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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
COMMISSION FILE NUMBER: 0-11223
PROFESSIONAL BANCORP, INC.
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 95-3701137
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
606 BROADWAY
SANTA MONICA, CALIFORNIA 90401
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (310) 458-1521
Securities registered pursuant to Section 12(b) of the Act:
COMMON STOCK $0.008 PAR VALUE AMERICAN STOCK EXCHANGE
(Title of Class) (Name of exchange on which registered)
Securities registered pursuant to Section 12(g) of the Act: None
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING
THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS
REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant as of March 17, 1997: $15,646,925.
The number of shares of $0.008 par value common stock outstanding as of March
17, 1997: 1,343,048.
DOCUMENTS INCORPORATED BY REFERENCE
PART III - Proxy Statement for Registrant's 1997 Annual Meeting of Shareholders
to be filed within 120 days of fiscal year-end.
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FORM 10-K
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TABLE OF CONTENTS AND CROSS REFERENCE SHEET
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Page
in Incorporation
10-K by Reference
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PART I
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Item 1. Business 3
-------
Item 2. Properties 13
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Item 3. Legal Proceedings 13
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Item 4. Submission of Matters to a Vote of Security Holders 14
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PART II
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Item 5. Market for Registrant's Common Equity
------- and Related Stockholder Matters 15
Item 6. Selected Financial Data 17
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Item 7. Management's Discussion and Analysis of Financial
------- Condition and Results of Operations 18
Item 8. Financial Statements and Supplementary Data 38
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Item 9. Changes in and Disagreements with Accountants on
------- Accounting and Financial Disclosure 38
PART III
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Item 10. Directors and Executive Officers of the Registrant 38 1997 Proxy
-------- Statement
Item 11. Director and Executive Officer Compensation 38 1997 Proxy
-------- Statement
Item 12. Security Ownership of Certain Beneficial Owners 38 1997 Proxy
-------- and Management Statement
Item 13. Certain Relationships and Related Transactions 38 1997 Proxy
-------- Statement
PART IV
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Item 14. Exhibits, financial Statement Schedules and
-------- Reports on Form 8-K 38
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES 42
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PART I
ITEM 1. BUSINESS
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HISTORY
Professional Bancorp, Inc. (the "Bancorp") is a bank holding company
engaged primarily in the commercial banking business through its wholly-owned
subsidiary, First Professional Bank, N.A. (the "Bank"). Bancorp was organized
under the laws of the State of California in July 1981 and reincorporated under
the laws of the Commonwealth of Pennsylvania in August 1989. Both Bancorp and
the Bank commenced operations in August 1982. On the commencement date, Bancorp
purchased all of the outstanding stock of the Bank from the proceeds of its
initial stock offering. Bancorp's principal asset is the stock of the Bank and,
as the Bank's sole shareholder, the primary function of Bancorp is to coordinate
the general strategy, policies and activities of the Bank and holding company as
appropriate.
PRINCIPAL MARKETING AREA AND CONCENTRATION
The principal service areas of the Bancorp and Bank (the "Company")
consists of the California counties of Los Angeles, Orange, Riverside, San
Bernardino and Ventura and limited business in Northern California with a
full-service office at its Santa Monica headquarters and four full-service
branches located in Beverly Hills, Tarzana, Pasadena and Redlands. In addition,
the Company has a limited service facility in Los Angeles at Cedars Sinai
Medical Center. The Company also develops business in the Northern California
counties surrounding the San Francisco East Bay Area and the City of Sacramento.
Other western states are serviced on a limited basis. Since inception, the
Company has operated an in-house courier service which permits the Company to
serve areas outside of each branch's immediate vicinity. Couriers are licensed
branches of the Company.
The Company directs its services towards the professional market place with
an emphasis on medical practitioners, as well as outpatient services companies.
Attorneys, accountants and other clientele compose the remainder of the
Company's market. There is no significant concentration of outstanding loans in
the control of a single person or group. One health care company maintained
deposit balances at December 31, 1996 of approximately $14,283,000 or 5.4% of
the Company's assets with several other health care companies maintaining
deposit balances of between 1% and 5% of the assets of the Company.
COMMERCIAL BANKING
The Company is engaged in the business of general commercial banking and
provides a wide range of commercial banking services primarily directed towards
the health care community. The services which are offered include those
traditionally offered by commercial banks, such as checking and savings
accounts, time certificates of deposit, and commercial, consumer/installment,
home equity and short-term real estate loans. The Company also offers cashier's
checks, travelers checks, safe deposit boxes, collection services, night deposit
facilities, wire transfers, notary services, contract collections, courier
services, mortgage banking, merchant accounts, on-line banking, TouchTone
Banking and five 24-hour automated teller machines which are located at the
Company's Santa Monica, Cedars Sinai Medical Center, Tarzana, Pasadena and
Redlands facilities.
COMPETITION
The Company faces competition in attracting both deposits and originating
loans. The Company's competition in loans comes principally from community
based, regional and national commercial banks, investment banks, asset based
finance companies, savings and loan associations, mortgage companies, and to a
lesser degree, thrift and loan companies, credit unions and insurance companies.
Many of the nation's
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largest commercial banks and savings and loan associations with which the
Company competes have significantly greater lending limits than the Company and
perform other services for their customers which the Company can offer only
through correspondents or other vendors, if at all. Deregulation of the banking
industry and increased competition from non-bank entities for the cash balances
of individuals and businesses has had and will continue to have an impact on the
competitive position of the Company. Among the advantages of these larger
institutions is their ability to make larger loans, finance extensive
advertising campaigns, access international money markets and generally allocate
their assets to regions of highest yield and demand. Management believes that
its most direct competition for deposits comes from commercial banks, stock
brokerage firms, savings and loan associations, thrift and loan companies and
credit unions. In addition, competition for deposits may be expected to arise
from corporate and governmental debt securities, as well as money market mutual
funds. The Company does not have a significant market share of the deposits or
loans in the northern or southern California marketplace.
In order to compete with other financial service entities in its service
area, the Company relies principally upon promotional activity, personal
contacts obtained through its officers, directors, employees and shareholders as
well as high levels of client service and responsiveness. The Company's
promotional activities emphasize the advantages of banking with a locally
headquartered institution attuned to the particular needs of the medical
services community. Additionally, the Company is informed of the current trends
and changing financial services needs of the health care industry through
membership in trade associations, directorates of health care organizations and
through feedback from existing health care clients of the Company. For clients
whose credit demands exceed the Company's lending limits, the Company attempts
to arrange for such loans on a participated basis with institutions who desire
to work with the Company to leverage its industry expertise. The Company also
assists clients requiring services not offered by the Company by obtaining these
services through its correspondent banks and/or other joint relationships.
SUPERVISION AND REGULATION
THE EFFECT OF GOVERNMENTAL POLICY ON BANKING
The earnings and growth of the Company are affected not only by local
service area factors and general economic conditions, but also by governmental
monetary and fiscal policies. For example, the Federal Reserve Bank (the "FRB")
influences the supply of money through its open market operations in U.S.
Government securities and adjustments to the discount rates applicable to
borrowings by depository institutions and others. Such actions influence the
growth of loans, investments and deposits and also affect interest rates earned
on loans and paid on deposits. The nature and impact of future changes in such
policies on the business and earnings of the Company cannot be predicted.
As a consequence of the extensive regulation of commercial banking
activities in the United States, the business of the Company is particularly
susceptible to the enactment of federal and state legislation which may have the
effect of increasing or decreasing the cost of doing business, modifying
permissible activities or enhancing the competitive position of the other
financial institutions. Any change in applicable laws or regulations may have a
material adverse effect on the business and prospects of the Company. In
response to various business failures in the savings and loan industry and in
the banking industry, Congress enacted, and the President signed the Federal
Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") into law.
FDICIA substantially revised the bank regulatory framework and deposit insurance
funding provisions of the Federal Deposit Insurance Act and made revisions to
several other federal banking statutes.
REGULATION AND SUPERVISION OF BANKS AND BANK HOLDING COMPANIES
Bancorp is a bank holding company subject to the Banking Holding Company
Act of 1956, as amended ("BHCA"). Bancorp reports to, is registered with, and
may be examined by the FRB. The FRB also has the authority to examine Bancorp's
subsidiaries.
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The FRB has significant supervisory and regulatory authority over Bancorp
and its affiliates. The FRB requires Bancorp to maintain certain levels of
capital. See "-Capital Standards." The FRB also has the authority to take
enforcement action against any bank holding company that commits any unsafe or
unsound practice, or violates certain laws, regulations or conditions imposed in
writing by the FRB. See "Prompt Corrective Action and Other Enforcement
Mechanisms."
Under BHCA, a company generally must obtain the prior approval of the FRB
before it exercises a controlling influence over or acquires, directly or
indirectly, more than 5% of any class of voting shares or substantially all of
the assets of any bank or bank holding company or other company. Thus, Bancorp
is required to obtain the prior approval of the FRB before it acquires, merges
or consolidates with any bank or bank holding company; any company seeking to
acquire, merge or consolidate with Bancorp also would be required to obtain the
approval of the FRB.
In addition, and subject to certain exceptions, the Change in Bank Control
Act (the "Control Act") and regulations promulgated thereunder by the FRB
require any person acting directly or indirectly, or through or in concert with
one or more persons, to give the FRB 60 days written notice before acquiring
control of a bank holding company. Transactions which are presumed to constitute
the acquisition of control include the acquisition of any voting securities of a
bank holding company having securities registered under section 12 of the
Securities Exchange Act (such as the Common Stock of Bancorp) if, after the
transaction, the acquiring person (or persons acting in concert) owns, controls
or holds with power to vote 10% or more of any class of voting securities of the
institution. The acquisition may not be consummated subsequent to such notice if
the FRB issues a notice within the 60 days, or within certain extensions of such
period, disapproving the same.
Bancorp is generally prohibited under the BHCA from acquiring ownership or
control of more than 5% of any class of voting shares of any company that is not
a bank or bank holding company and from engaging directly or indirectly in
activities other than banking, managing banks, or providing services to
affiliates of the holding company. A bank holding company, with the approval of
the FRB, may engage, or acquire the voting shares of companies engaged in
activities that the FRB has determined to be so closely related to banking or
managing or controlling banks as to be a proper incident thereto. A bank holding
company must demonstrate that the benefits to the public of the proposed
activity will outweigh the possible adverse effects associated with such
activity.
The FRB generally prohibits a bank holding company from declaring or paying
a cash dividend which would impose undue pressure on the capital of subsidiary
banks or would be funded only through borrowing or other arrangements that might
adversely affect a bank holding company's financial position. The FRB's policy
is that a bank holding company should not continue its existing rate of cash
dividends on its common stock unless its net income is sufficient to fully fund
each dividend and its prospective rate of earnings retention appears consistent
with its capital needs, asset quality and overall financial condition.
Transactions between Bancorp and the Bank are subject to a number of other
restrictions. FRB policies forbid the payment by bank subsidiaries of management
fees which are unreasonable in amount or exceed the fair market value of the
services rendered (or, if no market exists, actual costs plus a reasonable
profit). Additionally, a bank holding company and its subsidiaries are
prohibited from engaging in certain tie-in arrangements in connection with the
extension of credit, sale or lease of property, or furnishing of services.
Subject to certain limitations, depository institution subsidiaries of bank
holding companies may extend credit to, invest in the securities of, purchase
assets from, or issue a guarantee, acceptance or letter of credit on behalf of,
an affiliate, provided that the aggregate of such transactions with affiliates
may not exceed 10% of the capital stock and surplus of the institution, and the
aggregate of such transactions with all affiliates may not exceed 20% of the
capital stock and surplus of such institution. Bancorp may only borrow from
depository institution subsidiaries if the loan is secured by marketable
obligations with a value of a
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designated amount in excess of the loan. Further, Bancorp may not sell a
low-quality asset to a depository institution subsidiary.
The Community Reinvestment Act ("CRA") requires that, in connection with
examinations of depository financial institutions within their jurisdiction, the
FRB or the Office of the Comptroller of the Currency (the "OCC") shall evaluate
the record of the financial institutions in meeting the credit needs of their
local communities, including low and moderate income neighborhoods, consistent
with the safe and sound operation of those banks. These factors are considered
in evaluating mergers, acquisitions and applications to open a branch or
facility. In September 1994, President Clinton signed into law H.R. 3474, more
commonly known as the "Riegle Community Development and Regulatory Improvement
Act of 1994" (the "1994 Act"). In addition to establishment of a Community
Development Financial Institutions Fund (the "Fund"), which will provide
assistance to new and existing community development lenders to help to meet the
needs of low- and moderate-income communities and groups, the new legislation
covers a wide range of banking issues. These changes include modifications to
the present publication requirements for Call Reports, less frequent regulatory
examination schedules for small institutions, small business and commercial real
estate loan securitization, amendments to the money laundering and currency
transaction reporting requirements of the Bank Secrecy Act, clarification of the
coverage of the Real Estate Settlement Procedures Act ("RESPA") for business
commercial and agricultural real estate secured transactions, amendments to the
national flood insurance program, and amendments to the Truth in Lending Act to
provide new protection for consumers by reducing discrimination against the
disadvantaged.
In September 1992, the FRB adopted a new regulation, Regulation DD, to
implement the Truth in Savings Act (the "Savings Act") which was contained in
FDICIA. The Savings Act and the new regulations require the Bank and other
depository institutions to disclose fees, interest rates and other terms
concerning deposit accounts to consumers before they open accounts. The Savings
Act will also require the Bank to include information in periodic statements to
clients about fees imposed, interest earned and the annual percentage yield
earned on deposit accounts. The regulations also impose substantive limitations
on the methods by which institutions determine the balance on which interest is
calculated and rules which impose restrictions on advertisements for deposit
accounts. Regulation DD became effective as of June 21, 1993. Compliance with
the new rule has had no material impact on the Company's operations.
BANK REGULATION AND SUPERVISION
As a national bank, the Bank is regulated, supervised and regularly
examined by the OCC. Deposit accounts at the Bank are insured by the Bank
Insurance Fund (the "BIF"), as administered by the Federal Deposit Insurance
Corporation (the "FDIC"), to the maximum amount permitted by law. The Bank is
also subject to applicable provisions of California law and Pennsylvania law for
the holding company, insofar as such provisions are not in conflict with or
preempted by federal banking law.
CAPITAL STANDARDS
The federal banking agencies have risk-based capital adequacy guidelines
intended to provide a measure of capital adequacy that reflects the degree of
risk associated with a banking organization's 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 these guidelines, 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. Government securities, to 100% for assets with relatively
higher credit risk, such as certain business loans.
A banking organization's risk-based capital ratios are obtained by dividing
its total qualifying capital by its total risk-adjusted assets and off-balance
sheet items. The regulators measure risk-adjusted assets and
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off-balance sheet items against both total qualifying capital (the sum of Tier 1
capital and limited amounts of Tier 2 capital) and Tier 1 capital. Tier 1
capital consists of common stock, retained earnings, noncumulative perpetual
preferred stock (and with respect to bank holding companies, a limited amount of
cumulative perpetual preferred stock) and minority interests in certain
subsidiaries, less most other intangible assets. Tier 2 capital may consist of a
limited amount of the allowance for possible loan and lease losses, cumulative
preferred stock, term preferred stock, term subordinated debt and certain other
instruments with some characteristics of equity. The inclusion of elements of
Tier 2 capital are subject to certain other requirements and limitations of the
federal banking agencies. Since December 31, 1992, the federal banking agencies
have required a minimum ratio of total qualifying capital to risk-adjusted
assets and off-balance sheet items of 8%, and a minimum ratio of Tier 1 capital
to risk-adjusted assets and off-balance sheet items of 4%.
In addition to the risk-based guidelines, federal banking regulators
require banking organizations to maintain a minimum amount of Tier 1 capital to
adjusted average total assets, referred to as the leverage ratio. For a banking
organization rated in the highest of the five categories used by regulators to
rate banking organizations, the minimum leverage ratio of Tier 1 capital to
adjusted average total assets must be 3%. It is improbable, however, that an
institution with a 3% leverage ratio would receive the highest rating by the
regulators since a strong capital position is a significant part of the
regulators' rating. For all banking organizations not rated in the highest
category, the minimum leverage ratio must be at least 100 to 200 basis points
above the 3% minimum. Thus, the effective minimum leverage ratio, for all
practical purposes, must be at least 4% or 5%. In addition to these uniform
risk-based capital guidelines and leverage ratios that apply across the
industry, the regulators have the discretion to set individual minimum capital
requirements for specific institutions at rates significantly above the minimum
guidelines and ratios.
FDICIA requires the regulators to improve capital standards by considering
risks other than credit risk. On September 14, 1993, the federal banking
agencies (excluding the Office of Thrift Supervision) published a proposed rule
to take account of interest rate risk in calculating risk-based capital.
Although the joint agency promulgation did not include any proposals relating to
concentration of credit risk and risks of nontraditional activities, the
proposed rule includes a supervisory model for taking account of interest rate
risk. Under that supervisory model, institutions would report their assets,
liabilities and off-balance sheet positions in time bands based upon their
remaining maturities. The banking agencies would then calculate a net
risk-weighted interest rate exposure. If that interest rate risk exposure were
in excess of a certain threshold (1% of assets), the institution could be
required to hold additional capital proportionate to that excess risk.
Alternatively, the agencies have proposed making interest rate risk exposure a
subjective factor in considering capital adequacy. Exposures would be measured
in terms of the change in the present value of an institution's assets minus the
change in the present value of its liabilities and off-balance sheet positions
for an assumed 100 basis point parallel shift in market interest rates. However,
the banking agencies have proposed to let banks and bank holding companies use
their own internal measurement of interest rate risk if it is declared adequate
by regulatory examiners.
On December 28, 1993, the FRB published a proposed rule to amend the
capital adequacy guidelines for bank holding companies to include in Tier 1
capital that component of shareholders' equity concerning unrealized gains and
losses on securities available-for-sale. Securities available-for-sale are
carried at market value with the unrealized gain or loss, net of income taxes,
shown as an addition to or deduction from shareholders' equity. Accordingly, the
Company's and the Bank's shareholders' equity will be increased or decreased as
the market value of the securities available-for-sale portfolio changes.
Effective January 17, 1995, the federal banking agencies issued a final
rule relating to capital standards and the risks arising from the concentration
of credit and nontraditional activities. Institutions which have significant
amounts of their assets concentrated in high risk loans or nontraditional
banking activities and who fail to adequately manage these risks, will be
required to set aside capital in excess of the regulatory minimums. The federal
banking agencies have not imposed any quantitative assessment for
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determining when these risks are significant, but have identified these issues
as important factors they will review in assessing an individual bank's capital
adequacy.
Effective September 1, 1995, the federal banking agencies revised their
risk based capital rules to require higher levels of capital for banks with
significant exposure to interest rate risk. Interest rate risk is defined as the
exposure of a bank's current and future earnings from adverse changes in
interest rates. Initially, interest rate risk will be a factor in evaluating a
bank's capital adequacy. It is contemplated that the Bank regulatory agencies
will ultimately issue a rule which quantifies the amount of capital required for
levels of interest rate exposure.
In December 1993, the federal banking agencies issued an interagency policy
statement on the allowance for loan and lease losses which, among other things,
presented certain average ratios of loan loss allowance to classified assets.
The averages indicated by such policy statement is the sum of (a) assets
classified loss; (b) 50 percent of assets classified doubtful; and (c) 15
percent of assets classified substandard.
The federal banking agencies issued final rules governing banks and bank
holding companies, which became effective April 1, 1995, limiting the amount of
deferred tax assets that are allowable in computing an institution's regulatory
capital. Deferred tax assets that can be realized for taxes paid in prior
carryback years and from future reversals of existing taxable temporary
differences are generally not limited. Deferred tax assets that can only be
realized through future taxable earnings are limited for regulatory capital
purposes to the lesser of (i) the amount that can be realized within one year of
the quarter-end report date, or (ii) 10% of Tier 1 Capital. The amount of any
deferred tax in excess of this limit would be excluded from Tier 1 Capital and
total assets and regulatory capital calculations.
Future changes in regulations or practices could further reduce the amount
of capital recognized for purposes of capital adequacy. Such a change could
affect the ability of the Bank to grow and could restrict the amount of profits,
if any, available for the payment of dividends.
The following table presents the capital ratios for the Company and the
Bank, compared to the standards for well capitalized depository institutions
(which standards do not apply to bank holding companies) and the minimum
required capital ratios to be deemed adequately capitalized under applicable
federal regulations, as of December 31, 1996.
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TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSE ACTION PROVISIONS
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(in thousands) AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
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COMPANY
Leverage/1/ $14,477 5.80% $ 9,987 4.00% $12,483 5.00%
Tiger 1 Risk-Based 14,477 11.10 5,216 4.00 7,824 6.00
Total Risk-Based 21,456 16.45 10,432 8.00 13,040 10.00
BANK
Leverage $18,962 7.62% $ 9,951 4.00% $12,438 5.00%
Tier 1 Risk-Based 18,962 14.64 5,181 4.00 7,771 6.00
Total Risk-Based 20,589 15.90 10,362 8.00 12,952 10.00
</TABLE>
/1/ The minimum required by the FRB is 3%; for all but the most highly-rated
bank holding companies, the FRB expects a leverage ratio of 3% plus 100 to
200 basis points.
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PROMPT CORRECTIVE ACTION AND OTHER ENFORCEMENT MECHANISMS
FDICIA requires each federal banking agency to take prompt corrective
action to resolve the problems of insured depository institutions (but not bank
holding companies), including but not limited to those that fall below one or
more prescribed minimum capital ratios. The law requires each federal banking
agency to promulgate regulations defining the following five categories in which
an insured depository institution will be placed, based on the level of its
capital ratios: well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized and critically undercapitalized. At December 31,
1996, the Bank was deemed to be well capitalized.
In September 1992, the federal banking agencies (other than the Office of
Thrift Supervision) published uniform final regulations implementing the prompt
corrective action provisions of FDICIA. An insured depository institution
generally will be classified in the following categories based on capital
measures indicate below, provided the institution is not operating under a
capital order:
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"WELL CAPITALIZED" "ADEQUATELY CAPITALIZED"
Total risk-based capital of 10%; Total risk-based capital of 8%;
Tier 1 risk-based capital of 6%; and Tier 1 risk-based capital of 4%; and
Leverage ratio of 5%. Leverage ratio of 4%./1/
"UNDERCAPITALIZED" "SIGNIFICANTLY UNDERCAPITALIZED"
Total risk-based capital less than 8%; Total risk-based capital less than 6%;
Tier 1 risk-based capital less than 4%; or Tier 1 risk-based capital less than 3%; or
Leverage ratio less than 4%./1/ Leverage ratio less than 3%.
"CRITICALLY UNDERCAPITALIZED"
Tangible equity to total assets less than 2%.
</TABLE>
/1/ 3% if the institution has the highest rating by regulators.
An institution that, based upon its capital levels, is classified as "well
capitalized," "adequately capitalized" or "undercapitalized" may be treated as
though it were in the next lower capital category if the appropriate federal
banking agency, after notice and opportunity for hearing, determines that an
unsafe or unsound condition or an unsafe or unsound practice warrants such
treatment. At each successive lower capital category, an insured depository
institution is subject to more restrictions. The federal banking agencies,
however, may not treat an institution as "critically undercapitalized" unless
its capital ratio actually warrants such treatment.
If an insured depository institution is undercapitalized, it will be
closely monitored by the appropriate federal banking agency. Undercapitalized
institutions must submit an acceptable capital restoration plan with a guarantee
of performance issued by the holding company. Further restrictions and sanctions
are required to be imposed on insured depository institutions that are
critically undercapitalized. The most important additional consequence is that
the appropriate federal banking agency is required to either appoint a receiver
for the institution within 90 days, or obtain the concurrence of the FDIC in
another form of action.
In addition to measures taken under the prompt corrective action
provisions, commercial banking organizations may be subject to potential
enforcement actions by the federal regulators for unsafe or unsound practices in
conducting their businesses or for violations of any law, rule, regulation or
any condition imposed in writing by the agency or any written agreement with the
agency. Enforcement actions may include, among other things, the imposition of a
conservator or receiver, the issuance of a cease-and-desist order that can be
judicially enforced, the termination of insurance of deposits (in the case of a
depository
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institution), the imposition of civil money penalties, the issuance of
directives to increase capital, the issuance of formal and informal agreements,
the issuance of removal and prohibition orders against institution-affiliated
parties and the enforcement of such actions through injunctions or restraining
orders based upon a judicial determination that the agency would be harmed if
such equitable relief were not granted. Additionally, a holding company's
inability to serve as a source of strength to its subsidiary banking
organizations could serve as an additional basis for a regulatory action against
the holding company.
SAFETY AND SOUNDNESS STANDARDS
FDICIA also implemented certain specific restrictions on transactions and
required federal banking regulators to adopt overall safety and soundness
standards for depository institutions related to internal control, loan
underwriting and documentation and asset growth. Among other things, FDICIA
limits the interest rates paid on deposits by undercapitalized institutions, the
use of brokered deposits and the aggregate extensions of credit by a depository
institution to an executive officer, director, principal shareholder or related
interest, and reduces deposit insurance coverage for deposits offered by
undercapitalized institutions for deposits by certain employee benefits
accounts.
In December 1992, the federal banking agencies issued final regulations
prescribing uniform guidelines for real estate lending. The regulations, which
became effective on March 19, 1993, require insured depository institutions to
adopt written policies establishing standards, consistent with such guidelines,
for extensions of credit secured by real estate. The policies must address loan
portfolio management, underwriting standards and loan to value limits that do
not exceed the supervisory limits prescribed by the regulations.
RESTRICTIONS ON DIVIDENDS AND OTHER DISTRIBUTIONS
The power of the board of directors of an insured depository institution to
declare a cash dividend or other distribution with respect to capital is subject
to statutory and regulatory restrictions which limit the amount available for
such distribution depending upon the earnings, financial condition and cash
needs of the institution, as well as general business conditions. FDICIA
prohibits insured depository institutions from paying management fees to any
controlling persons or, with certain limited exceptions, making capital
distributions, including dividends, if, after such transaction, the institution
would be undercapitalized.
