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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
MARK ONE:
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-10794
STERLING WEST BANCORP
(Exact name of registrant as specified in its charter)
CALIFORNIA 95-3712404
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3287 WILSHIRE BOULEVARD, LOS ANGELES, CALIFORNIA 90010
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (213) 384-4444
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK
(Title of class)
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 the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ X ]
As of March 15, 1997, the aggregate market value of the common stock held by
non-affiliates of the Registrant was approximately $4,061,000.
Number of shares of common stock of the Registrant outstanding
as of March 15, 1997: 1,710,214.
DOCUMENTS INCORPORATED BY REFERENCE
Definitive Proxy Statement For Annual Meeting of Part III of Form 10-K
Shareholders which will be filed within 120 days
of the fiscal year ended December 31, 1996.
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TABLE OF CONTENTS
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PART I
Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Item 3. Legal Proceedings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Item 4. Submission of Matters to A Vote of Securities Holders. . . . . . . . . . . . . . . . . 23
Item 4. (A) Executive Officers of Registrant . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Item 6. Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
Item 8. Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . 50
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
PART III
Item 10. Directors and Executive Officers of the Registrant . . . . . . . . . . . . . . . . . . 51
Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
Item 12. Security Ownership of Certain Beneficial Owners and Management . . . . . . . . . . . . 51
Item 13. Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . 51
PART IV
Item 14. Exhibits, Financial Statements, Schedules and Reports on Form 8-K . . . . . . . . . 52
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PART 1
Discussions of certain matters contained in this Annual Report on Form
10-K may constitute forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995 (the "Reform Act") and as
such, may involve risks and uncertainties. These forward- looking statements
relate to, among other things, expectations of the business environment in
which the Company operates, projections of future performance, perceived
opportunities in the market and statements regarding the Company's mission and
vision. The Company's actual results, performance or achievements may differ
significantly from the results, performance, or achievements expressed or
implied in such forward- looking statements. For discussion of the factors that
might cause such a difference, see "Item 1. Business -- Factors That May
Affect Future Results".
ITEM 1. BUSINESS.
Sterling West Bancorp
Sterling West Bancorp (the "Company") is a bank holding company
organized as a California corporation on January 21, 1982 under the name of
Sterling Bancorporation. As a bank holding company, the Company is subject to
the Bank Holding Company Act of 1956, as amended (the "BHC Act"). The
Company commenced business on December 15, 1982 when, pursuant to a
reorganization, it acquired all of the voting stock of Sterling Bank
("Bank"). On September 15, 1983, Sterling Business Credit, Inc., a
commercial finance corporation, was formed as a wholly-owned subsidiary of the
Company ("Business Credit"). The Company is in the process of liquidating
the assets of Business Credit. "See Item 7. MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Sale of Business
Credit Assets". On November 11, 1983, BSC Mortgage Corporation ("BSC"), a
mortgage banking subsidiary, commenced operations as a wholly-owned subsidiary
of the Bank. During the fourth quarter of 1994 the Company discontinued the
mortgage banking operations of BSC. "See Item 7. MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Discontinued
Operations and Note 5 to Consolidated Financial Statements." In May 1992, the
Company changed its name to Sterling West Bancorp.
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The Company's principal business is to serve as a holding company for the
Bank, Business Credit and for other banking or finance-related subsidiaries
which the Company may establish or acquire. During 1996, the Company's
principal sources of income were management fees paid by the Company's
subsidiaries. Legal and contractual limitations are imposed on the amount of
dividends that may be paid by the Bank and Business Credit, respectively, to
the Company. See "ITEM 1. BUSINESS -- Supervision and Regulation --
Restrictions on Transfers of Funds to the Company by the Bank and Business
Credit" and "ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -- Note
13 to Consolidated Financial Statements." At December 31, 1996, the Company
had total consolidated assets of approximately $104.6 million, total
consolidated net loans of approximately $67.6 million, total consolidated
deposits of approximately $96.2 million and total consolidated stockholders'
equity of $7.3 million. The discussion and analysis for the year ended December
31, 1996 primarily reflect the operations of the Bank. The financial results
for the year ended December 31, 1995 and 1994 includes results of operations
of the formerly active subsidiary, Sterling Business Credit, Inc., as well as
the mortgage banking operations of BSC, which have since been discontinued. The
remaining assets of Business Credit and BSC made no material contribution to
the financial results for the year ended December 31, 1996.
Sterling Bank
General
The Bank was incorporated under the laws of the State of California
on March 3, 1980, was licensed by the California Superintendent of Banks
("Superintendent") and commenced operations as a California state-chartered
bank on November 5, 1980. The Bank employs a regional banking concept whereby
each regional banking office serves several communities. The Bank currently
maintains a Wilshire Center Office located at 3287 Wilshire Boulevard, Los
Angeles, California ("Wilshire Center Office") and regional branch offices
located at 16661 Ventura Boulevard, Suite 110, Encino, California ("West
Valley Regional Office"), 372 East Olive Avenue, Burbank, California
("Mid-Valley Branch Office"), 550 North Brand Boulevard, Glendale, California
("East Valley Regional Office"), and 433 North Camden Avenue, Suite 1050,
Beverly Hills, California ("Beverly Hills Regional Office"). See "ITEM 1.
BUSINESS -- Supervision and Regulation -- The Bank".
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Banking Services
The Bank provides a wide range of commercial banking services
primarily for professionals and small and medium-sized businesses. Deposit
services include those traditionally offered by commercial banks, such as
checking accounts, savings accounts, interest-bearing negotiable orders of
withdrawal ("NOW") accounts, money market deposit accounts, and time
certificates of deposit. The Bank engages in a variety of lending activities,
including commercial, asset-based, real estate-construction and development,
real estate-collateralized and mortgage, personal, Small Business
Administration ("SBA"), home improvement, and other installment and term
loans. The Bank offers a wide range of traditional services designed to
attract and serve the needs of its customers, such as travelers' checks, safe
deposit boxes at the Wilshire Regional Office, collection services and
telephone transfers. All of the above-mentioned services are offered to the
Bank's clients on a personalized basis, except at the Mid-Valley Branch Office
which is a drive-up facility. Each Bank client is assigned to one "Sterling
Banker" who is primarily responsible for serving the client's banking needs.
The Bank does not presently operate nor does it intend in the near future to
operate a trust department. The Bank makes arrangements with correspondent
institutions to provide international banking services.
BSC
BSC, a wholly-owned mortgage banking subsidiary of the Bank, was
engaged in the business of originating, acquiring, processing, selling in the
secondary market and servicing of first and second trust deed loans secured by
residential properties. During the fourth quarter of 1994 the Company
discontinued its mortgage banking operations, substantially all of which were
performed by BSC. By December 31, 1994 the Company had ceased solicitation of
new applications, had funded the mortgages in its pipeline and had completed
the sale of substantially all of its residential mortgage servicing portfolio.
BSC's servicing activities required it to perform certain administrative
duties relating to the loans it originated or acquired and sold under
agreements that provided for payment to BSC of a servicing fee. The servicing
fee was generally based on the outstanding principal balance of the loans.
Servicing includes, among other duties, collecting monthly payments from the
borrower, maintaining escrow accounts and making payments of real estate taxes
and insurance premiums. BSC was licensed by the California Department of Real
Estate. During 1995, the Company settled a dispute over repurchase liability
relating to mortgage loans originated by BSC. See "ITEM 7. MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS --
Discontinued Operations, and Note 5 to the Consolidated Financial Statements".
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Business Credit
Business Credit was formed as a wholly-owned subsidiary of the
Company on September 15, 1983 and commenced operations on June 27, 1984.
Business Credit operates as a commercial finance company, financing accounts
receivables, inventory and equipment. Business Credit maintains one office
which is located at the Wilshire Center Office. On September 7, 1995,
Business Credit sold approximately $15.2 million of loans to First Capital
Corporation. Business Credit retained certain assets and at December 31, 1996
had approximately $1.5 million in total assets which included $1.0 million in
net loans. The Company is in the process of liquidating these loans and other
assets and has agreed with the purchaser to not compete within California until
September 7, 1997. Business Credit made no material contribution to the results
of operations for the year ended December 31, 1996. See "ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -- Sale of Business Credit Assets."
Competition
The banking and financial services business in California generally,
and in the Bank's market areas specifically, is highly competitive. The
increasingly competitive environment is a result primarily of changes in
regulation, changes in technology and product delivery systems, and the
accelerating pace of consolidation among financial services providers. The
Bank competes for loans, deposits and customers for financial services with
other commercial banks, savings and loan associations, securities and brokerage
companies, mortgage companies, insurance companies, finance companies, money
market funds, credit unions, and other nonbank financial service providers.
Many of these competitors are much larger in total assets and capitalization,
have greater access to capital markets and offer a broader array of financial
services than the Bank. In order to compete with the other financial services
providers, the Bank principally relies upon local promotional activities,
personal relationships established by officers, directors and employees with
its customers, and specialized services tailored to meet its customers' needs.
In those instances where the Bank is unable to accommodate a customer's needs,
the Bank may arrange for those services to be provided by its correspondents.
The Bank has 5 offices located in the Greater Los Angeles area.
Effect of Governmental Policies and Legislation
Banking is a business that depends on rate differentials. In general,
the difference between the interest rate paid by the Bank on its deposits and
its other borrowings and the interest rate received by the Bank on loans
extended to its customers and securities held in the Bank's portfolio
comprises the major portion of the Company's earnings. These rates are highly
sensitive to many factors that are beyond the control of the Company or the
Bank. Accordingly, the earnings and growth of the Company are subject to the
influence of domestic and foreign economic conditions, including inflation,
recession and unemployment.
The commercial banking business is not only affected by general
economic conditions but is also influenced by the monetary and fiscal policies
of the federal government and the policies of regulatory agencies, particularly
the Federal Reserve Board. The Federal Reserve Board implements national
monetary policies (with objectives such as curbing inflation and combating
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recession) by its open-market operations in United States Government
securities, by adjusting the required level of reserves for financial
institutions subject to its reserve requirements and by varying the discount
rates applicable to borrowings by depository institutions. The actions of the
Federal Reserve Board in these areas influence the growth of bank loans,
investments and deposits and also affect interest rates charged on loans and
paid on deposits. The nature and impact of any future changes in monetary
policies cannot be predicted.
From time to time, legislation is enacted which has the effect of
increasing the cost of doing business, limiting or expanding permissible
activities or affecting the competitive balance between banks and other
financial services providers. Proposals to change the laws and regulations
governing the operations and taxation of banks, bank holding companies and
other financial services provider are frequently made in Congress, in the
California legislature and before various bank regulatory and other
professional agencies. The likelihood of any major legislative changes and
the impact such changes might have on the Company are impossible to predict.
See "ITEM 1. BUSINESS - Supervision and Regulation."
Supervision and Regulation
Bank holding companies and banks are extensively regulated under both
federal and state law. Set forth below is a summary description of certain
laws which relate to the regulation of the Company and the Bank. The
description does not purport to be complete and is qualified in its entirety by
reference to the applicable laws and regulations.
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The Company
The Company, as a registered bank holding company, is subject to
regulation under the Bank Holding Company Act of 1956, as amended (the
"BHCA"). The Company is required to file with the Federal Reserve Board
quarterly and annual reports and such additional information as the Federal
Reserve Board may require pursuant to the BHCA. The Federal Reserve Board may
conduct examinations of the Company and its subsidiaries.
The Federal Reserve Board may require that the Company terminate an
activity or terminate control of or liquidate or divest certain subsidiaries or
affiliates when the Federal Reserve Board believes the activity or the control
of the subsidiary or affiliate constitutes a significant risk to the financial
safety, soundness or stability of any of its banking subsidiaries. The Federal
Reserve Board also has the authority to regulate provisions of certain bank
holding company debt, including authority to impose interest ceilings and
reserve requirements on such debt. Under certain circumstances, the Company
must file written notice and obtain approval from the Federal Reserve Board
prior to purchasing or redeeming its equity securities.
Under the BHCA and regulations adopted by the Federal Reserve Board, a
bank holding company and its nonbanking subsidiaries are prohibited from
requiring certain tie-in arrangements in connection with any extension of
credit, lease or sale of property or furnishing of services. Further, the
Company is required by the Federal Reserve Board to maintain certain levels of
capital. See "ITEM 1. BUSINESS - Supervision and Regulation - Capital
Standards."
The Company is required to obtain the prior approval of the Federal
Reserve Board for the acquisition of more than 5% of the outstanding shares of
any class of voting securities or substantially all of the assets of any bank
or bank holding company. Prior approval of the Federal Reserve Board is also
required for the merger or consolidation of the Company and another bank
holding company.
The Company is prohibited by the BHCA, except in certain statutorily
prescribed instances, from acquiring direct or indirect ownership or control of
more than 5% of the outstanding voting shares of any company that is not a bank
or bank holding company and from engaging directly or indirectly in activities
other than those of banking, managing or controlling banks or furnishing
services to its subsidiaries. However, the Company, subject to the prior
approval of the Federal Reserve Board, may engage in any, or acquire shares of
companies engaged in, activities that are deemed by the Federal Reserve Board
to be so closely related to banking or managing or controlling banks as to be a
proper incident thereto. In making any such determination, the Federal Reserve
Board is required to consider whether the performance of such activities by the
Company or an affiliate can reasonably be expected to produce benefits to the
public, such as greater convenience, increased competition or gains in
efficiency, that outweigh possible adverse effects, such as undue concentration
of resources, decreased or unfair competition, conflicts of interest or unsound
banking practices. The Federal Reserve Board is also empowered to
differentiate between activities commenced de novo and activities commenced by
acquisition, in whole or in part, of a going concern. In 1996, the Economic
Growth and Regulatory Paperwork Reduction Act of 1996 (the "Budget Act")
eliminated the requirement that bank holding companies seek Federal Reserve
Board approval before engaging de novo in permissible nonbanking activities
listed in Regulation Y, which governs bank holding companies,
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if the holding company and its lead depository institution are well-managed and
well-capitalized and certain other criteria specified in the statute are met.
For purposes of determining the capital levels at which a bank holding company
shall be considered "well-capitalized" under this section of the Budget Act
and Regulation Y, the FRB adopted as an interim rule, risk-based capital ratios
(on a consolidated basis) that are, with the exception of the leverage ratio
(which is lower), the same as the levels set for determining that a state
member bank is well capitalized under the provisions established under the
prompt corrective action provisions of federal law. See "ITEM 1. BUSINESS -
Supervision and Regulation - Prompt Corrective Action and Other Enforcement
Mechanisms."
In addition, the Federal Reserve Board is empowered to enter into a
memorandum of understanding with a bank holding company requiring specific
corrective actions. As a result of its examination of the Company in April
1995, the Federal Reserve Bank of San Francisco proposed that the Board of
Directors of the Company enter into a memorandum of understanding. In November
1995, the Federal Reserve Bank and the Board of Directors of the Company
entered into a memorandum of understanding (the "FRB Memorandum"). Under the
FRB Memorandum, the Company is required, among other things, to comply with the
FDIC Memorandum (see "ITEM 1. BUSINESS -- Supervision and Regulation -- The
Bank"); to ensure that the Company has sufficient cash to pay its expenses and
to service its debt; the Company may not, directly or indirectly, acquire or
sell any interest in any entity, line of business, problem loans or other
assets, without the prior written approval of the Federal Reserve Bank (the
sale, by the Company, of substantially all of Business Credit assets, and the
further liquidation of the remaining assets of Business Credit, shall be
exempt); and to not pay cash dividends without the prior written consent of the
Federal Reserve Bank.
The Company believes it was in compliance with all of the provisions
of the FRB Memorandum as of December 31, 1996. Failure to comply with the
terms of the FRB Memorandum could result in further regulatory action by the
Federal Reserve Bank.
Under Federal Reserve Board regulations, a bank holding company is
required to serve as a source of financial and managerial strength to its
subsidiary banks and may not conduct its operations in an unsafe or unsound
manner. In addition, it is the Federal Reserve Board's policy that in serving
as a source of strength to its subsidiary banks, a bank holding company should
stand ready to use available resources to provide adequate capital funds to its
subsidiary banks during periods of financial stress or adversity and should
maintain the financial flexibility and capital-raising capacity to obtain
additional resources for assisting its subsidiary banks. A bank holding
company's failure to meet its obligations to serve as a source of strength to
its subsidiary banks will generally be considered by the Federal Reserve Board
to be an unsafe and unsound banking practice or a violation of the Federal
Reserve Board's regulations or both. This doctrine has become known as the
"source of strength" doctrine. Although the United States Court of Appeals
for the Fifth Circuit found the Federal Reserve Board's source of strength
doctrine invalid in 1990, stating that the Federal Reserve Board had no
authority to assert the doctrine under the BHCA, the decision, which is not
binding on federal courts outside the Fifth Circuit, was recently reversed by
the United States Supreme Court on procedural grounds. The validity of the
source of strength doctrine is likely to continue to be the subject of
litigation until definitively resolved by the courts or by Congress.
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The Company is also a bank holding company within the meaning of
Section 3700 of the California Financial Code. As such, the Company and its
subsidiaries are subject to examination by, and may be required to file reports
with, the California State Banking Department ("the SBD").
Finally, the Company is subject to the periodic reporting requirements
of the Securities Exchange Act of 1934, as amended, including but not limited
to, filing annual, quarterly and other current reports with the Securities and
Exchange Commission.
The Bank
The Bank, as a California state chartered bank, is subject to primary
supervision, periodic examination and regulation by the SBD and the Federal
Depository Insurance Corporation ("FDIC"). If, as a result of an examination
of a Bank, the FDIC or the SBD, should determine that the financial condition,
capital resources, asset quality, earnings prospects, management, liquidity or
other aspects of the bank's operations are unsatisfactory or that the bank or
its management is violating or has violated any law or regulation, various
remedies are available to the FDIC and the SBD. Such remedies include the
power to enjoin "unsafe or unsound" practices, to require affirmative action
to correct any conditions resulting from any violation or practice, to issue an
administrative order that can be judicially enforced, to direct an increase in
capital, to restrict the growth of the bank, to assess civil monetary
penalties, to remove officers and directors and ultimately to terminate a
bank's deposit insurance, which for a California state-chartered bank would
result in a revocation of the bank's charter.
Additionally, the FDIC and the SBD are empowered to enter into a
memorandum of understanding with a bank requiring specific corrective actions.
As a result of examinations of the Bank in 1994, the FDIC and the SBD proposed
that the Board of Directors of the Bank enter into a memorandum of
understanding which would replace and supersede the provisions of any prior
memorandums of understanding. In March 1995, the FDIC, the SBD and the Board
of Directors of the Bank entered into memorandums of understanding with each of
the FDIC and the SBD ("the FDIC Memorandum" and "SBD Memorandum",
respectively). Under these Memorandums, the Bank is required, among other
things, to achieve and maintain Tier 1 capital equal to or above 6.75% of total
assets; establish and maintain an adequate allowance for loan losses; and not
pay cash dividends without the prior written consent of the FDIC and the
Superintendent.
The Bank believes it was in compliance with the provisions of the FDIC
Memorandum and the SBD Memorandum at December 31, 1996. Management believes
the Bank can continue to comply with the terms of these Memorandums and
otherwise meet regulatory capital requirements, and that any actions taken to
so comply in the future will not have a material adverse effect on the
Company's future financial condition or results of operations. However,
failure to comply with the terms of the FDIC Memorandum could result in further
regulatory action. See "ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Capital Resources, and Note 11
to the Financial Statements".
