11.28% for Tier 1
and 12.53% for total capital. The Company's risk-based capital ratios at
December 31, 1995 were 9.06% for Tier 1 capital and 11.21% for total capital and
the Bank's risk-based capital ratios were 10.40% for Tier 1 capital and 11.65%
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, 1996 and 1995, the Company's Tier 1
leverage capital ratios were 7.70% and 7.17%, respectively. The Tier 1 leverage
capital ratios of the Bank were 8.74% and 8.20% at December 31, 1996 and 1995,
respectively. (See "Description of Business -- Regulation and Supervision --
Capital Adequacy Requirements" and "Legal Proceedings").
At December 31, 1996, the Company had $1.5 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 $7.47 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 103.25% at December 31, 1996 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. A two for one stock split
resulted in an adjusted conversion price of $3.74 per share effective March 14,
1997.
The Company had $1.6 million outstanding under two term notes with current
and former directors of the Company as of December 31, 1996. The notes are
unsecured at an interest rate of 8.0% with varying interest and principal
payment schedules. Terms for one note for $1.2 million call for interest to be
compounded quarterly commencing April 1, 1996, with payment for principal and
interest in full on January 1, 1999. Terms for the remaining note of $318,000
call for principal and interest payments beginning October 1, 1995 until paid in
full on July 1, 1998. The Company also used the proceeds of these notes to
purchase $1.5 million of noncumulative perpetual preferred stock from the Bank.
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 of December 31, 1995,
the Bank, operating under the terms of the Order entered into with the FDIC in
May 1995, had agreed not to pay cash dividends to the Company without the prior
consent of the FDIC. Based upon the
40
<PAGE>
results of the Bank's FDIC examination conducted in December of 1995, the Order
was terminated in May of 1996. (See "Legal Proceedings").
During 1997, Management anticipates capital expenditures of approximately
$750,000 to $1.1 million primarily for upgrades to computer and data
communications equipment and computer software.
RESULTS OF OPERATIONS
NET INCOME
Net income for the year ended December 31, 1996 increased to $2.7 million
from $1.5 million for the year ended December 31, 1995, an increase of $1.2
million. Primary earnings per share increased to $1.36 in 1996 from $0.85 in
1995. Return on average assets and average stockholders' equity was 1.11% and
14.73%, respectively, for 1996, up from 0.66% and 9.97%, respectively, for
1995. The primary reasons for the increase in net income was a decrease in the
provision for loan and lease losses of $2.0 million, an increase in net interest
income of $606,000, an increase in other income of $363,000, offset by increases
of $233,000 in other expense and $1.5 million in the provision for income taxes.
(See "Management's Discussion and Analysis or Plan of Operation -- Results of
Operations -- Net Interest Income; Provision for Loan and Lease Losses, Other
Income, Other Expense and Income Taxes".)
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 $0.85 in 1995 from $0.05 in 1994.
Return on average stockholders' equity was 9.97% for 1995, up from 0.6% for
1994. The primary reasons for this increase are an increase in net interest
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 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
these 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, 1996 increased $606,000
or 4.3% to $14.7 million from $14.1 million for 1995. As illustrated in the
table on page 43, the increase in net interest income was comprised of a net
increase of $963,000 that was attributable to volume, partially offset by a net
decrease of $357,000 due to declining yields. Interest income for 1996
increased $554,000 of which $1.1 million was attributable to increased volume,
offset by a net decrease of $567,000 due to declining yields. The average yield
on interest-earning assets decreased to 9.53% for 1996 as compared to 9.95% for
1995. The average yield on loans, investment securities and Federal funds sold
for 1996 were 10.37%, 5.80% and 5.08%, respectively, compared to 10.65%, 6.15%
and 5.56%, respectively, for 1995. Offsetting the decrease in the yield on
interest-earning assets was an increase in total average interest-earning assets
to $209.3 million in 1996 compared to
41
<PAGE>
$194.9 million in 1995, an increase of $14.4 million or 7.4%. This increase was
primarily in total average loans which averaged $171.9 million in 1996 compared
to $165.4 million in 1995, an increase of $6.5 million or 4.0%. (See
"Management's Discussion and Analysis or Plan of Operation -- Financial
Condition -- Loans.") Average investments also increased $8.0 million or 36.9%
to $29.8 million in 1996 from $21.8 million. Average Federal funds sold
decreased to $7.6 million from $7.7 million, a decrease of $135,000 or 1.8%.
Interest expense for 1996 was $5.1 million, decreasing $52,000 or 1.0% from
$5.2 million for 1995. This decrease was primarily due to a decline in the
average rate paid on interest-bearing liabilities to 3.34% in 1996 from 3.48% in
1995, offset by an increase in average interest-bearing liabilities of $4.3
million or 2.9% to $152.8 million in 1996 from $148.5 million in 1995. (See
"Managements' Discussion and Analysis or Plan of Operation -- Financial
Condition -- Deposits".) Average short-term rates during 1996 were generally
lower than those in 1995 accounting for the decreases 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) decreased to 6.18% for 1996 from 6.47% for 1995 and the net
interest margin decreased to 7.09% for 1996 from 7.30% for 1995.
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 Federal 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".) 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 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.
The yield on approximately 46.3% and 53.8% at December 31, 1996 and 1995,
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% of the portfolios at December 31,
1996 and 1995, consisted 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
42
<PAGE>
margin for the year indicated. Tax-exempt income from investment securities and
loans is presented on a tax-equivalent basis assuming a 34% federal tax rate for
1996, 1995, and 1994.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------------------------------
1996 1995 1994
---------------------------- ---------------------------- ---------------------------
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). . . . . . . . . . $171,906 $ 17,831 10.37% $165,374 $ 17,617 10.65% $168,076 $ 16,459 9.79%
Taxable investment
securities . . . . . . . . 27,570 1,592 5.78 20,570 1,294 6.29 1,209 883 4.16
Tax-exempt investment
securities . . . . . . . . 2,261 138 6.09 1,223 47 3.81 1,095 68 6.19
Interest-bearing deposits. . -- -- -- 44 3 5.60 78 3 3.65
Federal funds sold . . . . . 7,573 385 5.08 7,708 429 5.56 9,655 378 3.91
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total earning assets . . . . 209,310 19,946 9.53 194,919 19,390 9.95 200,113 17,791 8.89
-------- -------- -------- -------- -------- -------- -------- -------- --------
Noninterest-earning assets:
Cash and due from banks. . . 22,560 21,070 24,643
Premises and equipment, net. 9,184 10,026 9,664
Other assets (2) . . . . . . 9,028 9,238 11,040
-------- -------- --------
Total noninterest-earning
assets . . . . . . . . . . 40,772 40,334 45,347
-------- -------- --------
Less allowance for loan
and lease losses . . . . . . 3,233 2,668 2,088
-------- -------- --------
Total assets . . . . . . . . $246,849 $232,585 $243,372
-------- -------- --------
-------- -------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Deposits:
Interest-bearing demand. . 36,791 528 1.44 33,744 574 1.70 34,977 596 1.70
Savings. . . . . . . . . . 75,583 2,488 3.29 79,031 2,705 3.42 81,751 2,485 3.04
Time . . . . . . . . . . . 35,166 1,677 4.77 30,600 1,457 4.76 32,680 1,039 3.18
Other short term borrowings. 1,622 74 4.43 1,483 84 5.65 1,433 57 4.00
Capital lease. . . . . . . . 444 65 14.59 476 72 14.18 495 70 14.14
Long term debt . . . . . . . 3,229 280 8.67 3,178 272 8.71 3,178 278 8.73
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total interest-bearing
liabilities. . . . . . . . 152,835 5,112 3.34 148,512 5,164 3.48 154,514 4,525 2.93
-------- -------- -------- -------- -------- -------- -------- -------- --------
Noninterest-bearing liabilities:
Demand deposits. . . . . . . 73,298 66,910 73,165
Other liabilities. . . . . . 2,102 1,799 1,601
-------- -------- --------
Total liabilities. . . . . . 228,235 217,221 229,280
Stockholders' equity . . . . . 18,614 15,364 14,092
-------- -------- --------
Total liabilities and
stockholders' equity . . . $246,849 $232,585 $243,372
-------- -------- --------
-------- -------- --------
Net interest income
(tax equivalent basis) . . . 14,834 14,226 13,266
Reversal of tax equivalent
adjustment . . . . . . . . . (106) (104) (144)
-------- -------- --------
Net interest income. . . . . . $ 14,728 $ 14,122 $ 13,122
-------- -------- --------
-------- -------- --------
Net interest spread(3) . . . . 6.18% 6.47% 5.96%
-------- -------- --------
-------- -------- --------
Net interest margin(4) . . . . 7.09% 7.30% 6.63%
-------- -------- --------
-------- -------- --------
</TABLE>
- -----------------------------
(Footnotes on following page)
43
<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>
1996 vs. 1995 1995 vs. 1994
------------------------------------ ------------------------------------
Increase (Decrease) Increase (Decrease)
Due to Changes in Due to Changes in
------------------------------------ ------------------------------------
Volume Rate Total Volume Rate Total
------ ------ ------ ------ ------ ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Earning assets -- Interest income:
Loans $ 682 $ (445) $ 237 $ (266) $1,458 $1,192
Investment securities:
Taxable 411 (113) 298 (27) 438 411
Non-taxable 38 27 65 5 (20) (15)
Federal funds sold (8) (36) (44) (87) 138 51
Interest-bearing deposits (2) -- (2) (1) 1 --
------ ------ ------ ------ ------ ------
Total 1,121 (567) 554 (376) 2,015 1,639
------ ------ ------ ------ ------ ------
Deposits and borrowed funds --
Interest expense:
Interest-bearing demand
deposits 49 (95) (46) (21) (1) (22)
Savings deposits (115) (101) (216) (85) 306 221
Time deposits 218 4 222 (70) 487 417
Other short term borrowings 7 (19) (12) 2 25 27
Long term debt 4 (1) 3 -- (1) (1)
Capital lease (5) 2 (3) (3) -- (3)
------ ------ ------ ------ ------ ------
Total 158 (210) (52) (177) 816 639
------ ------ ------ ------ ------ ------
Change in net interest income $ 963 $ (357) $ 606 $ (199) $1,199 $1,000
------ ------ ------ ------ ------ ------
------ ------ ------ ------ ------ ------
</TABLE>
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, 1996, the provision for loan and lease losses decreased
$2.0 million or 60.7%, to $1.3 million from $3.3 million for the year ended
December 31, 1995. This decrease was due to a decline in net loans charged off
to $1.1 million or 0.63% of average loans outstanding in 1996 from $3.1 million
or 1.89% of average loans outstanding in 1995, as well as decreased provisions
for loan and lease losses
- ----------------------------
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 1996 1995, and 1994 of $2.8 million, $3.3 million, and $4.9
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.
