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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, 1997
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
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant as of March 17, 1998: $20,243,745.
The number of shares of $0.008 par value common stock outstanding as of March
17, 1998: 1,357,222.
DOCUMENTS INCORPORATED BY REFERENCE
PART III - Proxy Statement for Registrant's 1998 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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<S> <C> <C> <C>
PART I
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Item 1. Business 1
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Item 2. Properties 10
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Item 3. Legal Proceedings 11
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Item 4. Submission of Matters to a Vote of Security Holders 11
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PART II
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Item 5. Market for Registrant's Common Equity
------- and Related Stockholder Matters 12
Item 6. Selected Financial Data 14
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Item 7. Management's Discussion and Analysis of Financial
------- Condition and Results of Operations 15
Item7A. Quantitative and Qualitative Disclosures About Market Risk 33
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Item 8. Financial Statements and Supplementary Data 36
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Item 9. Changes in and Disagreements with Accountants on Accounting
------- and Financial Disclosure 36
PART III
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Item 10. Directors and Executive Officers of the Registrant 36 1998 Proxy
-------- Statement
Item 11. Executive Compensation 36 1998 Proxy
-------- Statement
Item 12. Security Ownership of Certain Beneficial Owners and Management 36 1998 Proxy
-------- Statement
Item 13. Certain Relationships and Related Transactions 36 1998 Proxy
-------- Statement
PART IV
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Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 36
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INDEX TO FINANCIAL STATEMENTS AND SCHEDULES F-1
</TABLE>
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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 and
from the proceeds of its initial stock offering, Bancorp purchased all of the
outstanding stock of the Bank. 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 the Bank (the "Company")
consist 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 provides a wide range of commercial banking services primarily
directed towards the health care community. 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.
COMMERCIAL BANKING
The Company is engaged in the business of general commercial banking. 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 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
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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 health care
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, directorships 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.
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 the BHCA, an investor 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
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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 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
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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 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.
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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 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.
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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, 1997.
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To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adquacy Purposes Action Provisions
-------------------------- ---------------------------- ----------------------------
(in thousands) Amount Ratio Amount Ratio Amount Ratio
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COMPANY
Leverage/1/ $16,127 6.38% $10,111 4.00% $12,639 5.00%
Tier 1 Risk-Based 16,127 11.54 5,590 4.00 8,385 6.00
Total Risk-Based 23,311 16.68 11,180 8.00 13,975 10.00
BANK
Leverage $20,466 8.13% $10,069 4.00% $12,586 5.00%
Tier 1 Risk-Based 20,466 14.73 5,558 4.00 8,336 6.00
Total Risk-Based 22,203 15.98 11,115 8.00 13,894 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.
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,
1997, 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:
<TABLE>
<S> <C>
"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.
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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 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.
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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 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
1997 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 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.
8
<PAGE>
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.
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.
RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997 the FASB issued SFAS No. 129, "Disclosure of Information
Account Capital Structure." SFAS No. 129 consolidates existing reporting
standards for disclosing information about an entity's capital structure.
SFAS No. 129 also supersedes previously issued account statements. The Company
adopted SFAS No. 129 as of December 31, 1997. The impact on the Company is not
significant as the Company's existing disclosures are generally in compliance
with the disclosure requirements in SFAS No. 129.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." SFAS No. 130 establishes standards for reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements. SFAS No. 130 is effective for fiscal years beginning
after December 15, 1997. The impact on the Company of adopting SFAS No. 130 is
not expected to be material to the Company's existing disclosure.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." SFAS No. 131 establishes standards to
report information about operating segments in annual financial statements and
requires reporting of selected information about operating segments in interim
reports to shareholders. It also establishes standards for related disclosures
about products and services, geographic areas and major customers. SFAS No. 131
is effective for financial statement for periods beginning after December 15,
1997, with comparative information for earlier years to be restated. The
Company is currently assessing the effect of adopting SFAS No. 131.
9
<PAGE>
EMPLOYEES
As of December 31, 1997, the Bancorp had no full-time salaried employees.
All compensation of Bancorp's executive officers was paid by the Bank with a
portion of such compensation reimbursed by Bancorp. The Bank employed 113.5
full-time equivalent employees as of December 31, 1997.
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.
10
<PAGE>
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.
A settlement between Bancorp, the Bank and St. Paul Mercury Insurance
Company, Bancorp's and the Bank's director and officer liability insurance
carrier, was finalized in December 1997. Pursuant to the settlement agreement,
St. Paul reimbursed Bancorp and the Bank $600,000 for certain non-recurring
legal expenses in connection with the 1996 proxy contest and the litigation
related thereto.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
The Bancorp did not submit any matters to a vote of its stockholders during
the fourth quarter of 1997.
11
<PAGE>
Part II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
- ------------------------------------------------------------------------------
Market Information and Holders
- ------------------------------
The Bancorp 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
Bancorp's Common Stock began trading on the American Stock Exchange on December
3, 1991 under the symbol "MDB." On January 19, 1993, the Bancorp 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 Bancorp declared a 5% stock dividend paid on July 19, 1995. On May 14,
1996, the Bancorp declared a 5% stock dividend paid on June 21, 1996. As of
December 31, 1997, the Bancorp estimated there were approximately 730 registered
shareholders.
The following table sets forth the range of stock price for the Bancorp's
common stock for each of the quarters in the two years ended December 31, 1997,
adjusted for the 5% stock dividends mentioned above:
<TABLE>
<CAPTION>
Quarter High Low
-------------------- ------------ ------------
<S> <C> <C>
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
1st Quarter 1997 12.63 10.13
2nd Quarter 1997 12.00 11.50
3rd Quarter 1997 16.75 13.25
4th Quarter 1997 16.00 14.38
</TABLE>
The foregoing reflects information available to the Bancorp and does not
necessarily include all trades in the Bancorp's stock during the relevant
period. According to information available to the Bancorp, the closing price of
the Bancorp's common stock on December 31, 1997, was $15.56.
Dividends
- ---------
The Bancorp has not paid any cash dividends since its formation.
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.
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
12
<PAGE>
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 Bancorp 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 Bancorp'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 Bancorp by its
subsidiary. Statutory and regulatory requirements impose limitations on the
amount of dividends payable by the Bank to the Bancorp and on extensions of
credit by the Bank to the Bancorp.
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.
13
<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, 1997. 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,
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
STATEMENT OF OPERATIONS DATA: (Dollars in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Interest income $ 16,709 $ 17,650 $ 20,903 $ 17,799 $ 15,092
Interest expense 3,826 4,850 6,539 4,180 3,758
Net interest income 12,883 12,800 14,364 13,619 11,334
Provision for loan losses 180 4,136 1,539 703 253
Net (loss) gain on sale of securities
available-for-sale - (71) 1,018 (213) 398
Other operating income 1,793 1,515 1,435 1,524 1,419
Operating expense 12,125 15,545 12,090 12,093 10,624
Income tax (benefit) provision 892 (1,712) 1,182 881 922
Net earnings (loss) 1,479 (3,725) 2,006 1,253 1,352
PER SHARE DATA:
Basic (loss) earnings per share $ 1.10 $ (2.78) $ 1.57 $ 1.00 $ 1.08
Diluted (loss) earnings per share 0.97 (2.78) 1.28 0.82 1.03
Book value per share 11.69 10.47 13.69 12.37 11.74
BALANCE SHEET DATA:
Total assets $253,828 $264,287 $322,165 $315,005 $257,677
Total loans 105,857 93,133 100,085 103,745 117,803
Securities held-to-maturity 35,100 41,872 48,517 120,735 94,893
Securities available-for-sale 52,696 54,468 81,520 47,003 25,650
Total deposits 229,464 241,277 297,466 293,631 241,144
Stock subject to repurchase - - - - 781
Shareholders' equity 15,863 14,042 17,508 15,432 14,642
PERFORMANCE AND LEVERAGE RATIOS:
Return on average assets 0.61% -1.38% 0.64% 0.43% 0.53%
Return on average equity 9.48 -23.89 12.40 8.78 9.80
Average equity to average assets 6.45 5.78 5.14 5.27 5.36
Net interest margin/1/ 6.04 5.38 5.07 5.19 4.95
Efficiency ratio/2/ 82.62 109.13 71.89 81.00 80.78
ASSET QUALITY RATIOS:/3/
Nonperforming loans to total loans 0.83% 1.63% 4.18% 2.57% 2.04%
Nonperforming assets:
to total loans 1.09 1.93 4.27 2.67 2.13
to total loans and OREO 1.08 1.92 4.26 2.67 2.12
to total assets 0.45 0.68 1.32 0.88 0.97
Allowance for loan losses:
to total loans 1.70 2.42 1.07 0.95 0.89
to nonperforming loans 205.47 148.13 25.64 36.91 43.70
to nonperforming assets 156.83 125.66 25.11 35.50 41.85
Net charge-offs to average total loans 0.65 3.04 1.45 0.69 0.09
</TABLE>
/1/ Ratio of net interest income to average interest-earning assets.
/2/ Efficiency ratio equals operating expense divided by net interest income and
other operating income.
/3/ Nonperforming loans and nonperforming assets do not include accruing loans
90 days or more past due.
14
<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 net earnings of $1,479,000, or $0.97 diluted earnings
per share, for the year ended December 31, 1997, compared with a net loss of
$3,725,000, or $2.78 diluted loss per share, in 1996. The net loss in 1996
resulted from a decrease in net interest income as loan and deposit balances
declined, certain non-recurring costs relating to a proxy contest and related
litigation, and certain non-recurring costs relating to a management
restructuring. In 1995, the Company generated net earnings of $2,006,000 or
$1.28 diluted earnings per share. The provision for loan losses was $180,000 in
1997, compared to $4,136,000 in 1996 and $1,539,000 in 1995. The significant
increase in the provision for loan losses in 1996 was a result of an increase in
loans charged-off and management's evaluation of the risk inherent in the loan
portfolio.
The Company experienced an increase in gross loans of $12,724,000, or 13.7%
growth, from $105,857,000 at December 31, 1997 compared to $93,133,000 at
December 31, 1996. Conversely, deposits decreased $11,813,000, or 4.9%, from
$241,277,000 at December 31, 1996 to $229,464,000 at December 31, 1997. This
decrease occurred primarily in time certificates of deposits which decreased
$3,793,000 from $31,323,000 at December 31, 1996 to $27,530,000 at December 31,
1997 and savings and money market deposits which declined $9,633,000 from
$98,859,000 to $89,226,000 at December 31, 1996 and 1997, respectively.
At December 31, 1997, nonaccrual loans totaled $877,000, or 0.83%, of
total loans as compared with $1,521,000 or 1.63% of total loans at December 31,
1996. Net charge-offs decreased to $631,000 or 0.65% of average outstanding
loans of $97,197,000 in 1997, as compared with $2,953,000 or 3.04% of average
loans of $97,147,000 in 1996.
RESULTS OF OPERATIONS
For the year ended December 31, 1997, the Company recorded net earnings of
$1,479,000 or $1.10 basic earnings per share and $0.97 diluted earnings per
share. Included in pretax income in 1997 is $600,000 which the Company received
as reimbursement for certain non-recurring legal expenses in connection with a
1996 proxy contest and the litigation related thereto. This compares with a net
loss of $3,725,000, or $2.78 basic and diluted loss per share, in 1996 and net
earnings of $2,006,000 or $1.28 diluted earnings per share in 1995. This
resulted in a return on average equity of 9.48% in 1997 as compared to a
negative return on average equity of (23.89%) in 1996 and 12.40% in 1995.