Regulators also have authority to prohibit a depository institution from
engaging in business practices which are considered to be unsafe or unsound,
possibly including payment of dividends or other payments under certain
circumstances even if such payments are not expressly prohibited by statute.
Section 1551 of the Pennsylvania Business Corporation Law of 1988 (the
"PBCL") provides that the Board of Directors may authorize a business
corporation to make distributions to shareholders subject to certain
limitations. A distribution to shareholders may not be made if (i) the
corporation would be unable to pay its debts as they become due in the usual
course of business; or (ii) the total assets of the corporation would be less
than the sum of its total liabilities, plus the amount that would be needed, if
the corporation were to be dissolved, to satisfy the preferential rights upon
dissolution of shareholders whose preferential rights are superior to those
receiving the distribution.
PREMIUMS FOR DEPOSIT INSURANCE AND ASSESSMENTS FOR EXAMINATIONS
FDICIA established several mechanisms to increase funds to protect deposits
insured by the BIF administered by the FDIC. The FDIC is authorized to borrow up
to $30 billion from the U.S. Treasury Department; up to 90% of the fair market
value of assets of institutions acquired by the FDIC as receiver from the
Federal Financing Bank; and from depository institutions that are members of the
BIF. Any borrowings not repaid by asset sales are to be repaid through insurance
premiums assessed to member institutions. Such premiums must be sufficient to
provide insurance reserves of $1.25 for each $100 of insured deposits. The
10
<PAGE>
result of these provisions it that the assessment rate on deposits of BIF
members could increase in the future. FDICIA also provides authority for special
assessments against insured deposits. No assurance can be given at this time as
to what the future level of premiums will be.
Under the risk-based assessment system, a BIF member institution such as
the Bank is categorized into one of three capital categories (well capitalized,
adequately capitalized, and undercapitalized) and one of three categories based
on supervisory evaluations by its primary federal regulator. The three
supervisory categories are: financially sound with only a few minor weaknesses
(Group A), demonstrates weaknesses that could result in significant
deterioration (Group B), and poses a substantial probability of loss (Group C).
The capital ratios used by the federal regulators to define well capitalized,
adequately capitalized and undercapitalized are the same as in the prompt
corrective action regulations, discussed above. The BIF assessment rates during
1996 are summarized below; assessment figures are expressed in terms of cents
per $100 in deposits.
ASSESSMENT RATES EFFECTIVE JANUARY 1, 1996
<TABLE>
<CAPTION>
Group A Group B Group C
------- ------- -------
<S> <C> <C> <C>
Well Capitalized ....................... 0 3 17
Adequately Capitalized ................. 3 10 24
Undercapitalized ....................... 10 24 27
</TABLE>
FDICIA requires all insured depository institutions to undergo a full-scope
on-site examination by their primary federal banking agency at least once every
twelve months. The cost of examinations of insured depository institutions and
any affiliates may be assessed by the appropriate federal banking agency against
each institution or affiliate as it deems necessary or appropriate.
OTHER RECENTLY ENACTED AND PROPOSED LEGISLATION
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
(the "Riegle-Neal Act"), enacted on September 29, 1994, repealed the McFadden
Act of 1927, which required states to decide whether national or state banks
could enter their state, and allows banks to open branches across state lines
beginning on June 1, 1997. The Riegle-Neal Act also repealed the 1956 Douglas
Amendment to the Bank Holding Company Act, which placed the same requirements on
bank holding companies. The repeal of the Douglas Amendment now makes it
possible for banks to buy out-of-state banks in any state after September 29,
1995, which may then be converted into interstate branches in 1997.
The Riegle-Neal Act permits interstate banking to begin 12 months after the
enactment of the new law. The amendment of the Bank Holding Company Act permits
bank holding companies to acquire banks in other states provided that the
acquisition does not result in the bank holding company controlling more than
10% of the deposits in the United States, or 30% of the deposits in the state in
which the bank to be acquired is located. However, the Riegle-Neal Act also
provides that states have the authority to waive the state concentration limit.
Individual states may also require that the bank being acquired be in existence
for up to five years before an out-of-state bank or bank holding company may
acquire it.
The Riegle-Neal Act provides that interstate branching and merging of
existing banks is permitted beginning June 1, 1997, provided that the banks are
at least adequately capitalized and demonstrate good management. Interstate
mergers and branch acquisitions are permitted at an earlier time if a state
chooses to enact a law allowing such activity. The states are also authorized to
enact a law to permit interstate banks to branch de novo.
11
<PAGE>
On September 28, 1995, the California Interstate Banking and Branching Act
of 1995 ("CIBBA") was enacted and signed into law allowing early interstate
branching in California. CIBBA authorizes out-of-state banks to enter California
by the acquisition of or merger with a California bank that has been in
existence for at least five years, unless the California bank is in danger of
failing or in certain other emergency situations. CIBBA prohibits interstate
branching through the acquisition of a branch in California or the establishment
of a de novo branch by an out-of-state bank, which prohibition will lapse after
June 1, 1997, when the interstate branching provisions of the Riegle-Neal Act
become effective.
Various bills have been introduced in the United States Congress which
would expand, to a lesser or greater degree and subject to various conditions
and limitations, the authority of bank holding companies to engage in the
activity of underwriting and dealing in securities. Some of these bills would
authorize securities firms (through the holding company structure) to own banks,
which could result in greater competition between banks and securities firms. No
prediction can be made as to whether any of these bills will be passed by the
United States Congress and enacted into law, what provisions such a bill might
contain, or what effect it might have on the Bank.
ACCOUNTING PRONOUNCEMENTS
On January 1, 1996, the Company adopted Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation," which establishes
financial accounting and reporting standards for stock-based employee
compensation plans. This statement encourages all entities to adopt a new method
of accounting to measure compensation cost of all employee stock compensation
plans based on the estimated fair value of the award at the date it is granted.
Companies are, however, allowed to continue to measure compensation cost for
those plans using the intrinsic value based method of accounting, which
generally does not result in compensation expense recognition for most plans.
Compensation expense must be recognized, however, for stock awards to
non-employees for services rendered. Companies that elect to remain with the
existing accounting are required to disclose in a footnote to the financial
statements pro forma net income and earnings per share as if the Statement's
accounting provisions had been adopted. The Company elected to continue
accounting for stock options under the intrinsic value method. As there were no
options granted in 1995 or 1996, the pro forma disclosures are not currently
applicable.
In June of 1996, the FASB issued Statement of Financial Accounting
Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishment of Liabilities" ("SFAS No. 125"). SFAS No. 125 provides
accounting and reporting standards for transfers and servicing of financial
assets and extinguishment of liabilities based on control. Under this approach,
after a transfer of financial assets, the Company will recognize the financial
and servicing assets it controls and the liabilities incurred, and derecognize
financial assets when control has been surrendered and liabilities have been
extinguished. SFAS No. 125 provides standards for distinguishing transfers of
financial assets that are sales from transfers that are secured borrowings. SFAS
No. 125 must be adopted for financial statements for fiscal years beginning
after December 31, 1996. In December of 1996, the FASB issued Statement of
Financial Accounting Standards No. 127, "Deferral of the Effective Date of
Certain Provisions of FASB No. 125" ("SFAS No. 127"). SFAS No. 127 defers for
one year the effective date of certain provisions. The impact on the Company of
adopting SFAS No. 125 is not expected to be material.
EMPLOYEES
As of December 31, 1996, the Bancorp had no full-time salaried employees.
All compensation of the Bancorp's executive officer was paid by the Bank with a
portion of such compensation reimbursed by the Bancorp. The Bank employed 105
full-time equivalent employees as of December 31, 1996, inclusive of the
executive officer of the Bancorp.
12
<PAGE>
ITEM 2. PROPERTIES
- -------------------
The principal executive offices of the Company are located in leased
premises at 606 Broadway, Santa Monica, California. The original lease was
signed on February 1, 1982, for a ten-year period with two five-year renewal
options, covering the first floor and basement areas of the two-story building.
On March 23, 1984, the Company renegotiated this lease to include the entire
building and tenant improvements. In addition, both five-year options were
exercised at that time, and one additional five-year option was also granted,
permitting the Company to occupy the premises until January 31, 2007.
The Company acquired its second full-service branch office at 9647 Brighton
Way, Beverly Hills, California, on April 30, 1984 and assumed the lease for 10
years. The current lease calls for periodic rent adjustments and expires on
January 31, 1999.
The Company opened its third full-service office on December 1, 1986 at
5525 Etiwanda Street, Tarzana, California. The facility is located in a medical
building known as the Tarzana Clark Medical Center. The lease calls for periodic
rent adjustments and expires on November 30, 2001. The lease contains a
five-year option to renew at the then comparable market rate for similar space.
The Company opened its fourth full-service office on October 15, 1991 at 55
East California Boulevard, Pasadena, California. The facility is located in
close proximity to Huntington Memorial Hospital. The lease calls for periodic
rent adjustments, and expires on October 1, 2001. The lease contains two
five-year renewal options, the second of which adjusts the rent to the then
comparable market rate for similar space.
The Company opened its fifth full-service office also on October 15, 1991,
at 10 North 5th Street, Redlands, California. The lease calls for periodic rent
adjustments, and expires on March 31, 2001. The lease contains two five-year
options which continue the periodic rate adjustments.
The Company also leases two additional facilities. The first facility is a
limited service office located at 8600 West 3rd Street, Los Angeles, California,
in conjunction with an automated banking terminal facility. The second facility,
opened during 1992, is located at 9900 Norwalk Boulevard, Santa Fe Springs,
California, and contains the Company's note department and data processing
operations. In January 1994, this facility was granted status as a full-service
branch for the purpose of processing deposits. The lease calls for periodic rent
adjustments and expires on August 31, 2003. All of the leased properties are
suitable to the Company's needs and all of the leased areas were utilized in
1996.
ITEM 3. LEGAL PROCEEDINGS
- -------------------------
The Company is from time to time a party to various legal actions arising
in the ordinary course of business. Management believes that there is no
proceeding, threatened or pending, against Bancorp or the Bank which, if
determined adversely, would have a material adverse effect on the business,
financial position or results of operations of Bancorp or the Bank.
In connection with the 1996 Annual Shareholders Meeting, seven shareholders
of the Company, who owned in the aggregate approximately 11.81% of the
outstanding shares of the Company, formed a committee called the Shareholders
Protective Committee (the "SPC") to submit its own slate of seven directors for
election at the 1996 shareholders meeting. As a result of the proxy contest and
related litigation, the Company, the Bank, the SPC, Joel W. Kovner, David G.
Rodeffer, Daniel S. Rader, Richard A. Berger, James B. Jacobson, Anthony R.
Kovner, Ronald L. Katz and Lynn O. Poulson entered into an Agreement dated as of
July 8, 1996 (the "Settlement Agreement"), settling all litigation and disputes
respecting management of the Company and the Bank. The Settlement Agreement
confirmed the election to the Board of Directors of four SPC director nominees
(Ms. Thompson, Mr. Borstein, Dr. Oyakawa and Mr. Moskowitz) and three
13
<PAGE>
management director nominees (Mr. Poulson, Mr. Berger and Dr. Katz). The
Settlement Agreement also required that Mr. Kovner, Chairman of the Board and
Chief Executive Officer of the Company and Chairman of the Board, Chief
Executive Officer and President of the Bank, resign effective July 9, 1996, and
that John S. Buchanan be appointed as Interim Chief Executive Officer and
President. Management changes related to the settlement, including payments to
Mr. Kovner, resulted in severance payments of $1,006,000. As part of the
Settlement Agreement, proxy costs incurred by the SPC were reimbursed by the
Company.
The Settlement Agreement also provides that for the 1997 Annual
Shareholders Meeting, the four SPC directors nominees that were elected will, by
majority vote, propose four director nominees for election at the 1997 Annual
Shareholders Meeting, and the three management director nominees who were
re-elected will propose three director nominees for the 1997 meeting, and the
entire Board will take all efforts to cause the nomination and election of the
seven nominees selected in accordance with this procedure at the 1997 Annual
Shareholders Meeting.
The Company is pursuing the potential reimbursement of certain
non-recurring expenses in connection with the proxy contest and related
litigation under provisions of its Directors and Officers insurance.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
The Company did not submit any matters to a vote of its stockholders during
the fourth quarter of 1996.
14
<PAGE>
Part II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
- ------------------------------------------------------------------------------
Market Information and Holders
- ------------------------------
The Company sold its shares of Common Stock on a best-efforts basis
commencing May 12, 1982, at $7.62 per share. The offering was completed in
August 1982, and the stock was traded on NASDAQ until December 1991. The
Company's Common Stock began trading on the American Stock Exchange on December
3, 1991 under the symbol "MDB." On January 19, 1993, the Company completed a
private offering of 341,775 shares of common stock at a price of $12.62 per
share; 326,550 shares were purchased as of December 31, 1992. On June 23, 1995,
the Company declared a 5% stock dividend paid on July 19, 1995. On May 14, 1996,
the Company declared a 5% stock dividend paid on June 21, 1996. As of December
31, 1996, the Company estimated there were approximately 774 registered
shareholders.
The following table sets forth the range of stock price for the Company's
common stock for each of the quarters in the two years ended December 31, 1996,
adjusted for the 5% stock dividends mentioned above:
<TABLE>
<CAPTION>
High Low
------ ------
<S> <C> <C>
1st Quarter 1995 $ 9.06 $ 7.48
2nd Quarter 1995 10.47 8.50
3rd Quarter 1995 15.00 10.00
4th Quarter 1995 14.53 11.78
1st Quarter 1996 12.63 10.47
2nd Quarter 1996 11.78 10.23
3rd Quarter 1996 11.25 8.88
4th Quarter 1996 10.38 9.75
</TABLE>
The foregoing reflects information available to the Company and does not
necessarily include all trades in the Company's stock during the relevant
period. According to information available to the Company, the closing price of
the Company's common stock on December 31, 1996, was $10.13.
Dividends
- ---------
The Company has not paid any cash dividends since its formation. The Board
of Directors of the Company has decided not to pay cash dividends and retain all
earnings to support further growth of the Bank.
The power of the board of directors of insured depository institutions to
declare a cash dividend or other distribution with respect to capital is subject
to statutory and regulatory restrictions which limit the amount available for
such distributions depending upon the earnings, financial condition and cash
needs of the institution, as well as general business conditions. FDICIA
prohibits insured depository institutions from paying management fees to any
controlling persons or, with certain limited exceptions, making capital
distributions, including dividends, if after such transaction, the institution
would be undercapitalized.
Regulators also have authority to prohibit a depository institution from
engaging in any business practice which is considered to be unsafe or unsound,
possibly including payment of dividends or other payments under certain
circumstances even if such payments are not expressly prohibited by statute.
15
<PAGE>
In a policy statement adopted in November 1985, the Federal Reserve
Board advised banks and bank holding companies that payment of cash dividends in
excess of current earnings from operations is inappropriate and may be cause for
supervisory action. As a result of this policy, banks and their holding
companies may find it difficult to pay dividends out of retained earnings from
periods prior to the most recent fiscal year or to take advantage of earnings
generated by extraordinary items, such as sales of buildings, other large
assets, or business segments, in order to generate earnings sufficient for the
payment of future dividends.
The Company is a legal entity separate and distinct from its banking
subsidiary, and is not currently intending to engage in any activities other
than acting as a BHC. Accordingly, the Company's principal source of funds,
including funds available for payment of cash dividends to shareholders, will
consist of dividends paid and other funds advanced to the Company by its
subsidiary. Statutory and regulatory requirements impose limitations on the
amount of dividends payable by the Bank to the Company and on extensions of
credit by the Bank to the Company.
No national bank may, pursuant to 12 U.S.C. Section 56, pay dividends
from its capital (which includes capital stock, retained earnings and surplus
reserves for contingencies); all dividends must be paid out of net earnings then
on hand, after deducting expenses, including losses and bad debts. In addition,
the payment of dividends out of net earnings of a national bank is further
limited by 12 U.S.C. Section 60(a), which provides that until the surplus equals
the amount of capital stock, dividends can only be paid if there has been
transferred to the surplus fund not less than one-tenth of the bank's net
earnings for the preceding half-year in the case of quarterly or semi-annual
dividends. Pursuant to 12 U.S.C. Section 60(b), the approval of the OCC shall be
required if the total of dividends declared by a bank in any calendar year
exceeds the total of its net earnings for that year, less any required transfers
to surplus or to a fund for the retirement of any preferred stock.
Section 1551 of the Pennsylvania Business Corporation Law of 1988 (the
"PBCL") provides that the board of directors may authorize a business
corporation to make distributions to shareholders subject to certain
limitations. A distribution to shareholders may not be made if; (i) the
corporation would be unable to pay its debts as they become due in the usual
course of business; or (ii) the total assets of the corporation would be less
than the sum of its total liabilities, plus the amount that would be needed, if
the corporation were to be dissolved, to satisfy the preferential rights upon
dissolution of shareholders whose preferential rights are superior to those
receiving the distribution.
16
<PAGE>
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
------------------------------------
The following table presents selected consolidated financial data for
the Company at or for the five years ended December 31, 1996. The information
below is qualified in its entirety by the detailed information and financial
statements of the Company included elsewhere herein or incorporated by reference
and should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations," "Business" and the Company's
Consolidated Financial Statements and Notes thereto included elsewhere herein.
<TABLE>
<CAPTION>
At or For the Year Ended December 31,
--------------------------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Interest income $ 17,650 $ 20,903 $ 17,799 $ 15,092 $ 14,026
Interest expense 4,850 6,539 4,180 3,758 5,254
Net interest income 12,800 14,364 13,619 11,334 8,772
Provision for loan losses 4,136 1,539 703 253 903
Securities transactions, net (71) 1,018 (213) 398 3,748
Other noninterest income 1,515 1,435 1,524 1,419 1,005
Noninterest expense 15,545 12,090 12,093 10,624 10,048
Income tax (benefit) provision (1,712) 1,182 881 922 1,062
Net (loss) earnings (3,725) 2,006 1,253 1,352 1,512
Per Share Data:
Primary (loss) earnings per share $ (2.84) $ 1.30 $ 0.82 $ 0.85 $ 1.43
Fully diluted (loss) earnings per share (2.84) 1.21 0.82 0.85 1.43
Book value per share 10.47 13.69 12.37 11.74 10.65
Balance Sheet Data:
Total assets $263,539 $322,165 $315,005 $257,677 $225,042
Total loans 93,133 100,085 103,745 117,803 115,851
Securities held-to-maturity 41,872 48,517 120,735 94,893 52,038
Securities available-for-sale 54,468 81,520 47,003 25,650 19,943
Total deposits 241,277 297,466 293,631 241,144 209,829
Stock subject to repurchase - - - 781 1,161
Shareholders' equity 14,042 17,508 15,432 14,642 13,096
Performance and Leverage Ratios:
Return on average assets -1.38% 0.64% 0.43% 0.53% 0.67%
Return on average equity -23.89 12.40 8.78 9.80 16.63
Average equity to average assets 5.78 5.14 5.27 5.36 4.00
Net interest margin/1/ 5.38 5.07 5.19 4.95 4.30
Efficiency ratio/2/ 109.13 71.89 81.00 80.78 74.29
Asset Quality Ratios:/3/
Nonperforming loans to total loans 1.63% 4.18% 2.57% 2.04% 1.40%
Nonperforming assets:
to total loans 1.93 4.27 2.67 2.13 1.40
to total loans and OREO 1.92 4.26 2.67 2.12 1.40
to total assets 0.68 1.32 0.88 0.97 0.72
Allowance for loan losses:
to total loans 2.42 1.07 0.95 0.89 0.78
to nonperforming loans 148.13 25.64 36.91 43.70 55.45
to nonperforming assets 125.66 25.11 35.50 41.85 55.45
Net charge-offs to average total loans 3.04 1.45 0.69 0.09 0.81
</TABLE>
/1/ Ratio of net interest income to average interest-earning assets.
/2/ Efficiency ratio equals noninterest expense divided by net interest income
and noninterest income.
/3/ Nonperforming loans and nonperforming assets do not include accruing loans
90 days or more past due.
17
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
---------------------------------------------------------------
RESULTS OF OPERATIONS
---------------------
OVERVIEW
The following presents management's discussion and analysis of the
Company's consolidated financial condition and results of operations as of the
dates and for the periods indicated. This discussion should be read in
conjunction with "Selected Consolidated Financial Data," the Company's
Consolidated Financial Statements and the accompanying Notes included elsewhere
herein.
The Company's business strategy is to provide commercial banking
products and services to individuals and other organizations related to the
health care services industry as well as other professionals in California and
on a limited basis in other western states. The Company is seeking to increase
its market share of loans and deposits through marketing in areas where there is
a concentration of health care and health care related activities, through
possible acquisitions of other financial institutions and/or branches within its
target market, emphasizing the expertise and understanding of the medical
marketplace that the Company has stressed since its inception, and through
development of joint relationships expanding the product capability of the
Company.
The Company recorded a net loss of $3,725,000 for the year ended
December 31, 1996, compared with net earnings of $2,006,000 in 1995. The loss
per share for 1996 was $2.84 compared with fully diluted earnings per share of
$1.21 in 1995. The net loss resulted in part from a decrease in net interest
income as loan and deposit balances declined, certain non-recurring costs
relating to a proxy contest, and certain non-recurring costs relating to a
management restructuring in 1996. Provisions for loan losses also increased from
$1,539,000 for 1995 to $4,136,000 in 1996, as a result of charge-offs and
management's evaluation of the risk inherent in the loan portfolio.
The Company experienced a modest decrease in loan demand as gross loans
decreased $6,952,000 or 7% during the year to $93,133,000 at December 31, 1996.
The Company also experienced a decrease in deposits of 19% to $241,277,000 at
December 31, 1996, as compared with $297,466,000 at December 31, 1995. This
decrease occurred primarily in time certificates of deposits and was primarily
attributable to one client who moved its cash management activities to the
corporate headquarters.
At December 31, 1996, nonperforming assets totaled $1,793,000 or 0.68%
of total assets as compared with $4,263,000 or 1.32% of total assets at
December 31, 1995. Net charge-offs increased to $2,953,000 or 3.04% of average
outstanding loans in 1996, as compared with $1,452,000 or 1.45% of average loans
in 1995.
RESULTS OF OPERATIONS
For the year ended December 31, 1996, the Company recorded a net loss
of $3,725,000 or $2.84 per share. This compares with net earnings of $2,006,000
or $1.21 per share on a fully diluted basis in 1995. Return on average equity
for 1996 was -23.89%, as compared with 12.40% in 1995. Additionally, the return
on average assets for 1996 and 1995 was -1.38% and 0.64%, respectively.
The following table presents the distribution of average assets,
liabilities and shareholders' equity as well as the total dollar amount of
interest income from average interest-earning assets and resultant yields, and
the dollar amounts of interest expense and average interest-bearing liabilities,
expressed both in dollars and rates for the three years ended December 31, 1996.
18
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------------------------------------------------
1996 1995 1994
----------------------------- ----------------------------- -----------------------------
Average Yield/ Average Yield/ Average Yield/
(in thousands) Balance Rate Interest Balance Rate Interest Balance Rate Interest
-------- ------ -------- ------- ------ -------- ------- ------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Assets
Interest-earning assets:
Securities $119,819 6.29% $ 7,541 $160,612 6.47% $10,395 $137,873 5.58% $ 7,700
Loans/1/ 97,147 9.30 9,030 100,985 9.18 9,267 111,446 8.55 9,524
Federal funds sold 20,020 5.27 1,056 21,074 5.83 1,228 12,849 4.45 571
Interest-earning deposits -
banks 992 2.32 23 596 2.18 13 84 4.16 4
-------- ------- -------- ------- -------- -------
Total interest-earning assets 237,978 7.42 17,650 283,267 7.38 20,903 262,252 6.79 17,799
-------- ------- -------- ------- -------- -------
Deferred loan fees (87) (74) (78)
Allowance for loan losses (2,260) (948) (1,077)
Nonearning assets:
Cash and due from banks 24,318 25,226 23,081
Premises and equipment 1,741 1,603 1,702
Accrued interest receivable 1,320 1,488 1,184
Other assets 6,810 4,062 5,005
-------- -------- --------
Total assets $269,820 $314,624 $292,069
======== ======== ========
Liabilities and shareholders'
equity
Interest-bearing liabilities:
Interest-bearing deposits $ 13,247 0.72% $ 96 $ 14,396 0.73% $ 105 $ 14,907 0.72% $ 107
Savings and money market
deposits 98,363 1.72 1,693 113,974 1.72 1,959 126,678 1.71 2,170
Time deposits 49,065 4.89 2,399 74,639 5.07 3,786 37,697 3.49 1,316
Convertible notes 4,818 9.90 477 4,673 10.38 485 2,860 10.38 297
Repurchase agreements 3,422 5.41 185 3,458 5.90 204 4,469 3.50 156
Stock subject to repurchase -- -- -- -- -- -- 777 17.32 134
-------- ------- -------- ------- -------- -------
Total interest-bearing
liabilities 168,915 2.87 4,850 211,140 3.10 6,539 187,386 2.23 4,180
-------- ------- -------- ------- -------- -------
Noninterest-bearing liabilities:
Noninterest-bearing demand
deposits 81,869 85,116 88,359
Other liabilities 3,447 2,197 943
Shareholders' equity 15,589 16,171 15,381
-------- -------- --------
Total liabilities and
shareholders' equity $269,820 $314,624 $292,069
======== ======== ========
Interest income as a percentage
of average earning assets 7.42% 7.38% 6.79%
Interest expense as a percentage
of average interest-bearing
liabilities 2.87 3.10 2.23
Net interest margin and income 5.38 $12,800 5.07 $14,364 5.19 $13,619
======= ======= =======
</TABLE>
/1/ Nonaccrual loans are included in average balances and rate calculations.