44
<PAGE>
that in Management's opinion reflected the improvement in the Southern
California economy and in the real estate market. During 1996, the Company
provided $400,000 to the provision for loan and lease losses to supplement its
Title I HUD reserves. For the year ended December 31, 1995, the provision for
loan and lease losses increased $171,000 or 5.5%, to $3.3 million from $3.1
million for the year ended December 31, 1994. This increase was 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 that, in Management's opinion,
were necessitated by the weakness in the Southern California economy and the
downturn in the real estate market. As of December 31, 1996 and 1995 the
allowance for loan and lease losses represented 1.73% and 1.80% 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, 1996, other income increased to $7.0
million from $6.6 million for 1995, an increase of $363,000 or 5.5%. This
increase was due primarily to an increase of $749,000 or 24.3% in service
charges on deposit accounts, essentially overdraft and non-sufficient fund fees,
a result of revisions to the Bank's policy regarding overdrawn accounts.
Servicing fees on sold loans also grew $250,000 to $747,000 in 1996 from
$497,000 in 1995. A decrease in gains on loan sales of $815,000, partially
offsetting the above increases, consisted of decreases related to the sales of
SBA loans of $297,000 and Title I loans of $1.0 million, offset by an increase
of $493,000 in gains on the sale of other equity loans. The decline in gains on
the sale of SBA and Title I loans is due to 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. During 1996, $8.3 million and $5.3 million of SBA
and Title I loans, respectively, were sold as compared to $14.1 million and
$32.5 million, respectively, in 1995. During 1996, the Company sold $15.0
million in other equity loans as compared to $595,000 in 1995.
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 during a period of low loan demand.
OTHER EXPENSE
Other expense increased $233,000 or 1.5% to $15.6 million in 1996 from
$15.3 million in 1995. The largest increases were $591,000, $213,000 and
$148,000 in salaries and employee benefits, branch losses, and expenses
associated with the collection effort on loans and other potential losses,
respectively. Regulatory assessments were decreased $389,000 primarily due to
an improvement in the Bank's risk-based assessment category. Decreases of
$178,000 and $103,000, respectively, were also experienced in expenses
associated with the maintenance of other real estate owned and occupancy.
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
45
<PAGE>
a decline in the carrying costs of other real estate owned of $256,000 due to
the lower volume of OREO during 1995.
INCOME TAXES
For 1996, the Company's provision for federal and state income taxes was
$2.1 million, reflecting an effective tax rate of 43.3% which was an increase
from an effective rate of 26.8% for 1995. The increase over 1995 was due to a
significant increase in pretax income for 1996, augmented by a decrease in the
valuation provision for deferred tax assets in 1995. There was no change in
1996 to the valuation provision for deferred tax assets which represent future
tax deductions. At December 31, 1996 and 1995, the Company's deferred tax
assets totaled $1.3 million and $1.4 million, respectively, before the
application of the valuation allowance. Management has analyzed the deferred
tax assets and determined that a valuation allowance of $225,000 at December 31,
1996 and 1995, was appropriate.
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 was due to a significant increase in pretax income,
offset by a decrease in the amount of valuation provision for deferred tax
assets. At December 31, 1995 and 1994 the Company's net deferred tax assets
totaled $1.4 million and $1.3 million, respectively, before application of the
valuation allowance which was $225,000 and $350,000, respectively.
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. A bank's liquidity
is normally considered in terms of the nature and mix of its 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 24.3% and 25.7% of the Company's total
assets at December 31, 1996 and 1995, respectively. Liquidity management also
includes the management of unfunded commitments to make loans and undisbursed
amounts under lines of credit. At December 31, 1996 these commitments totaled
$29.7 million in commercial loans, $1.9 million in letters of credit, $3.6
million in real estate construction loans, and $9.8 million in installment and
consumer loans. 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 installment and consumer loans. Average
Federal funds sold were $7.6 million in 1996 and $7.7 million in 1995.
The Bank also has several secondary sources of liquidity. Many of the
Bank's real estate construction, mortgage, Title I, equity 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 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 and may borrow funds from the
Federal Home Loan Bank and at the Federal Reserve discount window subject to the
Bank's ability to supply collateral. Average Federal funds purchased were
$74,000 and $506,000 in 1996 and 1995, 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
46
<PAGE>
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, 1996 and 1995, approximately 56.2% and 64.9%, respectively, of the
Company's total loans and 51.9% and 61.7%, 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 1996 and in 1995)
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,
1996, 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 . . . . . . . $ 3,008 $ 165 $ 308 $ 3,481
Commercial, financial and
agricultural loans . . . . . . . . . . . . 25,654 23,555 32,483 81,692
------- ------- ------- -------
Total . . . . . . . . . . . . . . . . . $28,662 $23,720 $32,791 $85,173
------- ------- ------- -------
------- ------- ------- -------
</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. . . . . . . . . . . . $11,239 $ 3,199 $14,438
With floating rate interest . . . . . . . . . . 12,481 29,592 42,073
------- ------- -------
Total. . . . . . . . . . . . . . . . . . . . $23,720 $32,791 $56,511
------- ------- -------
------- ------- -------
</TABLE>
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 table on the following page sets forth the rate-sensitivity of the
Company's interest-earning assets and interest-bearing liabilities as of
December 31, 1996, 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.
47
<PAGE>
<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 . . . . . . . . . . $ 57,820 $ 34,165 $ 9,459 $58,932 $20,034 $180,410
Investment securities. . . 6,616 669 1,799 18,146 7,231 34,461
Federal funds sold . . . . 2,200 -- -- -- -- 2,200
Interest-bearing deposits. -- -- -- -- -- --
-------- -------- -------- ------- ------- --------
Total. . . . . . . . . . 66,636 34,834 11,258 77,078 27,265 217,071
INTEREST-BEARING LIABILITIES:
Interest-bearing demand
deposits . . . . . . . . 35,631 -- -- -- -- 35,631
Savings deposits . . . . . 72,237 -- -- -- -- 72,237
Time deposits. . . . . . . 19,268 7,615 8,110 2,491 55 37,539
Borrowed funds . . . . . . 2,419 44 90 1,373 1,963 5,889
-------- -------- -------- ------- ------- --------
Total. . . . . . . . . . 129,555 7,659 8,200 3,864 2,018 151,296
Interest rate-sensitivity gap (62,919) 27,175 3,058 73,214 25,247 $ 65,775
Cumulative interest rate
sensitivity gap. . . . . . $(62,919) $(35,744) $(32,686) $40,528 $65,775
Interest rate-sensitivity
gap ratio. . . . . . . . . .51x 4.55x 1.37x 19.95x 13.51x 1.43x
Cumulative interest rate
sensitivity gap ratio. . . .51x .74x .78x 1.27x 1.43x
</TABLE>
As of December 31, 1996, the Company was liability-sensitive within one
year and asset-sensitive beyond one year. Liability sensitive 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 sensitive 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 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 noninterest 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 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 ( the
difference between variable rate assets and variable rate liabilities). The
Company attempts to structure
48
<PAGE>
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 57 of this
report.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
49
<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 1997 Annual Meeting of Shareholders
which the Company intends to file with the Commission within 120 days after the
close of the Company's 1996 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.