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The deposits of the Bank are insured by the FDIC in the manner and to
the extent provided by law. For this protection, the Bank pays a semiannual
statutory assessment. See "ITEM 1. BUSINESS - Supervision and Regulation -
Premiums for Deposit Insurance." Although the Bank is not a member of the
Federal Reserve System, it is nevertheless subject to certain regulations of
the Federal Reserve Board.
Various requirements and restrictions under the laws of the State of
California and the United States affect the operations of the Bank. State and
federal statutes and regulations relate to many aspects of the Bank's
operations, including reserves against deposits, interest rates payable on
deposits, loans, investments, mergers and acquisitions, borrowings, dividends,
locations of branch offices and capital requirements. Further, the Bank is
required to maintain certain levels of capital. See "ITEM 1. BUSINESS -
Supervision and Regulation - Capital Standards."
Restrictions on Transfers of Funds to the Company by the Bank
The Company is a legal entity separate and distinct from the Bank.
The Compan's ability to pay cash dividends is limited by California law.
Under California law, shareholders of the Company may receive dividends when
and as declared by the Board of Directors out of funds legally available for
such purpose. With certain exceptions, a California corporation may not pay a
dividend to its shareholders unless (i) its retained earnings equal at least
the amount of the proposed dividend or (ii) after giving effect to the
dividend, the corporation's assets would equal at least 1.25 times its
liabilities and, for corporations with classified balance sheets, the current
assets of the corporation would be at least equal to its current liabilities
or, if the average of the earnings of the corporation before taxes on income
and before interest expense for the two preceding fiscal years was less than
the average of the interest expense of the corporation for those fiscal years,
at least equal to 1.25 times its current liabilities.
Federal Reserve Board policy 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 borrowings or other
arrangements that might adversely affect the holding company's financial
position. The policy further declares 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. Other Federal Reserve Board policies forbid the
payment by bank subsidiaries to their parent companies of management fees which
are unreasonable in amount or exceed the fair market value of the services
rendered.
There are statutory and regulatory limitations on the amount of
dividends which may be paid to the Company by the Bank. California law
restricts the amount available for cash dividends by state chartered banks to
the lesser of retained earnings or a bank's net income for its previous three
fiscal years (less any distributions made to shareholders by the bank or by any
majority-owned subsidiary of the bank during such period). Notwithstanding
this restriction, a bank may, with the prior approval of the Superintendent,
make a distribution to its shareholders in an amount not exceeding the greatest
of the retained earnings of the bank, net income for such bank's last fiscal
year or the net income of the bank for its current year.
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The FDIC and the Superintendent also have authority to prohibit the
Bank from engaging in activities that, in such agencies' opinions, constitute
unsafe or unsound practices in conducting its business. It is possible,
depending upon the financial condition of the bank in question and other
factors, that the FDIC or the Superintendent could assert that the payment of
dividends or other payments might, under some circumstances, be such an unsafe
or unsound practice. Further, the FDIC and the Federal Reserve Board have
established guidelines with respect to the maintenance of appropriate levels of
capital by banks or bank holding companies under their jurisdiction.
Compliance with the standards set forth in such guidelines and the restrictions
that are or may be imposed under the prompt corrective action provisions of
federal law could limit the amount of dividends which the Bank or the Company
may pay. See "ITEM 1. BUSINESS - Supervision and Regulation - Prompt
Corrective Regulatory Action and Other Enforcement Mechanisms" and - "Capital
Standards" for a discussion of these additional restrictions on capital
distributions.
At present, substantially all of the Company's revenues, including
funds available for the payment of dividends and other operating expenses, are,
and will continue to be, primarily dividends and certain management and service
fees paid by the Bank. At December 31, 1996, the Bank, as a result of losses,
had no retained earnings legally available for the payment of cash dividends.
Under the terms of the FDIC Memorandum, the Bank is prohibited from paying cash
dividends to the Company unless the payment is approved in advance by the
Regional Director of the FDIC and the Superintendent.
The Bank is subject to certain restrictions imposed by federal law on
any extensions of credit to, or the issuance of a guarantee or letter of credit
on behalf of, the Company or other affiliates, the purchase of or investments
in stock or other securities thereof, the taking of such securities as
collateral for loans and the purchase of assets of the Company or other
affiliates. Such restrictions prevent the Company and such other affiliates
from borrowing from the Bank unless the loans are secured by marketable
obligations of designated amounts. Further, such secured loans and investments
by the Bank to or in the Company or to or in any other affiliate is limited to
10% of the Bank's capital stock and surplus (as defined by federal
regulations) and such secured loans and investments are limited, in the
aggregate, to 20% of the Bank's capital stock and surplus (as defined by
federal regulations). California law also imposes certain restrictions with
respect to transactions involving the Company and other controlling persons of
the Bank. Additional restrictions on transactions with affiliates may be
imposed on the Bank under the prompt corrective action provisions of federal
law. See "ITEM 1. BUSINESS - Supervision and Regulation - Prompt Corrective
Regulatory Action and Other Enforcement Mechanisms."
Capital Standards
The Federal Reserve Board and the FDIC have adopted risk-based minimum
capital guidelines intended to provide a measure of capital that reflects the
degree of risk associated with a banking organization's operations for both
transactions reported on the balance sheet as assets and transactions, such as
letters of credit and recourse arrangements, which are recorded as off- balance
sheet items. Under 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. Treasury securities, to 100% for assets with
relatively high credit risk, such as commercial loans.
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A banking organization's risk-based capital ratios are obtained by
dividing its qualifying capital by its total risk adjusted assets. The
regulators measure risk-adjusted assets, which includes 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, among other things, (i) common stockholders' equity capital (includes
common stock and related surplus, and undivided profits); (ii) noncumulative
perpetual preferred stock (cumulative perpetual preferred stock for bank
holding companies), including any related surplus; and (iii) minority interests
in certain subsidiaries, less most intangible assets. Tier 2 capital may
consist of: (i) a limited amount of the allowance for possible loan and lease
losses; (ii) cumulative perpetual preferred stock; (iii) perpetual preferred
stock (and any related surplus); (iv) term subordinated debt and certain other
instruments with some characteristics of equity. The inclusion of elements of
Tier 2 capital is subject to certain other requirements and limitations of the
federal banking agencies. The federal banking agencies require a minimum ratio
of qualifying total capital to risk-adjusted assets of 8% and a minimum ratio
of Tier 1 capital to risk-adjusted assets 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
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 total assets
must be 3%. 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, or 4% to 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. In
the case of the Bank, as a result of entering into the FDIC Memorandum and the
SBD Memorandum, the Bank is required, among other things, to achieve and
maintain Tier 1 capital equal to or above 6.75% of total assets. Additionally,
pursuant to the FRB Memorandum, the Company is required to maintain the Bank's
Tier 1 capital at such level. For discussion of the Companys' and the Bank's
capital, see "Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERTIONS -- Capital Resources".
In June 1996, the federal banking agencies adopted a joint agency
policy statement to provide guidance on managing interest rate risk. These
agencies indicated that the adequacy and effectiveness of a bank's interest
rate risk management process and the level of its interest rate exposures are
critical factors in the agencies' evaluation of the bank's capital adequacy.
A bank with material weaknesses in its risk management process or high levels
of exposure relative to its capital will be directed by the agencies to take
corrective action. Such actions will include recommendations or directions to
raise additional capital, strengthen management expertise, improve management
information and measurement systems, reduce levels of exposure, or some
combination thereof depending upon the individual institution's circumstances.
This policy statement augments the August 1995 regulations adopted by the
federal banking agencies which addressed risk-based capital standards for
interest rate risk.
In December 1993, the federal banking agencies issued an interagency
policy statement on the allowance for loan and lease losses ("ALLL") which,
among other things, establishes certain benchmark ratios of loan loss reserves
to classified assets. The benchmark set forth by such
13
<PAGE> 14
policy statement is the sum of (a) assets classified loss; (b) 50 percent of
assets classified doubtful; (c) 15 percent of assets classified substandard;
and (d) estimated credit losses on other assets over the upcoming 12 months.
This amount is neither a "floor" nor a "safe harbor" level for an
institution's ALLL.
Federally supervised banks and savings associations are currently
required to report deferred tax assets in accordance with SFAS No. 109. The
federal banking agencies issued final rules governing banks and bank holding
companies, which became effective April 1, 1995, which limit 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, based on projected taxable income for that year
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 available for the payment of dividends.
14
<PAGE> 15
Prompt Corrective Action and Other Enforcement Mechanisms
Federal law requires each federal banking agency to take prompt
corrective action to resolve the problems of insured depository institutions,
including but not limited to those that fall below one or more prescribed
minimum capital ratios. In accordance with federal law, each federal banking
agency has promulgated 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. An insured
depository institution will be classified in the following categories based, in
part, on the capital measures indicated below:
<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%.
"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%. Leverage ratio less than 3%.
"Critically undercapitalized"
-----------------------------
Tangible equity to total assets less than 2%.
</TABLE>
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 a significantly undercapitalized institution
as "critically undercapitalized" unless its capital ratio actually warrants
such treatment.
The law prohibits insured depository institutions from paying
management fees to any controlling persons or, with certain limited exceptions,
making capital distributions if after such transaction the institution would be
undercapitalized. If an insured depository institution is undercapitalized, it
will be closely monitored by the appropriate federal banking agency, subject to
asset growth restrictions and required to obtain prior regulatory approval for
acquisitions, branching and engaging in new lines of business. Any
undercapitalized depository institution must submit an acceptable capital
restoration plan to the appropriate federal banking agency 45 days after
receiving notice, or is deemed to have notice, that the institution is
undercapitalized. The appropriate federal banking agency cannot accept a
capital plan unless, among other things, it determines that the plan: (i)
specifies: (a) the steps the institution will take to become adequately
capitalized; (b) the levels of capital to be attained during each year in which
the plan will be in effect; (c) how the institution will comply with the
restrictions or requirements then in effect
15
<PAGE> 16
under Section 38 of the FDIA; and (d) the types and levels of activities in
which the institution will engage; (ii) is based on realistic assumptions and
is likely to succeed in restoring the depository institution's capital; and
(iii) would not appreciably increase the risk (including credit risk,
interest-rate risk, and other types of risk) to which the institution is
exposed. In addition, each company controlling an undercapitalized depository
institution must guarantee that the institution will comply with the capital
plan until the depository institution has been adequately capitalized on
average during each of four consecutive calendar quarters and must otherwise
provide appropriate assurances of performance. The aggregate liability of such
guarantee is limited to the lesser of (a) an amount equal to 5% of the
depository institution's total assets at the time the institution became
undercapitalized or (b) the amount which is necessary to bring the institution
into compliance with all capital standards applicable to such institution as of
the time the institution fails to comply with its capital restoration plan.
Finally, the appropriate federal banking agency may impose any of the
additional restrictions or sanctions that it may impose on significantly
undercapitalized institutions if it determines that such action will further
the purpose of the prompt correction action provisions.
An insured depository institution that is significantly
undercapitalized, or is undercapitalized and fails to submit, or in a material
respect to implement, an acceptable capital restoration plan, is subject to
additional restrictions and sanctions. These include, among other things: (i)
a forced sale of voting shares to raise capital or, if grounds exist for
appointment of a receiver or conservator, a forced merger; (ii) restrictions on
transactions with affiliates; (iii) further limitations on interest rates paid
on deposits; (iv) further restrictions on growth or required shrinkage; (v)
modification or termination of specified activities; (vi) replacement of
directors or senior executive officers; (vii) prohibitions on the receipt of
deposits from correspondent institutions; (viii) restrictions on capital
distributions by the holding companies of such institutions; (ix) required
divestiture of subsidiaries by the institution; or (x) other restrictions as
determined by the appropriate federal banking agency. Although the appropriate
federal banking agency has discretion to determine which of the foregoing
restrictions or sanctions it will seek to impose, it is required to: (i) force
a sale of shares or obligations of the bank, or require the bank to be acquired
by or combine with another institution; (ii) impose restrictions on affiliate
transactions and (iii) impose restrictions on rates paid on deposits, unless it
determines that such actions would not further the purpose of the prompt
corrective action provisions. In addition, without the prior written approval
of the appropriate federal banking agency, a significantly undercapitalized
institution may not pay any bonus to its senior executive officers or provide
compensation to any of them at a rate that exceeds such officer's average rate
of base compensation during the 12 calendar months preceding the month in which
the institution became undercapitalized.
Further restrictions and sanctions are required to be imposed on
insured depository institutions that are critically undercapitalized. For
example, a critically undercapitalized institution generally would be
prohibited from engaging in any material transaction other than in the ordinary
course of business without prior regulatory approval and could not, with
certain exceptions, make any payment of principal or interest on its
subordinated debt beginning 60 days after becoming critically undercapitalized.
Most importantly, however, except under limited circumstances, the appropriate
federal banking agency, not later than 90 days after an insured depository
institution becomes critically undercapitalized, is required to appoint a
conservator or receiver for the institution. The board of directors of an
insured depository institution would not
16
<PAGE> 17
be liable to the institution's shareholders or creditors for consenting in
good faith to the appointment of a receiver or conservator or to an acquisition
or merger as required by the regulator.
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. See "ITEM 1. BUSINESS - Supervision and Regulation - Potential
Enforcement Actions."
Safety and Soundness Standards
Effective July 1995, the federal banking agencies adopted final
guidelines establishing standards for safety and soundness, as required by the
Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA").
These standards are designed to identify potential safety- and-soundness
concerns and ensure that action is taken to address those concerns before they
pose a risk to the deposit insurance funds. The standards relate to (i)
internal controls, information systems and internal audit systems; (ii) loan
documentation; (iii) credit underwriting; (iv) asset growth; (v) earnings; and
(vi) compensation, fee and benefits. If a federal banking agency determines
that an institution fails to meet any of these standards, the agency may
require the institution to submit to the agency an acceptable plan to achieve
compliance with the standard. In the event the institution fails to submit an
acceptable plan within the time allowed by the agency or fails in any material
respect to implement an accepted plan, the agency must, by order, require the
institution to correct the deficiency. Effective October 1, 1996, the
federal banking agencies promulgated safety and soundness regulations and
accompanying interagency compliance guidelines on asset quality and earnings
standards. These new guidelines provide six standards for establishing and
maintaining a system to identify problem assets and prevent those assets from
deteriorating. The institution should: (i) conduct periodic asset quality
reviews to identify problem assets; (ii) estimate the inherent losses in those
assets and establish reserves that are sufficient to absorb estimated losses;
(iii) compare problem asset totals to capital; (iv) take appropriate corrective
action to resolve problem assets; (v) consider the size and potential risks of
material asset concentrations; and (vi) provide periodic asset reports with
adequate information for management and the board of directors to assess the
level of asset risk. These new guidelines also set forth standards for
evaluating and monitoring earnings and for ensuring that earnings are
sufficient for the maintenance of adequate capital and reserves. If an
institution fails to comply with a safety and soundness standard, the
appropriate federal banking agency may require the institution to submit a
compliance plan. Failure to submit a compliance plan or to implement an
accepted plan may result in enforcement action.
Premiums for Deposit Insurance
The FDIC has adopted final regulations implementing a risk-based
premium system required by federal law. On November 14, 1995, the FDIC issued
regulations that establish a new assessment rate schedule ranging from 0 cents
per $100 of deposits to 27 cents per $100 of deposits applicable to members of
the Bank Insurance Fund ("BIF"). To determine the risk-based assessment for
each institution, the FDIC will categorize an institution as well capitalized,
17
<PAGE> 18
adequately capitalized or undercapitalized based on its capital ratios using
the same standards used by the FDIC for its prompt corrective action
regulations. A well-capitalized institution is generally one that has at least
a 10% total risk-based capital ratio, a 6% Tier 1 risk-based capital ratio and
a 5% Tier 1 leverage capital ratio. An adequately capitalized institution
will generally have at least an 8% total risk-based capital ratio, a 4% Tier 1
risk-based capital ratio and a 4% Tier 1 leverage capital ratio. An
undercapitalized institution will generally be one that does not meet either of
the above definitions. The FDIC will also assign each institution to one of
three subgroups based upon reviews by the institution's primary federal or
state regulator, statistical analyses of financial statements and other
information relevant to evaluating the risk posed by the institution. 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 BIF assessment rates are set forth below for institutions
based on their risk-based assessment categorization.
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>
*Assessment figures are expressed in terms of cents per $100 per
deposits.
During 1996, the Bank's annual assessment rate was 17 cents
per $100 of deposits, and at January 1, 1997 was 3 cents per $100 of deposits.
On September 30, 1996, Congress passed the Budget Act, which
capitalized the Savings Association Insurance Fund ("SAIF") through a
one-time special assessment on SAIF-insured deposits and required banks to now
share in part of the interest payments on the Financing Corporation ("FICO")
bonds which were issued to help fund the federal government costs associated
with the savings and loan crisis of the late 1980's. The special thrift SAIF
assessment has been set at 65.7 cents per $100 insured by the thrift funds as
of March 31, 1995. Effective January 1, 1997 and continuing through December
31, 1999, for the FICO payments, SAIF-insured institutions will pay 3.2 cents
per $100 in domestic deposits and BIF-insured institutions, like the Bank, will
pay 0.64 cents per $100 in domestic deposits. Full pro rata sharing of the
FICO interest payments takes effect on January 1, 2000.
The federal banking regulators are also authorized to prohibit
depository institutions and their holding companies from facilitating or
encouraging the shifting of deposits from SAIF to BIF for the purpose of
evading thrift assessment rates. The Budget Act also prohibits the FDIC from
setting premiums under the risk-based schedule above the amount needed to meet
the designated reserve ratio (currently 1.25%).
18
<PAGE> 19
Interstate Banking and Branching
On September 29, 1994, the President signed into law the Riegel-Neal
Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate
Act"). Under the Interstate Act, beginning one year after the date of
enactment, a bank holding company that is adequately capitalized and managed
may obtain approval under the BHCA to acquire an existing bank located in
another state without regard to state law. A bank holding company is not
permitted to make such an acquisition if, upon consummation, it would control
(a) more than 10% of the total amount of deposits of insured depository
institutions in the United States or (b) 30% or more of the deposits in the
state in which the bank is located. A state may limit the percentage of total
deposits that may be held in that state by any one bank or bank holding company
if application of such limitation does not discriminate against out-of-state
banks or bank holding companies. An out-of-state bank holding company may not
acquire a state bank in existence for less than a minimum length of time that
may be prescribed by state law except that a state may not impose more than a
five year existence requirement.
The Interstate Act also permits, beginning June 1, 1997, mergers of
insured banks located in different states and conversion of the branches of the
acquired bank into branches of the resulting bank. Each state may permit such
combinations earlier than June 1, 1997, and may adopt legislation to prohibit
interstate mergers after that date in that state or in other states by that
state's banks. The same concentration limits discussed in the preceding
paragraph apply. The Interstate Act also permits a national or state bank to
establish branches in a state other than its home state if permitted by the
laws of that state, subject to the same requirements and conditions as for a
merger transaction.
The Interstate Act is likely to increase competition in the Company's
market areas especially from larger financial institutions and their holding
companies. It is difficult to assess the impact such likely increased
competition will have on the Company's operations.