NET INTEREST INCOME
The Company's operating results depend primarily on net interest
income, which represents the difference between the interest and fees earned on
loans and investments less interest paid on deposits and other liabilities. Net
interest margin is calculated based on the margin between the yields earned on
interest-earning assets and the interest rates paid on interest-bearing
liabilities, as well as the difference between the balances of average interest-
earning assets and average interest-bearing liabilities.
Net interest income before provision for loan losses for the year ended
December 31, 1996 was $12,800,000, a decrease of $1,564,000 or 10.89% from 1995.
The decrease in the net interest margin was primarily due to a decrease of
approximately $45,289,000 in average interest-earning assets, including a
19
<PAGE>
decline in loan volume and a restructuring of the investment portfolio, and a
decrease of $42,225,000 in average interest-bearing liabilities, primarily time
deposits. Loss of net interest income attributable to a decrease in earning
assets was partially offset by a 31 basis point increase in net interest margin
to 5.38% in 1996 from 5.07% in 1995.
Net interest income before provision for loan losses was $14,364,000 in
1995, representing a 5.5% increase over 1994. Net interest income increased
primarily due to an increase of approximately $23,727,000 in deposits which were
then placed in higher yielding assets. Time deposits were the primary source of
deposit growth and also represented the highest cost of funds. This increase in
earning assets funded primarily by these costly deposits reduced the net
interest margin from 5.19% in 1994 to 5.07% in 1995.
The Company's net interest income is affected by changes in the amount
and mix of interest-earning assets and interest-bearing liabilities, referred to
as "volume change." It is also affected by changes in yields earned on interest-
earning assets and interest rates paid on interest-bearing deposits and other
borrowed funds, referred to as a "rate change." The following table sets forth
changes in interest income and interest expense for each major category of
interest-earning assets and interest-bearing liabilities, and the amount of
change attributable to volume and rate changes for the years indicated. The
changes due to rate and volume have been allocated to rate and volume in
proportion to the relationship between their absolute dollar amounts. The
effects of tax-equivalent yields have not been presented because they were
deemed to be immaterial.
<TABLE>
<CAPTION>
1996 Compared With 1995 1995 Compared With 1994
----------------------------- -----------------------------
(In thousands) Volume Rate Total Volume Rate Total
------- ----- ------- ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Increase (decrease) in interest income:
Securities $(2,575) $(279) $(2,854) $1,373 $1,322 $2,695
Loans (356) 119 (237) (931) 674 (257)
Federal funds sold (59) (113) (172) 443 214 657
Interest-bearing deposits - banks 9 1 10 11 (2) 9
------- ----- ------- ------ ------ ------
(2,981) (272) (3,253) 896 2,208 3,104
Increase (decrease) in interest expense:
Interest-bearing demand deposits (8) (1) (9) (3) 1 (2)
Savings and money market deposits (269) 3 (266) (219) 8 (211)
Time deposits (1,255) (132) (1,387) 1,689 781 2,470
Convertible notes 15 (23) (8) 188 -- 188
Repurchase agreements (2) (17) (19) (41) 89 48
Stock subject to repurchase -- -- -- (134) -- (134)
------- ----- ------- ------ ------ ------
(1,519) (170) (1,689) 1,480 879 2,359
------- ----- ------- ------ ------ ------
Increase (decrease) in net interest income $(1,462) $(102) $(1,564) $ (584) $1,329 $ 745
======= ===== ======= ====== ====== ======
</TABLE>
Interest income for 1996 was $17,650,000, a decrease of $253,000 from
1995. This decrease was primarily due to a decrease in the securities' portfolio
in the amount of approximately $40,793,000, which resulted in a $2,575,000
decrease in interest income. Interest expense was $4,850,000 in 1996,
representing a decrease of approximately $1,689,000 when compared with 1995.
Interest-bearing deposits, primarily time deposits, decreased $42,334,000 from
1995. This decrease in average deposits reduced interest expense approximately
$1,532,000. In addition, the reduction in time deposits lowered the overall
interest rate paid on interest-bearing liabilities 23 basis points from 3.10%
during 1995 to 2.87% in 1996.
20
<PAGE>
In 1995, the increase in interest income of $3,104,000 was comprised of
an $896,000 increase associated with the $21,015,000 increase in average
interest-earning assets, of which approximately $1,373,000 can be attributed to
an increase in the securities portfolio, as well as approximately $2,208,000 of
the total interest increase associated with an increase in the yield on average
interest-earning assets to 7.38% in 1995 from 6.79% in 1994. The increase in
total interest expense of $2,359,000 was comprised of a increase of $1,480,000
associated with the increase of $23,754,000 in average interest-bearing
liabilities and a $879,000 decrease associated with an increase in the cost of
funds to 3.10% in 1995 from 2.23% in 1994. The increase in the cost of funds
occurred as the funding of the investment portfolio increase was accomplished
through higher costing time deposits.
A changing interest rate environment may have a significant impact on
the Company's net interest margin as measured against average interest-earning
assets. Management monitors the Company's net interest margin by utilizing an
interest rate simulation model under various interest rate scenarios. This
process quantifies the impact of changes in interest rates on the Company's net
interest margin. Interest rate scenarios are increased and decreased up to 300
basis points in determining the impact on net interest income. Management has
limited the impact under these scenarios to no more than 15 percent of net
interest income. These results provide a basis for repricing loan and deposit
products after giving consideration to such factors as competition, the economic
environment and expected maturities in the loan, investment securities and
deposit portfolios.
PROVISION FOR LOAN LOSSES
The Company maintains an allowance for loan losses in order to
adequately provide for the risks of loss associated with its loan portfolio. See
"-Balance Sheet Analysis - Credit Risk Management and Asset Quality." Additions
to the allowance for loan losses are made through charges to operations as a
provision for loan losses. The provision for loan losses for 1996 was $4,136,000
as compared with $1,539,000 in 1995 and $703,000 in 1994. The increase in the
provision for 1996 was primarily due to charge-offs, net of recoveries, of
$2,953,000 as compared with $1,452,000 and $768,000 in 1995 and 1994,
respectively. Net charge-offs to average outstanding loans increased to 3.04% in
1996 compared with 1.45% in 1995 and 0.69% in 1994. Based on management's
evaluation of the inherent risk in the loan portfolio, the allowance for loan
losses was increased to 2.42% of total loans as of December 31, 1996, as
compared with 1.07% as of December 31, 1995. See "Allowance for Loan Losses" for
further information on net charge-offs.
OTHER OPERATING INCOME
Other operating income decreased $1,009,000 in 1996 to $1,444,000, when
compared with $2,453,000 in 1995. This decrease was primarily attributable to a
net loss of $71,000 in securities transactions during 1996, compared with a net
gain of $1,018,000 in 1995. Securities were sold during 1996 to reflect the
decreased deposit base as well as the restructuring of the investment portfolio.
In addition, other income increased $80,000 over 1995.
Other operating income increased $1,142,000 or 87% in 1995 from 1994
due to the recognition of increased profits attributable to securities
transactions. Securities were sold in 1995 at a net gain of $1,018,000 compared
with a net loss of $213,000 in 1994. Excluding securities transactions, other
income decreased by $88,000 in 1995 compared with 1994 as an increase in service
charges on deposits was offset by a decline in mortgage banking fees. Mortgage
banking operations were initiated in 1992 and consist solely of a broker
function. The Company, as broker, provides all loan documentation required by
the applicable underwriting criteria and RESPA and sends the material to a
funding institution. The funding institution then approves or declines the loan
and, if approved, subsequently funds the loan directly. The Company earns
certain fees on the loan for this service.
21
<PAGE>
OTHER OPERATING EXPENSES
For the year ended December 31, 1996, other operating expenses were
$15,545,000 representing an increase of $3,455,000 from $12,090,000 in 1995.
This increase was due primarily to the recognition of approximately $2,579,000
in nonrecurring legal expenses, settlement costs associated with the proxy
contest, certain other nonrecurring costs associated with a management
restructuring and other one time expenses related to prior benefits. The ratios
of operating expenses to average assets for 1996, 1995 and 1994 were 5.76%,
3.84% and 4.14%, respectively. Excluding the nonrecurring costs, the ratio for
1996 would have been 4.81%. The following table summarizes changes in other
operating expenses for the years ended December 31, 1996, 1995 and 1994.
<TABLE>
<CAPTION>
Increase (Decrease)
-------------------------
(in thousands) 1996 1995 1994 1996/1995 1995/1994
------- ------- ------- --------- ----------
<S> <C> <C> <C> <C> <C>
Salaries and employee benefits $ 5,945 $ 5,859 $ 5,476 $ 86 $ 383
Occupancy 1,386 1,382 1,429 4 (47)
Legal fees 2,754 799 659 1,955 140
Furniture and equipment 697 736 688 (39) 48
Professional services 930 605 536 325 69
FDIC assessment 1 321 576 (320) (255)
Office supplies 288 281 209 7 72
Other assessments 299 271 259 28 12
Telephone 272 227 213 45 14
Audit, accounting and examinations 201 149 160 52 (11)
Postage 154 147 144 7 3
Messenger service 177 121 102 56 19
Imprinted checks 138 121 145 17 (24)
Donations 135 113 160 22 (47)
Meetings and business development 126 66 115 60 (49)
Severance payments and accruals 1,006 -- -- 1,006 --
Termination of interest rate exchange contract -- -- 385 -- (385)
Other 1,036 892 837 144 55
------- ------- ------- ------ -----
Total other operating expenses $15,545 $12,090 $12,093 $3,455 $ (3)
======= ======= ======= ====== =====
</TABLE>
The increase in operating expenses in 1996 was primarily the result of
the expenses incurred in connection with a contested election of directors at
the 1996 Annual Shareholders Meeting and related litigation, including legal
fees in the amount of $1,404,000, proxy solicitation costs of $58,000, and
printing costs of $111,000. Management changes related to the settlement,
including payments to Mr. Kovner, resulted in severance payments of $1,006,000.
As part of the Settlement Agreement, proxy costs incurred by the Shareholders
Protective Committee were reimbursed by the Company.
The Company and the Bank entered into a Consulting Agreement dated
August 12, 1996 with Network Health Financial Services, Inc. ("NHFS"), a
California corporation for which Melinda McIntyre-Kolpin serves as President and
Chief Executive Officer. Pursuant to the Consulting Agreement, NHFS provides
consulting services to the Company and the Bank with respect to personnel
matters, operational procedures and client development and retention. NHFS is
paid its actual costs incurred in the performance of its duties under the
Consulting Agreement (including hourly rates for certain specified NHFS
personnel while they are performing consulting services), plus an additional 25%
of such costs. In addition, the Company and Bank pay flat monthly rates for the
services of Ms. McIntyre-Kolpin and Patti Derry. During 1996, the Company and
the Bank paid NHFS total fees in the amount of $288,432 pursuant to the
Consulting Agreement. Any party may terminate the Consulting Agreement by giving
30 days' notice to the other
22
<PAGE>
parties. The Company is also exploring some form of strategic alliance with NHFS
as a primary focus of the Company's growth strategy.
Excluding these nonrecurring expenses, other operating expenses
increased $876,000 or approximately 7% from 1995. Legal fees increased $551,000
from 1995 due to management's efforts to collect on a number of certain problem
loans, of which approximately $400,000 was recovered/reimbursed through
recoveries. Professional services also increased $325,000 in 1996 as temporary
personnel, including outside consultants, were required to continue business on
an ongoing basis. This increase was partially offset by decreased salaries of
approximately $180,000 during the third and fourth quarter of 1996 as compared
with the first six months of 1996. Additionally, during 1996, the FDIC insurance
premium decreased $320,000 from 1995.
In 1995, other operating expenses were $12,090,000 or an amount which
was fairly consistent with the 1994 level. Salaries and employee benefits
increased $383,000 in 1995 from 1994 due in part to an increase in staff as the
number of full-time equivalent employees totaled 107 at December 31, 1995
compared to 96 at December 31, 1994. Legal fees increased $140,000 to $799,000
as a result of the increased costs of collecting on problem loans. Office
supplies increased $72,000 to $281,000 in 1995 due to increased data processing
costs.
These increases in operating expenses were offset by a decrease in the
Bank's FDIC assessment of $255,000 or 44% in 1995, as the Bank was assessed
deposit insurance premiums of four cents per one hundred dollars in deposits, as
compared with twenty-three cents in 1994. Additionally in 1994, the Bank
recorded a $385,000 charge to eliminate a cap on an interest rate exchange
contract.
INCOME TAXES
The effective tax rate for 1996 was 31.5% compared with the effective
tax rate of 37.1% in 1995 and 41.3% in 1994. For further information, see Note 7
of Notes to Consolidated Financial Statements.
BALANCE SHEET ANALYSIS
Total assets were $263,539,000 at December 31, 1996, representing a
decrease of $58,626,000 or 18% from December 31, 1995. Average assets during
1996 and 1995 were $269,820,000 and $314,624,000, respectively. The decrease in
average assets during 1996 was due primarily to a decrease in total deposits,
primarily time deposits. Gross loans at December 31, 1996 were $93,133,000,
compared with $100,085,000 at December 31, 1995. Total deposits at December 31,
1996 and 1995 were $241,277,000 and $297,466,000, respectively. Decreased
deposits in large part reflect the loss of time deposits of one large client
whose cash management activities were moved to the corporate headquarters. Other
factors impacting deposit declines were uncertainty created by the proxy contest
and staffing turnover throughout 1996. Decreased loan demand is reflective of
impaired marketing efforts related to staff shortages as well as an internal
focus on credit administrative practices in lieu of marketing efforts. Moreover,
continued consolidation within the health services industry (which the Company
serves) has resulted in decreased credit demand in certain of the Company's
market sectors. At the same time, this same consolidation has in other sectors
created demand for credit in excess of the Company's capacity.
LOAN PORTFOLIO
The Company focuses its lending activities in three principal areas:
commercial loans, lines of credit and installment loans. Commercial loans
include commercial loans secured by the operating cash flow and business assets
of the borrower, and to a lesser extent real estate, and unsecured commercial
loans. Lines of credit include equity lines, overdraft protection lines and
other secured, collateralized and unsecured lines of credit. Installment loans
include automobile and boat loans and other loans for personal and corporate
use.
23
<PAGE>
The interest rates charged for the loans made by the Company vary with the
degree of risk, the size and maturity of the loan, the borrowers' depository
relationships with the Company, and prevailing market rates.
Although the risk of non-payment exists with respect to all types of
loans, certain other specific risks are associated with each type of loan. The
primary risks associated with commercial loans, including real estate secured
commercial loans, are the quality of the borrower's management and a number of
economic and other factors, including competition, insufficient capital, changes
in laws and regulations and general changes in the marketplace, which induce
business failures and cause the value of business assets pledged to secure the
loan to depreciate. Although the Company's portfolio concentration in the health
care services industry may expose the Company to risks or adverse developments
in this sector, including any such developments resulting from health care
reform, these risks are mitigated in part by the diversity of clientele within
the market niche. Equity lines of credit, installment loans and other lines of
credit are affected primarily by domestic instability and a variety of factors
that may lead to the borrower's unemployment, including deteriorating economic
conditions in one or more segments of a local or broader economy.
The following table sets forth the amounts of loans outstanding by type
of credit extension as of the dates indicated.
<TABLE>
<CAPTION>
December 31,
--------------------------------------------------------------------------------------------
(in thousands) 1996 1995 1994 1993 1992
-------------- -------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial $73,577 $ 77,012 $ 83,239 $ 94,406 $ 89,088
Real estate secured commercial 10,079 13,241 8,863 9,655 11,162
------- -------- -------- -------- --------
Subtotal 83,656 90,253 92,102 104,061 100,250
Equity lines of credit 6,202 6,070 7,195 8,138 8,444
Other lines of credit 1,832 1,997 2,119 2,261 2,426
Installment 1,375 1,625 2,072 2,887 4,047
Lease financing 68 140 257 456 684
------- -------- -------- -------- --------
Total loans 93,133 100,085 103,745 117,803 115,851
Less: allowance for loan losses (2,253) (1,070) (983) (1,048) (900)
Less: deferred loan fees, net (121) (71) (82) (78) (120)
------- -------- -------- -------- --------
Net loans $90,759 $ 98,944 $102,680 $116,677 $114,831
======= ======== ======== ======== ========
Fixed rate $ 7,075 8% $ 11,240 11% $ 7,756 7% $ 7,703 7% $ 14,355 12%
Variable rate 86,058 92% 88,845 89% 95,989 93% 110,100 93% 101,496 88%
------- -------- -------- -------- --------
Total loans $93,133 $100,085 $103,745 $117,803 $115,851
======= ======== ======== ======== ========
</TABLE>
There was no category of loans exceeding 10% of total loans which was
not otherwise disclosed as a distinct line item in the above table. Commercial
loans represent extensions to a wide array of individuals, companies, both
within and outside of the Company's market area. In addition, there were no
construction loans outstanding at December 31, 1996 and 1995.
The Company generally underwrites loans on the basis of adequate cash
flow, historical, current and as appropriate pro forma, and looks to supporting
collateral as a secondary source of repayment in most extensions. In the opinion
of management, the Company's loan policies conform with applicable regulatory
lending standards.
Commercial Loans and Real Estate Secured Commercial Loans. The
Company's commercial and real estate secured commercial loans totaled
$83,656,000 or 90% of total loans and $90,253,000 or 90% of total loans on
December 31, 1996 and 1995, respectively. Of the total, real estate secured
commercial loans accounted for only $10,079,000 at December 31, 1996 and
$13,241,000 at December 31, 1995. Commercial and real estate secured commercial
loans consist primarily of short- to medium-term financing for small- to medium-
sized
24
<PAGE>
health care-related companies and professionals located in Southern
California. The commercial and real estate secured commercial loans are
primarily concentrated in the same sectors of the medical community as the
Company's deposit base is drawn from and consists of sole medical practitioners,
small groups practices, large single-specialty groups, multi-specialty medical
groups and other outpatient health care service companies. Real estate
transactions are underwritten with cash flow adequacy and diversity as the
primary underwriting criteria. Although collateral offered provides adequate
secondary support, the underwriting additionally considers other assets/net
worth available to support repayment. Approximately 79% of total loans at
December 31, 1996 were commercial loans which were unsecured or collateralized
by various business and personal property assets, including equipment, accounts
receivable contracts, and proceeds thereof, including capitation payments. As a
matter of policy, the Company's commercial loan borrowers are required to submit
financial statements and other financial data (for example, accounts receivable
agings and enrollment summaries) on a periodic basis, in conformity with loan
policies and procedures and regulatory guidelines, to loan officers for their
review in monitoring the financial position and cash flows trends of borrowers.
Under this policy, management generally places a higher level of scrutiny on
borrowers failing to submit the required financial information. Senior lending
officers review delinquency reports, overdrafts, borrowers' payment histories
and periodic financial data to monitor creditworthiness and identify potential
problem loans. Loan to value ratios on commercial loans secured by real estate
generally range from approximately 30% to 80% at origination. Approximately 11%
of total loans at December 31, 1996 were commercial loans secured by real
estate, but because the Company's commercial loans are repaid typically through
cash flows from the borrowers' business with shorter term maturities (three to
five years) and amortizations usually no longer than 15 years, the commercial
loans are not classified by the Company as real estate-mortgage loans.
Equity Lines of Credit. At December 31, 1996 and 1995, equity lines of
credit aggregated approximately $6,202,000 or 7% of total loans, and $6,070,000
or 6% of total loans, respectively. Loan-to-appraised value ratios at the loan
origination date generally do not exceed 85% and all such loans have variable
rate structures. A majority of these lines of credit are secured by junior trust
deeds on residential real estate and require monthly principal payments. Equity
lines generally have a five year maturity and are subject to an annual review of
the financial condition of the borrower.
Other Lines of Credit. At December 31, 1996 and 1995, other lines of
credit aggregated approximately $1,832,000 or 2% of total loans, and $1,997,000
or 2% of total loans, respectively. Other lines of credit are generally
unsecured and include overdraft protection facilities and revolving lines of
credit. Overdraft lines are attached to checking accounts to cover short-term
shortfalls in cash flow. Interest rates are fixed at 18%.
Installment Loans. At December 31, 1996 and 1995, installment loans
aggregated approximately $1,375,000 and $1,625,000, respectively. This loan
category primarily includes automobile loans. Loan-to-appraised value ratios at
the loan origination date range up to 100% for automobile installment loans with
maturity and amortizations generally up to 60 months.
25
<PAGE>
The following table shows the maturity distribution of the Company's
loans outstanding at December 31, 1996, and is based on the remaining scheduled
repayments of principal, as due within the periods indicated.
<TABLE>
<CAPTION>
After One After
Through through Five
(in thousands) One Year Five Years Years Total
-------------- ------------- -------------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Commercial $49,492 $23,576 $ 509 $73,577
Real estate commercial 4,052 3,470 2,557 10,079
Equity lines of credit 2,286 3,292 624 6,202
Other lines of credit 1,372 460 -- 1,832
Installment 499 841 35 1,375
Lease financing 21 47 -- 68
------- ------- ------ -------
Total $57,722 $31,686 $3,725 $93,133
======= ======= ====== =======
Fixed rate $ 3,309 6% $ 2,897 9% $ 869 23% $ 7,075
Variable rate 54,413 94% 28,789 91% 2,856 77% 86,058
------- ------- ------ -------
Total $57,722 $31,686 $3,725 $93,133
======= ======= ====== =======
</TABLE>
LOAN COMMITMENTS
In the normal course of business, there are various commitments
outstanding to extend credit that are not reflected in the consolidated
financial statements. These financial instruments include commitments to extend
credit for working capital, tenant improvements, other term purposes and include
standby letters of credit. These instruments involve, to varying degrees,
elements of credit and interest rate risk. The Company's exposure to credit loss
in the event of nonperformance by the other party to commitments to extend
credit and standby letters of credit is represented by the contractual notional
(principal) amount of those instruments. However, other than letters of credit,
all such documents contain legal language that would allow the Company an
ability for non-advance. Accordingly, loss potential is minimized for
commitments extended under such document. At December 31, 1996 and 1995, the
Company had commitments to extend credit of approximately $38,931,000 and
$50,415,000, respectively, and obligations under standby letters of credit of
approximately $4,610,000 and $4,984,000, respectively.
Standby letters of credit are commitments issued by the Company to
support the performance of a client to a third party. Those standby letters of
credit are primarily issued to support public and private borrowing
arrangements, including commercial paper, bond financing, lease arrangements and
similar transactions. All such standby letters of credit are extended for a
period of two years or less. In making commitments and issuing letters of
credit, the Company uses credit policies similar to those used in connection
with extension of credit to all customers with creditworthiness evaluated on a
case-by-case basis. The amount of collateral obtained, if deemed necessary by
the Company upon extension of credit, is based on a credit evaluation of the
customer. Collateral held varies but may include accounts receivable, inventory,
property, plant and equipment, contract, contract rights and income-producing
commercial real estate.
CREDIT RISK MANAGEMENT AND ASSET QUALITY.
Management believes that the objective of sound credit policy is to
extend loans to qualified customers while managing risks which could affect
shareholders' returns. The loan committee, made up of outside members of the
Board of Directors of the Bank and executive management, approve credit policy,
review asset quality, and determining compliance to credit policy and procedure.
Management periodically reviews loan quality and monitors the progress of watch
list loans, some of which may require an action plan
26
<PAGE>
for rehabilitation or refinancing. In addition, credit underwriting guidelines
are periodically reviewed and adjusted to reflect current economic conditions,
industry practices and regulatory guidelines.
In accordance with management's credit administration and regulatory
policy, loans are placed on nonaccrual status when collection of principal or
interest is questionable. Generally, this means that loans are put on nonaccrual
status when interest is 90 days or more past due, unless the loan is well
secured and in the process of collection or in the process of renewal.
The table below sets forth information about nonperforming assets,
which included nonaccrual loans and other real estate owned ("OREO"), and
accruing loans 90 days or more past due and certain ratios:
<TABLE>
<CAPTION>
December 31,
----------------------------------------------------------
(in thousands) 1996 1995 1994 1993 1992
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Nonperforming Assets:
Nonperforming loans $1,521 $4,173 $2,663 $2,398 $1,623
Other real estate owned (OREO) -- 90 106 106 --
Other repossessed assets 272 -- -- -- --
------ ------ ------ ------ ------
Total nonperforming assets $1,793 $4,263 $2,769 $2,504 $1,623
====== ====== ====== ====== ======
Accruing loans 90 days or more past due $ 507 $ 632 $ 964 $ 8 $ 41
====== ====== ====== ====== ======
Nonperforming loans to total loans/(1)/ 1.63% 4.18% 2.57% 2.04% 1.40%
Nonperforming assets/(1)/
to total loans 1.93 4.27 2.67 2.13 1.40
to total loans, OREO and repossessed assets 1.92 4.26 2.67 2.12 1.40
to total assets 0.68 1.32 0.88 0.97 0.72
</TABLE>
/(1)/ Nonperforming loans and nonperfoming assets do not include accruing loans
90 days or more past due where loan quality is not impaired but rather
renewal in process pending receipt of updated financial data.
ALLOWANCE FOR LOAN LOSSES
Management's determination of the allowance for loan losses requires
the use of estimates and assumptions related to the both actual and inherent
risks in the loan portfolio. Actual results may, however, differ significantly
from such estimates. In connection with the determination of the allowance for
loan losses where real estate secures the loan, management generally obtains
independent appraisals for all properties. Management believes its current
appraisal policy conforms to regulatory guidelines.
An evaluation of the overall quality of the portfolio is performed
monthly, but not less than quarterly, to determine the level of the allowance
for loan losses. This evaluation takes into consideration the classification of
loans and the application of loss estimates attributable to these
classifications. The Company classifies loans as pass, watch, special mention,
substandard, doubtful, or loss based on classification criteria believed by
management to be consistent with the criteria applied by regulatory agencies and
consistent with sound banking practices. These classifications and loss
estimates take into consideration all sources of repayment, underlying
collateral, the value of such collateral, current and anticipated economic
conditions, trends, and uncertainties and the historical accuracy of specific
reserves attached to loans with serious perceived weakness. Additionally, the
Company utilizes "migration analysis" as another means to assist management in
estimating the level of the allowance for loan losses. Migration analysis is a
statistical method which examines historic charge-off and classification trends
prior to charge-off to estimate potential losses inherent in the loan portfolio.