50
<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 57
Report of Independent Accountants
Consolidated Balance Sheet - December 31, 1996 and 1995
Consolidated Statement of Income - Years ended December 31, 1996 and
1995
Consolidated Statement of Stockholders' Equity - Years ended December
31, 1996 and 1995
Consolidated Statement of Cash Flows - Years ended December 31, 1996
and 1995
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 53 through 56 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, 1996
51
<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 19, 1997 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.
Signature Title Date
- --------- ----- ----
/s/ Alan P. Chamberlain Director March 19, 1997
- ----------------------------
Alan P. Chamberlain
/s/ G. Bruce Dunn Director March 19, 1997
- ----------------------------
G. Bruce Dunn
/s/ Michael J. Gilligan Vice President and Chief March 19, 1997
- ---------------------------- Financial Officer
Michael J. Gilligan
/s/ Ronald K. Goode Director March 19, 1997
- ----------------------------
Ronald K. Goode
/s/ James M. Gregg Chairman of the Board and March 19, 1997
- ---------------------------- Chief Executive Officer
James M. Gregg
/s/ Rodney D. Jones President and Director March 19, 1997
- ----------------------------
Rodney D. Jones
/s/ Jack Port Director March 19, 1997
- ----------------------------
Jack Port
/s/ Clarence R. Smith Director March 19, 1997
- ----------------------------
Clarence R. Smith
/s/ Raymond V. Stone Director March 19, 1997
- ----------------------------
Raymond V. Stone
/s/ Burnet F. Wohlford Director March 19, 1997
- ----------------------------
Burnet F. Wohlford
52
<PAGE>
INDEX TO EXHIBITS
EXHIBIT TABLE PAGE NUMBER IN
REFERENCE SEQUENTIAL
NUMBER NUMBERING
- ------------- ITEM SYSTEM
---- --------------
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)
- --------------------
Footnotes on page 56
53
<PAGE>
EXHIBIT TABLE PAGE NUMBER IN
REFERENCE SEQUENTIAL
NUMBER NUMBERING
- ------------- ITEM SYSTEM
---- --------------
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)
- --------------------
Footnotes on page 56
54
<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)
10.18 Deferred Compensation and Stock Purchase
Agreement between Rodney D. Jones and North
County Bank, dated December 31, 1996.
22 Subsidiaries of North County Bancorp
24 Consent of Price Waterhouse
- ---------------------------
Footnotes on following page
55
<PAGE>
- -----------------------------
Footnotes from following page
(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.
56
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders and Board of Directors
of North County Bancorp
In our opinion, the accompanying consolidated balance sheets and and the related
consolidated statements of income, of 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, 1996 and 1995, 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
February 19, 1997
See accomanying notes to financial statements.
57
<PAGE>
NORTH COUNTY BANCORP
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
December 31,
-------------------------------
1996 1995
------------ ------------
<S> <C> <C>
ASSETS
Cash and cash equivalents:
Cash and due from banks $ 25,936,000 $ 24,233,000
Federal funds sold 2,200,000 10,500,000
------------ ------------
28,136,000 34,733,000
Investment securities:
Available for sale 23,117,000 18,250,000
Held to maturity 11,344,000 7,922,000
Loans 180,410,000 161,950,000
Less: Allowance for loan and lease losses 3,129,000 2,916,000
------------ ------------
177,281,000 159,034,000
Other real estate owned 2,756,000 2,402,000
Premises and equipment, net 8,710,000 9,526,000
Accrued interest receivable and other assets 5,962,000 5,167,000
------------ ------------
$257,306,000 $237,034,000
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Noninterest-bearing $ 83,937,000 $ 70,728,000
Interest-bearing 145,407,000 143,108,000
------------ ------------
229,344,000 213,836,000
Accrued expenses and other liabilities 1,901,000 1,788,000
U. S. Treasury demand note 2,376,000 543,000
Notes payable 1,550,000 1,500,000
Capital lease obligation 429,000 462,000
Convertible subordinated debentures 1,534,000 1,678,000
------------ ------------
Total liabilities 237,134,000 219,807,000
------------ ------------
Stockholders' equity:
Common stock, no par value; authorized
5,000,000 shares; outstanding shares 2,003,193
in 1996 and 1,789,779 in 1995 11,758,000 9,156,000
Retained earnings 8,500,000 8,164,000
Unrealized loss on available for sale securities (86,000) (93,000)
------------ ------------
Total stockholders' equity 20,172,000 17,227,000
------------ ------------
Commitments and contingencies (Notes 8 and 16) ------------ ------------
$257,306,000 $237,034,000
------------ ------------
------------ ------------
</TABLE>
See accompanying notes to consolidated financial statements.
58
<PAGE>
NORTH COUNTY BANCORP
CONSOLIDATED STATEMENT OF INCOME
<TABLE>
<CAPTION>
December 31,
-------------------------------
1996 1995
------------ ------------
<S> <C> <C>
Interest income:
Interest and fees on loans $17,764,000 $17,527,000
Investment securities:
Taxable 1,510,000 1,115,000
Exempt from Federal income taxes 98,000 33,000
Dividends 83,000 179,000
Federal funds sold 385,000 429,000
Deposits with other financial institutions --- 3,000
----------- -----------
Total interest income 19,840,000 19,286,000
----------- -----------
Interest expense:
Deposits 4,695,000 4,736,000
Federal funds purchased 4,000 33,000
U. S. Treasury demand note 68,000 51,000
Other borrowings 345,000 344,000
----------- -----------
Total interest expense 5,112,000 5,164,000
----------- -----------
Net interest income 14,728,000 14,122,000
Provision for loan and lease losses 1,300,000 3,306,000
----------- -----------
Net interest income after
provision for loan and lease losses 13,428,000 10,816,000
Other income 6,975,000 6,612,000
Other expense 15,567,000 15,334,000
----------- -----------
Income before income taxes 4,836,000 2,094,000
Provision for income taxes 2,092,000 562,000
----------- -----------
Net income $ 2,744,000 $ 1,532,000
----------- -----------
----------- -----------
Earnings per share:
Primary $ 1.36 $ .85
----------- -----------
----------- -----------
Fully diluted $ 1.26 $ .80
----------- -----------
----------- -----------
Pro forma earnings per share:
(Notes 1and 17)
Primary $ 0.68 $ 0.42
----------- -----------
----------- -----------
Fully diluted $ 0.63 $ 0.40
----------- -----------
----------- -----------
</TABLE>
See accompanying notes to consolidated financial statements.
59
<PAGE>
NORTH COUNTY BANCORP
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Common Stock
------------------------- Unrealized Loss Total
Shares Amount Retained Earnings on Securities Stockholders' Equity
---------- ------------ ----------------- --------------- --------------------
<S> <C> <C> <C> <C> <C>
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 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
Five percent stock dividend including cash for
fractional shares declared February 21, 1996,
payable on March 29, 1996, to stockholders
as of March 1, 1996 89,288 759,000 (761,000) (2,000)
Five percent stock dividend including cash for
fractional shares declared January 23, 1997,
payable on February 28, 1997, to stockholders
of record as of January 31, 1997 95,140 1,642,000 (1,647,000) (5,000)
Exercise of stock options 10,628 68,000 68,000
Conversion of debentures 18,358 133,000 133,000
Decrease in unrealized loss on available
for sale securities 7,000 7,000
Net income 2,744,000 2,744,000
--------- ----------- ----------- --------- -----------
Balance at December 31, 1996 2,003,193 $11,758,000 $ 8,500,000 $ (86,000) $20,172,000
--------- ----------- ----------- --------- -----------
--------- ----------- ----------- --------- -----------
</TABLE>
See accompanying notes to consolidated financial statements.
60
<PAGE>
NORTH COUNTY BANCORP
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
December 31,
-------------------------------
1996 1995
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 2,744,000 $ 1,532,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization of:
Premises and equipment 1,348,000 1,471,000
Deferred loan fees and costs, net (418,000) (495,000)
Investment premiums and discounts, net 103,000 50,000
Loan servicing rights 214,000 320,000
Other 50,000 50,000
Provision for loan and lease losses 1,300,000 3,306,000
(Increase) decrease in interest receivable (204,000) 173,000
(Decrease) increase in taxes payable (41,000) 136,000
Increase in accrued expenses 361,000 251,000
(Decrease) increase in interest payable (114,000) 192,000
Decrease in loan sales receivable --- 1,282,000
Other, net (1,012,000) 754,000
------------ ------------
Net cash provided by operating activities 4,331,000 9,022,000
------------ ------------
Cash flows from investing activities:
Proceeds from maturities of investment securities 11,070,000 12,103,000
Proceeds from sale of available for sale securities 2,535,000 5,150,000
Purchases of investment securities (22,020,000) (16,325,000)
Net (increase) decrease in loans (22,217,000) 1,129,000
Purchase of premises and equipment (532,000) (612,000)
Proceeds from sale of other real estate owned 2,826,000 3,292,000
------------ ------------
Net cash (used in) provided by investing activities (28,338,000) 4,737,000
------------ ------------
Cash flows from financing activities:
Cash payments on capital lease obligations (32,000) (29,000)
Net increase (decrease) in deposits 15,508,000 (12,266,000)
Net increase (decrease) in U.S. Treasury demand note 1,833,000 (1,560,000)
Net decrease in other borrowings (94,000) ---
Cash proceeds from sale of common stock 195,000 1,776,000
------------ ------------
Net cash provided by (used in) financing activities 17,410,000 (12,079,000)
------------ ------------
Net (decrease) increase in cash and cash equivalents (6,597,000) 1,680,000
Cash and cash equivalents at beginning of year 34,733,000 33,053,000
------------ ------------
Cash and cash equivalents at end of year $ 28,136,000 $ 34,733,000
------------ ------------
------------ ------------
Supplemental disclosure of cash flow information:
Total interest paid $ 5,226,000 $ 4,972,000
Total income taxes paid $ 2,374,000 $ 793,000
Real estate acquired through foreclosure $ 3,088,000 $ 2,668,000
</TABLE>
See accompanying notes to consolidated financial statements.
