<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MAY 15, 1997
REGISTRATION NO. 333-21455
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
POST-EFFECTIVE AMENDMENT NO. 1
TO
FORM S-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
----------------
NATIONAL MERCANTILE BANCORP
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 95-3819685
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1840 CENTURY PARK EAST
LOS ANGELES, CALIFORNIA 90067
(310) 277-2265
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
----------------
SCOTT A. MONTGOMERY
EXECUTIVE VICE PRESIDENT AND CHIEF ADMINISTRATIVE OFFICER
NATIONAL MERCANTILE BANCORP
1840 CENTURY PARK EAST
LOS ANGELES, CALIFORNIA 90067
(310) 277-2265
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF AGENT FOR SERVICE)
----------------
COPIES TO:
NANCY H. WOJTAS MARY M. SJOQUIST
SEEMA L. NENE MULDOON, MURPHY & FAUCETTE
MANATT, PHELPS & PHILLIPS, LLP 5101 WISCONSIN AVENUE, N.W.
11355 W. OLYMPIC BOULEVARD WASHINGTON, D.C. 20016
LOS ANGELES, CALIFORNIA 90064 (202) 362-0840
(310) 312-4000
----------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO PUBLIC: As soon as
practicable after the Registration Statement becomes effective.
If the securities being registered on this Form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933 check the following box. [_]
If the Registrant elects to deliver its latest annual report to security
holders, or a complete and legible facsimile thereof, pursuant to Item
11(a)(1) of this Form, check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering.
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
----------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(a) OF THE SECURITIES ACT OF 1933, AS AMENDED OR UNTIL THE
REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION,
ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE.
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<PAGE>
EXPLANATORY NOTE
This Registration Statement contains a Prospectus relating to an offering to
holders of record ("Rights Holders") of common stock, no par value, of
National Mercantile Bancorp (the "Company") pursuant to nontransferable rights
to purchase shares of the Company's 6.5% noncumulative convertible preferred
stock, $10.00 stated value ("Preferred Stock"), together with separate
prospectus pages relating to an offering of shares of Preferred Stock to
Standby Purchasers. The Prospectus for the offering to Rights Holders follows
immediately. After such Prospectus are the following alternate pages for the
Standby Purchasers: a front cover page, a "Standby Purchasers" section of the
Prospectus Summary, and a "Standby Purchasers" section. All other pages of the
Prospectus for the offering to Rights Holders are to be used for both the
offering to Rights Holders and the offering to Standby Purchasers.
<PAGE>
PROSPECTUS
[LOGO OF NATIONAL MERCANTILE BANCORP]
NATIONAL MERCANTILE BANCORP
6.5% NONCUMULATIVE CONVERTIBLE PREFERRED STOCK, $10.00 STATED VALUE
$2.5 MILLION (MINIMUM)
$8.0 MILLION (MAXIMUM)
---------------
National Mercantile Bancorp (the "Company") is distributing to holders of
the Company's common stock, no par value (the "Common Stock"), of record at
the close of business on May 5, 1997 (the "Record Date"), nontransferable
rights (the "Rights") to subscribe for and purchase up to $5.5 million
(550,000 shares) of its 6.5% noncumulative convertible preferred stock, $10.00
stated value (the "Preferred Stock"), at a price of $10.00 per share (the
"Subscription Price"), subject to reduction by the Company under certain
circumstances (the "Rights Offering"). Shareholders will receive one Right for
each share of Common Stock (after giving effect to the Reverse Stock Split
described below) held as of the Record Date. Holders of Rights (the "Rights
Holders") may exercise their Rights until 5:00 p.m., Pacific time, on June 13,
1997, unless extended by the Company (the "Expiration Time"). Each Right
entitles the Rights Holder to subscribe for 1.624 shares (the "Underlying
Preferred Shares") of Preferred Stock (the "Basic Subscription Privilege") at
the Subscription Price. Each share of the Preferred Stock will be immediately
convertible at the option of the holder thereof at the initial rate of one
share of Common Stock for each share of Preferred Stock based on an initial
conversion price of $10.00 per share, subject to adjustment upon the
occurrence of certain dilutive and other events. See "Description of Capital
Stock" and "Risk Factors--Restrictions on Preferred Stock Dividends."
The Company has not shown a profit in each of the past three years and is
unable to assess at this time whether it will return to profitability during
1997. The Company cannot assess at this time its ability to pay dividends in
the immediate future.
(continued on next page)
THE PURCHASE OF PREFERRED STOCK IN THE PUBLIC OFFERING INVOLVES A
SIGNIFICANT DEGREE OF INVESTMENT RISK. RIGHTS HOLDERS AND STANDBY
PURCHASERS ARE URGED TO READ AND CAREFULLY CONSIDER THE
INFORMATION SET FORTH UNDER THE HEADING "RISK FACTORS"
BEGINNING ON PAGE 18.
THE SECURITIES OFFERED HEREBY ARE NOT SAVINGS OR DEPOSIT ACCOUNTS AND
ARE NOT INSURED OR GUARANTEED BY THE FEDERAL DEPOSIT INSURANCE
CORPORATION OR ANY OTHER GOVERNMENTAL AGENCY.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION (THE "COMMISSION") OR ANY STATE SECURITIES COMMISSIONER
NOR HAS THE COMMISSION OR ANY STATE SECURITIES COMMISSIONER PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
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<CAPTION>
SUBSCRIPTION UNDERWRITERS' PROCEEDS
PRICE COMMISSIONS(1) TO COMPANY(2)
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<S> <C> <C> <C>
Per Share
Total Minimum.................................... $10.00 $250,000 $6,650,000
Total Maximum.................................... $10.00 $372,500 $7,527,500
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</TABLE>
(1) Sandler O'Neill & Partners, L.P. ("Sandler O'Neill") will receive 3% of
the aggregate purchase price of the shares of Preferred Stock sold in the
Rights Offering (except for Rights exercised in Arizona) and 5% of the
aggregate value of funds committed by Standby Purchasers. Sandler O'Neill
also will receive 1.5% of the aggregate value of funds committed in the
Private Offering. The Company has agreed to reimburse Sandler O'Neill for
its reasonable out-of-pocket expenses, including fees of legal counsel,
and has agreed to indemnify Sandler O'Neill against certain liabilities
under the securities laws.
(2) Before deducting expenses of the Public Offering and the Private Offering
payable by the Company estimated at $1,100,000.
---------------
Sandler O'Neill & Partners, l.p.
---------------
The date of this Prospectus is May 16, 1997
<PAGE>
(continued from previous page)
Pursuant to a private offering exemption from the registration requirements
of the Securities Act of 1933, as amended (the "Securities Act"), the Company
entered into purchase agreements (the "Private Purchase Agreements") with two
purchasers (collectively, the "Private Purchasers"). The Private Purchasers
have severally agreed, subject to certain conditions, to purchase and the
Company has agreed to sell (the "Private Offering"), in the aggregate, up to
$5.5 million (550,000 shares) (the "Maximum Private Offering") of Preferred
Stock at a purchase price (the "Private Purchasers Price") equal to $1.10 per
share (equal to $10.00 after giving effect to a 9.09 to 1 reverse stock split
of the Common Stock (the "Reverse Stock Split") that the Company plans to
effect prior to the closing of the Public Offering and the Private Offering
and after obtaining shareholder approval), subject to reduction under certain
circumstances. The Company has guaranteed the availability of an aggregate
minimum of $2.5 million (250,000 shares) of Preferred Stock to the Private
Purchasers at the Private Purchasers Price (the "Private Purchasers Minimum
Obligation") irrespective of the number of shares available after the exercise
of the Basic Subscription Privilege. See "The Private Offering."
Each Rights Holder who fully exercises the Basic Subscription Privilege will
be eligible to subscribe for 0.376 shares of Preferred Stock (the "Excess
Underlying Preferred Shares"), for each Right held, which remain available
after the exercise of the Basic Subscription Privilege and purchased in the
Private Offering, subject to availability, proration and reduction by the
Company under certain circumstances (the "Oversubscription Privilege"). A
Rights Holder's election to exercise the Oversubscription Privilege must be
made at the time the Basic Subscription Privilege is exercised. Once a Rights
Holder has exercised the Basic Subscription Privilege or the Oversubscription
Privilege, such exercise may not be revoked. The maximum amount of Preferred
Stock available to Rights Holders under the Basic Subscription Privilege and
the Oversubscription Privilege is $5.5 million.
The Company has entered into purchase agreements (the "Standby Purchase
Agreements") pursuant to which certain institutional investors (the "Standby
Purchasers") have severally agreed, subject to certain conditions, to purchase
$2.5 million (250,000 shares) of Preferred Stock at the Subscription Price
(the "Maximum Standby Offering"), to the extent available after the exercise
of the Basic Subscription Privilege, the consummation of the Private Offering
and the exercise of the Oversubscription Privilege (the "Standby Purchaser
Offering"). See "Standby Purchasers" for the identities of the Standby
Purchasers. The Standby Purchasers have agreed to purchase and the Company has
guaranteed the availability of an aggregate minimum of $1.0 million (100,000
shares) of Preferred Stock at the Subscription Price if a sufficient number of
shares of Preferred Stock is not available after the exercise of the Basic
Subscription Privilege, the consummation of the Private Offering and the
exercise of the Oversubscription Privilege (the "Minimum Standby Obligation").
See "The Standby Purchasers." The Rights Offering and the Standby Purchaser
Offering may sometimes be referred to collectively as the "Public Offering."
The minimum amount to be raised in the Public Offering and the Private
Offering will be $8.0 million (assuming no rights are exercised in the Rights
Offering), consisting of $5.5 million (550,000 shares) of Preferred Stock
purchased by the Private Purchasers and $2.5 million (250,000 shares) of
Preferred Stock purchased by the Standby Purchasers. The maximum amount to be
raised in the Public Offering and the Private Offering will be $9.0 million,
consisting of $5.5 million (550,000 shares) pursuant to the Rights Offering,
$2.5 million (250,000 shares) of Preferred Stock purchased by the Private
Purchasers and $1.0 million (100,000 shares) of Preferred Stock purchased by
the Standby Purchasers. The maximum amount which could be raised in the Public
Offering will be $8.0 million, consisting of $5.5 million (550,000 shares) of
Preferred Stock pursuant to the Rights Offering and $2.5 million (250,000
shares) of Preferred Stock pursuant to the Maximum Standby Offering.
The number of Underlying Preferred Shares issuable by the Company as a
result of exercises of the Basic Subscription Privilege and the
Oversubscription Privilege in the aggregate or to any Rights Holder or the
Standby Purchasers may be limited by the Company, if necessary, with certain
exceptions, in its sole judgment and discretion, to reduce the risk that
certain tax benefits will be subject to limitation under Section 382 of the
Internal Revenue Code of 1986, as amended (the "Code"), or the risk of any
other adverse tax consequences to the Company, either at the time of the
Public Offering and the Private Offering or at any subsequent time. See "The
Rights Offering--Limitations--Tax Limitation." The number of shares issuable
by the Company to the Private Purchasers also may be limited by the Company
pursuant to the terms of the Private Purchase Agreements. See "The Private
Offering."
2
<PAGE>
THE COMPLETION OF THE PUBLIC OFFERING AND THE PRIVATE OFFERING IS SUBJECT TO
CERTAIN CONDITIONS INCLUDING, BUT NOT LIMITED TO, THE RECEIPT BY THE COMPANY
OF MINIMUM PROCEEDS OF $5.5 MILLION (THE "MINIMUM CONDITION"). EVEN IF THE
PRIVATE OFFERING IS NOT CONSUMMATED, THE PUBLIC OFFERING COULD CLOSE AND THE
MINIMUM CONDITION SATISFIED IF THE RIGHTS HOLDERS SUBSCRIBE FOR AT LEAST $3.0
MILLION OF PREFERRED STOCK AND THE STANDBY PURCHASERS PURCHASE $2.5 MILLION OF
PREFERRED STOCK. IN THE EVENT THE MINIMUM CONDITION IS NOT ACHIEVED, ANY FUNDS
THAT HAVE BEEN DEPOSITED WITH THE SUBSCRIPTION AGENT WILL BE RETURNED
PROMPTLY, WITHOUT INTEREST. SEE "THE PRIVATE OFFERING--CONDITIONS TO CLOSING;
AMENDMENT AND TERMINATION" AND "THE RIGHTS OFFERING--MINIMUM CONDITION."
The Rights are not transferable. There will be no trading market for the
Rights. The Company intends to apply to the National Association of Securities
Dealers Automated Quotation ("Nasdaq") Stock Market ("Nasdaq Stock Market")
for quotation of the Preferred Stock on the Small Cap tier of the Nasdaq Stock
Market under the trading symbol "MBLAP" if there are an adequate number of
publicly held shares of Preferred Stock to meet the requirements of Nasdaq. No
assurance can be given that there will be an adequate number of publicly held
shares or that a market will develop for the Preferred Stock. On April 23, the
last reported trade price of the Common Stock as quoted on the Small Cap tier
of the Nasdaq Stock Market under the symbol "MBLA" was $1.50. See "Market
Price for Common Stock and Dividends."
3
<PAGE>
AVAILABLE INFORMATION
The Company is subject to the information, reporting and proxy statement
requirements of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), and in accordance therewith files reports, proxy statements and other
information with the Securities and Exchange Commission (the "Commission").
Such reports, proxy statements and other information can be inspected and
copied at the public reference facilities maintained by the Commission at Room
1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549; and at
the Commission's Regional Offices located at Room 1228, 7 World Trade Center,
Suite 1300, New York, New York 10048 and Northwest Atrium Center, 500 West
Madison Street, Suite 1400, Chicago, Illinois 60661. Copies of such material
may also be obtained at prescribed rates from the Public Reference Section of
the Commission at Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C.
20549. The reports, proxy statements and other information can also be
inspected and copied at the offices of the National Association of Securities
Dealers, Inc., 9513 Key West Avenue, Rockville, Maryland 20850. The Commission
maintains a World Wide Web site at http://www.sec.gov containing reports,
proxy and information statements and other information regarding registrants
that file electronically with the Commission, including the Company.
The Company has filed with the Commission a Registration Statement on Form
S-2 (333-21455) (the "Registration Statement") pursuant to the Securities Act
of 1933, as amended (the "Securities Act"), with respect to the securities
offered hereby. This Prospectus does not contain all of the information set
forth or incorporated by reference in the Registration Statement and the
exhibits and schedules relating thereto as permitted by the rules and
regulations of the Commission. For further information pertaining to the
Company and the securities offered hereby, reference is made to the
Registration Statement and the exhibits thereto. Items of information omitted
from this Prospectus, but contained in the Registration Statement, may be
obtained at prescribed rates or inspected without charge at the offices of the
Commission set forth above. Any statements contained herein concerning the
provisions of any document are not necessarily complete, and, in each
instance, reference is made to the copy of such document filed as an exhibit
to the Registration Statement or otherwise filed with the Commission. Each
such statement is qualified in its entirety by such reference.
DOCUMENTS INCORPORATED BY REFERENCE
The following documents filed by the Company with the Commission under the
Exchange Act are incorporated herein by reference and made a part hereof; (i)
the Company's Annual Report on Form 10-K for the fiscal year ended December
31, 1996, (ii) the Company's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1997 and (iii) all other reports filed with the Commission
pursuant to Sections 13(a), 13(e), 14 or 15(d) of the Exchange Act by the
Company after December 31, 1996 and prior to the date of this Prospectus.
Any statement contained in a document incorporated or deemed to be
incorporated by reference herein shall be deemed to be modified or superseded
for all purposes to the extent that a statement contained in this Prospectus
or in any other subsequently filed document which is also incorporated by
reference modifies or supersedes such statement. Any statement so modified or
superseded shall not be deemed, except as so modified or superseded, to
constitute a part of this Prospectus. The Company will provide without charge
to each person to whom a copy of this Prospectus is delivered, upon the
written or oral request of such person, a copy of any or all of the documents
incorporated by reference herein other than exhibits to such documents.
Requests should be directed to National Mercantile Bancorp, 1840 Century Park
East, Los Angeles, California 90067, Attention: Scott A. Montgomery, Executive
Vice President and Chief Administrative Officer, (310) 277-2265.
4
<PAGE>
PROSPECTUS SUMMARY
The following information is qualified in its entirety by reference to, and
should be read in conjunction with, the detailed information and consolidated
financial statements and notes thereto set forth elsewhere in this Prospectus.
Unless otherwise indicated, all information contained in this Prospectus
reflects the Reverse Stock Split anticipated to be effected prior to the
closing of the Public Offering and the Private Offering.
THE COMPANY
The Company is a bank holding company conducting business through its sole
subsidiary, Mercantile National Bank (the "Bank"). The Bank currently has one
office located in the Century City area of Los Angeles. As of December 31, 1996
the Company had total assets of $109.4 million, total deposits of $103.9
million and total stockholders' equity of $4.8 million. For the year ended
December 31, 1996, the Company suffered a net loss of $1.2 million (which
includes a $1.0 million charge to earnings for the settlement of a lawsuit and
a $579,000 income tax benefit) compared to a net loss of $7.2 million for the
year ended December 31, 1995. See "Business--Litigation" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Income Taxes."
HISTORY
Since commencing operations in 1982 with an initial capitalization of $15.0
million, the Bank focused primarily on providing banking products and services
to the niche markets of business and private banking and entertainment in its
primary service area (a four mile radius from its office). Throughout the
1980s, the Company experienced substantial growth and profitability. In
February 1990, the Company raised additional capital of $5.7 million through
the sale of Common Stock to two investor groups at $11.00 per share (without
giving effect to the Reverse Stock Split). At December 31, 1990, the Company
had total assets of $492.8 million and total stockholders' equity of $28.5
million.
Beginning in 1990, the Bank's primary service area was severely affected by
an economic recession, including substantial declines in real estate values.
Commencing in 1991, the ongoing recession began to affect adversely the values
of collateral securing the Bank's loans and the ability of borrowers to repay
their loans. As a result of the combined effects of this prolonged recession
and the rapid growth of the Bank in the late 1980s, the Bank began to
experience substantial increases in nonperforming assets resulting in
significant losses. Although the Bank undertook to enhance credit underwriting
policies and internal controls and procedures to address operational
weaknesses, from January 1, 1991 through December 31, 1996, the Company
suffered cumulative net losses of $23.7 million. These losses were primarily
the result of substantial provisions for credit losses attributable to losses
embedded in the existing loan portfolio and losses associated with a bulk loan
purchase from the Federal Deposit Insurance Corporation (the "FDIC"), losses on
interest rate hedges and swaps, and sales of securities combined with the
adverse effects of the substantial reduction in the asset levels of the Bank.
In addition, nonperforming assets increased from $14.8 million, or 3.0% of
total assets at December 31, 1990 to a high of $22.0 million, or 7.3% of total
assets, at December 31, 1993 notwithstanding net loan chargeoffs of $15.2
million during the three year period ended December 31, 1993.
Concurrent with the deterioration in the Company's financial condition and
operations, the bank regulatory authorities designated the Company and the Bank
for special supervisory attention. Following regulatory examinations in late
1990 and early 1991, the Bank entered into a formal regulatory agreement (the
"1991 Formal Agreement") with the Office of the Comptroller of the Currency
(the "OCC"), and the Company entered into a Memorandum of Understanding (the
"1991 MOU") with the Federal Reserve Bank of San Francisco (the "Reserve
Bank"). As a result of the Bank's continuing problems, following regulatory
examinations during 1995, the Bank in December 1995 entered into a formal
regulatory agreement with the OCC (the "1995 Formal Agreement") and the Company
in October 1995 entered into a Memorandum of Understanding (the "1995
5
<PAGE>
MOU") with the Reserve Bank. The 1995 Formal Agreement and 1995 MOU supersede
and replace in their entirety the 1991 Formal Agreement and 1991 MOU,
respectively. These regulatory agreements have affected virtually every area of
the Company's and the Bank's operations, imposed on the Bank higher minimum
regulatory capital requirements than would otherwise be applicable and
restricted the ability of the Company and the Bank to pay dividends. See "The
Company--Regulatory Agreements."
RESPONSIVE MEASURES
In November 1995, the Board of Directors hired a new President of the Bank.
The President and the Board of Directors developed and began implementing a
restructuring plan to address the challenges confronting the Bank and to return
the Bank to consistent profitability. The plan includes (1) improving
management, (2) reducing nonperforming and classified assets, (3) reducing
operating expenses, (4) focusing business strategy on core business and market
opportunities, (5) enhancing policies and procedures to improve asset quality,
(6) increasing regulatory capital ratios and (7) resolving pending litigation.
Management believes that the Company has made significant progress in
implementing this plan, which is summarized below and described in greater
detail under the caption "The Company--Responsive Measures":
. Improving Management. As of August 1996, the Company and the Bank
changed senior management by hiring Scott A. Montgomery in November 1995
as President and Chief Executive Officer of the Bank and Executive Vice
President and Chief Administrative Officer of the Company, Joseph W.
Kiley III in August 1996 as Executive Vice President and Chief Financial
Officer of the Company and the Bank, Carol Ward in July 1996 as
Executive Vice President and Operations Administrator of the Bank, Allan
Dietrich in November 1996 as Senior Vice President of Business Banking,
Carl Raggio, III as of May 1, 1997 as Executive Vice President and Chief
Credit Officer and Melanie Krinsky in April 1997 as Senior Vice
President and Head of the Entertainment Department. In addition, as of
April 28, 1997, five middle management officers, with an average of 16
years of banking experience, have been hired by the Bank in departments
such as management information systems, note department, business and
private banking and entertainment.
. Reducing Nonperforming and Classified Assets. The Bank has reduced the
level of nonperforming assets through asset sales, write-downs,
enhancing collection procedures and improving underwriting policies and
procedures. From the peak of $22.0 million at December 31, 1993,
nonperforming assets have decreased to $6.8 million at December 31,
1996. From the peak of $47.1 million at December 31, 1991, classified
assets have been reduced to $8.3 million at December 31, 1996. One loan,
a troubled debt restructure, with a balance of $4.9 million is included
in the total of $6.8 million of nonperforming assets and is included in
the total of $8.3 million of classified assets.
. Reducing Operating Expenses. Since November 1995, management has pursued
a program to increase operational efficiencies and reduce other
operating expenses. For the year ended December 31, 1996, the Company
reduced other operating expense by $3.2 million to $8.0 million from
$11.2 million for December 31, 1995. Excluding a $1.0 million charge
relating to the settlement of a pending lawsuit, other operating
expenses for the year ended December 31, 1996 declined $4.2 million from
1995. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Other Operating Expenses." These savings
resulted primarily from the renegotiation of the lease for the Bank's
office and a restructuring of each operating department of the Bank.
. Focusing Business Strategy on Core Business and Market
Opportunities. Management has pursued a business strategy which focuses
on the Bank's traditional market niches of business and private banking
and entertainment. As part of its business and private banking focus,
the Bank intends to increase its emphasis on medical banking
relationships by taking advantage of its proximity to several major
hospital/medical centers and numerous health service-related companies
in West Los Angeles. Management also intends to expand its focus to
include technology/multimedia companies. Management believes the
technology/multimedia market represents a logical extension of the
Bank's focus on the entertainment industry as more technology companies
seek to develop and market applications to the entertainment industry.
6
<PAGE>
. Enhancing Policies and Procedures to Improve Asset Quality. The Bank has
strengthened its credit administration and loan review functions. The Bank's
loan policies and procedures have been revised in an attempt to reduce the
Bank's exposure to future loan problems. The Bank (i) has expanded the role
of an outside loan review firm to include a migration analysis on its loan
portfolio on a quarterly basis, (ii) has established an underwriting
department to standardize loan write-ups, enhance portfolio quality and
allow officers time to service their clients and prospects and (iii) is in
the process of hiring several experienced lending and underwriting officers
to strengthen the Bank's loan origination and monitoring functions. Total
nonperforming loans have decreased from $15.9 million at December 31, 1993
to $6.2 million at December 31, 1996. See "Business--Troubled Debt
Restructurings."
. Increasing Regulatory Capital Ratios. Primarily as a result of a
restructuring of the balance sheet and a decreasing asset base, capital
ratios have remained constant. The Bank's Tier I risk-based capital ratio
was 6.95% at December 31, 1996 and 1995. The Bank's leverage capital ratio
was 4.67% at December 31, 1996 and 1995. The Bank's total risk-based capital
ratio was 8.24% at December 31, 1996 and 1995. The Bank, however, has not
yet met the requirements of the 1995 Formal Agreement that requires a Tier 1
risk-based capital ratio of at least 10% and a leverage capital ratio of at
least 6.5% which would require a minimum net investment in the Bank of
approximately $2.5 million. See "Risk Factors--Regulatory Agreements" and
"--Capital Requirements" and "The Company--Regulatory Agreements."
Assuming gross proceeds from the Public Offering and the Private Offering of
between $8.0 million and $9.0 million, management anticipates downstreaming
sufficient capital (i.e., approximately $2.5 million) from the Company to
the Bank to comply with the capital requirements of the 1995 Formal
Agreement and the 1995 MOU and to implement the Bank's business strategy and
retaining the balance of the proceeds, if any, at the Company to be used for
general corporate purposes, including possible strategic acquisitions. See
"Reasons for the Offerings and Use of Proceeds."