Additionally, the return on average assets for 1997, 1996 and 1995 was 0.61%,
(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, 1997.
15
<PAGE>
<TABLE>
<CAPTION>
1997
----
Average Yield/
(in thousands) Balance(2) Rate Interest
------- -------- --------
<S> <C> <C> <C>
Assets
Interest-earning assets:
Securities $ 94,084 6.20% $ 5,834
Loans/(1)/ 97,197 9.97 9,686
Federal funds sold 21,510 5.39 1,160
Interest-earning deposits - banks 463 6.26 29
-------- -------
Total interest-earning assets 213,149 7.84 16,709
-------- -------
Deferred loan fees (170)
Allowance for loan losses (2,157)
Nonearning assets:
Cash and due from banks 22,264
Premises and equipment 1,658
Accrued interest receivable 1,152
Other assets 5,951
--------
Total assets $241,952
========
Liabilities and shareholders' equity
Interest-bearing liabilities:
Interest-bearing deposits $ 12,887 0.84% $ 108
Savings and money market deposits 94,755 1.92 1,821
Time deposits 29,377 4.79 1,408
Convertible notes 5,572 8.49 473
Repurchase agreements 274 5.84 16
Stock subject to repurchase - - -
-------- ------
Total interest-bearing liabilities 142,865 2.68 3,826
-------- ------
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits 81,379
Other liabilities 2,113
Shareholders' equity 15,595
--------
Total liabilities and
shareholders' equity $241,952
========
Interest income as a percentage of average
earning assets 7.84%
Interest expense as a percentage of average
interest-bearing liabilities 2.68
Net interest margin and income (3) 6.04 $12,883
-------
<CAPTION>
1996
----
Average Yield/
Balance(2) Rate Interest
------- -------- --------
<S> <C> <C> <C>
Assets
Interest-earning assets:
Securities $ 119,819 6.29% $ 7,541
Loans/(1)/ 97,147 9.30 9,030
Federal funds sold 20,020 5.27 1,056
Interest-earning deposits - banks 992 2.32 23
--------- -------
Total interest-earning assets 237,978 7.42 17,650
--------- -------
Deferred loan fees (87)
Allowance for loan losses (2,260)
Nonearning assets:
Cash and due from banks 24,318
Premises and equipment 1,741
Accrued interest receivable 1,320
Other assets 6,810
--------
Total assets $269,820
========
Liabilities and shareholders' equity
Interest-bearing liabilities:
Interest-bearing deposits $ 13,247 0.72% $ 96
Savings and money market deposits 98,363 1.72 1,693
Time deposits 49,065 4.89 2,399
Convertible notes 5,612 8.50 477
Repurchase agreements 3,422 5.41 185
Stock subject to repurchase - - -
-------- -------
Total interest-bearing liabilities 169,709 2.86 4,850
-------- -------
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits 81,869
Other liabilities 2,653
Shareholders' equity 15,589
--------
Total liabilities and
shareholders' equity $269,820
========
Interest income as a percentage of average
earning assets 7.42%
Interest expense as a percentage of average
interest-bearing liabilities 2.86
Net interest margin and income 5.38 $12,800
=======
<CAPTION>
1995
----
Average Yield/
Balance(2) Rate Interest
------- -------- --------
<S> <C> <C> <C>
Assets
Interest-earning assets:
Securities $160,612 6.47% $10,395
Loans/(1)/ 100,985 9.18 9,267
Federal funds sold 21,074 5.83 1,228
Interest-earning deposits - banks 596 2.18 13
-------- -------
Total interest-earning assets 283,267 7.38 20,903
-------- -------
Deferred loan fees (74)
Allowance for loan losses (948)
Nonearning assets:
Cash and due from banks 25,226
Premises and equipment 1,603
Accrued interest receivable 1,488
Other assets 4,062
--------
Total assets $314,624
========
Liabilities and shareholders' equity
Interest-bearing liabilities:
Interest-bearing deposits $ 14,396 0.73% $ 105
Savings and money market deposits 113,974 1.72 1,959
Time deposits 74,639 5.07 3,786
Convertible notes 5,706 8.50 485
Repurchase agreements 3,458 5.90 204
Stock subject to repurchase - - -
-------- ------
Total interest-bearing liabilities 212,173 3.08 6,539
-------- ------
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits 85,116
Other liabilities 1,164
Shareholders' equity 16,171
--------
Total liabilities and
shareholders' equity $314,624
========
Interest income as a percentage of average
earning assets 7.38%
Interest expense as a percentage of average
interest-bearing liabilities 3.08
Net interest margin and income 5.07 $14,364
=======
</TABLE>
/(1)/ Nonaccrual loans are included in average balance calculations; however,
interest on such loans has been excluded in computing the average yields for the
periods.
/(2)/ Average balances are primarily computed on daily balances during the
period. When such balances are not available, averages are computed on a
monthly basis.
/(3)/ The net interest margin for a period is net interest income divided by
average interest-earning assets.
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 as the net interest income recognized for a period
over the average interest-earning assets for the same period.
Net interest income before provision for loan losses for the year ended
December 31, 1997 was $12,883,000 or approximately the same as December 31,
1996. In 1997 net interest margin was impacted by a decline in average
interest-earning assets which declined $24,724,000, or 10.4%, from $237,978,000
at December 31, 1996 to
16
<PAGE>
$213,254,000 at December 31, 1997 coupled with an increase in the yield on
average interest-earning assets which increased 42 basis points from 7.42% to
7.84% at December 31, 1996 and 1997, respectively. The primary decline in
average interest-earning assets in 1997 was in average securities which declined
$25,735,000 from December 31, 1996 to December 31, 1997 and federal funds sold
which declined for the same period.
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 income was primarily due to a decrease of
approximately $45,289,000 in average interest-earning assets, including a
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. A reduction 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>
1997 Compared With 1996 1996 Compared With 1995
----------------------- -----------------------
(in thousands) Volume Rate Total Volume Rate Total
------ ---- ----- ------ ---- -----
<S> <C> <C> <C> <C> <C> <C>
Increase (decrease) in interest income:
Securities $(1,598) $(109) $(1,707) $(2,575) $(279) $(2,854)
Loans 5 651 656 (356) 119 (237)
Federal funds sold 80 24 104 (59) (113) (172)
Interest-bearing deposits - banks (17) 23 6 9 1 10
------- ----- ------- ------- ----- -------
(1,530) 589 (941) (2,981) (272) (3,253)
Increase (decrease) in interest expense:
Interest-bearing demand deposits (3) 15 12 (8) (1) (9)
Savings and money market deposits (64) 192 128 (269) 3 (266)
Time deposits (945) (46) (991) (1,255) (132) (1,387)
Convertible notes (3) (1) (4) 15 (23) (8)
Repurchase agreements (183) 14 (169) (2) (17) (19)
Stock subject to repurchase - - - - - -
------- ----- ------- ------- ----- -------
(1,197) 173 (1,024) (1,519) (170) (1,689)
------- ----- ------- ------- ----- -------
Increase (decrease) in net interest income $ (333) $ 416 $ 83 $(1,462) $(102) $(1,564)
======= ===== ======= ======= ===== =======
</TABLE>
Interest income for 1997 was $16,709,000 compared to $17,650,000 for 1996
and $20,903,000 for 1995. This decrease was primarily due to a decrease in the
securities held-to-maturity and available-for-sale which resulted in a
$1,598,000 decrease in interest income in 1997 and $2,575,000 decrease in 1996.
Interest expense declined in 1997 to 3,826,000 from $4,850,000 in 1996,
representing a decrease of approximately $1,024,000. Interest expense
17
<PAGE>
decreased in 1997 primarily as a result of a decline in time deposits which
declined $19,688,000, or 40.1%, from an average of $49,065,000 in 1996 to
$29,377,000 in 1997. Average interest-bearing deposits decreased $23,656,000
from an average balance of $160,675,000 in 1996 to $137,019,000 in 1997. The
net effect of this decrease in average interest-bearing deposits and increase in
rates paid was a reduction in interest expense of approximately $851,000 in
1997.
In 1995 interest income of $20,903,000 was greater than recorded in 1996
primarily due to an increase in average interest-earning assets from
$283,267,000 in 1995 compared to $237,978,000 in 1996. The decrease in total
interest expense of $1,689,000 from $6,539,000 for the year ended December 31,
1995 to $4,850,000 for the year ended December 31, 1996 was associated with the
decrease of $42,225,000 in average interest-bearing liabilities The cost of
funds in 1995 was significantly higher than in 1996 due to the funding of the
investment portfolio which was accomplished through higher cost 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 1997 was $180,000,
$4,136,000 for 1996 and $1,539,000 for 1995. The decrease in the provision for
loan losses in 1997 was a result of an overall improvement in the loan portfolio
as a result of improved credit administration practices. The increase in the
provision for 1996 over 1995 was primarily due to charge-offs, net of
recoveries, of $2,953,000 as compared with $1,452,000 in 1995. Net charge-offs
to average outstanding loans decreased to 0.65% in 1997 from 3.04% in 1996 and
1.45% in 1995. Based on management's evaluation of the inherent risk in the
loan portfolio, the allowance for loan losses was decreased to 1.70% of total
loans as of December 31, 1997 compared to 2.42% of total loans as of December
31, 1996, and 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 increased $349,000 in 1997 over 1996 primarily due
to an increase in service charges on deposits which increased $122,000 over 1996
and an increase in other income of $119,000. Other operating income in 1996
decreased $1,009,000 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 approximately $95,000 over 1995.
Other Operating Expenses
For the year ended December 31, 1997, other operating expenses were
$12,125,000, representing a decrease of $3,420,000 from $15,545,000 in 1996.
Other operating expenses in 1996 were higher than 1997 due primarily to the
recognition of approximately $2,579,000 in nonrecurring legal expenses,
settlement costs associated with the proxy contest and related litigation,
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 1997, 1996 and 1995 were 5.01%, 5.76% and 3.84%,
respectively. Excluding the nonrecurring costs, the ratio for 1996 would have
been
18
<PAGE>
4.81%. The following table summarizes changes in other operating expenses
for the years ended December 31, 1997, 1996 and 1995.
<TABLE>
<CAPTION>
Increase (Decrease)
-------------------
(in thousands) 1997 1996 1995 1997/1996 1996/1995
----- ---- ---- -------------------
<S> <C> <C> <C> <C> <C>
Salaries and employee benefits $ 5,804 $ 5,945 $ 5,859 $ (141) $ 86
Occupancy 1,481 1,386 1,382 95 4
Legal fees, net of legal settlement (106) 2,754 799 (2,860) 1,955
Furniture and equipment 829 697 736 132 (39)
Professional services 1,346 930 605 416 325
Strategic planning and investor relations 375 - - 375 -
FDIC assessment 27 1 321 26 (320)
Office supplies 227 288 281 (61) 7
Other assessments 225 299 271 (74) 28
Telephone 273 271 227 2 44
Audit, accounting and examinations 132 201 149 (69) 52
Postage 150 154 147 (4) 7
Messenger service 71 178 121 (107) 57
Imprinted checks 91 138 121 (47) 17
Donations 101 135 113 (34) 22
Meetings and business development 163 126 66 37 60
Severance payments and accruals - 1,006 - (1,006) 1,006
Other 936 1,036 892 (100) 144
------- ------- ------- ------- -------
Total other operating expenses $12,125 $15,545 $12,090 $(3,420) $ 3,455
======= ======= ======= ======= =======
</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. As part of the Settlement Agreement, proxy costs incurred by
the Shareholders Protective Committee were reimbursed by the Company. In
December 1997, Bancorp and Bank received a settlement of $600,000 for
reimbursement of a portion of these fees from St. Paul Mercury Insurance
Company. Management changes related to the settlement, including payments to
Mr. Kovner, resulted in severance payments of $1,006,000.