61
<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 accepted 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.
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.
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
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 home equity loans and Federal Home Administration Title I
loans to secondary market investors. Gains or losses on the sale of these loans
are recognized upon sale as the difference between the net sales
62
<PAGE>
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.
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 future 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 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
2,014,909 and 1,804,765 in 1996 and 1995, respectively. Such shares have been
adjusted retroactively for stock dividends. The calculation of fully diluted
earnings per share assumes the issuance of 224,933 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 2,255,925
and 2,040,421 in 1996 and 1995, respectively.
Pro forma earnings per share reflects the effect of a two for one stock split
declared February 19, 1997. (See Note 17 - Subsequent Events.) The weighted
average number of shares used for primary earnings per share was 4,029,818 and
3,609,530 in 1996 and 1995, respectively. The calculation of fully diluted
earnings per share assumes the issuance of 449,866 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 4,511,850
and 4,080,842 in 1996 and 1995, respectively.
NOTE 2 - REGULATORY CAPITAL:
The Federal Reserve Bank (the FRB) and the Federal Deposit Insurance Corporation
(FDIC) have adopted substantially similar capital adequacy guidelines to which
the Company and the Bank, respectively, are subject. Those 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. Failure to meet
minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by the regulators that, if undertaken, could
have a direct material effect on the Company's financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action as administered by the FDIC, the Bank must meet specific
capital requirements that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance sheet items as calculated under regulatory
accounting practices. Based upon this framework, a bank's capitalization is
defined as well capitalized, adequately capitalized, undercapitalized,
significantly
63
<PAGE>
NORTH COUNTY BANCORP
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
undercapitalized or critically undercapitalized. The Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators
regarding components, risk weightings, and other factors. The FRB, as the
regulatory body of the Company, has issued minimum capital ratio requirements
for all bank holding companies under the its Capital Adequacy Guidelines.
Quantitative measures established by regulation require the Company and the Bank
to maintain minimum amounts and ratios of Tier 1 and total capital to
risk-weighted assets and of Tier 1 capital to average assets as set forth in the
table below. The Company and the Bank meet all minimum capital adequacy
requirements to which they are subject at December 31, 1996.
At December 31, 1996, the most recent notification from the FDIC categorized the
Bank as well capitalized under the regulatory framework for prompt corrective
action. To be categorized as well capitalized the Bank must maintain minimum
Tier 1 risk-based, total risk-based and Tier 1 leverage capital ratios as set
forth in the table. There are no conditions or events since that notification
that management believes have changed the institution's category.
The Company's and the Bank's actual capital amounts and ratios as of December
31, 1996 are also presented in the table.
<TABLE>
<CAPTION>
Well Capitalized
Actual Requirement Minimum Required
-------------------------- -------------------------- --------------------------
Amount Ratio Amount Ratio Amount Ratio
------------ ----- ---------- ----- ----------- -----
<S> <C> <C> <C> <C> <C> <C>
North County Bancorp:
Risk-based capital
Tier 1 $19,907,000 9.94% --- --- $ 8,011,000 4.00%
Total 23,953,000 11.96% --- --- 16,023,000 8.00%
Tier 1 leverage capital 19,907,000 7.70% --- --- 10,340,000 4.00%
North County Bank:
Risk-based capital
Tier 1 22,528,000 11.28% $11,987,000 6.00% 7,992,000 4.00%
Total 25,034,000 12.53% 19,979,000 10.00% 15,983,000 8.00%
Tier 1 leverage capital 22,528,000 8.74% 12,893,000 5.00% 10,314,000 4.00%
</TABLE>
As a result of the December 1995 FDIC examination of the Bank, the Order to
Cease and Desist which was entered into in May of 1995 between the FDIC and the
Bank was terminated in May of 1996.
64
<PAGE>
NORTH COUNTY BANCORP
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
NOTE 3 - INVESTMENT SECURITIES:
The amortized cost and market value of investment securities as of December 31,
1996 and 1995 are as follows:
Available for sale at December 31, 1996:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
----------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
U. S. Government and
Federal agencies $ 9,539,000 $10,000 $ (26,000) $ 9,523,000
States and municipalities 2,134,000 8,000 --- 2,142,000
Mortgage-backed 7,387,000 28,000 (53,000) 7,362,000
Equity securities 4,213,000 -- (123,000) 4,090,000
----------- ------- --------- -----------
$23,273,000 $46,000 $(202,000) $23,117,000
----------- ------- --------- -----------
----------- ------- --------- -----------
Held to maturity at December 31, 1996:
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
----------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
U. S. Government and
Federal agencies $ 6,421,000 $17,000 $(29,000) $ 6,409,000
States and municipalities 1,751,000 10,000 (6,000) 1,755,000
Mortgage-backed 3,172,000 9,000 (13,000) 3,168,000
----------- ------- -------- -----------
$11,344,000 $36,000 $(48,000) $11,332,000
----------- ------- -------- -----------
----------- ------- -------- -----------
Available for sale at December 31, 1995:
<CAPTION>
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
----------- ------- --------- -----------
----------- ------- --------- -----------
Held to maturity at December 31, 1995:
<CAPTION>
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>
Investment securities with a carrying value of $12,466,000 and $6,501,000 at
December 31, 1996 and 1995, respectively, were pledged to secure public deposits
as well as for other purposes required by law. Sales of available for sale
securities during 1996 resulted in gross gains and losses of $2,000 and $26,000,
respectively, and resulted in net taxes of $9,000. 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.
65
<PAGE>
NORTH COUNTY BANCORP
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
The following tables summarize the maturity distribution of debt securities
based on final maturity at December 31, 1996 and 1995:
<TABLE>
<CAPTION>
Available for Sale Held to Maturity
-------------------------- --------------------------
December 31, 1996: Amortized Estimated Amortized Estimated
Cost Market Value Cost Market Value
----------- ------------ ----------- ------------
<S> <C> <C> <C> <C>
Within one year $ 1,591,000 $1,595,000 $ 2,177,000 $ 2,184,000
After one but within five years 9,678,000 9,673,000 5,918,000 5,904,000
After five but within ten years 404,000 397,000 77,000 77,000
After ten years --- --- --- ---
Mortgage-backed securities 7,387,000 7,362,000 3,172,000 3,167,000
----------- ----------- ----------- -----------
$19,060,000 $19,027,000 $11,344,000 $11,332,000
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
<CAPTION>
Available for Sale Held to Maturity
-------------------------- --------------------------
December 31, 1996: Amortized Estimated Amortized Estimated
Cost Market Value Cost Market Value
----------- ------------ ----------- ------------
<S> <C> <C> <C> <C>
Within one year $ 2,077,000 $ 2,074,000 $1,250,000 $1,253,000
After one but within five years 8,845,000 8,825,000 6,258,000 6,284,000
After five but within ten years 103,000 105,000 76,000 77,000
After ten years 1,118,000 1,120,000 --- ---
Mortgage-backed securities 3,000,000 3,014,000 338,000 338,000
----------- ----------- ---------- ----------
$15,143,000 $15,138,000 $7,922,000 $7,952,000
----------- ----------- ---------- ----------
----------- ----------- ---------- ----------
</TABLE>
NOTE 4 - LOANS:
Loans at December 31 are summarized as follows:
<TABLE>
<CAPTION>
1996 1995
------------ ------------
<S> <C> <C>
Commercial, financial and agricultural $ 81,692,000 $ 74,755,000
Installment and consumer 53,815,000 46,748,000
Real estate mortgage 38,352,000 26,870,000
Real estate construction 3,481,000 9,212,000
Lease financing receivables 2,329,000 3,586,000
Other 741,000 779,000
------------ ------------
$180,410,000 $161,950,000
------------ ------------
------------ ------------
A summary of the changes in the allowance for loan and lease losses is as follows:
<CAPTION>
1996 1995
----------- -----------
<S> <C> <C>
Balance at beginning of year $ 2,916,000 $ 2,739,000
Provision charged to operating expense 1,300,000 3,306,000
Recoveries on loans previously charged off 333,000 115,000
Loans charged off (1,420,000) (3,244,000)
----------- -----------
Balance at end of year $ 3,129,000 $ 2,916,000
----------- -----------
----------- -----------
</TABLE>
At December 31, 1996 and 1995, loans on a nonaccrual basis were $3,541,000 and
$5,290,000, respectively. Interest income collected relating to nonaccrual
loans was $84,000 and $208,000 for the years ended December 31, 1996 and
66
<PAGE>
NORTH COUNTY BANCORP
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
1995. Additional interest income of $327,000 and $489,000 would have been
recorded during 1996 and 1995, respectively, if the loans had been paid in
accordance with their original terms.