. Resolving Litigation. The Company entered into a settlement agreement
relating to a lawsuit against the Bank. The total amount of the settlement
of $1.0 million was accrued in the quarter ended June 30, 1996 and was
reflected in the consolidated statement of operations for the year ended
December 31, 1996. The settlement was originally conditioned on the
recapitalization of the Bank on or before March 31, 1997. However, the
Company and all affected parties agreed to a single payment of the
settlement on a discounted lump sum basis, which payment was made prior to
December 31, 1996. See "Business--Legal Proceedings--Other Litigation."
USE OF PROCEEDS
The primary purposes of the Public Offering and the Private Offering are to
enable the Company to downstream sufficient capital, approximately $2.5
million, regardless of whether the minimum or maximum amount is raised in the
Public Offering and the Private Offering, to the Bank to enable it to comply
with the requirements of the 1995 Formal Agreement and the 1995 MOU, and to
facilitate the Company's and Bank's business strategies. The Company
established the Minimum Condition of $5.5 million for such purposes and to make
the Public Offering and the Private Offering cost effective. See "The Company--
Business Strategy" and "--Regulatory Agreements." The Company anticipates that
the net proceeds contributed to the Bank will ultimately be invested in
interest earning assets. The immediate use of proceeds retained by the Company
will be for general corporate purposes, including possible strategic
acquisitions and to establish a fixed income investment securities portfolio.
The Company has no current understandings or agreements, is not presently
negotiating any such acquisitions and currently is not able to effect any
acquisitions due to regulatory constraints. Proceeds from the Public Offering
and the Private Offering will not be used to pay dividends on the Preferred
Stock. The terms of the Preferred Stock provide that dividends may be paid
commencing July 1, 1999. Notwithstanding the foregoing, the Company may not pay
dividends unless the Bank is in full compliance with federal regulatory capital
requirements, the Company and the Bank are permitted to pay dividends by their
7
<PAGE>
regulators and the Company has adequate retained earnings in accordance with
California law. At present, the Company is prohibited by the terms of the 1995
MOU from declaring or paying a dividend without prior approval of the Reserve
Bank and does not have adequate retained earnings to declare a dividend in
accordance with California law. The Company cannot assess at this time its
ability to pay dividends in the immediate future. See "Risk Factors--
Restrictions on Preferred Stock Dividends," and "The Company--Regulatory
Agreements."
RISK FACTORS
THE PURCHASE OF PREFERRED STOCK IN THE PUBLIC OFFERING INVOLVES A SIGNIFICANT
DEGREE OF INVESTMENT RISK. RIGHTS HOLDERS AND OTHER PROSPECTIVE PURCHASERS
SHOULD CAREFULLY CONSIDER THE INFORMATION SET FORTH UNDER THE HEADING "RISK
FACTORS" WHICH FOLLOWS THIS SUMMARY, BEGINNING ON PAGE 21.
THE PRIVATE OFFERING
Securities Offered..........
The Company offered and guaranteed the
availability of, pursuant to a private offering
exemption from the registration requirements of
the Securities Act, a minimum of $2.5 million
(250,000 shares) of Preferred Stock to the
Private Purchasers ($2,250,000 for the Conrad
Company and $250,000 for Wildwood Enterprises
Inc. Profit Sharing Plan and Trust ("Wildwood
Enterprises")). The Private Purchasers have
agreed to purchase a maximum of $5.5 million
(550,000 shares) of Preferred Stock ($4,950,000
for the Conrad Company and $550,000 for Wildwood
Enterprises), at the Private Purchasers Price.
See "The Private Offering."
Private Purchase
Agreements................. The Company has entered into Private Purchase
Agreements with the Private Purchasers. The
Private Purchase Agreements impose on the Company
material indemnification obligations in certain
events. See "The Private Offering--Private
Purchase Agreements." The Private Purchase
Agreements also set forth certain conditions
which must be met to complete the Private
Offering. See "The Private Offering--Conditions
to the Closing; Amendment and Termination."
Private Purchasers.......... The Private Purchasers are Conrad Company, a bank
holding company which is controlled by Carl
Pohlad, and Wildwood Enterprises. In connection
with its purchase of Preferred Stock in the
Private Offering, Conrad Company is required to
seek approval from the Board of Governors of the
Federal Reserve System to purchase more than 4.9%
of the voting stock of the Company.
Private Purchasers Minimum
Obligation................. The Company has guaranteed the availability, and
will sell an aggregate minimum, of $2.5 million
(250,000 shares) of Preferred Stock to the
Private Purchasers if the Basic Subscription
Privilege is exercised in full by the Rights
Holders, subject to certain conditions. See "The
Private Offering--The Private Offering."
Maximum Private Offering....
The Company will sell up to an aggregate maximum
of $5.5 million (550,000 shares) of Preferred
Stock to the Private Purchasers, subject to
reduction by the Company to reduce the risk that
certain tax benefits will be subject to
limitation under Section 382 of the Code
("Section 382"). See "Certain Federal Income Tax
Consequences."
8
<PAGE>
THE PUBLIC OFFERING
Securities Offered..........
The Company is offering in the Public Offering a
minimum of $2.5 million and a maximum of
$8.0 million of Preferred Stock. A total of
550,000 Underlying Preferred Shares are being of-
fered in the Public Offering pursuant to the ex-
ercise of Rights, which includes the Basic Sub-
scription Privilege, the Oversubscription Privi-
lege and the Standby Purchaser Offering. See "The
Rights Offering--Minimum Condition" and "--Sub-
scription Privileges." In addition, the Standby
Purchasers have agreed to purchase and the Com-
pany has guaranteed the availability of an aggre-
gate minimum of $1.0 million (100,000 shares) of
Preferred Stock at the Subscription Price if, as
a result of the exercise of the Basic Subscrip-
tion Privilege, the consummation of the Private
Offering and the Oversubscription Privilege, an
aggregate of $8.0 million of Preferred Stock has
been sold. See "The Standby Purchasers."
Once the Rights are distributed and until the Ex-
piration Time, other than the Reverse Stock Split
discussed below, the Company will not effect a
reclassification of the Company's equity securi-
ties which could have the effect of materially
altering the value of the Rights during the pen-
dency of the Rights Offering.
Basic Subscription
Privilege.................. Shareholders of record of the Company's Common
Stock at the close of business on the Record Date
will receive one nontransferable Right for each
share of Common Stock held as of the Record Date.
Each Right will entitle the Rights Holder to sub-
scribe for 1.624 Underlying Preferred Shares at
the Subscription Price. No fractional Rights will
be issued. Fractional Rights will be "rounded up"
to the next nearest whole number. ONCE A RIGHT
HAS BEEN PROPERLY EXERCISED, IT CANNOT BE RE-
VOKED.
Oversubscription Privilege.. Each Rights Holder who elects to exercise the
Basic Subscription Privilege in full also will be
eligible to subscribe at the Subscription Price
for 0.376 shares of Preferred Stock (the "Excess
Underlying Preferred Shares"), for each Right
held, that are not otherwise subscribed for
pursuant to the exercise of the Basic
Subscription Privilege and are not purchased by
the Private Purchasers pursuant to the terms of
the Private Offering (i.e., an aggregate of
$8.0 million of Preferred Stock has not been
purchased by the shareholders pursuant to the
Basic Subscription Privilege and the Private
Purchasers pursuant to the Private Offering),
subject to availability, proration and reduction
by the Company under certain circumstances. If an
insufficient number of Excess Underlying
Preferred Shares is available to satisfy fully
all exercises of the Oversubscription Privilege,
then the available Excess Underlying Preferred
Shares will be prorated among Rights Holders who
exercise their Oversubscription Privilege based
upon the respective number of shares of Common
Stock owned as of the Record Date, and all excess
payments shall be returned by mail without
interest
9
<PAGE>
or deduction promptly after the Expiration Time
and after all prorations and adjustments
contemplated by the Public Offering and the
Private Offering have been effected.
Oversubscription Privileges are not transferable.
If 45.5% of the Basic Subscription Privilege is
exercised by the Rights Holders, and assuming
$5.5 million of Preferred Stock is sold pursuant
to the Private Offering, participation in the
Oversubscription Privilege will not be available
to the Rights Holders.
Standby Purchasers.......... The Company has entered into Standby Purchase
Agreements pursuant to which the Standby Purchas-
ers have severally agreed to purchase up to $2.5
million (250,000 shares) of Preferred Stock at
the Subscription Price to the extent available
after exercise of the Basic Subscription Privi-
lege, the consummation of the Private Offering
and the exercise of the Oversubscription Privi-
lege. The Company has guaranteed the availability
of the Minimum Standby Obligation if as a result
of the exercise of the Basic Subscription Privi-
lege, the consummation of the Private Offering
and the exercise of the Oversubscription Privi-
lege, an aggregate of $8.0 million (800,000
shares) of Preferred Stock have been sold.
Reasons for the Public
Offering and the Private
Offering................... The Board of Directors decided to conduct both
the Private Offering and the Public Offering (i)
to minimize the dilutive effect of the Private
Offering and the Standby Purchaser Offering to
current shareholders and (ii) to ensure, through
the Private Offering, that the Company would ob-
tain sufficient capital to meet bank regulatory
requirements and (iii) to finance the Company's
business strategy in the event the Company's
shareholders chose not to participate in the
Rights Offering.
Transferability of Rights... THE RIGHTS ARE NOT TRANSFERABLE.
Record Date................. May 5, 1997
Subscription Price.......... $10.00 per share. Shares purchased by the Private
Purchasers will be purchased at the Subscription
Price. Shares purchased by Standby Purchasers
pursuant to the Standby Purchase Agreements shall
be at the Subscription Price. See "The Rights Of-
fering--Subscription Price."
Expiration Time............. The Rights will expire if not exercised prior to
5:00 p.m., Pacific Time, on June 13, 1997, unless
extended in the sole discretion of the Company.
The number and length of any such extensions will
be set at the time of any such extension. See
"The Rights Offering--Expiration Time." RIGHTS
NOT EXERCISED PRIOR TO THE EXPIRATION TIME WILL
EXPIRE AND BECOME WORTHLESS.
Preferred Stock
Outstanding................ No shares of Preferred Stock are currently out-
standing. Giving effect to the Maximum Private
Offering and the Maximum Standby Offering, a min-
imum of 800,000 shares of Preferred Stock will be
outstanding after the completion of the Public
Offering and the Private Offering. Giving effect
to the exercise in full of the Basic Subscription
Privilege, the Private Purchasers Minimum Obliga-
tion and the
10
<PAGE>
Minimum Standby Obligation, a maximum of 900,000
shares of Preferred Stock will be outstanding af-
ter the completion of the Public Offering and the
Private Offering. Rights Holders may experience
substantial dilution of their equity ownership
interest and voting power in the Company if they
do not exercise the Basic Subscription Privilege
and the Oversubscription Privilege. Even if
Rights Holders exercise their Basic Subscription
Privilege and Oversubscription Privilege in full,
they will experience dilution due to the Private
Purchasers Minimum Obligation and the Minimum
Standby Obligation. See "Risk Factors--Dilution
of Ownership Interest," "Dilution," and "Busi-
ness--Legal Proceedings."
Subscription Agent.......... U.S. Stock Transfer Corporation
Information Agent........... Kissel-Blake Inc.
Financial Advisor........... The Company and Sandler O'Neill have entered into
an agreement pursuant to which Sandler O'Neill is
acting as the Company's financial advisor in con-
nection with the Public Offering and the Private
Offering. The Company has agreed to pay certain
fees to, and expenses of, Sandler O'Neill for its
services in the Public Offering and the Private
Offering. See "The Rights Offering--Financial Ad-
visor."
Procedure for Exercising
Rights..................... The Basic Subscription Privilege and the
Oversubscription Privilege may be exercised by
properly completing the Subscription Right Cer-
tificate distributed to each Rights Holder with
this Prospectus and forwarding it (or following
the Guaranteed Delivery Procedures, as defined
below) with payment of the Subscription Price for
each Underlying Share subscribed for pursuant to
the Basic Subscription Privilege and the
Oversubscription Privilege, to the Subscription
Agent, which must receive such Subscription Right
Certificate or Notice of Guaranteed Delivery and
payment at or prior to the Expiration Time. If
Subscription Right Certificates are sent by mail,
Rights Holders are urged to use insured, regis-
tered mail, return receipt requested. See "The
Rights Offering--Method of Subscription."
If the aggregate Subscription Price paid by an
exercising Rights Holder is insufficient to pur-
chase the number of Underlying Preferred Shares
that the Rights Holder indicates are being sub-
scribed for, or if no number of Underlying Pre-
ferred Shares to be purchased is specified, then
the Rights Holder will be deemed to have exer-
cised the Basic Subscription Privilege to pur-
chase Underlying Preferred Shares to the full ex-
tent of the payment price tendered. If the aggre-
gate Subscription Price paid by an exercising
Rights Holder exceeds the amount necessary to
purchase the number of Underlying Preferred
Shares for which the Rights Holder has indicated
an intention to subscribe, then the Rights Holder
will be deemed to have exercised the
Oversubscription Privilege to the full extent of
the excess payment tendered.
11
<PAGE>
ONCE A RIGHTS HOLDER HAS EXERCISED THE BASIC SUB-
SCRIPTION PRIVILEGE OR THE OVERSUBSCRIPTION PRIV-
ILEGE, SUCH EXERCISE MAY NOT BE REVOKED. RIGHTS
NOT EXERCISED PRIOR TO THE EXPIRATION DATE WILL
EXPIRE AND BECOME WORTHLESS.
Persons Holding Common
Stock, or Wishing to
Exercise Rights, Through
Others..................... Persons holding shares of Common Stock benefi-
cially and receiving the Rights issuable with re-
spect thereto, through a broker, dealer, commer-
cial bank, trust company or other nominee, as
well as persons holding certificates for Common
Stock directly who would prefer to have such in-
stitutions effect transactions relating to the
Rights on their behalf should contact the appro-
priate institution or nominee and request it to
effect such transaction for them. See "The Rights
Offering--Method of Subscription--Exercise of
Rights."
Minimum Condition........... The Public Offering and the Private Offering are
conditioned upon the receipt of minimum offering
proceeds of $5.5 million. In the event the Mini-
mum Condition is not achieved, any funds that
have been deposited with the Subscription Agent
will be returned promptly, without interest. As a
result of the Private Purchase Agreements and
Standby Purchase Agreements, pursuant to which
the Private Purchasers and the Standby Purchasers
have agreed to acquire in the aggregate $8.0 mil-
lion of Preferred Stock (subject to reduction to
avoid certain adverse tax consequences), the Com-
pany believes that the Minimum Condition will be
satisfied.
Federal Income Tax
Consequences............... For United States federal income tax purposes,
receipt of Rights by a Rights Holder pursuant to
the Rights Offering should be treated as a
nontaxable distribution with respect to the
Common Stock. See "Certain Federal Income Tax
Consequences."
Issuance of Preferred
Stock...................... Certificates representing shares of Preferred
Stock purchased pursuant to the exercise of the
Rights pursuant to the Basic Subscription
Privilege and the Oversubscription Privilege will
be delivered to subscribers as soon as
practicable after the Expiration Time and after
all prorations and adjustments contemplated by
the terms of the Public Offering and the Private
Offering have been effected.
The Regulatory Limitation... The Company will not be required to issue
Preferred Stock pursuant to the exercise of the
Basic Subscription Privilege, the
Oversubscription Privilege or the Standby
Purchase Agreements to any Rights Holder or to
any Standby Purchaser who, in the opinion of the
Company, could be required to obtain prior
clearance or approval from or submit a notice to
any state or federal bank regulatory authority to
acquire, own or control such shares if, at the
Expiration Time, such clearance or approval has
not been obtained or any required waiting period
has not expired. If the Company elects not to
issue shares of Preferred Stock in such case,
such shares
12
<PAGE>
will become available to Rights Holders, the
Private Purchasers or Standby Purchasers as to
whom such conditions do not apply. See "The
Rights Offering--Limitations--The Regulatory
Limitation."
The Tax Limitation.......... The number of Underlying Preferred Shares
issuable by the Company as a result of exercises
of the Basic Subscription Privilege and the
Oversubscription Privilege in the aggregate to
any Rights Holder or the issuance of shares to
the Private Purchasers or the Standby Purchasers
shall be limited, with certain exceptions, by the
Company, if necessary, in its sole judgment and
discretion, to reduce the risk that certain tax
benefits will be subject to limitation under
Section 382 (the "Section 382 Limitation"), or
the risk of any other adverse tax consequences to
the Company, either at the time of the Public
Offering and the Private Offering or at any
subsequent time. Based on current circumstances,
the Company does not anticipate that it will have
to reduce the number of shares to any Rights
Holder or to the Private Purchasers or Standby
Purchasers to avoid an adverse effect upon the
Company's ability to utilize any federal and
state income tax benefits. See "The Rights
Offering--Limitations--Tax Limitation."
The Transfer Limitation.....
As part of the Company's efforts to avoid the
Section 382 Limitation on the use of its existing
tax net operating loss ("NOLs") carryforwards,
the terms of the Preferred Stock as reflected in
the Company's Amended and Restated Articles of
Incorporation (the "Restatement") shall prohibit,
and the certificates evidencing the Preferred
Stock and the shares of Common Stock issued upon
conversion of the Preferred Stock will contain a
legend prohibiting, transfer of such Preferred
Stock or Common Stock to any person (other than
persons to whom the Company is contractually
obligated on or before the date of issuance (the
"Date of Issuance") of the Preferred Stock in the
Public Offering and the Private Offering to
transfer up to 4.9% of the Company's stock) if
such person is or would become by reason of such
transfer the beneficial owner of 4.5% or more (or
4.9% as described above) (a "4.5% Holder") of
shares of the Company's stock, as the term is
defined, and such ownership is determined, under
Section 382 (the "NOL Transfer Restriction"). The
NOL Transfer Restriction and the legend will not
restrict future transfers (up to 4.9%) by any
holder to those persons to whom the Company is
contractually obligated on or before the Date of
Issuance to transfer up to 4.9% of the Company's
stock. The Restatement also will impose the NOL
Transfer Restriction on shares of Common Stock
currently outstanding and those issued upon
conversion of the Preferred Stock or otherwise
issued by the Company in the future. The Company
has the right to demand that any stock
transferred in violation of the NOL Transfer
Restriction (the "Transferred Stock") be
transferred to the Company and any distributions
received on the Transferred Stock be remitted to
the Company. In addition, the Company has the
right to demand remittance of
13
<PAGE>
proceeds received from such initial transfer. The
Company shall sell the Transferred Stock in an
arm's length transaction and remit the proceeds
thereof to the original shareholder. The NOL
Transfer Restriction expires (i) on or after
three years from the Date of Issuance of the
Preferred Stock in the Public Offering and the
Private Offering or (ii) upon the occurrence of
any transaction in which holders of all
outstanding shares of capital stock of the
Company receive, or are offered the opportunity
to receive, cash, stock or other property for all
such shares and upon the consummation of which
the acquiror will own at least a majority of the
outstanding shares of capital stock. In addition,
the Board of Directors of the Company is
expressly empowered to waive application of the
Transfer Restriction to any specific transaction,
provided that such waiver is by resolution of the
Board of Directors duly considered and approved
by at least a majority of the Board of Directors
prior to any such transfer of stock. See "Risk
Factors--Restrictions on Transfer" and "The
Rights Offering-- Limitations--Transfer
Limitation."
Dividends................... Proceeds from the Public Offering and the Private
Offering will not be used to pay dividends on the
Preferred Stock. The Company's primary source of
funds for the payment of dividends on the
Preferred Stock will be dividends received from
the Bank and earnings (if any) on proceeds from
the Public Offering and the Private Offering
retained by the Company. Both the Bank's ability
to pay dividends to the Company and the Company's
ability to pay dividends on the Preferred Stock
are subject to significant regulatory and state
law restrictions. See "Risk Factors--Restrictions
on Preferred Stock Dividends." The terms of the
Preferred Stock provide that dividends may be
paid commencing two years after the Date of
Issuance. Generally, the Preferred Stock has
preference over the payment to or declaration of
dividends in respect of stock ranking junior to,
and places certain restrictions on dividends in
respect to stock ranking on a parity with, the
Preferred Stock. Notwithstanding the foregoing,
the Company may not pay dividends unless the Bank
is in full compliance with federal regulatory
capital requirements and is permitted by the OCC
to pay dividends to the Company, the Company is
permitted by the Reserve Bank to pay dividends
and the Company has sufficient retained earnings
under California law to pay dividends. When
payable, dividends on the Preferred Stock will be
paid at the stated rate of 6.5% per share per
annum, quarterly, in arrears, in cash. Dividends
on the Preferred Stock are not cumulative. See
"Description of Capital Stock--Preferred Stock--
Dividends." The Company cannot assess at this
time its ability to pay dividends in the
immediate future.
Conversion.................. Each share of the Preferred Stock will be
immediately convertible at the option of the
holder thereof into shares of Common Stock at an
initial rate of one share of Common Stock per
share of Preferred Stock based on an initial
conversion price of $10.00 per share which shall
be subject to adjustment upon the occurrence of
certain dilutive and other events. See
"Description of Capital Stock--Preferred Stock--
Conversion."
14
<PAGE>
Voting Rights............... Each holder of Preferred Stock is entitled to
that number of votes on all matters submitted to
the shareholders that is equal to the number of
shares of Common Stock into which such holder's
shares of Preferred Stock are then convertible.
The holders of the Preferred Stock will vote
together with the holders of the Common Stock as
a single class on all matters except the
Preferred Stock will have a separate class vote
on (i) matters as to which California law
requires a separate class vote of Preferred Stock
and (ii) any action to (a) authorize any
additional shares of Preferred Stock or authorize
or issue shares of capital stock having priority
over or ranking on parity with the Preferred
Stock, (b) amend, alter or repeal any of the
provisions of the Restatement or adopt any
Certificate of Designation with respect to any
class or series of capital stock so as to
adversely affect the rights, preferences and
privileges relating to the Preferred Stock or the
holders thereof, or waive any of the rights
granted to the holders of the Preferred Stock,
(c) amend, alter or repeal any of the provisions
of the Restatement, or the bylaws, of the Company
with respect to the election of directors by
cumulative voting or (d) the issuance of any
authorized shares of Preferred Stock except in
connection with the Public Offering and the
Private Offering or the Warrant (as defined
herein). See "Description of Capital Stock."
Redemption.................. The Preferred Stock will be redeemable by the
Company, in whole or in part, at the option of
the Company at any time after three years after
the Date of Issuance (the "Beginning Redemption
Date"), at a redemption price per share in cash
equal to 105% of the original purchase price of
$10.00 per share, plus declared but unpaid divi-
dends. The applicable percentage of the original
purchase price will decline by one percentage
point every anniversary of the Beginning Redemp-
tion Date thereafter until five years after the
Beginning Redemption Date and thereafter when the
Preferred Stock may be redeemed at 100% of the
original purchase price per share, plus declared
but unpaid dividends.
There is no sinking fund requirement for redemp-
tion of the Preferred Stock. See "Description of
Capital Stock--Preferred Stock--Redemption Option
of the Company."
Liquidation Preference...... Each share of Preferred Stock will have a liqui-
dation preference of $10.00 per share plus de-
clared but unpaid dividends, but subordinated to
any and all indebtedness of the Company and the
Bank, including deposits. See "Description of
Capital Stock--Preferred Stock--Liquidation
Rights."
No Board or Financial
Advisor Recommendations.... An investment in the Preferred Stock must be made
pursuant to each investor's evaluation of such
investor's best interests. ACCORDINGLY, NEITHER
THE BOARD OF DIRECTORS OF THE COMPANY NOR SANDLER
O'NEILL MAKES ANY RECOMMENDATION TO RIGHTS HOLD-
ERS OR STANDBY PURCHASERS REGARDING WHETHER THEY
SHOULD EXERCISE THEIR RIGHTS OR OTHERWISE PUR-
CHASE PREFERRED STOCK.
15
<PAGE>
Nasdaq Stock Market Symbol
for Common Stock........... "MBLA"
Nasdaq Stock Market for
Preferred Stock............ The Company intends to file an application to
have the Preferred Stock approved for quotation
on the Small Cap tier of the Nasdaq Stock Market
if there are an adequate number of publicly held
shares of Preferred Stock to meet the require-
ments of Nasdaq. No assurance can be made that
such application will be approved. See "Risk Fac-
tors--Absence of Market for the Preferred Stock."
Nasdaq Stock Market Symbol
for Preferred Stock........ "MBLAP"
Right to Terminate Public
Offering................... The Company expressly reserves the right, in its
sole and absolute discretion, at any time prior
to delivery of the shares of Preferred Stock of-
fered hereby, to terminate the Public Offering if
the Public Offering is prohibited by law or regu-
lation or the Board of Directors concludes, in
its judgment, that it is not in the best inter-
ests of the Company, and its shareholders, to
complete the Public Offering under the circum-
stances. The Company will terminate the Public
Offering in the event that (i) the Company does
not receive minimum proceeds of $5.5 million from
the Public Offering and the Private Offering,
(ii) the Reverse Stock Split is not approved by
the Company's shareholders, (iii) the NOL Trans-
fer Restriction is not approved by the Company's
shareholders or (iv) the terms and conditions of
the Preferred Stock are not approved by the
Company's shareholders. If the Public Offering is
terminated, all funds received pursuant to the
Public Offering will be promptly refunded, with-
out interest.