The above processes provide management with a reasonable basis to estimate
27
<PAGE>
the risk both actual and inherent in the portfolio. In addition, the Company
utilizes a comprehensive program that considers numerous variables, of which
migrations is one, to determine the adequacy of the allowance for loan losses
for reserves nonspecific to certain credits. This program is consistent with
methodologies in Banking Circular 201. Amongst others, consideration is given to
historical and current trends in past due loans, charged-off loans, nonaccruals,
and the nature and mix of the loan portfolio; and local, regional, industry, and
national economic trends in determining loan loss adequacy. Finally, credit
administration, corresponding loan policies and procedures, and timely problem
loan identification are integral to a sound determination of the allowance for
loan losses. Based on information available at December 31, 1996, management was
of the opinion that a $2,253,000 allowance for loan losses, which constitutes
2.42% of total loans, was adequate as an allowance against probable and
estimable losses.
While the Company's policy is to charge-off in the current period those
loans for which a loss is considered probable, there also exists the risk of
future losses which cannot be precisely quantified or attributed to particular
loans. As this risk is continually changing in response to factors beyond the
control of the Company, such as the state of the economy, management's judgment
as to the adequacy of the allowance for loan losses in future periods, while
approximate, is in part based on a reasonable methodology. In addition, various
regulatory agencies, as an integral part of their examination process, review
the Company's allowance for loan losses. Such agencies may require the Bank to
record additions or deletions to the allowance based on their judgments of
information available to them at the time of their examination.
The following tables provide a summary of the Company's allowance for
loan losses and charge-off and recovery activity.
<TABLE>
<CAPTION>
December 31,
------------------------------------------
(in thousands) 1996 1995 1994 1993 1992
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Allowance for Loan Losses:
Balance at beginning of period $1,070 $ 983 $1,048 $ 900 $ 801
Provision for loan losses 4,136 1,539 703 253 903
Charge-offs:
Commercial 3,118 1,166 701 176 407
Real estate secured commercial 154 396 -- -- 211
Equity lines of credit -- -- 71 -- 116
Other lines of credit 57 16 13 40 23
Installment 24 11 95 -- 60
Lease financing -- -- -- -- 11
------ ------ ------ ------ ------
Total charge-offs 3,353 1,589 880 216 828
------ ------ ------ ------ ------
Recoveries:
Commercial 308 113 91 111 19
Real estate secured commercial 81 22 -- -- --
Equity lines of credit 9 -- -- -- --
Other lines of credit 2 2 3 -- 5
Installment -- -- 18 -- --
Lease financing -- -- -- -- --
------ ------ ------ ------ ------
Total recoveries 400 137 112 111 24
------ ------ ------ ------ ------
Net charge-offs 2,953 1,452 768 105 804
------ ------ ------ ------ ------
Balance at end of period $2,253 $1,070 $ 983 $1,048 $ 900
====== ====== ====== ====== ======
</TABLE>
28
<PAGE>
<TABLE>
<CAPTION>
December 31,
---------------------------------------------------------------
(in thousands) 1996 1995 1994 1993 1992
------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Loans outstanding at end of period $93,133 $100,085 $103,745 $117,803 $115,851
Average loans outstanding 97,147 100,985 111,446 115,421 99,590
Net charge-offs to average loans 3.04% 1.45% 0.69% 0.09% 0.81%
Allowance for loan losses:
to total loans 2.42 1.07 0.95 0.89 0.78
to nonperforming loans/(1)/ 148.13 25.65 36.91 43.70 55.45
to nonperforming assets/(1)/ 125.66 25.11 35.50 41.85 55.45
</TABLE>
/(1)/ Nonperforming loans and nonperforming assets do not include accruing loans
90 days or more past due.
The following table shows the historical allocation of the Company's
allowance for loan losses and the percent of loans in each category to total
loans at the dates indicated.
<TABLE>
<CAPTION>
December 31,
--------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
Allowance Allowance Allowance Allowance Allowance
for Loan % of for Loan % of for Loan % of for Loan % of for Loan % of
(in thousands) Losses Loans Losses Loans Losses Loans Losses Loans Losses Loans
--------- ----- --------- ----- --------- ----- --------- ----- --------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial $1,584 79% $ 711 77% $587 80% $ 797 80% $576 77%
Real estate secured commercial 237 11 46 13 76 9 122 8 23 10
Equity lines of credit 150 7 118 6 220 7 61 7 63 7
Other lines of credit 24 2 7 2 7 2 12 2 12 2
Installment 5 1 5 2 5 2 7 2 20 3
Lease financing -- -- -- -- 1 -- 1 1 2 1
Unallocated 253 -- 183 -- 87 -- 48 -- 204 --
------ --- ------ --- ---- --- ------ --- ---- ---
Total $2,253 100% $1,070 100% $983 100% $1,048 100% $900 100%
====== === ====== === ==== === ====== === ==== ===
</TABLE>
The Company had approximately $1,894,000 in impaired loans as of
December 31, 1996. The carrying value of impaired loans for which there is a
related allowance for loan losses was $700,000, with the amount of specific
allowance for loan losses allocated to these loans of $379,000. There were
$1,194,000 in impaired loans for which there was no related specific allowance
for loan losses. However, general allowance consistent with the level of
allowance for similar loans with similar risk characteristics were maintained
for impaired loans without specific allowance. The average recorded investment
in impaired loans during 1996 was $4,161,000 and income recorded utilizing the
cash basis and accrual basis method of accounting was $53,000. Nonaccrual loans
at December 31, 1996, included $1,521,000 of impaired loans.
The Company had approximately $5,240,000 in impaired loans as of
December 31, 1995. The carrying value of impaired loans for which there is a
related allowance for loan losses was $2,629,000, with the amount of specific
allowance for loan losses allocated to these loans of $311,000. There were
$2,607,000 in impaired loans for which there was no related specific allowance
for loan losses. The average recorded investment in impaired loans during 1995
was $4,200,000 and income recorded utilizing the cash basis and accrual basis
method of accounting was $91,000.
At December 31, 1996, the Company had troubled debt restructurings
totaling $778,000, of which $510,000 was on nonaccrual. The remaining $268,000
was performing according to the renegotiated terms. The gross interest income
that would have been recorded in 1996 on troubled debt restructurings if the
loans had been current in accordance with the original terms totaled $70,000,
which includes $41,000 on the
29
<PAGE>
restructured loans on nonaccrual. The amount of interest income actually
recognized in 1996 on those loans totaled $29,000. At December 31, 1996, there
were no additional loan commitments outstanding to borrowers of troubled debt
restructurings.
At December 31, 1995, the Company had troubled debt restructurings
totaling $1,167,000 of which $104,000 was on nonaccrual. The remaining
$1,063,000 was performing according to the renegotiated terms. The gross
interest income that would have been recorded in 1995 on troubled debt
restructurings if the loans had been current in accordance with the original
terms totaled $140,000 which includes $13,000 on the restructured loans on
nonaccrual. The amount of interest income actually recognized in 1995 on those
loans totaled $91,000. At December 31, 1995, there were no additional loan
commitments outstanding to borrowers of troubled debt restructurings.
SECURITIES
The average yield on the Company's securities was 6.29% in 1996
compared with 6.47% in 1995 and 5.58% in 1994. The decrease in yield in 1996 was
due to restructuring of the securities portfolio in order to better meet the
Company's liquidity needs. Securities sold in connection with the restructuring
during 1996 resulted in a net loss of approximately $71,000.
The following table sets forth the carrying value of securities
available-for-sale at the dates indicated.
<TABLE>
<CAPTION>
December 31,
---------------------------
(in thousands) 1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
U.S. Treasury securities $ -- $ -- $14,534
U.S. Government Agency
mortgage-backed securities 35,786 42,124 3,620
Small Business Administration securities 1,742 1,975 --
Collateralized mortgage obligations 16,940 37,421 28,849
------- ------- -------
Total $54,468 $81,520 $47,003
======= ======= =======
</TABLE>
The following table sets forth the maturities of securities available-
for-sale at December 31, 1996 and the weighted average yields of such
securities. Borrowers may have the right to prepay obligations with or without
prepayment penalties. This right may cause actual maturities to differ from the
contractual maturities summarized below. Collateralized mortgage obligations
often have stated maturities of over ten years but are subject to prepayments
which accelerate actual maturities. See Notes 1 and 3 of Notes to Consolidated
Financial Statements for further information about the available-for-sale
portfolio.
<TABLE>
<CAPTION>
Maturing
---------------------------------------------------------------------------------------------
After One After Five
Within Through Through After
One Year Five Years Ten Years Ten Years Total
(in thousands) Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
-------- ----- ---------- ----- ---------- ----- --------- ----- ------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Securities Available-for-Sale:
U.S. Government Agency
mortgage-backed securities $ -- --% $ -- --% $ -- --% $35,786 6.14% $35,786 6.14%
Small Business Administration
securities -- -- -- -- -- -- 1,742 7.00 1,742 7.00
Collateralized mortgage obligations -- -- -- -- -- -- 16,940 6.10 16,940 6.10
---- ---- ---- ------- -------
Total $ -- --% $ -- --% $ -- --% $54,468 6.15% $54,468 6.15%
==== ==== ==== ======= =======
</TABLE>
30
<PAGE>
The following table sets forth the amortized cost of securities
held-to-maturity.
<TABLE>
<CAPTION>
December 31,
------------------------------
(in thousands) 1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
U.S. Treasury securities $ 3,064 $ 3,074 $ 3,084
U.S. Government Agency securities 3,250 3,749 4,249
U.S. Government Agency
mortgage-backed securities 35,119 41,263 107,945
Collateralized mortgage obligations - - 5,026
Federal Reserve Bank stock 439 431 431
-------- -------- --------
Total $ 41,872 $ 48,517 $120,735
======== ======== ========
</TABLE>
The following table sets forth the maturities of securities held-to-
maturity at December 31, 1996 and the weighted average yields of such
securities. Borrowers may have the right to prepay obligations with or without
call or prepayment penalties. This right may cause actual maturities to differ
from the contractual maturities summarized below. Mortgage-backed securities
generally have stated maturities of over ten years but are subject to likely and
substantial prepayments which effectively accelerate actual maturities. See
Notes 1 and 3 of Notes to Consolidated Financial Statements for further
information about the held-to-maturity portfolio.
<TABLE>
<CAPTION>
Maturing
-------------------------------------------------------------------------------------------------
After One After Five
Within Through Through After
One Year Five Years Ten Years Ten Years Total
(in thousands) Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Securities Held-to-Maturity:
U.S. Treasury securities $ - -% $ 1,028 6.81% $ 2,036 5.89% $ - -% $ 3,064 6.20%
U.S. Government Agency securities - - - - 3,250 5.65 - - 3,250 5.65
U.S. Government Agency
mortgage-backed securities - - - - 744 6.21 34,375 6.47 35,119 6.46
Federal Reserve Bank stock - - 439 6.00 - - - - 439 6.00
----- -------- -------- ------- ----------
Total $ - -% $ 1,467 6.57% $ 6,030 5.80% $34,375 6.47% $ 41,872 6.37%
===== ======== ======== ======= ==========
</TABLE>
31
<PAGE>
Deposits and Short-term Borrowings
The Company attracts deposits primarily from individuals and businesses
related to the health care services industry. The Company has no brokered
deposits and the Company's current practice is to not purchase brokered
deposits. The Company has no known foreign deposits. The average daily amount of
deposits and interest rates paid on deposits is summarized below.
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------------------------------
1996 1995 1994
---------------------- --------------------- -------------------
Average Average Average
(in thousands) Balance Rate Balance Rate Balance Rate
-------- ---- ---------- ------- -------- ----
<S> <C> <C> <C> <C> <C> <C>
Noninterest-bearing transaction accounts $ 81,869 -% $ 85,116 -% $ 88,359 -%
Interest-bearing transaction accounts 13,247 0.72 14,396 0.73 14,907 0.72
Savings and money market accounts 98,363 1.72 113,974 1.72 126,678 1.71
-------- -------- --------
111,610 1.60 $128,370 1.61 141,585 1.61
-------- -------- --------
Time deposits:
Less than $100,000 9,936 4.55 10,713 4.29 9,774 3.17
More than $100,000 39,129 4.98 63,926 5.20 27,923 3.60
-------- -------- --------
Total time deposits 49,065 4.89 74,639 5.07 37,697 3.49
-------- -------- --------
Total deposits $242,544 1.73% $288,125 2.03% $267,641 1.34%
======== ======== ========
</TABLE>
Time deposits of $100,000 or more are generally received from the Company's
medical and professional client base. The impact on the Company's liquidity from
the potential withdrawal of these deposits is considered in the Company's
asset/liability management policies, which anticipates the Company's liquidity
needs through the management of investments, federal funds sold, and/or by
generating additional deposits.
The table below sets forth the remaining maturities of time deposits of
$100,000 or more at December 31, 1996:
<TABLE>
<CAPTION>
(in thousands) December 31, 1996
-----------------
<S> <C>
Three months or less $19,321
Over three through six months 2,815
Over six through twelve months --
Over twelve months --
-------
Total $22,136
=======
</TABLE>
A significant amount of the Company's time deposits are in accounts with
balances of more than $100,000. At December 31, 1996, there were 477 such time
deposit accounts with balances totaling $157,611,000. These accounts are
reviewed for purposes of monitoring the Company's liquidity. While increased
volatility to the Company's deposit base may be present in this group of
accounts, the investment management practices of the Company consider such
potential volatility.
The Company also uses repurchase agreements from time to time as an
additional source of funds. On December 31, 1996 and 1995, there were no
repurchase agreements outstanding.
32
<PAGE>
The following table sets forth certain information with respect to the
Company's repurchase agreements for the periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------
(in thousands) 1996 1995 1994
------ ------ ------
<S> <C> <C> <C>
Maximum daily amount outstanding $17,929 $41,773 $ 30,093
Average amount outstanding 3,422 3,458 4,469
Average interest rate 5.41% 5.90% 3.50%
</TABLE>
Capital Resources
The Office of the Comptroller of the Currency ("OCC"), the Bank's primary
regulator, has established minimum leverage ratio guidelines for national banks.
These guidelines provide for a minimum Tier 1 capital leverage ratio (Tier 1
capital to adjusted average total assets) of 3.0% for national banks that meet
certain specified criteria, including having the highest regulatory rating. All
other national banks will generally be required to maintain a minimum Tier 1
capital leverage ratio of 3.0% plus an additional cushion of 100 to 200 basis
points. The OCC has not advised the Bank of any specific minimum Tier 1 capital
leverage ratio applicable to it.
The FRB, as Bancorp's primary regulator, has similarly established minimum
leverage ratio guidelines for bank holding companies. These guidelines also
provide for a minimum Tier 1 leverage ratio of 3.0% for bank holding companies
that meet certain specified criteria, including having the highest regulatory
rating. All other bank holding companies will generally be required to maintain
a minimum Tier 1 capital leverage ratio of 3.0% plus an additional cushion of
100 to 200 basis pints. The FRB has not advised the Company of any specific
minimum Tier 1 capital leverage ratio applicable to it.
Risk-based capital standards were implemented on December 31, 1992. Since
December 31, 1992, banking organizations have been expected to meet a minimum
ratio for qualifying total capital to risk-weighted assets of 8.0%, 4.0% of
which must be Tier 1 capital. A banking organization's risk-based capital ratios
are obtained by dividing its qualifying capital by its total risk-adjusted
assets and risk-weighted off-balance-sheet items.
Although the Company and the Bank at December 31, 1996 were considered well
capitalized and exceeded all applicable minimum capital requirements, the
capital requirements of the federal banking regulators could limit the Company's
future growth if the Company were to rely solely on the retention of earnings to
generate additional capital or rapid growth. The Company completed a $5.75
million convertible note offering in May 1994. The interest rate is 8.5% to
March 1998 at which time the rate resets at 150 basis points over the 5 year
Constant Maturity Treasury Index. The conversion price of the notes is $12.6984
per share and is scheduled to mature in March 2004. Of the proceeds, $3.6
million was invested in First Professional Bank in order to increase the Bank's
regulatory capital ratios and allow the Bank to grow, within the bounds of
safety and soundness. $930,000 of the proceeds were used to retire the Company's
remaining indebtedness as required by a stock repurchase agreement.
33
<PAGE>
The following table sets forth the minimum required federal capital ratios
for a bank holding company and bank, and various federal regulatory capital
ratios of the Company and the Bank at December 31, 1996.
<TABLE>
<CAPTION>
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
------------------------ -------------------------- ---------------------------
(in thousands) Amount Ratio Amount Ratio Amount Ratio
-------- ---------- ----------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Company
Leverage/1/ $14,477 5.80% $ 9,987 4.00% $12,483 5.00%
Tier 1 Risk-Based 14,477 11.10 5,216 4.00 7,824 6.00
Total Risk-Based 21,456 16.45 10,432 8.00 13,040 10.00
Bank
Leverage $18,962 7.62% $ 9,951 4.00% $12,438 5.00%
Tier 1 Risk-Based 18,962 14.64 5,181 4.00 7,771 6.00
Total Risk-Based 20,589 15.90 10,362 8.00 12,952 10.00
</TABLE>
/1/ The minimum required by the FRB is 3%; for all but the most highly-rated
bank holding companies, the FRB expects a leverage ratio of 3% plus 100 to 200
basis points.
Warrants
In connection with a private placement of common stock (the "Private
Placement"), the Company issued (i) a warrant to Robert H. Leshner, principal of
the placement agent, to purchase 110,250 shares of Common Stock (the "Leshner
Warrant") and (ii) warrants to each of Andrew E. Haas and Curtis Swindal to
purchase 13,781 shares of Common Stock, each at a purchase price of $12.70 per
share exercisable in full on or after December 31, 1994 and before December 31,
2002. The Company agreed to grant the holders of the shares issued upon exercise
of the warrant ("Warrant Shares") the right, on two occasions during the five-
year period beginning December 31, 1994, to require the Company to register (the
"Demand Registration") the Warrant Shares under the Act. The Company will pay
the expenses of one Demand Registration. In addition, the holders of the Warrant
Shares will have the right during the period December 31, 1994 to December 31,
1997 to have the Warrant Shares included in registrations of the Common Stock
under the Act at the expense of the Company. Assuming the Demand Registration
could be filed under a Form 3, such expense would be minimal. See Note 8 of
Notes to Consolidated Financial Statements.
Under the terms of the Leshner Warrant, if Dr. Joel W. Kovner, former
Chairman of the Board and Chief Executive Officer of the Company, dies before
December 31, 2002, then the Company will purchase, at the option of Mr. Leshner,
some or all of the warrants and/or Warrant Shares then owned by Mr. Leshner,
provided that (i) the maximum aggregate purchase price paid by the Company shall
be not more than $1,000,000 and (ii) the funds to purchase such warrants and/or
Warrant Shares shall come solely from the proceeds of the key person insurance
policy on Dr. Kovner. Since such life insurance is in excess of the cash value
recognized on the Company's balance sheet, there would be no net reduction in
capital nor any impact on liquidity. Furthermore, if at any time prior to
December 31, 2002, Mr. Leshner wishes to sell some or all of the warrants and/or
Warrant Shares to a third party, Mr. Leshner must offer to sell such warrants
and/or Warrant Shares to the Company on the same terms and conditions being
offered to such third party. Another term of the Leshner Warrant restricts the
Company's ability to issue certain types of preferred stock which would entitle
the holders thereof to receive dividends or distributions of assets which vary
in amount with the Company's performance.
34
<PAGE>
Interest Rate Sensitivity
An interest rate sensitive asset or liability is one that, within a defined
time period, either matures or can experience an interest rate change. As
interest rate sensitive assets and liabilities have various repricings and
maturities, changes in interest rates may increase or decrease the Bank's net
interest income. This exposure to changes in interest rates is measured among
other methodologies by an institutions "gap," or the difference between interest
rate sensitive assets and interest rate sensitive liabilities within specified
periods of time.
An excess of maturing or repricing assets over maturing or repricing
liabilities during a given period will serve to increase net interest income in
a rising rate environment and decrease net interest income when interest rates
decline. In a rising interest rate environment, the assets will reprice at
current interest rates earlier than the liabilities thus increasing the Bank's
net interest margin. Conversely, when maturing or repricing liabilities exceed
maturing or repricing assets during a given period, a rising interest rate
environment generally will reduce the Bank's net interest margin.
The following table sets forth the distribution of the Company's interest
rate sensitive assets and liabilities as of December 31, 1996. The table also
sets forth the time period in which assets and liabilities will mature or
reprice in accordance with their contractual terms. Mortgage-backed securities
provide cash flows on a monthly basis; however, this analysis does not include
prepayment assumptions. Prepayments assumptions are utilized in an interest rate
simulation model which is routinely used by the Company in evaluating the impact
of changes in interest rates on the Bank's net interest income.
<TABLE>
<CAPTION>
As of December 31, 1996
----------------------------------------------------------------------------------
After Three After One
Next Day Months Year After
through Three through 12 through Five Five
(in thousands) Immediately Months Months Years Years Total
----------- ------------- ------------ ------------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Loans/1/ $ 84,711 $ 1,578 $ 790 $ 3,564 $ 969 $ 91,612
Investment securities -- 15,368 48,846 14,088 18,037 96,339
Federal funds sold 33,400 -- -- -- -- 33,400
Due from banks 238 -- 380 -- -- 618
--------- --------- --------- --------- --------- ---------
Total interest-earning assets $ 118,349 $ 16,946 $ 50,016 $ 17,652 $ 19,006 $ 221,969
========= ========= ========= ========= ========= =========
Interest-bearing transaction
accounts $ 14,886 $ -- $ -- $ -- $ -- $ 14,886
Savings accounts 98,859 -- -- -- -- 98,859
Time deposits -- 25,741 5,528 54 -- 31,323
Convertible notes -- -- -- 4,869 -- 4,869
--------- --------- --------- --------- --------- ---------
Total interest-bearing liabilities $ 113,745 $ 25,741 $ 5,528 $ 4,923 $ -- $ 149,937
========= ========= ========= ========= ========= =========
Interest sensitive Gap $ 4,604 $ (8,795) $ 44,488 $ 12,729 $ 19,006
Effect of interest rate swaps (15,000) 15,000 -- -- --
--------- --------- --------- --------- ---------
Hedged Gap $ (10,396) $ 6,205 $ 44,488 $ 12,729 $ 19,006
Hedged Gap as a percentage
of earning assets -5% 3% 20% 6% 9%
Cumulative hedged Gap $ (10,396) $ (4,191) $ 40,297 $ 53,026 $ 72,032
Cumulative hedged Gap as a
percentage of earning assets -5% -2% 18% 24% 32%
</TABLE>
/1/ Loans exclude $1,521,000 in nonaccrual loans
35
<PAGE>
In January 1993, in order to lock in a higher rate of return, the Company
entered into two interest rate exchange agreements (swaps). These interest rate
exchange agreements have a total aggregate notional amount of $40,000,000. Under
the terms of these swaps, the Company received a fixed rate of 7.21% for a
three-year period while the Company paid the prime rate over the same term. Due
in part to these swaps, the Company's net interest margin for 1993 increased to
4.95%. During 1994, as interest rates rose, the Company began paying more on
these swaps than it received and while the Company's net interest margin
continued to rise. These swaps terminated in January 1996.
In addition, the Company desired to maintain the existing spread between a
portion of its repricing liabilities and its repriceable assets and
subsequently, entered into an interest rate exchange agreement in May 1994 with
a notional amount of $15,000,000. This swap is intended to protect against the
rise of deposit costs relative to the prime rate. Under the terms of the basic
swap, for a period of five years, the Company pays an interest rate of prime
rate less 190 basis points while receiving the three-month London Interbank
Offered Rate ("LIBOR"). Because the Company's repricing liabilities typically
move to a lesser degree than does the three-month LIBOR, the terms of the
original swap included limits on the interest rate to be received by the
Company. This feature of the swap required mark-to-market accounting and the
Company terminated this feature of the swap and recorded a pre-tax expense of
$385,000 in 1994. Although this swap reduces current earnings, the management of
the Company believes this reduction in earnings is justified by the protection
against a narrowing spread.
As additional protection against lower interest rates, in December 1994 and
January 1995, the Company entered into three interest rate floor contracts with
a notional amount of $60,000,000. The agreements entitled the Company to receive
from counterparties on a monthly basis the amounts, if any, by which the one-
month LIBOR rate falls below 6%. The floor agreements were for a period of three
years. The average premium paid for the floor agreements was approximately 20
basis points or $120,000, and was being amortized over three years. In May 1995,
the Company sold the floor contracts for total consideration of $722,500. This
amount is being amortized over the original three year term.
In order to protect the fair value of a portion of the Company's GNMA
variable rate securities, in December 1995, the Company purchased two interest
rate caps with a notional amount $10,000,000 each. The agreements entitled the
Company to receive from counterparties on a quarterly basis the amounts, if any,
by which the one year CMT rate rises above 6.50% for one of the agreements and
6.75% on the other. The cap agreements are for a period of three years. The
average premium paid for the cap agreements was 63.5 basis points or $127,000,
which is being amortized over the three year period.
Liquidity
Adequate liquidity and maintenance of an appropriate balance between
interest rate sensitive earning assets and interest rate sensitive liabilities
are the principal imperatives associated with the asset/liability management
function of a financial institution. Liquidity management involves the ability
to meet the cash flow requirements of clients who may be depositors desiring to
withdraw funds or borrowers requiring assurance that sufficient funds will be
available to meet their credit needs. Aside from asset/liability management, the
Company maintains short-term sources of funds to meet periodic planned and
unplanned increases in loan demand and deposit withdrawals and maturities.
The initial source of liquidity is the excess funds sold daily to other
banks in the form of federal funds. In addition to cash and cash equivalents,
the Company maintains a large percentage of its assets in investment securities.