Impaired loans are measured at the present value of expected future cash flows
discounted at the loan's effective rate, or as a practical expedient, at the
loan's observable market price or the fair value of the collateral if the loan
is collateral dependent. A loan is impaired when, based on current information
and events, it is probable that the Company will be unable to collect all
amounts due (principal and interest) according to the contractual terms.
The Company's recorded investment in impaired loans at December 31, 1996 and
1995, was $2,271,000 and $4,160,000, respectively. Reserves for loan losses of
$342,000 and $423,000 were established for impaired loans at December 31, 1996
and 1995, respectively. The average recorded investments in impaired loans
during 1996 and 1995 were $3,602,000 and $4,387,000, respectively. Interest
income on impaired loans of $49,000 and $173,000 was recognized for cash
payments received in 1996 and 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
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:
1996 1995
----------- -----------
Commercial loans $29,677,000 $24,596,000
Installment and consumer loans 9,832,000 9,085,000
Real estate construction loans 3,641,000 6,036,000
Letters of credit 1,944,000 2,600,000
----------- -----------
$45,094,000 $42,317,000
----------- -----------
----------- -----------
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.
67
<PAGE>
NORTH COUNTY BANCORP
--------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
------------------------------------------------------
NOTE 5 - PREMISES AND EQUIPMENT:
Premises and equipment at December 31 are as follows:
1996 1995
----------- -----------
Land $ 2,068,000 $ 2,068,000
Building and improvements 7,407,000 7,389,000
Furniture, fixtures and equipment 8,097,000 7,737,000
----------- -----------
17,572,000 17,194,000
Less: Accumulated depreciation and amortization 8,862,000 7,668,000
----------- -----------
$ 8,710,000 $ 9,526,000
----------- -----------
----------- -----------
Building and improvements include a capitalized lease on the main branch
premises of $580,000, less accumulated amortization of $401,000, as of December
31, 1996 (see Note 8). Amortization on this capital lease was $20,000 in both
1996 and 1995.
NOTE 6 - DEPOSITS:
Deposits at December 31 are summarized as follows:
1996 1995
------------ ------------
Noninterest-bearing demand $ 83,937,000 $ 70,728,000
Interest-bearing demand 35,631,000 35,119,000
Savings 72,237,000 74,216,000
Time deposits of $100,000 or more 9,227,000 7,022,000
Time deposits of less than $100,000 28,312,000 26,751,000
------------ ------------
$229,344,000 $213,836,000
------------ ------------
------------ ------------
The following table summarizes the maturity distribution of time deposits of
$100,000 or more at December 31:
1996 1995
---------- ----------
Three months or less $5,076,000 $4,919,000
Over three months through six months 1,978,000 658,000
Over six months through one year 1,973,000 1,445,000
Over one year through three years 200,000 ---
---------- ----------
$9,227,000 $7,022,000
---------- ----------
---------- ----------
NOTE 7 - NOTES PAYABLE AND CONVERTIBLE SUBORDINATED DEBENTURES:
Notes payable at December 31, 1996, included $1,232,000 and $318,000 outstanding
under two term notes with a current and a former director of the Company. Both
notes are unsecured and carry a fixed interest rate of 8.00%. Terms on the
$1,232,000 note call for interest to be compounded quarterly commencing April 1,
1996, with final payment on
68
<PAGE>
NORTH COUNTY BANCORP
--------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
------------------------------------------------------
January 1, 1999 for principal and interest in full. Terms for the $318,000 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 of which $1,534,000
are outstanding at December 31, 1996. 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 $7.47 per share,
subject to adjustment for stock splits, stock dividends or certain other events.
During 1996, debentures that totaled $144,000 were converted at the option of
the holders. The debentures are redeemable in whole or in part at the option of
the Company at declining redemption prices that range from 103.25% at December
31, 1996 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.
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, 1996:
Capital Operating
Lease Leases
----------- ----------
1997 $ 214,000 $ 318,000
1998 214,000 315,000
1999 214,000 321,000
2000 214,000 327,000
2001 214,000 333,000
Thereafter 913,000 1,101,000
----------- ----------
Total minimum lease payments 1,983,000 $2,715,000
----------
----------
Amounts representing interest (457,000)
Cost escalation (1,097,000)
-----------
Present value of net minimum lease payments $ 429,000
-----------
-----------
The amount of future lease payments is contingent upon normal cost escalation
clauses. Rent expense on the operating leases was $319,000 in 1996 and $312,000
in 1995.
69
<PAGE>
NORTH COUNTY BANCORP
--------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
------------------------------------------------------
NOTE 9 - FAIR VALUES OF FINANCIAL INSTRUMENTS:
The carrying amount and estimated fair value of the Company's financial
instruments as of December 31, 1996 are as follows:
Carrying Fair
Amount Value
------------ ------------
Financial assets:
Cash and due from banks $ 25,936,000 $ 25,936,000
Federal funds sold 2,200,000 2,200,000
Investment securities 34,461,000 34,449,000
Loans 180,410,000 181,658,000
Financial liabilities:
Deposits $229,344,000 $229,349,000
U.S. Treasury demand note 2,376,000 2,376,000
Note Payable 1,550,000 1,550,000
Convertible subordinated debentures 1,534,000 1,534,000
The following methods and assumptions were used to estimate the fair value of
each material class of financial instruments at December 31, 1996:
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 equal to the rate at which
similar loans would be made to borrowers with similar credit ratings and for
similar maturities. 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.
Title I and SBA loans were valued based on quoted market prices.
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 fair value of U.S. Treasury demand note is
estimated to approximate carrying value.
NOTES PAYABLE The fair value of notes 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 to approximate carrying value.
70
<PAGE>
NORTH COUNTY BANCORP
--------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
------------------------------------------------------
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.
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:
1996 1995
---------- ----------
Service charges on deposits $3,827,000 $3,078,000
Gain on sale of loans 1,425,000 2,240,000
Loan servicing fees 747,000 497,000
Fees on sold loans 119,000 192,000
Escrow fees 86,000 90,000
Other 771,000 515,000
---------- ----------
$6,975,000 $6,612,000
---------- ----------
---------- ----------
Other expense consists of:
1996 1995
----------- -----------
Salaries and employee benefits $ 8,136,000 $ 7,545,000
Occupancy expense 3,095,000 3,198,000
Telephone and postage 645,000 582,000
Other real estate owned 614,000 792,000
Advertising and public relations 524,000 447,000
Branch losses 323,000 110,000
Collection expense 321,000 173,000
Professional services 315,000 270,000
Printing, stationery and supplies 275,000 322,000
Regulatory assessments 228,000 617,000
Other 1,091,000 1,278,000
----------- -----------
$15,567,000 $15,334,000
----------- -----------
----------- -----------
71
<PAGE>
NORTH COUNTY BANCORP
--------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
------------------------------------------------------
NOTE 11 - INCOME TAXES:
The provision for income taxes consists of the following:
1996 1995
---------- --------
Current taxes:
Federal $1,393,000 $741,000
State 611,000 202,000
---------- --------
2,004,000 943,000
Deferred taxes:
Federal 122,000 (384,000)
State (34,000) 3,000
---------- --------
88,000 (381,000)
---------- --------
$2,092,000 $562,000
---------- --------
---------- --------
Deferred tax (assets) liabilities are comprised of the following:
1996 1995
----------- ------------
Writedown of other real estate owned $ (545,000) $ (726,000)
Provision for loan and lease losses (526,000) (521,000)
Loan fees deferred (405,000) (387,000)
Deferred compensation (177,000) (141,000)
Capital lease amortization (113,000) (119,000)
Securities held for sale (67,000) (116,000)
Unrealized loss on securities (71,000) (76,000)
----------- -----------
Gross deferred tax assets (1,904,000) (2,086,000)
----------- -----------
Depreciation 361,000 466,000
Loan origination cost capitalized 95,000 80,000
Loan servicing rights 24,000 33,000
Other 94,000 84,000
----------- -----------
Gross deferred tax liabilities 574,000 663,000
----------- -----------
Deferred tax assets valuation allowance 225,000 225,000
----------- -----------
$(1,105,000) $(1,198,000)
----------- -----------
----------- -----------
72
<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:
1996 1995
---------- ----------
Federal tax at statutory rates $1,644,000 $ 711,000
State tax, net of Federal tax effect 381,000 157,000
Tax exempt income (83,000) (83,000)
Deferred valuation allowance --- (125,000)
Other 150,000 (98,000)
---------- ----------
$2,092,000 $ 562,000
---------- ----------
---------- ----------
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 284,613 shares of common stock at December 31,
1996. No compensation cost has been recognized for its employee stock option
grants, which are fixed in nature, as the options have been granted at a price
equal to the market value of the Company's common stock at the date of grant.