Under the Interstate Act, the extent of a commercial bank's ability to
branch into a new state will depend on the law of the state. In October 1995,
California adopted an early "opt in" statute under the Interstate Act that
permits out-of-state banks to acquire California banks that satisfy a five-year
minimum age requirement (subject to exceptions for supervisory transactions) by
means of merger or purchases of assets, although entry through acquisition of
individual branches of California institutions and de novo branching into
California are not permitted. The Interstate Act and the California branching
statute will likely increase competition from out-of-state banks in the markets
in which the Company operates, although it is difficult to assess the impact
that such increased competition may have on the Company's operations.
19
<PAGE> 20
Community Reinvestment Act and Fair Lending Developments
The Bank is subject to certain fair lending requirements and reporting
obligations involving home mortgage lending operations and Community
Reinvestment Act ("CRA") activities. The CRA generally requires the federal
banking agencies to evaluate the record of a financial institution in meeting
the credit needs of its local communities, including low and moderate income
neighborhoods. In addition to substantial penalties and corrective measures
that may be required for a violation of certain fair lending laws, the federal
banking agencies may take compliance with such laws and CRA into account when
regulating and supervising other activities.
In May 1995, the federal banking agencies issued final regulations
which change the manner in which they measure a bank's compliance with its CRA
obligations. The final regulations adopt a performance-based evaluation system
which bases CRA ratings on an institution's actual lending service and
investment performance, rather than the extent to which the institution
conducts community needs assessments, documents community outreach, activities
or complies with other procedural requirements.
In March 1994, the Federal Interagency Task Force on Fair Lending
issued a policy statement on discrimination in lending. The policy statement
describes the three methods that federal agencies will use to prove
discrimination: overt evidence of discrimination, evidence of disparate
treatment and evidence of disparate impact.
In connection with its assessment of CRA performance, the Bank's
regulators assign a rating of "outstanding," "satisfactory," "needs to
improve" or "substantial noncompliance." Based on an examination conducted
during January, 1996, the Bank was rated "Satisfactory".
Potential Enforcement Actions
Commercial banking organizations, such as the bank, and their
institution-affiliated parties, which include the Company, may be subject to
potential enforcement actions by the Federal Reserve Board, the FDIC and the
Superintendent 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 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 the Bank), 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 imposition of restrictions and
sanctions under the prompt corrective action provisions of the FDIC Improvement
Act. 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.
20
<PAGE> 21
Recent Accounting Pronouncements
In June 1996, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 125 "SFAS No. 125"),
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities". SFAS No. 125 is effective for transfers and
servicing of financial assets and extinguishments of liabilities occurring
after December 31, 1996 and is to be applied prospectively. This Statement
provides accounting and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities based on consistent
application of a financial-components approach that focuses on control. It
distinguishes transfers of financial assets that are sales from transfers that
are secured borrowings. Management of the Company does not expect that adoption
of SFAS No. 125 will have a material impact on the Company's financial
position, results of operations, or liquidity.
Employees
At December 31, 1996, the Company, and the Bank, employed 63 individuals. The
Company believes that its employee relations are excellent.
Factors That May Affect Future Results
The following is a discussion of certain factors which may affect the Company's
financial results and operations, and should be considered in evaluating the
Company.
Economic Conditions and Geographic Concentration. The Company's operations are
concentrated in Southern California. The results of the Company depend largely
upon economic conditions in this area, which have been relatively volatile over
the last several years. While the Southern California economy recently has
exhibited positive economic and employment trends, there is no assurance that
such trends will continue. A deterioration in economic conditions could have
material adverse impact on the quality of the Company's loan portfolio and the
demand for its products and services.
Interest Rates. The Company anticipates that interest rate levels will remain
generally stable in the near future, but if interest rates vary substantially
from present levels, the Company's results may differ materially from the
results currently anticipated. Changes in interest rates will influence the
growth of loans, investments and deposits and affect the rates received on
loans and investment securities and those paid on deposits.
Government Regulation and Monetary Policy. The banking industry is subject to
extensive federal and state supervision and regulation. Significant new laws
or changes in, or repeals of, existing laws may cause the Company's results to
differ materially. Further, federal monetary policy, particularly as
implemented through the Federal Reserve System, significantly affects credit
conditions for the Company, primarily through open market operations in United
States government securities, the discount rate for bank borrowings and bank
reserve requirements, and a material change in these conditions would be likely
to have a material impact on the Company's results.
21
<PAGE> 22
Competition. The banking and financial services business in the Company's
market areas are highly competitive. The increasingly competitive environment
is a result in part of changes in regulation, changes in technology and product
delivery systems, and the accelerating pace of consolidation among financial
services providers. The results of the Company may differ if circumstances
affecting the nature or level of competition change.
Credit Quality. A significant source of risk arises from the possibility that
losses will be sustained because borrowers, guarantors and related parties may
fail to perform in accordance with the terms of their loans. The Company has
adopted underwriting and credit monitoring procedures and credit policies,
including the establishment and review of the allowance for credit losses, that
management believes are appropriate to minimize this risk by assessing the
likelihood of nonperformance, tracking loan performance and diversifying the
Company's credit portfolio. Such policies and procedures, however, may not
prevent unexpected losses that could materially adversely affect the Company's
results.
Other Risks. From time to time, the Company details other risks with respect
to its business and/or financial results in its filings with the Commission.
22
<PAGE> 23
ITEM 2. PROPERTIES.
The head offices of the Company, Business Credit and the Bank are
located at the Wilshire Center Office at 3287 Wilshire Boulevard, Los Angeles,
California. The Bank leases 16,500 square feet of a three-story building under
a twenty-five year lease which expires June 2, 2005. The Company occupies
office space within the premises leased by the Bank. The total lease payment
is currently $35,429 per month and the total lease expense was $425,148 and
$434,820 for the years 1996 and 1995, respectively.
Except for the Mid-Valley Branch Office, which is owned by the
Bank, all regional branch properties include options to renew. For the year
ended December 31, 1996, annual rental payments under these leases aggregated
$129,951. The Mid-Valley Branch Office is not subject to any encumbrances.
The Company's total rental expense for the year ended December
31, 1996, exclusive of furniture and equipment expense, was approximately
$593,000. Management believes that its existing facilities are adequate for
its present purposes.
ITEM 3. LEGAL PROCEEDINGS.
The Company, BSC, Bank and Business Credit are involved in various
legal proceedings and litigation in the normal course of their business. See
"ITEM 1. BUSINESS - Supervision and Regulation -- The Bank" and "-- The
Company," for a discussion of the FDIC Memorandum between the Board of
Directors of the Bank and the FDIC; and the FRB Memorandum between the Board of
Directors of the Company and the Federal Reserve Bank. While no assurance can
be given as to the likelihood of an unfavorable outcome of any such litigation
or the estimated amount of potential loss, if any, based upon currently
available information the Company does not believe that the outcome of any such
litigation will have a material adverse effect on the results of operations or
financial condition of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders during the
fourth quarter of 1996.
23
<PAGE> 24
ITEM 4(A). EXECUTIVE OFFICERS OF REGISTRANT.
As of March 15, 1997, the executive officers of the Company were:
<TABLE>
<CAPTION>
Current Position with
Name Age Company and its Subsidiaries
-----------------------------------------------------------
<S> <C> <C>
Joseph C. Carona 55 Chief Financial Officer, Executive Vice President,
Company; President, Sterling Bank
Reginald R. Prout 52 Chief Financial Officer and Cashier, Sterling Bank
Allan E. Dalshaug 65 Chairman of the Board, Chief Executive Officer and
President, Company; Chairman of the Board
and Chief Executive Officer, Sterling Bank; Chairman of
the Board, Chief Executive Officer, Sterling
Business Credit, Inc.
Donald Mintz 53 Chief Financial Officer, Sterling Business Credit,
Inc.
</TABLE>
Mr. Carona was President of Columbia National Bank, a national
banking association located in Santa Monica, California, from May 1982 until
joining Sterling Bank as President in August 1989. Mr. Carona became
Executive Vice President of the Company in January 1991.
Mr. Prout was Executive Vice President and Chief Operating Officer of
Columbia National Bank, a national banking association located in Santa Monica,
California, from September 1982 until joining Sterling Bank as Executive Vice
President and Chief Administrative Officer in July 1990. Mr. Prout became Chief
Financial Officer and Cashier of the Bank in June 1996.
Mr. Dalshaug has served as Chairman of the Board, Chief Executive
Officer and President of the Company since 1982. Mr. Dalshaug also serves as
Chief Executive Officer of the Bank and Business Credit, and, prior to 1989,
served in the additional capacity of President of Sterling Bank.
Mr. Mintz was Senior Vice President & Manager of First Charter Bank
located in Los Angeles, CA. from June 1989 until joining Sterling Bank as Vice
President of Asset Based Lending, in June 1996. Mr. Mintz became Vice
President of Sterling Business Credit in July 1996 and Chief Financial Officer
of Sterling Business Credit in September 1996.
24
<PAGE> 25
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
Since July 1992 the common stock of the Company has traded on The
Nasdaq Stock Market as a National Market Issue under the symbol SWBC. The
number of shareholders of record at March 15, 1997 was approximately 360.
The following table sets forth high and low sales prices for the
Company's common stock for the period from January 1, 1995 to December 31,
1996 as reported by The Nasdaq Stock Market:
<TABLE>
<CAPTION>
Quarter Ended High Low
-------------
<S> <C> <C>
March 31, 1995 $2.00 $1.25
June 30, 1995 $3.00 $1.25
September 30, 1995 $3.00 $1.75
December 31, 1995 $3.25 $2.25
March 31, 1996 $4.13 $2.88
June 30, 1996 $3.00 $2.63
September 30, 1996 $3.25 $2.88
December 31, 1996 $3.63 $3.00
</TABLE>
The Company declared no cash dividends in 1995 or 1996. The Board of
Directors suspended the quarterly cash dividends of $0.05 per common share in
the third quarter of 1993 in order to conserve capital. The Company expects
that future dividends will depend on continued profitability and the
maintenance of acceptable financial results in the future. There are
restrictions on the ability of the Company's subsidiaries to transfer funds to
the Company in the form of dividends. See "ITEM 1. BUSINESS -- Supervision
and Regulation -- Restrictions on Transfers of Funds to the Company by the Bank
and Business Credit" and "ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY
DATA - Note 13 to Consolidated Financial Statements."
25
<PAGE> 26
ITEM 6. SELECTED FINANCIAL DATA.
<TABLE>
<CAPTION>
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Consolidated Statements
- -----------------------
of Operations
- -------------
Interest income $8,790,000 $ 12,380,000 $ 12,436,000 $ 13,396,000 $ 14,676,000
Interest expense 2,529,000 4,208,000 3,986,000 4,045,000 4,786,000
Net interest income 6,261,000 8,172,000 8,450,000 9,351,000 9,890,000
Provision for loan losses 886,000 1,104,000 266,000 1,025,000 815,000
Net income (loss) from
continuing operations 343,000 (1,515,000) 29,000 (99,000) (507,000)
Net income (loss) from
discontinued operations -- (1,924,000) (2,904,000) (667,000) 374,000
Net income (loss) (1) 343,000 (3,439,000) (2,875,000) (366,000) (133,000)
Per share (2) (3):
Net income (loss) (1) $0.20 $(2.01) $(1.68) $(0.22) $(0.08)
Cash dividends -- -- -- $0.10 $0.19
Consolidated Balance Sheets
----------------------------
Total assets $104,561,000 $122,419,000 $132,491,000 $153,018,000 $174,752,000
Total loans (4) 68,889,000 72,406,000 91,075,000 91,061,000 120,268,000
Allowance for loan losses 1,260,000 1,510,000 1,613,000 1,899,000 1,980,000
Investment securities 7,224,000 7,614,000 6,974,000 7,587,000 7,807,000
Total deposits 96,186,000 112,376,000 107,098,000 122,511,000 133,238,000
Stockholders' equity 7,261,000 6,918,000 10,357,000 13,232,000 13,589,000
</TABLE>
- --------------------------
(1) Net loss for 1993 includes income of $400,000 or $0.23 per share related
to the cumulative effect of a change in accounting for income taxes.
(2) Income (loss) per share from discontinued operations was $(1.12), $(1.70)
and $(0.39) for 1995, 1994 1993, respectively.
(3) Adjusted to reflect a 5% stock dividend paid in October 1993.
(4) Gross loans net of undisbursed loan funds and deferred fees and costs.
26
<PAGE> 27
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
Certain statements under this caption may constitute "forward-looking
statements" under the Reform Act, which involve risks and uncertainties. The
Company's actual results may differ significantly from the results discussed
in such forward-looking statements. Factors that might cause such a difference
include, but are not limited to, economic conditions, competition in the
geographic and business areas in which the Company conducts its operations,
fluctuations in interest rates, credit quality and government regulation. For
additional information concerning these factors, see "Item 1. Business --
Factors That May Affect Future Results".
Management's Discussion and Analysis of Financial Condition and Results of
Operations is intended to provide a better understanding of the material
changes in trends relating to the financial condition, results of operations,
and liquidity of the Company. The discussion and analysis for the year ended
December 31, 1996 primarily reflect the operations of the Bank. Financial
condition and Results of Operations for each of the two years ending December
31, 1995 include assets and income earned by the formerly active subsidiary,
Business Credit and the discontinued mortgage banking operations of BSC.
During the third quarter of 1995, the Company sold substantially all of the
assets of Sterling Business Credit, Inc. (See "Item 7. Sale of Business Credit
Assets"). In addition, during the fourth quarter of 1994, the Company
discontinued the its mortgage banking operations, substantially all of which
were performed by BSC. ( See "Item 7. Discontinued Operations"). The few
remaining assets of Business Credit and BSC made no material contribution to
the results of operations for the period ending December 31, 1996. The Bank and
Business Credit are wholly-owned subsidiaries of the Company. Unless otherwise
specified, the discussion below relates to the Company's consolidated
financial condition and operations.
The Company's results of operations are dependent primarily on net interest
income, which is the difference between the interest income earned on its loan
portfolio, securities and other earning assets, and its cost of funds,
consisting of interest paid on its deposits and borrowings. The Company's
operating results are also impacted by provisions for loan losses, and to a
lesser extent service charges on deposit accounts and other noninterest income.
In addition, the Company's operating expenses principally consist of salaries,
wages and employee benefits, occupancy expenses, real estate operations expense
and other general noninterest expenses. The Company's results of operations
are also significantly affected by general economic and competitive conditions,
particularly changes in interest rates and actions of regulatory authorities.
27
<PAGE> 28
FINANCIAL CONDITION
Distribution of Assets, Liabilities, and Stockholders' Equity
The following table sets forth the Company's consolidated average
balances of each principal category of assets, liabilities and stockholders'
equity and the percentage distribution of these items for each of the past two
fiscal years (dollars in thousands).
<TABLE>
<CAPTION>
1996 1995
---- ----
Average Percent Average Percent
ASSETS: Balance of Total Balance of Total
- ------
<S> <C> <C> <C> <C>
Cash and due from banks $ 5,531 5.33% $ 5,132 4.11%
Federal funds sold 14,925 14.38 14,881 11.90
Securities held to maturity 7,505 7.23 7,328 5.87
Loans receivable, net 69,703 67.13 82,503 66.01
Real estate held for sale 2,888 2.78 5,013 4.00
Fixed assets, net 1,231 1.18 1,296 1.04
Other assets 2,043 1.97 8,837 7.07
----------------------------------------------
Total assets $103,826 100.00% $124,990 100.00%
==============================================
LIABILITIES AND STOCKHOLDERS' EQUITY:
- -------------------------------------
Deposits:
Demand $27,401 26.39% $30,360 24.29%
Savings and NOW accounts 52,966 51.02 55,088 44.07
Money market accounts 6,324 6.09 7,823 6.26
Time deposits 7,416 7.14 7,623 6.10
Notes payable 443 0.43 10,216 8.17
Other liabilities 1,988 1.91 3,889 3.11
----------------------------------------------
Total liabilities 96,538 92.98 114,994 92.00
Stockholders' equity 7,288 7.02 9,996 8.00
----------------------------------------------
Total liabilities and
stockholders' equity $103,826 100.00% $124,990 100.00%
==============================================
</TABLE>
28
<PAGE> 29
The Company's total average assets decreased 16.9% to $103.8 million at
December 31, 1996 as compared to $125.0 million at December 31, 1995. The
Company's ratio of average earning assets to average assets was 88.7% for 1996
compared to 83.8% for 1995. The significant change in average assets was
primarily attributable to a 15.5% decrease in loans receivable. Average loans
receivable, net at December 31, 1996, are significantly less than the average
balances shown at December 31, 1995 primarily as a result of the sale of most
of Business Credit's loan portfolio.
Loan Portfolio
The following table sets forth the amount of loans outstanding
and their respective percentages, as of the dates indicated by major categories
(dollars in thousands).
<TABLE>
<CAPTION>
December 31,
------------
1996 1995
---- ----
Amount Percent Amount Percent
------ ------- ------ -------
<S> <C> <C> <C> <C>
Real estate - construction and
development $5,930 8.6% $7,816 10.8%
Real estate - mortgage 15,234 22.1 17,658 24.4
Commercial and industrial 46,205 67.1 42,542 58.7
Loans to individuals 1,444 2.1 3,971 5.5
All other loans 76 0.1 419 0.6
------- ------ ------- ------
Total Loans receivable (1) $68,889 100.0% $72,406 100.0%
</TABLE>
- --------------------
(1) Net of undisbursed loan funds and deferred fees and costs.
Loans receivable decreased to $68.9 million at December 31, 1996 from
$72.4 million at December 31, 1995. The reduction was primarily due to $2.0
million of payoffs from the remaining Business Credit assets, and to a lessor
extent payoffs in the Bank's Real estate-construction and development and
Real estate-mortgage loan portfolio. At December 31, 1996, Real
estate-construction and development loans, and Real estate-mortgage loans
accounted for 30.7% of total loans as compared to 35.2% of total loans at
December 31, 1995. This reduction was offset by a 8.6% increase in Commercial
and industrial loans. Commercial and industrial loans accounted for 67.1% of
the total loan portfolio at December 31, 1996, as compared to 58.7% for the
period ending December 31, 1995.
29
<PAGE> 30
Maturities and Sensitivity to Changes in Interest Rates
The following table sets forth the maturity distribution of the
Company's loan portfolio at December 31, 1996 (dollars in thousands):
<TABLE>
<CAPTION>
Maturing
--------
After One After Five After
Within But Within But Within Ten
One Year Five Years Ten Years Years Total
-------- ---------- --------- ----- -----
<S> <C> <C> <C> <C> <C>
Real estate -
construction
and development $5,750 $ -- $ -- $180 $5,930
Real estate -
mortgage 3,527 7,089 3,297 1,321 15,234
Commercial and industrial 25,775 15,017 1,366 4,047 46,205
Loan to individuals 1,044 400 -- -- 1,444
All other loans 76 -- -- -- 76
--------------------------------------------------------------------
Total loans (1) $36,172 $22,506 $4,663 $5,548 $68,889
====================================================================
</TABLE>
- --------------
(1) Net of undisbursed loan funds and deferred fees and costs.