Shareholder Approval........ The Annual Meeting of Shareholders will be held
on June 18, 1997 at 7:00 p.m. at Mercantile
National Bank, 1840 Century Park East, Main
Floor, Los Angeles, California (the "Annual
Meeting"). At the Annual Meeting, shareholders
will be asked to vote on, among other things, (i)
the election of directors; (ii) approval of the
Reverse Stock Split, (iii) approval of the NOL
Transfer Restriction and (iv) approval of the
terms and conditions of the Preferred Stock. A
separate proxy statement is being sent to Record
Holders with respect to the Annual Meeting. No
assurance can be made that the Reverse Stock
Split, NOL Transfer Restriction or terms and
conditions of the Preferred Stock will be
approved by the requisite vote of the Company's
shareholders.
16
<PAGE>
SUMMARY SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
The following table presents selected consolidated financial and other data
of the Company for each of the years in the five years ended December 31, 1996.
The data as of and for each of the five years in the period ended December 31,
1996 should be read in conjunction with, and is qualified in its entirety by,
the more detailed information included elsewhere in this Prospectus, including
the Company's audited Consolidated Financial Statements and the Notes thereto.
<TABLE>
<CAPTION>
AT DECEMBER 31,
----------------------------------------------------------
1996 1995 1994 1993 1992
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Assets................. $ 109,416 $ 131,992 $ 232,979 $ 303,120 $ 351,638
Securities............. 18,630 20,417 62,056 83,674 101,233
Loans receivable....... 62,547 82,012 115,284 161,791 175,736
Allowance for credit
losses................ 2,969 3,805 3,063 6,697 6,009
Deposits:
Interest-bearing
demand, money market
accounts and savings.. 28,454 28,565 44,363 61,876 73,663
Noninterest-bearing de-
mand.................. 34,752 44,579 87,430 110,607 141,849
Time certificates of
deposit............... 40,648 47,099 76,022 96,363 92,724
---------- ---------- ---------- ---------- ----------
Total deposits......... 103,854 120,243 207,815 268,846 308,236
---------- ---------- ---------- ---------- ----------
Shareholders' equity... 4,845 6,011 10,308 22,199 21,601
Book value per
share(1).............. 1.57 1.95 3.35 7.29 7.12
Book value per
share(2).............. 14.31 17.75 30.44 66.28 64.69
Shares of common stock
outstanding(1)........ 3,078,146 3,078,146 3,078,146 3,044,446 3,035,379
Shares of common stock
outstanding(2)........ 338,630 338,630 338,630 334,923 333,925
CONSOLIDATED CAPITAL RA-
TIOS:
Tier 1 risk-based...... 6.96% 6.96% 9.84% 11.94% 9.85%
Total risk-based....... 8.25% 8.25% 11.11% 13.25% 11.12%
Leverage............... 4.68% 4.68% 5.65% 7.11% 7.39%
ASSET QUALITY:
Nonaccrual loans....... $ 928 $ 573 $ 3,426 $ 7,780 $ 6,316
Troubled debt
restructurings........ 5,016 5,167 5,582 5,584 5,043
Loans contractually
past due 90 or more
days with respect to
either principal or
interest and still
accruing interest..... 300 221 1,507 2,502 47
---------- ---------- ---------- ---------- ----------
Total nonperforming
loans................ 6,244 5,961 10,515 15,866 11,406
Other real estate
owned(3).............. 556 581 1,529 6,175 5,613
---------- ---------- ---------- ---------- ----------
Total nonperforming as-
sets.................. 6,800 6,542 12,044 22,041 17,019
ASSET QUALITY RATIOS:
Nonaccrual loans to to-
tal assets............ 0.8% 0.4% 1.5% 2.6% 1.8%
Nonaccrual assets to
total assets(4)....... 1.4% 0.9% 2.1% 4.6% 3.4%
Allowance for credit
losses to nonaccrual
loans................. 319.9% 664.0% 89.4% 86.1% 95.1%
Allowance for credit
losses to nonaccrual
assets(4)............. 200.1% 329.7% 61.8% 48.0% 50.4%
Classified assets to
allowance for credit
losses plus
shareholders' equity.. 106.2% 79.1% 149.2% 139.4% 156.7%
Classified assets to
allowance for credit
losses plus
shareholders'
equity(5)............. 43.9% 29.5% 112.8% 122.5% 139.1%
OTHER DATA:
Full-time equivalent
employees............. 44 52 61 92 113
</TABLE>
(continued on following page)
17
<PAGE>
<TABLE>
<CAPTION>
FOR THE YEAR
ENDED DECEMBER 31,
-------------------------------------------------------------
1996 1995 1994 1993 1992
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF INCOME
DATA:
Net interest income.... $ 5,678 $ 7,655 $ 15,374 $ 14,692 $ 14,956
Provision for credit
losses................ -- 2,307 7,330 2,000 3,050
Other operating (loss-
es) income............ 502 (1,315) (2,857) 1,474 2,140
Other operating ex-
penses(6)............. 8,003 11,233 13,714 14,058 17,014
---------- ---------- ---------- ---------- ----------
(Loss) Income before
income taxes and
cumulative effect of
change in accounting
principle............. (1,823) (7,200) (8,527) 108 (2,968)
Income tax benefit..... (579) -- -- -- --
Cumulative effect of
change in accounting
principle............. -- -- -- 63 --
---------- ---------- ---------- ---------- ----------
Net (loss) income...... $ (1,244) $ (7,200) $ (8,527) $ 171 $ (2,968)
========== ========== ========== ========== ==========
PER SHARE DATA:
(Loss) income per share
before income taxes
and cumulative effect
of change in
accounting
principle(7).......... $ (0.59) $ (2.34) $ (2.79) $ 0.03 $ (0.98)
(Loss) income per share
before income taxes
and cumulative effect
of change in
accounting
principle(2).......... (5.38) (21.26) (25.37) 0.31 (8.89)
Net (loss) income per
share (fully
diluted)(7)........... (0.40) (2.34) (2.79) 0.05 (0.98)
Net (loss) income per
share (fully
diluted)(2)........... (3.67) (21.26) (25.37) 0.49 (8.89)
Weighted average shares
outstanding(7)........ 3,078,146 3,078,146 3,055,584 3,041,268 3,035,379
Weighted average shares
outstanding(2)........ 338,630 338,630 336,148 334,573 333,925
SELECTED PERFORMANCE
RATIOS:
(Loss) return on
average shareholders'
equity................ (22.16)% (79.71)% (44.68)% 0.79% (12.04)%
(Loss) return on aver-
age assets............ (1.11)% (4.82)% (3.47)% 0.06% (1.01)%
Other operating expense
to average assets(8).. 6.24 % 7.52 % 5.58 % 4.83% 5.78 %
Net interest margin.... 5.31 % 5.52 % 6.77 % 5.56% 5.53 %
</TABLE>
- -------
(1) Does not give effect to outstanding options and warrants to purchase Common
Stock. See "Dilution."
(2) Pro forma after giving effect to the Reverse Stock Split.
(3) Includes other real estate owned ("OREO") acquired by the Bank through
legal foreclosure or deed-in-lieu of foreclosure and loans classified as
in-substance foreclosures.
(4) Nonaccrual assets include nonaccrual loans plus OREO.
(5) Excludes one loan, a trouble debt restructuring, with a principal balance
of $4.9 million at December 31, 1996, 1995, 1994, 1993 and 1992,
respectively. This loan is secured by a first deed of trust on a single-
family residence which, as of December 1996, had an appraised value of
$10.0 million.
(6) Includes a $1.0 million legal settlement for the year ended December 31,
1996. See "Business--Legal Proceedings--Other Litigation."
(7) The weighted average number of shares of Common Stock outstanding for the
years ended December 31, 1996, 1995 and 1994 was used to compute loss per
share data as the use of average shares outstanding including Common Stock
equivalents would be antidilutive. The weighted average number of shares
used to compute fully diluted earnings per share in 1993 and 1992 was
3,171,250 and 3,035,660, respectively. The weighted average number of
shares used to compute (loss) income per share does not give effect to the
proposed 9.09 to one reverse stock split.
(8) Excluding a $1.0 million legal settlement for the year ended December 31,
1996.
18
<PAGE>
SUMMARY OF RECENT DEVELOPMENTS
The following tables set forth certain unaudited financial data at March 31,
1997 and for the three months ended March 31, 1997 and 1996. The data at March
31, 1997 and for the three months ended March 31, 1997 and 1996 is derived from
the unaudited financial statements of the Company. In the opinion of
management, such unaudited financial statements have been prepared on the same
basis as the audited financial statements, and include all adjustments,
consisting solely of normal recurring adjustments, necessary for a fair
statement of the results for the unaudited interim periods. Results for the
three months ended March 31, 1997 should not be considered necessarily
indicative of the results to be expected for the full year. The information
presented below is qualified in its entirety by the detailed information and
financial statements included elsewhere in this Prospectus and should be read
in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations," "Business" and the audited consolidated
financial statements of the Company and notes thereto appearing elsewhere in
this Prospectus.
<TABLE>
<CAPTION>
AT AT
MARCH 31, DECEMBER 31,
1997 1996
----------- ------------
(UNAUDITED)
<S> <C> <C>
BALANCE SHEET DATA:
Assets............................................. $ 102,768 $ 109,416
Securities......................................... 24,612 18,630
Loans receivable................................... 59,949 62,547
Allowance for credit losses........................ 2,646 2,969
Deposits:
Interest-bearing demand, money market accounts
and savings..................................... 27,890 28,454
Noninterest-bearing demand....................... 35,121 34,752
Time certificates of deposit..................... 34,152 40,648
Total deposits..................................... 97,163 103,854
Shareholders' equity............................... 4,672 4,845
Shares of common stock outstanding................. 3,078,146 3,078,146
Period end book value per share.................... $ 1.50 $ 1.57
CONSOLIDATED CAPITAL RATIOS:
Tier 1 risk based.................................. 7.11% 6.96%
Total risk based................................... 8.39% 8.25%
Leverage........................................... 4.64% 4.68%
ASSET QUALITY:
Nonaccrual loans................................... $ 871 $ 928
Nonperforming assets............................... 6,408 6,800
ASSET QUALITY RATIOS:
Nonaccrual loans to total assets................... 0.8% 0.8%
Nonaccrual assets to total assets.................. 1.4% 1.4%
Allowance for credit losses to nonaccrual loans.... 303.8% 319.9%
Allowance for credit losses to nonaccrual assets... 190.4% 200.1%
</TABLE>
<TABLE>
<CAPTION>
FOR THE THREE MONTHS
ENDED MARCH 31,
-----------------------
1997 1996
---------- ----------
<S> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net interest income................................ $ 1,304 $ 1,453
Provision for credit losses........................ -- --
Other operating income............................. 118 168
Other operating expense............................ 1,557 1,757
Loss before taxes.................................. (135) (136)
Income tax benefit................................. -- --
Net loss........................................... (135) (135)
SELECTED PERFORMANCE RATIOS:(1)
Return on average assets........................... (0.52)% (0.44)%
Return on average shareholders' equity............. (11.08)% (8.74)%
Other operating expense to average assets.......... 6.04 % 5.67 %
Net interest margin................................ 5.32 % 4.93 %
</TABLE>
- --------
(1) Ratios for the three months ended March 31, 1997 and 1996 are annualized.
19
<PAGE>
GENERAL
The Company recorded a net loss of $135,000 for the first quarter of 1997,
compared with a net loss of $136,000 for the first quarter of 1996. The
consistency in the loss for 1997 versus 1996 was primarily attributable to
reductions in net interest income and noninterest income offset by similar
reductions in noninterest expense.
Total nonperforming assets decreased to $6.4 million at March 31, 1997 from
$6.8 million at December 31, 1996. Classified assets at March 31, 1997
decreased to $7.8 million from $8.3 million at March 31, 1996. The Company
continues to aggressively pursue strategies for reducing nonperforming and
classified assets.
NET INTEREST INCOME
For the first quarter of 1997, net interest income decreased $149,000, or
10.3%, from the first quarter of 1996. Net interest income decreased primarily
due to the decrease in interest income exceeding the decrease in interest
expense. Interest income decreased $330,000, or 14.1%, due primarily to a $15.8
million or 20.9% decrease in loans. Investment securities (including federal
funds sold) decreased by $3.3 million or 8.1%. The impact on earnings of
reduced interest income was partially offset by a $181,000, or 20.3%, decrease
in interest expense the first quarter of 1997, compared with 1996. The decrease
resulted primarily from an $11.2 million, or 15.3%, decrease in interest
bearing deposits. Despite the decrease in interest income, net interest margin
improved from 4.93% to 5.32%, due primarily to improved yield on earning assets
and the decrease in interest bearing liabilities noted above.
PROVISION FOR LOAN LOSSES
As a result of management's periodic analysis of the adequacy of the
allowance for credit losses, there was no provision for credit losses for the
quarters ended March 31, 1997 and 1996. Recoveries on loans previously charged-
off during the first quarter of 1997 amounted to $126,000.
OTHER OPERATING INCOME
Other operating income decreased $50,000 in the first quarter of 1997
compared with the first quarter of 1996, primarily because of a reduction in
investment service income due to the restructuring of the Investment Service
Division in 1996. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Other Operating Income."
OTHER OPERATING EXPENSES
Other operating expenses decreased $200,000 during the first quarter of 1997
compared with the first quarter of 1996, primarily due to a $141,000 decrease
in professional services as a result of reductions of the use of outside
consultants and the streamlining of operating functions.
DEPOSITS
Total deposits decreased to $97.2 million at March 31, 1997 from $103.9
million at December 31, 1996, primarily as a result of a reduction of
$6.5 million in time certificate of deposits.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1997, the Company's and the Bank's Tier 1 risk based capital
ratios were 7.11% and 7.10%, respectively, total risk based capital ratios were
8.39% and 8.38%, respectively, and leverage ratios were 4.64% and 4.63%,
respectively. The Bank is not in compliance with the requirements of the Formal
Agreement that it achieve and maintain a leverage ratio of 6.50% and achieve
and maintain a Tier 1 risk based capital ratio of 10.00%. As of March 31, 1997,
$1,954,000 additional capital was necessary for the Bank to meet the capital
requirements of the Formal Agreement. See "Risk Factors--Regulatory Agreements
and Capital Requirements."
20
<PAGE>
RISK FACTORS
THE PURCHASE OF PREFERRED STOCK IN THE PUBLIC OFFERING INVOLVES A
SIGNIFICANT DEGREE OF INVESTMENT RISK. IN DETERMINING WHETHER TO MAKE AN
INVESTMENT IN THE PREFERRED STOCK, RIGHTS HOLDERS AND STANDBY PURCHASERS
SHOULD CAREFULLY CONSIDER THE MATTERS SET FORTH BELOW, AS WELL AS THE OTHER
INFORMATION CONTAINED HEREIN. CERTAIN MATTERS DISCUSSED IN THIS PROSPECTUS AND
THE DOCUMENTS INCORPORATED HEREIN BY REFERENCE MAY CONSTITUTE FORWARD-LOOKING
STATEMENTS WITHIN THE MEANING OF THE PRIVATE LITIGATION REFORM ACT OF 1995 AND
AS SUCH MAY INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES, AND OTHER FACTORS
WHICH MAY CAUSE THE ACTUAL RESULTS, PERFORMANCE, OR ACHIEVEMENTS OF THE
COMPANY TO BE MATERIALLY DIFFERENT FROM ANY FUTURE RESULTS, PERFORMANCE, OR
ACHIEVEMENT EXPRESSED OR IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS.
SPECIFICALLY, THE FOLLOWING IMPORTANT FACTORS COULD AFFECT THE COMPANY'S
BUSINESS AND CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED IN
ANY FORWARD-LOOKING STATEMENT MADE BY, OR ON BEHALF OF THE COMPANY IN THIS
PROSPECTUS: (1) GENERAL ECONOMIC CONDITIONS IN ITS MARKET AREA WHICH COULD
HAVE A MATERIAL ADVERSE IMPACT ON THE QUALITY OF THE BANK'S LOAN PORTFOLIO AND
THE DEMAND FOR ITS PRODUCTS AND SERVICES; (2) INTEREST RATES MAY VARY
SUBSTANTIALLY FROM PRESENT LEVELS AND RESULTS MAY DIFFER MATERIALLY FROM THE
RESULTS CURRENTLY ANTICIPATED; (3) THE BANKING INDUSTRY IS SUBJECT TO
EXTENSIVE FEDERAL AND STATE REGULATIONS, AND SIGNIFICANT NEW LAWS OR CHANGES
IN, OR REPEALS OF, EXISTING LAWS MAY CAUSE RESULTS TO DIFFER MATERIALLY; (4)
CIRCUMSTANCES AFFECTING THE NATURE OR LEVEL OF COMPETITION MAY CHANGE, SUCH AS
THE MERGER OF COMPETING FINANCIAL INSTITUTIONS OR THE ACQUISITION OF
CALIFORNIA INSTITUTIONS BY OUT-OF-STATE COMPANIES, AND RESULTS MAY DIFFER
MATERIALLY FROM THE RESULTS CURRENTLY ANTICIPATED; AND (5) LOSSES MAY BE
SUSTAINED BECAUSE BORROWERS, GUARANTORS AND RELATED PARTIES MAY FAIL TO
PERFORM IN ACCORDANCE WITH THE TERMS OF THEIR LOANS AND THE BANK'S POLICIES
AND PROCEDURES MAY NOT PREVENT UNEXPECTED LOSSES THAT COULD MATERIALLY
ADVERSELY AFFECT THE COMPANY'S RESULTS OF OPERATIONS AND FINANCIAL CONDITION.
RISK OF FAILURE TO EXECUTE BUSINESS STRATEGY
The Bank's business strategy represents a refinement of its historical focus
since it contemplates that the Bank will emphasize further its current market
niches of business and private banking and entertainment and will extend its
operations to include the closely related niche market of
technology/multimedia. As part of its business and private banking focus, the
Bank intends to increase its emphasis on medical banking relationships, taking
advantage of the proximity of several major hospital/medical centers and
numerous health services-related companies in West Los Angeles. There can be
no assurance, however, that the Company will be successful in maintaining or
increasing its access to these markets. In addition, part of the Company's
business strategy following the Public Offering and the Private Offering is to
acquire other financial service-related companies including "in-market"
acquisitions with banks of similar size and market presence. No assurance can
be made that such acquisitions can be made, or that the Company will be able
to obtain regulatory approval to make any acquisitions. The Company has no
current understandings or agreements and is not presently negotiating with
respect to any such acquisitions. Further, the Company's ability to execute
its business strategy depends upon many factors, including competitive and
economic conditions, such as the ability to retain qualified personnel, which
are beyond the Company's control. See "The Company--Business Strategy."
RISK OF CONTINUING LOSSES
The economic recession and substantial declines in real estate values in
Southern California, combined with certain operational deficiencies noted by
the Company's and the Bank's primary regulators, led to high levels of
nonperforming assets and net charge-offs from 1991 through 1996. The foregoing
factors significantly contributed to a decline in earnings experienced by the
Bank during that time, culminating with a net loss of $7.2 million or $21.26
per share (pro forma after giving effect to the Reverse Stock Split) for the
year ended December 31, 1995. The net loss for the year ended December 31,
1996 was $1.2 million or $3.67 per share (pro forma after giving effect to the
Reverse Stock Split), including a charge of $1.0 million for the settlement of
a pending lawsuit against the Bank. See "Business--Litigation." The ability of
management to restore the Bank to consistent profitability will depend on,
among other factors, its ability to increase the level of earning assets and
to continue to reduce and control the level of nonperforming assets and other
operating expenses. There can be no assurance that the Bank will be able to
achieve these objectives and thereby return the Bank to consistent
profitability and the Company is unable to assess at this time whether it will
return to profitability during 1997.
21
<PAGE>
ECONOMIC CONDITIONS IN THE COMPANY'S MARKET AREA
The Bank's business is subject to fluctuations in interest rates, general
national and local economic conditions and consumer and institutional
confidence in the Bank. Virtually all of the Bank's lending activities are
conducted in Southern California. The Southern California economy and real
estate market have suffered from the effects of a prolonged recession that has
had a substantial adverse impact on the Company and the Bank, affecting the
ability of certain borrowers of the Bank to repay their obligations to the
Bank. While the Southern California economy has recently shown signs of
recovery in certain segments, a continuation of the recession or a worsening
of economic conditions in the region or in the Bank's market areas could have
an adverse impact on the Company's operations and financial condition.
Fluctuations in economic conditions are neither predictable nor controllable
and may have materially adverse consequences on the Company's business, even
if other favorable events occur. Such adverse effects could include further
deterioration in the quality of the loan portfolio, a continuation of high
levels of nonaccrual loans and charge-offs, a limited ability to increase
loans and increased provisions for loan losses.
ADEQUACY OF ALLOWANCE FOR CREDIT LOSSES
Substantial provisions for credit losses for the years ended December 31,
1990 through 1995 were necessitated by high levels of nonperforming loans and
charge-offs. The provision for credit losses for the year ended December 31,
1995 decreased 68.5% from the year ended December 31, 1994. During 1995, the
Company's net charge-offs were $1.6 million, compared with $11.0 million of
net charge-offs for the year ended December 31, 1994. For the year ended
December 31, 1996, the Company's net charge-offs were $836,000. There was no
provision for credit losses during 1996.
At December 31, 1996, the allowance for credit losses was $3.0 million or
4.7% of loans receivable. The Bank's ratio of classified assets (loans that
have been graded substandard and doubtful according to the Bank's grading
policy and "OREO") to allowance for credit losses plus shareholders' equity
was 106% and 79% at December 31, 1996 and 1995, respectively. The Board of
Directors reviews the adequacy of the allowance for credit losses on a
quarterly basis. Management utilizes its judgment in conjunction with an
analysis prepared by an outside loan review firm to determine the provision
for credit losses and establish the allowance for credit losses. However, the
allowance is established based on information that exists at any given point
in time and may require substantial additions depending on future events. In
addition, regulatory agencies, as an integral part of their examination
process, periodically review the adequacy of the Bank's allowance for credit
losses. Federal banking agencies may require the Bank to recognize additions
to the allowance for credit losses based upon their judgment of the
information available to them at the time of their examination. See
"Business--Allowance for Credit Losses."
EXPOSURE TO FLUCTUATIONS IN VALUE OF REAL ESTATE COLLATERAL
At December 31, 1996, approximately 63% of the Bank's aggregate principal
amount of loans were secured by real estate collateral. Approximately 42% of
the Bank's loans were secured by commercial real estate, approximately 5% were
secured by multifamily real estate, approximately 11% were secured by single
family real estate and approximately 5% were secured by real estate
construction and land development projects. See "Business--Loan Portfolio."
The value of the Bank's real estate collateral has been, and could in the
future continue to be, adversely affected by the economic recession and its
impact on the real estate market in Southern California. See "Risk Factors--
Economic Conditions in the Company's Market Area."
HIGH LEVEL OF NONPERFORMING ASSETS
Although nonperforming assets have decreased significantly since 1993, the
level remains high. As of December 31, 1996, total nonperforming assets were
$6.8 million comprised of $928,000 of nonaccrual loans, $300,000 of loans
delinquent for 90 days or more but still accruing interest, $5.0 million of
restructured loans and $556,000 of OREO. Nonperforming assets totaled 10.9% of
total loans receivable as of such date. One loan
22
<PAGE>
represents $4.9 million of the total $6.8 million of restructured loans. The
level of nonperforming assets may remain high in the future and the levels of
nonaccrual loans and OREO may fluctuate from period to period as problem loans
are worked out and in some instances additional properties are taken into
OREO. Further, depending on real estate values, the overall economy in
Southern California and other circumstances, the resolution of problem loans
and liquidation of OREO may be more costly than presently anticipated and may
require the Bank to make provisions for loan losses and incur OREO-related
expenses higher than in prior periods.
REQUIREMENT OF SHAREHOLDER APPROVAL OF REVERSE STOCK SPLIT
Under Section 902 of the General Corporation Law of the State of California,
the shareholders of the Company must approve the Reverse Stock Split. The
Company is seeking such approval at its annual meeting to be held June 18,
1997. The Company currently has authorized one million shares of Preferred
Stock. The Reverse Stock Split would reduce the number of outstanding shares
of Common Stock thereby ensuring that the Company will have enough authorized
shares of Preferred Stock to issue in connection with the Public Offering and
the Private Offering. In connection with the Bank's restructure of its lease
for its headquarters, the Company issued to the Bank's landlord a seven-year
warrant (the "Warrant") to purchase up to 9.9% of the outstanding shares of
Company capital stock at the lower of $1.50 per share or the lowest price at
which such shares are offered in a public offering (with certain exceptions)
or may be purchased by any other person pursuant to an option, warrant or
other right granted by the Company (with certain exceptions) on or before
December 31, 1997. If the Reverse Stock Split does not occur, and the Company
proceeds with the Public Offering and the Private Offering, the Company would
be required to sell to the Bank's landlord Preferred Stock at $1.50 per share
as opposed to the proposed $10.00 per share price contemplated by the Public
Offering and the Private Offering.