Excluding these nonrecurring expenses, other operating expenses in 1996
were $841,000 greater than other operating expenses in 1997. Substantially,
most of the decline in 1997 was in the area of legal fees which were improved
due to receipt of an insurance settlement regarding certain non-recurring legal
expenses. Legal fees increased $551,000 in 1996 from 1995 due to management's
efforts to collect on a number of certain problem loans, of which approximately
$400,000 was collected through recoveries. Professional services also increased
in 1997 over 1996 and in 1996 over 1995 as temporary personnel, including
outside consultants, were required to continue business on an ongoing basis.
This increase was partially offset during 1996 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.
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 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 1997, the Company and the Bank paid NHFS the amount of $708,000
pursuant to the Consulting Agreement. Any party may terminate the Consulting
Agreement by giving 30 days' notice to the other parties. The Company is also
exploring some form of strategic alliance with NHFS as a primary focus of the
Company's growth strategy.
19
<PAGE>
Income Taxes
The Company recorded an income tax provision (benefit) of $892,000,
$(1,712,000) and $1,182,000 in 1997, 1996 and 1995 respectively. The effective
tax rate in these years were 37.6%, 31.5% and 37.1%. For further information,
see Note 7 of Notes to Consolidated Financial Statements.
BALANCE SHEET ANALYSIS
Total assets were $253,828,000 at December 31, 1997, representing a
decrease of $10,459,000, or 4.0% from $264,287,000 at December 31, 1996.
Average assets during 1997 and 1996 were $241,952,000 and $269,820,000,
respectively. The decrease in average assets during 1997 was due primarily to a
decrease in securities held-to-maturity and available-for-sale which declined
$25,735,000 from an average of $119,819,000 for 1996 to an average of
$94,084,000 for 1997. Gross loans at December 31, 1997 were $105,857,000,
compared with $93,133,000 at December 31, 1996. Total deposits at December 31,
1997 and 1996 were $229,464,000 and $241,277,000, respectively. The majority of
the decline in deposits occurred in savings and money market deposits which
declined $9,633,000 from $98,859,000 at December 31, 1996 to $89,226,000 at
December 31, 1997. Increased loan demand is reflective of improved marketing
efforts as well as an internal focus on credit administrative practices.
Moreover, continued consolidation within the health services industry, which the
Company serves, has created demand for credit.
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. 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.
20
<PAGE>
The following table sets forth the amounts of loans outstanding by type of
credit extension as of the dates indicated.
<TABLE>
<CAPTION>
(in thousands) 1997 1996 1995 1994 1993
---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Commercial $ 86,243 $73,577 $ 77,012 $ 83,239 $ 94,406
Real estate secured commercial 10,512 10,079 13,241 8,863 9,655
-------- ------- -------- -------- --------
Subtotal 96,755 83,656 90,253 92,102 104,061
Equity lines of credit 6,288 6,202 6,070 7,195 8,138
Other lines of credit 1,524 1,832 1,997 2,119 2,261
Installment 1,253 1,375 1,625 2,072 2,887
Lease financing 37 68 140 257 456
-------- ------- -------- -------- --------
Total loans 105,857 93,133 100,085 103,745 117,803
Less: allowance for loan losses (1,802) (2,253) (1,070) (983) (1,048)
Less: deferred loan fees, net (155) (121) (71) (82) (78)
-------- ------- -------- -------- --------
Net loans $103,900 $90,759 $ 98,944 $102,680 $116,677
======== ======= ======== ======== ========
Fixed rate $ 6,935 7% $ 7,075 8% $ 11,240 11% $ 7,756 7% $ 7,703 7%
Variable rate 98,922 93% 86,058 92% 88,845 89% 95,989 93% 110,100 93%
-------- ------- -------- -------- --------
Total loans $105,857 $93,133 $100,085 $103,745 $117,803
======== ======= ======== ======== ========
</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, 1997 or 1996.
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. At December 31,
1997 the Company's commercial and real estate secured commercial loans totaled
$96,755,000 or 91% of total loans compared to $83,656,000 or 90% of total loans
on December 31, 1996. Of the total, real estate secured commercial loans
accounted for only $10,512,000 at December 31, 1997 and $10,079000 at December
31, 1996. Commercial and real estate secured commercial loans consist primarily
of short- to medium-term financing for small- to medium-sized 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 81% of total loans at December 31, 1997 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
21
<PAGE>
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. The Company's real
estate secured 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 and are not classified by the
Company as real estate-mortgage loans.
Equity Lines of Credit. At December 31, 1997 and 1996, equity lines of
credit aggregated approximately $6,288,000 or 6% of total loans, and $6,202,000
or 7% 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, 1997 and 1996, other lines of
credit aggregated approximately $1,524,000 or 1% of total loans, and $1,832,000
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, 1997 and 1996, installment loans
aggregated approximately $1,253,000 and $1,375,000, 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.
The following table shows the maturity distribution of the Company's loans
outstanding at December 31, 1997, 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>
Commercial $57,356 $28,474 $ 413 $ 86,243
Real estate commercial 3,255 6,375 882 10,512
Equity lines of credit 1,276 4,553 458 6,287
Other lines of credit 1,095 429 2 1,526
Installment 401 822 29 1,252
Lease financing 37 - - 37
------- ------- ------- --------
Total $63,420 $40,653 $ 1,784 $105,857
======= ======= ======= ========
Fixed rate $ 2,897 5% $ 3,002 6% $ 1,036 22% $ 6,935
Variable rate 50,598 95% 44,591 94% 3,733 78% 98,922
------- ------- ------- --------
Total $53,495 $47,593 $ 4,769 $105,857
======= ======= ======= ========
</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
22
<PAGE>
potential is minimized for commitments extended under such document. At December
31, 1997 and 1996, the Company had commitments to extend credit of approximately
$32,048,000 and $38,931,000, respectively, and obligations under standby letters
of credit of approximately $6,832,000 and $4,610,000, 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 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) 1997 1996 1995 1994 1993
------ ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Nonperforming Assets:
Nonperforming loans $ 877 $1,521 $4,173 $2,663 $2,398
Other real estate owned (OREO) - - 90 106 106
Other repossessed assets 272 272 - - -
------ ------ ------ ------ ------
Total nonperforming assets $1,149 $1,793 $4,263 $2,769 $2,504
====== ====== ====== ====== ======
Accruing loans 90 days or more past due $ 17 $ 507 $ 632 $ 964 $ 8
====== ====== ====== ====== ======
Nonperforming loans to total loans/(1)/ 0.83% 1.63% 4.18% 2.57% 2.04%
Nonperforming assets/(1)/
to total loans 1.09 1.93 4.27 2.67 2.13
to total loans, OREO and repossessed assets 1.08 1.92 4.26 2.67 2.12
to total assets 0.45 0.68 1.32 0.88 0.97
</TABLE>
/(1)/ Nonperforming loans and nonperforming 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.
23
<PAGE>
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 at least
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 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, 1997, management was of
the opinion that a $1,802,000 allowance for loan losses, which constitutes 1.70%
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.
24
<PAGE>
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) 1997 1996 1995 1994 1993
---------- -------- ---------- --------- ---------
<S> <C> <C> <C> <C> <C>
Gross loans outstanding at end of period $105,857 $93,133 $100,085 $103,745 $117,803
Average loans outstanding 97,197 97,147 100,985 111,446 115,421
Net charge-offs to average loans 0.65% 3.04% 1.45% 0.69% 0.09%
Allowance for loan losses:
to total loans 1.70 2.42 1.07 0.95 0.89
to nonperforming loans/(1)/ 205.47 148.13 25.65 36.91 43.70
to nonperforming assets/(1)/ 156.83 125.66 25.11 35.50 41.85
</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,
----------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
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 $ 683 82% $1,584 79% $ 711 77% $587 80% $ 797 80%
Real estate secured commercial 104 10% 237 11 46 13 76 9 122 8
Equity lines of credit 111 6% 150 7 118 6 220 7 61 7
Other lines of credit 43 1% 24 2 7 2 7 2 12 2
Installment 177 1% 5 1 5 2 5 2 7 2
Lease financing - - - - - - 1 - 1 1
Unallocated 684 - 253 - 183 - 87 - 48 -
------ ---- ------ ---- ------ ---- ---- ---- ------ ----
Total $1,802 100% $2,253 100% $1,070 100% $983 100% $1,048 100%
</TABLE>
The Company had approximately $1,199,000 in impaired loans as of December
31, 1997. The carrying value of impaired loans for which there is a related
allowance for loan losses was $234,000, with the amount of specific allowance
for loan losses allocated to these loans of $80,000. There were $965,000 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 1997 was $1,342,000 and there was no income recorded utilizing
either the cash basis or accrual basis method of accounting. Impaired loans at
December 31, 1997 included $877,000 of nonaccrual loans.
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
25
<PAGE>
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. 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.
Securities
The average yield on the Company's securities was 6.20% in 1997 compared
with 6.29% in 1996 and 6.47% in 1995. The yield on securities in 1997 was
approximately the same as in 1996. The decrease in yield in 1996 compared to
1995 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) 1997 1996 1995
------- ------ -------
<S> <C> <C> <C>
U.S. Government securities $ 2,004 $ - $ -
U.S. Government agency and
mortgage-backed securities 34,740 35,786 42,124
Small Business Administration securities 1,292 1,742 1,975
Collateralized mortgage obligations 14,660 16,940 37,421
------- ------- -------
Total $52,696 $54,468 $81,520
======= ======= =======
</TABLE>
The following table sets forth the maturities of securities available-for-
sale at December 31, 1997 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 securities $2,004 6.03% $ - -% $ - -% $ - -% $ 2,004 6.03%
U.S. Government agency and
mortgage-backed securities - 4,553 6.28 - 30,187 6.18 34,740 6.19
Small Business Administration
securities - - - - 315 7.57 977 1.47 1,292 2.96
Collateralized mortgage obligations - - - - - - 14,660 6.23 14,660 6.23
------ ------ ---- ------- -------
Total $2,004 6.03% $4,553 6.28% $315 7.57% $45,824 6.10% $52,696 6.12%
====== ====== ==== ======= =======
</TABLE>
26
<PAGE>
The following table sets forth the amortized cost of securities held-to-maturity
at the dates indicated.