The following table sets forth the maturity distribution of the
Company's loan portfolio by type of interest rate at December 31, 1996
(dollars in thousands):
<TABLE>
<CAPTION>
After One After Five After
Within But Within But Within Ten
One Year Five Years Ten Years Years Total
-------- ---------- --------- ----- -----
<S> <C> <C> <C> <C> <C>
Fixed
interest rates $7,334 $8,183 $2,001 $1,067 $18,585
Floating or
adjustable
interest rates $28,838 $14,323 $2,662 $4,481 $50,304
--------------------------------------------------------------------
Total loans(1) $36,172 $22,506 $4,663 $5,548 $68,889
====================================================================
</TABLE>
- --------------------
(1) Net of undisbursed loan funds and deferred fees and costs.
30
<PAGE> 31
Nonperforming Assets
The Company's consolidated loan portfolio is comprised primarily of the
Bank's loan portfolio. The risk of non-payment of loans is an inherent aspect
of commercial banking. The degree of perceived risk is taken into account in
establishing the structure of, interest rates on and security for specific
loans and for various types of loans. The Bank attempts to minimize its credit
risk exposure by using thorough loan application, credit review and approval
procedures. Lending officers of the Bank have been assigned lending authority
up to $10,000 on an unsecured basis. Two executive officers of the Bank have
lending authority up to $50,000. Loans which exceed $50,000 are submitted for
approval to the Bank's Loan Committee. The Bank's loan portfolio is
continually reviewed by loan officers, the President, and the Board of
Directors' Audit and Loan Committees. The performance of loans is evaluated on
the basis of a thorough review of each borrower's overall creditworthiness,
collateral, and other elements which in the judgment of officers and senior
management demonstrate the ability of the borrower to continue in business and
to meet the repayment terms of the loan(s). If subsequent events lead to a
reasonable doubt as to the repayment of a loan in accordance with the agreed
upon repayment terms, even though the financial condition of the borrower or
the collateral may ultimately be sufficient to reduce or satisfy the
obligation, the loan may be placed on a non-accrual basis pending sale of any
collateral or the determination that other sources of repayment exist. When a
loan is placed on a non-accrual basis, income recognition is discontinued. No
further interest income is recognized on such loans until a subsequent
determination removes doubt as to collectibility.
It is the current policy of the Bank to place loans which are unpaid 90
days past their maturity date, or loans which have principal or interest
payments 90 days past due, on a non-accrual status unless a determination is
made upon evaluation of the collateral or other circumstances indicate that the
Bank, as the case may be, will be able to recover all principal and accrued
interest.
31
<PAGE> 32
The following table summarizes nonperforming assets by (1) loans past
due 90 days or more and not on non-accrual, (2) loans accounted for on a
non-accrual basis and (3) real estate held for sale (dollars in thousands):
<TABLE>
<CAPTION>
December 31,
------------
1996 1995
------ ------
<S> <C> <C>
Accruing loans past due
90 days or more $210 $25
Non-accrual loans $1,424 $2,539
--------------------------
Total nonperforming loans $1,634 $2,564
Real estate held for sale $2,749 $4,409
--------------------------
Total nonperforming assets $4,383 $6,973
==========================
Nonperforming loans to total loans 2.37% 3.54%
Nonperforming assets to total assets 4.19% 5.70%
Allowance for loan losses to
nonperforming assets 28.75% 21.65%
Allowance for loan losses to nonperforming loans 77.11% 58.89%
</TABLE>
Non-performing loans, comprised of non-accrual loans and accruing loans
past due 90 days or more, decreased by 36.2% from December 31, 1995, and
represented 1.6% of total assets at December 31, 1996, as compared to 2.1% of
total assets at December 31, 1995. Non-performing loans represented 2.4% of
total loans for the year ended December 31, 1996 as compared to 3.5% for the
year ended December 31, 1995. The reduction in non-performing loans is the
result of management's continued efforts to address its problem loans and its
continued efforts to liquidate its nonperforming assets.
The amount of interest income foregone in 1996 and 1995 on non-accrual
loans was $135,000 and $108,000, respectively. The amount of interest actually
included in income in 1996 and 1995 on non-accrual loans was $51,000 and
$114,000, respectively.
32
<PAGE> 33
At December 31, 1996 and 1995, the Company's total recorded investment
in impaired loans was $3.7 million and $2.5 million, respectively. At December
31, 1996, $2.6 million of the $3.7 million in impaired loans, had a specific
allowance for loan losses in the amount of $0.5 million, and an additional $1.1
million of the recorded investment in impaired loans, at December 31, 1996,
for which there was no specific allowance for loan losses. The average
recorded investment in impaired loans for the years ended December 31, 1996
and 1995 were $1.7 million and $2.0 million, respectively. The related amount
of interest income recognized during the period on loans impaired was $0.1
million for the year 1996 and $0.1 million for the year ended 1995.
There were no loans at December 31, 1996 where the known credit problems
of a borrower caused the Bank or Business Credit to have serious doubts as to
the borrower's ability to comply with the present loan repayment terms and
which would result in such loan being included as a non-accrual, past due or
restructured loan at some future date. Neither the Bank or Business Credit has
any loans to borrowers outside the United States.
The Company had real estate held for sale of $2.7 million at December
31, 1996 as compared to $4.4 million at December 31, 1995. The Company is
carrying these properties at fair value, less estimated selling costs and less
a valuation allowance which amounted to $120,000 and $1,100,000 at December 31,
1996 and 1995, respectively. While management does not expect any substantial
additional losses on the sale of the remaining properties in excess of the
allowances already provided in the consolidated financial statements, no
assurance can be given that additional losses will not occur.
Summary of Loan Loss Experience
The Bank and Business Credit each maintain an allowance for loan losses,
which is reduced by net loan charge-offs and increased by the provision for
loan losses charged to operating expense. The amount of additions to the
provision for loan losses and the level of the allowance for loan losses are
based upon the Bank's and Business Credit's loan loss experience, the
performance of loans in the Bank's and Business Credit's respective
portfolios, evaluations of collateral for such loans, the prospects and
financial condition of the respective borrowers or guarantors, general economic
conditions, and such other factors as, in management's judgment, deserve
current recognition in the estimation of probable loan losses.
33
<PAGE> 34
The following table shows the allowance for loan losses, loans charged
off, recoveries on loans previously charged off, the amount of the provision
for loan losses charged to operating expense, the loans outstanding, and
certain pertinent ratios as of the dates indicated (dollars in thousands):
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
1996 1995
---- ----
<S> <C> <C>
Balance at beginning of period $1,510 $1,613
Less: allowance related to sold
Business Credit loans -- (550)
Loans charged-off:
Real estate
Construction (57) (47)
Mortgage (542) (166)
Commercial and industrial (560) (476)
Loans to individuals -- (26)
-----------------------
Total loans charged-off (1,159) (715)
Recoveries on loans charged-off 23 58
-----------------------
Net charge-offs (1,136) (657)
Provision for loan losses 886 1,104
-----------------------
Balance at end of period $1,260 $1,510
Total loans
Average $69,703 $82,503
At end of period (1) $68,889 $72,406
Ratios:
Net charge-offs
to average total loans 1.63% 0.80%
Allowance for loan losses
to total loans at end of period 1.83% 2.09%
Allowance for loan losses
as a % of nonperforming loans 77.11% 58.89%
</TABLE>
__________________
(1) Net of undisbursed loan funds and deferred fees and costs.
34
<PAGE> 35
An allocation of the allowance for loan losses to the major loan
categories has been made for the purposes of this report as set forth in the
following table (dollars in thousands). The allocations are estimates based
upon the same factors as considered by management in determining the amount of
additional provisions to the allowance for loan losses and the aggregate level
of the allowance for loan losses.
<TABLE>
<CAPTION>
December 31,
-------------
1996 1995
-------------------------- -------------------------
Percent Percent
of Loans of Loans
Allowance in each Allowance in each
for Loan Category to for Loan Category to
Losses Total Loans Losses Total Loans
------ ----------- ------ -----------
<S> <C> <C> <C> <C>
Real estate - construction
and development $159 8.6% $ 178 10.9%
Real estate - mortgage 612 22.1 806 24.4
Commercial and industrial 466 67.1 468 58.8
Loans to individuals 22 2.1 55 5.5
All other loans 1 0.1 3 0.4
---------------------------------------------------
Total $ 1,260 100.0% $ 1,510 100.0%
===================================================
</TABLE>
Management believes that the allowance for loan losses of $1.3 million
and $1.5 million or approximately 1.83% and 2.09% of total loans at December
31, 1996 and 1995 was adequate to absorb known and inherent risks in the loan
portfolio. Allowance for loan losses to nonperforming loans improved to 77.1%
at December 31, 1996, from 58.9% at December 31, 1995. No assurance can be
given, however, that economic conditions which may adversely affect the Bank's
or Business Credit's service areas or other circumstances will not be
reflected in increased losses in the Bank's or Business Credit's loan
portfolio. In addition, 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 recognize additions to the allowance or
to take charge-offs (reductions in the allowance) in anticipation of losses.
See "ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- Capital Resources."
While management believes it has adequately provided for losses and
does not expect any material loss on the above loans in excess of allowances
already recorded in the consolidated financial statements, no assurance can be
given that additional loans will not become delinquent or that the collateral
for such loans will be sufficient to prevent losses in the event of
foreclosure.
35
<PAGE> 36
The allowance for loan losses should not be interpreted as an
indication that charge-offs will occur in these amounts or proportions, or that
the allocation indicates future charge-off trends. Furthermore, the portion
allocated to each loan category is not the total amount available for future
losses that might occur within such categories, since, as previously stated,
the total allocation and provision is a general allocation and provision
applicable to the entire portfolio.
Asset/Liability Management and Liquidity
Asset/Liability Management
The Company's policy is to closely match its level of rate sensitive
assets and rate sensitive liabilities within a limited range thereby reducing
its exposure to interest rate fluctuations. In connection with the asset and
liability management objectives, various plans have been put into effect
including changes in the composition of assets and liabilities and the
initiation and emphasis on adjustable and floating rate loan programs to
achieve a closer match between assets and liabilities with various maturities
or repricing characteristics as considered desirable. Generally, when rate
sensitive assets exceed rate sensitive liabilities, the net interest margin is
expected to be positively impacted during periods of increasing interest rates
and negatively impacted during periods of decreasing interest rates, and
conversely when rate sensitive liabilities exceed rate sensitive assets, net
interest margin is expected to be negatively impacted during periods of
increasing interest rates and positively impacted during periods of decreasing
interest rates.
36
<PAGE> 37
The following table sets forth information concerning interest rate sensitivity
of the Company's consolidated interest earning assets and interest bearing
liabilities as of December 31, 1996 (dollars in thousands). Assets and
liabilities are classified by the earliest possible repricing date or maturity,
whichever comes first.
<TABLE>
<CAPTION>
Non-rate
Sensitive
Immediate Three Six &
Through Through Through Over
Three Six Twelve Twelve
Months Months Months Months Total
<S> <C> <C> <C> <C> <C>
Interest earning Assets
Cash equivalents $18,393 -- -- -- $18,393
Securities held to maturity 601 393 1,100 5,130 7,224
Loans receivable 52,159 1,125 3,253 12,352 68,889
------------------------------------------------------------
Total interest earning assets $71,153 $1,518 $4,353 $17,482 $94,506
Interest bearing liabilities
Interest-bearing deposits $60,135 $431 $2,089 990 63,645
------------------------------------------------------------
Total interest bearing liabilities $60,135 $431 $2,089 $990 $63,645
------------------------------------------------------------
Interest rate sensitivity gap $11,018 $1,087 $2,264 $16,492
======= ====== ====== =======
Cumulative interest rate sensitivity gap $11,018 $12,105 $14,369 $30,861
======= ======= ======= =======
</TABLE>
Liquidity
The Bank's Asset-Liability Management Committee manages a liquidity
position, the parameters of which are approved by the Board of Directors.
Liquidity is derived from both the asset and liability sides of the balance
sheet. While the Bank relies primarily on deposits for its source of funds,
the Bank had available $18.4 million of federal funds sold and a $7.2 million
investment portfolio at December 31, 1996, all of which could be used as
immediate sources of funds. In addition, the Bank has access to a $3.5 million
federal funds purchase line of credit from Community Bank, subject to
cancellation, which the Bank can use to meet short term needs. The Bank also
has access to funds through the Federal Reserve Bank discount window. The Bank
maintained at December 31, 1996 approximately 31% of its total assets in
liquid assets.
37
<PAGE> 38
The Committee members are the Chairman of the Board, the President,
who monitors loan funding needs; the Chief Financial Officer & Cashier, who
monitors sources of funds, and who carries out the instructions of the
Committee for securities and large denomination time deposit transactions; and
one outside member of the Board of Directors.
The Company relies on asset/liability management to accommodate
changes in loan demand and core deposit levels. A key aspect of
asset/liability management is liquidity, or the Company's ability to meet
possible deposit withdrawals, to provide for the credit needs of its customers
and to take advantage of investment opportunities as they arise.
Sources of liquidity include payment of dividends from its subsidiary
companies. Payment of dividends is subject to statutory and regulatory
limitations. As a result of past losses, at December 31, 1996, the Bank had no
retained earnings legally available for the payment of cash dividends. See Note
13 to the Consolidated Financial Statements.
The Company's most liquid assets are cash and cash equivalents and
its investment portfolio. The levels of these assets are dependent on the
Company's operating, financing and investing activities during any given
period. The liquidity needs of the Company, primarily relate to the Bank. The
liquidity needs of the Company at this time are minimal.
Investment Portfolio
The following table shows the carrying value of the Company's portfolio
of Securities held to maturity at December 31, 1996 and December 31, 1995
(dollars in thousands). Securities held to maturity are stated at cost,
adjusted for amortization of premiums and accretion of discounts.
<TABLE>
<CAPTION>
December 31,
------------
1996 1995
---- ----
<S> <C> <C>
Obligations of U.S. and U.S.
government agencies . . . . . . . . . . . . $6,814 $7,166
Non-taxable municipal bonds . . . . . . . . . 213 250
Interest-bearing deposits . . . . . . . . . . 197 198
------------------------
Total investment securities
held to maturity . . . . . . . . . $7,224 $7,614
========================
</TABLE>
38
<PAGE> 39
Maturity Distributions of Investment Portfolio
The following table shows the maturities of securities held to
maturity at December 31, 1996 and the weighted average yields of such
securities (dollars in thousands):
<TABLE>
<CAPTION>
Maturing
------------------------------------------------------------------------
After One After Five
Within But Before But Before
One Year Five Years Ten Years
-------------------- -------------------- --------------------
Weighted Weighted Weighted
Book Average Book Average Book Average
Value Yield(1) Value Yield(1) Value Yield(1)
----- -------- ----- -------- ----- --------
<S> <C> <C> <C> <C> <C> <C>
Obligations of U.S. and U.S.
government agencies $1,896 5.50% $4,417 5.94% $501 5.84%
Non-taxable municipal bonds -- -- 213 6.50% -- --
Interest-bearing deposits 197 5.89% -- -- -- --
------------------------------------------------------------------------
Total $2,093 5.70% $4,630 6.22% $501 5.84%
========================================================================
</TABLE>
- ------------------
(1) Weighted average yield is computed on a yearly basis and yields on
tax-exempt obligations are computed on a tax equivalent basis.
As of December 31, 1996, the Company held no securities held to
maturity of any issuer (other than securities issued by the U.S. and U.S.
government agencies) with an aggregate carrying value which exceeded 10% of
stockholders' equity.
Sources of Funds - Deposits
The average amounts of deposits, together with average rates paid
thereon, are summarized below (dollars in thousands):
<TABLE>
<CAPTION>
1996 1995
---- ----
Average Average Average Average
Balance Rate Paid Balance Rate Paid
------- --------- ------- ---------
<S> <C> <C> <C> <C>
Demand deposits $27,401 --% $30,360 --%
Savings deposits (1) 52,966 3.85 55,088 4.82
Money market accounts 6,324 1.50 7,823 1.76
Time deposits 7,416 4.71 7,623 4.33
------- ----- -------- -----
$94,107 3.35% $100,894 3.64%
======= ===== ======== =====
</TABLE>
- ------------------
(1) Includes NOW Accounts.
39
<PAGE> 40
Total average deposits decreased by 6.73% or $6.8 million at December
31, 1996 as compared to December 31, 1995. The decrease was primarily related
to normal fluctuations in Demand deposits, Savings deposits and Money market
accounts, as well as, decisions made by the Banks asset-liability committee.
The remaining maturities of the certificates of deposit $100,000 or more
at December 31, 1996 are as follows (dollars in thousands):
<TABLE>
<S> <C>
3 months or less $2,406
Over 3 through 6 months 430
Over 6 through 12 months 485
Over 12 months 399
------
Total $3,720
======
</TABLE>
The Banks primary sources of funds are deposits and principal and interest
payments on its loan and securities portfolios. While maturities and scheduled
amortization of loans and securities are, in general, a predictable source of
funds, deposit flows and loan prepayments are greatly influenced by general
interest rates, economic conditions and competition.
40
<PAGE> 41
The Company's liquidity position is monitored on a daily basis. Action
may be taken by any two members of the Committee to satisfy daily liquidity
requirements. Recognizing the cost of liquidity, the Bank maintains
approximately 20% of total assets in liquid assets. The remaining assets are
invested to yield higher rates of return with minimized market or credit risk.
Short-Term Borrowings
At December 31, 1996, the Company had no short-term borrowings
outstanding. At December 31, 1995, the Company had short-term borrowings in the
form of secured borrowings from financial institutions of $1.4 million. The
weighted average interest rate, during 1995, of such borrowings was
approximately 10.63%. Short-term borrowings from financial institutions
outstanding at December 31, 1995, were under a $1.5 million line of credit from
First Capital Corporation ("FCC") collateralized by the loan portfolio of
Business Credit. The loan agreement with FCC provided for interest to be
charged at the rate of 1-3/4% over the prime rate charged, from time to time,
by NatWest Bank N.A. ("NatWest") based on the daily outstanding loan balance
of Business Credit. NatWest's prime rate was 8.50% at December 31, 1995.
The line of credit matured September 7, 1996. Business Credit is continuing to
liquidate its remaining assets and does not have further need for a line of
credit.
Capital Resources
Management seeks to maintain a level of capital adequate to support
asset growth and credit risks and to ensure that the Company is within
established regulatory guidelines and industry standards. The Company and the
Bank are required to achieve risk-based capital standards and leverage capital
standards. The risk-based capital standards establish capital requirements
that are more sensitive to risk differences between various assets, consider
off balance sheet activities in assessing capital adequacy and minimize the
disincentive to holding liquid, low risk assets. The Company and the Bank are
required to achieve a minimum 8.0% total capital to risk-weighted assets ratio
(of which at least 4.0% must be Tier 1 capital consisting primarily of common
stock and retained earnings, less goodwill).
41
<PAGE> 42
The following table sets forth the capital ratios of the
Company and the Bank at December 31, 1996 (dollars in thousands).