POSSIBLE LOSS OF TAX BENEFITS
As of December 31, 1996, the Company had NOL carryforwards of $22.3 million
and $11.8 million for federal and state purposes, respectively. The
acquisition of the Underlying Preferred Shares as a result of the exercise of
Rights pursuant to the Basic Subscription Privilege or the Oversubscription
Privilege, or the issuance of shares to Private Purchasers or Standby
Purchasers, combined with future trading in the Company's Common or Preferred
Stock, could result in an "ownership change" within the meaning of Section 382
of the Code. If the Public Offering and the Private Offering, or if future
trading in the Common or Preferred Stock was to cause such an ownership
change, the Company's ability to use its NOL carryforwards in the future could
be adversely affected. The Company has reserved the right in its sole judgment
and discretion to limit the number of Underlying Preferred Shares issued to
any person or control group as a result of exercises of Rights or under the
Private Purchase Agreements and Standby Purchase Agreements to reduce the risk
that the limitation imposed by Section 382 will apply. The Company has
obtained the opinion of Deloitte & Touche LLP that, subject to certain
limitations, the Public Offering and the Private Offering should not result in
an ownership change within the meaning of Section 382 of the Code. However,
even though management believes the Public Offering and the Private Offering
are structured to preserve the NOL carryforwards, there can be no assurance
that the Company's ability to use the NOL carryforwards will not be adversely
affected by future trading in the Company's Common or Preferred Stock. See
"The Rights Offering--Limitations--Tax Limitation."
RESTRICTIONS ON TRANSFER
As part of the Company's efforts to avoid the Section 382 Limitation on the
use of its NOL carryforwards, the NOL Transfer Restriction shall prohibit, and
the certificates evidencing all outstanding and newly issued shares of capital
stock of the Company will contain a legend prohibiting, transfer of any
capital stock to any person if such person is or would become by reason of
such transfer a 4.5% Holder (or the beneficial owner of more than 4.9% with
respect to persons to whom the Company is contractually obligated on or before
the Date of Issuance to transfer up to 4.9% of the Company's stock) as the
term "stock" is defined, and such ownership is determined, under Section 382.
See "The Rights Offering--Limitations--Tax Limitation" and "The Rights
Offering--Limitations--Transfer Limitation." The NOL Transfer Restriction will
limit the ability of the
23
<PAGE>
Company's current and future shareholders from transferring shares to persons
whose beneficial ownership would consequently exceed the limit without the
prior approval of the Company. See "The Rights Offering--Limitations--Transfer
Limitation." The NOL Transfer Restriction may result in the Company's capital
stock being less liquid than stock without such a transfer restriction.
POTENTIAL INFLUENCE ON THE COMPANY BY THE CONRAD COMPANY
Pursuant to one of the Private Purchase Agreements, the Conrad Company has
agreed to acquire in the Private Offering between 25.0% and 55.0% of the
Preferred Stock (or between 18.2% and 40.0% of the Common Stock assuming full
conversion), assuming the maximum amount of $9.0 million is raised in the
Public Offering and the Private Offering, depending on the level of
participation of the Rights Holders in the Rights Offering. In addition,
pursuant to the terms of the Private Offering, each of the Private Purchasers
has a right of first refusal, under certain circumstances, to acquire
additional shares of capital stock of the Company, to retain its pro rata
existing ownership of capital stock, upon the same terms and conditions
pursuant to which the Company may propose to offer shares of its capital stock
for sale in the future. See "The Private Offering--Certain Covenants--Right of
First Refusal." The NOL Transfer Restriction applies equally to the transfer
of shares by the Conrad Company. Following the consummation of the Public
Offering and the Private Offering, the Conrad Company may be in a position to
exert significant influence over corporate policy and the outcome of matters
submitted to a vote of shareholders. Conrad Company may have interests
different from that of other shareholders. Pursuant to the terms of the
Private Offering, the Company has agreed to nominate, and to use its
reasonable best efforts to cause to be elected as directors of the Company,
that number of persons designated by the Conrad Company which Conrad Company
or any affiliate thereof is entitled to elect based on the cumulative voting
provisions of the Company's bylaws. Other Board members and senior management
of the Company are not obligated to vote their respective shares of capital
stock in the Company in favor of such nominees. Based on a Board of Directors
of the Company consisting of eight directors, the Conrad Company will be
entitled to have between 1 and 3 directors nominated, depending on the
percentage ownership the Conrad Company acquires in the Private Offering.
Until such time as a nominee of Conrad Company shall have been elected to the
Board of Directors, Conrad Company is entitled to have its representative in
attendance at all meetings of the Board. In addition, there can be no
assurance that the concentration of ownership will not have an adverse effect
on the market for remaining shares of Common and Preferred Stock.
REQUIREMENT OF REGULATORY APPROVAL FOR INVESTMENT OF PRIVATE PURCHASER
Conrad Company, a Private Purchaser, and currently a bank holding company,
has filed an application with the Reserve Bank to acquire more than 4.9% of
the voting stock of the Company. If Conrad Company's application is not
approved by the Board of Governors of the Federal Reserve System, the Public
Offering and the Private Offering will not be consummated unless there is
adequate participation by the Company's shareholders in the Rights Offering
and by the Standby Purchasers to meet the Minimum Condition.
RESTRICTIONS ON PREFERRED STOCK DIVIDENDS
There can be no assurance that the Company will generate earnings in the
future which would permit the declaration of dividends. Further, it is
anticipated that for the foreseeable future any earnings which may be
generated will be retained for the purpose of increasing the Company's and the
Bank's capital and reserves to facilitate growth. The Company is prohibited by
the terms of the 1995 MOU from declaring or paying a dividend without approval
of the Reserve Bank. In addition, the primary source of such dividends is
likely to be dividends from the Bank. Under the 1995 Formal Agreement and OCC
regulations, the Bank is precluded from paying dividends without OCC approval
until it is in compliance with applicable capital requirements. The capital
requirements set forth in the 1995 Formal Agreement require the Bank to
maintain a Tier 1 risk-based capital ratio of at least 10% and a leverage
capital ratio of at least 6.5%. Such ratios currently maintained by the Bank
are 6.95% and 4.67%, respectively. See "The Company--Regulatory Agreements."
As a California corporation, the Company may not make a distribution to its
shareholders (which includes a payment of dividends but not stock dividends)
unless the Company has sufficient retained earnings under the Retained
Earnings Test. The Retained Earnings Test is defined as the Company's retained
earnings (determined on a consolidated basis
24
<PAGE>
according to generally accepted accounting principles) or if, immediately
after giving effect to the distribution, all of the Company's assets equal
1.25 times the Company's liabilities (the "Retained Earnings Test"). The
Company's accumulated deficit of $19.7 million as of March 31, 1997 requires
the Company to record cumulative net earnings in excess of $19.7 million
before a dividend can be paid under the Retained Earnings Test. If assets
equal 1.25 times liabilities subsequent to a distribution, the Company may pay
a dividend prior to recording cumulative earnings of $19.7 million. At the
present time, the Company does not meet the Retained Earnings Test and no
assurance can be made as to when, if ever, such test will be met. The terms of
the Preferred Stock provide that dividends on the Preferred Stock may be paid
commencing two years after the Date of Issuance. Notwithstanding the
foregoing, the Company may not pay dividends unless the Bank is in full
compliance with federal regulatory capital requirements, the Company and the
Bank are permitted by the OCC to pay dividends to the Company and the Company
meets the Retained Earnings Test. Dividends on the Preferred Stock will not
accumulate. The Company cannot assess at this time its ability to pay
dividends in the immediate future.
DEPENDENCE ON EXECUTIVE MANAGEMENT
The successful implementation of the Company's business strategy is
dependent upon the efforts of certain of its executive management. The loss of
the services of any of the Company's executive officers or the failure to
replace such persons promptly with qualified personnel should their services
become unavailable could place the Company in noncompliance with the 1995
Formal Agreement and the 1995 MOU, could lead to further regulatory action
against the Company, and could have a material adverse effect on the Company's
results of operations. The Company and the Bank have experienced significant
changes in senior management since November 1995, including the hiring of
Scott A. Montgomery in November 1995 as Executive Vice President and Chief
Administrative Officer of the Company and President and Chief Executive
Officer of the Bank, Joseph W. Kiley III in August 1996 as Executive Vice
President and Chief Financial Officer of the Company and the Bank, Carol Ward
in July 1996 as Executive Vice President and Operations Administrator of the
Bank, Allan Dietrich in November 1996 as Senior Vice President of Business
Banking, Carl Raggio, III as of May 1, 1997 as Executive Vice President and
Chief Credit Officer and Melanie Krinsky in April 1997 as Senior Vice
President and Head of the Entertainment Department. See "Directors and
Executive Officers." In addition, as of April 28, 1997, five middle management
officers, with an average of 16 years of banking experience, have been hired
by the Bank in departments such as management information systems, note
department, business and private banking and entertainment. The implementation
of the Company's business strategy will require the hiring of additional
personnel with specific product experience. The Company faces substantial
competition for skilled and experienced personnel and there can be no
assurance that the Company will be successful in attracting such personnel.
Historically, the Company has experienced difficulty in attracting and
retaining qualified senior and executive management. The Company has entered
into an employment agreement with Scott Montgomery which expires on December
31, 1999. Apart from the agreement with Mr. Montgomery, there can be no
assurance, however, that the Company can retain the services of its current
management team, or that the Company can replace any of its executives
promptly should their services become unavailable.
REGULATORY AGREEMENTS AND CAPITAL REQUIREMENTS
Following supervisory examinations of the Bank conducted in 1995, the Bank
entered into the 1995 Formal Agreement with the OCC. The 1995 Formal
Agreement, among other requirements, provides that the Bank must maintain a
Tier 1 risk-based capital ratio of at least 10% and a leverage capital ratio
of at least 6.5%. The Company also entered into the 1995 MOU with the Reserve
Bank. Among other requirements, the 1995 MOU prohibits the Company from paying
dividends without prior approval of the Reserve Bank and requires the
submission of a plan to increase the Bank's capital ratios. See "The Company--
Regulatory Agreements." At December 31, 1996, the Bank's Tier 1 risk-based
capital ratio was 6.95% and its leverage capital ratio was 4.67%. In order to
reach compliance with the capital requirements of the 1995 Formal Agreement,
the Company will have to receive and downstream to the Bank approximately $2.5
million of net proceeds in the Public Offering and the Private Offering,
assuming the level of assets remains constant with that of December 31, 1996
and the investment of such proceeds in 100% risk-weighted assets. See
"Regulation."
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POTENTIAL ADDITIONAL REGULATORY ACTIONS
Bank holding companies and banks, such as the Company and the Bank, and
their institution-affiliated parties are subject to potential enforcement
actions by the OCC or the Reserve Bank for any unsafe or unsound practices in
conducting their business or for violations of any law, rule or regulation,
any cease and desist or consent order, or any written agreement with the
agency, such as the 1995 Formal Agreement and the 1995 MOU. Enforcement
actions may include cease and desist orders and written agreements, the
imposition of civil money penalties and removal or prohibition orders against
institution-affiliated parties and, in the most severe instances, the
termination of insurance of deposits and/or the imposition of a conservator or
receiver for an insured depository institution. Even if the Company and the
Bank achieve full compliance with all regulatory capital and other operating
requirements, including those required by the 1995 Formal Agreement and the
1995 MOU, there can be no assurance that the Company and the Bank will remain
in compliance with all such requirements. Any deficiency in compliance with
regulatory requirements such as the 1995 Formal Agreement or the 1995 MOU
could result in penalties or further regulatory restrictions that would have a
material adverse effect on the Company. See "Regulation--Supervision and
Regulation--Potential and Existing Enforcement Actions."
ABSENCE OF MARKET FOR THE PREFERRED STOCK
There is currently no Preferred Stock outstanding and therefore there is no
organized trading market for the Preferred Stock (i.e. there are no market
makers who actively trade such stock). Sandler O'Neill has agreed to act as a
market maker in the Preferred Stock. No assurance can be given that an active
trading market for the Preferred Stock will develop or be maintained, or that
price quotations for the Preferred Stock will be available. The Company
intends to file an application to have the Preferred Stock approved for
quotation on the Small Cap tier of the Nasdaq Stock Market if there are an
adequate number of publicly held shares of Preferred Stock to meet the
requirements of Nasdaq. However, the Small Cap tier may be less liquid than
the National Market tier of the Nasdaq Stock Market and there can be no
assurance that such application will be approved or that an active trading
market for the Preferred Shares will develop on the Nasdaq Stock Market. The
Subscription Price is not based on any estimate of the market value of the
Preferred Stock and no representation is made that the shares of Preferred
Stock offered hereby have a market value equivalent to, or could be resold at,
the Subscription Price. See "The Rights Offering--Determination of
Subscription Price." In addition, no representation is made that the dividend
rate on the Preferred Stock is comparable to the rates paid on equity
investments with similar risks. Investors may be required to convert their
shares of Preferred Stock into shares of the Company's Common Stock to have
market liquidity for their investment. As of April 23, 1997, there are 5
market makers in the Company's Common Stock, which is traded on the Small Cap
tier of the Nasdaq Stock Market.
MARKET CONSIDERATIONS
There can be no assurance that the market price of the Common Stock will not
decline during or after the subscription period or that following the exercise
of the Rights and the sale of the shares of Preferred Stock upon exercise of
Rights or otherwise, a subscribing Rights Holder will be able to sell shares
purchased in the Rights Offering at a price equal to or greater than the
Subscription Price. For a discussion of the determination of the Subscription
Price see "The Rights Offering--Determination of Subscription Price." THE
ELECTION OF A RIGHTS HOLDER TO EXERCISE RIGHTS IN THE RIGHTS OFFERING IS
IRREVOCABLE. Moreover, until certificates are delivered, subscribing Rights
Holders and other Purchasers may not be able to sell the shares of Preferred
Stock that they have purchased in the Public Offering. Subject to satisfaction
of the Minimum Condition, certificates representing shares of Preferred Stock
purchased in the Public Offering will be delivered as soon as practicable
after the Expiration Time and after all prorations and adjustments
contemplated by the Public Offering have been effected. The Company reserves
the right to extend the period for the Public Offering. There can be no
assurance that the market price of the Preferred Stock purchased pursuant to
the Public Offering will not decline below the Subscription Price before the
certificates representing such shares have been delivered. NO INTEREST WILL BE
PAID TO ANY SUBSCRIBER IN THE RIGHTS OFFERING.
The market price of the Preferred Stock and the Common Stock could be
subject to significant fluctuations in response to quarterly variations in the
Company's actual or anticipated operating results, changes in general market
conditions and other factors. On April 23, 1997, the last reported trade price
of the Common Stock was $1.50.
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There are two persons holding 474,536 shares of Common Stock and options and
warrants to purchase additional shares of Common Stock with rights, subject to
certain conditions, to require the Company to file registration statements
covering the shares such persons own or may acquire through option or warrant
exercises. These persons also have rights, subject to certain limitations, to
"piggyback" registrations if the Company files a registration statement for
any other purpose. The Private Purchasers also have certain registration
rights. If such persons exercise such registration rights, the Company will
have to bear expense of such registration and the market price of the Common
Stock (or the Preferred Stock) may be adversely affected by such proposed
sales. See "Description of Capital Stock--Registration Rights."
DILUTION OF OWNERSHIP INTEREST
Rights Holders may experience substantial dilution of their percentage of
equity ownership interest and voting power in the Company if they do not
exercise the Basic Subscription Privilege and the Oversubscription Privilege.
Depending upon the degree to which the Rights Holders exercise their Basic
Subscription Privilege and Oversubscription Privilege, they will experience a
minimum dilution of 18% (assuming shares are available pursuant to the
Oversubscription Privilege) and a maximum dilution of 72% (assuming no Rights
are exercised) in their voting rights and in their proportional interest in
any future net earnings of the Company due to the Private Purchasers Minimum
Obligation and the Minimum Standby Obligation. See "The Private Offering" and
"The Standby Purchasers." In addition, it is possible that additional capital
may be necessary or appropriate and shares of Common Stock or securities
convertible into Common Stock may be offered for sale in the future. In that
event, the relative voting power and equity interests of persons purchasing
Preferred Stock in the Public Offering and the Private Offering could be
reduced, as neither the Preferred Stock nor the Common Stock has preemptive
rights. Pursuant to the terms of the Private Offering, each of the Private
Purchasers has a right of first refusal, under certain circumstances, to
acquire additional shares of capital stock of the Company, to retain its pro
rata existing ownership of capital stock, upon the same terms and conditions
pursuant to which the Company may propose to offer shares of its capital stock
for sale in the future. See "Description of Capital Stock--Preferred Stock--
Preemptive Rights."
Rights Holders also may experience substantial dilution if options and
warrants to purchase shares of the Company's Common Stock currently
outstanding are exercised. See "Dilution" and "Business--Legal Proceedings."
RECENT LEGISLATIVE AND REGULATORY DEVELOPMENTS
The financial institutions industry is subject to significant regulation,
which has materially affected the financial institutions industry in the past
and will do so in the future. Such regulations, which affect the Company on a
daily basis, may be changed at any time, and the interpretation of the
relevant law and regulations are also subject to interpretive change by the
authorities who examine the Company and the Bank and interpret those laws and
regulations. For a description of the potentially significant regulatory
changes which have been enacted and proposals which have recently been put
forward see "Regulation--Effect of Government Policies and Recent
Legislation." There can be no assurance that any present or future changes in
the laws or regulations or in their interpretation will not adversely and
materially affect the Company.
MONETARY POLICY AND ECONOMIC CONDITIONS
On a consolidated basis, the operating income and net income of the Company
depend to a great extent on the difference between the interest paid by the
Bank on its deposits and its other borrowings and the interest received by the
Bank on its loans, securities and other earning assets. These rates are highly
sensitive to many factors that are beyond the control of the Company,
including general economic conditions and the monetary and fiscal policies of
the federal government and the policies of regulatory agencies, particularly
the Board of Governors of the Federal Reserve System (the "Federal Reserve
Board"). The nature and impact of any future changes in monetary policies
cannot be predicted. Adverse economic conditions could result in smaller net
interest margin, increased nonperforming assets, increased charge-offs and
higher provision for loan losses, any of which could adversely affect the
Company's net income.
FLUCTUATIONS IN INTEREST RATES AND RELIANCE ON VOLATILE LIABILITIES
Increases in interest rates may reduce the amount of demand for loans and,
thus the amount of loan and commitment fees. In addition, fluctuations in
interest rates may also result in disintermediation, which is the flow
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of funds away from depository institutions into direct investments which pay a
higher rate of return and may affect the value of the Bank's investment
securities and other interest-earning assets.
Because the Bank's assets consist of a substantial number of loans with
interest rates which change in accordance with prevailing market rates, sharp
rises in interest rates would require many of the Bank's borrowers to make
higher interest payments on their loans. Thus, increases in interest rates may
cause the Bank to experience an increase in delinquent loans and defaults to
the extent that borrowers are unable to meet their increased debt servicing
obligations.
VOLATILITY OF FUNDING SOURCES
The Bank maintains demand deposits for title and escrow companies and issues
certificates of deposit to persons, including other financial institutions,
not otherwise having banking relationships with the Bank. Such liabilities are
potentially unstable sources of deposits because they are generally attracted
to the financial institution based primarily upon the services provided and
the interest rate paid on deposits by the institution and the general
financial condition of the institution and may be withdrawn on relatively
short notice. Further, the proceeds of such liabilities are generally invested
in relatively low-yielding, short-term investment securities rather than
higher-yielding loans. Demand deposits owned by title and escrow companies
represented 8.5% and 9.5% of total deposits at December 31, 1996 and 1995,
respectively. Certificates of deposit held by other financial institutions
represented 17.9% and 22.6% of total deposits at December 31, 1996 and 1995,
respectively. The Bank no longer seeks brokered certificates of deposit.
Remaining brokered certificates of deposit maintained by the Bank represented
3.8% and 4.9% of total deposits at December 31, 1996 and 1995, respectively.
COMPETITION
The Bank faces substantial competition for loans, deposits and financial
services in its market area. The Bank competes on a daily basis with other
commercial banks, savings institutions, thrift and loans, credit unions, and
other financial service providers. The Bank's competitors are local
institutions, which have a large presence in the Bank's market area, as well
as out-of-state financial service providers which have offices in the Bank's
market area. Many of these institutions offer higher lending limits and
services which the Bank currently does not offer, such as trust services.
Further, banks with a larger capital base and financial service providers not
subject to the restrictions imposed by bank regulation have larger lending
limits and can therefore serve the needs of larger customers. The Bank will
face significant competition in implementing its business strategy,
maintaining its share of the business and private banking and entertainment
markets, expanding its focus to include the closely related niche market of
technology/multimedia and increasing its emphasis in the medical market.
Accordingly, no assurance can be made that the Company will successfully
implement its business strategy. See "The Company--Business Strategy" and
"Business--Competition."
RIGHT TO TERMINATE OFFERING
The Company expressly reserves the right, in its sole and absolute
discretion, at any time prior to delivery of any shares of Preferred Stock
offered hereby, to terminate the Public Offering by giving oral or written
notice thereof to the Subscription Agent and making a public announcement
thereof. The Company will terminate the Public Offering in the event that (i)
the Company does not receive minimum proceeds of $5.5 million from the Public
Offering and the Private Offering, (ii) the Reverse Stock Split is not
approved by the Company's shareholders, (iii) the NOL Transfer Restriction is
not approved by the Company's shareholders or (iv) the terms and conditions of
the Preferred Stock are not approved by the Company's shareholders. If the
Public Offering is terminated, all funds received pursuant to the Public
Offering will be refunded promptly, without interest.
PERIOD OF ESCROW
Payment of the Subscription Price will be held in an escrow account to be
maintained by the U.S. Stock Transfer Corporation as Subscription Agent.
Assuming no extensions of the Expiration Time, Rights Holders who place
subscription orders prior to the Expiration Time will lose access to funds
tendered for a maximum of 40 days and not acquire any or all of the Excess
Underlying Preferred Shares to which they subscribe. See "The Rights
Offering--Subscription Privileges--Oversubscription Privilege."
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THE COMPANY
GENERAL
National Mercantile Bancorp was formed as a California corporation on
January 17, 1983 and is a registered bank holding company under the Bank
Holding Company Act of 1956, as amended ("BHC Act"). The Company currently
conducts its business through its subsidiary bank, Mercantile National Bank,
which was organized as a national banking association on October 29, 1981 and
began operating under a Certificate of Authority from the OCC on March 22,
1982. From its single location in Century City, the Bank currently provides
traditional banking services to the niche markets of business and private
banking and entertainment in its primary market area, a four mile radius from
its headquarters ("primary market"). As part of its business and private
banking focus, the Bank intends to increase its emphasis on medical banking
relationships, taking advantage of its proximity to several major
hospital/medical centers and numerous health service-related companies in West
Los Angeles. The Bank intends to extend its focus on the entertainment market
to include the closely related niche market of technology/multimedia
businesses in Los Angeles, Ventura and Orange Counties. In addition, the Bank
provides investment and specialized deposit services, handling the needs of
large deposit clients.
BACKGROUND
Since commencing operations in 1982 with an initial capitalization of $15.0
million, the Bank has focused primarily on providing banking products and
services to the niche markets of business and private banking and
entertainment in its primary market. Throughout the l980s, the Company
experienced substantial growth and profitability. In February 1990, the
Company raised additional capital of $5.7 million through the sale of Common
Stock to two investor groups at $11.00 per share (without giving effect to the
Reverse Stock Split). At December 31, 1990, the Company had total assets of
$492.8 million and total stockholders' equity of $28.5 million.
Beginning in 1990, the Bank's primary service area was severely affected by
an economic recession, including substantial declines in real estate values.
Commencing in 1991, the ongoing recession began to affect adversely the values
of collateral securing the Bank's loans and the ability of borrowers to repay
their loans. As a result of the combined effects of this prolonged recession
and the rapid growth of the Bank in the late 1980s, the Bank began to
experience substantial increases in nonperforming assets resulting in
significant losses. Although the Bank undertook to enhance credit underwriting
policies and internal controls and procedures to address operational
weaknesses, from January 1, 1991 through December 31, 1996, the Company
suffered cumulative net losses of $23.7 million. These losses were primarily
the result of substantial provisions for credit losses attributable to losses
in the existing loan portfolio and losses associated with a bulk loan purchase
from the FDIC, losses on interest rate hedges and swaps and sales of
securities combined with the adverse effects of the substantial reduction in
the asset levels of the Bank. In addition, nonperforming assets increased from
$14.8 million, or 3.0% of total assets at December 31, 1990 to a high of $22.0
million, or 7.3% of total assets, at December 31, 1993 notwithstanding net
loan chargeoffs of $15.2 million during the three year period ended December
31, 1993.