<TABLE>
<CAPTION>
December 31,
------------------------------------
(in thousands) 1997 1996 1995
-------- -------- -------
<S> <C> <C> <C>
U.S. Government securities $ 3,054 $ 3,064 $ 3,074
U.S. Government Agency securities 2,750 3,250 3,749
U.S. Government Agency
mortgage-backed securities 28,857 35,119 41,263
Collateralized mortgage obligations - - -
Federal Reserve Bank stock 439 439 431
------- ------- -------
Total $35,100 $41,872 $48,517
======= ======= =======
</TABLE>
The following table sets forth the maturities of securities held-to-
maturity at December 31, 1997 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. Government securities $ - -% $1,023 6.81% $ 2,031 5.89% $ - -% $ 3,054 6.20%
U.S. Government Agency securities - - - - 2,750 5.65 - - 2,750 5.65
U.S. Government Agency
mortgage-backed securities - - - - 13,020 6.55 15,837 6.34 28,857 6.46
Federal Reserve Bank stock - - - - - - 439 6.00 439 6.00
----- ------ ------- ------- -------
Total $ - -% $1,023 6.81% $17,801 6.33% $16,276 6.33% $35,100 6.31%
===== ====== ======= ======= =======
</TABLE>
27
<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>
1997 1996 1995
---- ---- ----
Average Average Average
(in thousands) Balance Rate Balance Rate Balance Rate
------- ---- ------- ---- ------- ----
<S> <C> <C> <C> <C> <C> <C>
Noninterest-bearing transaction accounts $ 81,379 -% $ 81,869 -% $ 85,116 -%
Interest-bearing transaction accounts 12,887 0.84 13,247 0.72 14,396 0.73
Savings and money market accounts 94,755 1.92 98,363 1.72 113,974 1.72
-------- -------- --------
107,642 1.79 111,610 1.60 128,370 1.61
-------- -------- --------
Time deposits:
Less than $100,000 8,737 4.48 9,936 4.55 10,713 4.29
More than $100,000 20,640 4.93 39,129 4.98 63,926 5.20
-------- -------- --------
Total time deposits 29,377 4.79 49,065 4.89 74,639 5.07
-------- -------- --------
Total deposits $218,398 1.53% $242,544 1.73% $288,125 2.03%
======== ======== ========
</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, 1997:
<TABLE>
<CAPTION>
(in thousands) December 31, 1997
-----------------
<S> <C>
Three months or less $17,792
Over three through six months 1,324
Over six through twelve months 940
Over twelve months 100
-------
Total $20,156
=======
</TABLE>
In addition to the time deposits of $100,000 or more, a significant
amount of the Company's deposits are in accounts with balances in excess of
$100,000. At December 31, 1997, there were 333 such deposit accounts with
balances totaling $127,173,000. 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, 1997 and 1996, there were no
repurchase agreements outstanding.
28
<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) 1997 1996 1995
------ ------- -------
<S> <C> <C> <C>
Maximum daily amount outstanding $8,000 $17,929 $41,773
Average amount outstanding 274 3,422 3,458
Average interest rate 5.77% 5.41% 5.90%
</TABLE>
The Company had no repurchase agreements outstanding at December 31, 1997,
1996, or 1995, respectively.
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 points. 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, 1997 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.
29
<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 Bancorp and the Bank at December 31, 1997.
<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/ $16,127 6.38% $10,110 4.00% $12,639 5.00%
Tier 1 Risk-Based 16,127 11.54 5,590 4.00 8,385 6.00
Total Risk-Based 23,311 16.68 11,180 8.00 13,975 10.00
BANK
Leverage $20,466 8.13% $10,069 4.00% $12,586 5.00%
Tier 1 Risk-Based 20,466 14.73 5,558 4.00 8,336 6.00
Total Risk-Based 22,203 15.98 11,115 8.00 13,894 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. 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.
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.
30
<PAGE>
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, 1997. 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, 1997
-----------------------------------------------------------------------------------
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)/ $ 98,737 $ 1,653 $ 1,433 $2,998 $ 1,036 $105,857
Investment securities - 2,004 - 5,576 80,216 87,796
Federal funds sold 25,600 - - - - 25,600
Due from banks 112 - - - - 112
----------- ---------- ----------- ----------- -------- --------
Total interest-earning assets $ 124,449 $ 3,657 $ 1,433 $8,574 $ 81,252 $219,365
=========== ========== =========== =========== ======== ========
Interest-bearing transaction
accounts $ 14,961 $ - $ - $ - $ - $ 14,961
Savings accounts 89,226 - - - - 89,226
Time deposits - 22,657 4,522 351 - 27,530
Convertible notes - - - - 5,437 5,437
----------- ---------- -------- ------------ -------- --------
Total interest-bearing liabilities $ 104,187 $ 22,657 $ 4,522 $ 351 $ 5,437 $137,154
=========== ========== ======== ============ ======== ========
Interest sensitive Gap $ 20,262 $ (19,000) $ (3,089) $8,223 $ 75,815
Effect of interest rate swaps (15,000) 15,000 - - -
----------- ---------- -------- ------ --------
Hedged Gap $ 5,262 $ (4,000) $ (3,089) $8,223 $ 75,815
Hedged Gap as a percentage
of earning assets 2% -2% -1% 4% 34%
Cumulative hedged Gap $ 5,262 $ 1,262 $ (1,827) $6,396 $ 82,211
Cumulative hedged Gap as a
percentage of earning assets 2% 1% -1% 3% 37%
/(1)/ Nonaccrual loans of $877,000 are included in average balances and rate calculations.
</TABLE>
(1) Non
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.
31
<PAGE>
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 collateral for reverse repurchase agreements. The Company had no reverse
repurchase agreements on December 31, 1997 and 1996. As evidence of the
Company's high level of liquidity at December 31, 1997, cash and cash
equivalents totaled $54,340,000, while securities available for reverse
repurchase agreements totaled approximately $84,770,000. The combined amount of
$139,110,000 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.
32
<PAGE>
YEAR 2000
The Year 2000 problem is the result of computer programs being written
using two digits rather than four to define the applicable year. In 1997 the
Company developed a plan to resolve these issues. The plan provides for the
conversion efforts to be completed by the end of 1998.
The Company utilizes a third party mainframe software for the
processing of its loan, deposit and financial data. The vendor has certified in
1997 that the software is "Year 2000 compliant." Accordingly, the Company does
not expect the costs required to be expensed to prepare the remaining systems
for Year 2000 to have a material effect on its financial position or results of
operations. The Company currently estimates that its Year 2000 project,
including costs incurred in 1997 and through the year 2000, may range between
$200,000 to $500,000. These costs include estimates for internal staff costs as
well as consulting, hardware and software, lease expense and other expenses
related to infrastructure and facilities enhancements necessary to prepare the
systems for the year 2000. The Company is funding these costs through operating
cash flows and is expensing the costs as incurred. The amount expensed in 1997
was immaterial to the Company's results of operations.
FORWARD-LOOKING INFORMATION
The discussions contained above in "Management's Discussion and
Analysis of Financial condition and Results of Operations" and Item 1.
"Business" are intended to provide information to facilitate the understanding
and assessment of the consolidated financial statements and footnotes and should
be read and considered in conjunction therewith. These discussions included
forward-looking statements within the meaning of Section 21E of the Exchange Act
regarding management's beliefs, estimates, projections, and assumptions with
respect to future operations. Actual results and operations for any future
period may vary materially from those projected herein and from past results
discussed herein.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- -------------------------------------------------------------------
INTEREST RATE SENSITIVITY
The table below provides information about the Company's derivative financial
instruments and other financial instruments that are sensitive to changes in
interest, including interest swaps. Investment securities and loans,
certificates of deposit and convertible notes are presented based upon
contractual maturity and related weighted average interest rates by expected
maturity dates. For interest rate swaps and caps, the table present notioinal
amounts equivalents, which is the Company's reporting currency.
33
<PAGE>
<TABLE>
<CAPTION>
There Fair
1998 1999 2000 2001 2002 After Total Value
---- ---- ---- ---- ---- ----- ----- -----
(U.S. $ equivalent in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS
- ------
Securities
U.S. government securities
Fixed $2,004 $ - $ - $1,023 $ - $2,031 $5,059 $5,113
Weighted average interest rate 6.03% - - 6.81% - 5.89% 6.11%
U.S. government agency and
mortgage backed securities
Fixed - - 4,553 - - 20,795 25,348 25,302
Weighted average interest rate - - 6.28% - - 6.30% 6.29%
Variable - - - - - 40,999 40,999 41,038
Weighted average interest rate - - - - - 6.23% 6.23%
Small Business Administration securities
Variable - - - - - 1,292 1,292 1,292
Weighted average interest rate - - - - - 2.96% 2,96%
Collaterized mortgage securities
Fixed - - - - - 2,181 2,181 2,181
Weighted average interest rate - - - - - 5.71% 5.71%
Variable - - - - - 12,479 12,479 12,479
Weighted average interest rate - - - - - 6.30% 6.30%
Federal Reserve Bank Stock
Fixed - - - - - 439 439 439
Weighted average interest rate - - - - - 6% 6%
Loans
Fixed 2,897 435 1,118 629 819 1,036 6,935 7,347
Weighted average interest rate 8.83% 8.31% 9.33% 9.03% 9.92% 6.91% 8.74%
Variable 50,598 13,394 6,338 8,055 16,805 3,733 98,922 98,922
Weighted average interest rate 9.85% 9.29% 9.78% 9.85% 9.69% 9.46% 9.72%
</TABLE>
The table below provides information about the Company's derivative financial
instruments and other financial instruments that are sensitive to changes in
interest rates, including interest swaps. Certificates of deposit and
convertible notes are presented based upon contractual maturity and related
weighted average interest rates by expected maturity dates. For interest rate
swaps and caps, the table present notional amounts and weighted average interst
rates by contractual maturity dates. The information is presented in US dollar
equivalents, which is the Company's reporting currency.
34
<PAGE>
<TABLE>
<CAPTION>
1998 1999 2000 2001 2002 After Total Value
---- ---- ---- ---- ---- ----- ----- -----
(U.S. $ equivalent in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
LIABILITIES(1)
- -----------
Deposits
Noninterest-bearing transaction accounts $97,746 $ - $ - $ - $ - $ - $97,746 $97,746
Weighted average interest rate - - - - - - 0.00%
Interest-bearing transaction accounts 14,961 - - - - - 14,961 14,961
Weighted average interest rate 0.84% - - - - - 0.84%
Savings and money market accounts 89,226 - - - - - 89,226 89,226
Weighted average interest rate 1.92% - - - - - 1.92%
Certificates of deposit and other time deposits
Fixed 27,179 351 - - - - 27,530 27,526
Weighted average interest rate 4.79% - - - - - 4.79%
Convertible notes - - - - - 5,437 5,437 6,518
Weighted average interest rate - - - - - 8.50% 8.50%
OFF-BALANCE SHEET ASSETS
- ------------------------
Interest rate swaps - 15,000 - - - - 15,000 15,000
Weighted average interest rate - pay - 6.60% - - - - 6.60%
Weighted average interest rate - receive - 5.72% - - - - 5.72%
Interest rate caps 20,000 - - - - - 20,000 20,000
Weighted average interest rate 6.63% - - - - - 6.63%
</TABLE>
(1) The Company used certain assumptions to estimate fair values and expected
maturities. For loans, expected maturities are contractual maturities adjusted
for estimated prepayments of principal based on market indicators. Investment
securities are at quoted market rates and stated maturities. For loan fair value
computations, the company used a discounted cashflow model with discount rates
based upon prevailing market rates for similar types of loans, incorporating
adjustments for credit risk. For deposit liabilities, fair values were
calculated using discounted cashflow models based on market interest rates for
different product types and maturity dates for which the deposits are held.
Exchange Rate Sensitivity
All of the Company's derivative financial instruments and other financial
instruments are denominated in US dollars. The Company does not have, or
anticipate having, any foreign currency exchange rate exposure.
Commodity Price Sensitivity
The Company does not have, or anticipate having, any derivative commodity
instruments.