<TABLE>
<CAPTION>
Company Bank
------- ----
Amount Ratio Amount Ratio
------ ----- ------ -----
<S> <C> <C> <C> <C>
Tier 1 capital $7,262 9.78% $7,500 10.18%
Tier 1 capital
minimum requirements 2,971 4.00% 2,947 4.00%
----- ------ ----- -----
Excess $4,291 5.78% 4,553 6.18%
Total capital $8,195 11.03% $8,425 11.44%
Total capital
minimum requirement 5,941 8.00% 5,894 8.00%
----- ----- ----- -----
Excess $2,254 3.03% $2,531 3.44%
Risk-weighted
-------------
assets $74,265 $73,670
Tier 1 capital $7,262 7.12% $7,500 7.47%
Tier 1 capital
minimum requirement 4,078 4.00%
----- -----
Memorandum requirement 6,781 6.75%
----- -----
Excess $3,184 3.12% 719 0.72%
Total average assets $101,950 $100,461
</TABLE>
_____________
The leverage ratio consists of tangible Tier 1 capital divided by total average
assets. As of December 31, 1996, the Company and the Bank had leverage ratios
of 7.12% and 7.47%, respectively. Regulators have established a minimum
leverage ratio of 4.0% for the highest rated banks. However, institutions
experiencing or anticipating significant growth, or those with other than
minimum risk profiles, will be expected to maintain capital well above the
minimum. The Company is required under the terms of the Memorandums' to
maintain a minimum leverage ratio of 6.75%.
42
<PAGE> 43
In the year 1995, the Board of Directors of the Company and the Bank
entered into memorandum' of understanding with the Federal Reserve Bank ("the
FRB Memorandum"), the FDIC ("FDIC Memorandum") and the State Banking
Department ("SBD Memorandum"). Under these Memorandums, the Company, among
other things, may not directly or indirectly, acquire or sell any interest in
any entity, line of business, problem loans or other assets, without the prior
written approval of the Federal Reserve Bank; and may not pay cash dividends
without the prior written consent of the Federal Reserve Bank. The Bank is
also required, among other things, to achieve and maintain Tier 1 capital equal
to or above 6.75% of total assets; establish and maintain an adequate allowance
for loan losses; and not pay cash dividends without the prior written consent
of the FDIC and the California Superintendent of Banks.
The Company and the Bank believe they are currently in full compliance, and
management believes that it can continue to comply with the terms of the FRB
Memorandum, the FDIC Memorandum and the SBD Memorandum, and otherwise meet
regulatory capital requirements, and that any actions taken to so comply in the
future will not have a material adverse effect on the Company's future
financial condition or results of operations. However, failure to comply with
any Memorandum could result in regulatory action.
The Company expects that future dividends will depend on continued
profitability and the maintenance of acceptable financial results.
Effects of Inflation
The financial statements and related data presented herein have been
prepared in accordance with generally accepted accounting principles which
require the measurement of financial position and operating results in terms of
historical dollars without considering changes in the relative purchasing power
of money over time due to inflation.
Virtually all of the assets and liabilities of a financial institution
are monetary in nature. As a result, interest rates have a more significant
impact on a financial institution's performance than the effects of general
levels of inflation.
43
<PAGE> 44
RESULTS OF OPERATIONS
Net Income (Loss)
The Company had net income of $0.3 million in 1996 compared with net
losses of $3.4 million in 1995 and $2.9 million in 1994. The improved results
for the period ending December 31, 1996 as compared to the same periods in 1995
and 1994, primarily relate to continued benefits from the reductions in
non-interest expenses and substantial reductions in salaries, and employee
benefits, real estate operations, other non-interest expenses and the
Company's discontinuance of its mortgage banking operations, in the fourth
quarter of 1994.
The primary reasons for the net loss in 1995 were the $2.1 million
charge, excluding income tax benefit, representing a settlement during 1995 of
a dispute over repurchase liability relating to mortgage loans originated by
BSC, whose operations were discontinued during the fourth quarter of 1994 (see
"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- Discontinued Operations and Note 5 to the Consolidated
Financial Statements"), losses of $2.7 million on the sale or writedown of
real estate held for sale, and loan loss provisions of $1.1 million at the
Bank. These losses more than offset the $1.5 million gain on the sale of assets
by Business Credit during 1995. Additionally, the Company did not take full
financial statement benefit for tax losses at the Bank because of uncertainty
as to whether such tax benefit would be realized in the future.
Net Interest Income
A significant component of the Compan's operations is net interest
income, which is the difference between interest and fees received on earning
assets and interest paid on deposits and other sources of funds. Net interest
income, when expressed as a percentage of average total interest earning
assets, is referred to as the net interest margin. The Company's net interest
income is affected by the change in the amount and mix of interest-earning
assets and interest-bearing liabilities. It is also affected by changes in
yields earned on interest-earning assets and rates paid on deposits and other
borrowed funds. Approximately 73% of the Bank's loan portfolio adjusts with
the prime rate.
44
<PAGE> 45
Analysis of Net Interest Income
Certain information concerning average interest-earning assets and
interest-bearing liabilities and yields earned and rates paid thereon is set
forth in the following table (dollars in thousands).
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
1996 1995
---- ----
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS:
- -----------------------
Taxable securities $7,197 $ 435 6.04% $6,933 $525 7.57%
Non-taxable securities(1) 308 17 5.52% 395 19 4.81%
Federal funds sold 14,925 786 5.27% 14,881 839 5.64%
Net loans(2) 69,743 7,552 10.83% 82,503 10,997 13.33%
------ ----- ------ ------ ------ ------
Total interest earning assets $92,173 8,790 9.54% $104,712 $12,380 11.82%
======= ===== ===== ======== ======= ======
INTEREST-BEARING LIABILITIES:
- ----------------------------
Savings deposits(3) 52,966 2,041 3.85% $55,088 $2,654 4.82%
Money market accounts 6,324 95 1.50% 7,823 138 1.76%
Time deposits 7,416 349 4.71% 7,623 330 4.33%
Notes payable 443 44 9.93% 10,216 1,086 10.63%
--- -- ----- ------ ----- ------
Total interest bearing liabilities $67,149 $2,529 3.77% $80,750 $4,208 5.21%
======= ====== ===== ======= ====== =====
Net interest income $6,261 $8,172
Net interest spread 5.77% 6.61%
Net interest margin(4) 6.79% 7.80%
</TABLE>
- --------------------
(1) Yield is computed on a tax equivalent basis assuming a 34% tax rate.
(2) The principal amount of nonaccrual loans is included in the average
balance of net loans but only the actual interest recognized during the
year is included in income/expense.
(3) Includes NOW Accounts.
(4) Net interest margin is net interest income divided by total average
interest-earning assets
45
<PAGE> 46
Analysis of Changes in Net Interest Income
The following table presents the dollar amount of changes in interest
income and interest expense for the major categories of interest-earning assets
and interest-bearing liabilities and the amount of change attributable to
changes in volumes and changes in interest rates for 1996 compared to 1995 and
1995 compared to 1994 (dollars in thousands). The change in interest income
due to both volume and yield/rate has been allocated to volume and yield/rate
changes in proportion to the relationship of the absolute dollar amounts of the
change in each.
<TABLE>
<CAPTION>
1996 vs. 1995 1995 vs. 1994
Increase (Decrease) Increase (Decrease)
Due to Changes in: Due to Changes in:
----------------- -----------------
Yield/ Net Yield/ Net
Volume Rate Change Volume Rate Change
------ ----- ------ ------ ----- ------
<S> <C> <C> <C> <C>
Income from Interest
earning assets:
Federal funds sold $2 $(55) $(53) $85 $214 $299
Taxable securities 20 (110) (90) (48) 71 23
Non-taxable securities(1) (5) 3 (2) (2) 3 1
Net loans (1,557) (1,888) (3,445) (797) 418 (379)
------- ------- ------- ----- --- -----
Total interest income (1,540) (2,050) (3,590) (762) 706 (56)
Expense on Interest
bearing liabilities:
Savings deposits(2) (99) (514) (613) 184 605 789
Money money accounts (24) (19) (43) (83) (10) (93)
Time deposits (9) 28 19 (483) 152 (331)
Notes payable (975) (67) (1,042) (201) 58 (143)
----- ---- ------- ----- -- -----
Total interest expense (1,106) (573) (1,679) (583) 805 222
------- ----- ------- ----- --- ---
Change in net interest income $(434) $(1,477) $(1,911) $(179) $(99) $(278)
====== ======== ======== ====== ===== ======
</TABLE>
____________________
(1) Computed on a tax equivalent basis.
(2) Includes NOW Accounts.
46
<PAGE> 47
Net interest income decreased $1.9 million or 23.4% for the period ended
December 31, 1996 as compared to the same period in 1995. The decrease in net
interest income was primarily a result of a $2.1 million reduction in interest
income due to lower yielding assets without a commensurate decrease in interest
rates payable on interest bearing liabilities. Average yield on loans
receivable decreased to 10.83% in 1996 from 13.33% in 1995 due principally to
the sale of the higher yielding Business Credit loans, during the third quarter
of 1995. Interest income also decreased in 1996 due in part to a decrease in
the average volume of interest earning assets of $12.5 million or 12.0% due to
the sale of such loans.
The reductions in interest income were partially offset by a $1.0
million reduction in interest paid on Notes payable and a $546,000 decrease in
interest expense as a result of lower average rates paid on interest-bearing
deposits. Average Notes payable decreased by $8.3 million or 95.8% during 1996
compared to 1995. During 1996, the Company paid off its Notes payable, which
represent short-term borrowings of the Company which were used to fund loans by
Business Credit.
Net interest income decreased by $278,000 or 3.3% for the year ended
December 31,1 995 compared to the year ended December 31, 1994 due primarily to
an increase in the average rate paid on interest bearing liabilities of 1.1%,
and a decrease in the average volume of interest earning assets of $10.7
million. In the fourth quarter of 1995, the Bank change the rate it pays on
"prime savings accounts" to the prime rate posted in the Wall Street Journal
less 4%; however, during most of 1995, the Bank paid the prime rate less 3.5%
on such deposits.
Provision for Loan Losses
The provision for loan losses is determined by management based upon the
Company's loan loss experience, the performance of loans in the Company's
portfolio, the quality of loans in the Company's portfolio, evaluation of
collateral for such loans, the economic conditions affecting collectibility of
loans, the prospects and financial condition of the respective borrowers or
guarantors and such other factors which in management's judgment deserve
recognition in the estimation of probable loan losses. In addition, 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
recognize additions to the allowance or to take charge-offs (reductions in the
allowance) in anticipation of losses.
A substantial portion of the Company's loan portfolio, including a
substantial portion of its commercial and industrial loans, is secured by real
estate collateral, substantially all of which is located in Southern
California. While in most cases the amount of the loan is less than 75% of the
appraised value of the property or the cost of the project, the Company has
suffered from the effects of the downturn in the real estate market and
continues to be vulnerable to further such downturns. See "ITEM 1. BUSINESS.
- -- Economic Environment".
47
<PAGE> 48
The Company recorded a loan loss provision in 1996 of $886,000, compared
to $1,104,000 in 1995 and $266,000 in 1994. The lower provision in 1996 is a
reflection of the $2.5 million or 37% reduction in nonperforming assets at
December 31, 1996 as compared to December 31, 1995. The 1995 provision was
higher than 1994 because of higher levels of non-performing loans, foreclosures
on defaulted loans and charge-offs. See "ITEM 7. MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Nonperforming
Assets and Summary of Loan Loss Experience."
Non-Interest Income
The following table sets forth information by category of non-interest
income for the Company for the past three years (dollars in thousands):
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Service charges on deposit
accounts $512 $319 $278
Gain on sale of SBA loans 11 133 69
Gain on sale of
Business Credit Assets -- 1,504 --
Other 1,106 518 578
----- --- ---
Total $1,629 $2,474 $925
====== ====== ====
</TABLE>
Non-interest income decreased to $1.6 million in 1996 from $2.5
million in 1995. Non-interest income for 1995 included a gain from the sale of
Business Credit assets. In addition the Bank continued to benefit from
increased service charges on deposit accounts during 1996. The increase in
other non-interest income during 1996 primarily related to approximately
$850,000 of income from (i) income recognized from the reversal of various
accrued liabilities which were deemed no longer necessary, and (ii) the
settlement of certain litigation.
The increase to $2.5 million in 1995 from $0.9 million in 1994 was
primarily a result of the gain on the sale of Business Credit assets. The
Company recorded a net gain of $1.5 million on the sale. See "RESULTS OF
OPERATIONS - Sale of Business Credit Assets". In addition, the Bank recorded
an increase in the origination of loans guaranteed by the SBA and an increase
in the gain on sale of such loans to $133,000 in 1995 from $69,000 in 1994.
48
<PAGE> 49
Sale of Business Credit Assets
During the third quarter of 1995, the Company sold substantially all
the assets of Business Credit. The sale of Business Credit assets was
initiated, in order to raise capital to meet and exceed capital requirements
previously imposed by regulators on the Bank, due to losses in the mortgage
banking subsidiary, and to take advantage of an opportunity to make a
substantial premium on the sale at this time in the market. Approximately
$15.2 million of Business Credit loans were sold to First Capital Corporation
in a transaction which resulted in a $1.5 million gain, after deducting
expenses relating to the transaction. The Company is continuing to pursue
liquidation of the remaining assets and expects to do so at the book value of
those assets.
Non-Interest Expense
Non-interest expense as a percentage of average total assets was 6.5%
in 1996, compared with 9.7% in 1995, and 8.3% in 1994. The reduction in
non-interest expense primarily relate to savings achieved through operating
efficiencies in salaries and employee benefits, real estate operations, net and
other non-interest expenses.
Non-interest expense decreased to $6.7 million in 1996 from $10.1
million in 1995 and $9.1 million in 1994. The reduction is directly related to
savings in salaries and employee benefits of $1.1 million or 27.2%, real
estate operations, net of $2.0 million or 72.2% and other non-interest expenses
of $0.3 million or 14.8% for the period ending December 31, 1996 as compared to
the same period in 1995. The savings achieved in salaries and employee benefits
during 1996, reflects the lower cost associated with the limited operations of
Business Credit, as well as continued downsizing in the Bank. Real estate
operations, net has continued to decline as a result of the Bank disposing of
its real estate held for sale and the elimination of costs associated with
maintaining those assets. Further, the Company and Bank has benefited from
lower cost expended on professional consulting and legal fees during 1996.
Non-interest expense increased to $10.1 million in 1995 from $9.1
million in 1994. The Company reduced assets through the sale of most of the
assets of Business Credit, and the Bank reduced assets by $10.1 million, which
was accompanied by reductions in employees, salaries, wages and employee
benefits. Occupancy costs were also reduced as the Bank experienced a full
year of the benefit of branch closures and relocations effected in 1994.
However, the $1.1 million increase in non-interest expense in 1995 was
primarily due to $2.7 million of expense for real estate operations, net, a
$1.3 million increase over 1994. In addition, during 1995 the Company incurred
writedowns and losses of $2.6 million on other real estate owned and expended
$75,000 for the maintenance and operation of such properties. During 1995 the
Company sold 10 foreclosed properties and held a valuation allowance on real
estate held for sale at December 31, 1995 of $1.1 million. The increase in
furniture and equipment costs resulted from the Bank's implementation of a
remote area network utilizing personal computers. The increase in other
non-interest expense was due to increases in professional, consulting and legal
expenses.
49
<PAGE> 50
Income Taxes
Income tax expense for 1996 amounted to $3,000 compared to $929,000 in
1995 and $17,000 in 1994. The large income tax provision in 1995 was related to
the substantial income from the sale of assets of Business Credit, which was
not offset by income tax benefits at the Bank because of uncertainty as to the
Bank's ability to realize such benefits in the future. The low tax expense for
1996 was due to the reduction in the valuation allowance for deferred tax
assets. For further discussion see Note 9 to the Consolidated Financial
Statements.
Discontinued Operations
As a result of continued losses from operations, higher interest rates
and the generally poor market for residential mortgage loans, the Company, in
the fourth quarter of 1994, discontinued its mortgage banking operations. The
Company recorded an after tax loss in 1994 from discontinued operations of $2.9
million, which was comprised of a $0.6 million loss from discontinuing the
mortgage banking operation, and $2.3 million in after tax losses incurred by
the mortgage banking operation prior to its closing. Included in the closure
charge and the loss in 1994 was an estimate for future repurchase liability.
During 1995, the Company significantly reduced its exposure to future
repurchase liability, by settling a dispute over repurchase liability relating
to mortgage loans originated by BSC. As a result of the settlement, an
additional $2.1 million charge, excluding income tax benefit, was incurred
representing substantially all of the loss from discontinued operations for
1995.
At December 31, 1996, the Company had outstanding repurchase requests
relating to loans with a principal balance of $0.6 million and requests from
investors to make them whole ("make wholes") for losses on loan foreclosures
and sale of the related real estate which are alleged to be $0.1 million. The
Company maintained an allowance for losses on loan repurchases which amounted
to $0.4 million at December 31, 1996 as compared to $0.8 million at December
31, 1995. This allowance is carried in other liabilities on the balance sheet.
In determining the amount of this allowance, the Company considered the
exposure of the Company to repurchases which takes into account the Company's
past experience with repurchases, the potential for future repurchases and the
losses thereon.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See Index to Financial Statements included at page F-2 of this Report
on Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
50
<PAGE> 51
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Except as hereinafter noted, the information concerning directors and
executive officers of the Company is incorporated by reference from the
Company's definitive Proxy Statement to be filed pursuant to Regulation 14A
within 120 days after the end of the last fiscal year. For information
concerning executive officers of the Company, see "ITEM 4(A). EXECUTIVE
OFFICERS OF REGISTRANT."
ITEM 11. EXECUTIVE COMPENSATION.
Information concerning executive compensation is incorporated by
reference from the Company's definitive Proxy Statement to be filed pursuant
to Regulation 14A within 120 days after the end of the last fiscal year.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Information concerning security ownership of certain beneficial owners
and management is incorporated by reference from the Company's definitive Proxy
Statement to be filed pursuant to Regulation 14A within 120 days after the end
of the last fiscal year.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information concerning certain relationships and related transactions
with management and others is incorporated by reference from the Company's
definitive Proxy Statement to be filed pursuant to Regulation 14A within 120
days after the end of the last fiscal year.
51
<PAGE> 52
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Financial Statements and Report. Reference is made to the Index to
Financial Statements at page F-2 for a list of financial statements filed as
part of this Report on Form 10-K. Financial Statement schedules have been
omitted either because they are not required or not applicable or the required
information is shown in the consolidated financial statements or related notes
thereto.
(b) Reports on Form 8-K. No reports on Form 8-K were filed during the fourth
quarter of 1996.
(c) Exhibits.
(1) Reference is made to the Index to Exhibits at page F-34 for a list of
exhibits filed as part of this Report on Form 10-K.
(2) Included among the Exhibits filed as part of this Report on Form 10-K are
the following Executive Compensation Plans and Arrangements:
1. 1982 Stock Option Plan, as amended -- Annual Report on Form
10-K for the fiscal year ended December 31, 1988, Exhibit 10.5.
2. Sterling Bancorporation Employee Stock Ownership Plan and Trust
-- Annual Report on Form 10-K for the fiscal year ended
December 31, 1986, Exhibit 10.6.
3. Amended and Restated Sterling Bancorporation Employee Stock
Ownership Plan and Trust -- Annual Report on Form 10-K for the
fiscal year ended December 31, 1995, Exhibit 10.6.1.