These securities include both securities available-for-sale and securities held-
to-maturity. Securities available-for-sale can be sold in response to liquidity
needs or used as collateral under reverse repurchase agreements. Securities
held-to-maturity are available for liquidity needs solely as
36
<PAGE>
collateral for reverse repurchase agreements. The Company had no reverse
repurchase agreements on December 31, 1996 and 1995. As evidence of the
Company's high level of liquidity at December 31, 1996, cash and cash
equivalents totaled $66,340,000, while securities available for reverse
repurchase agreements totaled approximately $93,275,000. The combined amount of
$159,615,000 represents approximately 61% of the Company's total assets.
Management is of the opinion that the existing level of liquidity and borrowing
capacity is sufficient to insulate the Bank against unforeseen liquidity
demands.
On a stand-alone basis, the Company's primary source of liquidity is
dividends from the Bank. Dividends by the Bank to the Company are subject to
regulatory restrictions. For further information on the Bank's dividend
restrictions, see "Business - Supervision and Regulation - Restrictions on
Dividends and Other Distributions" and Note 11 of Notes to Consolidated
Financial Statements.
37
<PAGE>
Item 8. Financial Statements and Supplementary Data
- -----------------------------------------------------
The Company's Financial Statements are identified in Item 14(a) below.
Item 9. Changes in and Disagreements with Accountants on Accounting and
- -------------------------------------------------------------------------
Financial Disclosure
- --------------------
None
PART III
Item 10. Directors and Executive Officers of the Registrant
- ------------------------------------------------------------
The information requested by Item 10 is provided in the section entitled
"COMPENSATION TABLES" of the Proxy Statement for the 1997 Annual Meeting of the
Shareholders to be filed with the Commission within 120 days of the end of the
Company's fiscal year and which is incorporated herein by this reference.
Item 11. Director and Executive Officer Compensation
- -----------------------------------------------------
The information requested by Item 11 is provided in the section entitled
"COMPENSATION TABLES" of the Proxy Statement for the 1997 Annual Meeting of the
Shareholders to be filed with the Commission within 120 days of the end of the
Company's fiscal year and which is incorporated herein by this reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
- ------------------------------------------------------------------------
The information requested by Item 12 is provided in the section entitled
"SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT" of the Proxy
Statement for the 1997 Annual Meeting of the Shareholders to be filed with the
Commission within 120 days of the end of the Company's fiscal year and which is
incorporated herein by this reference.
Item 13. Certain Relationships and Related Transactions
- --------------------------------------------------------
The information requested in Item 13 is provided in the section entitled
"INTEREST OF MANAGEMENT AND OTHERS IN CERTAIN TRANSACTIONS" of the Proxy
Statement for the 1997 Annual Meeting of the Shareholders to be filed with the
Commission within 120 days of the end of the Company's fiscal year and which is
incorporated herein by this reference.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
- ---------------------------------------------------------------------------
(a) Financial Statements
See Index to Financial Statements of Professional Bancorp, Inc. and
Subsidiary which is part of this Form 10-K.
(b) Reports on Form 8-K
During the fourth quarter of 1996, the Company did not file any
Current Reports on Form 8-K.
(c) Exhibits
38
<PAGE>
Exhibit No.
- -----------
3.1 Articles of Incorporation (filed as Exhibit 3.3 to Bancorp's
1989 10-K Report and incorporated herein by this reference).
3.2 Bylaws adopted April 25, 1990, as amended July 25, 1990 (filed
as Exhibit 3.2 to Bancorp's 1995 10-K/A Report filed on June 3,
1996 and incorporated herein by this reference).
3.3 Amendment to Articles of Incorporation, dated September 8, 1992
(filed as Exhibit 3.3 to Bancorp's 1995 10-K/A Report filed on
June 3, 1996 and incorporated herein by this reference).
4.1 Warrant to purchase 100,000 shares of Common Stock dated 12-31-
92, issued to Robert H. Leshner (filed as Exhibit 4.1 in
Bancorp's 1992 10-K Report and incorporated herein by this
reference).
10.1* 1982 Stock Option Plan and Agreement (filed as Exhibit 10(b) to
Bancorp's Registration Statement on Form S-1, File No. 2-76371
filed March 8, 1982, and incorporated herein by this reference).
10.2* Indemnity Agreement entered into with directors and certain
officers dated October 25, 1989 (filed as Exhibit 10.11 to
Bancorp's 1995 10-K/A Report filed on June 3, 1996 and
incorporated herein by this reference).
10.3* 1990 Stock Option Plan (filed as Exhibit 28.A in Bancorp's 1990
10-K Report on Form 8, Amendment No. 1 dated April 29, 1991 and
incorporated herein by this reference).
10.4* 1992 Stock Option Plan (filed as Exhibit A in Bancorp's 1992
Proxy Statement and incorporated herein by this reference).
10.5* Stock repurchase agreement (filed as Exhibit 10.1 in Form 8-K,
dated December 18, 1990 and incorporated herein by this
reference).
10.6 Consulting Agreement dated as of August 12, 1996 between
Bancorp, First Professional Bank, N.A. and Network Health
Financial Services.
10.7* Salary Continuation Agreement entered into between the Bank and
Joel W. Kovner dated May 1, 1992 (filed as Exhibit 10.25 to
Bancorp's 1992 10-K Report and incorporated herein by this
reference).
10.8 Settlement Agreement dated as of July 8, 1996 among Bancorp, the
Bank, the Shareholders Protective Committee and certain officers
and directors (filed as Exhibit 1 to Bancorp's Form 8-k filed
July 22, 1996 and incorporated herein by this reference).
10.9 Lease for premises at 606 Broadway, Santa Monica, California
(filed as Exhibit 10(a) to Bancorp's Registration Statement on
Form S-1, File No. 2-76371 filed March 8, 1982 and incorporated
herein by this reference).
10.10 Lease for premises at 520 Broadway, Santa Monica, California
(filed as Exhibit 10.5 in Bancorp's 1983 10-K Report and
incorporated herein by this reference).
10.11 Lease for premises at 8600 West 3rd Street, Suite #1, Los
Angeles, California (filed as Exhibit 10.6 in Bancorp's 1983
10-K Report and incorporated herein by this reference.
39
<PAGE>
10.12 Lease for second floor premises and extension of lease of entire
premises at 606 Broadway, Santa Monica, California (filed as
Exhibit 10.8 in Bancorp's 1984 10-K Report and incorporated
herein by this reference).
10.13 Lease for premises at 9629 Brighton Way, Beverly Hills,
California (filed as exhibit 10.9 in Bancorp's 1984 10-K Report
and incorporated herein by this reference).
10.14 Lease for premises at 5525 Etiwanda Street, Tarzana, California
(filed as Exhibit 10.8 in Bancorp's 1986 10-K Report and
incorporated herein by this reference).
10.15 Lease for premises at 55 E. California, Pasadena, California
(filed as Exhibit 10.65 in Bancorp's 1991 10-K Report and
incorporated herein by this reference).
10.16 Lease for premises at 10 North 5th Street, Redlands, California,
(filed as Exhibit 10.7 in Bancorp's 1991 10-K Report and
incorporated herein by this reference).
10.17 Lease for premises at 9900 Norwalk Boulevard, Santa Fe Springs,
California, (filed as Exhibit 10.75 in Bancorp's 1992 10-K
Report and incorporated herein by this reference).
11 Earnings (loss) per share computation.
21 Subsidiaries of the Registrant (filed as Exhibit in Bancorp's
1986 10-K Report and incorporated herein by this reference).
27 Financial Data Schedule
* Identified as a management contract or compensatory agreement pursuant to Item
14(a)# of Form 10-K.
(d) Financial Statements
All schedules are omitted because they are not required, not applicable or
because the information is included in the financial statements or notes
thereto or is not material.
40
<PAGE>
SIGNATURES
Pursuant to 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 hereunto duly authorized.
Date: March 26, 1997 PROFESSIONAL BANCORP, INC.
(Registrant)
By: /s/ Chris Chan
------------------------------
Chris Chan
Acting 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 the registrant and in
the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
/s/ Richard A. Berger Director March 26, 1997
- ------------------------------ --------------
Richard A. Berger
/s/ Alan S. Borstein Director March 26, 1997
- ------------------------------ --------------
Alan S. Borstein
/s/ Ronald L. Katz, M.D. Director March 26, 1997
- ------------------------------ --------------
Ronald L. Katz, M.D.
/s/ Joel S. Moskowitz, J.D. Director March 26, 1997
- ------------------------------ --------------
Joel S. Moskowitz, J.D.
/s/ Ray T. Oyakawa, M.D. Director March 26, 1997
- ------------------------------ --------------
Ray T. Oyakawa, M.D.
/s/ Lynn O. Poulson, J.D. Director March 26, 1997
- ------------------------------ --------------
Lynn O. Poulson, J.D.
/s/ Julie P. Thompson Chairman of the Board March 26, 1997
- ------------------------------ --------------
Julie P. Thompson Director
</TABLE>
41
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Independent Auditors' Report.......................................... 43
Consolidated Financial Statements of Professional Bancorp, Inc.
Consolidated Balance Sheets......................................... 44
Consolidated Statements of Operations............................... 45
Consolidated Statements of Changes in Shareholders' Equity.......... 46
Consolidated Statements of Cash Flows............................... 47
Notes to Consolidated Financial Statements.......................... 48
</TABLE>
42
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors of Professional Bancorp, Inc.:
We have audited the accompanying consolidated balance sheets of
Professional Bancorp, Inc. (a Pennsylvania corporation) and subsidiary as of
December 31, 1996 and 1995, and the related consolidated statements of
operations, changes in shareholders' equity and cash flows for each of the years
in the three-year period ended December 31, 1996. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Professional
Bancorp, Inc. and subsidiary as of December 31, 1996 and 1995, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 1996, in conformity with generally accepted accounting
principles.
KPMG Peat Marwick LLP
Los Angeles, California
February 4, 1997
43
<PAGE>
PROFESSIONAL BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
Notes 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Assets:
Cash and due from banks:
Non-interest bearing 2 $ 32,322,030 $ 41,791,145
Interest-bearing 617,948 1,008,528
Federal funds sold 33,400,000 42,400,000
------------ ------------
Cash and cash equivalents 66,339,978 85,199,673
Securities held-to-maturity (fair value of $41,478,000
and $48,159,000, respectively) 3 41,871,563 48,517,017
Securities available-for-sale (cost of $55,225,000 and 3 54,467,683 81,520,398
$82,396,000, respectively)
Loans, net of allowance for loan losses of $2,253,000
and $1,070,000, respectively 4, 10 90,759,161 98,944,274
Premises and equipment 5 1,611,482 1,817,982
Deferred tax asset 7 3,296,474 908,964
Accrued interest receivable and other assets 5,193,157 5,256,598
------------ ------------
$263,539,498 $322,164,906
============ ============
Liabilities:
Deposits: 3, 6
Demand, non-interest-bearing 96,208,449 $ 97,641,982
Demand, interest-bearing 14,886,488 14,474,546
Savings and money market 98,859,034 97,209,310
Time certificates of deposit 31,322,777 88,139,864
------------ ------------
Total deposits 241,276,748 297,465,702
Convertible notes 12 4,869,292 4,766,658
Accrued interest payable and other liabilities 7 3,351,864 2,424,792
------------ ------------
Total liabilities 249,497,904 304,657,152
------------ ------------
Commitments and contingent liabilities 9
Shareholders' equity: 8, 11
Common stock, $.008 par value; 12,500,000 shares
authorized; 1,410,783 and 1,388,169 issued and
1,341,316 and 1,278,988 outstanding 11,286 10,620
Additional paid-in-capital 12,488,001 11,682,751
Retained earnings 2,514,501 6,983,629
Treasury stock, at cost (69,467 and 109,181 shares) (537,251) (655,085)
Unrealized loss on securities available-for-sale, net of taxes 3 (434,943) (514,161)
------------ ------------
Total shareholders' equity 14,041,594 17,507,754
------------ ------------
$263,539,498 $322,164,906
============ ============
</TABLE>
See notes to consolidated financial statements
44
<PAGE>
PROFESSIONAL BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Year Ended December 31,
Notes 1996 1995 1994
----- ------------- ----------- -----------
<S> <C> <C> <C> <C>
Interest income
Loans 4 $ 9,030,090 $ 9,266,623 $ 9,524,744
Securities 3 7,540,804 10,395,495 7,699,495
Federal funds sold and securities purchased
under agreements to resell 1,056,214 1,227,702 571,679
Interest-bearing deposits in other banks 23,348 13,000 3,500
------------- ----------- -----------
Total interest income 17,650,456 20,902,820 17,799,418
------------- ----------- -----------
Interest expense 6
Deposits 4,187,859 5,850,106 3,592,596
Convertible notes 477,348 485,038 296,792
Federal funds purchased and securities
sold under agreements to repurchase 185,023 204,178 156,432
Stock repurchase agreement 12 - - 134,509
------------- ----------- -----------
Total interest expense 4,850,230 6,539,322 4,180,329
------------- ----------- -----------
Net interest income 12,800,226 14,363,498 13,619,089
Provision for loan losses 4 4,136,000 1,539,000 703,425
------------- ----------- -----------
Net interest income after provision for loan losses 8,664,226 12,824,498 12,915,664
------------- ----------- -----------
Other operating income
Securities transactions, net 3
Available-for-sale (71,309) 1,017,590 6,517
Trading - - (219,045)
Merchant discount 224,745 197,714 238,371
Mortgage banking fees 117,275 72,404 145,454
Service charges on deposits 668,855 756,632 700,320
Other income 504,213 408,972 439,588
------------- ----------- -----------
Total other operating income 1,443,779 2,453,312 1,311,205
------------- ----------- -----------
Other operating expenses
Salaries and employee benefits 5,944,998 5,858,779 5,475,611
Occupancy 1,386,322 1,382,103 1,428,679
Legal fees 2,754,123 798,497 658,908
Furniture and equipment 697,291 736,112 687,967
Professional services 10 930,381 605,298 536,271
FDIC assessment 1,000 321,184 576,124
Office supplies 288,397 281,183 209,211
Other assessment 298,695 270,986 258,783
Telephone 271,602 226,642 212,966
Audit, accounting and examinations 200,840 148,725 160,139
Postage 153,825 146,871 144,017
Messenger service 177,993 121,305 102,490
Imprinted checks 137,670 120,592 145,014
Donations 134,615 113,160 159,767
Meetings and business development 125,942 66,145 115,111
Settlement costs 9 1,006,000 - -
Termination of interest rate exchange contract - - 385,000
Other expense 1,035,628 891,960 836,758
------------- ----------- -----------
Total other operating expenses 15,545,322 12,089,542 12,092,816
------------- ----------- -----------
(Loss) earnings before taxes (5,437,317) 3,188,268 2,134,053
(Benefit) provision for income taxes 7 (1,712,400) 1,182,371 881,100
------------- ----------- -----------
Net (loss) earnings $ (3,724,917) $ 2,005,897 $ 1,252,953
============= =========== ===========
(Loss) earnings per share 1
Primary $ (2.84) $ 1.30 $ 0.82
Fully diluted $ (2.84) $ 1.21 $ 0.82
</TABLE>
See notes to consolidated financial statements
45
<PAGE>
PROFESSIONAL BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Years ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
Net
Treasury Unrealized
Stock and Holding Loss
Common Stock Additional Shares on Securities
-------------------- Paid-In Retained Subject to Available-
Shares Amount Capital Earnings Repurchase for-Sale Total
--------- ------- ----------- ----------- --------- --------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1994 1,247,248 $10,379 $11,322,467 $ 4,301,588 $(992,729) $ -- $14,641,705
Net unrealized holding loss on
securities available-for-sale -- -- -- -- -- (462,540) (462,540)
Net earnings -- -- -- 1,252,953 -- -- 1,252,953
--------- ------- ----------- ----------- --------- --------- -----------
Balance, December 31, 1994 1,247,248 10,379 11,322,467 5,554,541 (992,729) (462,540) 15,432,118
Conversion of notes (Note 8) 10,316 78 110,239 -- -- -- 110,317
Dividend in lieu of fractional
shares (Note 8) -- -- (3,271) -- -- -- (3,271)
Reissuance of treasury stock (Note 8) -- -- (337,644) -- 337,644 -- --
Issuance of stock dividend (Note 8) -- -- 576,809 (576,809) -- -- --
Exercise of stock options (Note 8) 21,424 163 14,151 -- -- -- 14,314
Change in net unrealized holding loss
on securities available-for-sale -- -- -- -- -- (51,621) (51,621)
Net earnings -- -- -- 2,005,897 -- -- 2,005,897
--------- ------- ----------- ----------- --------- --------- -----------
Balance, December 31, 1995 1,278,988 10,620 11,682,751 6,983,629 (655,085) (514,161) 17,507,754
Conversion of notes (Note 8) 157 1 1,699 -- -- -- 1,700
Dividend in lieu of fractional
shares (Note 8) -- -- (3,664) -- -- -- (3,664)
Reissuance of treasury stock (Note 8) -- -- (388,284) -- 388,284 -- --
Purchase of treasury stock (25,000) -- -- -- (270,450) -- (270,450)
Issuance of stock dividend (Note 8) -- -- 744,211 (744,211) -- -- --
Exercise of stock options (Note 8) 87,171 665 181,234 -- -- -- 181,899
Tax benefit on stock options exercised -- -- 270,054 -- -- -- 270,054
Change in net unrealized holding loss
on securities available-for-sale -- -- -- -- -- 79,218 79,218
Net loss -- -- -- (3,724,917) -- -- (3,724,917)
--------- ------- ----------- ----------- --------- --------- -----------
Balance, December 31, 1996 1,341,316 $11,286 $12,488,001 $ 2,514,501 $(537,251) $(434,943) $14,041,594
========= ======= =========== =========== ========= ========= ===========
</TABLE>
See notes to consolidated financial statements
46
<PAGE>
PROFESSIONAL BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended December 31,
1996 1995 1994
------------ ------------ ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net (loss) earnings $ (3,724,917) $ 2,005,897 $ 1,252,953
Adjustments to reconcile net (loss) earnings to net
cash provided by operating activities:
Depreciation and amortization 605,771 536,880 500,237
Provision for loan losses 4,136,000 1,539,000 703,425
Loss (gain) on securities available-for-sale 71,309 (1,017,590) (6,517)
Loss on trading securities -- -- 219,045
Purchases of trading account securities -- -- (8,897,969)
Sales of trading account securities -- -- 8,678,924
Amortization of convertible note expense 104,334 105,990 61,672
Amortization of interest on stock repurchase agreement -- -- 134,509
Increase in deferred tax asset (2,426,243) (223,382) (38,426)
Decrease (increase) in accrued interest receivable
and other assets 63,441 (100,343) (651,274)
Increase in accrued interest payable and other liabilities 1,197,126 1,254,331 60,164
Net amortization of premiums and discounts
on securities held-to-maturity 326,475 344,025 85,949
Net amortization of premiums and discounts
on securities available-for-sale 181,351 80,565 (54,732)
Other -- -- 14,694
------------ ------------ ------------
Net cash provided by operating activities 534,647 4,525,373 2,062,654
------------ ------------ ------------
Cash flows from investing activities:
Proceeds from maturities of securities held-to-maturity 7,332,983 12,538,223 13,650,786
Proceeds from maturities of securities available-for-sale 10,769,426 8,413,751 1,309,167
Proceeds from sales of securities available-for-sale 26,053,425 69,267,028 9,840,862
Purchases of securities held-to-maturity (1,014,004) (29,048,765) (39,578,541)
Purchases of securities available-for-sale (9,904,845) (22,965,020) (33,229,160)
Net decrease in loans 4,049,113 2,196,536 13,294,179
Purchases of bank premises and equipment, net (399,271) (706,129) (425,428)
------------ ------------ ------------
Net cash provided by (used in) investing activities 36,886,827 39,695,624 (35,138,135)
------------ ------------ ------------
Cash flows from financing activities:
Net increase (decrease) in demand deposits
and savings accounts 628,133 (30,344,282) 27,451,697
Net increase (decrease) in time certificates of deposit (56,817,087) 34,178,726 25,035,699
Net proceeds from convertible notes -- -- 4,709,312
Proceeds from exercise of stock options 181,899 14,314 --
Purchase of treasury stock (270,450) -- (930,000)
Dividend in lieu of fractional shares (3,664) (3,271) --
------------ ------------ ------------
Net cash (used in) provided by financing activities (56,281,169) 3,845,487 56,266,708
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents (18,859,695) 48,066,484 23,191,227
Cash and cash equivalents, beginning of year 85,199,673 37,133,189 13,941,962
------------ ------------ ------------
Cash and cash equivalents, end of year $ 66,339,978 $ 85,199,673 $ 37,133,189
============ ============ ============
Supplemental disclosure of cash flow information (see
notes 6, 7 and 12) - cash paid during the year for:
Interest $ 5,021,080 $ 6,618,552 $ 4,061,011
Income taxes $ 61,482 $ 1,304,804 $ 1,045,704
Supplemental disclosure of noncash items:
Pretax change in unrealized losses on securities
available-for-sale $ 117,951 $ (87,879) $ (787,438)
Transfer from held-to-maturity to available-for-sale -- $ 88,384,090 $ --
Conversion of notes (see note 12) $ 1,700 $ 110,317 $ --
Tax benefit on stock options exercised $ 270,054 -- $ --
</TABLE>
See notes to consolidated financial statements
47
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Professional Bancorp, Inc. and Subsidiary (the "Company") is engaged
in the general commercial banking business and provides a wide range of
commercial banking services primarily directed towards the professional
community. Services include those traditionally offered by commercial banks such
as checking and savings accounts; time certificates of deposit; and commercial,
consumer/installment, home equity and short-term real estate loans, with an
emphasis on cash flow lending. The service area of the Company consists of the
California counties of Los Angeles, Orange, Riverside, San Bernardino and
Ventura with a full-service office at its Santa Monica headquarters and four
full-service branches located in Beverly Hills, Tarzana, Pasadena and Redlands.
The Company directs its services towards the professional market place with a
heavy emphasis on medical practitioners, and to a lesser extent, attorneys and
accountants.
The accounting and reporting policies of the Company are in accordance
with generally accepted accounting principles and conform to general practices
within the banking industry. The preparation of these financial statements
requires management to make estimates and assumptions that effect the reported
amount of assets and liabilities, and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reported periods. The allowance for loan losses
and the deferred tax asset are material estimates subject to change.
Consolidation
The consolidated financial statements include the accounts of
Professional Bancorp, Inc. (the "Bancorp") and its wholly owned subsidiary,
First Professional Bank, N.A. (the "Bank"). All material intercompany accounts
and transactions have been eliminated in the consolidated financial statements.
Financial Instruments
Statement of Financial Accounting Standards No. 107 "Disclosures about
Fair Value of Financial Instruments" ("SFAS No. 107") requires the disclosure of
the fair value of financial instruments, whether or not recognized on the
statement of financial condition, for which it is practicable to estimate the
value. A significant portion of the Bank's assets and liabilities are financial
instruments as defined under SFAS No. 107. Fair values, estimates and
assumptions are set forth in Note 14, Fair Value of Financial Instruments.
Interest Rate Risks
The Company, as an institution with long-term assets (both loans and
investments), may experience a decrease in profitability and the value of such
assets if the general level of interest rates rise. Interest rates paid on
certain deposits may rise more quickly in a rapidly rising interest rate
environment than do interest rates on investment securities, in which case the
Company would be exposed to the risk that its cost of funds may rise more
quickly than its interest income. Changes in the general level of interest rates
affect the Company's various investment securities in differing ways. In a
declining interest rate environment, the rate at which the underlying mortgages
of mortgage-backed securities are prepaid tends to increase as borrowers
refinance their loans. If a higher than anticipated level of prepayments were to
continue for an extended period of time, there could be an adverse effect on the
level of the Company's outstanding securities. Securities held in the Company's
available-for-sale portfolio are reported at fair value, with unrealized gains
and losses, net of taxes, excluded from earnings and reported as a separate
component of shareholders' equity. In a rising interest rate environment,
unrealized losses may negatively affect the Company's shareholders' equity from
quarter to quarter.
48
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Concentration of Credit Risk
Concentrations of credit risk exist for groups of borrowers when they
have similar economic characteristics that would cause their ability to meet
contractual obligations to be similarly affected by changes in economic or other
conditions. The ability of the Bank's borrowers to repay their commitments is
contingent on several factors, including the economic conditions in the
borrowers' geographic area and the individual financial condition of the
borrowers. The Bank's lending activities are primarily conducted in Southern
California. The Bank currently focuses on the origination of commercial loans to
health care organizations ranging from single practitioners to large multi-
specialty medical groups. Ongoing changes in the delivery of health care could
negatively impact certain borrowers. The Bank has several loans and loan
commitments to individual clients that total between $2,000,000 and the Bank's
legal lending limit of approximately $3.2 million.
Statement of Cash Flows
For purposes of reporting cash flows, cash and cash equivalents include
cash on hand, amounts due from banks and federal funds sold. Generally, federal
funds are purchased and sold for one day periods.
Securities
The Company classifies its investment in debt and equity securities as
held-to-maturity, available-for-sale or trading securities, as applicable.
Securities held-to-maturity are those debt securities for which the Company has
the ability and intent to hold until maturity. Trading securities are acquired
and sold to benefit from short-term movements in market prices. All other
securities are classified as available-for-sale. All securities are under the
control of the Company.
Securities held-to-maturity are recorded at amortized cost, adjusted
for the amortization or accretion of premiums or discounts. Trading securities
are carried at fair value and are recorded as of their trade dates. Gains or
losses on trading securities, both realized and unrealized, are recognized
currently in income. Securities classified as available-for-sale are recorded at
fair value with any unrealized gains or losses, net of taxes, reflected as an
addition or reduction of shareholders' equity. Unrealized losses on securities,
reflecting a decline in value judged to be other than temporary, are charged to
income in the consolidated statements of operations.