Concurrent with the deterioration in the Company's financial condition and
operations, the bank regulatory authorities designated the Company and the
Bank for special supervisory attention. Following regulatory examinations in
late 1990 and early 1991, the Bank entered into the 1991 Formal Agreement with
the OCC, and the Company entered into the 1991 MOU with the Reserve Bank. As a
result of the Bank's continuing problems, following the regulatory examination
in 1995 of the Bank, the Bank in December 1995 entered into the 1995 Formal
Agreement with the OCC, and the Company in October 1995 entered into the 1995
MOU with the Reserve Bank. The 1995 Formal Agreement and 1995 MOU supersede
and replace in their entirety the 1991 Formal Agreement and 1991 MOU,
respectively. These regulatory agreements have affected virtually every area
of the Company's and the Bank's operations, imposed on the Bank higher minimum
regulatory capital requirements than would otherwise be applicable and
restricted the ability of the Company to pay dividends. See "The Company--
Regulatory Agreements."
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RESPONSIVE MEASURES
In November 1995, the Board of Directors hired a new President of the Bank.
The President and the Board of Directors developed and began implementing a
restructuring plan to address the challenges confronting the Bank and to
return the Bank to consistent profitability. The plan includes (1) improving
management, (2) reducing nonperforming and classified assets, (3) reducing
operating expenses, (4) focusing business strategy on core business and market
opportunities, (5) enhancing policies and procedures to improve asset quality,
(6) increasing capital ratios, and (7) resolving pending litigation.
Management believes that the Company has made significant progress in
implementing this plan, which is described in greater detail below:
. Improving Management. As of August 1996, the Company and the Bank
changed senior management by hiring Scott A. Montgomery in November 1995
as President and Chief Executive Officer of the Bank and Executive Vice
President and Chief Administrative Officer of the Company, Joseph W.
Kiley III in August 1996 as Executive Vice President and Chief Financial
Officer of the Company and the Bank, Carol Ward in July 1996 as
Executive Vice President and Operations Administrator of the Bank, Allan
Dietrich in November 1996 as Senior Vice President of Business Banking,
Carl Raggio, III as of May 1, 1997 as Executive Vice President and Chief
Credit Officer and Melanie Krinsky in April 1997 as Senior Vice
President and Head of the Entertainment Department. In addition, as of
April 28, 1997, five middle management officers with an average of
16 years of banking experience have been hired by the Bank in
departments such as management information systems, note department,
business banking and entertainment. This new management team, at the
direction of the Board of Directors of the Company and the Bank, has
undertaken and implemented a revision of policies, procedures and
reporting systems in almost every area of the Bank.
. Reducing Nonperforming and Classified Assets. The Bank has reduced the
level of nonperforming assets through asset sales, write-downs,
substantially enhanced collection procedures and improved underwriting
policies and procedures. From the peak of $22.0 million at December 31,
1993, nonperforming assets have decreased to $6.8 million at December
31, 1996. One loan, a troubled debt restructure, represents $4.9 million
of the total $6.8 million of nonperforming assets. From the peak of
$47.1 million at December 31, 1991, classified assets have been reduced
to $8.3 million at December 31, 1996. Excluding the $4.9 million
troubled debt restructure loan referenced above, classified assets
represent 5.5% of loans receivable. See "Business--Nonperforming
Assets," "--Troubled Debt Restructurings" and "--Asset Quality."
Notwithstanding the reduction of nonperforming loans and classified
assets, the decrease in total assets has caused the ratios of
nonperforming loans to total assets and nonperforming assets to total
assets to increase from 4.5% and 5.0%, respectively, at December 31,
1995 to 5.7% and 6.2%, respectively, at December 31, 1996. The volume of
loans receivable declined from $231.3 million at December 31, 1991 to
$62.5 million at December 31, 1996 as the result of (i) the ongoing
recession affecting the Company's primary market area; (ii) scheduled
loan amortizations; (iii) management's planned restructuring of the loan
portfolio to reduce criticized and classified assets and non-strategic
loan relationships; and (iv) the reduction of loans originated by the
Bank. Excluding the troubled debt restructure loan described above,
which is contractually performing and secured by a first deed of trust
on real property which, as of December 1996, had an appraised value of
$10.0 million, total nonperforming assets were $1.9 million,
representing 3.1% of loans receivable at December 31, 1996. The property
is currently for sale. No assurance can be given, however, that the
property will be sold at 100% of, or above, the value at which it is
carried by the Bank.
. Reducing Operating Expenses. Since November 1995, new management has
pursued a program to increase operational efficiencies and reduce other
operating expenses. For the year ended December 31, 1996, the Company
reduced other operating expenses by $3.2 million to $8.0 million from
$11.2 million for the year ended December 31, 1995. Excluding a $1.0
million charge relating to a settlement of a pending lawsuit, other
operating expenses for the year ended December 31, 1996 decreased
$4.2 million from 1995. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Other Operating Expenses"
and "Business--Legal Proceedings--Other Litigation."
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These savings resulted primarily from the renegotiation of the lease for
the Bank's office and a restructuring of each operating department of
the Bank. In December 1995, the Bank entered into an agreement with its
landlord (the "Lease Restructuring Agreement") to restructure the lease
on its office located at 1840 Century Park East (its only location). The
Lease Restructuring Agreement will reduce costs by $850,000 per year
over the five years ending December 31, 2000 for a total cumulative
savings of $4.3 million. In conjunction with the signing of the Lease
Restructuring Agreement, the Company issued to its landlord a seven-year
warrant to purchase up to 9.9% of the outstanding shares of the
Company's capital stock and granted the landlord certain registration
rights with respect to the shares of capital stock subject to the
Warrant. See "Business--Properties" and "Description of Capital Stock--
Registration Rights."
In addition to the lease restructure, each operating department of the
Bank was reviewed for profitability and potential for future
profitability. As a result, the International Department, excluding the
letter of credit operations, was closed in December 1995. Despite
filling certain executive and upper management positions needed to
implement the Company's business strategy, the Bank reduced its full-
time equivalent employees from 52 at December 31, 1995 to 44 at December
31, 1996 primarily through the elimination of inefficient functions,
unprofitable divisions, and general staff reductions.
. Focusing Business Strategy on Core Business and Market
Opportunities. Management has pursued a business strategy which focuses
on the Bank's traditional market niches of business and private banking
and entertainment. Management believes that the Bank has an advantage
relative to its competitors by being located in Century City, the
headquarters for many entertainment and professional services clients
and prospects. As part of its business and private banking focus, the
Bank intends to increase its emphasis on medical banking relationships,
taking advantage of its proximity to several major hospital/medical
centers and numerous health service-related companies in West Los
Angeles. Management believes that the technology/multimedia industry is
an under-served market in Southern California. The technology/multimedia
market represents a logical extension of the Bank's focus on the
entertainment industry as more technology companies seek to develop and
market applications to the entertainment industry. See "The Company--
Business Strategy."
. Enhancing Policies and Procedures to Improve Asset Quality. The Bank has
strengthened its credit administration and loan review functions. The
Bank's loan policies and procedures have been revised to reduce the
Bank's exposure to future loan problems. In addition to reducing officer
lending limits, the Bank has established an officers loan committee,
with senior lending officers serving as voting members. Loans from
$100,000 to $750,000 require the approval of the officers loan
committee. The committee reviews delinquencies and documentation
exceptions and assigns a risk rating grade to each loan. Loan loss
exposure and grade performance histories are tracked and used as a part
of the quarterly loan migration analysis, to ensure that appropriate
levels of allowance for credit losses are maintained. The Bank (i) has
expanded the role of an outside loan review firm to include a migration
analysis on its loan portfolio on a quarterly basis; (ii) has
established an underwriting department to standardize loan write-ups,
enhance portfolio quality and allow officers time to service their
clients and prospects; and (iii) is in the process of hiring three
additional experienced lending and underwriting officers to further
strengthen the Bank's loan origination and monitoring functions.
Following the OCC's March 1996 examination of the Bank, the OCC accepted
the Bank's allowance for credit losses. No provision for credit losses
has been allocated to the allowance for credit losses during 1996. At
December 31, 1996, the allowance for credit losses represented 4.75% of
loans receivable. OREO has been reduced to two properties, both of which
have been written down to current fair values. See "Business--Asset
Quality."
. Increasing Regulatory Capital Ratios. Primarily as a result of balance
sheet restructuring and the decreasing asset base, capital ratios have
remained constant. The Bank's Tier I risk-based capital ratio was 6.95%
at December 31, 1996 and 1995. The Bank's leverage capital ratio was
4.67% at
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December 31, 1996 and 1995. The Bank's total risk-based capital ratio
was 8.24% at December 31, 1996 and 1995. The 1995 Formal Agreement
requires a Tier 1 risk-based capital ratio of at least 10% and a
leverage capital ratio of at least 6.5%. To reach compliance with these
capital requirements, assuming the Company's level of assets remains
constant with that of December 31, 1996, the Company will have to
receive and downstream to the Bank approximately $2.5 million of net
proceeds in the Public Offering and the Private Offering. See "Risk
Factors--Regulatory Agreements" and "--Capital Requirements" and "The
Company--Regulatory Agreements."
Assuming gross proceeds from the Public Offering and the Private
Offering of between $8.0 million and $9.0 million, management
anticipates downstreaming sufficient capital (i.e., approximately
$2.5 million) from the Company to the Bank to comply with the capital
requirements of the 1995 Formal Agreement and the 1995 MOU and to
implement the Bank's business strategy, retaining the balance of the
proceeds, if any, at the Company to be used for general corporate
purposes, including possible strategic acquisitions. The Company has no
current understandings or agreements and is not presently negotiating
with respect to any such acquisitions. See "Reasons for the Offering and
Use of Proceeds" and "The Company--Business Strategy."
. Resolving Litigation. The Company entered into a settlement agreement
relating to a lawsuit against the Bank. The total amount of the
settlement of $1.0 million, was accrued during the quarter ended June
30, 1996 and is reflected in the consolidated statement of operations
for the year ended December 31, 1996. The settlement was originally
conditioned on the recapitalization of the Bank and provided for the
payment of $500,000 on the earlier of the seventh day following the
closing of the Public Offering and the Private Offering or March 31,
1997 and an additional $500,000 on the second anniversary of that
payment. However, the Company and all affected parties agreed to a
single payment of the settlement on a discounted basis, which payment
was made prior to December 31, 1996. See "Business--Legal Proceedings--
Other Litigation."
BUSINESS STRATEGY
Generally
The business strategy of the Company and the Bank will be to continue
implementing each item of the responsive measures outlined above while
building upon the Bank's established market niches of business and private
banking and entertainment. The Bank also plans a market extension into
technology/multimedia companies as a logical extension of its focus on the
entertainment industry. In addition, as part of its business and private
banking focus, the Bank intends to increase its emphasis on medical banking
relationships, taking advantage of its proximity to several major
hospital/medical centers and numerous health service-related companies in West
Los Angeles.
The Bank is in the process of expanding upon or developing products and
services specifically tailored for each of its market niches and hiring
relationship managers who are knowledgeable about the specialized needs and
product requirements of these markets. The Bank intends to deliver these
products and services through a team approach, combining an experienced
relationship management officer with an operations support professional to
ensure the smooth transition from establishment of the account relationships
to ongoing account maintenance and service. The Bank believes that this team
approach will enable it to provide a higher level of consistent service to its
clients and enable the Bank to differentiate itself from its competitors and,
particularly, from the large banks.
Given the Bank's current size, it will primarily focus on small-sized to
medium-sized companies in its primary service area with specific emphasis on
professionals and executives, business managers, large deposit clients,
technology/multimedia companies, hospitals and health care providers. The
Company believes recent merger activity in the banking arena has created
opportunities for the Bank to compete for the business of companies and
individuals in the Bank's existing markets. A secondary benefit of such merger
activity is that a significant number of highly qualified bankers are in the
market looking for new opportunities.
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Niche Markets. The Company has begun the process of increasing the size of
its Board of Directors by adding directors that have significant contacts in
the market niches the Company serves. Robert E. Gipson recently joined the
Board of Directors of the Company. Mr. Gipson is the managing partner of
Gipson, Hoffman and Pancione, a law firm focusing on the entertainment,
business and technology markets. The Company believes that the combination of
local decision making bankers who know and understand the client's business,
and a Board of Directors whose members are actively involved in the community
will result in a substantial number of potential relationship referrals. To
achieve the goals of the Company's ongoing strategy, highly directed marketing
efforts aimed at increasing the Company's market share in its primary niche
markets have been developed. Each division of the Bank has a separate
marketing strategy with special products developed for that market.
Business Banking Division
The Company estimates that, based on demographic data from the 1990 census,
within the Bank's primary market, there are in excess of 40,000 businesses in
the manufacturing, transportation, communications and trade (wholesale and
retail) businesses many of which are believed by the Company to be small-sized
to medium-sized companies that fit the Company's target profile.
The products sold by the Business Banking Division include lines of credit,
revolving lines of credit, equipment loans, term loans, Small Business
Administration ("SBA") loans, real estate loans, cash management services,
online banking and investment services.
Private Banking Division
The Company estimates that, within its primary market, and based on
demographic data from the 1990 census, there are in excess of 65,000 potential
clients for the Private Banking Division in the professional, health,
personal, finance, insurance, real estate and repair service businesses.
Products sold by the Private Banking Division include personal lines of
credit, investment services, term loans, professional practice development
loans, cash management services, online banking and a full line of travel-
related services such as traveler's checks and foreign currency exchange.
These services are tailored to the unique requirements of the individuals who
compose this market. Following the recapitalization of the Bank, trust
services will be offered through certain strategic alliances.
Health Services. The Bank has served the medical community in its primary
market for a number of years but has not specialized in serving the needs
of this industry. Based on its proximity to several major hospital/medical
centers and numerous health service-related companies, the Bank plans to
expand its focus on the medical community. The Bank is located in the
center of one of the major medical markets in Los Angeles. Located on the
west side of Los Angeles are Cedars-Sinai Medical Center, Daniel Freeman
Hospital and the UCLA Medical Center. The university is approximately three
miles from the Bank. Cedars-Sinai Medical Center is located three miles to
the east and Daniel Freeman Hospital has facilities within five miles of
the Bank. The Company estimates that, within its primary market, based on
demographic data from the 1990 census, there are in excess of 12,800 health
services-related companies. Although no specific person has been
designated, the Company intends to add a director to its Board of Directors
with significant contacts in the medical community who can facilitate the
Company's expansion into that market. No assurance can be made that the
Company will be successful in adding such a director.
Technology/Multimedia Division
The Company estimates that, within its primary market, based on demographic
data from the 1990 census, there are in excess of 25,000 potential clients for
its Technology/Multimedia Division in the entertainment, recreational and
educational service businesses. Products sold by the Technology/Multimedia
Division will
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include lines of credit, revolving lines of credit, term loans, investment
services, foreign exchange, letters of credit, cash management services and
special handling of the needs of business managers and their clients.
High Technology. The Company estimates that, based on demographic data
from the 1990 census, over 9,000 additional companies within the three
counties of Los Angeles, Ventura and Orange become target clients of the
Bank. The Bank plans to build a banking services capability for high
technology clients by expanding its entertainment niche into the multimedia
arena and then into technology itself. This two-step approach will enable
the Bank to develop systems, train employees and expand its lending
capabilities while minimizing the increase of risk in its loan portfolio.
The Bank anticipates that in lending to technology multimedia companies its
role will not be to participate at the start-up capital level but to
finance productive capacity once the technology company has developed and
is producing and marketing a product. In the early stages of the company's
development, the Bank's objective will be to build a strong relationship
with the management of the company, develop an understanding of the
Company's products and provide appropriate financing when production is
undertaken. Niche directors will be sought from both the technology
industry as well as from among professional firms supporting the technology
industry. No assurance can be made that the Company will be successful in
adding such directors.
The Company is positioned to serve the small-sized to medium-sized
companies in this market from its central location through the use of
courier services. Recent media reports have identified a number of factors
to account for the growth of the high-tech industry in Los Angeles County,
among them, the proximity of entertainment industry consumers of
technology/multimedia products, competitive real estate costs and leasing
rates, large numbers of technologically skilled workers and the aggressive
efforts of city governments to provide incentives for high-tech companies
to locate in the area.
While the Company's high technology market will extend to three counties,
technology companies tend to be clustered in areas where the infrastructure
exists to serve their needs. The communities of Moorpark in Ventura County
and Burbank and Santa Monica in Los Angeles County are experiencing
increases in the number of technology/multimedia companies located within
their communities. Orange County has become a favored location for bio-
technology companies. DreamWorks, SKG has proposed to locate its new major
entertainment production company's 100-acre studio campus on City of Los
Angeles land in Playa Vista, approximately 10 miles from the Bank.
Barriers to Entry. Technology/multimedia represents a new market for the
Company and a developing market in the Los Angeles area. Several barriers to
entry in this market exist, including a lack of trained and experienced
lending officers in this area and the fact that the Bank is a new participant
in this market. While it is anticipated that these barriers are significant,
the Company believes that it can successfully penetrate this market based on
(i) significant contacts that Robert E. Gipson, who recently joined the
Company's Board, has in the technology/multimedia industry; (ii) the
experience and background of the Bank's Chief Executive Officer, who had
experience with Silicon Valley Bank and Cupertino National Bank in Northern
California; (iii) growing demand from the technology/multimedia industry for
banking services tailored to its needs; and (iv) the Bank's ability to offer
these services in a responsive manner.
Acquisitions
Part of the Company's business strategy following the Public Offering and
the Private Offering is to acquire other financial service-related companies
including "in-market" acquisitions with banks of similar size and market
presence. The Company and the Bank have hired a seasoned management team and
plan to build on the strengths of that team and the Company's enhanced capital
structure following the Public Offering and the Private Offering. The Company
has no current arrangements, understandings or agreements regarding any such
acquisition. Further, the Company would need bank regulatory approval before
such acquisitions could be consummated. No assurance can be made that such
regulatory approval would be obtained.
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REGULATORY AGREEMENTS
Formal Agreement (OCC)
The OCC conducted examinations of the Bank in late 1990 and early 1991 which
identified deficiencies in the Bank's loan underwriting and administrative
policies and procedures. Information derived from these examinations resulted
in significant increases in loans identified as nonperforming in 1991 and
concurrent increases in the 1991 provision for credit losses, charge-offs of
nonperforming loans and the allowance for credit losses. These developments
caused the OCC to determine that the Bank required special supervisory
attention. Accordingly, the OCC and the Bank entered into the 1991 Formal
Agreement.
The 1991 Formal Agreement provided, among other things, that the Bank must:
(i) employ a Chief Credit Officer subject to approval by the OCC; (ii) retain
an independent management consultant to evaluate the Bank's operations and
personnel; (iii) develop a strategic plan; (iv) review and revise existing
loan policies, develop written policies and procedures for loan administration
and nonaccrual loans, implement a written plan to reduce the level of
classified assets and establish an independent loan review program; (v)
develop written policies for liquidity maintenance and asset and liability
management; and (vi) achieve by October 31, 1991, and thereafter maintain, a
Tier 1 risk-based capital ratio of at least 10% and a leverage capital ratio
of at least 6.5%.
Subsequent to the 1991 Formal Agreement and 1991 MOU discussed below, the
Company continued to experience losses due to the prolonged nature of the
recession in Southern California, losses embedded in the existing loan
portfolio and losses associated with a bulk loan purchase from the FDIC in
1993. From January 1, 1991 through December 31, 1996, the Company's cumulative
net losses amounted to $23.7 million. These losses were primarily the result
of substantial provisions for credit losses, losses on interest rate hedges
and swaps and losses on the sale of securities combined with the adverse
effects of the substantial reduction in the asset levels of the Bank.
Nonperforming assets increased from $14.8 million at December 31, 1990, to a
peak of $22.0 million at December 31, 1993.
As a result of these losses, following the OCC's examination of the Bank in
1995, the Bank entered into a second formal agreement with the OCC, the 1995
Formal Agreement, which supersedes and replaces in its entirety the 1991
Formal Agreement. The 1995 Formal Agreement provides that the Bank must: (i)
provide monthly progress reports to the OCC; (ii) within sixty (60) days
thereof, employ a Chief Financial Officer subject to approval by the OCC;
(iii) not pay directors fees until the Bank has regained profitability and is
deemed to be in satisfactory condition by the OCC; (iv) review all management
fees, consulting contracts and severance plans; (v) analyze new products and
services; (vi) maintain sufficient liquidity; (vii) maintain a Tier 1 risk-
based capital ratio of at least 10% and a leverage capital ratio of at least
6.5%; (viii) develop a three-year capital plan; (ix) develop a strategic plan;
and (x) implement a written loan administration program. A capital plan was
submitted to the OCC on February 8, 1996, a loan administration program was
submitted on February 29, 1996 and a strategic plan was submitted in May,
1996. In addition, a Chief Financial Officer was employed in August, 1996. As
required under the 1995 Formal Agreement, the Bank reports quarterly on the
status of its progress to the OCC. The Bank has developed a detailed internal
tracking system for determining and reporting compliance with the Formal
Agreement.
At December 31, 1996, the Bank's Tier 1 risk-based capital ratio was 6.95%
and its leverage capital ratio was 4.67%. With the exception of the minimum
capital ratio requirements, loan administration requirements (with which the
Bank is in the process of achieving compliance), and the consulting contracts
requirements (with which the Bank is in the process of achieving compliance),
the Bank is in compliance with the 1995 Formal Agreement. The Company believes
that, following completion of the Public Offering and the Private Offering, it
will be in substantial compliance with all requirements of the 1995 Formal
Agreement. However, there can be no assurance as to whether or when the OCC
will lift the 1995 Formal Agreement. Failure to comply with the 1995 Formal
Agreement can result in further regulatory action such as a cease and desist
order, the imposition of civil money penalties against the Bank and its
directors and executive officers or the removal of one or more directors or
executive officers. See "Regulation--Supervision and Regulation--Potential and
Existing Enforcement Actions."
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Memorandum of Understanding (Reserve Bank)
The Reserve Bank periodically conducts inspections of the Company as part of
its oversight of bank holding companies. Following the Reserve Bank's
inspection of the Company in mid-1991, the Reserve Bank and the Company
entered into the 1991 MOU. In accordance with the 1991 MOU, the Company
submitted to the Reserve Bank a plan to improve its financial condition and to
assure compliance by the Bank with the 1991 Formal Agreement. Pursuant to the
1991 MOU, the Company adopted written policies concerning dividends,
intercompany transactions and tax allocations and management or service fees.
Further, the Company agreed to refrain from paying dividends or incurring debt
without the prior written approval of the Reserve Bank.
The Reserve Bank's examination of the Company as of June 30, 1993, found the
Company to be in compliance with all provisions of the 1991 MOU except one,
which was to improve the financial condition of the Bank. Based on the results
of this examination, the Reserve Bank determined that the Company continued to
require supervisory attention and required the Company to have new
appointments of senior executive officers reviewed by the Reserve Bank prior
to their appointment.
As a result of the Reserve Bank's examination of the Company as of March 31,
1995, the Company entered into the 1995 MOU on October 26, 1995, which
supersedes and replaces the 1991 MOU. Among other things, the 1995 MOU: (i)
prohibits the Company from paying dividends without the prior approval of the
Reserve Bank; (ii) requires the submission of a plan to increase the Bank's
capital ratios; (iii) requires the Company to conduct a review of the senior
and executive management of the Company and the Bank; (iv) prohibits the
incurrence or renewal of debt without the Reserve Bank's approval; (v)
restricts cash expenditures in excess of $10,000 in any month; and (vi)
prohibits the Company from making acquisitions or divestitures or engaging in
new lines of business without the Reserve Bank's approval. The Company may be
subject to further regulatory enforcement action by the Reserve Bank and its
ability to effect acquisitions may be limited by regulatory constraints. See
"Regulation--Supervision and Regulation--Potential and Existing Enforcement
Actions." The Company believes that, following the completion of the Public
Offering and the Private Offering, it will be in full compliance with the 1995
MOU. However, there can be no assurance as to whether or when the Reserve Bank
will terminate the 1995 MOU.
Management expects that, until terminated, the 1995 Formal Agreement will
substantially impair the ability of the Bank to declare and pay dividends to
the Company, since the Bank currently intends to retain any earnings to
augment its regulatory capital. Since the Company's only source of funds for
the payment of dividends on the Preferred Stock will be dividends received
from the Bank, it is unlikely that the Company will declare and pay dividends
in the foreseeable future. In accordance with the 1995 MOU, the Company has
agreed to refrain from paying dividends without the prior written approval of
the Reserve Bank. The Company's ability to pay dividends is also dependent on
whether it has adequate retained earnings under California law. See "Risk
Factors--Restrictions on Preferred Stock Dividends."
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THE PRIVATE OFFERING
THE PRIVATE PURCHASERS
Pursuant to a private offering exemption from the registration requirements
of the Securities Act, the Company has offered and guaranteed the availability
of a minimum of $2.5 million (250,000 shares) of Preferred Stock and a maximum
of $5.5 million (550,000 shares) of Preferred Stock to the Private Purchasers,
and the Private Purchasers have agreed to buy such shares at the Private
Purchasers Price. The shares of Preferred Stock sold to the Private Purchasers
are sometimes referred to as the "Private Shares." The Company entered into
Private Purchase Agreements with Conrad Company, and Wildwood Enterprises. In
connection with its purchase of the Preferred Shares in the Private Offering,
Conrad Company is required to seek approval of the Board of Governors of the
Federal Reserve System to acquire more than 4.9% of the voting stock of the
Company.