4. Employment Agreement, dated January 1, 1990, between the
Company and Allan Dalshaug -- Annual Report on Form 10-K for
the fiscal year ended December 31, 1990, Exhibit 10.19.
5. Amendment No. 1, effective September 30, 1990, to Employment
Agreement, dated January 1, 1990 between the Company and Allan
E. Dalshaug -- Annual Report on Form 10-K for the fiscal year
ended December 31, 1992, Exhibit 10.19.1.
6. Amendment No. 2, effective December 30, 1992, to Employment
Agreement, between the Company and Allan E. Dalshaug -- Annual
Report on Form 10-K for the fiscal year ended December 31,
1992, Exhibit 10.19.2.
7. Amendment No. 3, effective May 15, 1995, to Employment
Agreement between the Company and Allan E. Dalshaug -- Annual
Report on Form 10-K for the fiscal year ended December 31,
1995, Exhibit 10.19.3.
52
<PAGE> 53
8. Employment Agreement, dated March 21, 1996, between the Company
and Allan E. Dalshaug -- Annual Report on Form 10-K for the
fiscal year ended December 31, 1995, Exhibit 10.31.
9. Employment Agreement, dated January 1, 1994, between Sterling
Bank and Joseph Carona -- Annual Report on Form 10-K for the
fiscal year ended December 31, 1993, Exhibit 10.26.
53
<PAGE> 54
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized on the 28th day of
March, 1996.
STERLING WEST BANCORP
(Registrant)
By /s/ ALLAN E. DALSHAUG
----------------------------------
Allan E. Dalshaug,
Chairman of the Board and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
/s/ ALLAN E. DALSHAUG Chairman of the March 28, 1997
- --------------------- Board, President, Chief
Allan E. Dalshaug Executive Officer and
Director (Principal
Executive Officer)
/s/ JOSEPH C. CARONA Chief Financial March 21, 1997
- -------------------- Officer (Principal
Joseph C. Carona Financial and Accounting
Officer)
/s/ HOWARD M. BORRIS Director March 26, 1997
- --------------------
Howard M. Borris
</TABLE>
54
<PAGE> 55
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
/s/ AUDREY J. FIMPLER Director March 25, 1997
- ------------------------
Audrey J. Fimpler
/s/ ROBERT J. SCHILLER Director March 25, 1997
- ------------------------
Robert J. Schiller
/s/ MICHAEL WAGNER Director March 28, 1997
- ------------------------
Michael Wagner
</TABLE>
55
<PAGE> 56
REPORT ON CONSOLIDATED
FINANCIAL STATEMENTS
STERLING WEST BANCORP AND SUBSIDIARIES
December 31, 1996, 1995 and 1994
<PAGE> 57
INDEX
FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of KPMG Peat Marwick LLP, Independent Auditors ................ F-3
Consolidated balance sheets as of December 31, 1996 and 1995.......... F-4
Consolidated statements of operations for the years ended December
31, 1996, 1995, and 1994.............................................. F-5
Consolidated statements of stockholders' equity for the years ended
December 31, 1996, 1995, and 1994..................................... F-6
Consolidated statements of cash flows for the years ended December
31, 1996, 1995, and 1994.............................................. F-7
Notes to consolidated financial statements............................ F-8
</TABLE>
F-2
<PAGE> 58
Independent Auditors' Report
The Board of Directors
Sterling West Bancorp:
We have audited the accompanying consolidated balance sheets of Sterling West
Bancorp and subsidiaries (the Company) as of December 31, 1996 and 1995 and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the years in the three-year period ended December 31, 1996.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatements. 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 Sterling West
Bancorp and subsidiaries as of December 31, 1996 and 1995, and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 1996, in conformity with generally accepted accounting
principles.
/s/ KPMG PEAT MARWICK LLP
Los Angeles, California
February 14, 1997
F-3
<PAGE> 59
Sterling West Bankkcorp and subsidiaries
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
==============================
1996 1995
------------------------------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 5,929,000 $ 12,072,000
Federal funds sold 18,393,000 24,000,000
Securities held to maturity
(fair value of $7,204,000 at December 31, 1996 and
$7,664,000 at December 31, 1995) (Note 3) 7,224,000 7,614,000
Loans receivable, net (Notes 4 and 7) 67,629,000 70,896,000
Real estate held for sale (Note 6) 2,749,000 4,409,000
Fixed assets
Land and building 243,000 227,000
Furniture and equipment 3,088,000 2,972,000
Leasehold improvements 1,408,000 1,411,000
------------- -------------
Less accumulated depreciation 4,739,000 4,610,000
(3,583,000) (3,395,000)
------------- -------------
1,156,000 1,215,000
Accrued interest receivable 589,000 725,000
Other assets (Note 9) 892,000 858,000
Assets of discontinued operations (Note 5) -- 630,000
============= =============
$ 104,561,000 $ 122,419,000
============= =============
LIABILITIES
Deposits
Demand $ 32,541,000 $ 37,598,000
Savings and NOW 50,786,000 61,316,000
Money market 5,778,000 6,990,000
Time deposits $100,000 or greater 3,720,000 3,281,000
Other time deposits 3,361,000 3,191,000
------------- -------------
96,186,000 112,376,000
Notes payable (Note 8) -- 1,372,000
Other liabilities (Note 5) 1,114,000 1,753,000
------------- -------------
97,300,000 115,501,000
Commitments and contingencies (Note 4, 10 and 11)
STOCKHOLDERS' EQUITY (Note 13)
Common stock - authorized 5,000,000
shares without par value; issued and
outstanding 1,710,214 shares in 1996 and 1995 8,686,000 8,686,000
Accumulated deficit (1,425,000) (1,768,000)
------------- -------------
7,261,000 6,918,000
------------- -------------
$ 104,561,000 $ 122,419,000
============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 60
Sterling West Bancorp and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the years ended December 31,
------------------------------------------
1996 1995 1994
----------- ------------ ------------
<S> <C> <C> <C>
Interest income
Loans $ 7,552,000 $ 10,997,000 $ 11,376,000
Federal funds sold 786,000 839,000 540,000
Securities held to maturity (Note 3) 452,000 544,000 520,000
------------------------------------------
8,790,000 12,380,000 12,436,000
Interest expense
Savings and NOW 2,041,000 2,654,000 1,865,000
Money market 95,000 138,000 231,000
Time deposits $100,000 or greater 237,000 165,000 443,000
Other time deposits 112,000 165,000 218,000
Notes payable 44,000 1,086,000 1,229,000
----------- ------------ ------------
2,529,000 4,208,000 3,986,000
----------- ------------ ------------
Net interest income 6,261,000 8,172,000 8,450,000
Provisions for loan losses (Note 4) 886,000 1,104,000 266,000
----------- ------------ ------------
Net interest income after provisions for loan losses 5,375,000 7,068,000 8,184,000
Non-interest income
Service charges on deposit accounts 512,000 319,000 278,000
Gain on sale of SBA loans 11,000 133,000 69,000
Gain on sale of Business Credit assets -- 1,504,000 --
Other (Note 14) 1,106,000 518,000 578,000
----------- ------------ ------------
1,629,000 2,474,000 925,000
Non-interest expenses
Salaries, wages and employee benefits 2,850,000 3,914,000 4,374,000
Occupancy (Note 15) 830,000 841,000 943,000
Furniture and equipment 251,000 343,000 224,000
Real estate operations, net (Note 6) 756,000 2,717,000 1,311,000
Other (Note 14) 1,971,000 2,313,000 2,211,000
----------- ------------ ------------
6,658,000 10,128,000 9,063,000
Income (loss) from continuing operations
before income taxes 346,000 (586,000) 46,000
Income tax provision (Note 9) 3,000 929,000 17,000
----------- ------------ ------------
Income (loss) from continuing operations 343,000 (1,515,000) 29,000
Loss from discontinued operations, net of taxes (Note 5) -- (1,924,000) (2,904,000)
------------------------------------------
NET INCOME (LOSS) $ 343,000 $ (3,439,000) $ (2,875,000)
==========================================
Income (loss) per common share:
From continuing operations $ 0.20 $ (0.89) $ 0.02
From discontinued operations -- (1.12) (1.70)
------------------------------------------
Net income (loss) per share $ 0.20 $ (2.01) ($ 1.68)
==========================================
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE> 61
Sterling West Bancorp and Subsidiaries
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Three years ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
Retained
earnings
(accumulated
Shares Common deficit),
outstanding Stock restricted Total
----------- ----- ---------- -----
<S> <C> <C> <C> <C>
Balance at January 1, 1994 1,710,214 $8,686,000 $ 4,546,000 $ 13,232,000
Net loss -- -- (2,875,000) (2,875,000)
-------------------------------------------------------------
Balance at December 31, 1994 1,710,214 8,686,000 1,671,000 10,357,000
Net loss -- -- (3,439,000) (3,439,000)
-------------------------------------------------------------
Balance at December 31, 1995 1,710,214 8,686,000 (1,768,000) 6,918,000
Net income -- -- 343,000 343,000
Balance at December 31, 1996 1,710,214 $8,686,000 $(1,425,000) $ 7,261,000
=============================================================
</TABLE>
See accompanying notes to consolidated financial statements.
F6
<PAGE> 62
Sterling West Bancorp and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the years ended December 31,
--------------------------------------------------
1996 1995 1994
------------ ------------ ------------
<S> <C> <C> <C>
Cashflows from operating activities
Net Income (loss) $ 343,000 $ (3,439,000) $ (2,875,000)
Adjustments to reconcile net loss to
net cash provided by operating activities:
Depreciation and amortization 270,000 305,000 237,000
Provision for loan losses 886,000 1,104,000 266,000
Provision for deferred taxes -- 655,000 508,000
Provision for real estate held for sale 193,000 2,424,000 1,090,000
Decrease in accrued interest receivable 136,000 229,000 (79,000)
Decrease (increase) in other assets (34,000) 41,000 (213,000)
Decrease in assets of discontinued operations 630,000 3,541,000 14,247,000
Decrease in other liabilities (639,000) (1,611,000) (1,131,000)
------------ ------------ ------------
Total adjustments 1,442,000 6,636,000 14,925,000
------------ ------------ ------------
Net cash provided by operating activities 1,785,000 3,197,000 12,050,000
------------ ------------ ------------
Cashflows from investing activities
Proceeds from maturities of securities 1,948,000 4,675,000 8,799,000
Purchase of securities (1,558,000) (5,313,000) (2,149,000)
Net (increase) decrease in loans receivable (328,000) 18,916,000 (1,982,000)
Proceeds from sale of real estate 4,175,000 1,150,000 2,726,000
Payments on real estate repurchased
from investors -- (1,629,000) (1,048,000)
Purchase of (proceeds from sale) fixed assets (211,000) (347,000) 88,000
------------ ------------ ------------
Net cash provided by investing activities 4,026,000 17,452,000 20,970,000
------------ ------------ ------------
Cash flows from financing activities
Net increase (decrease) in demand deposits,
savings and other money market accounts (16,798,000) 6,972,000 14,421,000
Net increase (decrease) in time deposit 609,000 (1,468,000) (30,061,000)
Net increase (decrease) in note payable (1,372,000) (9,034,000) 172,000
Proceeds from Issuance of commercial paper -- -- 88,000
Payments on maturing promissory notes -- (1,493,000) (1,142,000)
--------------------------------------------------
Net cash used in financing activities (17,561,000) (5,023,000) (16,522,000)
------------ ------------ ------------
Net (decrease) increase in cash and cash equivalents (11,750,000) 15,626,000 1,962,000
------------ ------------ ------------
Cash and cash equivalents at beginning of period 36,072,000 20,446,000 18,484,000
------------ ------------ ------------
Cash and cash equivalents at end of period $ 24,322,000 $ 36,072,000 $ 20,446,000
==================================================
</TABLE>
See accompanying notes to consolidated financial statements.
F-8
<PAGE> 63
Sterling West Bancorp and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996 and 1995
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
Sterling West Bancorp (the Company) is a bank holding company organized as a
California corporation in 1982. It is the parent company for its wholly owned
subsidiaries, Sterling Bank (Bank), and the Bank's wholly owned subsidiary BSC
Mortgage Corporation (BSC); and Sterling Business Credit, Inc. (Business
Credit). Through its subsidiaries the Company continues to conduct banking and
commercial finance business in the state of California. During the fourth
quarter of 1994 the Company discontinued its mortgage banking operation
substantially all of which were performed by BSC. During the third quarter of
1995 the Company sold most of the assets of Business Credit.
Principles of consolidation
The consolidated financial statements include the accounts of Sterling West
Bancorp and its wholly-owned subsidiaries. All material intercompany balances
and transactions have been eliminated in consolidation. In preparing the
consolidated financial statements, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
revenues and expenses. Actual results could differ from those estimates. Certain
reclassifications have been made to the consolidated financial statements for
1995 and 1994 to conform to the 1996 presentation.
Material estimates that are particularly susceptible to significant change in
the near-term relate to the determination of the allowance for loan losses, the
valuation of real estate and the valuation of deferred tax assets. Management
believes that the allowances established for losses on loans and real estate are
adequate. While management uses available information to recognize losses on
loans and real estate, future additions to the allowances may be necessary based
on changes in economic conditions. In addition, various regulatory agencies, as
an integral part of their examination process, periodically review the Company's
allowances for losses on loans and real estate. Such agencies may require the
Company to recognize additions to allowances based on their judgments about
information available to them at the time of their examination.
The Company is required to carry its real estate owned at fair value. Fair value
estimates for real estate owned is determined by current appraisals and, where
no active market exists for a particular property, discounting a forecast of
expected cash flows at a rate commensurate with the risk involved.
Cash equivalents
Cash and cash equivalents include cash and due from banks and federal funds
sold. Generally, federal funds are purchased and sold for a one-day period. For
purposes of the Statements of cash flows, the Company considers all highly
liquid debt instruments with original maturities of three months or less to be
cash equivalents.
F-8
<PAGE> 64
Sterling West Bancorp and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996 and 1995
NOTE 1- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Securities held to maturity
Securities held to maturity are stated at cost, adjusted for amortization of
premiums and accretion of discounts. The amortization and accretion is based on
a method which approximates the interest method. Such amortization and accretion
are reflected in interest income on securities held to maturity in the
accompanying consolidated statements of operations. The carrying value of these
assets is not adjusted for temporary declines in fair value since the Company
intends and has the ability to hold them to their maturity. To the extent that
there is a decline in fair value which is other than temporary, the security
shall be written down to fair value with a charge to earnings for the difference
between such value and amortized cost.
Interest and fees on loans
Interest income is accrued daily as earned on all loans. Interest income is not
recognized on loans if collection of the interest is deemed by management to be
unlikely. Loans are generally placed on non accrual status after being
delinquent 90 days. Loan origination, commitment and other fees and direct costs
associated with the origination of loans are deferred and amortized into
interest income over the lives of the respective loans using a method which
approximates the interest method.
Provision and allowance for loan losses
The determination of the allowance for loan losses is based on analysis of the
loan portfolio and reflects an amount which, in management's judgment, is
adequate to provide for probable and estimable loan losses after giving
consideration to the character of the loan portfolio, current economic
conditions, past loan loss experience, geographic and industry concentration,
delinquency trends and such other factors as deserve current recognition in
estimating loan losses. While management uses available information to recognize
loan losses, future additions to the allowance may be necessary based on changes
in the aforementioned factors. Regulatory agencies, as an internal part of their
examination process, periodically review the Bank's allowance for loan losses.
Such agencies may require the Bank to recognize additions to the allowance or to
take charge-offs in anticipation of losses.
Effective January 1, 1995, the Company adopted Statement of Financial Accounting
Standards No. 114, "Accounting by Creditors for Impairment of a Loan", as
amended in October 1995 by Statement of Financial Accounting Standards No. 118,
"Accounting by Creditors for Impairment of a Loan-Income Recognition and
Disclosures". A loan is impaired when, based on current circumstances and
events, a creditor will be unable to collect all amounts contractually due (both
principal and interest) under a loan agreement. Loans are evaluated for
impairment as part of the Company's normal internal assets review process.
F-9
<PAGE> 65
Sterling West Bancorp and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996 and 1995
NOTE 1- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
When a loan is determined to be impaired, a writedown is taken or an allowance
is established which is based upon the difference between the investment in the
loan and one of the following methodologies as prescribed by SFAS 114: (I) the
present value of expected cash flows from the loan discounted at the loan's
effective interest rate, (ii) an observable market price, or (iii) the fair
value of the loan's underlying collateral. While the measurement of impairment
depends upon the specific facts and circumstances involving each applicable
loan, the Company generally measures such impairment utilizing the latter
methodology. Impaired loans which are performing under the contractual terms are
reported as performing loans, and cash payments are allocated to principal and
interest in accordance with the terms of the loan.
Loan sales
The Company periodically sells the guaranteed portion of Small Business
Administration (SBA) loans and other loans that if originates. The gain recorded
approximates the gain that would be recorded using the guidance of the Emerging
Issues Task Force Consensus (EITF) 88-11, "Allocation of Recorded Investment
When a Loan or Part of a Loan is Sold."
Impairment of Long-Lived Assets
The Company adopted the provisions of SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, on
January 1, 1996. This Statement requires that long-lived assets and certain
identifiable intangibles be reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceed the fair value of the assets. Assets to be disposed
of are reported at the lower of the carrying amount or fair value less costs to
sell. The adoption of this Statement had no impact upon the financial condition
or results of operations of the Company.
Current Accounting Pronouncements
In June 1996, the Financial Accounting Standards Board issued SFAS No. 125,
Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities. SFAS No. 125 is effective for transfers and servicing of
financial assets and extinguishments of liabilities occurring after December 31,
1996 and is to be applied prospectively. This Statement provides accounting and
reporting standards for transfers and servicing of financial assets and
extinguishments of liabilities based on consistent application of a
financial-components approach that focuses on control. It distinguishes
transfers of financial assets that are sales from transfers that are secured
borrowings. Management of the Company does not expect that adoption of SFAS No.
125 will have a material impact on the Company's financial position, results of
operations, or liquidity.
Fixed assets
Depreciation is provided in amounts sufficient to relate the cost of depreciable
assets to operations over their estimated useful lives. Leasehold improvements
are amortized over the lives of the respective leases or the service lives of
the improvements, whichever is shorter. The straight-line method of depreciation
is used.
F-10
<PAGE> 66
Sterling West Bancorp and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996 and 1995
NOTE 1- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Real estate held for sale
Real estate acquired through foreclosure is initially recorded at estimated fair
value less estimated selling costs. Fair value is generally estimated based on
the most recent appraisal received by the Company and adjusted for known trends
in local markets. Subsequent declines in fair value are charged to income, along
with the estimated costs to sell, and are recorded in a valuation allowance.
Subsequent increases in fair value are only recognized to the extent that
decreases in fair value were recorded through the valuation allowance. Operating
expenses for REO, REO writedowns, and gains and losses on sale of REO are
reported in the statement of operations as real estate operations expense.
Income taxes
The Company files consolidated Federal and combined state income tax returns.
The Company accounts for income taxes under the asset and liability method. This
method requires that deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases and operating loss and tax credit carryforwards. Deferred
tax assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period the
change is enacted.
Restricted cash balances
Aggregate reserves in the form of deposits with the Federal Reserve Bank of
approximately $224,000 were maintained to satisfy federal regulatory
requirements at December 31, 1996.