35
<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 sections entitled
"PROPOSAL 1 ELECTION OF DIRECTORS," and "INDENTIFICATION OF EXECUTIVE OFFICERS"
and "SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE" of the Proxy
Statement for the 1998 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. EXECUTIVE COMPENSATION
- --------------------------------
The information requested by Item 11 is provided in the section entitled
"COMPENSATION TABLES" of the Proxy Statement for the 1998 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 1998 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 1998 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 1997, the Company did not file any Current
Reports on Form 8-K.
(c) Exhibits
36
<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 (filed as Exhibit 10.6 to Bancorp's 1996 Form 10-K
Report and incorporated herein by this reference).
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 ref erence).
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.
37
<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).
23.1 Consent of KPMG Peat Marwick LLP.
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.
38
<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, 1998 PROFESSIONAL BANCORP, INC.
(Registrant)
By: /s/ Melissa Lanfre
----------------------
Melissa Lanfre
Senior Vice President and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf 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, 1998
- ------------------------------ --------------
Richard A. Berger
/s/ James A. Markley, Jr. Director March 26, 1998
- ------------------------------ --------------
James A. Markley, Jr.
/s/ Ronald L. Katz, M. Director March 26, 1998
- ------------------------------ --------------
Ronald L. Katz, M.D.
/s/Walter T. Mullikin, M.D. Director March 26, 1998
- ------------------------------ --------------
Walter T. Mullikin, M.D.
/s/ Ray T. Oyakawa, M.D. Director March 26, 1998
- ------------------------------ --------------
Ray T. Oyakawa, M.D.
/s/ Lynn O. Poulson, J.D. Director March 26, 1998
- ------------------------------ --------------
Lynn O. Poulson, J.D.
/s/ Julie P. Thompson Chairman of the Board March 26, 1998
- ------------------------------ --------------
Julie P. Thompson Director
</TABLE>
39
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Independent Auditors' Report...................................... F-2
Consolidated Financial Statements of Professional Bancorp, Inc.
Consolidated Balance Sheets..................................... F-3
Consolidated Statements of Operations........................... F-4
Consolidated Statements of Changes in Shareholders' Equity...... F-5
Consolidated Statements of Cash Flows........................... F-6
Notes to Consolidated Financial Statements...................... F-7
</TABLE>
F-1
<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, 1997 and 1996, 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, 1997. 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, 1997 and 1996, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 1997, in conformity with generally accepted accounting
principles.
KPMG Peat Marwick LLP
Los Angeles, California
February 16, 1998
F-2
<PAGE>
PROFESSIONAL BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
NOTES 1997 1996
--------- ------------ ------------
<S> <C> <C> <C>
ASSETS
Cash and due from banks:
Non-interest bearing 2 $ 28,627,771 $ 32,322,030
Interest-bearing 111,899 617,948
Federal funds sold 25,600,000 33,400,000
------------ ------------
Cash and cash equivalents 54,339,670 66,339,978
Securities available-for-sale (cost of $53,145,000 in 1997 3 52,696,180 54,467,683
and $55,225,000 in 1996)
Securities held-to-maturity (fair value of $35,147,000 in 1997 3 35,099,572 41,871,563
and $41,478,000 in 1996)
Loans, net of allowance for loan losses of $1,802,000
in 1997 and $2,253,000 in 1996 4, 10 103,900,082 90,759,161
Premises and equipment, net 5 1,547,771 1,611,482
Deferred tax asset 7 1,239,207 1,873,276
Accrued interest receivable and other assets 5,005,079 7,364,063
------------ ------------
$253,827,561 $264,287,206
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits: 3, 6
Demand, non-interest-bearing $ 97,746,304 $ 96,208,449
Demand, interest-bearing 14,961,400 14,886,488
Savings and money market 89,226,025 98,859,034
Time certificates of deposit 27,529,935 31,322,777
------------ ------------
Total deposits 229,463,664 241,276,748
Convertible notes 12 5,437,000 5,617,000
Accrued interest payable and other liabilities 7 3,063,744 3,351,864
------------ ------------
Total liabilities 237,964,408 250,245,612
------------ ------------
Commitments and contingent liabilities 9
Shareholders' equity: 8, 11
Common stock, $0.008 par value; 12,500,000 shares
authorized; 1,426,689 in 1997 and 1,410,783 in 1996 issued
and 1,357,222 in 1997 and 1,341,316 in 1996 outstanding 11,413 11,286
Additional paid-in-capital 12,659,774 12,488,001
Retained earnings 3,993,026 2,514,501
Treasury stock, at cost (69,467 shares in 1997 and 1996) (537,251) (537,251)
Unrealized loss on securities available-for-sale, net of taxes 3 (263,809) (434,943)
------------ ------------
Total shareholders' equity 15,863,153 14,041,594
------------ ------------
$253,827,561 $264,287,206
============ ============
</TABLE>
See accompanying notes to consolidated financial statements
F-3
<PAGE>
PROFESSIONAL BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Year Ended December 31,
NOTES 1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C> <C>
INTEREST INCOME
Loans 4 $ 9,686,133 $ 9,030,090 $ 9,266,623
Securities 3 5,834,456 7,540,804 10,395,495
Federal funds sold and securities purchased
under agreements to resell 1,159,971 1,056,214 1,227,702
Interest-bearing deposits in other banks 28,779 23,348 13,000
----------- ----------- -----------
TOTAL INTEREST INCOME 16,709,339 17,650,456 20,902,820
----------- ----------- -----------
INTEREST EXPENSE 6
Deposits 3,336,954 4,187,859 5,850,106
Convertible notes 473,619 477,348 485,038
Federal funds purchased and securities
sold under agreements to repurchase 15,807 185,023 204,178
----------- ----------- -----------
Total interest expense 3,826,380 4,850,230 6,539,322
----------- ----------- -----------
Net interest income 12,882,959 12,800,226 14,363,498
Provision for loan losses 4 180,000 4,136,000 1,539,000
----------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 12,702,959 8,664,226 12,824,498
----------- ----------- -----------
OTHER OPERATING INCOME
Net gain (loss) on sale of securities 3
available-for-sale - (71,309) 1,017,590
Merchant discount 272,763 224,745 197,714
Mortgage banking fees 105,660 117,275 72,404
Service charges on deposits 791,247 668,855 756,632
Other income 622,964 504,213 408,972
----------- ----------- -----------
TOTAL OTHER OPERATING INCOME 1,792,634 1,443,779 2,453,312
----------- ----------- -----------
OTHER OPERATING EXPENSES
Salaries and employee benefits 5,803,575 5,944,998 5,858,779
Occupancy 1,481,016 1,386,322 1,382,103
Legal fees, net of legal settlement (105,834) 2,754,123 798,497
Furniture and equipment 828,845 697,291 736,112
Professional services 10 1,346,273 930,381 605,298
Strategic planning and investor relations 375,086 - -
FDIC assessment 27,063 1,000 321,184
Office supplies 226,620 288,397 281,183
Other assessment 224,613 298,695 270,986
Telephone 272,692 271,602 226,642
Audit, accounting and examinations 131,603 200,840 148,725
Postage 150,353 153,825 146,871
Messenger service 70,692 177,993 121,305
Imprinted checks 90,939 137,670 120,592
Donations 101,427 134,615 113,160
Meetings and business development 163,488 125,942 66,145
Settlement costs 9 - 1,006,000 -
Other expense 936,317 1,035,628 891,960
----------- ----------- -----------
TOTAL OTHER OPERATING EXPENSES 12,124,768 15,545,322 12,089,542
----------- ----------- -----------
Earnings (loss) before income taxes 7 2,370,825 (5,437,317) 3,188,268
Provision (benefit) for income taxes 892,300 (1,712,400) 1,182,371
----------- ----------- -----------
NET EARNINGS (LOSS) $ 1,478,525 $(3,724,917) $ 2,005,897
=========== =========== ===========
1
EARNINGS (LOSS) PER SHARE
Basic $ 1.10 $ (2.78) $ 1.57
Diluted $ 0.97 $ (2.78) $ 1.28
</TABLE>
See accompanying notes to consolidated financial statements
F-4
<PAGE>
PROFESSIONAL BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
NET
UNREALIZED
HOLDING LOSS
COMMON STOCK ADDITIONAL ON SECURITIES
------------ PAID-IN RETAINED TREASURY AVAILABLE-
SHARES AMOUNT CAPITAL EARNINGS STOCK FOR-SALE TOTAL
----------- ----------- ---------- -------------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C> <C>
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
Conversion of notes (Note 8) 14,174 113 158,433 - - - 158,546
Exercise of stock options (Note 8) 1,732 14 13,340 - - - 13,354
Change in net unrealized holding loss
on securities available-for-sale - - - - - 171,134 171,134
Net earnings - - - 1,478,525 - - 1,478,525
--------- ------ ---------- ---------- -------- -------- ----------
Balance, December 31, 1997 1,357,222 11,413 12,659,774 3,993,026 (537,251) (263,809) 15,863,153
========= ====== ========== ========== ======== ======== ==========
</TABLE>
See accompanying notes to consolidated financial statements
F-5
<PAGE>
PROFESSIONAL BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (loss) $ 1,478,525 $ (3,724,917) $ 2,005,897
Adjustments to reconcile net earnings (loss) to net
cash provided by operating activities:
Depreciation and amortization 563,171 605,771 536,880
Provision for loan losses 180,000 4,136,000 1,539,000
Loss (gain) on securities available-for-sale - 71,309 (1,017,590)
Amortization of convertible note expense 103,495 104,334 105,990
Decrease (increase) in deferred tax asset 1,919,341 (2,426,243) (223,382)
Decrease (increase) in accrued interest receivable
and other assets 810,837 63,441 (100,343)
Increase (decrease) in accrued interest payable and
other liabilities (288,120) 1,197,126 1,254,331
Net amortization of premiums and discounts
on securities held-to-maturity 262,390 326,475 344,025
Net amortization of premiums and discounts
on securities available-for-sale 263,101 181,351 80,565
------------ ------------ ------------
Net cash provided by operating activities 5,292,740 534,647 4,525,373
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from:
Maturities of securities held-to-maturity 3,000,000 500,000 250,000
Maturities of securities available-for-sale 4,000,000 4,363,817 7,693,132
Principal payments/maturities of mortgage-
backed securities held-to-maturity 6,501,551 6,832,983 21,424,041
Principal payments/maturities of mortgage-
backed securities available-for-sale 8,404,884 6,405,609 13,085,834
Sales of securities available-for-sale - 26,053,425 12,197,944
Sales of mortgage-backed securities
available-for-sale - - 35,568,051
Purchases of:
Securities held-to-maturity (2,991,950) (8,100) (29,048,765)
Securities available-for-sale (10,587,422) (9,904,845) (22,965,020)
Mortgage-backed securities held-to-maturity - (1,005,904) -
Net (increase) decrease in loans (13,320,921) 4,049,113 2,196,536
Purchases of bank premises and equipment, net (499,460) (399,271) (706,129)
------------ ------------ ------------
Net cash provided by (used in) investing activities (5,493,318) 36,886,827 39,695,624
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in demand deposits
and savings accounts (8,020,242) 628,133 (30,344,282)
Net increase (decrease) in time certificates
of deposit (3,792,842) (56,817,087) 34,178,726
Proceeds from exercise of stock options 13,354 181,899 14,314
Purchase of treasury stock - (270,450) -
Dividend in lieu of fractional shares - (3,664) (3,271)
------------ ------------ ------------
Net cash (used in) provided by financing activities (11,799,730) (56,281,169) 3,845,487
------------ ------------ ------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (12,000,308) (18,859,695) 48,066,484
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 66,339,978 85,199,673 37,133,189
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 54,339,670 $ 66,339,978 $ 85,199,673
============ ============ ============
Supplemental disclosure of cash flow information (see
Notes 6, 7 and 12) - cash paid during the year for:
Interest $ 3,907,889 $ 5,021,080 $ 6,618,552
Income taxes $ 523,009 $ 61,482 $ 1,304,804
Supplemental disclosure of noncash items:
Pretax change in unrealized losses on securities
available-for-sale $ 309,059 $ 117,951 $ (87,879)
Transfer from held-to-maturity to
available-for-sale $ - $ - $ 88,384,090
Conversion of notes (see Note 12) $ 158,546 $ 1,700 $ 110,317
Tax benefit on stock options exercised $ - $ 270,054 $ -
</TABLE>
See accompanying notes to consolidated financial statements
F-6
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Professional Bancorp, Inc. and its subsidiary (together, the
"Company") is engaged in the general commercial banking business and provides a
wide range of commercial banking services primarily directed towards meeting the
financial needs of the medical services community and other distinct non-medical
service organizations. 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 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 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 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.