THE PRIVATE OFFERING
The Company has guaranteed that it will sell an aggregate minimum of $2.5
million (250,000 shares) of Preferred Stock to the Private Purchasers (i.e.
$2.25 million for the Conrad Company and $250,000 for Wildwood Enterprises) if
the Basic Subscription Privilege is exercised in full by Rights Holders. If
the Basic Subscription Privilege is not exercised in full, the Company will
sell up to an aggregate of $5.5 million (550,000 shares) of Preferred Stock to
the Private Purchasers, subject to reduction by the Company to reduce the risk
that certain tax benefits will be subject to the Section 382 Limitation. See
"Certain Federal Income Tax Consequences."
TERMS OF THE PRIVATE PURCHASE AGREEMENTS
The following is a summary of the terms of the Private Purchase Agreements.
The Company will provide without charge to each person that so requests in
writing a copy of the Private Purchase Agreements. This summary is qualified
in its entirety by reference to the full text of the Private Purchase
Agreements which is included as an exhibit to the Registration Statement.
Capitalized terms used and not defined below or elsewhere in this Registration
Statement have the respective meanings assigned to them in the Private
Purchase Agreements. Parenthetical section references appearing at the end of
paragraphs in this summary refer to relevant sections in the Private Purchase
Agreement and are provided for convenience of reference only. All shareholders
are encouraged to read the Private Purchase Agreements carefully and in their
entirety.
SALE AND PURCHASE OF PRIVATE SHARES
The closing of the sale and purchase of the Private Shares (the "Closing")
is subject to the satisfaction of certain conditions set forth in the Private
Purchase Agreements. See "--Conditions to the Closing; Amendment and
Termination." Subject to the satisfaction or waiver of such conditions, the
Closing shall take place immediately after the closing of the sale of the
shares of Preferred Stock in the Public Offering, which date shall be no later
than five (5) business days after the Company notifies each of the Private
Purchasers as to the number of Available Shares with respect to such Private
Purchaser. At the Closing, the Company will issue the Available Shares to the
Private Purchasers in exchange for the aggregate Private Purchasers Price
therefor. (Sections 2 and 3.)
REPRESENTATIONS AND WARRANTIES
The Private Purchase Agreements contain customary representations and
warranties of the Company and each Private Purchaser, including, among other
things, by the Company as to due organization and standing; corporate power
and authority; enforceability of the Private Purchase Agreement;
capitalization; consents, approvals, and filings; conformity in all material
respects of the Registration Statement and Proxy Statement to requirements of
the Securities Act and the Exchange Act; requisite licenses; title to
property; subsidiaries of the Company; delivery of all SEC documents and
financial statements; absence of certain changes; absence of
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undisclosed liabilities; payment of taxes; absence of litigation; and by each
of the Private Purchasers as to due organization and standing; corporate
authority with respect to Conrad Company and trust authority with respect to
Wildwood Enterprises; enforceability of the respective Private Purchase
Agreement; qualification as an accredited investor and certain investment
representations. The representations and warranties generally shall survive
delivery of, and payment for, the Available Shares for a period of two (2)
years. (Sections 4, 5 and 13.8)
CERTAIN COVENANTS
The Private Purchase Agreements contain numerous covenants and agreements,
certain of which are summarized below.
Conduct of the Company's Business Pending the Closing. The Company has
agreed that until the Closing Date: (a) the Company will maintain its
corporate existence in good standing and will operate its business
substantially as presently planned or operated and only in the ordinary, usual
and customary manner, and, consistent with such operation, it will use its
reasonable efforts to preserve intact its present business organization and
its relationships with persons having business relationships with it; (b) no
amendment will be made to the Articles of Incorporation of the Company except
as contemplated under the Private Purchase Agreements; (c) there will be no
changes in the number of shares, par value or class of authorized or issued
capital stock of the Company, other than shares of Common Stock issued
pursuant to the exercise of currently outstanding options and warrants except
for or pursuant to the Rights Offering; the Company will not grant or issue
any option, warrant, convertible security, or other right to acquire any
shares of capital stock of the Company other than options under existing stock
option plans, certain warrant and employment agreements; (d) the Company will
not declare or pay any dividend or other distribution in respect to the
capital stock of the Company; and (e) the Company will not enter into any
material transaction outside of the ordinary course of business.
(Section 6.1.)
Right of First Refusal. Pursuant to the Private Purchase Agreement, the
Company has agreed that if the Company should decide to issue and sell
additional shares of any capital stock of the Company or any warrants,
securities convertible into capital stock of the Company or other rights to
subscribe for or to purchase any capital stock of the Company (with certain
exceptions), the Company shall first offer to sell such securities to the
Private Purchasers, upon the same terms and conditions as the Company is
proposing to issue and sell such securities, pro rata to its existing
ownership of capital stock. Notwithstanding the foregoing, no securities may
be sold to a Private Purchaser to the extent a change of ownership within the
meaning of the Section 382 Limitation would occur. (Section 6.8.)
Nomination of Directors; Board Observation. So long as Conrad Company is a
holder of shares of Preferred Stock, the Company shall, at the request of
Conrad Company and subject to any applicable federal or state banking law or
regulation, cause to be nominated for election as directors of the Company,
and use its reasonable best efforts to cause to be elected, that number of
persons designated by Conrad Company (but not Wildwood Enterprises) which
Conrad Company or any affiliate thereof is entitled to elect based on
cumulative voting thereby in the election of directors. Based on a Board of
Directors of the Company consisting of eight directors, Conrad Company will be
entitled to have between 1 and 3 directors nominated, depending on the
percentage ownership Conrad Company acquires in the Private Offering.
So long as Conrad Company has not so designated one or more directors or a
designee of Conrad Company is not otherwise a director of the Company, the
Company shall notify Conrad Company (but not Wildwood Enterprises) of all
regular meetings and special meetings of the Board of Directors of the Company
at least two business days in advance of such meeting and afford any
representative designated by Conrad Company the right and opportunity to
attend any such meeting. Such representative shall be entitled to receive all
written materials and such other information given to directors of the Company
in connection with any such meeting at the time such materials or information
are given to such directors; provided that such representative shall have
executed a confidentiality agreement in a form acceptable to the Company.
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The Company shall maintain as part of its Articles of Incorporation or By-
laws a provision for the indemnification and limitation on liability of its
directors to the full extent permitted by law and use its reasonable best
efforts to maintain director and officer liability insurance in amounts and on
terms no less favorable than included in the Company's existing policy.
(Section 6.9.)
NASDAQ. The Company has agreed that it shall use all reasonable efforts to
(i) cause the Preferred Stock and the Common Stock issuable pursuant to the
terms of the Preferred Stock to be eligible for quotation on the Nasdaq Stock
Market--National Market (ii) maintain the continued authorization for trading
of the Common Stock of the Company on the Nasdaq Stock Market--National Market
or (iii) in the event the Company is unable, after undertaking all such
reasonable efforts, to maintain such authorization, be listed or otherwise
authorized for trading on the Nasdaq Stock Market--Small Cap or a national
securities exchange and to comply with all applicable maintenance criteria of
such exchange or Nasdaq applicable to continued eligibility for trading on
such market.
CONDITIONS TO THE CLOSING; AMENDMENT AND TERMINATION
Conditions to the Closing. The obligations of the Company and the Private
Purchasers to consummate the transactions contemplated by the Private Purchase
Agreements are subject to a number of conditions, including but not limited
to: (a) the receipt at the Annual Meeting of shareholder approval of the terms
of the Preferred Stock as set forth in the Restatement; (b) the receipt of all
consents, approvals and filings required to be obtained or made by the Company
or the Private Purchasers from or to applicable federal and state banking
authorities, and any other governmental body; (c) the receipt of an opinion
from Deloitte & Touche LLP, independent accountants to the Company, to the
effect that, subject to certain limitations, as of the Closing Date, there
will be no change in ownership within the meaning of the Section 382
Limitation; (d) receipt and acceptance by the Company of valid subscriptions
for shares of Preferred Stock from shareholders, the Private Purchasers and
Standby Purchasers aggregating not less than $5.5 million which shall not
trigger the Section 382 Limitation; and (e) resolution of certain claims and
litigation, in such form and substance satisfactory to Conrad Company (but not
Wildwood Enterprises). (Sections 7, 8.)
Termination. The Private Purchase Agreements may be terminated at any time
prior to the Closing Date by (a) mutual consent of the Company and the Private
Purchasers, (b) either the Company or either of the Private Purchasers if: (i)
any governmental entity of competent jurisdiction shall have issued a final
nonappealable order enjoining or otherwise prohibiting the consummation of the
transactions contemplated by the Private Purchase Agreements; (ii) the
shareholders of the Company have not approved the Restatement; (iii) the
transactions contemplated hereunder have not been consummated on or before
June 30, 1997, unless the failure of consummation shall be due to the failure
of the party seeking to terminate to perform or observe in all material
respects the covenants and agreements thereunder to be performed or observed
by such party; or (iv) there shall have been an inaccuracy in any of the
representations or warranties on the part of the other party or material
breach of any covenant or agreement set forth in the Private Purchase
Agreements on the part of the other party, which breach shall not have been
cured within twenty (20) business days following receipt by the breaching
party of written notice of such breach from the other party, and (c) by either
of the Private Purchasers if there shall have occurred relative to the Company
or any subsidiary any event, change, or effect that would have Material
Adverse Effect. (Section 10.1.)
INDEMNIFICATION BY THE COMPANY
Indemnification. The Company has agreed to indemnify and hold harmless the
Private Purchasers, and their respective directors, officers, agents or
employees or persons who control the Private Purchaser within the meaning of
the Securities Act, from and against any losses, claims, damages or
liabilities, joint or several, arising out of or based directly or indirectly
upon (i) any material inaccuracy in any representation and warranty of the
Company contained in the Private Purchase Agreements and not qualified as to
materiality, and any inaccuracy in any representation and warranty of the
Company contained in the Private Purchase Agreements and qualified as to
materiality; (ii) any untrue statement or alleged untrue statement of a
material fact contained in the
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Registration Statement, any Preliminary Prospectus, the Prospectus, the Proxy
Statement, or any amendment or supplement thereto or arise out of or are based
upon the omission or alleged omission to state therein a material fact
required to be stated therein or necessary to make the statements therein not
misleading; and (iii) any other act or omission of the Company, its officers
or directors, or any alleged act or omission. The Company will reimburse the
Private Purchaser for any legal or other expenses reasonably incurred by it in
connection with investigating or defending against such loss, claim, damage,
liability or action; provided, however, that the Company shall not be liable
in any such case to the extent that any such loss, claim, damage, liability or
action arises out of or is based upon an untrue statement or alleged untrue
statement or omission or alleged omission made in the Registration Statement,
any Preliminary Prospectus, the Prospectus, the Proxy Statement, or any such
amendment or supplement, in reliance upon and in conformity with written
information furnished to the Company by the Private Purchaser specifically for
use in the preparation thereof. (Sections 11.1, 11.2.)
FEES AND EXPENSES; EXPENSE REIMBURSEMENT
The Company has agreed, regardless of whether the Closing takes place, to
pay the reasonable out-of-pocket expenses incurred by Conrad Company (but not
Wildwood Enterprises) in connection with the transactions contemplated by the
Private Purchase Agreements, including, without limitation, the reasonable
fees and out-of-pocket expenses of the special counsel and tax accountants for
Conrad Company (but not Wildwood Enterprises) for services in connection with
the transactions contemplated by the Private Purchase Agreement; provided,
however, that subject to certain exceptions as set forth below, the Company's
obligation to reimburse such expenses shall not exceed $150,000. The Company
has agreed to pay all fees and expenses incurred by Conrad Company (but not
Wildwood Enterprises) (a) in connection with any amendments or waivers
requested after the execution of the Private Purchase Agreement by the Company
and (b) with respect to the enforcement of the rights granted under the
Private Purchase Agreement or the agreements contemplated by the Private
Purchase Agreement.
In the event that (i) there shall occur any termination of the Private
Purchase Agreement with Conrad Company (but not Wildwood Enterprises) for any
reason pursuant to the termination provisions therein, other than by the
mutual consent of the Company and Conrad Company or by the Company in
accordance with subsection 10.1(b)(iv) of the Private Purchase Agreement with
Conrad Company (relating to breaches of the Private Purchase Agreement by
Conrad Company), and (ii) either (a) at the time of such termination there
exists a bona fide Investment Proposal from a person other than Conrad
Company, or (b) at any time prior to such termination the Company or any
affiliate, officer, director, representative or agent of the Company has had
any discussions, conversations, negotiations or other communications regarding
any Investment Proposal with any person other than Conrad Company and before
such termination or within twelve months thereafter, the Company or any
affiliate thereof enters into any agreement with such person, or such person
acquires or has the right to acquire beneficial ownership of 25% or more of
the voting capital stock of the Company or the Bank, or (c) the Board of
Directors of the Company shall have withdrawn, modified or amended in any
respect its approval or recommendation of the Restatement, shall not have
included such recommendation in the Proxy Statement or shall have resolved to
do any of the foregoing, then the Company shall, upon termination of the
Agreement in the case of clauses (a) and (c) above, or upon execution of such
agreement or acquisition of such shares or rights thereto, in the case of
clause (b) above, promptly pay to Conrad Company in immediately available
funds $250,000. (Section 12.)
THE RIGHTS OFFERING
THE RIGHTS
The Company is hereby issuing nontransferable Rights at no cost to each
holder of record of Common Stock as of the close of business on May 5, 1997.
The Company will issue one Right for each share of Common Stock held on the
Record Date. The Rights will be evidenced by Subscription Right Certificates,
which are being distributed to each Rights Holder contemporaneously with the
delivery of this Prospectus.
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The Company's Board of Directors, with the assistance of Sandler O'Neill,
determined the ratio of one Right for each share of Common Stock based on
factors the Board considered to be relevant to such determination, including
the amount of proceeds sought to be raised, pricing and dilution
characteristics of other rights offerings, negotiations with the Private
Purchasers and the then current trading price of the Common Stock. See "The
Rights Offering--Determination of Subscription Price."
No fractional Rights or cash in lieu thereof will be issued or paid.
Instead, the number of Rights issued to a Rights Holder will be rounded up to
the nearest whole number. A depository, bank, trust company or securities
broker or dealer holding shares of Common Stock on the Record Date for more
than one beneficial owner may exchange its Subscription Right Certificate to
obtain a Subscription Right Certificate for the number of Rights to which all
such beneficial owners in the aggregate would have been entitled had each been
a holder on the Record Date; no other Subscription Right Certificate may be so
divided as to increase the number of Rights to which the original recipient
was entitled. The Company reserves the right to refuse to issue any
Subscription Right Certificate if such issuance would be inconsistent with the
principle that each beneficial owner's holdings will be rounded up to the
nearest whole number of Rights. The Subscription Agent must receive the
completed Subscription Right Certificate for the purpose of exchange no later
than 5:00 p.m., Pacific Time, on June 6, 1997, after which time no new
Subscription Right Certificates will be issued.
Because the number of Rights issued to each Rights Holder will be rounded up
to the nearest whole number, beneficial owners of Common Stock who are also
the Record Date holders of their shares will receive more Rights under certain
circumstances than beneficial owners of Common Stock who are not the Record
Date holders of their shares and who do not obtain (or cause the Record Date
holder of their shares of Common Stock to obtain) a separate Subscription
Right Certificate with respect to the shares beneficially owned by them,
including shares held in an investment advisory or similar account. To the
extent that Record Date holders or beneficial owners of Common Stock who
obtain a separate Subscription Right Certificate receive more Rights, they
will be able to subscribe for more shares pursuant to the Basic Subscription
Privilege and Oversubscription Privilege. See "The Rights Offering--Method of
Subscription--Exercise of Rights."
Once the Rights are distributed and until the Expiration Time, the Company
will not effect a reclassification of the Company's equity securities (other
than the Reverse Stock Split) which could have the effect of materially
altering the value of the Rights during the pendency of the Rights Offering.
MINIMUM CONDITION
The Public Offering and the Private Offering are conditioned upon the
receipt by the Company of minimum offering proceeds of $5.5 million, which can
be achieved through the Maximum Private Offering alone, or through a
combination of participation by the Rights Holders and the Standby Purchasers
in the Public Offering and the Private Purchasers in the Private Offering or
through a combination of participation by the Rights Holders and the Standby
Purchasers in the Public Offering. In the event the Minimum Condition is not
achieved, any funds that have been deposited with the Subscription Agent will
be returned, without interest. As a result of the Private Purchase Agreements
and Standby Purchase Agreements pursuant to which the Private Purchasers and
Standby Purchasers have agreed to acquire in the aggregate up to $8.0 million
of Preferred Stock (subject to reduction to avoid certain adverse tax
consequences to the Company), the Company believes that the Minimum Condition
will be satisfied.
EXPIRATION TIME
The Rights will expire at 5:00 p.m., Pacific Time, on June 13, 1997, subject
to extension in the sole discretion of the Company. The Company does not
currently contemplate any such extensions. After the Expiration Time,
unexercised Rights will be null and void. The Company will not be obligated to
honor any purported exercise of Rights received by the Subscription Agent
after the Expiration Time, regardless of when the documents relating to that
exercise were sent, except pursuant to the Guaranteed Delivery Procedures
described below. The Company may extend the Expiration Time by giving oral or
written notice to the
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Subscription Agent on or before the Expiration Time, followed by a press
release no later than 9:00 a.m., Pacific Time, on the next business day after
the previously scheduled Expiration Time. The Rights Offering will not be
extended to a time later than 5:00 p.m., Pacific Time, on June 23, 1997.
RIGHT TO TERMINATE OFFERING
The Company expressly reserves the right, in its sole discretion, at any
time prior to delivery of the shares of Preferred Stock offered hereby, to
terminate the Public Offering if the Public Offering is prohibited by law or
regulation or the Board of Directors concludes, in its judgment, that it is
not in the best interests of the Company and its shareholders, to complete the
Public Offering under the circumstances. If the Public Offering is terminated,
all funds received pursuant to the Public Offering will be promptly refunded,
without interest.
SUBSCRIPTION PRIVILEGES
Basic Subscription Privilege. Each Right will entitle the holder thereof to
purchase at the Subscription Price 1.624 Underlying Preferred Shares, subject
to reduction by the Company under certain circumstances. See "The Rights
Offering--Limitations--Tax Limitation" and "--Regulatory Limitation." Each
Rights Holder is entitled to subscribe for all, or any portion of, the
Underlying Preferred Shares which may be acquired through the exercise of
Rights. Payment of the Subscription Price will be held in an escrow account to
be maintained by U.S. Stock Transfer Corporation as Subscription Agent and
will be applied to the purchase of Preferred Stock or promptly returned
without interest following the Expiration Time. Subject to satisfaction of the
Minimum Condition, the certificates representing Underlying Preferred Shares
purchased pursuant to the Basic Subscription Privilege will be delivered to
subscribers as soon as practicable after the Expiration Time and all
prorations and reductions contemplated by the Public Offering and the Private
Offering have been effected. The Basic Subscription Privilege is not
transferable.
Oversubscription Privilege. Subject to proration and possible reduction, as
described below and in "The Rights Offering--Limitations--Tax Limitation" and
"--Regulatory Limitation," Rights Holders who elect to exercise the Basic
Subscription Privilege in full will also be eligible to subscribe at the
Subscription Price for 0.376 shares of Preferred Stock, for each Right held,
that are not otherwise subscribed for pursuant to the Basic Subscription
Privilege and are not purchased by the Private Purchasers pursuant to the
terms of the Private Offering (the "Oversubscription Privilege"). Only Rights
Holders who exercise the Basic Subscription Privilege in full will be entitled
to exercise the Oversubscription Privilege, which must be exercised at the
same time as the Basic Subscription Privilege is exercised. The
Oversubscription Privilege is not transferable. If 45.5% of the Basic
Subscription Privilege is exercised by the Rights Holders and assuming $5.5
million of Preferred Stock is sold pursuant to the Private Offering,
participation in the Oversubscription Privilege will be precluded.
Shares of Preferred Stock will be available for purchase pursuant to the
Oversubscription Privilege only to the extent that any Underlying Preferred
Shares are not subscribed for through exercise of the Basic Subscription
Privilege and not purchased by the Private Purchasers (i.e. an aggregate of
$8.0 million of Preferred Stock has not been purchased by the shareholders
pursuant to the Basic Subscription privilege and the Private Purchasers
pursuant to the Private Offering. If the Underlying Preferred Shares are not
sufficient to satisfy all subscriptions pursuant to the Oversubscription
Privilege, the Excess Underlying Preferred Shares will be allocated pro rata
(subject to the elimination of fractional shares) among the Rights Holders who
exercise their Oversubscription Privilege in proportion to the number of
shares of Common Stock owned as of the Record Date; provided, however, that if
such pro rata allocation results in any Rights Holder being allocated a
greater number of Excess Underlying Preferred Shares than such holder
subscribed for pursuant to the exercise of the Oversubscription Privilege,
each Rights Holder will be allocated only that number of Excess Underlying
Preferred Shares for which such holder oversubscribed, and the remaining
Excess Underlying Preferred Shares will be allocated among all other Rights
Holders exercising the Oversubscription Privilege on the same pro rata basis
outlined above. Such proration will be repeated until all Excess Underlying
Preferred Shares have been allocated to the full extent of the
Oversubscription Privilege exercised. Payments for exercises of the
Oversubscription Privilege will be deposited upon receipt by the Subscription
Agent and held in a segregated account pending a final
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determination of the number of Excess Underlying Preferred Shares to be issued
pursuant to such Oversubscription Privilege. THEREFORE, ASSUMING NO EXTENSIONS
OF THE EXPIRATION TIME, RIGHTS HOLDERS WHO PLACE OVERSUBSCRIPTION ORDERS PRIOR
TO THE EXPIRATION TIME WILL LOSE ACCESS TO FUNDS TENDERED FOR A MAXIMUM OF 40
DAYS AND MAY NOT ACTUALLY ACQUIRE ANY OR ALL OF THE EXCESS UNDERLYING
PREFERRED SHARES TO WHICH THEY SUBSCRIBE. If a proration of the Excess
Underlying Preferred Shares results in a Rights Holder receiving fewer Excess
Underlying Preferred Shares than such Rights Holder subscribed for pursuant to
the Oversubscription Privilege, then the excess funds paid by that holder for
shares not issued will be returned without interest or deduction. Subject to
satisfaction of the Minimum Condition, certificates representing Excess
Underlying Preferred Shares purchased pursuant to the Oversubscription
Privilege will be delivered to subscribers as soon as practicable after the
Expiration Time and after all prorations and adjustments contemplated by the
terms of the Public Offering and the Private Offering have been effected.
To exercise the Oversubscription Privilege, banks, brokers and other
nominees of Rights Holders who exercise the Oversubscription Privilege on
behalf of beneficial owners of Rights will be required to certify to the
Subscription Agent and the Company the aggregate number of Rights as to which
the Oversubscription Privilege has been exercised and the number of Excess
Underlying Preferred Shares thereby subscribed for by each beneficial owner of
Rights on whose behalf such nominee holder is acting.
SUBSCRIPTION PRICE
The Subscription Price is $10.00. Shares purchased by the Private Purchasers
will be purchased at the Subscription Price. Shares purchased by Standby
Purchasers pursuant to the Standby Purchase Agreements shall be at the
Subscription Price.
DETERMINATION OF SUBSCRIPTION PRICE
The Subscription Price was set by the Company's Board of Directors, taking
into consideration factors which the Board believes relevant to a
determination of the value of the Preferred Stock. Among the factors
considered by the Board in determining the Subscription Price, which is not an
exclusive list, were: (i) the Company's unsuccessful attempts to sell the Bank
in 1995; (ii) the Company's history of losses; (iii) the potential value of
the NOLs and advice from the Company's tax advisor regarding the structure of
the transaction as it relates to the Company's ability to raise the maximum
amount of capital in the Public Offering and the Private Offering without
subjecting the Company to the Section 382 Limitation; (iv) management's and
the Board of Directors' view that the involvement of Conrad Company would be
beneficial; (v) the benefit to the Company of raising additional capital in
excess of the requirements of the 1995 Formal Agreement; (vi) the average
price/tangible book value of the Common Stock of selected comparable
California community banks relative to the pro forma price/tangible book value
of the Preferred Stock on a fully converted basis proposed in the Public
Offering and the Private Offering; (vii) the current trading value of the
Company's Common Stock; (viii) present and projected operating results and
financial condition of the Company; (ix) an assessment of the Company's
management and management's analysis of the growth potential of the Company
and the Company's primary market; and (x) the advice of Sandler O'Neill. See
"Capitalization," "Risk Factors--Dilution of Ownership Interest" and "The
Right's Offering--Financial Advisor."
There can be no assurance, however, that the market price of the Common
Stock will not decline during the subscription period to a level equal to or
below the Subscription Price, or that, following the issuance of the Rights
and of the Preferred Stock upon exercise of Rights or pursuant to the Standby
Purchase Agreements, a subscribing Rights Holder or Standby Purchaser will be
able to sell shares purchased in the Public Offering at a price equal to or
greater than the Subscription Price.