Had compensation cost for the Company's stock-based compensation plans been
determined based on the fair value at the grant date rather than market value
during the year ended December 31, 1996, the Company's net income and earnings
per share would have been reduced to the pro forma amounts indicated below. No
options were granted during 1995.
Earnings Per Share
-------------------------
Net Income Primary Fully Diluted
---------- ------- -------------
As reported $2,744,000 $1.36 $1.26
Pro forma 2,724,000 1.35 1.25
The fair value of each option grant has been estimated on the date of grant
using the following assumptions: a dividend yield of 0.0%; expected option life
of ten years; a risk-free interest rate of 6.60%; and a volatility factor of
20%.
73
<PAGE>
NORTH COUNTY BANCORP
--------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
------------------------------------------------------
A summary of transactions for the two years ended December 31, 1996, after
giving retroactive effect for stock dividends declared, is as follows:
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
--------------------------- ---------------------------
Weighted Average Weighted Average
Shares Exercise Price Shares Exercise Price
------ ---------------- ------ ----------------
<S> <C> <C> <C> <C>
Outstanding at beginning of year 189,707 $6.35 202,801 $6.36
Granted 50,715 7.71 --- ---
Exercised 11,247 6.10 13,094 6.64
Expired 18,130 6.23 --- ---
------- ----- ------- -----
Outstanding at end of year 211,045 $6.70 189,707 $6.35
------- ----- ------- -----
------- ----- ------- -----
Options exercisable at end of year
and weighted average exercise price 87,022 $6.42 81,071 $6.39
Weighted average fair value per share of
options granted during the year $5.32
</TABLE>
At December 31, 1996, the Company had outstanding options to purchase 211,045
shares of common stock at exercise prices that ranged from $5.23 to $7.71 per
share with a weighted average exercise price of $6.70 per share. The
outstanding options have a weighted average remaining contractual life of 5.46
years.
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 contributed
$150,000 in 1996 and made no contribution to the ESOP in 1995. The ESOP has
purchased $684,000 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 six months 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 six
months of service and who elect to contribute under the plan. The Company
contributed $94,000 to the plan in 1996 and $89,000 in 1995.
74
<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 BALANCE SHEET
December 31,
---------------------------------
1996 1995
----------- -----------
ASSETS
Cash $ 301,000 $ 650,000
Investment securities 145,000 ---
Investment in subsidiary 22,808,000 19,841,000
Premises and equipment, net 180,000 199,000
Other assets 340,000 254,000
----------- -----------
$23,774,000 $20,944,000
----------- -----------
----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Accrued expenses and other liabilities $ 89,000 $ 77,000
Notes payable 1,550,000 1,500,000
Capital lease obligation 429,000 462,000
Convertible subordinated debentures 1,534,000 1,678,000
----------- -----------
3,602,000 3,717,000
----------- -----------
Stockholders' equity
Common stock, no par value 11,758,000 9,156,000
Retained earnings 8,414,000 8,071,000
----------- -----------
Total stockholders' equity 20,172,000 17,227,000
----------- -----------
$23,774,000 $20,944,000
----------- -----------
----------- -----------
CONDENSED STATEMENT OF INCOME
Years Ended December 31,
--------------------------------
1996 1995
---------- ----------
Interest income $ 4,000 $ ---
Other income 261,000 247,000
---------- ----------
Total income 265,000 247,000
Interest expense 345,000 344,000
Other operating expense 282,000 439,000
---------- ----------
Total expenses 627,000 783,000
Loss before income tax (362,000) (536,000)
Applicable income tax benefit 145,000 243,000
Equity in undistributed income of subsidiary 2,961,000 1,825,000
---------- ----------
Net income $2,744,000 $1,532,000
---------- ----------
---------- ----------
75
<PAGE>
NORTH COUNTY BANCORP
--------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
------------------------------------------------------
CONDENSED STATEMENT OF CASH FLOWS
Years Ended December 31,
--------------------------
1996 1995
---------- -----------
Cash flows from operating activities:
Net income $2,744,000 $1,532,000
Adjustments to reconcile net income to net
cash used in operating activities:
Depreciation and amortization 42,000 20,000
Equity in undistributed income of subsidiary (2,961,000) (1,825,000)
(Decrease) increase in accrued expenses (119,000) 83,000
Other, net 21,000 14,000
---------- -----------
Net cash flows used in operating activities (273,000) (176,000)
---------- -----------
Cash flows used in investing activities:
Purchase of investment securities (145,000) ---
Cash invested in subsidiary --- (1,000,000)
---------- -----------
Net cash used in investing activities (145,000) (1,000,000)
---------- -----------
Cash flows from financing activities:
Cash payments on capital lease obligations (32,000) (29,000)
Net increase in notes payable 50,000 ---
Net decrease in convertible subordinated debentures (144,000) ---
Issuance of common stock 195,000 1,776,000
---------- -----------
Net cash provided by financing activities 69,000 1,747,000
---------- -----------
Net (decrease) increase in cash and cash equivalents (349,000) 571,000
Cash and cash equivalents at beginning of year 650,000 79,000
---------- -----------
Cash and cash equivalents at end of year $ 301,000 $ 650,000
---------- -----------
---------- -----------
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 $617,000 and $971,000 at
December 31, 1996 and 1995, respectively. During 1996 new loans (including
drawdowns on revolving lines of credit and loan renewals) aggregated $456,000
and repayments (including payments on revolving lines of credit and loan
renewals) aggregated $359,000.
NOTE 16 - COMMITMENTS AND CONTINGENCIES:
At December 31, 1996, 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.
76
<PAGE>
NORTH COUNTY BANCORP
--------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
------------------------------------------------------
At December 31, 1996, 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 from the Federal Home Loan Bank and at the
Federal Reserve discount window, subject to the Company's ability to supply
collateral.
NOTE 17 - SUBSEQUENT EVENTS:
On February 19, 1997, the Company declared a two for one stock split to
stockholders effective March 14, 1997. This will result in the issuance of
2,003,193 shares of common stock.
77
<PAGE>
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------
EXHIBITS
TO
1996 FORM 10-KSB
Under
The Securities Exchange Act of 1934
--------------------
78
<PAGE>
EXHIBIT 10.18
-------------
<PAGE>
EXHIBIT 10.18
-------------
NORTH COUNTY BANK
SALARY CONTINUATION AGREEMENT
This Salary Continuation Agreement (the "Agreement") is entered into
effective the LSAT day of December, 1996, by and between North County Bank, a
California banking corporation, and Rod D. Jones, a full-time salaried officer
thereof (the "Participant"). The term "Bank" as used in this Agreement, shall
mean and include North County Bank, any bank holding company affiliate thereof
and any consolidated subsidiary corporations and successors.
1. GRANT OF SALARY CONTINUATION BENEFITS. Pursuant to the action of the
Board of Directors, the Bank hereby grants to the Participant the salary
continuation benefits set forth in subsections 1 (a) through (e) hereof. For
purposes of this Section 1, the Participant will be deemed to have been
"continuously employed" by the Bank if he has performed his duties as an
employee of the Bank on a full-time basis without any material break in
employment. A "material break in employment" shall be defined as (I) voluntary
termination by the Participant of his employment or termination by the Bank
without cause of the Participants employment for a period in excess of ninety
(90) consecutive days during any calendar year, (ii) termination by the Bank
with cause, or (iii) any other period of time totaling ninety (90) days during
any calendar year, during which time the Participant has ceased to perform his
duties as an employee of the Bank on a full-time basis; provided, however, that
a material break in employment shall not include any military leave, sick leave
or other bona fide leave of absence (to be determined by the Board of Directors)
of the Participant and, solely for purposes of calculating benefits under
Section 2 herein, a material break in employment also shall not include any
termination of the Participant as a result of total disability as described in
subsection 1 (e) herein. For purposes of determining the amount of benefits to
be paid to the Participant under this Agreement, commencing upon the effective
date of the Agreement, each twelve-month period in which the Participant has
been continuously employed by the Bank shall be deemed a "Full Year of
Employment With the Bank Completed."