NOTE 2- SUPPLEMENTAL CASH FLOW INFORMATION
<TABLE>
<CAPTION>
Years ended December 31,
1996 1995 1994
------------- ------------- -------------
<S> <C> <C> <C>
Cash paid during the year for
Interest $ 2,511,000 $4,131,000 $3,686,000
Income taxes (refunds received) $ (522,285) -- --
Non-cash investing and
financing activities:
Real estate acquired
through foreclosure 2,054,000 4,309,000 6,701,000
Loans to facilitate
disposition of real estate 1,418,000 954,000 2,246,000
</TABLE>
F-11
<PAGE> 67
Sterling West Bancorp and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3- SECURITIES HELD TO MATURITY
Securities held to maturity at December 31 are as follows:
<TABLE>
<CAPTION>
1996
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ---------- ----------
<S> <C> <C> <C>
Obligations of U.S. and U.S.
government agencies $6,814,000 -- $ 20,000 $6,794,000
Non-taxable municipal bonds 213,000 -- -- 213,000
Interest-bearing deposit 197,000 -- -- 197,000
---------- ---------- ---------- ----------
$7,224,000 -- $ 20,000 $7,204,000
========== ========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
1995
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ---------- ----------
<S> <C> <C> <C>
Obligations of U.S. and U.S.
government agencies $7,166,000 $50,000 -- $7,216,000
Non-taxable municipal bonds 250,000 -- -- 250,000
Interest-bearing deposit 198,000 -- -- 198,000
---------- ------- ---------- ----------
$7,614,000 $50,000 -- $7,664,000
========== ======= ========== ==========
</TABLE>
Taxable interest income on securities held to maturity totaled $435,000,
$525,000 and $502,000 for the years ended December 31, 1996, 1995 and 1994,
respectively. Non-taxable interest income on securities held to maturity totaled
$17,000, $19,000 and $18,000 for the years ended December 31, 1996, 1995, 1994,
respectively.
F-12
<PAGE> 68
Sterling West Bancorp and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3- SECURITIES HELD TO MATURITY (Continued)
Maturities of securities held to maturity at December 31, 1996 were as follows:
(dollars in thousands)
<TABLE>
<CAPTION>
Within one year After one year but After five years but
before five years before ten years
------------------- ------------------- --------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
--------- ------ --------- ------ --------- -------
<S> <C> <C> <C> <C> <C> <C>
Obligations of U.S. and
U.S. government
agencies $1,896 $1,900 $4,417 $4,405 $501 $489
Non-taxable municipal
bonds -- -- 213 213 -- --
Interest -bearing deposit 197 197 -- -- -- --
------ ------ ------ ------ ---- ----
$2,093 $2,097 $4,630 $4,618 $501 $489
====== ====== ====== ====== ==== ====
</TABLE>
NOTE 4- LOANS RECEIVABLE, NET
The composition of the Company's loan portfolio at December 31, is as follows:
<TABLE>
<CAPTION>
1996 1995
----------- -----------
<S> <C> <C>
Real estate loans
Construction and development $ 6,865,000 $11,639,000
Mortgage 15,234,000 18,033,000
Commercial and industrial 50,564,000 48,735,000
Loan to individuals 2,435,000 3,971,000
All other loans 556,000 419,000
----------- -----------
Less: 75,654,000 82,797,000
Undisbursed loan funds 6,765,000 10,391,000
Allowance for loan losses 1,260,000 1,510.,000
----------- -----------
$67,629,000 $70,896,000
=========== ===========
</TABLE>
F-13
<PAGE> 69
Sterling West Bancorp and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4- LOANS RECEIVABLE, NET (continued)
The unamortized balance of deferred loan origination, commitment and other fees
(net of related direct lending costs), totaling $352,000 and $452,000 as of
December 31, 1996 and 1995, are treated above as a reduction of the applicable
loan balances.
The balance of loans on non-accrual was approximately $1,424,000 and $2,539,000
at December 31, 1996 and 1995, respectively. Interest income foregone on
non-accrual loans approximated $135,000 in 1996, $108,000 in 1995 and $232,000
in 1994. Interest income recognized on non-accrual loans was approximately
$51,000 in 1996, $114,000 in 1995 and $10,000 in 1994.
At December 31, 1996 and 1995, the Company's total recorded investment in
impaired loans was $3.7 million and $2.5 million, respectively. At December 31,
1996, $2.6 million of the $3.7 million in impaired loans, had a specific
allowance for loan losses in the amount of $0.5 million, and an additional $1.1
million of the recorded investment in impaired loans, at December 31, 1996, for
which there was no specific allowance for loan losses. The average recorded
investment in impaired loans for the years ended December 31, 1996 and 1995 were
$1.7 million and $2.0 million, respectively. The related amount of interest
income recognized during the period that such loans were impaired was $0.1
million for the year 1996 and $0.1 million for the year ended 1995.
Activity in the allowance for loan losses is summarized as follows:
<TABLE>
<CAPTION>
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Balance at beginning of year $ 1,510,000 $ 1,613,000 $ 1,899,000
Provision 886,000 1,104,000 266,000
Sale of Business Credit loans -- (550,000) - -
Charge offs (1,159,000) (715,000) (567,000)
Recoveries 23,000 58,000 15,000
----------- ----------- -----------
Balances at end of year $ 1,260,000 $ 1,510,000 $ 1,613,000
=========== =========== ===========
</TABLE>
The Company is party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit and standby letters
of credit. Those instruments involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the consolidated
balance sheets. The contract or notional amounts of those instruments reflect
the extent of involvement the Company has in particular classes of financial
instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit is
represented by the contractual notional amounts of those instruments. The
Company uses the same credit policies in making commitments and conditional
obligations as it does for on-balance sheet instruments. The contract or
notional amounts of forward contacts do not represent exposure to credit loss.
Commitments to extend credit at December 31, 1996 primarily consisting of
undisbursed loan commitments were $8,181,000.
F-14
<PAGE> 70
Sterling West Bancorp and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4- LOANS RECEIVABLE, NET (continued)
Standby letters of credit at December 31, 1996 totaled approximately $255,000,
of which $41,000 were unsecured and $214,000 were collateralized. Standby
letters of credit are conditional commitments issued by the Company to guarantee
the performance of a customer to a third party. Those guarantees are primarily
issued to support private borrowing arrangements. The credit risk involved in
issuing letters of credit is essentially the same as that involved in extending
loan facilities to customers. Where appropriate, cash or other security support
is held as collateral.
The Company grants real estate, commercial and industrial loans to customers
located within Southern California. Although the Company has a diversified loan
portfolio, a substantial portion of its debtors' ability to honor their
contracts is dependent upon the real estate development and construction market
sector and general economic conditions within Southern California.
NOTE 5- DISCONTINUED OPERATIONS
As a result of continued losses from operations, higher interest rates and the
generally poor market for residential mortgage loans, the Company, in the fourth
quarter of 1994, discontinued its mortgage banking operations which were
primarily carried out by its wholly owned subsidiary, BSC. All revenues and
expenses, net of income tax effect, attributable to mortgage banking operations
are included in the accompanying statements of operations under the caption
"Loss from discontinued operations". Assets related to mortgage banking
operations are presented in the accompanying balance sheets as "Assets of
discontinued operations".
As a result of the discontinuation of its mortgage banking operations, the
Company recorded an after tax loss relating to that closure in the fourth
quarter of 1994 of $ 0.6 million in addition to the after tax loss incurred by
the mortgage banking operations for the year 1994 of $2.3 million. During 1995,
the Company settled a dispute over a repurchase liability relating to mortgage
loans originated by BSC. As a result of this settlement the Company
significantly reduced its exposure to future repurchase liability, however, an
additional $2.1 million charge, excluding income tax benefit, was incurred,
representing substantially all of the loss from discontinued operations for
1995. Except where indicated, footnote disclosures relate solely to continuing
operations.
Selected financial data for the discontinued mortgage banking operations are as
follows:
<TABLE>
<CAPTION>
1995 1994
-------- -------
<S> <C> <C>
Gain on sale of mortgage loans $ (3) $ 1,995
Service fee income, net (7) 206
Net interest income (120) 208
Other income 42 175
------- -------
(88) 2,584
Salaries, wages and benefits - - 2,763
Real estate operations, net 12 2,394
Other expenses 2,108 2,068
------- -------
2,120 7,225
------- -------
Loss before taxes (2,208) (4,641)
Income tax benefit (284) (1,737)
------- -------
Net loss $(1,924) $(2,904)
======= =======
</TABLE>
F-15
<PAGE> 71
Sterling West Bancorp and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - DISCONTINUED OPERATIONS (continued)
Assets of discontinued operations at December 31, 1995 consisted primarily of a
receivable of $0.2 million related to the transfer of servicing in the fourth
quarter of 1995 and tax receivable of $0.3 million as a result of the losses
incurred by the mortgage banking operation. Included in other liabilities in the
accompanying balance sheets for 1996 and 1995, respectively is a $0.4 million
and $0.8 million allowance for losses on loan repurchases. In determining the
amount of this allowance the Company considered its past experience with
repurchases, the potential for further repurchases and the related losses. While
management believes that the balance of this allowance at December 31, 1996 is
adequate to provide for exposure to losses on loan repurchases, future additions
to the allowance may be necessary as a result of changes in the aforementioned
factors. BSC made no material contribution to the financial results for the year
ended December 31, 1996.
NOTE 6 - REAL ESTATE HELD FOR SALE
Real estate held for sale at December 31, is as follows:
<TABLE>
<CAPTION>
1996 1995
----------- -----------
<S> <C> <C>
Acquired through foreclosure $ 2,869,000 $ 5,509,000
Valuation allowance (120,000) (1,100,000)
----------- -----------
$ 2,749,000 $ 4,409,000
=========== ===========
</TABLE>
For the years ended December 31, 1996, 1995, 1994, real estate operations, net
was comprised of the following:
<TABLE>
<CAPTION>
1996 1995 1994
--------- ----------- -----------
<S> <C> <C> <C>
Net loss on sale of real estate $(196,000) $ (17,000) --
Provision for losses (193,000) (2,424,000) $(1,090,000)
Other valuation adjustments
charged to operations -- (201,000) (136,000)
Other holding costs (367,000) (75,000) (85,000)
--------- ----------- -----------
Real estate operations, net $(756,000) $(2,717,000) $(1,311,000)
========= =========== ===========
</TABLE>
Activity in the allowance for real estate losses is a follows:
<TABLE>
<CAPTION>
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Balance at beginning of year $ 1,100,000 $ 218,000 $ 400,000
Provision for losses 193,000 2,424,000 1,090,000
Charge offs (1,173,000) (1,542,000) (1,272,000)
----------- ----------- -----------
Balance at end of year $ 120,000 $ 1,100,000 $ 218,000
=========== =========== ===========
</TABLE>
F-16
<PAGE> 72
Sterling West Bancorp and Subsidiaries
NOTE TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 - RELATED PARTY TRANSACTIONS
In the ordinary course of business, the Bank has granted loans to certain
officers, directors and the companies with which they are associated. In
management's opinion such loans are within applicable regulatory bank lending
limitations. The following is an analysis of the activity of all such loans
during 1996 and 1995:
<TABLE>
<CAPTION>
1996 1995
----------- -----------
<S> <C> <C>
Balance at beginning of year $ 2,225,000 $ 2,186,000
New loans granted, including renewals 4,000 321,000
Repayments (499,000) (282,000)
----------- -----------
Balance at end of year $ 1,730,000 $ 2,225,000
=========== ===========
</TABLE>
NOTE 8 - NOTES PAYABLE
Notes payable at December 31, are comprised of the following:
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Notes payable to financial institutions -- $ 1,372,000
============================
</TABLE>
Notes payable to financial institutions at December 31, 1995 represent draws on
a $1.5 million line of credit secured by the finance receivable portfolio of
Business Credit of approximately $ 2.9 million at December 31, 1995. Interest is
payable monthly at the rate of NatWest Bank prime plus 1.75% (prime of 8.5% at
December 31, 1995). The line matured on September 7, 1996.
The maximum amounts of short-term borrowings at any month end during 1996 and
1995 were $0.4 million and $12.5 million, respectively. The average amounts
outstanding during 1996 and 1995 were $0.4 million and $10.2 million,
respectively, and the weighted average interest rates thereon during 1996 and
1995 were 9.93% and 10.63%, respectively.
F-17
<PAGE> 73
Sterling West Bancorp and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 - INCOME TAXES
The provision for income taxes from continuing operations is a follows:
<TABLE>
<CAPTION>
1996 1995 1994
--------- ----------- ---------
<S> <C> <C> <C>
Current
Federal -- $ (927,000) $(244,000)
State $ 3,000 -- (247,000)
--------- ----------- ---------
$ 3,000 (927,000) (491,000)
Deferred
Federal 131,000 655,000 226,000
State 181,000 -- 282,000
--------- ----------- ---------
312,000 655,000 508,000
Increase (decrease) in
valuation allowance on
deferred tax assets (312,000) 1,201,000 --
--------- ----------- ---------
$ 3,000 $ 929,000 $ 17,000
========= =========== =========
</TABLE>
Current income taxes receivable of $529,000 and $987,000 at December 31, 1996
and 1995, respectively, are included in Other assets.
As a result of the following items, total income tax expense was different from
the amount computed by applying the statutory U.S. income tax rate of 34%.
<TABLE>
<CAPTION>
1996 1995 1994
--------- ----------- --------
<S> <C> <C> <C>
Federal income
tax expense
at statutory rate $ 118,000 $ (199,000) $ 16,000
Increase (decrease) in valuation
allowance on deferred tax assets (312,000) 1,201,000 - -
State tax, net of federal benefit 184,000 63,000 (3,000)
Other 13,000 (136,000) 4,000
--------- ----------- --------
$ 3,000 $ 929,000 $ 17,000
========= =========== ========
</TABLE>
F-18
<PAGE> 74
Sterling West Bancorp and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 - INCOME TAXES (Continued)
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and liabilities which are included in other assets on
the accompanying balance sheet at December 31, 1996 and 1995 are presented
below. The amounts as of December 31, 1995 have been adjusted to reflect the tax
return actually filed.
<TABLE>
<CAPTION>
1996 1995
--------- ----------
<S> <C> <C>
Deferred tax assets:
Allowance
for loan losses $ 165,000 $ 393,000
Allowance for potential
loan repurchase 160,000 330,000
Deferred loan fees 157,000 187,000
Real estate valuation allowances 138,000 232,000
Net operating loss carryforwards 775,000 261,000
Other 107,000 399,000
---------- ----------
Total gross deferred tax assets 1,502,000 1,802,000
less: valuations allowance 1,274,000 1,586,000
---------- ----------
Net deferred tax assets 228,000 216,000
Deferred tax liabilities:
Depreciation 228,000 216,000
---------- ----------
Total gross deferred tax liabilities $ 228,000 $ 216,000
---------- ----------
Net deferred tax assets -- --
========== ==========
</TABLE>
During 1996 the valuation allowance on gross deferred tax assets decreased by
$312,000 from $1,586,000 at December 31, 1995 to $1,274,000 at December 31,
1996. The Bank has approximately $4,425,000 of net operating loss carryforward
available for California Franchise Tax purposes. This carryforward expires
between 1998 and 2001. Additionally, the Bank has approximately $870,000 of net
operating loss carryforward available for Federal Income Tax purposes. This
carryforward expires in 2011.
F-19
<PAGE> 75
Sterling West Bancorp and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 - INCOME TAXES (Continued)
In determining the possible realization of deferred tax assets, SFAS No. 109
requires that future taxable income from the following sources be taken into
account: (a) the reversal of taxable temporary differences , (b) future
operations exclusive of temporary differences and (c) tax planning strategies
that if necessary, would be implemented to accelerate taxable income into years
in which net operating losses might otherwise expire. Management believes that
it is more likely than not that the Company will not realize the tax benefits
from the deferred tax assets.
NOTE 10- COMMITMENTS AND CONTINGENCIES
The Company leases facilities under non-cancellable operating leases. The
minimum annual rental payments (excluding property taxes and insurance) for the
following periods are approximately:
<TABLE>
<CAPTION>
Year Amount
-------------------------------------
<S> <C>
1997 $602,000
1998 564,000
1999 499,000
2000 425,000
2001 425,000
2002 and thereafter 1,453,000
==========
$3,968,000
==========
</TABLE>
The minimum annual rental payments which are included in the above schedule are
for existing lease obligations and are not a forecast of future rental expense.
Total rent expense for 1996, 1995 and 1994 was approximately $593,000, $580,000
and $717,000, respectively.
The Company has employment agreements with certain of its executives which
expire through 1997. In addition to a base salary, the agreements provide for
incentive compensation at the Discretion of the Company (or subsidiary
applicable to the individual employee).
The Company, BSC, Bank and Business Credit are involved in various legal
proceedings and litigation in the normal course of their business. While no
assurance can be given as to the likelihood of an unfavorable outcome of any
such litigation or the estimated amount of potential loss, if any, based upon
currently available information, the Company does not believe that the outcome
of such litigation will have a material adverse effect on the results of
operations or financial condition of the Company.
F-20
<PAGE> 76
Sterling West Bancorp and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11- REGULATORY MATTERS
In 1995, the Board of Directors of the Company and the Bank entered into
memorandums' of understanding with the Federal Reserve Bank ("the FRB
Memorandum"), the FDIC ("FDIC Memorandum) and the State Banking Department ("SBD
Memorandum"). Under these Memorandums, the Company, among other things, may not
directly or indirectly, acquire or sell any interest in any entity, line of
business, problem loans or other assets, without the prior written approval of
the Federal Reserve Bank; and may not pay cash dividends without the prior
written consent of the Federal Reserve Bank. The Bank is also required, among
other things, to achieve and maintain Tier 1 capital equal to or above 6.75% of
total assets; establish and maintain an adequate allowance for loan losses; and
not pay cash dividends without the prior written consent of the FDIC and the
California Superintendent of Banks.
Management believes the Company and the Bank are currently in full compliance,
and that it can continue to comply with the terms of the FRB Memorandum, the
FDIC Memorandum and the SBD Memorandum, and otherwise meet regulatory capital
requirements, and that any actions taken to so comply in the future will not
have a material adverse effect on the Company's future financial condition or
results of operations. However, failure to comply with any Memorandum could
result in regulatory action.
On December 19, 1992 the federal regulations implementing prompt corrective
action provisions of the Federal Deposit Insurance Corporation Improvement Act
of 1991 ("FDICIA") became effective. Those regulations provide for certain
mandatory and discretionary action by federal agencies based upon a institutions
ranking within five capital levels -- well capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized, and critically
undercapitalized. All undercapitalized institutions are required to file a
capital restoration plan, undergo close monitoring of their condition and are
subject to restrictions on operations requiring regulatory approval.
Significantly undercapitalized or critically undercapitalized institutions and
undercapitalized institutions which fail to implement an acceptable capital plan
are subject to more severe actions which may include divestiture of subsidiaries
and replacement of senior management and directors. At December 31, 1996 the
Bank's capital ratios were in excess of amounts necessary to be considered
adequately capitalized as defined under FDICIA.
F-21
<PAGE> 77
Sterling West Bancorp and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 - REGULATORY MATTERS (continued)
The following table sets forth the capital ratios of the Company and the Bank at
December 31, 1996 (dollars in thousands).