Premiums and discounts are amortized or accreted over the life of the
related securities held-to-maturity and available-for-sale as an adjustment to
yield using the interest method. Interest income is recognized when earned.
Realized gains and losses on securities are included in operations and are
derived using the specific identification method for determining the cost of the
securities sold.
In December 1995, the Company reclassified securities with a book value
of $88.4 million and fair value of $88.5 million from the held-to-maturity
classification to available-for-sale pursuant to a pronouncement of the
Financial Accounting Standards Board.
49
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Securities Purchased Under Agreements to Resell and Securities Sold
Under Agreements to Repurchase
The Bank purchases securities under agreements to resell and sells
securities under agreements to repurchase. The agreements have a duration of one
business day and are fully collateralized. Securities purchased under resale
agreements are recorded as short-term investments, while securities sold under
repurchase agreements are recorded as short-term obligations. At December 31,
1996 and 1995, the Bank had no such agreements.
Derivatives
The Bank enters into interest rate exchange agreements and cap and
floor agreements for protection against future fluctuations in the interest
rates of specifically identified assets or liabilities. Interest rate swap
agreements are used to lock in a specific return on its loan portfolio. Interest
rate floor agreements are used to reduce the potential impact of lower interest
rates which would reduce the interest income on loans and on certain securities.
Interest rate cap agreements are used to reduce the potential impact of rising
interest rates which would reduce the interest income on certain securities.
Interest rate swap agreements and interest rate cap and floor agreements are
accounted for as hedges. Gains or losses on the sales of such agreements are
deferred and transferred into interest income or expense over the maturity
period of the agreement. Net interest income (expense) resulting from the
differential between interest rate exchange payments is recorded on a current
basis. Premiums paid for purchased interest rate cap and floor agreements are
amortized on a straight-line basis to interest expense over the terms of the
agreements. Unamortized premiums are included in other assets in the
consolidated financial statements. Amounts receivable under cap and floor
agreements are recorded as an increase to interest income.
Mortgage Banking Fees
The Bank's mortgage banking operations consist solely of a broker
function. This service is provided to assist the Bank's clients in obtaining
mortgage loans with other institutions. The Bank does not originate or sell
mortgage loans. The Bank earns the points and any documentation fees charged on
a loan but is otherwise not involved in the loan. Fees are recorded when payment
is received through escrow.
Merchant Discount Income
Merchant discount income consists of the fees charged on credit card
receipts submitted by the Bank's business clients for processing. The income
received and the fees paid by the Bank to credit card issuers and expenses for
third party processors are netted and reported as a component of other income.
Such amounts are recognized when received or paid.
Loans and the Related Allowance for Loan Losses
Loans are recorded at face value, less payments received. Interest on
loans is accrued daily as earned, except where a reasonable doubt exists as to
the full collectability of interest or principal, in which case the accrual of
income is discontinued and the balance of accrued interest is reversed.
Generally, this means that loans are put on nonaccrual status when interest is
ninety days or more past due, unless the loan is well secured and in the process
of collection. All payments received subsequent to the loan being put on
nonaccrual are used to reduce the principal balance. Only after the principal is
reduced to zero is interest income realized. Once a loan is placed on nonaccrual
it generally remains on nonaccrual unless the borrower has the capacity to make
payments as evidenced by tax returns and other financial statements and has the
intent to make payments as evidenced by keeping the loan current for a period of
three to six months.
50
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Loan fees in excess of certain direct origination costs are deferred
and amortized into interest income utilizing the interest method over the lives
of the related loans. When a loan is repaid or sold, any unamortized net
deferred fee balance is credited to income. Accretion of deferred loan fees is
discontinued when loans are placed on nonaccrual status.
The allowance for loan losses is maintained at a level considered
adequate by management to provide for potential loan losses. Credits deemed
uncollectible are charged to the allowance. Provisions for loan losses and
recoveries on loans previously charged off are added to the allowance.
Management, in determining the adequacy of the allowance for loan losses, takes
into consideration (1) loan loss experience, (2) collateral values, (3) changes
in the loan portfolio, (4) an assessment of the effect of current and
anticipated economic conditions on the loan portfolio and (5) examinations
conducted by Bank supervisory authorities. While management believes the
allowance for loan losses is adequate to absorb losses inherent in the loan
portfolio, there exists the risk of future losses which cannot be precisely
quantified. Because this risk is continually changing in response to factors
beyond the control of the Bank, such as the state of the economy, management's
judgment as to the adequacy of the allowance for loan losses in future periods
is necessarily an estimate. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review the Bank's
allowance for loan losses. Such agencies may require the Bank to record
additions to the allowance based on their judgments of information available to
them at the time of their examination.
Impaired Loans
The Company considers a loan to be impaired when, based upon current
information and events, it believes it is probable that the Company will be
unable to collect all amounts due according to the contractual terms of the loan
agreement on a timely basis. Impairment of a loan is measured by the present
value of expected future cash flows discounted at the loan's effective interest
rate, the loan's observable market price, or the fair value of the collateral if
the loan is collateral dependent. If the measure of the impaired loan is less
than the recorded investment in the loan, the Company recognizes impairment by
creating a valuation allowance with a corresponding charge to provision for loan
losses. Large groups of smaller balance homogenous loans that are collectively
evaluated from impairment are not subject to this accounting treatment.
For loans classified as nonaccrual and troubled debt restructurings,
specific valuation allowances are established at the difference between the loan
amount and the fair value of collateral less estimated selling costs. Impaired
loans which are performing under their contractual terms are reported as
performing loans, and cash payments are allocated to principal and interest in
accordance with the terms of the loan.
Premises and Equipment
Premises and equipment are stated at cost, less accumulated
depreciation and amortization. Depreciation on furniture, fixtures, and
equipment is computed using the straight-line method over the estimated useful
lives of the related assets, which range from two to fifteen years. Leasehold
improvements are capitalized and amortized over the lease term or estimated
useful lives of the improvements, whichever is shorter, using the straight-line
method.
Amortization of Convertible Note Expenses
Expenses associated with the convertible note offering in 1994 are
being amortized on a straight line basis over the 10 year term of the note. The
convertible notes are presented on the balance sheet net of unamortized
expenses.
51
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Income Taxes
The Company and its subsidiary file consolidated federal income and
state franchise tax returns. Provisions for income taxes are based on amounts
reported in the statements of income (after exclusion of non-taxable income such
as interest on state and municipal securities) and include deferred taxes on
temporary differences between tax and financial statement purposes. Deferred
taxes are computed using the asset and liability approach. A valuation allowance
is established for deferred tax assets if based on the weight of available
evidence, it is more likely than not that some portion or all of the deferred
tax assets will not be realized. The valuation allowance is sufficient to reduce
the deferred tax assets to the amount that is more likely than not to be
realized.
Earnings (Loss) Per Share
Primary earnings (loss) per share are based on the number of common
shares outstanding, adjusted to reflect any stock splits and stock dividends
during each year, and the assumed exercise of dilutive employee stock options
(less the number of treasury shares assumed to be purchased using the average
market price of the Company's common stock). Fully diluted earnings (loss) per
share include the dilutive effect of the shares to be issued under the terms of
the convertible notes issued in 1994. Due to the number of outstanding stock
options and warrants, earnings per share are based on the modified treasury
stock method. The modified treasury stock method counts all outstanding warrants
and stock options as outstanding and then assumes the proceeds are used to
repurchase up to 20% of the outstanding shares at the average market price. The
remaining proceeds are then assumed to be invested in U. S. Treasury securities
yielding 6.0%.
For the year ended December 31, 1996, the earnings (loss) per share
calculation, using the modified treasury stock method is antidilutive;
therefore, earnings per share are based on 1,312,750 shares, which represents
the actual average outstanding shares. Primary and fully diluted earnings per
share are based upon 1,704,945 and 2,126,370 weighted average shares,
respectively, for 1995. Primary and fully diluted earnings per share are based
upon 1,791,268 and 2,053,666 weighted average shares, respectively, for 1994.
401(k) Savings Plan
The Bank has a 401(k) savings plan in effect for substantially all of
its full-time employees who have completed six months of continuous service.
Employee contributions under the plan are matched by the Bank up to a maximum of
3.0% of the employee's annual salary for 1996 and 1995, and 2.0% of the
employee's annual salary for 1994. Salaries and employee benefits expense
includes $80,600, $73,800 and $44,600 for 1996, 1995 and 1994, respectively,
related to the Bank's contributions.
Reclassifications
Certain amounts have been reclassified in the 1995 and 1994 financial
statements to conform with the 1996 presentation of those items.
Recent Accounting Pronouncements
On January 1, 1996, the Company adopted Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation," which
establishes financial accounting and reporting standards for stock-based
employee compensation plans. This statement encourages all entities to adopt a
new method of accounting to measure compensation cost of all employee stock
compensation plans based on the estimated fair value of the award at the date it
is granted. Companies are, however, allowed to continue to measure compensation
cost for those plans using the intrinsic value based method of accounting, which
generally does
52
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
not result in compensation expense recognition for most plans. Compensation
expense must be recognized, however, for stock awards to non-employees for
services rendered. Companies that elect to remain with the existing accounting
are required to disclose in a footnote to the financial statements pro forma net
income and earnings per share as if the Statement's accounting provisions had
been adopted. The Company elected to continue accounting for stock options under
the intrinsic value method. As there were no options granted in 1995 or 1996,
the pro forma disclosures are not currently applicable.
In June of 1996, the FASB issued Statement of Financial Accounting
Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishment of Liabilities" ("SFAS No. 125"). SFAS No. 125 provides
accounting and reporting standards for transfers and servicing of financial
assets and extinguishment of liabilities based on control. Under this approach,
after a transfer of financial assets, the Company will recognize the financial
and servicing assets it controls and the liabilities incurred, and derecognize
financial assets when control has been surrendered and liabilities have been
extinguished. SFAS No. 125 provides standards for distinguishing transfers of
financial assets that are sales from transfers that are secured borrowings. SFAS
No. 125 must be adopted for financial statements for fiscal years beginning
after December 31, 1996. In December of 1996, the FASB issued Statement of
Financial Accounting Standards No. 127, "Deferral of the Effective Date of
Certain Provisions of FASB No. 125" ("SFAS No. 127"). SFAS No. 127 defers for
one year the effective date of certain provisions. The impact on the Company of
adopting SFAS No. 125 is not expected to be material.
NOTE 2 - RESTRICTED CASH BALANCES
Aggregate cash balances in the form of deposits with the Federal
Reserve Bank of approximately $4,180,000 and $4,144,000 were maintained to
satisfy federal regulatory requirements at December 31, 1996 and 1995,
respectively.
53
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3 - INVESTMENT SECURITIES
The amortized cost and fair value of securities available-for-sale are
as follows:
<TABLE>
<CAPTION>
December 31, 1996
------------------------------------------------------------------------
Gross Gross Gross
Amortized Unrealized Unrealized Fair Realized
(in thousands) Cost Gain Loss Value Gain
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
U.S. Government securities $ -- $ -- $ -- $ -- $ 21
U.S. Government agency
mortgage-backed securites 36,230 96 540 35,786 --
Small Business Administration securities 1,752 -- 10 1,742 --
Collaterized mortgage obligations 17,243 -- 303 16,940 (92)
-------- -------- -------- -------- --------
Total $ 55,225 $ 96 $ 853 $ 54,468 $ (71)
======== ======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
December 31, 1995
------------------------------------------------------------------------
Gross Gross Gross
Amortized Unrealized Unrealized Fair Realized
(in thousands) Cost Gain Loss Value Gain
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
U.S. Government securities $ -- $ -- $ -- $ -- $ 26
U.S. Government agency
mortgage-backed securites 42,845 -- 721 42,124 781
Small Business Administration securities 1,975 -- -- 1,975 120
Collaterized mortgage obligations 37,576 -- 155 37,421 91
-------- -------- -------- -------- --------
Total $ 82,396 $ -- $ 876 $ 81,520 $ 1,018
======== ======== ======== ======== ========
</TABLE>
During the years ended December 31, 1996, 1995 and 1994, securities
available-for-sale were sold for aggregate proceeds of $26,053,000, $69,267,000
and $9,841,000, respectively. These sales resulted in gross realized losses of
$71,000 in 1996, and gross realized gains of $1,018,000 and $7,000 in 1995 and
1994, respectively.
As of December 31, 1996, all securities available-for-sale mature after
ten years. Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without
prepayment penalties.
54
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The amortized cost and fair value of securities held-to-maturity are as
follows:
<TABLE>
<CAPTION>
December 31, 1996
-----------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
(in thousands) Cost Gain Loss Value
--------- ---------- ---------- --------
<S> <C> <C> <C> <C>
U.S. Government securities $ 3,064 $ -- $ -- $ 3,064
U.S. Government agency securities 3,250 -- 43 3,207
U.S. Government agency
mortgage-backed securites 35,119 50 401 34,768
Federal Reserve Bank stock 439 -- -- 439
-------- --------- --------- --------
Total $ 41,872 $ 50 $ 444 $ 41,478
======== ========= ========= ========
</TABLE>
<TABLE>
<CAPTION>
December 31, 1995
-----------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
(in thousands) Cost Gain Loss Value
--------- ---------- ---------- --------
<S> <C> <C> <C> <C>
U.S. Government securities $ 3,074 $ 88 $ -- $ 3,162
U.S. Government agency securities 3,749 24 -- 3,773
U.S. Government agency
mortgage-backed securites 41,263 -- 470 40,793
Federal Reserve Bank stock 431 -- -- 431
-------- --------- --------- --------
Total $ 48,517 $ 112 $ 470 $ 48,159
======== ========= ========= ========
</TABLE>
The amortized cost and estimated fair value of securities held-to-
maturity at December 31, 1996 by contractual maturity is shown below. Expected
maturities will differ from contractual maturities because borrowers may have
the right to call or prepay obligations with or without prepayment penalties.
<TABLE>
<CAPTION>
Amortized Fair
(in thousands) Cost Value
--------- -------
<S> <C> <C>
Due after one year through five years $ 1,467 $ 1,496
Due after five years through ten years 6,030 5,955
Due after ten years 34,375 34,027
------- -------
Total $41,872 $41,478
======= =======
</TABLE>
There were no gross realized gain and losses for the trading account in
1996 and 1995. During 1994, the gross realized gains and losses for the trading
account were approximately $31,000 and $250,000, respectively.
During 1996, the highest daily balance and the average balance for the
available-for-sale account was $86,125,000 and $75,522,000, respectively. During
1995, the highest daily outstanding balance and average balance in the
available-for-sale account was $123,869,000 and $42,282,000, respectively. There
was no activity in the trading account during 1996 and 1995.
55
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Pledged Securities
U.S. Treasury securities with a carrying value of approximately
$3,064,000 and $3,074,000 were pledged to secure treasury tax and loan deposits
as required by law at December 31, 1996 and 1995, respectively.
NOTE 4 - LOANS AND THE RELATED ALLOWANCE FOR LOAN LOSSES
A summary of the major components of loans outstanding at December 31,
1996 and 1995 is as follows:
<TABLE>
<CAPTION>
(in thousands) 1996 1995
-------- --------
<S> <C> <C>
Commercial loans $ 73,577 $ 77,012
Real estate secured commercial loans 10,079 13,241
Equity lines of credit 6,202 6,070
Other lines of credit 1,832 1,997
Installment loans 1,375 1,625
Lease financing 68 140
-------- --------
Total 93,133 100,085
-------- --------
Less:
Allowance for loan losses 2,253 1,070
Deferred loan fees, net 121 71
-------- --------
Loans, net $ 90,759 $ 98,944
======== ========
Fixed rate $ 7,075 $ 11,240
Variable rate 86,058 88,845
-------- --------
Total $ 93,133 $100,085
======== ========
</TABLE>
The following table provides information with respect to the Company's
past due loans.
<TABLE>
<CAPTION>
December 31,
(in thousands) 1996 1995
-------- --------
<S> <C> <C>
Loans 90 days or more past due
and still accruing $ 507 $ 632
Nonaccrual loans 1,521 4,173
-------- --------
Total past due loans $ 2,028 $ 4,805
======== ========
</TABLE>
Total accrued interest on loans 90 days past due and still accruing was
approximately $19,000 at December 31, 1996 and $20,000 at December 31, 1995.
56
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The effect of nonaccrual loans on interest income for the years 1996
and 1995 is presented below:
<TABLE>
<CAPTION>
(in thousands) 1996 1995
---- ----
<S> <C> <C>
Contractual interest due $434 $441
Interest recognized 47 78
---- ----
Net interest foregone $387 $363
==== ====
</TABLE>
The Company had approximately $1,894,000 in impaired loans as of
December 31, 1996. The carrying value of impaired loans for which there is a
related allowance for loan losses was $700,000, with the amount of specific
allowance for loan losses allocated to these loans of $379,000. There were
$1,194,000 in impaired loans for which there was no related specific allowance
for loan losses. However, general allowance consistent with the level of
allowance for similar loans with similar risk characteristics were maintained
for impaired loans without specific allowances. The average recorded investment
in impaired loans during 1996 was $4,161,000 and income recorded utilizing the
cash basis and accrual basis method of accounting was $53,000. Nonaccrual loans
at December 31, 1996, included $1,521,000 of impaired loans.
The Company had approximately $5,240,000 in impaired loans as of
December 31, 1995. The carrying value of impaired loans for which there is a
related allowance for loan losses was $2,629,000, with the amount of specific
allowance for loan losses allocated to these loans of $311,000. There were
$2,607,000 in impaired loans for which there was no related specific allowance
for loan losses. The average recorded investment in impaired loans during 1995
was $4,200,000 and income recorded utilizing the cash basis and accrual basis
method of accounting was $91,000.
At December 31, 1996, the Company had troubled debt restructurings
totaling $778,000 of which $510,000 was on nonaccrual. The remaining $268,000
was performing according to the renegotiated terms. The gross interest income
that would have been recorded in 1996 on troubled debt restructurings if the
loans had been current in accordance with the original terms totaled $70,000,
which includes $41,000 on the restructured loans on nonaccrual. The amount of
interest income actually recognized in 1996 on those loans totaled $29,000. At
December 31, 1996, there were no additional loan commitments outstanding to
borrowers of troubled debt restructurings.
At December 31, 1995, the Company had troubled debt restructurings
totaling $1,167,000 of which $104,000 was on nonaccrual. The remaining
$1,063,000 was performing according to the renegotiated terms. The gross
interest income that would have been recorded in 1995 on troubled debt
restructurings if the loans had been current in accordance with the original
terms totaled $140,000 which includes $13,000 on the restructured loans on
nonaccrual. The amount of interest income actually recognized in 1995 on those
loans totaled $91,000. At December 31, 1995, there were no additional loan
commitments outstanding to borrowers of troubled debt restructurings.
57
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
A summary of the activity within the allowance for loan losses is as
follows:
<TABLE>
<CAPTION>
(in thousands) 1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
Balance, beginning of year $ 1,070 $ 983 $ 1,048
Provision charged to operating expense 4,136 1,539 703
Loans charged-off (3,353) (1,589) (880)
Recoveries on loans previously charged-off 400 137 112
------- ------- -------
Balance, end of year $ 2,253 $ 1,070 $ 983
======= ======= =======
</TABLE>
The Company's commercial loans as of December 31, 1996 are secured by
the following collateral:
<TABLE>
<CAPTION>
(in thousands) December 31, 1996
-----------------
<S> <C>
Stock $ 1,315
Cash 1,849
Furniture, equipment and/or accounts receivables 46,993
Unsecured, real estate, automobiles, or assignment
of life insurance 23,420
--------
Total $ 73,577
========
</TABLE>
NOTE 5 - PREMISES AND EQUIPMENT
A summary of the major components of premises and equipment at December
31, 1996 and 1995 is as follows:
<TABLE>
<CAPTION>
(in thousands) 1996 1995
------- -------
<S> <C> <C>
Furniture, fixtures and equipment $ 3,205 $ 4,940
Leasehold improvements 1,645 1,633
------- -------
Total premises and equipment, at cost 4,850 6,573
Less accumulated depreciation and amortization (3,239) (4,755)
------- -------
Net premises and equipment $ 1,611 $ 1,818
======= =======
</TABLE>
Depreciation and amortization expense related to property and leasehold
improvements was approximately $606,000, $537,000 and $500,000 for the years
ended December 31, 1996, 1995 and 1994, respectively.
58
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6 - DEPOSITS AND SHORT-TERM BORROWINGS
A summary of time certificates of deposit outstanding at December 31,
1996 and 1995 is as follows:
<TABLE>
<CAPTION>
(in thousands) 1996 1995
------- -------
<S> <C> <C>
Time certificates of deposit under $100,000 $ 9,187 $11,143
Time certificates of deposit of $100,000 and over 22,136 76,997
------- -------
Total $31,323 $88,140
======= =======
</TABLE>
Interest expense for the years ended December 31, 1996, 1995 and 1994
relating to interest-bearing deposits and other borrowings amounted to the
following:
<TABLE>
<CAPTION>
(in thousands) 1996 1995 1994
------ ------ ------
<S> <C> <C> <C>
Interest-bearing demand deposits $ 96 $ 105 $ 107
Savings and money market deposits 1,693 1,959 2,170
Time certificates of deposit under $100,000 452 460 310
Time certificates of deposit of $100,000 and over 1,947 3,326 1,006
------ ------ ------
Interest expense on deposits 4,188 5,850 3,593
------ ------ ------
Federal funds purchased and securities sold under
agreements to repurchase 185 204 156
Stock subject to repurchase -- -- 134
Convertible notes 477 485 297
------ ------ ------
Interest expense on deposits and other borrowings $4,850 $6,539 $4,180
====== ====== ======
</TABLE>
The Bank sells securities under agreements to repurchase. Securities
sold under repurchase agreements are recorded as short-term obligations. During
1996, the highest daily outstanding balance and the average balance of
securities sold under agreements to repurchase was $17,929,000 and $3,422,0000,
respectively; the average rate paid was 5.41%. During 1995, the highest daily
outstanding balance and the average balance of securities sold under agreements
to repurchase was $41,773,000 and $3,458,000, respectively; the average rate
paid was 5.90%. During 1994, the highest daily outstanding balance and the
average balance of securities sold under agreements to repurchase was
$30,093,000 and $4,469,000, respectively; the average rate paid was 3.50%.
59
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7 - INCOME TAXES
The provision for income taxes for the years ended December 31, 1996,
1995 and 1994 is comprised of the following:
<TABLE>
<CAPTION>
(in thousands) 1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Current taxes:
Federal $ 559 $ 989 $ 675
State 155 338 244
-------- -------- --------
Total current taxes 714 1,327 919
-------- -------- --------
Deferred taxes (credits):
Federal (1,999) (128) (24)
State (427) (17) (14)
-------- -------- --------
Total deferred taxes (2,426) (145) (38)
-------- -------- --------
(Benefit) provision for income taxes $ (1,712) $ 1,182 $ 881
======== ======== ========
</TABLE>
The following summarizes the differences between the income taxes
reported for financial statement purposes and income taxes at the federal
statutory rate of 34%, in 1996, 1995 and 1994, respectively:
<TABLE>
<CAPTION>
(in thousands) 1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Tax expense at statutory rate $ (1,849) $ 1,084 $ 726
Increase (decrease) in taxes resulting from:
State franchise taxes, net of federal
income tax benefit (179) 212 152
Other 316 (114) 3
-------- -------- --------
Total $ (1,712) $ 1,182 $ 881
======== ======== ========
Effective tax rate 31.5% 37.1% 41.3%
</TABLE>
The net deferred tax asset includes current income taxes (payable) and
receivable of ($294,000) and $162,000 at December 31, 1996 and 1995,
respectively.
60
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The components of the net deferred tax asset are as follows:
<TABLE>
<CAPTION>
(in thousands) 1996 1995
------ ------
<S> <C> <C>
Deferred tax liabilities:
Prepaid expenses $ 134 $ 116
------ ------
Gross deferred tax liabilities 134 116
------ ------
Deferred tax assets:
Depreciation, leasing transactions, fixed asset gain or loss 127 73
Bad debt deductions 400 194
Deferred compensation 671 161
Core deposit amortization 20 21
Loan fee amortization 50 29
California franchise tax 34 111
Accrued vacation 110 75
Contributions carryforward 46 --
Net operating loss carryforward 1,650 --
Unrealized loss on securities available-for-sale 322 361
------ ------
Gross deferred tax assets 3,430 1,025
------ ------
Net deferred tax asset $3,296 $ 909
====== ======
</TABLE>
The gross net operating loss carryover for federal income taxes of
approximately $4,384,000 expires in fifteen years. The gross net operating loss
carryover for state income taxes of approximately $2,233,000 expires in five
years.
In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of the
deferred tax assets will not be realized. The ultimate realization of deferred
tax assets is dependent upon the generation of future taxable income during the
periods in which those temporary differences become deductible. Management
considers the projected future taxable income and tax planning strategies in
making this assessment. Based upon the level of historical taxable income and
projections for future taxable income over the periods in which the deferred tax
assets are deductible, management believes it is more likely than not the
Company will realize all benefits related to these deductible differences.
NOTE 8 - SHAREHOLDERS' EQUITY
The Company's stock option plans allow option holders to "pyramid"
their options upon exercise. Through this process, which utilizes the intrinsic
value of the options at the time of exercise, the option holders avoid incurring
additional costs. As a result, more options will be exercised than shares
issued, depending on the intrinsic value of the options at the time of exercise.
The Company applies Accounting Principles Board Opinion No. 25 in
accounting for its stock option plans and, accordingly, no compensation cost has
been recognized for its stock options in the financial statements. Compensation
cost based on the fair value at the grant date for stock options under SFAS No.
123 was not determined as no stock options were granted in 1995 and 1996.
61
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company has a stock option plan dated April 20, 1983 (the "1983
Plan"), which authorizes the issuance of up to 165,894 shares of the Company's
unissued common stock to directors, officers and other personnel. Option prices
may not be less than 100% of the fair market value at the date of the grant.