F-7
<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 loans and loan commitments
to a small number of clients that total between $2,000,000 and the Bank's legal
lending limit of approximately $3.3 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. As of December 31, 1997, the Company does not have, nor
contemplates having, any securities classified as trading securities.
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.
F-8
<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, 1997 and 1996, 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 for the purpose of synthetically altering the interest rates on a
portion of the Bank's super NOW and money market accounts. 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 revenue, in the form of 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 collectibility 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.
F-9
<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 regulatory agencies. 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 for impairment are not subject to this accounting treatment.
For loans classified as nonaccrual and troubled debt restructurings,
specific valuation allowances are established for 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, net
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.
F-10
<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
The Company Bancorp adopted, effective December 31, 1997, Statement of
Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128") simplifies the
standards for computing and presenting earnings per share ("EPS") as previously
prescribed by Accounting Principles Board Opinion No. 15, "Earnings per Share."
SFAS 128 replaces primary EPS with basic EPS and fully diluted EPS with diluted
EPS. Basic EPS excludes dilution and is computed by dividing income available
to common stockholders by the weighted average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution that
could occur if securities or other contracts to issue common stock were
exercised or converted into common stock or resulted from issuance of common
stock that then shared in earnings.
Stock Option Plan
Prior to January 1, 1996, the Company accounted for its stock option
plan in accordance with the provisions of Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), and related
interpretations. As such, compensation expense would be recorded on the date of
grant only if the current market price of the underlying stock exceeded the
exercise price. On January 1, 1996, the Company adopted Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation"
("SFAS"), which permits entities to recognize as expense over the vesting period
the fair value of all stock-based awards on the date of grant. Alternatively,
SFAS 123 also allows entities to continue to apply the provisions of APB 25 and
provide pro forma net income and pro forma net income per share disclosures for
employee stock option grants made in 1995 and future years as if the fair-value-
based method defined in SFAS 123 had been applied. The Company has elected to
continue to apply the provisions of APB 25 and provide the pro forma disclosure
provisions of SFAS 123. However, as there were no options granted in 1995,
1996, or 1997, the pro forma disclosure provisions are not currently applicable.
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 one year 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 1997, 1996 and 1995. Salaries and
employee benefits expense includes $71,700, $80,600, and $73,800 for 1997, 1996,
and 1995, respectively, related to the Bank's contributions.
Reclassifications
Certain amounts have been reclassified in the 1996 and 1995 financial
statements to conform with the 1997 presentation of those items.
F-11
<PAGE>
Year 2000
The Year 2000 problem is the result of computer programs being written
using two digits rather than four to define the applicable year. In 1997 the
Company developed a plan to resolve these issues. The plan provides for the
conversion efforts to be completed by the end of 1998.
The Company utilizes a third party mainframe software for the
processing of its loan, deposit and financial data. The vendor has certified in
1997 that the software is "Year 2000 compliant." Accordingly, the Company does
not expect the costs required to be expensed to prepare the remaining systems
for Year 2000 to have a material effect on its financial position or results of
operations. The Company currently estimates that its Year 2000 project,
including costs incurred in 1997 and through the year 2000, may range between
$200,000 to $500,000. These costs include estimates for internal staff costs as
well as consulting, hardware and software, lease expense and other expenses
related to infrastructure and facilities enhancements necessary to prepare the
systems for the year 2000. The Company is funding these costs through operating
cash flows and is expensing the costs as incurred. The amount expensed in 1997
was immaterial to the Company's results of operations.
Recent Accounting Pronouncements
In February 1997 the FASB issued SFAS No. 129, "Disclosure of
Information Account Capital Structure." SFAS No. 129 consolidates existing
reporting standards for disclosing information about an entity's capital
structure. SFAS No. 129 also supersedes previously issued account statements.
The Company adopted SFAS No. 129 as of December 31, 1997. The impact on the
Company is not significant as the Company's existing disclosures are generally
in compliance with the disclosure requirements in SFAS No. 129.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." SFAS No. 130 establishes standards for reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements. SFAS No. 130 is effective for fiscal years beginning
after December 15, 1997. The impact on the Company of adopting SFAS No. 130 is
not expected to be material to the Company's existing disclosure.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." SFAS No. 131 establishes
standards to report information about operating segments in annual financial
statements and requires reporting of selected information about operating
segments in interim reports to shareholders. It also establishes standards for
related disclosures about products and services, geographic areas and major
customers. SFAS No. 131 is effective for financial statement for periods
beginning after December 15, 1997, with comparative information for earlier
years to be restated. The Company is currently assessing the effect of adopting
SFAS No. 131.
NOTE 2 - RESTRICTED CASH BALANCES
Aggregate cash balances in the form of deposits with the Federal
Reserve Bank of approximately $4,351,000 and $4,180,000 were maintained to
satisfy federal regulatory requirements at December 31, 1997 and 1996,
respectively.
F-12
<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, 1997
-----------------------------------------------------------------------
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 $ 2,003 $ 1 $ - 2,004 $ -
U.S. Government agency and
mortgage-backed securites 34,963 99 322 34,740 -
Small Business Administration securities 1,281 11 - 1,292 -
Collaterized mortgage obligations 14,898 - 238 14,660 -
--------- ---------- ---------- -------- ----------
Total $ 53,145 $ 111 $ 560 $ 52,696 $ -
========= ========== ========== ======== ==========
<CAPTION>
December 31, 1996
-----------------------------------------------------------------------
Gross Gross Gross
Amortized Unrealized Unrealized Fair Realized
(in thousands) Cost Gain Loss Value Gain (Loss)
--------- ---------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C>
U.S. Government securities $ - $ - $ - $ - $ 21
U.S. Government agency and -
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>
There were no sales of securities available-for-sale in 1997. During
the years ended December 31, 1996 and 1995, securities available-for-sale were
sold for aggregate proceeds of $26,053,000, and $69,267,000, respectively.
These sales resulted in gross realized gains and losses of $21,000 and ($92,000)
in 1996 and gross realized gains of $1,018,000 in 1995.
The amortized cost and estimated fair value of securities
available-for-sale at December 31, 1997, 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 within one year $ 2,003 $ 2,004
Due after one year through five years 4,550 4,553
Due after five years through ten years 312 315
Due after ten years 46,280 45,824
---------- ----------
Total $ 53,145 $ 52,696
========== ==========
</TABLE>
F-13
<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, 1997
----------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
(in thousands) COST GAIN LOSS VALUE
--------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
U.S. Government securities $ 3,054 $ 55 $ - $ 3,109
U.S. Government agency securities 2,750 - 10 2,740
U.S. Government agency
mortgage-backed securites 28,857 72 70 28,859
Federal Reserve Bank stock 439 - - 439
--------- ---------- ---------- -----------
Total $ 35,100 $ 127 $ 80 $ 35,147
========= ========== ========== ===========
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>
The amortized cost and estimated fair value of securities
held-to-maturity at December 31, 1997 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 $ 1,023 $ 1,062
Due after five years through ten years 17,801 17,833
Due after ten years 16,276 16,252
--------- ---------
Total $ 35,100 $ 35,147
========= =========
</TABLE>
There were no trading securities during 1997 and 1996.
During 1997, the highest daily balance and the average balance for the
securities was $98,828,000 and $94,084,000, respectively. During 1996, the
highest daily outstanding balance and average balance for the securities was
$86,125,000 and $75,522,000, respectively.
F-14
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Pledged Securities
U.S. Treasury securities with a carrying value of approximately
$3,054,000 and $3,064,000 were pledged to secure treasury tax and loan deposits
as required by law at December 31, 1997 and 1996, respectively.
NOTE 4 - LOANS AND THE RELATED ALLOWANCE FOR LOAN LOSSES
A summary of the major components of loans outstanding at December 31,
1997 and 1996 is as follows:
<TABLE>
<CAPTION>
(in thousands) 1997 1996
-------- -------
<S> <C> <C>
Commercial loans $ 86,243 $73,577
Real estate secured commercial loans 10,512 10,079
Equity lines of credit 6,288 6,202
Other lines of credit 1,524 1,832
Installment loans 1,253 1,375
Lease financing 37 68
-------- -------
Total 105,857 93,133
-------- -------
Less:
Allowance for loan losses 1,802 2,253
Deferred loan fees, net 155 121
======== =======
Loans, net $103,900 $90,759
======== =======
The composition of gross loans outstanding
between fixed and variable is as follows:
Fixed rate $ 6,935 $ 7,075
Variable rate 98,922 86,058
-------- -------
Total $105,857 $93,133
======== =======
</TABLE>
The following table provides information with respect to the Company's
past due loans.
<TABLE>
<CAPTION>
DECEMBER 31,
(in thousands) 1997 1996
-------- --------
<S> <C> <C>
Loans 90 days or more past due
and still accruing $ 17 $ 507
Nonaccrual loans 877 1,521
-------- --------
Total past due loans $ 894 $ 2,028
======== ========
</TABLE>
Total accrued interest on loans 90 days past due and still accruing was
approximately $1,000 at December 31, 1997 and $19,000 at December 31, 1996.
F-15
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The effect of nonaccrual loans on interest income for the years 1997
and 1996 is presented below:
<TABLE>
<CAPTION>
(in thousands) 1997 1996
----- -----
<S> <C> <C>
Contractual interest due $ 98 $ 434
Interest recognized 40 47
----- -----
Net interest foregone $ 58 $ 387
===== =====
</TABLE>
The Company had approximately $1,199,000 in impaired loans as of
December 31, 1997. The carrying value of impaired loans for which there is a
related allowance for loan losses was $234,000, with the amount of specific
allowance for loan losses allocated to these loans of $80,000. There was
$965,000 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 1997 was $1,342,000 and there was no income recorded utilizing
either the cash basis or accrual basis method of accounting. Impaired loans at
December 31, 1997, included $877,000 of nonaccrual loans.
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 was
$1,194,000 in impaired loans for which there was no related specific allowance
for loan losses. The average recorded investment in impaired loans during 1996
was $4,161,000 and income recorded utilizing either the cash basis or accrual
basis method of accounting was $53,000.
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 allowances 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 either the cash basis or accrual
basis method of accounting was $91,000.