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NO BOARD OR FINANCIAL ADVISOR RECOMMENDATION
An investment in the Preferred Stock must be made pursuant to each
investor's evaluation of such investor's best interests. ACCORDINGLY, NEITHER
THE BOARD OF DIRECTORS OF THE COMPANY NOR SANDLER O'NEILL MAKE ANY
RECOMMENDATION TO RIGHTS HOLDERS OR OTHER PROSPECTIVE PURCHASERS REGARDING
WHETHER THEY SHOULD EXERCISE THEIR RIGHTS OR OTHERWISE SUBSCRIBE FOR SHARES OF
PREFERRED STOCK.
FINANCIAL ADVISOR
The Company has engaged Sandler O'Neill as its financial advisor in
connection with the Public Offering pursuant to an agreement between the
Company and Sandler O'Neill. Sandler O'Neill is a nationally recognized
investment banking firm whose principal business specialty is banks and
savings institutions and is regularly engaged in the valuation of such
businesses and their securities in connection with mergers and acquisitions
and other corporate transactions.
In its capacity as financial advisor, Sandler O'Neill provided advice to the
Company regarding the structure of the Public Offering as well as with respect
to marketing the shares of Preferred Stock to be issued in the Public
Offering. Sandler O'Neill also assisted the Company in reviewing the Private
Purchase Agreements. Sandler O'Neill will identify potential Standby
Purchasers and will assist the Company in negotiating Standby Purchase
Agreements with the Standby Purchasers.
Sandler O'Neill has not prepared any report or opinion constituting a
recommendation or advice to the Company or its shareholders, nor has Sandler
O'Neill prepared an opinion as to the fairness of the Subscription Price or
the terms of the Public Offering to the Company or its current shareholders.
Sandler O'Neill expresses no opinion and makes no recommendation to Rights
Holders or Standby Purchasers as to the purchase by any person of shares of
Preferred Stock in the Public Offering. Sandler O'Neill also expresses no
opinion as to the prices at which shares to be distributed in connection with
the Public Offering may trade if and when they are issued or at any future
time. See "The Rights Offering--Determination of Subscription Price."
As compensation for its services, the Company has agreed to pay Sandler
O'Neill: (i) a fee of 3.0% of the aggregate purchase price of the shares of
Preferred Stock sold in the Rights Offering (other than shares of Preferred
Stock sold in the Rights Offering in Arizona) and (ii) a fee of 5.0% of the
aggregate value of funds committed by the Standby Purchasers. Sandler O'Neill
will also receive 1.5% of the aggregate value of funds committed in the
Private Offering. The fees set forth above are subject to Sandler O'Neill
receiving minimum aggregate compensation upon closing of the Public Offering
and the Private Offering of $250,000. The Company also has agreed to reimburse
Sandler O'Neill for its reasonable out-of-pocket expenses pertaining to its
engagement, including legal fees, in an aggregate amount not to exceed
$125,000. The Company has agreed to indemnify Sandler O'Neill against certain
liabilities arising out of its engagement, including certain liabilities
arising under the securities laws.
LIMITATIONS
Regulatory Limitation
The Company will not be required to issue shares of Preferred Stock pursuant
to the Public Offering to any Rights Holder or Standby Purchaser who, in the
Company's sole judgment and discretion, is required to obtain prior clearance,
approval or nondisapproval from any state or federal bank regulatory authority
to own or control such shares unless, prior to the Expiration Time, evidence
of such clearance, approval or nondisapproval has been provided to the
Company. If the Company elects not to issue shares in such case, such shares
will become available to the Rights Holders, Private Purchasers or Standby
Purchasers as to whom such conditions do not apply.
The Change in Bank Control Act of 1978 prohibits a person or group of
persons "acting in concert" from acquiring "control" of a bank holding company
unless the Reserve Bank has been given 60 days' prior written
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notice of such proposed acquisition and within that time period the Reserve
Bank has not issued a notice disapproving the proposed acquisition or
extending for up to another 30 days the period during which such a disapproval
may be issued. An acquisition may be made prior to the expiration of the
disapproval period if the Reserve Bank issues written notice of its intent not
to disapprove the action. Under a rebuttable presumption established by the
Reserve Bank, the acquisition of more than 10% of a class of voting stock of a
bank holding company with a class of securities registered under Section 12 of
the Exchange Act (such as the Common Stock into which the Preferred Stock is
convertible) would, under the circumstances set forth in the presumption,
constitute the acquisition of control.
In addition, any "company" would be required to obtain the approval of the
Reserve Bank under the BHC Act before acquiring 25% (5% in the case of an
acquiror that is, or is deemed to be, a bank holding company) or more of the
outstanding shares of any class of voting securities, or such lesser number of
shares as constitute control over, the Company. Conrad Company, a bank holding
company and one of the Private Purchasers, has filed an application with the
Reserve Bank for approval to acquire more than 5.0% of the voting stock of the
Company. See "The Private Offering" and "Risk Factors--Requirement of
Regulatory Approval for Investment of Private Purchaser."
Tax Limitation
As of December 31, 1996, the Company had NOL carryforwards of $22.3 million
and $11.8 million for federal and state purposes, respectively. The
acquisition of Underlying Preferred Shares pursuant to the Basic Subscription
Privilege or Excess Underlying Preferred Shares pursuant to the
Oversubscription Privilege, or the issuance of shares to Private Purchasers or
Standby Purchasers, combined with future trading in the Company's Common or
Preferred Stock, could result in an "ownership change" within the meaning of
Section 382. The Company has reserved the right, with certain exceptions, in
its sole judgment and discretion to limit the number of Underlying Preferred
Shares issued as a result of exercises of Basic Subscription Privileges and
Oversubscription Privileges in the aggregate or to any Rights Holder or the
Standby Purchasers to reduce the risk that the Section 382 Limitation will
apply. The Company has reserved the right to limit in certain circumstances,
the number of shares of Preferred Stock the Private Purchasers may acquire to
reduce the risk that the Section 382 Limitation will apply. The Company will
determine whether to exercise this discretion by comparing the benefits of a
successful offering with any tax detriments associated with an ownership
change. The Company has obtained the opinion of Deloitte & Touche LLP that,
subject to certain limitations, the Public Offering and the Private Offering
should not result in an ownership change within the meaning of Section 382. If
the Public Offering and the Private Offering were to cause such an ownership
change, or if future trading in the Company's shares were to cause such an
ownership change, the Company's ability to use its NOL carryforwards in the
future could be adversely affected.
An "ownership change" will occur if the aggregate percentage point ownership
increase for all 5% shareholders for a "testing period" exceeds 50%. For this
purpose, a "5% shareholder" is any direct or indirect holder, taking certain
attribution rules into account, of 5% or more of a corporation's stock. For
this purpose, all holders of less than 5% are collectively treated as a single
5% shareholder. In general, the "testing period" is the three-year period
ending on the date an ownership change has occurred. Such period may be less
than three years and will begin on the first day of the most recent taxable
year from which a net operating loss or excess credit is carried forward. Once
an "ownership change" has occurred, as of that date, only subsequent ownership
changes are tested. In determining the amount by which 5% shareholders have
increased their percentage, the percentage interest of each 5% shareholder on
the testing date is compared to the lowest percentage interest of such
shareholder at any time during the testing period. For example, a shareholder
whose percentage ownership increased from 6% to 20% during the testing period
will be considered to have had an increase of 14%. If the aggregate change of
all 5% shareholders exceeds 50% as of the end of the "testing period," then an
"ownership change" will have occurred. This would impose an annual Section 382
Limitation on the ability of the Company to use its net operating loss
beginning in the year in which the "ownership change" has occurred. The amount
of the NOL carryforwards that could be used by the Company annually would be
determined by multiplying the value of the Company as of the "ownership
change" date by the long-term, tax-exempt bond rate at that time, a rate that
was 5.50% at March 31, 1997.
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Transfer Limitation
As part of the Company's efforts to avoid the Section 382 Limitation on the
use of its NOLs, the terms of the Preferred Shares as reflected in the
Restatement shall prohibit, and the certificates evidencing the Preferred
Shares and the shares of Common Stock issued upon conversion of the Preferred
Stock will contain a legend prohibiting, transfer of such Preferred Stock or
Common Stock to any person (other than persons to whom the Company is
contractually obligated on or before the Date of Issuance to transfer up to
4.9% of the Company's Stock) if such person is or would become by reason of
such transfer the beneficial owner of more than 4.5% (or 4.9% as described
above) of the Company's stock, as the term "stock" is defined and such
ownership is determined under Section 382. The Restatement also will impose
the NOL Transfer Restriction on shares of Common Stock currently outstanding
and those issued by the Company in the future. The NOL Transfer Restriction
and the legend will not restrict future transfers (up to 4.9%) by any holder
to those persons to whom the Company is contractually obligated on or before
the Date of Issuance to transfer up to 4.9% of the Company's stock. The
Company has the right to demand that any stock transferred in violation of the
NOL Transfer Restriction (the "Transferred Stock") be transferred to the
Company and any distributions received on the Transferred Stock be remitted to
the Company. In addition, the Company has the right to demand remittance of
proceeds received from such initial transfer. The Company shall sell the
Transferred Stock in an arm's length transaction and remit the proceeds
thereof to the original shareholder. The NOL Transfer Restriction expires
(i) on or after three years from the Date of Issuance or (ii) upon the
occurrence of any transaction in which holders of all outstanding shares of
capital stock receive, or are offered the opportunity to receive, cash, stock
or other property for all such shares and upon the consummation of which the
acquiror will own at least a majority of the outstanding shares of capital
stock. In addition, the Board of Directors of the Company is expressly
empowered to waive application of the NOL Transfer Restriction to any specific
transaction provided that such waiver is by resolution of the Board of
Directors duly considered and approved by at least a majority of the Board of
Directors prior to any such transfer of stock.
METHOD OF SUBSCRIPTION
Exercise of Rights
Rights Holders may exercise their Rights by delivering to the Subscription
Agent, at the addresses specified below, at or prior to the Expiration Time,
properly completed and executed Subscription Right Certificate(s) evidencing
those Rights, with any signatures guaranteed as required, together with
payment in full of the Subscription Price for each Underlying Share subscribed
for pursuant to the Basic Subscription Privilege and the Oversubscription
Privilege. Payment may be made only (i) by check or bank draft drawn upon a
U.S. bank, or postal, telegraphic or express money order, payable to U.S.
Stock Transfer Corporation, as Subscription Agent; or (ii) by wire transfer of
funds to the escrow account maintained by the Subscription Agent for the
purpose of accepting subscriptions at First Professional Bank NA (with
Subscriber's name, for further credit to National Mercantile Bancorp Account)
(the "Subscription Account"). The Subscription Price will be deemed to have
been received by the Subscription Agent only upon (i) clearance of any
uncertified check; (ii) receipt by the Subscription Agent of any certified
check or bank draft drawn upon a U.S. bank or any postal, telegraphic or
express money order; or (iii) receipt of collected funds in the Subscription
Agent's account designated above. Funds paid by uncertified personal check may
take up to five business days to clear. ACCORDINGLY, RIGHTS HOLDERS WHO WISH
TO PAY THE SUBSCRIPTION PRICE BY MEANS OF UNCERTIFIED PERSONAL CHECK ARE URGED
TO MAKE PAYMENT SUFFICIENTLY IN ADVANCE OF THE EXPIRATION TIME TO ENSURE THAT
SUCH PAYMENT IS RECEIVED AND CLEARS BY SUCH TIME AND ARE URGED TO CONSIDER IN
THE ALTERNATIVE PAYMENT BY MEANS OF CERTIFIED CHECK, BANK DRAFT, MONEY ORDER
OR WIRE TRANSFER OF FUNDS. All funds received in payment of the Subscription
Price shall be held by the Subscription Agent and invested at the direction of
the Company in short-term certificates of deposit, short-term obligations of
the United States or any state or any agency thereof or money market mutual
funds investing in the foregoing instruments. Subscription funds paid to
exercise the Oversubscription Privilege will be returned to the Rights Holder
in the event there are insufficient Excess Underlying Preferred Shares to
fulfill any Oversubscription Privilege. See "The Rights Offering--Subscription
Privileges." The account in which such funds will be held will not be insured
by the FDIC. Any interest earned on such funds will be retained by the
Company.
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The Subscription Right Certificates and payment of the Subscription Price
or, if applicable, Notices of Guaranteed Delivery or DTC Participant
Oversubscription Exercise Forms, as defined below, must be delivered to the
Subscription Agent, by mail, hand delivery, overnight or other courier
service, at the following address:
National Mercantile Bancorp Account
U.S. Stock Transfer Corporation
1745 Gardena Avenue, Suite 200
Glendale, California 91204
Telephone number: (800) 835-8775
Facsimile number: (818) 502-0674
The Company will absorb the costs of the fees and expenses of the
Subscription Agent and has agreed to indemnify the Subscription Agent from
certain liabilities which it may incur in connection with the Public Offering.
Except for fees absorbed by the Company, and transfer taxes, if any, which
shall be paid by the Company, all commissions, fees and other expenses
(including brokerage commissions) incurred in connection with the exercise of
Rights will be for the account of the Rights Holder, and none of such
commissions, fees or expenses will be paid by the Company.
If a Rights Holder wishes to exercise Rights, but time will not permit such
Rights Holder to cause the Subscription Right Certificate(s) evidencing those
Rights to reach the Subscription Agent prior to the Expiration Time, such
Rights may nevertheless be exercised if all of the following conditions (the
"Guaranteed Delivery Procedures") are met:
(i) the Rights Holder has caused payment in full of the Subscription
Price for each Underlying Share being subscribed for pursuant to the Basic
Subscription Privilege and, if applicable, the Oversubscription Privilege,
to be received (in the manner set forth above) by the Subscription Agent at
or prior to the Expiration Time;
(ii) the Subscription Agent receives, at or prior to the Expiration Time,
a guarantee notice (a "Notice of Guaranteed Delivery"), substantially in
the form provided with the Instructions as to Use of National Mercantile
Bancorp Subscription Rights Certificates (the "Instructions") distributed
with the Subscription Right Certificates, guaranteed by a member firm of an
approved Signature Guarantee Medallion Program (an "Eligible Institution"),
stating the name of the exercising Rights Holder, the number of Underlying
Preferred Shares being subscribed for pursuant to the Basic Subscription
Privilege, and, if any, pursuant to the Oversubscription Privilege, and
guaranteeing the delivery to the Subscription Agent of the Subscription
Right Certificate(s) evidencing those Rights within two (2) business days
following the date of the Notice of Guaranteed Delivery; and
(iii) the properly completed Subscription Right Certificate(s) evidencing
the Rights being exercised, with any signatures guaranteed as required, is
received by the Subscription Agent within two (2) business days following
the date of the Notice of Guaranteed Delivery relating thereto. The Notice
of Guaranteed Delivery may be delivered to the Subscription Agent in the
same manner as Subscription Right Certificates at the address set forth
above or may be transmitted to the Subscription Agent by telegram or
facsimile transmission. Additional copies of the form of Notice of
Guaranteed Delivery are available upon request from the Information Agent
whose address and telephone number are set forth below.
If an exercising Rights Holder does not indicate the number of Rights being
exercised, or does not forward full payment of the aggregate Subscription
Price for the number of Rights that the Rights Holder indicates are being
exercised, then the Rights Holder will be deemed to have exercised the Basic
Subscription Privilege with
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respect to the maximum number of Rights that may be exercised for the
aggregate payment delivered by the Rights Holder and, to the extent that the
aggregate payment delivered by the Rights Holder exceeds the product of the
Subscription Price multiplied by the number of Rights evidenced by the
Subscription Right Certificates delivered by the Rights Holder (such excess
being the "Subscription Excess"), the Rights Holder will be deemed to have
exercised the Oversubscription Privilege to purchase, to the extent available,
that number of whole Excess Underlying Shares equal to the quotient obtained
by dividing the Subscription Excess by the Subscription Price. Any amount
remaining after application of the foregoing procedures shall be returned to
the Rights Holder promptly by mail without interest or deduction.
Funds received in payment of the Subscription Price for Excess Underlying
Shares subscribed for pursuant to the Oversubscription Privilege will be held
in a Subscription Account and segregated from its other accounts pending
issuance of the Excess Underlying Shares. If a Rights Holder exercising the
Oversubscription Privilege is allocated less than all of the Excess Underlying
Shares for which that Rights Holder subscribed pursuant to the
Oversubscription Privilege, then the excess funds paid by the Rights Holder as
the Subscription Price for shares not allocated to such Rights Holder shall be
returned by mail, without interest, as soon as practicable after the
Expiration Time and after all prorations and adjustments contemplated by the
terms of the Public Offering and the Private Offering have been effected. See
"Risk Factors--Period of Escrow."
Subject to satisfaction of the Minimum Condition, certificates representing
shares of Preferred Stock subscribed for and issued pursuant to the Basic
Subscription Privilege and the Oversubscription Privilege will be mailed as
soon as practicable after the Expiration Time and after all prorations and
adjustments contemplated by the terms of the Public Offering and the Private
Offering have been effected. Certificates for shares of Preferred Stock issued
pursuant to the exercise of Rights will be registered in the name of the
Rights Holder exercising such Rights. There can be no assurance that the value
of the Preferred Stock will not decline below the Subscription Price before
such shares of Preferred Stock are delivered. See "Risk Factors--Market
Considerations."
Unless a Subscription Right Certificate provides that the Underlying Shares
to be issued pursuant to the exercise of the Rights represented thereby are to
be issued to the Rights Holder or is submitted for the account of an Eligible
Institution, signatures on each Subscription Right Certificate must be
guaranteed by an Eligible Institution.
Holders of Common Stock of record at the Record Date ("Record Date Holders")
who hold shares of Common Stock for the account of others, such as brokers,
trustees or depositories for securities, should contact the respective
beneficial owners of such shares as soon as possible to ascertain these
beneficial owners' intentions and to obtain instructions with respect to their
Rights. If a beneficial owner so instructs, the Record Date Holder of that
beneficial owners' Rights should complete appropriate Subscription Right
Certificate(s) and submit them to the Subscription Agent with the proper
payment by noon of the next business day after the receipt of any funds from
the beneficial owner pursuant to NASD Notice to Members 84-7. In addition,
beneficial owners of Rights through such a nominee holder should contact the
nominee holder and request the nominee holder to effect transactions in
accordance with the beneficial owners' instructions. If a beneficial owner
wishes to obtain a separate Subscription Right Certificate, he, she or it
should contact the nominee as soon as possible and request that a separate
Subscription Right Certificate be issued. A Nominee may request any
Subscription Right Certificate held by it to be split into such smaller
denominations as it wishes, provided that the Subscription Right Certificate
is received by the Subscription Agent, properly endorsed, no later than 5:00
p.m., Pacific Time, on June 6, 1997.
The Instructions accompanying the Subscription Right Certificates should be
read carefully and followed in detail. SUBSCRIPTION RIGHT CERTIFICATES SHOULD
BE SENT WITH PAYMENT TO THE SUBSCRIPTION AGENT. DO NOT SEND SUBSCRIPTION RIGHT
CERTIFICATES TO THE COMPANY.
THE METHOD OF DELIVERY OF SUBSCRIPTION RIGHT CERTIFICATES AND PAYMENT OF THE
SUBSCRIPTION PRICE TO THE SUBSCRIPTION AGENT WILL BE AT THE ELECTION AND RISK
OF THE RIGHTS HOLDERS. IF SUBSCRIPTION RIGHT CERTIFICATES AND PAYMENTS ARE
SENT BY MAIL, RIGHTS HOLDERS ARE URGED TO SEND SUCH MATERIALS BY REGISTERED
MAIL, PROPERLY INSURED, WITH RETURN RECEIPT REQUESTED, AND ARE URGED TO ALLOW
A
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SUFFICIENT NUMBER OF DAYS TO ENSURE DELIVERY TO THE SUBSCRIPTION AGENT AND
CLEARANCE OF PAYMENT PRIOR TO THE EXPIRATION TIME. BECAUSE UNCERTIFIED CHECKS
MAY TAKE AT LEAST FIVE BUSINESS DAYS TO CLEAR, RIGHTS HOLDERS ARE STRONGLY
URGED TO PAY, OR ARRANGE FOR PAYMENT, BY MEANS OF CERTIFIED CHECK, BANK DRAFT,
MONEY ORDER OR WIRE TRANSFER OF FUNDS.
Certain directors and officers of the Company will assist the Company in the
Public Offering by, among other things, participating in informational
meetings regarding the Public Offering, generally being available to answer
questions of potential subscribers and soliciting orders in the Public
Offering. None of such directors and officers will receive additional
compensation for such services. None of such directors and officers are
registered as securities brokers or dealers under the federal or applicable
state securities laws, nor are any of such persons affiliated with any broker
or dealer. Because none of such persons are in the business of either
effecting securities transactions for others or buying and selling securities
for their own account, they are not required to register as brokers or dealers
under the federal securities laws. In addition, the proposed activities of
such directors and officers are exempted from registration pursuant to a
specific safe-harbor provision under Rule 3a4-1 under the Exchange Act.
Substantially similar exemptions from registration are available under
applicable state securities laws.
All questions concerning the timeliness, validity, form and eligibility of
any exercise of Rights will be determined by the Company, whose determination
will be final and binding. The Company, in its sole discretion, may waive any
defect or irregularity, or permit a defect or irregularity to be corrected
within such time as it may determine, or reject the purported exercise of any
Right. Subscription Right Certificates will not be deemed to have been
received or accepted until all irregularities have been waived or cured within
such time as the Company determines, in its sole discretion. Neither the
Subscription Agent or the Company will be under any duty to give notification
of any defect or irregularity in connection with the submission of
Subscription Right Certificates or incur any liability for failure to give
such notification. The Company reserves the right to reject any exercise if
such exercise is not in accordance with the terms of the Rights Offering or
not in proper form or if the acceptance thereof or the issuance of the
Preferred Stock pursuant thereto could be deemed unlawful. See "The Rights
Offering--Limitations--Regulatory Limitation" and "--Tax Limitation."
All questions or requests for assistance concerning the method of exercising
Rights or requests for additional copies of this Prospectus, the Instructions
or the Notice of Guaranteed Delivery should be directed to the Information
Agent at its address set forth below (telephone (800) 554-7733 or call collect
(212) 344-6733). See "The Rights Offering--The Information Agent."
Procedures for DTC Participants
It is anticipated that the Rights will be eligible for transfer through, and
that the exercise of the Basic Subscription Privilege (but not the
Oversubscription Privilege) may be effected through, the facilities of The
Depository Trust Company ("DTC"); Rights which the holder exercises through
the DTC are referred to as ("DTC Rights"). A holder of DTC Rights may exercise
the Oversubscription Privilege in respect thereof by properly exercising and
delivering to the Subscription Agent, at or prior to the Expiration Time, a
DTC Participant Oversubscription Exercise Form, together with payment of the
appropriate Subscription Price for the number of Excess Underlying Preferred
Shares for which the Oversubscription Privilege is exercised. Copies of the
DTC Participant Oversubscription Exercise Form may be obtained from the
Information Agent or the Subscription Agent.
NO REVOCATION
ONCE A RIGHTS HOLDER HAS PROPERLY EXERCISED THE BASIC SUBSCRIPTION PRIVILEGE
OR THE OVERSUBSCRIPTION PRIVILEGE, SUCH EXERCISE MAY NOT BE REVOKED.
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LATE DELIVERY OF SUBSCRIPTION RIGHT CERTIFICATES
If the Subscription Agent has received prior to the Expiration Time full
payment as specified above for the total number of shares of Preferred Stock
subscribed for, together with a letter, telegram or facsimile transmission
from a bank or trust company or a member of a recognized securities exchange
in the United States stating the name of the subscriber, the number of Rights
represented by the Subscription Right Certificate and the number of Underlying
Preferred Shares of Preferred Stock subscribed for and guaranteeing that the
Subscription Rights Certificate will be delivered promptly to the Subscription
Agent, such subscription will be deemed to be received prior to the Expiration
Time, subject to withholding of the stock certificates representing the
Underlying Preferred Shares pending receipt of the duly executed Subscription
Rights Certificate. RIGHTS HOLDERS WHO FAIL TO DELIVER THEIR SUBSCRIPTION
RIGHT CERTIFICATE(S) AND FULL PAYMENT TO THE COMPANY OR PAYMENT WITH GUARANTY
OF DELIVERY AS SET FORTH ABOVE PRIOR TO THE EXPIRATION TIME WILL BE DEEMED TO
HAVE WAIVED THEIR SUBSCRIPTION RIGHTS IN THIS OFFERING IN THEIR ENTIRETY.
INFORMATION AGENT
The Company has appointed Kissel-Blake Inc. as Information Agent for the
Rights Offering. Any questions or requests for assistance concerning the
method of subscribing for shares of Preferred Stock or for additional copies
of this Prospectus, the Instructions, the Notice of Guaranteed Delivery or the
DTC Participant Oversubscription Exercise Form may be directed to the
Information Agent at the address and telephone number below:
Kissel-Blake Inc.
110 Wall Street
New York, New York 10005
Telephone No.: (800) 554-7733 or
(212) 344-6733 (call collect)
Banks and Brokers call: (212) 344-6733
The Company will pay the fees and expenses of the Information Agent and has
also agreed to indemnify the Information Agent from certain liabilities which
it may incur in connection with the Rights Offering.