Options granted under the 1983 Plan expire not more than five years after the
date of grant and must be fully paid when exercised. The status of options
granted under the 1983 Plan is shown as follows:
<TABLE>
<CAPTION>
Exercise Options
Price ($) Outstanding
------------- -----------
<S> <C> <C>
Outstanding at December 31, 1993 5.95 - 13.57 153,211
Canceled 5.95 - 13.57 (3,675)
--------
Outstanding at December 31, 1994 5.95 - 6.91 149,536
Exercised 5.95 (29,868)
--------
Outstanding at December 31, 1995 5.95 - 6.91 119,668
Exercised 5.95 - 6.91 (119,668)
--------
Outstanding at December 31, 1996 -- --
========
</TABLE>
The Company also has a stock option plan dated December 18, 1990 (the
"1990 Plan"), which authorizes the issuance of up to 120,000 shares of the
Company's unissued common stock to directors, officers and other personnel.
Option prices may not be less than 100% of the fair market value at the date of
the grant for incentive stock options and 85% of the fair market value for non-
qualified stock options. Options granted under the 1990 Plan expire not more
than ten years after the date of grant and must be fully paid when exercised.
The status of options granted under the 1990 Plan is shown as follows:
<TABLE>
<CAPTION>
Exercise Options
Price ($) Outstanding
------------- -----------
<S> <C> <C>
Outstanding at December 31, 1993 7.71 - 14.22 74,272
Issued 10.89 27,563
Canceled 7.71 (1,654)
--------
Outstanding at December 31, 1994 7.71 - 14.22 100,181
Exercised 7.71 (4,167)
Canceled 12.92 - 14.22 (11,245)
--------
Outstanding at December 31, 1995 7.71 - 14.22 84,769
Exercised 7.71 (11,688)
Canceled 12.92 (10,474)
--------
Outstanding at December 31, 1996 7.71 - 14.22 62,607
========
($10.59 weighted-average)
Available for future grant at
December 31, 1996 40,603
=======
</TABLE>
62
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
At December 31, 1996, 57,095 option shares were exercisable and 5,512
options become exercisable in 1997. The weighted-average exercise price per
share of these options was $10.56 and $10.89, respectively, at December 31,
1996.
The Company also has a stock option plan dated December 31, 1992 (the
"1992 Plan"), which authorizes the issuance of up to 393,750 shares of the
Company's unissued common stock to directors, officers and other personnel.
Option prices may not be less than 100% of the fair market value at the date of
the grant for incentive stock options and 85% of the fair market value for non-
qualified stock options. Options granted under the 1992 Plan expire not more
than ten years after the date of grant and must be fully paid when exercised.
The status of options granted under the 1992 Plan is shown as follows:
<TABLE>
<CAPTION>
Exercise Options
Price ($) Outstanding
--------- -----------
<S> <C> <C>
Outstanding at December 31, 1993 12.70 413,438
Outstanding at December 31, 1994 12.70 413,438
Outstanding at December 31, 1995 12.70 413,438
Canceled 12.70 (55,125)
-------
Outstanding at December 31, 1996 12.70 358,313
=======
</TABLE>
At December 31, 1996, all 358,313 option shares were exercisable at a
weighted-average exercise price per share of $12.70.
On May 14, 1996, the Company declared a 5% stock dividend paid on June
21, 1996, primarily by a distribution of 64,714 treasury shares. On June 23,
1995, the Company declared a 5% stock dividend primarily paid by a distribution
of 56,274 treasury shares on July 19, 1995.
On January 19, 1993, the Company concluded a private placement offering
of 341,250 shares of common stock at a price of $12.70 per share. All but 15,225
shares were sold as of December 31, 1992. In connection with the offering,
413,438 options and 137,812 warrants were issued on December 31, 1992 and are
considered issued and outstanding. The options and warrants became exercisable
on December 31, 1994 at a price of $12.70 per share and expire on December 31,
2002. Proceeds to the Company from the offering totaled $3,559,000 as of
December 31, 1992. Additional proceeds of $182,000 were received on January 19,
1993.
In connection with the private placement, the Company issued (i) a
warrant to Robert H. Leshner, principal of the placement agent, to purchase
110,250 shares of Common Stock (the "Leshner Warrant") and (ii) a warrant to
Andrew E. Haas, which was subsequently reissued as two warrants to purchase
13,781 shares to each of Mr. Haas and Curtis Swindal, each at a purchase price
of $12.70 per share exercisable in full on or after December 31, 1994 and before
December 31, 2002. The Company agreed to grant the holders of the shares issued
upon exercise of the warrants ("Warrant Shares") the right, on two occasions
during the five-year period beginning December 31, 1994, to require the Company
to register (the "Demand Registration") the Warrant Shares under the Securities
Exchange Act of 1934 (the "Act"). The Company will pay the expenses of one
Demand Registration. In addition, the holders of the Warrant Shares will have
the right during the period December 31, 1994 to December 31, 1997 to have the
Warrant Shares included in registrations of the Common Stock under the Act at
the expense of the Company.
63
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Under the terms of the Leshner Warrant, if Dr. Joel W. Kovner, former
Chairman of the Board and Chief Executive Officer of the Company, dies before
December 31, 2002, then the Company will purchase, at the option of Mr. Leshner,
some or all of the warrants and/or Warrant Shares then owned by Mr. Leshner,
provided that (i) the maximum aggregate purchase price paid by the Company shall
be not more than $1,000,000 and (ii) the funds to purchase such warrants and/or
Warrant Shares shall come solely from the proceeds of the key person life
insurance policy on Dr. Kovner. Furthermore, if at any time prior to December
31, 2002 Mr. Leshner wishes to sell some or all of the warrants and/or Warrant
Shares to a third party, Mr. Leshner must offer to sell such warrants and/or
Warrant Shares to the Company on the same terms and conditions being offered to
such third party. Another term of the Leshner Warrant restricts Bancorp's
ability to issue certain types of preferred stock which would entitle the
holders thereof to receive dividends or distributions of assets that vary in
amount with Bancorp's performance.
NOTE 9 - COMMITMENTS AND CONTINGENT LIABILITIES
The Company leases its premises and certain equipment under several
noncancellable operating leases which expire on various dates through August 31,
2003. Rental expense for the years ended December 31, 1996, 1995 and 1994
amounted to approximately $1,000,000, $990,000 and $1,011,000, respectively.
The following is a schedule of future minimum rental commitments
required under operating leases that have initial or remaining noncancellable
lease terms in excess of one year as of December 31, 1996:
<TABLE>
<CAPTION>
Year ending December 31, (in thousands)
-----------------------
<S> <C>
1997 $ 948
1998 936
1999 800
2000 772
2001 601
2002 and thereafter 1,787
------
Total $5,844
======
</TABLE>
The building lease commitments are subject to cost-of-living adjustments to
reflect future changes in the consumer price index or a fixed periodic rate
increase. Those leases with fixed periodic rate increases and/or specified
months with no rent due are amortized so that the average monthly cost of the
lease is charged each month.
Lending Commitments
The Company is a party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of its clients.
These financial instruments include commitments to extend credit and standby
letters of credit. These instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the
consolidated balance sheet. The Bank's exposure to credit loss in the event of
nonperformance by the other party to commitments to extend credit and standby
letters of credit is represented by the contractual notional amount of those
instruments. At December 31, 1996 and 1995, the Company had commitments to
extend credit of approximately $38,931,000 and $50,415,000, respectively, and
obligations under standby letters of credit of approximately $4,610,000 and
$4,984,000, respectively. These commitments and obligations were variable rate
in structure.
64
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Standby letters of credit are conditional commitments issued by the Company
to guarantee the performance of a client to a third party. Those guarantees are
primarily issued to support public and private borrowing arrangements, including
commercial paper, bond financing and similar transactions. At December 31, 1996,
all guarantees extended for a period of 12 months or less. The Company uses the
same credit policies in making commitments and conditional obligations as it
does for extending loan facilities to clients. The Company evaluates each
client's creditworthiness on a case-by-case basis. The amount of collateral
obtained, if necessary by the Company upon an extension of credit, is based on
management's credit evaluation of the counterparty. Collateral held varies but
may include accounts receivable, inventory, property plant and equipment and
income-producing commercial real estate.
Litigation
The Company and its subsidiary are defendants in legal actions arising from
transactions conducted in the ordinary course of their business. Based upon
discussion with the Company's attorneys, management believes that the ultimate
liability, if any, arising from such actions will not materially affect the
Company's consolidated financial statements.
A settlement agreement between the Bancorp, Bank, certain officers and
directors of the Company, and the Shareholders Protective Committee was
finalized in July 1996. The settlement agreement set the terms and conditions of
the change in management of Bancorp, including the Board of Directors and the
interim Chief Executive Officer, required payments of $1,006,000 to certain
outgoing executive officers, and termination of litigation and indemnification
of the parties involved.
NOTE 10 - TRANSACTIONS INVOLVING DIRECTORS AND AFFILIATED PARTIES
As part of its normal banking activities, the Company has extended credit
to various directors and employees and their related interest. The credit
extended to these individuals and affiliates for the two years ended December
31, 1996, is summarized as follows:
<TABLE>
<CAPTION>
(in thousands) 1996 1995
------- -------
<S> <C> <C>
Balance, beginning of year $ 2,932 $ 3,223
Credit granted 1,615 1,377
Loan payments (1,614) (1,668)
------- -------
Balance, end of year $ 2,933 $ 2,932
======= =======
</TABLE>
Interest income earned on these loans amounted to approximately $276,000,
$299,000 and $258,000 during the years 1996, 1995 and 1994, respectively. In the
opinion of management, all such extensions of credit are on terms similar to
transactions with nonaffiliated parties and involve only normal credit risk.
Amounts included in deposits at December 31, 1996, related to directors and
affiliated parties was approximately $740,000.
The Company and the Bank entered into a Consulting Agreement with Network
Health Financial Services, Inc. ("NHFS"), a California Corporation for which
Melinda McIntyre-Kolpin serves as President and Chief Executive Officer.
Pursuant to the Consulting Agreement, NHFS provides consulting services to the
65
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Company and the Bank with respect to personnel matters, operational procedures
and client development and retention. NHFS is paid its actual costs incurred in
the performance of its duties under the Consulting Agreement (including hourly
rates for certain specified NHFS personnel while they are performing consulting
services), plus an additional 25% of such costs. In addition, the Company and
Bank pay flat monthly rates for the services of Ms. McIntyre-Kolpin and Ms.
Patti Derry. During 1996, the Company and the Bank paid NHFS total fees in the
amount of $288,432 pursuant to the Consulting Agreement. Any party may terminate
the Consulting Agreement by giving 30 days' notice to the other parties.
NOTE 11 - CAPITAL ADEQUACY AND RESTRICTIONS ON DIVIDEND PAYMENTS
The Office of the Comptroller of the Currency (the "OCC"), the Bank's
primary regulator, has established minimum leverage ratio guidelines for
national banks. These guidelines provide for a minimum Tier 1 capital leverage
ratio (Tier 1 capital to adjusted total assets) of 3.0% for national banks that
meet certain specified criteria, including having the highest regulatory rating.
All other national banks will generally be required to maintain a minimum Tier 1
capital leverage ratio of 3.0% plus an additional 100 to 200 basis points. The
OCC has not advised the Bank of any specific minimum Tier 1 capital leverage
ratio applicable to it.
The Federal Reserve Board, as the Company's primary regulator, has
similarly established minimum leverage ratio guidelines for bank holding
companies. These guidelines also provide for a minimum Tier 1 leverage ratio of
3.0% for bank holding companies that meet certain specified criteria, including
having the highest regulatory rating. All other bank holding companies will
generally be required to maintain a minimum Tier 1 capital leverage ratio of
3.0% plus an additional 100 to 200 basis points. The Federal Reserve Board has
not advised the Company of any specific minimum Tier 1 capital leverage ratio
applicable to it. Under risk-based capital standards, banking organizations are
expected to meet a minimum ratio for qualifying total capital to risk-weighted
assets of 8.0%, 4.0% of which must be Tier 1 capital.
The Federal Deposit Insurance Act of 1991 contains "prompt correction
action" provisions pursuant to which insured depository institutions are to be
classified into one of five categories based primarily upon capital adequacy,
ranging from "well capitalized" to "critically undercapitalized" and which
require, subject to certain exceptions, the appropriate federal banking agency
to take prompt corrective action with respect to an institution which becomes
"undercapitalized" and to take additional actions if the institution becomes
"significantly undercapitalized" or "critically undercapitalized." At December
31, 1996, the Company's and Bank's regulatory capital exceeded the thresholds
necessary to be considered well capitalized.
66
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following table sets forth the minimum required regulatory capital
ratios for a bank holding company and bank, and various regulatory capital
ratios of the Company and the Bank at December 31, 1996.
<TABLE>
<CAPTION>
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
---------------- ----------------- -----------------
(in thousands) Amount Ratio Amount Ratio Amount Ratio
------- ------ -------- ----- ------- ------
<S> <C> <C> <C> <C> <C> <C>
Company
Leverage $14,477 5.80% $ 9,987 4.00% $12,483 5.00%
Tier 1 Risk-Based 14,477 11.10 5,216 4.00 7,824 6.00
Total Risk-Based 21,456 16.45 10,432 8.00 13,040 10.00
Bank
Leverage $18,962 7.62% $ 9,951 4.00% $12,438 5.00%
Tier 1 Risk-Based 18,962 14.64 5,181 4.00 7,771 6.00
Total Risk-Based 20,589 15.90 10,362 8.00 12,952 10.00
</TABLE>
Under federal banking law, dividends declared by the Bank in any calendar
year may not, without the approval of the OCC, exceed its net earnings, as
defined, for that year combined with its retained net earnings for the preceding
two years. Dividends declared may not exceed amounts necessary to satisfy the
aforementioned capital requirements. As of December 31, 1996, the Bank could
declare dividends of $114,000 without obtaining regulatory approval.
Federal banking law also restricts the Bank from extending credit to the
Company in excess of 10% of the capital stock and surplus, as defined. Any such
extensions of credit are subject to strict collateral requirements.
Note 12 - Convertible Notes
On June 19, 1994, the Company completed a public offering of $5,750,000 in
convertible subordinated reset notes (the "Notes") which mature on March 1, 2004
and incurred expenses of $1,205,000. Interest on the Notes is payable
semiannually on March 1 and September 1 of each year, commencing on September 1,
1994 at the rate of 8.50% per annum until March 1, 1998, and from March 2, 1998
until the principal thereof is paid or made available for payment at a rate per
annum equal to the Reference Rate (as defined below) plus 150 basis points. The
"Reference Rate" is the most recent "Five Year Constant Treasury Maturity Index"
published by the Federal Reserve Bank, or its successor, at least 60 days prior
to March 2, 1998. The Notes are convertible into common stock of the Company at
any time prior to maturity, unless previously redeemed, at a conversion price of
$12.6984 per share, subject to adjustment in certain events. The Notes are
redeemable in whole or in part at the option of the Company at any time on or
after March 2, 1998 at the redemption prices set, subject to the prior approval
of the Board of Governors of the Federal Reserve System. During 1996, $2,000 of
the Notes were converted into 157 common stock shares. During 1995, $131,000 of
the Notes were converted into 10,316 common stock shares. If all $5,617,000 of
the remaining Notes were converted into common stock, 442,339 shares of common
stock would be issued. Of the proceeds, $3,615,000 was invested in the Bank and
$930,000 was used to extinguish a stock repurchase obligation. The Notes are
counted as Tier 2 capital at the Company and the investment of $3,615,000 is
counted as Tier 1 capital at the Bank.
67
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Note 13 - Derivative Financial Instruments
The Company has only limited involvement with derivative financial
instruments and does not use them for trading purposes. They are used to manage
well-defined interest rate price risks.
Interest rate floor and cap agreements are used to reduce the potential
impact of changes in interest rates which would reduce the interest income
and/or market value on loans and on certain securities. The Company entered into
three interest rate floor agreements during December 1994 and January 1995 for a
total notional amount of $60 million. The agreements entitled the Company to
receive from counterparties on a monthly basis the amounts, if any, by which the
one-month London Interbank Offered Rate ("LIBOR") falls below 6%. The floor
agreements were for a period of three years. The average premium paid for the
floor agreements was approximately 20 basis points or $120,000 and was being
amortized over three years. In May 1995, the Company sold the floor contracts
for total consideration of $722,500. This amount is being amortized over the
original three year term. In 1996 and 1995, net interest income was increased
$235,000 and $141,000, respectively, as a result of the interest rate floor
agreements.
In December 1995, the Company entered into two interest rate cap agreements
for a notional amount of $10 million each. The agreements entitle the Company to
receive from counterparties on a quarterly basis the amounts, if any, by which
the one year Constant Maturity Treasury Index ("CMT") rises above 6.50% on a $10
million notional amount and 6.75% on a $10 million notional amount. The cap
agreements are for a period of three years. The average premium paid for the cap
agreements was approximately 63.5 basis points or $127,000 and is being
amortized over three years. Net interest income in 1996 and 1995 was decreased
by the interest rate caps by $42,000 and $1,000, respectively.
The Company uses interest rate swap agreements in order to lock in a
specific return on its loan portfolio. In January 1993, the Company entered into
two interest rate swap agreements that paid the Company a fixed rate of 7.21%
for three years beginning in January 1993, while the Company paid the prime
rate. These swaps had a total notional amount of $40 million and terminated in
January 1996. Net interest income for 1996 and 1995 was reduced by the two swaps
by $15,000 and $694,000, respectively. In November 1993, the Bank entered into a
swap with a notional amount of $15 million. The effective date of the swap is
May 26, 1994 and it covers a period of five years ending in May 1999. Under the
terms of the swap, the Bank pays a rate of prime less 190 basis points while
receiving the three-month LIBOR. The rate the Bank pays adjusts daily while the
rate the Bank receives adjusts quarterly. The terms of the swap originally
included an interest rate cap which was terminated in 1994 and an expense of
$385,000 was recorded. Net interest income for 1996 and 1995 was reduced by the
swap by $134,000 and $135,000, respectively. As of December 31, 1996, the
Company was paying 6.35% and receiving 5.50%.
The Company is exposed to potential credit losses in the event of
nonperformance by the counterparties to its interest rate floor agreements,
interest rate swap agreements and nonderivative financial assets, but has no
off-balance-sheet credit risk of accounting loss. The Company anticipates,
however, that counterparties will be able to fully satisfy their obligations
under the contracts. The Company does not obtain collateral or other security to
support financial instruments subject to credit risk but monitors the credit
standing of counterparties.
68
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Note 14 - Fair Value of Financial Instruments
The estimated fair value amounts have been determined by the Bank using
available market information and appropriate valuation methodologies. However,
considerable judgment is necessarily required to interpret market data to
develop the estimates of fair value. Accordingly, the estimates presented herein
are not necessarily indicative of the amounts the Bank could realize in a
current market exchange. The use of different market assumptions and/or
estimation methodologies may have a material effect on the estimated fair value
amounts.
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
--------------------- ---------------------
Carrying Estimated Carrying Estimated
(in thousands) Value Fair Value Value Fair Value
--------- ---------- -------- ----------
<S> <C> <C> <C> <C>
Assets:
Cash and cash equivalents $ 66,340 $ 66,340 $ 85,200 $ 85,200
Securities available-for-sale 54,468 54,468 81,520 81,520
Securities held-to-maturity 41,872 41,478 48,517 48,159
Loans, net 90,759 91,684 98,944 99,129
Liabilities:
Noninterest-bearing transaction accounts 96,208 96,208 97,642 97,642
Interest-bearing transaction accounts 14,887 14,887 14,475 14,475
Savings and money market accounts 98,859 98,859 97,209 97,209
Certificates of deposit and other time deposits 31,323 31,352 88,140 88,155
Convertible notes 4,869 4,820 4,767 4,565
Off-balance sheet assets:
Interest rate swaps -- (283) -- (392)
Interest rate caps 83 101 126 131
Lending commitments -- 97 -- 126
Standby letters of credit -- 46 -- 50
</TABLE>
The fair value of marketable securities and interest rate swaps and caps is
based on quoted market prices, dealer quotes, and prices obtained from
independent pricing services. The fair values of loans are estimated using
discounted cash flow analysis. The analysis was performed on a loan-by-loan
basis by projecting each loan's expected cash flows and discounting these flows
at appropriate discount rates. The expected cash flows were determined by
contractually scheduled payments of principal and interest, incorporating
scheduled rate adjustments, periodic caps, and lifetime ceilings and floors for
adjustable loans. The fair values are based on a stable interest rate scenario
and do not incorporate bid-ask spreads or discounts that might be required to
dispose of assets in bulk. Discount rates applied to the expected cash flows
were based on the Bank's offer rates for new loans with similar collateral and
terms, adjusted to reflect differential risk based on collateral value, payment
status, and/or credit classification at December 31, 1996 and 1995,
respectively.
The fair value of deposits with no defined maturities, such as demand
deposits, money market deposits and savings accounts, is the amount payable on
demand at the valuation date. For deposit liabilities with defined maturities,
such as time certificates of deposit, estimation of fair value was based on the
discounted value of future cash flows expected to be paid, where the discount
rate was the Bank's offer rate
69
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
for similar deposits with maturities equivalent to the remaining terms on the
deposits being valued at December 31, 1996 and 1995, respectively.
Standby letters of credit principally support corporate obligations and
include $330,000 and $823,000 that was collateralized with cash at December 31,
1996 and 1995, respectively. At December 31, 1996, $4,260,000 of the standby
letters of credit and $29,505,000 of other lending commitments expire within one
year. The estimated fair value of lending commitments and letters of credit is
estimated using fees currently charged for similar arrangements, adjusted for
changes in interest rates and credit that occurred subsequent to origination.
The fair value estimates presented herein are based on pertinent
information available to management as of December 31, 1996 and 1995. Although
management is not aware of any factors that would significantly affect the
estimated fair value amounts, such amounts have not been comprehensively
revalued for purposes of these financial statements since those dates and,
therefore, current estimates of fair value may differ significantly from the
amounts presented herein.
Note 15 - Parent Company Information
The Bancorp has met its obligations principally from the payment of
dividends from the Bank. As of December 31, 1996, the Bank has $114,000
available for payment of dividends without obtaining regulatory approval.
The following financial information represents the balance sheets of the
Bancorp as of December 31, 1996 and 1995, the related statements of operations
and of cash flows for each of the three years in the period ended December 31,
1996.
Balance Sheets
December 31, 1996 and 1995
<TABLE>
<CAPTION>
1996 1995
------- ------
(in thousands)
<S> <C> <C>
Assets:
Cash in First Professional Bank, N.A $ 300 $ 28
Investment in First Professional Bank, N.A 18,787 22,208
Loans 100 163
Other assets 36 35
------- -------
$19,223 $22,434
======= =======
Liabilities:
Accrued expenses $ 312 $ 159
Convertible notes 4,869 4,767
------- -------
Total liabilities 5,181 4,926
Shareholders' equity 14,042 17,508
------- -------
$19,223 $22,434
======= =======
</TABLE>
70
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Statement of Operations
Years ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
1996 1995 1994
------- ------- -------
(in thousands)
<S> <C> <C> <C>
Income:
Cash dividends from First Professional Bank, N.A $ 2,819 $ 800 $ --
Interest 7 6 4
------- ------- -------
Total income 2,826 806 4
------- ------- -------
Expenses:
Interest 477 485 431
Salaries and employer taxes 85 86 80
Amortization of convertible note expenses 104 106 62
Legal fees 1,805 62 7
Other professional services 101 -- --
Settlement costs 184 -- --
Pamphlets and brochures 8 48 2
Other 16 33 32
------- ------- -------
Total expenses 2,780 820 614
------- ------- -------
Earnings (loss) before income taxes and equity in
undistributed net earnings of First Professional Bank, N.A 46 (14) (610)
Provision for income taxes 1 -- 1
------- ------- -------
Earnings before equity in undistributed net earnings of
First Professional Bank, N.A 45 (14) (611)
Equity in undistributed net (loss) earnings of First
Professional Bank, N.A (3,770) 2,020 1,864
------- ------- -------
Net (loss) earnings $(3,725) $ 2,006 $ 1,253
======= ======= =======
</TABLE>
71
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Statement of Cash Flows
Years ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
1996 1995 1994
------- ------- -------
(in thousands)
<S> <C> <C> <C>
Cash flows from operating activities:
Net (loss) earnings $(3,725) $ 2,006 $ 1,253
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
(Increase) decrease in other assets (1) (5) --
Increase (decrease) in accrued expenses 153 (6) 165
Amortized interest on stock repurchase agreement -- -- 135
Amortization of convertible note expenses 104 106 62
Equity in undistributed loss (earnings) of First Professional
Bank, N.A 3,770 (2,020) (1,864)
------- ------- -------
Net cash provided by (used in) operating activities 301 81 (249)
------- ------- -------
Cash flows from investing activities:
Net decrease (increase) in loans 63 (163) --
Additional investment in First Professional Bank, N.A -- -- (3,615)
------- ------- -------
Net cash provided by (used in) investing activities 63 (163) (5,531)
------- ------- -------
Cash flows from financing activities:
Issuance of convertible notes, net -- -- 4,709
Purchase of treasury stock (270) -- (930)
Proceeds from exercise of stock options 182 14 --
Other (4) (3) 14
------- ------- -------
Net cash provided by (used in) financing activities (92) 11 3,793
------- ------- -------
Net increase (decrease) in cash 272 (71) (71)
Cash, beginning of year 28 99 170
------- ------- -------
Cash, end of year $ 300 $ 28 $ 99
======= ======= =======
Supplemental disclosure of cash flow information cash
paid during the year for:
Interest $ 477 $ 485 $ 268
Income taxes $ 8 $ -- $ 1
</TABLE>
72
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Note 16 - Quarterly Financial Data (Unaudited)
The following tables set forth the Company unaudited data regarding
operations for each quarter of 1996, 1995 and 1994. This information, in the
opinion of management, includes all normal recurring adjustments necessary to
state fairly the information set forth therein. The operating results for any
quarter are not necessarily indicative of results for any future period.