(a) BENEFITS UPON RETIREMENT. The Bank shall pay to the Participant
an annual retirement benefit of Seventy Thousand Dollars ($70,000) per year for
fifteen (15) consecutive years. Such payments shall be made in one hundred
eighty (180) equal monthly installments commencing on the first business day of
the month following the Participant's retirement date (as set forth below) and
continuing on the first business day of each month thereafter until the
specified number of installments have been paid in full. The Bank shall have no
obligation under this subsection 1 (a), except as provided- in subsection 1 -C-
or (d) herein, if the Participant was not continuously employed (as defined
above) by the Bank during the period from the date of execution of this
Agreement until the Participant's retirement date set forth below. For purposes
of this Agreement, the Participant's retirement date shall be the first day of
the calendar month following the Participant's sixty-fifth (65th) birthday.
(b) BENEFIT UPON DEATH PRIOR TO RETIREMENT. In the event the Participant
dies prior to retirement while still employed by the Bank, the Bank shall pay to
the beneficiary designated by the Participant, the Participant's surviving
spouse, if any, or to the Personal Representative of the Participant's estate,
as the case may be (as more fully described in Section 6 hereof), an annual
death benefit of Seventy Thousand Dollars ($70,000) per year for fifteen (15)
consecutive years. Such death benefit shall be payable for fifteen (15)
consecutive years in one hundred eighty (180) equal monthly installments
commencing on the first business day of the month following the Participant's
death and continuing on the first business day of each month thereafter until
all of the specified number of installments have been paid in full.
(c) BENEFITS UPON TERMINATION OF EMPLOYMENT FOLLOWING A REORGANIZATION. In
the event the Bank or any successor corporation terminates the Participant's
employment following any Reorganization (as defined in Section 5 herein), the
Bank or such successor corporation shall pay to the Participant the full
retirement benefits granted by the Bank in subsection 1 (a) of this Agreement.
Such retirement payments shall be payable for fifteen (15) consecutive years
<PAGE>
in one hundred eighty (180) equal monthly installments commencing upon the first
business day of the month following the Participant's retirement date (as set
forth in subsection 1 (a) hereof) and continuing on the first business day of
each month thereafter until the specified number of installments have been paid
in full.
(d) BENEFITS UPON TERMINATION OF EMPLOYMENT BY THE BANK WITHOUT CAUSE. In
the event the Bank terminates the Participant's employment with the Bank without
cause, the Bank shall pay to the Participant a certain percentage of the
retirement benefits granted by the Bank in subsection 1 (a) of this Agreement.
Solely for the purpose of determining benefits to be paid hereunder, termination
"without cause" shall mean termination of the Participant's employment with the
Bank for any reason whatsoever; provided, however, that termination "without
cause" shall not include any termination of Participant's employment with the
Bank for "cause," or as a result of the Participant's voluntary termination of
his employment with the Bank, the Participant's death or total disability, or as
a result of any Reorganization (as defined in Section 5 herein). The annual
retirement benefit payable by the Bank to the Participant pursuant to this
subsection 1 (d) shall be equal to the amount which corresponds to the
percentage of such retirement benefits which have vested as determined by the
following vesting schedule:
FULL YEARS OF PERCENT OF AMOUNT OF
EMPLOYMENT RETIREMENT ANNUAL
WITH THE BANK BENEFITS RETIREMENT
COMPLETED VESTED BENEFIT
1 20.00% $14,000.00
2 40.00% $28,000.00
3 60.00% $42,000.00
4 80.00% $56,000.00
5 100.00% $70,000.00
Such retirement payments shall be payable by the Bank for fifteen (15)
consecutive years in one hundred eighty (180) equal monthly installments
commencing upon the first business day of the month following the Participant's
retirement date (as set forth in subsection 1 (a) hereof) and continuing on the
first business day of each month thereafter until the specified number of
installments have been paid in full.
(e) BENEFITS UPON TERMINATION OF EMPLOYMENT DUE TO TOTAL DISABILITY.
In the event the Participant's employment with the Bank is terminated due to
"total disability" (as defined herein), the Bank shall pay to the Participant an
annual retirement of $70,000 per year, minus any amounts payable to the
Participant under any other disability insurance or plan provided by the Bank.
Such retirement payments shall be payable by the Bank for fifteen (15)
consecutive years in one hundred eighty (180) equal monthly installments
commencing upon the first business day of the month following the Participant's
retirement date (as set forth in subsection 1 (a) hereof) with the Bank and
continuing on the first business day of each month thereafter until the
specified number of installments have been paid in full.
In the event the Participant has entered into a written employment
agreement with the Bank, then, solely for the purpose of determining benefits to
be paid under this Agreement, "total disability" shall have the same definition
as that set forth in such employment agreement. If the Participant has not
entered into a written employment agreement with the Bank (or if "total
disability" is not defined in such employment agreement), then, solely for the
purpose of determining benefits to be paid under this Agreement, "total
disability" shall be defined as the inability of the Participant to engage in
his regular duties as an employee of the Bank by reason of any medically
determined physical or mental impairment for a period of one hundred eighty
(180) consecutive days or more. If there should be a dispute between the Bank
and the Participant as to the Participant's physical or mental disability for
purposes of this Agreement, the question shall be settled by the opinion of an
impartial reputable physician or psychiatrist agreed upon by the parties or
their representatives, or if the parties cannot agree within ten (10) days after
a request for designation of such party,
<PAGE>
then by a physician or psychiatrist designated by the San Diego County Medical
Association. The certification of such physician or psychiatrist as to the
question in dispute shall be final and binding upon the Bank and the
Participant.
2. DEATH SUBSEQUENT TO RETIREMENT, DISABILITY OR OTHER TERMINATION OF
EMPLOYMENT . In the event the Participant dies subsequent to the retirement date
set forth in subsection 1 (a), or as contemplated by Section 4, or subsequent to
the date of his termination of employment by the Bank as a result of any
Reorganization of the Bank as described in subsection 1 -C- or the date of his
termination of employment by the Bank without cause, or termination of
employment due to total disability, as described in subsections 1 (d) and (e),
all of the retirement benefits (or the remaining retirement benefits, as the
case may be) which are due the Participant pursuant to subsections 1 (a),
(C)-(e), or Section 4-, as applicable, shall be payable by the Bank to the
beneficiary designated by the Participant on Exhibit A hereto, to the
Participant's surviving spouse, or to the Participant's estate, as the case may
be (as more fully described in Section 6 herein), in such installments and on
such dates as were payable to the Participant prior to his death. Except as set
forth in this Section 2, no other benefits shall be payable hereunder to the
Participant's beneficiaries, surviving spouse or estate in the event the
Participant dies subsequent to either his retirement date or the date of any
termination of his employment with the Bank.
3. VOLUNTARY TERMINATION OF EMPLOYMENT BY PARTICIPANT OR TERMINATION OF
EMPLOYMENT FOR CAUSE . In the event the Participant voluntarily terminates his
employment with the Bank, or in the event the Bank terminates the Participant's
employment with the Bank for "cause," the Bank shall have no obligation to pay
any benefits under this Agreement to such Participant or any beneficiary
thereof. However, the Board of Directors reserves the right, in its sole
discretion, in the case of voluntary termination of employment by the
Participant, to allow the Participant to receive the same benefits as would
apply in the event of termination by the Bank without cause (see Section 1 (d)
hereinabove). If the Participant has entered into a written employment
agreement with the Bank, then, solely for the purpose of determining benefits to
be paid under this Agreement, "cause" shall have the same definition as that set
forth in such employment agreement. If the Participant has not entered into a
written employment agreement with the Bank, then, solely for the purpose of
determining benefits to be paid under this Agreement, "cause" shall be defined
as: (I) failure to perform or habitual neglect of the duties which the
Participant is required to perform as an employee of the Bank, (ii) the
Participant's suspension or removal from office by the Federal Deposit Insurance
Corporation, the Superintendent of Banks of the State of California or any
other regulatory agency having appropriate jurisdiction, (iii) engagement in
illegal activity which materially adversely affects the Bank's reputation in the
community or which evidences the lack of the Participant's fitness or ability
to perform his duties as an employee of the Bank as determined by the Board of
Directors in good faith, or (iv) the commission by the Participant of any act
which would cause termination of coverage under the Bank's Bankers' Blanket Bond
as to the Participant (as distinguished from termination of coverage as to the
Bank as a whole).
Notwithstanding any other provision of this Agreement, termination of the
Participant's employment with the Bank as a result of such Participant's death
or "total disability (as defined herein) will not be deemed to be termination
for "cause" for the purpose of determining benefits to be paid hereunder.
4. LATE RETIREMENT. The Participant may apply to the Board of Directors for
a late retirement. The decision whether to accept or reject such an application
shall be in the sole discretion of the Board of Directors, and the Board shall
have no obligation whatsoever to accept any such application. In the event the
Board of Directors accepts the Participant's application for late retirement,
this Agreement shall be amended to reflect the revised terms of such
Participant's retirement date and amount of such retirement benefits. Such
revised benefits shall be payable by the Bank pursuant to this Section 4 only to
the extent that the Participant was continuously employed by the Bank during the
period from the date of execution of this Agreement until the date of such
Participant's revised retirement date. Retirement benefits under this Section 4
shall be payable in equal monthly installments for a period of fifteen (15)
consecutive years commencing on the first business day of the month following
the Participant's revised retirement date and continuing on the first business
day of each month thereafter for one hundred eighty (180) consecutive months
until all of the specified installments have been paid in full.