F-16
<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) 1997 1996 1995
------ ------- -------
<S> <C> <C> <C>
Balance, beginning of year $2,253 $ 1,070 $ 983
Provision for loan losses 180 4,136 1,539
Loans charged-off (882) (3,353) (1,589)
Recoveries on loans previously charged-off 251 400 137
------ ------- -------
Balance, end of year $1,802 $ 2,253 $ 1,070
====== ======= =======
</TABLE>
The Company's commercial loans as of December 31, 1997 are secured by
the following collateral:
<TABLE>
<CAPTION>
(in thousands) DECEMBER 31, 1997
-----------------
<S> <C>
Stock $ 2,127
Cash 1,404
Furniture, equipment and/or accounts receivables 58,049
Unsecured, real estate, automobiles, or assignment
of life insurance 24,664
-------
Total $86,243
=======
</TABLE>
Note 5 - Premises and Equipment
A summary of the major components of premises and equipment at
December 31, 1997 and 1996 is as follows:
<TABLE>
<CAPTION>
(in thousands) 1997 1996
------- -------
<S> <C> <C>
Furniture, fixtures and equipment $ 3,262 $ 3,205
Leasehold improvements 1,444 1,645
------- -------
Total premises and equipment, at cost 4,706 4,850
Less accumulated depreciation and amortization (3,158) (3,239)
------- -------
Net premises and equipment $ 1,548 $ 1,611
======= =======
</TABLE>
Depreciation and amortization expense related to premises and
equipment was approximately $563,000, $606,000 and $537,000 for the years ended
December 31, 1997, 1996 and 1995, respectively.
F-17
<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,
1997 and 1996 is as follows:
<TABLE>
<CAPTION>
(in thousands) 1997 1996
------- -------
<S> <C> <C>
Time certificates of deposit under $100,000 $ 7,374 $ 9,187
Time certificates of deposit of $100,000 and over 20,156 22,136
------- -------
Total $27,530 $31,323
======= =======
</TABLE>
Interest expense for the years ended December 31, 1997, 1996 and 1995
relating to interest-bearing deposits and other borrowings amounted to the
following:
<TABLE>
<CAPTION>
(in thousands) 1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Interest-bearing demand deposits $ 108 $ 96 $ 105
Savings and money market deposits 1,821 1,693 1,959
Time certificates of deposit under $100,000 391 452 460
Time certificates of deposit of $100,000 and over 1,017 1,947 3,326
------ ------ ------
Interest expense on deposits 3,337 4,188 5,850
------ ------ ------
Federal funds purchased and securities sold under
agreements to repurchase 16 185 204
Convertible notes 473 477 485
------ ------ ------
Interest expense on deposits and other borrowings $3,826 $4,850 $6,539
====== ====== ======
</TABLE>
The Bank sells securities under agreements to repurchase. Securities
sold under repurchase agreements are recorded as short-term obligations. During
1997, the highest daily outstanding balance and the average balance of
securities sold under agreements to repurchase was $8,000,000 and $274,000,
respectively; the average rate paid was 5.77%. During 1996, the highest daily
outstanding balance and the average balance of securities sold under agreements
to repurchase was $17,929,000 and $3,422,000, 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%.
Securities subject to repurchase agreements are retained by the Company's
custodian under written agreements that recognize the customers' interests in
the securities.
F-18
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7 - INCOME TAXES
The provision for income taxes for the years ended December 31, 1997,
1996 and 1995 is comprised of the following:
<TABLE>
<CAPTION>
(in thousands) 1997 1996 1995
------ ------- ------
Current taxes:
<S> <C> <C> <C>
Federal $ 395 $ 559 $ 989
State 8 155 338
------ ------- ------
Total current taxes 403 714 1,327
------ ------- ------
Deferred taxes (credits):
Federal 248 (1,999) (128)
State 241 (427) (17)
------ ------- ------
Total deferred taxes 489 (2,426) (145)
------ ------- ------
Provision (benefit) for income taxes $ 892 $(1,712) $1,182
====== ======= ======
</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 1997, 1996 and 1995, respectively:
<TABLE>
<CAPTION>
(in thousands) 1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Tax expense at statutory rate $ 806 $ (1,849) $ 1,084
Increase (decrease) in taxes resulting from:
State franchise taxes, net of federal income tax benefit 164 (179) 212
Other (78) 316 (114)
-------- -------- --------
Total $ 892 $ (1,712) $ 1,182
======== ======== ========
Effective tax rate 37.6% 31.5% 37.1%
</TABLE>
Included in accrued interest payable and other liabilities is current
income taxes payable of $175,000 and $294,000 at December 31, 1997 and 1996,
respectively.
F-19
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The components of the net deferred tax asset are as follows:
<TABLE>
<CAPTION>
(in thousands) 1997 1996
------ ------
Deferred tax liabilities:
<S> <C> <C>
Prepaid expenses $ 220 $ 134
------ ------
Gross deferred tax liabilities 220 134
------ ------
Deferred tax assets:
Depreciation, leasing transactions, fixed asset gain or loss 145 99
Bad debt deductions 317 519
Deferred compensation 526 671
Core deposit amortization 20 20
Loan fee amortization 64 50
California franchise tax (10) 1
Accrued vacation 154 110
Contributions carryforward - 55
Net operating loss carryforward 59 160
Unrealized loss on securities available-for-sale 184 322
------ ------
Gross deferred tax assets 1,459 2,007
------ ------
Net deferred tax asset $1,239 $1,873
====== ======
</TABLE>
The gross net operating loss carryover for state income taxes of
approximately $827,000 expires in 2001.
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 may 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, 1996 and 1997.
F-20
<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 1983 Plan terminated
on April 19, 1993, therefore no further options pursuant to that plan may be
granted. 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, 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") as amended and restated on September 22, 1992, 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, 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)
Exercised 7.71 (1,732)
Canceled 12.92 (3,307)
=======
Outstanding at December 31, 1997 7.71 - 14.22 57,568
($10.54 weighted-average)
(4.1 years weighted average life)
Available for future grant at December 31, 1997 43,910
=======
</TABLE>
F-21
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
At December 31, 1997, 57,568 option shares were exercisable. The weighted-
average exercise price per share of these options was $10.54 at December 31,
1997.
The Company also has a stock option plan dated December 31, 1992 (the
"1992 Plan"), which authorizes the issuance of up to 393,750 shares of the
Company's unissued common stock to directors, officers and other personnel.
Option prices may not be less than 100% of the fair market value at the date of
the grant for incentive stock options and 85% of the fair market value for non-
qualified stock options. Options granted under the 1992 Plan expire not more
than ten years after the date of grant and must be fully paid when exercised.
The status of options granted under the 1992 Plan is shown as follows:
<TABLE>
<CAPTION>
EXERCISE OPTIONS
PRICE ($) OUTSTANDING
--------------- ----------------
<S> <C> <C>
Outstanding at December 31, 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
Outstanding at December 31, 1997 12.70 358,313
</TABLE>
At December 31, 1997, 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.
F-22
<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 January
31, 2007. Rental expense for the years ended December 31, 1997, 1996 and 1995
amounted to approximately $1,089,000, $1,000,000 and $990,000, 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, 1997:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31, (in thousands)
------------------------
<S> <C>
1998 $ 964
1999 828
2000 799
2001 622
2002 512
Thereafter 1,329
------
Total $5,054
======
</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, 1997 and 1996, the Company had commitments to
extend credit of approximately $32,048,000 and $38,931,000, respectively, and
obligations under standby letters of credit of approximately $6,832,000 and
$4,610,000, respectively. These commitments and obligations were variable rate
in structure.
F-23
<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, 1997, 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 between the Bancorp, Bank and St. Paul Mercury Insurance
Company ("St. Paul") , Bancorp's and the Bank's director and officer liability
insurance carrier, was finalized in December 1997. Pursuant to the settlement,
St. Paul reimbursed the Company and the Bank $600,000 for certain non-recurring
legal expenses in connection with the 1996 proxy contest and the litigation
related thereto.
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, 1997, is summarized as follows:
<TABLE>
<CAPTION>
(in thousands) 1997 1996
<S> <C> <C>
Balance, beginning of year $2,933 $ 2,932
Credit granted 1,079 1,615
Loan payments (301) (1,614)
------ -------
Balance, end of year $3,711 $ 2,933
====== =======
</TABLE>
Interest income earned on these loans amounted to approximately
$286,000, $276,000 and $299,000 during the years 1997, 1996 and 1995,
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, 1997, related to
directors and affiliated parties was approximately $68,000.
F-24
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 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 Bancorp and
Bank pay flat monthly rates for the services of Ms. McIntyre-Kolpin and Ms.
Patti Derry. During 1997, the Bancorp and the Bank paid NHFS total fees in the
amount of approximately $708,000 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, 1997, the Company's and Bank's regulatory capital exceeded the thresholds
necessary to be considered "well capitalized." There are no conditions or
events since that date that management believes have changed the institution's
category.
F-25
<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, 1997.
<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 $16,127 6.38% $10,111 4.00% $12,639 5.00%
Tier 1 Risk-Based 16,127 11.54 5,590 4.00 8,385 6.00
Total Risk-Based 23,311 16.68 11,180 8.00 13,975 10.00
BANK
Leverage $20,466 8.13% $10,069 4.00% $12,586 5.00%
Tier 1 Risk-Based 20,466 14.73 5,558 4.00 8,336 6.00
Total Risk-Based 22,203 15.98 11,115 8.00 13,894 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, 1997, the
Bank could not declare dividends 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 of 7.21% per annum, or 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 1997, $180,000 of the Notes were converted
into 14,174 common stock shares. 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 $5,437,000 of the remaining
Notes were converted into common stock, 428,164 shares of common stock would be
issued.
F-26
<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 1997, 1996 and 1995, net
interest income was increased approximately $235,000, $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 and expire December
1998. 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 1997, 1996 and 1995 was decreased by the interest rate caps by
approximately $42,000, $42,000 and $1,000, respectively.
The Company uses interest rate swap agreements for the purpose of
synthetically altering the interest rates on a portion of the Bank's super NOW
and money market accounts. 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
approximately $15,000 and $694,000, respectively. In November 1993, the Bank
entered into a swap with a notional amount of $15 million to synthetically alter
interest rates on a portion of the Bank's super NOW and money market accounts.
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 approximately $385,000 was recorded. Net
interest income for 1997, 1996 and 1995 was reduced by the swap by approximately
$134,000, $134,000 and $135,000, respectively. As of December 31, 1997, the
Company was paying 6.60% and receiving 5.875%.
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 the financial instruments subject to credit risk but monitors the
credit standing of counterparties.
F-27
<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 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, 1997 DECEMBER 31, 1996
-------------------------------------------------------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
(in thousands) VALUE FAIR VALUE VALUE FAIR VALUE
----------------- ---------- ----------------- ----------
Assets:
<S> <C> <C> <C> <C>
Cash and cash equivalents $ 54,340 $ 54,340 $66,340 $66,340
Securities available-for-sale 52,696 52,696 54,468 54,468
Securities held-to-maturity 35,100 35,147 41,872 41,478
Loans, net 103,900 104,979 90,759 91,684
Liabilities:
Noninterest-bearing transaction accounts 97,746 97,746 96,208 96,208
Interest-bearing transaction accounts 14,961 14,961 14,887 14,887
Savings and money market accounts 89,226 89,226 98,859 98,859
Certificates of deposit and other time deposits 27,530 27,526 31,323 31,352
Convertible notes 5,437 6,518 5,617 5,568
Off-balance sheet assets:
Interest rate swaps - (325) - (283)
Interest rate caps 41 8 83 101
Lending commitments - - - 97
Standby letters of credit - - - 46
</TABLE>
The carrying values of cash and cash equivalents reported in the
balance sheet approximate fair values due to the short-term nature of the
assets. 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, 1997 and 1996,
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 for similar deposits with maturities equivalent
to the remaining terms on the deposits being valued at December 31, 1997 and
1996, respectively.