<TABLE>
<CAPTION>
Quarter Ended
-----------------------------------------------------------------
Dec. 31, Sept. 30, June 30, Mar. 31, Dec. 31, Sept. 30,
(in thousands, except per share data) 1996 1996 1996 1996 1995 1995
-------- -------- -------- -------- ------- ---------
<S> <C> <C> <C> <C> <C> <C>
Interest income $ 4,188 $4,207 $ 4,477 $4,778 $5,227 $5,296
Interest expense 992 1,053 1,302 1,503 1,711 1,778
Net interest income 3,196 3,154 3,175 3,275 3,516 3,518
Provision for loan losses (120) 836 3,240 180 1,147 205
Gains (losses) on securities:
Available-for-sale (92) 21 -- -- 895 --
Other income 328 432 393 362 372 367
Other expenses 3,036 3,473 6,035 3,001 3,211 2,748
Earnings (loss) before income taxes 516 (702) (5,707) 456 425 932
Net earnings (loss) 333 (607) (3,726) 275 348 551
Earnings (loss) per share (as restated):
Primary 0.23 (0.43) (2.73) 0.20 0.23 0.35
Fully diluted 0.22 (0.43) (2.73) 0.20 0.23 0.32
<CAPTION>
Quarter Ended
---------------------------------------------------------------
June 30, Mar. 31, Dec. 31, Sept. 30, June 30, Mar. 31,
(in thousands, except per share data) 1995 1995 1994 1994 1994 1994
-------- -------- -------- --------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Interest income $ 5,329 $5,051 $5,074 $4,873 $4,066 $3,786
Interest expense 1,602 1,448 1,246 1,178 911 845
Net interest income 3,727 3,603 3,828 3,695 3,155 2,941
Provision for loan losses 125 62 50 373 200 80
Gains (losses) on securities:
Available-for-sale 97 26 -- -- -- 7
Trading -- -- -- -- (38) (181)
Other income 369 328 390 385 377 371
Other expenses 3,055 3,076 3,013 2,991 2,938 3,151
Earnings (loss) before income taxes 1,013 819 1,155 716 356 (93)
Net earnings (loss) 604 503 679 430 199 (55)
Earnings (loss) per share (as restated):
Primary 0.38 0.32 0.41 0.27 0.14 (0.04)
Fully diluted 0.35 0.30 0.37 0.26 0.14 (0.04)
</TABLE>
73
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
In the second quarter of 1996, the Company added $3,240,000 to the
allowance for loan losses in recognition that the quality of certain loans had
deteriorated and to provide protection against future potential losses. Of the
$3,240,000 provision, more than $1,915,000 related to one specific loan. In
addition, nonrecurring costs of approximately $2,579,000 associated with the
proxy contest and management restructuring were recorded in the same quarter.
The $1,147,000 provision for loan losses taken in the fourth quarter of
1995 was due to net charge-offs of approximately $936,000 coupled with increases
in the allowance based on management's assessment of the increased risk in the
loan portfolio.
Earnings (loss) per share is based on the weighted average number of shares
outstanding during each period. Full-year weighted average shares differ from
quarterly weighted average shares and, therefore annual earnings (loss) per
share may not equal the sum of the quarters.
74
<PAGE>
EXHIBIT 10.6
CONSULTING AGREEMENT
This CONSULTING AGREEMENT (the "Agreement") is effective as of the 12th
day of August, 1996, by and among PROFESSIONAL BANCORP, INC., a Pennsylvania
corporation ("Bancorp"), FIRST PROFESSIONAL' BANK, NATIONAL ASSOCIATION ("Bank")
and NETWORK HEALTH FINANCIAL SERVICES, INC., a California corporation ("NHFS").
RECITALS
WHEREAS, Bancorp and Bank desire to engage the services of NHFS to provide
certain consulting services, and NHFS desires to provide such consulting
service.
NOW THEREFORE, in consideration of the mutual promises, covenants and
agreements contained herein, the parties hereby agree as follows:
1. CONSULTING SERVICES. Bancorp and Bank hereby engage NHFS, and NHFS
-------------------
hereby accepts the engagement, to provide the following consulting services to
Bancorp and Bank during the term hereof:
(a) NHFS will assess the current personnel, staffing levels and other
staffing issues of Bancorp and Bank, and provide, as soon as practicable,
written recommendations concerning staffing issues to Bancorp's and Bank's
Chairman of the Board. The recommendations shall include advice concerning
staffing reassignments, staff additions, and recommendations of candidates to
fill any vacant positions. Unless requested by Bancorp and Bank, NHFS's
assessment will not include the executive positions of President and Chief
Executive Officer, for which a search firm has already been engaged by Bancorp
and Bank.
(b) NHFS will assess the Bank's current loan processes, procedures and
status, including loan clientele, marketing programs, collection strategy,
allowance for loan losses, credit administrative processes, accountability
systems and current client relationships, and shall provide, as soon as
practicable, initial written recommendations to Bancorp's and Bank's Chairman of
the Board. NHFS shall provide monthly reports thereafter on progress and results
and further recommendations.
(c) NHFS will assess the Bank's current operations, client services,
products and product development and shall provide, as soon as practicable,
written recommendations to Bancorp's and Bank's Chairman of the Board.
(d) As requested by Bancorp or Bank, NHFS shall provide training to
personnel specified by Bancorp and Bank. Also as requested by Bancorp or Bank,
NHFS shall provide interim personnel on an "as needed" basis.
Any final decision with regard to any matter in connection with the
business of Bancorp or the Bank, irrespective of whether the advice of NHFS has
been solicited or received,
<PAGE>
shall rest with the Boards of Directors of Bancorp and Bank, or to the extent
authorized by the Boards, with the Chairman of the Board of Bancorp and Bank
pursuant to the authority conferred by resolutions of the Boards. The parties
agree that the value of the recommendations from NHFS will be enhanced by prompt
consideration by Bancorp and Bank; therefore, Bancorp and Bank will
expeditiously take action in response to the advice and recommendations of NHFS.
2. JOINT COMMUNICATIONS. Any written communication in any form, from the
--------------------
date hereof, with any person who or entity which is not a party to the
Agreement, and which relates in any way to the Agreement or to the current,
future or planned relationship between, on the one hand Bancorp and/or Bank, and
on the other hand NHFS and/or Melinda McIntyre, must be approved in writing by
both an authorized representative of Bancorp or Bank and by Melinda McIntyre or
her designee, prior to distributing or otherwise disseminating such written
communication.
3. COMPENSATION. In consideration of the services to be provided by NHFS
------------
as set forth in Section 1, Bancorp and Bank shall pay NHFS a monthly consulting
fee equal to (a) the actual costs (as defined below) incurred by NHFS in its
performance of the consulting services for that month, plus an additional
twenty-five percent (25%) of such monthly costs, and (b) the flat, monthly
charges for the services of Melinda McIntyre and Patti Derry as described below.
NHFS shall provide an invoice by the 10th day of each month, detailing the
services provided and expenses incurred in the preceding month. NHFS shall keep
accurate, contemporaneous time records to substantiate all billings, which shall
be available to Bancorp and/or Bank upon request. Upon execution of this
Agreement, Bancorp and Bank will provide to NHFS a deposit of Fifty Thousand
Dollars ($50,000) to be applied to the last invoice of NHFS for the services
described in this Agreement. Any amount not so applied will be refunded to
Bancorp and Bank within thirty (30) days of the date receipt by NHFS of payment
for such last invoice and any unpaid balance.
"Actual costs" incurred shall include all reasonable out-of-pocket
expenses incurred by NHFS, and the hourly rates set forth below for NHFS
personnel:
<TABLE>
<CAPTION>
NHFS Employee Hourly Rate
- ------------- -----------
<S> <C>
Al Hester $80
Linda Flintzer 60
Lyla Oyakawa 40
Jenete Maslonka 50
Melinda Kirksey 25
</TABLE>
With respect to the services of Melinda McIntyre and Patti Derry, NHFS
will charge a flat monthly fee of: (a) Nineteen Thousand Dollars ($19,000) for
Melinda McIntyre, which sum is based on an allocation of approximately fifty
percent (50%) of her working time to Bancorp and Bank; and (b) Nine Thousand
Dollars ($9,000) for Patti Derry, which sum is based on an allocation of
approximately seventy percent (70%) of her working time to Bancorp and Bank. No
percentage markup of these flat monthly fees for Melinda McIntyre and Patti
Derry will be charged. Costs for all other NHFS personnel not specifically set
forth herein shall be billed at reasonable rates as mutually agreed to by the
parties.
4. TERMINATION. This Agreement may be terminated at any time (i) by the
-----------
mutual written consent of the parties, or (ii) by one party giving thirty (30)
days' prior written notice of
-2-
<PAGE>
termination to the other party. If Bancorp and/or Bank gives thirty days' notice
of termination as provided herein, the notice shall contain a description of the
services Bancorp and/or Bank desires NHFS to perform during the remaining thirty
day period. Bancorp's and Bank's only obligation to NHFS in the event of
termination by Bancorp and/or Bank shall be the payment to NHFS for the services
properly performed prior to the notice of termination and for the specific
services performed by NHFS during the last thirty days, as set forth in the
notice of termination from Bank and/or Bancorp.
5. DISCLOSURE OF INFORMATION.
-------------------------
(a) Bancorp and Bank will provide to NHFS all relevant business
information, including a reasonable and secure means of access to such
information, that shall be reasonably necessary to perform NHFS's services under
this Agreement. NHFS and its employees and agents acknowledge that the list of
Bancorp's and Bank's clients, Bancorp's and Bank's financial information,
customer information and other business documents and other proprietary
information (the "Confidential Information") are valuable, special, and unique
assets of Bancorp's and Bank's business. NHFS and its employees and agents,
shall not, during the term hereof or thereafter, directly or indirectly disclose
all or any part of the Confidential Information in any manner whatsoever to any
person, firm, corporation, association or other entity or use such Confidential
Information for its/their own purposes or benefit, other than in connection with
the consulting services provided hereunder. NHFS shall be responsible for
ensuring that its employees and agents do not disclose or use for their benefit
(other than in connection with the consulting services provided hereunder) any
Confidential Information. NHFS agrees that any of its employees participating in
the consulting services hereunder shall sign a Confidential Non-Disclosure
Agreement with Bancorp and Bank prior to being provided with any Confidential
Information. In the event of NHFS's or its employees' or agents' breach or
threatened breach of this paragraph, Bancorp and Bank shall be entitled to a
preliminary restraining order and an injunction restraining and enjoining NHFS
or the applicable employee(s) or agent(s) from disclosing or using all or any
part of the Confidential Information and from rendering any services to any
person, firm, corporation, association, or other entity to whom all or any part
of such Confidential Information has been, or is threatened to be, disclosed. In
addition to or in lieu of the above, Bancorp and Bank may pursue all other
remedies available to Bancorp and Bank for such breach or threatened breach,
including the recovery of damages from NHFS and the applicable employee(s) or
agent(s). Upon termination of this Agreement, NHFS shall promptly return all
Confidential Information in its possession, without retaining copies thereof.
(b) Bancorp, Bank and their respective employees and agents
acknowledge that the list of NHFS's clients, NHFS's financial information,
customer information and other business documents and other proprietary
information (the "NHFS Confidential Information") are valuable, special, and
unique assets of NHFS's business. Bancorp, Bank and their respective employees
and agents, shall not, during the term hereof or thereafter, directly or
indirectly disclose all or any part of the NHFS Confidential Information in any
manner whatsoever to any person, firm, corporation, association or other entity
or use such NHFS Confidential Information for its/their own purposes or benefit,
other than in connection with the consulting services provided by NHFS
hereunder. Bancorp and Bank shall be responsible for ensuring that their
employees and agents do not disclose or use for their benefit (other than in
connection with the consulting services provided by NHFS hereunder) any NHFS
Confidential Information. Bancorp and Bank agree that any of their
-3-
<PAGE>
respective employees participating in the consulting services hereunder shall
sign a Confidential Non-Disclosure Agreement with NHFS prior to being provided
with any NHFS Confidential Information. In the event of Bancorp's, Bank's or
their respective employees' or agents' breach or threatened breach of this
paragraph, NHFS shall be entitled to a preliminary restraining order and an
injunction restraining and enjoining Bancorp, Bank or the applicable employee(s)
or agent(s) from disclosing or using all or any part of the NHFS Confidential
Information and from rendering any services to any person, firm, corporation,
association, or other entity to whom all or any part of such NHFS Confidential
Information has been, or is threatened to be, disclosed. In addition to or in
lieu of the above, NHFS may pursue all other remedies available to NHFS for such
breach or threatened breach, including the recovery of damages from Bancorp,
Bank and the applicable employee(s) or agent(s). Upon termination of this
Agreement, Bancorp and Bank shall promptly return all NHFS Confidential
Information in their possession, without retaining copies thereof.
(c) If any of NHFS or Bancorp or Bank or any of their respective
employees and agents are requested or are required by applicable law (by
interrogatories, requests for information or documents, subpoena, civil
investigative demand or similar process) to disclose any Confidential
Information or NHFS Confidential Information, as applicable, it will provide
Bancorp and Bank, in the case of Confidential Information, or NHFS, in the case
of NHFS Confidential Information, with immediate notice of such request and
requirement so that the party receiving such notice may consider seeking a
protective order. If in the absence of a protective order or the receipt of a
waiver under this Agreement, NHFS or Bancorp or Bank is, in the written opinion
of independent counsel, compelled to disclose any Confidential Information or
NHFS Confidential Information, as applicable, to any tribunal or any other
person or else be subject to contempt or suffer other material censure or
penalty, it may disclose such information to such tribunal or other party
without liability hereunder.
(d) NHFS represents and warrants that it has, or will have at the time
of disclosure, authority from its clients to provide whatever client information
NHFS provides to Bancorp or Bank in connection with NHFS' performance of the
consulting services hereunder.
(e) There shall be no presumption that an unlawful use of Confidential
Information or NHFS Confidential Information or a breach of this Section has
occurred if a customer of a party becomes a customer of another party to this
Agreement.
6. INDEMNIFICATION.
---------------
(a) NHFS shall indemnify and hold harmless Bancorp, Bank and their
respective directors, officers, employees, shareholders, agents, successors and
assigns against any and all claims, liabilities, damages and losses (including
attorneys' fees and settlement costs) which arise or result from the gross
negligence or willful misconduct of NHFS in the performance of NHFS's duties and
services hereunder. NHFS shall not have any responsibility for day-to-day
operations on behalf of Bancorp or Bank, and is engaged only in an advisory
capacity.
(b) Bancorp and Bank shall indemnify and hold harmless NHFS and its
directors, officers, employees, shareholders, agents, successors and assigns
against any and all claims, liabilities, damages and losses (including
attorneys' fees and settlement costs) which arise or result
-4-
<PAGE>
from the performance of NHFS's duties and services hereunder, other than as set
forth in subparagraph 6(a).
(c) If a party believes that any of the persons entitled to
indemnification under this Section 6 has suffered or incurred any claims,
liabilities, damages or losses ("Loss"), such party shall notify the
indemnifying party promptly in writing describing such Loss, the amount thereof,
if known, and the method of computation of such Loss, all with reasonable
particularity; provided that the failure by such party to give notice as
provided herein shall not relieve the indemnifying party of its indemnification
obligation except to the extent that such indemnifying party is materially
damaged as a result of such failure to give notice. Any person entitled to
indemnification hereunder shall use reasonable effort to minimize any Loss for
which indemnification is sought hereunder.
(e) In the event of any claim for indemnification hereunder resulting
from or in connection with any claim or legal proceeding by a third party, the
indemnified person shall give notice thereof to the indemnifying party not later
than twenty (20) days prior to the time any response to the asserted claim is
required, and in any event within fifteen (15) days following the date such
indemnified person has actual knowledge thereof; provided that the failure by
such indemnified person to give notice as provided herein shall not relieve the
indemnifying party of its indemnification obligation except to the extent that
such indemnifying party is materially damaged as a result of such failure to
give notice. In the event of any such claim for indemnification resulting from
or in connection with a claim or legal proceeding by a third party, the
indemnifying party may, at its sole cost and expense, assume the defense
thereof; provided that counsel for the indemnifying party, who shall conduct the
defense of such claim or legal proceeding, shall be reasonably satisfactory to
the indemnified person; and provided further that, if the defendants in any such
action include both indemnified persons and the indemnifying party and the
indemnified persons shall have reasonably concluded that there may be legal
defenses or rights available to them which have not been waived and are in
actual or potential conflict with those available to the indemnifying party, the
indemnified persons shall have the right to select one law firm reasonably
acceptable to the indemnifying party to act as separate counsel on behalf of all
such indemnified persons, at the expense of the indemnifying party. Unless the
indemnified persons are represented by separate counsel pursuant to the second
proviso of the immediately preceding sentence, if an indemnifying party assumes
the defense of any such claim or legal proceeding, such indemnifying party shall
not consent to the entry of any judgment, or enter into any settlement, that (a)
is not subject to indemnification in accordance with the provisions in this
Section 6, (b) provides for injunctive or other nonmonetary relief affecting the
indemnified persons, or (c) does not include as a term thereof the giving by
each claimant or plaintiff to such indemnified persons of an unconditional
release from all liability with respect to such claim or legal proceeding,
without the prior written consent of the indemnified persons (which consent, in
the case of clauses (b) and (c) shall not be unreasonably withheld); and,
provided further, that unless the indemnified persons are represented by
separate counsel pursuant to the second proviso of the immediately preceding
sentence, the indemnified persons may, at their own expense, participate in any
such proceeding with counsel of their choice without any right or control
thereof. So long as the indemnifying party is in good faith defending such claim
or proceeding, the indemnified person shall not compromise or settle such claim
or proceeding without the prior written consent of the indemnifying party, which
consent shall not be unreasonably withheld. If the indemnifying party does not
assume the defense of any such claim or litigation in accordance with the terms
hereof, the indemnified persons may defend against such claim or litigation in
such manner as they may deem appropriate including, without limitation,
-5-
<PAGE>
settling such claim or litigation (after giving prior written notice of the same
to the indemnifying party and obtaining the prior written consent of the
indemnifying party, which consent shall not be unreasonably withheld) on such
terms as the indemnified persons may deem appropriate, and the indemnifying
party will promptly indemnify the indemnified persons in accordance with the
provisions of this Section 6.
7. INDEPENDENT CONTRACTOR RELATIONSHIP. NHFS is an independent contractor
-----------------------------------
retained only for the purposes and to the extent set forth in this Agreement,
and this Agreement shall not, under any circumstances, create an employer-
employee or agency relationship between the parties hereto. NHFS is not
authorized to make, and shall not make, any contracts, representations,
warranties, commitments or other obligations which are or purport to be binding
on Bancorp and/or Bank.
8. ARBITRATION. Any controversy or dispute arising out of or relating to
-----------
this Agreement, its enforcement or interpretation, shall be submitted to
arbitration to be held in Los Angeles County, California, in accordance with the
rules of the American Arbitration Association. In the event any party institutes
arbitration in connection with or concerning the subject matter of this
Agreement, the prevailing party shall be entitled to recover all costs and
expenses incurred by such party in connection therewith, including, but not
limited to, reasonable attorneys' fees, the arbitration fee, and the cost of a
court reporter.
9. ENTIRE AGREEMENT, MODIFICATION AND WAIVER. The provisions hereof
-----------------------------------------
constitute the entire agreement between the parties with respect to the subject
matter hereof. This Agreement shall supersede all prior agreements and
understandings between the parties and no representations or statements made by
any representative of Bancorp, Bank or NHFS which are not stated herein shall be
binding. There shall be no modification or amendment of this Agreement unless it
is in writing and signed by a duly authorized representative of each party.
Failure of either party to enforce rights under this Agreement will not
constitute a waiver of such rights.
10. SEVERABILITY. A finding by any court of competent jurisdiction that any
------------
provision of this Agreement or part thereof is invalid or unenforceable will not
affect the validity and enforceability of the remaining provisions of this
Agreement.
11. NOTICES. All notices, requests or other communications required or
-------
permitted to be given or made under this Agreement shall be deemed given or
served hereunder by any party to another if in writing and delivered personally
or sent by prepaid registered or certified mail, return receipt requested, to
the respective party at the following address, or at such other address as any
party may designate for itself by notice to the other parties given in
accordance with the provisions hereof:
If to Bancorp or Bank: Julie P. Thompson, Chairman of the Board
Professional Bancorp, Inc.
606 Broadway
Santa Monica, CA 90401
-6-
<PAGE>
With copy to: James R. Cummins, Esq.
Brown, Cummins & Brown Co., L.P.A.
3500 Carew Tower
441 Vine Street
Cincinnati, Ohio 45202
If to NHFS: Melinda McIntyre
Network Health Financial Services
11835 W. Olympic Blvd.,
Suite 650E
Los Angeles, CA 90064
With copy to: Paul A. Richler
Morgan, Lewis & Bockius, LLP
22nd Floor, 801 S. Grand Avenue
Los Angeles, CA 90017
12. ASSIGNMENT. NHFS may not assign this Agreement or any part thereof.
----------
13. GOVERNING LAW. This Agreement is deemed to be made under and shall be
-------------
construed according to the laws of the State of California.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
executed as of the day and year first above written.
NETWORK HEALTH FINANCIAL FIRST PROFESSIONAL BANK,
SERVICES, INC. NATIONAL ASSOCIATION
By: /s/ Melinda A. McIntyre By: /s/ Julie P. Thompson
----------------------- ----------------------
Title: President & CEO Title: Chairman
PROFESSIONAL BANCORP, INC.
By: /s/ Julie P. Thompson
----------------------
Title: Chairman
-7-
<PAGE>
EXHIBIT 11
Statement Regarding Computation of Per Share Earnings (Loss)
<TABLE>
<CAPTION>
Year ended December 31,
----------------------------------------
Primary Earnings (Loss) Per Share 1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Computation for Statement of Operations:
Net earnings per statement of operations
used in primary earnings per share
computation:
Net earnings (loss) $(3,724,917) $ 2,005,897 $ 1,252,953
Interest on borrowings, net of tax
effect, on application of assumed
exercise of warrants and options in
excess of 20% limitation (1) 211,780 216,455
----------- ----------- -----------
Net earnings (loss) as adjusted $(3,724,917) $ 2,217,677 $ 1,469,408
=========== =========== ===========
Weighted average number of shares
outstanding, as per primary computation
above 1,312,750 1,211,045 1,276,643
Net shares issuable from assumed exercise
of warrants and options, as determined by
the application of the Modified Treasury
Stock Method (1) 493,900 514,624
----------- ----------- -----------
Weighted average number of shares
outstanding 1,312,750 1,704,945 1,791,267
=========== =========== ===========
Primary earnings (loss) per share $ (2.84) $ 1.30 $ 0.82
=========== =========== ===========
</TABLE>
(1) Anti-dilutive
<PAGE>
Statement Regarding Computation of Per Share Earnings (Loss) - (Continued)
<TABLE>
<CAPTION>
Year ended December 31,
---------------------------------------
Fully Diluted Earnings (Loss) Per Share 1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Computation for Statement of Operations:
Net earnings per statement of operations
used in fully diluted earnings per
share computation:
Net earnings (loss) $(3,724,917) $ 2,005,897 $ 1,252,953
Interest and amortized costs on
convertible notes, net of tax effect (1) 347,169 210,558
Interest on borrowings, net of tax
effect, on application of assumed
exercise of warrants and options in
excess of 20% limitation (1) 211,780 216,445
----------- ----------- -----------
Net earnings (loss) as adjusted $(3,724,917) $ 2,564,846 $ 1,679,956
=========== =========== ===========
Weighted average number of shares
outstanding, as per fully diluted
computation above 1,312,750 1,211,045 1,276,643
Net shares issuable from assumed exercise
of warrants and options, as determined by
the application of the Modified Treasury
Stock Method (1) 493,900 514,626
Weighted average shares issuable from
assumed conversion of convertible notes (1) 421,425 262,397
----------- ----------- -----------
Weighted average number of shares
outstanding 1,312,750 2,126,370 2,053,666
=========== =========== ===========
Fully diluted earnings (loss) per share $ (2.84) $ 1.21 $ 0.82
=========== =========== ===========
</TABLE>
(1) Anti-dilutive
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 32,322,030
<INT-BEARING-DEPOSITS> 617,948
<FED-FUNDS-SOLD> 33,400,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 54,467,683
<INVESTMENTS-CARRYING> 41,871,563
<INVESTMENTS-MARKET> 41,478,000
<LOANS> 93,133,233
<ALLOWANCE> 2,253,031
<TOTAL-ASSETS> 263,539,498
<DEPOSITS> 241,276,748
<SHORT-TERM> 0
<LIABILITIES-OTHER> 3,351,864
<LONG-TERM> 4,869,292
0
0
<COMMON> 11,286
<OTHER-SE> 14,030,308
<TOTAL-LIABILITIES-AND-EQUITY> 263,539,498
<INTEREST-LOAN> 9,030,090
<INTEREST-INVEST> 7,540,804
<INTEREST-OTHER> 1,079,562
<INTEREST-TOTAL> 17,650,456
<INTEREST-DEPOSIT> 4,187,859
<INTEREST-EXPENSE> 4,850,230
<INTEREST-INCOME-NET> 12,800,226
<LOAN-LOSSES> 4,136,000
<SECURITIES-GAINS> (71,309)
<EXPENSE-OTHER> 15,545,322
<INCOME-PRETAX> (5,437,317)
<INCOME-PRE-EXTRAORDINARY> (3,724,917)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,724,917)
<EPS-PRIMARY> (2.84)
<EPS-DILUTED> (2.84)
<YIELD-ACTUAL> 5.38
<LOANS-NON> 1,521,000
<LOANS-PAST> 507,000
<LOANS-TROUBLED> 268,000
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 1,070,426
<CHARGE-OFFS> 3,353,113
<RECOVERIES> 399,718
<ALLOWANCE-CLOSE> 2,253,031
<ALLOWANCE-DOMESTIC> 2,000,000
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 253,031
</TABLE>