<PAGE>
5. REORGANIZATION. In the event of (I) a merger where the Bank is not the
surviving corporation, (ii) a consolidation, (iii) a transfer of all or
substantially all of the assets of the Bank, or (iv) any other transaction where
there is a change in ownership of at least fifty-one percent (51%) of all of the
outstanding voting stock of the Bank or its parent holding company (any of the
events described in subparagraphs (I) through (iv) above may be referred to in
this Agreement as a "Reorganization"), this Agreement shall not be terminated.
In the event of any Reorganization with the exception of a voluntary or
involuntary dissolution, the surviving or resulting corporation, or the
transferee of the Bank's assets or stock, whichever may apply, shall be bound by
and shall have the benefits of this Agreement. The Bank shall take all actions
necessary to ensure that such corporation or transferee is bound by the
provisions of this Agreement. In the event the employment of the Participant is
terminated at any time following a Reorganization, the Participant shall be
entitled to the full benefits hereunder as specified in subsection 1 (c) hereof.
6. BENEFICIARIES. The Participant may designate one or more ptimary or
contingent beneficiaries to receive all or any specified portion of any benefits
hereunder, at the time of the Participant's death remain payable by the Bank to
the Participant. The Participant may designate such beneficiaries on Exhibit A
attached hereto. The designation of any such beneficiaries may be changed or
revoked at any time prior to the Participant's death by giving the Bank three
(3) days written notice of such change or revocation in the manner provided in
Section 9 of this Agreement.
In the event the Participant shall fail to designate a beneficiary prior to
his death or designates a beneficiary and thereafter revokes such designation
without naming another beneficiary, or designates one or more beneficiaries and
all such beneficiaries so designated shall fail to survive the Participant, any
payments of benefits under this Agreement shall be made to the Participant's
surviving spouse, if any, or otherwise to the Personal Representative of the
Participant's estate.
Unless the Participant has otherwise specified in the beneficiary
designation, the beneficiary or beneficiaries designated by the Participant
shall become fixed as of the Participant's death so that, if a beneficiary
survives the Participant but dies prior to the receipt of all payments due such
beneficiary, such remaining payments shall be payable to the Personal
Representative of such beneficiary's estate.
The Participant and his beneficiaries shall not have any assignable
interest in the future payments due under this Agreement, nar any right to
anticipate, dispose of, pledge or enc|unber the same prior to actual receipt
thereof, nor shall the same be subject to attaclunent, garnislunent, or
execution following judgment or other legal process instituted by the
Participant's creditors or any such beneficiary; provided, however, that the
balance of the Participant's benefit payments shall at all times be subject to
offset for debts owed by the Participant to the Bank.
7. EFFECT ON EMPLOYMENT RIGHTS. Nothing in this Agreement shall be deemed
to give the Participant any right to remain in the employ of the Bank nor to
affect the right of the Bank to terminate the employment of the Participant at
any time, with or without cause, which right is hereby reserved. This Agreement
shall not be considered a supplement or amendment to any contract of employment,
either oral or written, between the Participant and the Bank.
8. LIMITATION ON THE BANK'S OBLIGATION TO FUND AGREEMENT. The Bank shall
have the right, but not an obligation, to earmark or segregate any funds or
other assets to be used for payment of any benefits hereunder, The Bank's
obligation to make payments hereunder is an unfunded and unsecured contractual
obligation only; and in the event any insurance company or other obligor issuing
a life insurance or annuity policy or other investment instrument purchased by
the Bank to fund this Agreement shall fail or be in imminent danger thereof, the
Bank shall have the right to take immediate action to recoup so much of its
investment as possible, and shall have no obligation to fund this Agreement or
portion thereof to the extent that this Agreement was intended to be funded by
the proceeds of such policy, annuity or other investment. Under no circumstances
shall the Participant or his beneficiaries have any beneficial or preferred
interest by way of trust, escrow, lien or otherwise, in any specific assets or
funds of the Bank, including any insurance or annuity contracts or the proceeds
therefrom, as described below. The Participant and his beneficiaries shall look
solely to the general credit of the Bank for satisfaction of any current or
future obligation due under this Agreement.
<PAGE>
No life insurance or annuity policy or other investment instrument
purchased by the Bank in connection with this Agreement shall in any way be
considered to be security for the performance of the Bank's obligations
hereunder. The Bank shall be the owner and beneficiary of such policy(ies) and
any such policy shall be, and remain, a general unpledged, unrestricted asset of
the Bank.
9. NOTICES. All notices or other communications required or permitted to be
given hereunder shall be in writing and shall be deemed to have been duly given,
upon personal delivery (professional courier acceptable) or three (3) business
days following deposit with the United States Postal Service, by registered or
certified mail, postage prepaid, with return receipt requested, to the following
addresses: (a) if to the Bank, to its principal place of business, and (b) if to
the Participant, to his address set forth on the signature page hereof. Such
persons or addresses may change from time to time by notice given pursuant to
the provisions of this Section.
10. GOVERNING LAW. This Agreement shall be governed by and construed in
accordance with the laws of the State of California.
11. TERMINATION OR MODIFICATION BY THE BANK. The Bank reserves the right to
terminate or modify this Agreement or the benefits payable hereunder in the
event of (I) any changes in federal tax laws which would limit the Bank's
available tax deductions in connection with the funding of this Agreement; or
(ii) any changes in applicable laws, regulations or regulatory policies which
would cause this Agreement to be legally impermissible or would subject the Bank
to criticism by a bank regulatory agency.
12. LEGAL AND TAX ADVICE. The Bank has not provided the Participant with
advice, warranties or representations regarding any of the legal or tax effects
to the Participant with respect to the grant of benefits herein. By accepting
this grant and by signing this Agreement, the Participant acknowledges that he
is familiar with the terms of this Agreement, that he has been encouraged by the
Bank to discuss this Agreement with his own legal and tax advisers, and that he
agrees to be bound by all of the terms and conditions of this Agreement.
NORTH COUNTY BANK, EMPLOYEE
A CALIFORNIA BANKING CORPORATION I
/s/ James M. Gregg /s/ Rod D. Jones
- ------------------ ----------------
Rod D. Jones
/s/ Michael J. Gilligan President and Chief Operating Officer
- -----------------------
Participant's Address:
44065 Highlander Dr.
--------------------
Temecula, CA 92592
------------------
<PAGE>
EXHIBIT 22
- ----------
<PAGE>
EXHIBIT 22
----------
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.
4. NCB Mortgage, a California corporation, is a subsidiary of North County
Bank.
<PAGE>
EXHIBIT 24
----------
<PAGE>
EXHIBIT 24
----------
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 February 19, 1997 appearing on page 57
of the Annual Report to Shareholders which is incorporated in this Annual Report
on Form 10-KSB.
PRICE WATERHOUSE LLP
San Diego, California
March 19, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY INFORMATION EXTRACTED FROM THE CONSOLIDATED
BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF INCOME FOUND ON PAGES 58 AND 59 OF
THE COMPANY'S 10-KSB FOR DECEMBER 31, 1996 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 25,936,000
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 2,200,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 23,117,000
<INVESTMENTS-CARRYING> 11,344,000
<INVESTMENTS-MARKET> 11,332,000
<LOANS> 180,410,000
<ALLOWANCE> 3,129,000
<TOTAL-ASSETS> 257,306,000
<DEPOSITS> 229,344,000
<SHORT-TERM> 2,376,000
<LIABILITIES-OTHER> 1,901,000
<LONG-TERM> 3,513,000
0
0
<COMMON> 11,758,000
<OTHER-SE> 8,414,000
<TOTAL-LIABILITIES-AND-EQUITY> 257,306,000
<INTEREST-LOAN> 17,764,000
<INTEREST-INVEST> 1,691,000
<INTEREST-OTHER> 385,000
<INTEREST-TOTAL> 19,840,000
<INTEREST-DEPOSIT> 4,695,000
<INTEREST-EXPENSE> 5,112,000
<INTEREST-INCOME-NET> 14,728,000
<LOAN-LOSSES> 1,300,000
<SECURITIES-GAINS> (24,000)
<EXPENSE-OTHER> 15,543,000
<INCOME-PRETAX> 4,836,000
<INCOME-PRE-EXTRAORDINARY> 2,744,000
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,744,000
<EPS-PRIMARY> 1.36
<EPS-DILUTED> 1.26
<YIELD-ACTUAL> 9.53
<LOANS-NON> 3,541,000
<LOANS-PAST> 0
<LOANS-TROUBLED> 5,405,000
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 2,916,000
<CHARGE-OFFS> 1,420,000
<RECOVERIES> 333,000
<ALLOWANCE-CLOSE> 3,129,000
<ALLOWANCE-DOMESTIC> 3,129,000
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