F-28
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Standby letters of credit principally support corporate obligations
and include $760,000 and $330,000 that was collateralized with cash at December
31, 1997 and 1996, respectively. At December 31, 1997, $6,832,000 of the
standby letters of credit and $26,393,000 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, 1997 and 1996. 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 - EARNINGS PER SHARE
The following table illustrates the computation of basic and diluted earnings
per share:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------------
1997 1996 1995
---------- ----------- ----------
<S> <C> <C> <C>
Numerator:
Net earnings per statement of operations
used in basic earnings per share consolidation:
Basic earnings (loss) $1,478,525 $(3,724,917) $2,005,897
Interest savings on conversion of convertible
notes, net of income taxes 279,435 /(1)/ 286,172
---------- ----------- ----------
Diluted earnings (loss) $1,757,960 /(1)/ $2,292,069
---------- ----------- ----------
Denominator:
Denominator for basic earnings per share -
weighted average number of shares
outstanding 1,345,972 1,341,316 1,276,195
Effect of dilutive securities:
Warrants and Options 33,835 /(1)/ 68,008
Convertible notes 428,164 - 442,339
---------- ----------- ----------
Denominator for diluted earnings per share 1,807,971 1,341,316 1,786,542
========== =========== ==========
Basic earnings (loss) per share $ 1.10 $ (2.78) $ 1.57
========== =========== ==========
Diluted earnings (loss) per share $ 0.97 $ (2.78) $ 1.28
========== =========== ==========
</TABLE>
F-29
<PAGE>
NOTE 16 - PARENT COMPANY INFORMATION
The Bancorp has met its obligations principally from the payment of
dividends from the Bank. As of December 31, 1997, the Bank was unable to pay
dividends without obtaining regulatory approval.
The following financial information represents the balance sheets of
the Bancorp as of December 31, 1997 and 1996, the related statements of
operations and of cash flows for the three-year period ended December 31, 1997.
<TABLE>
<CAPTION>
BALANCE SHEETS
December 31, 1997 and 1996
1997 1996
------- -------
(in thousands)
<S> <C> <C>
Assets:
Cash in First Professional Bank, N.A. $ 638 $ 300
Investment in First Professional Bank, N.A. 20,202 18,787
Loans 100 100
Other assets 666 784
------- -------
$21,606 $19,971
======= =======
Liabilities:
Accrued expenses $ 155 $ 312
Convertible notes 5,437 5,617
Other liabilities 151 -
------- -------
Total liabilities 5,743 5,929
Shareholders' equity 15,863 14,042
------- -------
$21,606 $19,971
======= =======
</TABLE>
F-30
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
STATEMENT OF OPERATIONS
Years ended December 31, 1997, 1996 and 1995
1997 1996 1995
-------------- -------------- ---------------
<S> <C> <C> <C>
(in thousands)
Income:
Cash dividends from First Professional Bank, N.A. $ 425 $ 2,819 $ 800
Interest 7 7 6
Other 4 - -
------ ------- ------
Total income 436 2,826 806
------ ------- ------
Expenses:
Interest 474 477 485
Salaries and employer taxes 31 85 86
Amortization of convertible note expenses 104 104 106
Legal fees, net of legal settlement (481) 1,805 62
Other professional services 67 101 -
Settlement costs - 184 -
Pamphlets and brochures - 8 48
Other 2 16 33
------ ------- ------
Total expenses 196 2,780 820
------ ------- ------
Earnings (loss) before income taxes and equity in
undistributed net earnings of First Professional Bank, N.A. 240 46 (14)
Provision for income taxes - 1 -
------ ------- ------
Earnings before equity in undistributed net earnings of
First Professional Bank, N.A. 240 45 (14)
Equity in undistributed net (loss) earnings of First
Professional Bank, N.A. 1,239 (3,770) 2,020
------ ------- ------
Net (loss) earnings $1,479 $(3,725) $2,006
====== ======= ======
</TABLE>
F-31
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
Statement of Cash Flows
Years ended December 31, 1997, 1996 and 1995
1997 1996 1995
------- ------- -------
(in thousands)
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings (loss) $ 1,479 $(3,725) $ 2,006
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
(Increase) decrease in other assets (14) (1) (5)
(Decrease) increase in accrued expenses and other liabilities (6) 153 (6)
Amortization of convertible note expenses 104 104 106
Equity in undistributed (earnings) loss of First Professional
Bank, N.A. (1,239) 3,770 (2,020)
------- ------- -------
Net cash provided by (used in) operating activities 324 301 81
------- ------- -------
Cash flows from investing activities:
Net decrease (increase) in loans - 63 (163)
Additional investment in First Professional Bank, N.A. - - -
------- ------- -------
Net cash provided by (used in) investing activities - 63 (163)
------- ------- -------
Cash flows from financing activities:
Purchase of treasury stock - (270) -
Proceeds from exercise of stock options 14 182 14
Other - (4) (3)
------- ------- -------
Net cash provided by (used in) financing activities 14 (92) 11
------- ------- -------
Net increase (decrease) in cash 338 272 (71)
Cash, beginning of year 300 28 99
------- ------- -------
Cash, end of year $ 638 $ 300 $ 28
======= ======= =======
Supplemental disclosure of cash flow information -
cash paid during the year for:
Interest $ 474 $ 477 $ 485
Income taxes $ - $ 8 $ -
</TABLE>
F-32
<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 1997, 1996 and 1995. 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) 1997 1997 1997 1997 1996 1996
-------------- --------- -------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Interest income $ 4,375 $4,168 $4,148 $4,019 $4,188 $4,207
Interest expense 1,044 965 896 921 992 1,053
Net interest income 3,331 3,203 3,252 3,098 3,196 3,154
Provision for loan losses - 60 60 60 (120) 836
Gains (losses) on securities:
Available-for-sale - - - - (92) 21
Other income 368 455 541 428 328 432
Other expenses 2,453 3,325 3,202 3,144 3,036 3,473
Earnings (loss) before income taxes 1,246 273 531 322 516 (702)
Net earnings (loss) 778 199 312 190 333 (607)
Earnings (loss) per share (as restated):
Basic 0.49 0.15 0.23 0.14 0.24 (0.44)
Diluted 0.45 0.15 0.23 0.14 0.24 (0.44)
QUARTER ENDED
-------------------------------------------------------------------------
JUNE 30, MAR. 31, DEC. 31, SEPT. 30, JUNE 30, MAR. 31,
(in thousands, except per share data) 1996 1996 1995 1995 1995 1995
-------------- --------- -------- --------- --------- ---------
Interest income $ 4,477 $4,778 $5,227 $5,296 $5,329 $5,051
Interest expense 1,302 1,503 1,711 1,778 1,602 1,448
Net interest income 3,175 3,275 3,516 3,518 3,727 3,603
Provision for loan losses 3,240 180 1,147 205 125 62
Gains (losses) on securities:
Available-for-sale - - 895 - 97 26
Other income 393 362 372 367 369 328
Other expenses 6,035 3,001 3,211 2,748 3,055 3,076
Earnings (loss) before income taxes (5,707) 456 425 932 1,013 819
Net earnings (loss) (3,726) 275 348 551 604 503
Earnings (loss) per share (as restated):
Basic (2.73) 0.21 0.27 0.44 0.48 0.40
Diluted (2.73) 0.20 0.23 0.35 0.39 0.35
</TABLE>
F-33
<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.
F-34
<PAGE>
EXHIBIT 11 - EARNINGS (LOSS) PER SHARE
Statement Regarding Computation of Per Share Earnings (Loss)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------
Basic Earnings (Loss) Per Share 1997 1996 1995
----------------- ------------------ -----------------
<S> <C> <C> <C>
Computation for Statement of Operations:
Net earnings per statement of
operations used in basic earnings
per share computation:
Basic earnings (loss) $ 1,478,525 $ (3,724,917) $ 2,005,897
================= ================= =================
Weighted average number of shares
outstanding 1,345,972 1,341,316 1,276,195
================= ================= =================
Basic earnings (loss) per share $ 1.10 $ (2.78) $ 1.57
================= ================= =================
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Statement Regarding Computation of Per Share Earnings (Loss) - (Continued)
YEAR ENDED DECEMBER 31,
----------------------------------------------------------
Diluted Earnings (Loss) Per Share 1997 1996 1995
----------------- ------------------ -----------------
<S> <C> <C> <C>
Computation for Statement of Operations:
Net earnings per statement of
operations used in diluted
earnings per share computation:
Basic earnings (loss) $ 1,478,525 $ (3,724,917) $ 2,005,897
Interest on convertible notes,
net of tax effect 279,435 /(1)/ 286,172
----------------- ------------------ -----------------
Basic earnings (loss) as adjusted $1,757,960 $(3,724,917) $2,292,069
================= ================= =================
Weighted average number of shares
outstanding, as per diluted
computation above 1,345,972 1,341,316 1,276,195
Net shares issuable from assumed exercise
of warrants and options, as determined by
the application of the Treasury Stock
Method 33,835 /(1)/ 68,008
Weighted average shares issuable from
assumed conversion of convertible notes 428,164 /(1)/ 442,339
----------------- -----------------
Weighted average number of shares
outstanding 1,807,971 1,341,316 1,786,542
================= ================= =================
Diluted earnings (loss) per share $0.97 $(2.78) $1.28
================= ================= =================
</TABLE>
/(1)/ Anti-dilutive
2
<PAGE>
EXHIBIT 23.1
Consent of Independent Auditors
-------------------------------
The Board of Directors
Professional Bancorp, Inc.:
We consent to incorporation by reference in the registration statement No.
33-75674 on Form S-8 of Professional Bancorp, Inc. and subsidiary of our report
dated February 16, 1998, relating to the consolidated balance sheets of
Professional Bancorp, Inc. and subsidiary as of December 31, 1997 and 1996 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, 1997, which report appears in the December 31, 1997, annual report
on Form 10-K of Professional Bancorp, Inc.
/s/ KPMG PEAT MARWICK LLP
KPMG PEAT MARWICK LLP
Los Angeles, California
March 30, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM PROFESSIONAL
BANCORP, INC. CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 54,339,670
<SECURITIES> 87,795,752
<RECEIVABLES> 103,900,082
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 6,244,286
<PP&E> 1,547,771
<DEPRECIATION> 0
<TOTAL-ASSETS> 253,827,561
<CURRENT-LIABILITIES> 232,527,408
<BONDS> 5,437,000
0
0
<COMMON> 11,413
<OTHER-SE> 15,851,740
<TOTAL-LIABILITY-AND-EQUITY> 253,827,561
<SALES> 16,709,339
<TOTAL-REVENUES> 18,501,973
<CGS> 3,352,761
<TOTAL-COSTS> 3,352,761
<OTHER-EXPENSES> 12,124,768
<LOSS-PROVISION> 180,000
<INTEREST-EXPENSE> 3,826,380
<INCOME-PRETAX> 2,370,825
<INCOME-TAX> 892,300
<INCOME-CONTINUING> 1,478,525
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,478,525
<EPS-PRIMARY> 1.10
<EPS-DILUTED> 0.97
</TABLE>