<TABLE>
<CAPTION>
Company Bank
----------------- ----------------
Amount Ratio Amount Ratio
------ ----- ------ -----
<S> <C> <C> <C> <C>
Tier 1 capital $7,262 9.78% $7,500 10.18%
Tier 1 capital 2,971 4.00% 2,947 4.00%
----- ------ ----- -----
minimum requirements
Excess $4,291 5.78% 4,553 6.18%
Total capital $8,195 11.03% $8,425 11.44%
Total capital 5,941 8.00% 5,894 8.00%
----- ----- ----- -----
minimum requirement
Excess $2,254 3.03% $2,531 3.44%
Risk-weighted
assets $74,265 $73,670
Tier 1 capital $7,262 7.12% $7,500 7.47%
Tier 1 capital
Minimum requirement 4,078 4.00%
----- -----
Memorandum requirement 6,781 6.75%
----- -----
Excess $3,184 3.12% 719 0.72%
Total average assets $101,950 $100,461
</TABLE>
- ----------
The leverage ratio consists of tangible Tier 1 capital divided by total average
assets. As of December 31, 1996, the Company and the Bank had leverage ratios of
7.12% and 7.47%, respectively. Regulators have established a minimum leverage
ratio of 4.0% for the highest rated banks. However, institutions experiencing or
anticipating significant growth, or those with other than minimum risk profiles,
will be expected to maintain capital well above the minimum. The Company is
required under the terms of the Memorandums' to maintain a minimum leverage
ratio of 6.75%.
F-22
<PAGE> 78
Sterling West Bancorp and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12- FAIR VALUE OF FINANCIAL INSTRUMENTS
FASB Statement 107 "Disclosures about Fair Values of Financial Instruments"
requires disclosures of fair value information about financial instruments. The
following methods and assumptions were used to estimate that value. Because no
active market exists for a significant portion of the Company's loan portfolio,
fair value estimates are based on subjective judgments regarding credit risk,
future economic conditions and other risk characteristics which cannot be
determined with precision. The fair value disclosed does not reflect any gain or
loss that could result from offering the instruments for sale. Potential taxes
and other expenses that would be incurred in an actual sale or settlement are
not reflected in amounts disclosed.
Cash and cash equivalents
The carrying value of cash and cash equivalents is assumed to be a reasonable
estimate of fair value.
Securities
Fair values of securities held to maturity and are based on quoted market
prices.
Loans
Fair value of loans are estimated for portfolios of loans with similar financial
characteristics. Each loan portfolio was further segmented into fixed and
adjustable rate and performing and non-performing categories. The fair value of
performing loans was calculated by discounting estimated cash flows through the
estimated maturity using estimated current replacement discount rates that
reflect the credit and interest rate risk inherent in the loans. Fair value for
nonperforming loans was based on the lower of recent external appraisals and
internal value estimates and related estimated cash flows discounted using a
rate commensurate with the risk and associated with the estimated cash flows.
Credit risk and cash flows are estimated using available market information and
specific borrower information.
Deposits
The fair value of demand, savings, now and money market deposits is the amount
payable on demand at the reporting date. The fair value of fixed maturity time
deposits is estimated using the rates currently offered for deposits of similar
remaining maturities. No benefit has been ascribed to core deposit intangibles.
Notes payable
Rates currently available to the Company for credit with similar terms are used
to estimate fair value of existing debt.
Undisbursed loans and standby letters of credit
The fair value of undisbursed loans and standby letters of credit is estimated
to be equal to the fees charged by the Bank as these are the same as replacement
rates and fees currently charged to enter into similar agreements. No disclosure
is provided as amounts are minor.
F-23
<PAGE> 79
Sterling West Bancorp and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12 - FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)
The estimated fair values of the Company's financial instruments at December 31,
1996 and 1995 are as follows:
<TABLE>
<CAPTION>
1996 1995
------------------------- -------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
----------- ----------- ------------ -------------
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash
equivalents $24,322,000 $24,322,000 $ 36,072,000 $ 36,072,000
Investment securities 7,224,000 7,204,000 7,614,000 7,664,000
Loans, net 67,629,000 66,434,000 70,896,000 69,376,000
Financial liabilities:
Fixed rate term
deposits $7,081,000 $6,998,055 $6,472,000 $5,900,000
Other deposits 89,105,000 89,105,000 105,904,000 105,904,000
Notes payable -- -- 1,372,000 1,372,000
</TABLE>
NOTE 13 - STOCKHOLDERS' EQUITY
Earnings per share - Net earnings per share amounts have been computed using the
weighted-average number of common and common equivalent shares outstanding.
Stock ownership plan - In 1986, the Company adopted a non-contributory
non-leveraged employee stock ownership plan (Stock Plan) to provide benefits to
all eligible employees upon termination of employment. The Stock Plan invests
primarily in Company stock. Equivalent full-time employees as defined by the
Stock Plan became participants in the Stock Plan after completing three months
of service with the Company. Participant accounts vest in increments over a
seven year period of service at which time full vesting occurs.
The Company's contributions may be made in cash or common stock of the Company
and are determined annually by the Board of Directors in their sole discretion.
The Company made a contribution of $8,000 in 1996, and no contribution for the
years 1995 and 1994., At December 31, 1996, the Stock Plan held 61,305 shares of
common stock of the Company.
The Company had a stock option plan which expired in 1992. As of December 31,
1996 there were 19,031 shares exercisable which had been granted under the old
plan. The exercise prices range from $4.32 to $5.36 with options expiring in the
year 2001.
F-24
<PAGE> 80
Sterling West Bancorp and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13 - STOCKHOLDERS' EQUITY (continued)
Dividends restrictions
Section 23A of the Federal Reserve Act restricts the Bank from making loans or
advances to the Company and its affiliates in excess of 20% of its capital stock
and surplus. The prompt corrective action provisions of FDICIA prohibit the Bank
from making a capital distribution to the Company if, after such a transaction,
the Bank would be undercapitalized. In addition, California Banking law limits
the amount of dividends which a bank can pay without obtaining prior approval
from bank regulators. At December 31, 1996, these provisions would allow the
Bank to make loans of approximately $1.5 million to the Company and its
affiliates. No dividends would be permitted without regulatory approval. In
addition, under an agreement with the Federal Reserve Bank of San Francisco
("FRB") the Company is prohibited from paying dividends to shareholders without
the prior written approval of the FDIC. Under the terms of the FDIC Memorandum
and the FRB Memorandum , the Bank, BSC and Business Credit are prohibited from
paying cash dividends to the Company unless the payment is approved in advance
by the Regional Director of the FDIC and the State Superintendent of Banks, as
well as the Federal Reserve Bank, respectively. Additionally, under the prompt
corrective action provisions of FDICIA, the Bank is prohibited from paying any
cash dividends that will result in the Bank becoming undercapitalized. No
dividend was paid by the Bank to the Company in 1994, 1995 or 1996.
Under the terms of the FDIC Memorandum and the FRB Memorandum the Bank, BSC and
Business Credit are prohibited from paying cash dividends to the Company unless
the payment is approved in advance by the Regional Director of the FDIC and the
State Superintendent of Banks, as well as the Federal Reserve Bank,
respectively. Additionally, under the prompt corrective action provisions of
FDICIA, the Bank is prohibited from paying any cash dividends that will result
in the Bank becoming undercapitalized.
Business Credit was prohibited from paying dividends to the Company under the
terms of its line of credit without the prior written consent of the lender (See
Note 8). In 1996, 1995 and 1994, Business Credit paid dividends to the Company
totaling $0, $4,100,000 and $500,000, respectively, with such approval.
F-25
<PAGE> 81
Sterling West Bancorp and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 14 - OTHER NONINTEREST EXPENSE/INCOME
Other noninterest expense is comprised of the following:
<TABLE>
<CAPTION>
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
Professional fees $ 465,000 $ 827,000 $ 276,000
Office supplies and expense 153,000 157,000 150,000
Communication 270,000 265,000 382,000
Insurance 293,000 525,000 614,000
Directors fees 77,000 128,000 295,000
Data processing fees 202,000 30,000 45,000
Other 511,000 381,000 449,000
---------- ---------- ----------
$1,971,000 $2,313,000 $2,211,000
========== ========== ==========
</TABLE>
Included in Other non-interest income for the year ended December 31, 1996 is
approximately $850,000 of income from (i) the reversal of various accrued
liabilities which were deemed no longer necessary, and (ii) the settlement of
certain litigation.
NOTE 15 - OCCUPANCY EXPENSE
Occupancy expense is comprised of the following:
<TABLE>
<CAPTION>
1996 1995 1994
------------------------------------
<S> <C> <C> <C>
Leasehold amortization $ 74,000 $ 77,000 $ 71,000
Utilities 40,000 45,000 45,000
Insurance bank premises 35,000 46,000 38,000
Rent bank premises 593,000 580,000 717,000
Other 88,000 93,000 72,000
------------------------------------
$830,000 $841,000 $943,000
====================================
</TABLE>
F-26
<PAGE> 82
Sterling West Bancorp and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16 - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY
Balance Sheets
(dollars in thousands)
<TABLE>
<CAPTION>
December 31,
1996 1995
------- -------
<S> <C> <C>
Assets
Cash in Sterling Bank $ 69 $ 38
Investment in Sterling Bank 7,500 7,171
Investment in non-bank subsidiary 411 412
Other assets 22 84
---------------------
$ 8,002 $ 7,705
=====================
Liabilities and Stockholder' Equity
Other liabilities $ 740 $ 787
Common stock 8,686 8,686
Accumulated deficit (1,424) (1,768)
---------------------
$ 8,002 $ 7,705
=====================
</TABLE>
Payment of dividends is subject to statutory and regulatory limitations. As a
result of losses, at December 31, 1996, the Bank had no retained earnings
legally available for the payment of cash dividends.
F-27
<PAGE> 83
Sterling West Bancorp and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16 - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY (Continued)
STATEMENTS OF OPERATIONS
(dollars in thousands)
<TABLE>
<CAPTION>
For the years ended December 31,
---------------------------------
1996 1995 1994
----- ------- -------
<S> <C> <C> <C>
Equity in net income (loss) of subsidiaries $ 329 $(3,428) (2,392)
Other income 204 458 776
Other expenses (189) (474) (809)
----- ------- -------
Income (loss) before taxes 344 (3,444) (2,425)
Income tax provision (benefit) 1 (5) 450
----- ------- -------
Net Income (loss) $ 343 $(3,439) $(2,875)
===== ======= =======
</TABLE>
F-28
<PAGE> 84
Sterling West Bancorp and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16- CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY (Continued)
STERLING WEST BANCORP
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
(dollars in thousands)
<TABLE>
<CAPTION>
1996 1995 1994
------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 343 $(3,439) $(2,875)
Adjustments to reconcile net income to
net cash from operating activities:
Equity in (income) loss of subsidiaries (329) 3,428 2,392
Dividends paid by non-bank subsidiary -- 4,100 500
Other, net 17 (253) 1,066
----- ------- -------
Total adjustments (312) 7,275 3,958
----- ------- -------
Net cash provided by operating activities 31 3,836 1,083
Cash from investing activities:
Payment for investment in bank subsidiary -- (3,650) (1,330)
----- ------- -------
Net cash used in investing
activities -- (3,650) (1,330)
Cash flows from financing activities:
Payments of commercial paper -- (1,493) (1,054)
Decrease in loans to subsidiary -- 1,339 1,303
----- ------- -------
Net cash provided by (used in) financing
activities -- (154) 249
----- ------- -------
Net increase in cash and cash equivalents 31 32 2
Cash and cash equivalents at beginning of year 38 6 4
----- ------- -------
Cash and cash equivalents at end of year $ 69 $ 38 $ 6
===== ======= =======
Supplemental cash flow information
Cash paid during the year for interest -- $ 152 $ 172
Cash paid during income -- -- --
===== ======= =======
</TABLE>
F-29
<PAGE> 85
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
No. Description Page
- ------------------------------------------------------------------------------
<S> <C> <C>
3.1 Articles of Company (1) *
3.1.1 Certificates of Amendment to Articles *
3.2.1 Bylaws of Company, as amended (2) *
4.1 RESERVED *
4.2 Form of Seven Year Registered Variable
Interest Rate Note (3) *
4.3 Form of Three Year Registered Variable
Interest Rate Note due June 1, 1995 *
4.4 Form of Seven Year Registered Variable
Interest Rate Note due June 1, 1999 *
4.5 Form of Seven Year Registered
Convertible Variable Interest Rate Note
due June 1, 1999 *
10.1 RESERVED *
10.2 RESERVED *
10.3 RESERVED *
10.4 Lease, dated June 2, 1980, between
Wilshire-Berendo Building Company, a
Limited Partnership, and Sterling Bank
and Lease amendment, effective
July 30, 1981 (1) *
10.5 Company's 1982 Stock Option plan, as
amended (5) *
10.6 Sterling Bancorporation Employee
Stock Ownership Plan and Trust (3) *
10.6.1 Amended and Restated Sterling West Bancorp
Employee Stock Ownership Plan and Trust (9) *
10.7 RESERVED *
10.8 RESERVED *
10.9 RESERVED *
10.11 RESERVED *
10.12 RESERVED *
10.13 RESERVED *
10.14 RESERVED *
10.15 Sublease, dated October 25, 1989, between
Jaffe & Clemens and Sterling Bank (4) *
10.16 RESERVED *
10.17 RESERVED *
10.18 RESERVED *
10.19 Employment Agreement, dated January 1,
1990, between Sterling Bancorporation and
Allan E. Dalshaug, and Amendment No. 1 thereto,
effective September 30, 1990 (2) *
</TABLE>
<PAGE> 86
EXHIBIT INDEX (CONTINUED)
<TABLE>
<CAPTION>
Exhibit
No. Description Page
- ------------------------------------------------------------------------------
<S> <C> <C>
10.19.2 Amendment No. 2, effective December 30, 1992,
to Employment Agreement, dated January 1, 1990,
between Sterling West Bancorp and
Allan E.Dalshaug (8) *
10.19.3 Amendment No. 3, effective May 15, 1995, to
Employment Agreement dated January 1, 1990
between Sterling West Bancorp and Allan E.
Dalshaug (10)
10.20 RESERVED *
10.21.2 Employment Agreement, dated January 1, 1994,
between Sterling Bank and Joseph Carona (6) *
10.23 RESERVED *
10.24 RESERVED *
10.25 RESERVED *
10.29 Sublease, dated February 2, 1994, between
Wells Fargo Bank, N.A. and Sterling Bank (9) *
10.30 RESERVED *
10.31 Employment Agreement, dated March 21, 1996,
between the Company and Allan E. Dalshaug (10) *
11 Statement of Computation of Net Income
per Share of Common Stock
21 Subsidiaries of Company (7) *
27 Financial Data Schedule
</TABLE>
<PAGE> 87
EXHIBIT INDEX (CONTINUED)
(1) These documents were previously filed as Exhibits 3.1 and 10.4,
respectively, to the Company's Registration Statement on Form S-14
(registration No.2-77211), effective June 1, 1982, and are incorporated
herein by this reference.
(2) These documents were previously filed as Exhibits 3.2.1and 10.19,
respectively, to the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 1990, and are incorporated herein by this
reference.
(3) These documents were previously filed as Exhibits 4.2 and 10.6,
respectively, to the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 1986, and are incorporated herein by this
reference.
(4) These documents were previously filed as Exhibit 10.15, to Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 1989,
and are incorporated herein by this reference.
(5) This document was previously filed as Exhibit 10.5 to the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 1988,
and is incorporated herein by this reference.
(6) These documents were previously filed as Exhibit 10.21.2 to the
Company's Annual Report on Form 10-K for the fiscal year ended December
31, 1993, and are incorporated herein by this reference.
(7) This document was previously filed as Exhibit 22 to the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 1984, and is
incorporated herein by this reference.
(8) These documents were previously filed as Exhibit 10.19.2, to the
Company's Annual Report on Form 10-K for the fiscal year ended December
31, 1992, and are incorporated herein by this reference.
(9) These documents were previously filed as Exhibits 10.6.1 and 10.29,
respectively, to the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 1994, and are incorporated herein by this
reference.
(10) These documents were previously filed as Exhibits 10.19.3 and 10.31,
respectively to the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 1995, and are incorporated herein by this
reference.
<PAGE> 1
Sterling West Bancorp
Computation of Net Income Per Share of Common Stock
<TABLE>
<CAPTION>
For the years ended December 31,
1996 1995 1994
<S> <C> <C> <C>
Weighted-average shares
outstanding
(used in the computation of primary
earnings per share) 1,710,214 1,710,214 1,710,214
Assumed exercise of options at
average market price -- -- --
---------------------------------------------
Weighted-average shares
outstanding and common stock
equivalents
(used in the computation of primary
earnings per share) 1,710,214 1,710,214 1,710,214
Additional shares issuable upon
the assumed exercise of options
at period-end market price -- -- --
Additional shares issuable upon
the assumed conversion of
convertible notes at period-end
market price -- -- 20,453
---------------------------------------------
Total shares outstanding
assuming full dilution 1,710,214 1,710,214 1,730,667
=============================================
Net income (loss) $ 343,000 $(3,439,000) $(2,867,000)
Interest, net of tax, on variable
interest rate convertible notes
assumed to be converted to
common stock -- -- 8,000
---------------------------------------------
Earnings applicable to common
stock used in the computation of
fully diluted earnings per share $ 343,000 $(3,439,000) $(2,867,000)
=============================================
Primary earnings per share $ 0.20 $ (2.01) $ (1.68)
=============================================
Fully diluted earnings per share $ 0.20 $ (2.01) $ (1.66)
=============================================
</TABLE>
Exhibit 11
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTENT SUMMARY FINANCIAL INFORMATION EXTRACTED FROM (STERLING
WEST BANCORP AND SUBSIDIARIES) AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 5,929
<INT-BEARING-DEPOSITS> 197
<FED-FUNDS-SOLD> 18,393
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 0
<INVESTMENTS-CARRYING> 7,027
<INVESTMENTS-MARKET> 7,007
<LOANS> 68,889
<ALLOWANCE> 1,260
<TOTAL-ASSETS> 104,561
<DEPOSITS> 96,186
<SHORT-TERM> 0
<LIABILITIES-OTHER> 1,114
<LONG-TERM> 0
0
0
<COMMON> 8,686
<OTHER-SE> (1,425)
<TOTAL-LIABILITIES-AND-EQUITY> 104,561
<INTEREST-LOAN> 7,552
<INTEREST-INVEST> 1,238
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 8,790
<INTEREST-DEPOSIT> 2,485
<INTEREST-EXPENSE> 2,529
<INTEREST-INCOME-NET> 6,261
<LOAN-LOSSES> 886
<SECURITIES-GAINS> 1,629
<EXPENSE-OTHER> 6,658
<INCOME-PRETAX> 346
<INCOME-PRE-EXTRAORDINARY> 346
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 343
<EPS-PRIMARY> 0.20
<EPS-DILUTED> 0.20
<YIELD-ACTUAL> 6.71
<LOANS-NON> 1,424
<LOANS-PAST> 210
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 1,510
<CHARGE-OFFS> 1,159
<RECOVERIES> 23
<ALLOWANCE-CLOSE> 1,260
<ALLOWANCE-DOMESTIC> 0
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