FOREIGN AND CERTAIN OTHER SHAREHOLDERS
Subscription Right Certificates will not be mailed to Record Date holders
whose addresses are outside the United States and Canada or who have an APO or
FPO address, but will be held by the Subscription Agent for each Record Date
holders' accounts. To exercise their Rights, such persons must notify the
Subscription Agent at or prior to 5:00 p.m., Pacific Time, on June 9, 1997.
Such Holder's Rights expire at the Expiration Time.
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CERTAIN FEDERAL INCOME TAX CONSEQUENCES
The following summary is a general discussion of certain of the anticipated
federal income tax consequences of the issuance, exercise, transfer or lapse
of the Rights and purchase and disposition of the Preferred Stock. The
following does not consider federal income tax consequences of the Public
Offering to any particular shareholder, or federal income tax consequences of
the Public Offering that may be relevant to particular classes of
shareholders, such as banks, insurance companies and foreign individuals and
entities. This summary is not intended as tax advice, and is based on the
Company's understanding of federal income tax laws as currently interpreted.
No representation is made regarding the continuation of such laws or of such
interpretations, and no discussion is contained herein regarding the possible
effects of any applicable state, local or foreign tax laws, or taxes other
than federal income taxes. EACH RIGHTS HOLDER, STANDBY PURCHASER AND OTHER
SUBSCRIBER IS URGED TO CONSULT HIS OR HER OWN TAX ADVISOR TO DETERMINE THE
PARTICULAR TAX CONSEQUENCES TO SUCH RIGHTS HOLDER OR SUBSCRIBER (INCLUDING THE
APPLICABILITY AND EFFECT OF THE CONSTRUCTIVE OWNERSHIP RULES AND STATE, LOCAL,
FOREIGN AND OTHER TAX LAWS) OF THE ISSUANCE, EXERCISE, TRANSFER OR LAPSE OF
RIGHTS AND THE PURCHASE AND DISPOSITION OF PREFERRED STOCK PURSUANT TO THE
PUBLIC OFFERING.
SUBSCRIPTION OFFER
Section 305(a) of the Code generally provides that gross income does not
include the amount of any distribution by a corporation to its shareholders of
stock or rights to acquire stock of that corporation. Although there are
exceptions to the general rule of Section 305(a), this discussion assumes that
the general rule of Section 305(a) applies to the distribution of Rights to
the shareholders of the Company. Under Section 307 of the Code, the tax basis
of the Rights in the hands of a shareholder of the Company to whom the Rights
were issued will be determined by allocating the tax basis of the Common Stock
with respect to which the distribution was made between the existing shares of
Common Stock the shareholder holds (the "Old Stock") and the Rights in
proportion to their relative fair market values on the date of distribution.
If the fair market value of the Rights on the date of distribution is less
than 15% of the fair market value of the Old Stock, the tax basis of the
Rights will be zero and the tax basis of the Old Stock will be unchanged
unless a shareholder makes an irrevocable election to compute the basis of all
Rights received in the manner described in the preceding sentence. This
election is made by attaching a statement to such shareholder's federal income
tax return filed for the taxable year in which the Rights are received by a
shareholder. The Company has not obtained an independent appraisal of the
valuation of the Old Stock or the Rights and, therefore, each shareholder
individually must determine how the rules of Section 307 of the Code will
apply in that shareholder's particular situation. If the Rights are not
exercised but are allowed to expire, no adjustment will be made to the basis
of the Old Stock held by such shareholder and no income or loss will be
recognized by such shareholder on the expiration of such Rights. In either
case, the holding period of such Rights will include the period during which
the shareholder has held the Old Stock.
STANDBY PURCHASE AGREEMENTS
Standby Purchasers will not be taxed as a result of entering into Standby
Purchase Agreements. Since Standby Purchasers pay nothing for entering into
Standby Purchase Agreements, they have no tax basis for such Standby Purchase
Agreements as a result of entering into them.
EXERCISE OF RIGHTS
No gain or loss will be recognized by shareholders upon exercise of Rights
pursuant to the Rights Offering. The holding period of the Preferred Stock
acquired by a shareholder upon exercise of the Rights will commence upon the
exercise of the Rights by the holder thereof. The tax basis of such shares
will be equal to the sum of the basis of the Rights exercised, if any, and the
exercise price paid for such shares. Persons who acquire
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Preferred Stock as Standby Purchasers will take a basis for the shares equal
to the Subscription Price and will have a holding period that commences with
the purchase.
EXPIRATION OF THE RIGHTS AND STANDBY PURCHASE AGREEMENTS
Rights Holders who allow the Rights received by them on the date of
distribution to expire unexercised will not recognize any gain or loss, and no
adjustment will be made to the basis of their common stock. Standby Purchasers
have no tax basis in their Standby Purchase Agreements and, accordingly, will
not recognize any gain or loss if those agreements expire.
PREFERRED STOCK
Basis and Holding Period
The basis of each share of Preferred Stock acquired upon exercise of Rights
will equal the sum of the Subscription Price and the basis, if any, in the
Rights exercised. The holding period for such Preferred Stock will begin on
the date the Rights are exercised.
Dividend Payments
A holder of the Preferred Stock who receives a distribution thereon will be
treated as having received, on the dividend payment date, a dividend taxable
as ordinary income to the extent of the Company's current and accumulated
earnings and profits in the year in which such distribution is made. Corporate
holders will generally be eligible for the dividends received deduction as set
forth in Section 243 of the Code. The amount of any distribution described
above will be the amount of cash plus the fair market value of any property
received. To the extent that the amount of any distribution exceeds the
Company's allocable current and accumulated earnings and profits, such excess
will first be applied against and reduce the recipient's adjusted tax basis in
the shares with respect to which such distribution is made and second, to the
extent that such excess is greater than the recipient's adjusted tax basis,
will be treated as capital gain (assuming the shares with respect to which
such distribution is made are held as a capital asset).
Corporate holders of shares of Preferred Stock otherwise entitled to the
dividends received deduction should consider the minimum holding period
requirements of Section 246(c) of the Code, the "debt-financed portfolio
stock" rules of Section 246A of the Code, and the "extraordinary dividend"
provisions of Section 1059 of the Code, the effects of which are to reduce or
eliminate the benefit of the dividends received deduction with respect to
shares of Preferred Stock subject to such rules. Corporate holders of shares
of Preferred Stock should also consider whether any dividends received
deduction allowed for dividends received on shares of Preferred Stock may
either cause or increase the holder's liability for the alternative minimum
tax.
Sale or Exchange
Upon the sale or taxable exchange of Preferred Stock, the holder will
recognize gain or loss equal to the difference between the amount realized and
the holder's adjusted tax basis in the Preferred Stock. The resulting gain or
loss will be a capital gain or loss and will be a long-term capital gain or
loss (assuming the shares are held as a capital asset) if the Preferred Stock
was held for more than one year.
Redemption of Preferred Stock
A redemption of Preferred Stock for cash will be a taxable event. Generally,
any redemption of the Preferred Stock would result in taxable gain or loss
equal to the difference between the amount of cash received (except to the
extent of accumulated dividends on the Preferred Stock) and the shareholder's
tax basis in the Preferred Stock redeemed if the redemption (a) results in a
"complete redemption" of the holder's stock interest in the Company under
Section 302(b)(3) of the Code, (b) is "substantially disproportionate" with
respect to the stockholder under Section 302(b)(2) of the Code, (c) is "not
essentially equivalent to a dividend" with respect to the stockholder under
Section 302(b)(1) of the Code, or (d) is from a non-corporate stockholder in
partial liquidation
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<PAGE>
of the Company under Section 302(b)(4) of the Code. In determining whether any
of these tests has been met, shares considered to be owned by the stockholder
by reason of the constructive ownership rules set forth in Section 318(a) of
the Code (pursuant to which a stockholder will be deemed to own shares owned
by certain related individuals and entities and shares that may be acquired
upon the exercise of an option, unless such constructive ownership can be
waived under Section 302(c) of the Code), as well as the shares actually
owned, would generally be taken into account. Such gain or loss would be a
capital gain or loss (assuming the shares with respect to which such
distribution is made are held as a capital asset).
If the redemption does not satisfy any of the tests under Section 302(b) of
the Code, then the gross proceeds will be treated under Section 301 of the
Code as a distribution taxable as a dividend to the extent of the Company's
current and accumulated earnings and profits (see "Certain Federal Income Tax
Consequences--Preferred Stock--Dividend Payments," above), and any excess will
be treated first as a non-taxable return of capital and then as a gain upon a
sale or exchange of the Preferred Stock, which gain will be long-term capital
gain (assuming the shares are held as a capital asset) if the Preferred Stock
has been held for more than one year. A holder who is taxed upon proceeds of
redemption as a dividend would transfer the tax basis in the Preferred Stock
(reduced for any amounts treated as a non-taxed portion of extraordinary
dividends or as a return of capital) to the holder's remaining stock interest
in the Company. If the stockholder does not retain any stock ownership in the
Company, the stockholder may lose such basis entirely.
Redemption Premium
Under Section 305 of the Code and applicable Treasury regulations, if the
redemption price of redeemable preferred stock exceeds its issue price, such
excess may constitute an unreasonable redemption which is deemed to be a
taxable distribution to the holder on an economic accrual basis over the
period during which the Preferred Stock cannot be redeemed. Such distribution
would be treated as a dividend to the extent of the Company's current and
accumulated earnings and profits, with any remaining distribution treated
first as a non-taxable return of capital and then as gain arising from a sale
or exchange.
The Company may not redeem the Preferred Stock until July 1, 2000.
Thereafter, the Company may redeem the Preferred Stock at any time at its
option for the issue price plus a premium of 5%, together with declared but
unpaid dividends. The premium will decrease by one percentage point on January
1 of each succeeding year such that, beginning July 1, 2005, no premium will
be paid upon redemption. A redemption premium on stock, other than stock which
is subject to mandatory redemption by the issuer or subject to redemption at
the option of the holder, is considered to be reasonable if it is in the
nature of a penalty for a premature redemption and if such premium does not
exceed the amount which the issuer would be required to pay for such
redemption right under the market conditions existing at the time of issuance
of the Preferred Stock. A redemption premium is generally considered
reasonable if it does not exceed 10% of the issue price on stock not
redeemable for five years from the date of issue. Because the Preferred Stock
can be redeemed in less than five years, there can be no assurance and none is
hereby given that the redemption premium with respect to the Preferred Stock
will be considered reasonable under Section 305 and applicable regulations.
Conversion to Common Stock
No gain or loss will be recognized for federal income tax purposes upon the
conversion of the Preferred Stock into shares of Common Stock, except with
respect to any cash received in exchange for a fractional interest. The tax
basis for the shares of Common Stock received upon conversion will be equal to
the tax basis of the Preferred Stock, reduced by the portion of such basis
allocable to any fractional interest exchanged for cash. Provided that the
Preferred Stock was held as capital assets, the holding period of the shares
of Common Stock will include the holding period of the Preferred Stock
converted. Gain realized upon the receipt of cash paid in lieu of fractional
shares of Common Stock will be taxed immediately to the holder of such
fractional shares.
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Adjustment of Conversion Ratio
Section 305 of the Code renders taxable certain actual or constructive
distributions of stock with respect to stock and convertible securities.
Regulations promulgated under Section 305 provide that an adjustment in the
conversion ratio of convertible preferred stock made pursuant to a bona fide,
reasonable formula which has the effect of preventing dilution of the interest
of the holders of such stock will not be considered to result in a taxable
dividend under Section 301 of the Code. Any adjustment in the conversion ratio
of the Preferred Stock to reflect taxable distributions on the Common Stock
would be treated as a constructive distribution of stock to the holders of
Preferred Stock and would be taxable as a dividend to the extent of current or
accumulated earnings and profits of the Company. The amount of the dividend to
a holder of Preferred Stock resulting from such an adjustment would be
measured by the fair market value of the additional Common Stock (or fraction
thereof) that would be obtainable as a result of adjustment of the conversion
price. Because the adjustments to the conversion price could occur more than
three years after the date of a taxable stock dividend, there can be no
assurance and none is hereby given that an adjustment to the conversion ratio
of the Preferred Stock will not result in a taxable dividend under Section
301.
GENERAL BACK UP WITHHOLDING AND REPORTING REQUIREMENTS
Under Section 3406 of the Code and applicable Treasury regulations, a holder
of Preferred Stock may be subject to backup withholding tax at the rate of 31%
with respect to dividends paid on or the proceeds of a sale or redemption of
Preferred Stock, as the case may be. The payor will be required to deduct and
withhold the tax if (a) the payee fails to furnish a taxpayer identification
number ("TIN") to the payor or fails to certify under the penalty of perjury
that such TIN is correct, (b) the IRS notifies the payor that the TIN
furnished by the payee is incorrect, (c) there has been a notified payee under
reporting with respect to interest, dividends or original issue discount
described in Section 3406(c) of the Code, or (d) there has been a failure of
the payee to certify under the penalty of perjury that the payees is not
subject to withholding under Section 3406(a)(1)(C) of the Code. As a result,
if any one of the events discussed above occurs, the payor will be required to
withhold a tax equal to 20% from any payment of dividends or proceeds made
with respect to the Preferred Stock unless an exemption applies under
applicable law and is established in a manner acceptable to the payor. Reports
will be made annually or otherwise as may be required to the IRS and to the
holders of record that are not excepted from such reporting requirements with
respect to distributions on the Preferred Stock. Such reporting will be made
on IRS Form 1099 or on such other form as may be prescribed under the rules
issued by the IRS.
STANDBY PURCHASERS
The Company has entered into Standby Purchase Agreements pursuant to which
the Standby Purchasers have severally agreed, subject in each case to a
maximum standby commitment and to certain conditions, to purchase up to $2.5
million (250,000 shares) of Preferred Stock at the Subscription Price to the
extent available after exercise of the Basic Subscription Privilege, the sale
of shares in the Private Offering and the exercise of the Oversubscription
Privilege. The Standby Purchasers have agreed to purchase and the Company has
guaranteed the availability of, an aggregate minimum of $1.0 million (100,000
shares) of Preferred Stock if a sufficient number of shares of Preferred Stock
is not available after the exercise of the Basic Subscription Privilege, the
sale of shares in the Private Offering and the Oversubscription Privilege. The
obligations of the Standby Purchasers are not subject to the purchase of any
minimum number of shares pursuant to the exercise of the Rights, but are
subject to certain conditions, including that the Public Offering shall have
been conducted substantially in the manner described in this Prospectus.
Each Standby Purchase Agreement provides that it may be terminated by the
Standby Purchaser only upon the occurrence of any of the following events: (i)
a material adverse change in the Company's financial condition prior to the
expiration of the Public Offering from that existing at December 31, 1996
(except as disclosed in the Prospectus); (ii) a suspension in the trading in
the Common Stock, a general suspension of trading or establishment of limited
or minimum prices on the Nasdaq Stock Market, any banking moratorium, any
suspension of payments with respect to banks in the United States or a
declaration of war or a national emergency
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by the United States; (iii) under any circumstances which would result in the
Standby Purchaser, individually or together with any other person or entity,
being required to register as a depository institution holding company under
federal or state laws or regulations, or to submit an application, or notice,
to a federal bank regulatory authority to acquire or retain control of a
depository institution or depository institution holding company; or (iv) if
the Public Offering, including sales of Preferred Stock to Standby Purchasers,
is not completed byJune 30, 1997 through no fault of the Standby Purchaser.
If the Company believes that the number of Underlying Preferred Shares
issuable by the Company pursuant to the Standby Purchase Agreements, both in
the aggregate and to any individual purchaser, will have an adverse effect
upon the Company's ability to utilize the NOL carryforwards, then the Company
may reduce the number of shares issuable to the Standby Purchasers, either pro
rata or individually to each Standby Purchaser whose purchase of Preferred
Stock may create such an adverse effect. Such reduction will be made to the
minimum extent necessary, in the sole opinion and discretion of the Company
after consultation with its tax advisor, to accomplish avoidance of such
adverse effect. Based on current circumstances, the Company does not
anticipate that it will have to reduce the number of shares issued to Standby
Purchasers to avoid an adverse effect upon the Company's ability to utilize
such federal income tax benefits. See "Risk Factors--Possible Loss of Tax
Benefit."
The Department of Corporations of the State of California (the "Department")
has advised the Company that the permit to be granted for the Public Offering
will provide that the Standby Purchasers (or their transferees) may not offer
or sell, in the State of California, any of the shares of Preferred Stock (or
shares of Common Stock into which such shares of Preferred Stock are
convertible) which the Standby Purchasers acquire in the Public Offering. The
condition will continue to apply until such time as the Company files, and the
Department approves, an application to remove such condition. The Company
understands that one of the factors the Department considered in placing this
condition was that the Company had not shown a net profit in the last several
years. The Company intends to file an application with the Department to
remove such condition as soon as practicable after such time as the Company's
results of operations for a fiscal year reflect a net profit. A Standby
Purchaser also may seek to qualify an offer or sale by a Standby Purchaser
with the Department.
The following table sets forth certain information relating to the Standby
Purchasers. Certain Standby Purchasers are acting on behalf of investment
accounts over which they have discretionary authority or otherwise have been
empowered to act.
<TABLE>
<CAPTION>
MAXIMUM MINIMUM
STANDBY STANDBY
STANDBY PURCHASER COMMITMENT COMMITMENT
----------------- ---------- ----------
(IN DOLLARS)
<S> <C> <C>
Basswood Partners, L.P. ........................... 375,000 150,000
Heartland Small Cap Cantrarian Fund................ 375,000 150,000
Rainbow Managers, LLC.............................. 375,000 150,000
Sandler O'Neill Asset Management, LLC.............. 375,000 150,000
Tidal Insurance Limited(1)......................... 375,000 150,000
Wellington Management Company, LLP................. 375,000 150,000
Stilwell Associates, L.P. ......................... 250,000 100,000
</TABLE>
- --------
(1) Tidal Insurance Limited is an affiliate of First Banks, Inc., a registered
bank holding company. The voting stock of First Banks, Inc. is owned by
various trusts which were created by and are administered for the benefit
of Mr. James F. Dierberg and members of his immediate family. Accordingly,
Mr. Dierberg controls management and the policies of First Banks, Inc. and
the election of its directors.
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<PAGE>
REASONS FOR THE PUBLIC OFFERING AND THE PRIVATE OFFERING AND USE OF PROCEEDS
The Board of Directors decided to conduct both the Public Offering and the
Private Offering to minimize the dilutive effect of the Private Offering and
the Standby Purchase Offering to current shareholders and to enable the
Company to downstream sufficient capital (approximately $2.5 million) to the
Bank to comply with the capital requirements of the 1995 Formal Agreement and
the 1995 MOU and to facilitate the implementation of the Company's and the
Bank's business strategy. The Company established the Minimum Condition of
$5.5 million for such purposes and to make the Public Offering and the Private
Offering cost effective. See "The Company--Business Strategy" and "--
Regulatory Agreements." The Company anticipates that the net proceeds,
contributed to the Bank will ultimately be invested in interest earning
assets. The immediate use of proceeds retained by the Company, if any, will be
for general corporate purposes, including possible strategic acquisitions and
to establish a fixed income investment securities portfolio. The Company has
no current arrangements, understandings or agreements, is not presently
negotiating with respect to any acquisitions and would need banking regulatory
approval prior to making any such acquisitions. PROCEEDS FROM THE PUBLIC
OFFERING AND THE PRIVATE OFFERING WILL NOT BE USED TO PAY DIVIDENDS ON THE
PREFERRED STOCK. THE TERMS OF THE PREFERRED STOCK PROVIDE THAT DIVIDENDS MAY
BE PAID COMMENCING JULY 1, 1999. NOTWITHSTANDING THE FOREGOING, THE COMPANY
MAY NOT PAY DIVIDENDS FOLLOWING SUCH DATE UNLESS THE BANK IS IN FULL
COMPLIANCE WITH FEDERAL REGULATORY CAPITAL REQUIREMENTS, THE COMPANY AND THE
BANK ARE PERMITTED TO PAY DIVIDENDS BY THEIR REGULATORS AND THE COMPANY MEETS
THE RETAINED EARNINGS TEST. THE COMPANY CANNOT ASSESS AT THIS TIME ITS ABILITY
TO PAY DIVIDENDS IN THE IMMEDIATE FUTURE.
DILUTION
Rights Holders may experience substantial dilution of their percentage of
equity ownership interest and voting power in the Company if they do not
exercise the Basic Subscription Privilege and Oversubscription Privilege.
Depending upon the degree to which the Rights Holders exercise their Basic
Subscription Privilege and Oversubscription Privilege, they will experience a
minimum dilution of 18% (assuming shares are available pursuant to the
Oversubscription Privilege) and a maximum dilution of 72% (assuming no Rights
are exercised) in their equity ownership interest and voting power in the
Company due to the Private Purchasers Minimum Obligation and Minimum Standby
Obligation. See "Risk Factors--Dilution of Ownership Interest."
Rights Holders also may experience substantial dilution if options and
warrants to purchase shares of Company Common Stock currently outstanding are
exercised. In connection with the Lease Restructure Agreement, the Company
issued to its landlord a warrant expiring in December 2002 to purchase up to
9.9% of the outstanding shares of Company capital stock. See "Business--
Properties." In connection with the settlement of a shareholders' class action
lawsuit, the Company issued to the plaintiffs warrants expiring in June 1999
to purchase up to 18,680 shares of Common Stock. Under the Company's 1983 and
1994 Stock Option Plans, certain executive officers of the Company were
granted options to purchase up to 10,525 shares of Common Stock, subject to
adjustment to prevent dilution, none of which options have been exercised. In
addition, Scott A. Montgomery has been granted an option to purchase up to
22,002 shares of Common Stock under the Company's 1990 Stock Option Plan,
which option becomes exercisable in June 1997 and expires in December 2006.
Mr. Montgomery's employment agreement also provides for the grant of stock
appreciation rights to purchase an additional 8,251 shares of Common Stock.
Pursuant to an amendment to Mr. Montgomery's employment agreement, (i) if as a
consequence of a recapitalization of the Company, such as through the Public
Offering and the Private Offering, Mr. Montgomery's percentage ownership of
Common Stock would be less than 6.5% of the issued and outstanding shares of
Common Stock after giving effect to his option to purchase 22,002 shares,
Mr. Montgomery is entitled to receive additional options to purchase the
number of shares of Common Stock equal to the difference between 22,002 shares
and the number constituting 6.5% of the issued and outstanding shares of
Common Stock immediately following such recapitalization, with such provision
being effected with respect to one recapitalization only and (ii) Mr.
Montgomery has agreed to limit his right to exercise the stock options for a
period of three years following the date of such recapitalization such that
his ownership of the Company's Common Stock and/or Preferred Stock convertible
to Common Stock does not exceed 4.9%.
56
<PAGE>
CAPITALIZATION
The following tables set forth the capitalization of the Company (i) at
December 31, 1996, and (ii) as adjusted to give effect to the issuance and
sale of Preferred Stock in the event that $8.0 million (minimum) and $9.0
million (maximum) is sold, and, in both cases, assuming expenses associated
with the Public Offering and the Private Offering of $1.4 million:
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1996
-------------------------------------------------------
AS ADJUSTED(1)
---------------------------------
PRIOR TO OFFERINGS MINIMUM(2) MAXIMUM(3)
-------------------- --------------- ---------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Shareholders' equity:
Preferred stock, no par
value. Authorized
1,000,000 shares; issued
0 shares; 800,000 shares,
and 900,000 shares, as
adjusted(5).............. $ -- $ 6,600 $ 7,600
Common stock, no par
value. Authorized
10,000,000 shares; issued
and outstanding 338,630
shares(4)(5)............. 24,614 24,614 24,614
Accumulated deficit....... (19,693) (19,693) (19,693)
Unrealized loss on
securities............... (76) (76) (76)
--------------- --------------- ---------------
Total shareholders'
equity................. $ 4,845 $ 11,445 $ 12,445
=============== =============== ===============
Book value per
share(4)(5).............. $ 14.31 $ 10.05 $ 10.05
</TABLE>
- --------
(1) Assumes a Subscription Price of $10.00 per share.
(2) Assumes the sale of 800,000 shares.
(3) Assumes the sale of 900,000 shares.
(4) Does not include a total of 86,052 shares that may be issued pursuant to
the exercise of stock options and warrants as follows: (i) 377 shares at
$17.04 per share under the Company's 1983 Stock Option Plan; (ii) 22,002
shares at $11.36 per share under the Company's 1990 Stock Option Plan;
(iii) 4,098 shares at $17.04 per share, 2,200 shares at $10.23 per share
and 3,850 shares at $12.50 per share under the Company's 1994 Stock Option
Plan; (iv) 1,320 shares at $26.09 per share to a director not granted
under any stock option plan; (v) 18,680 shares at $32.27 per share
pursuant to certain litigation (see "Business--Legal Proceedings--
Derivative and Class Action"); and (vi) 33,524 shares at $10.00 per share
pursuant to the Lease Restructuring Agreement (see "Business--
Properties").
(5) Pro forma after giving effect to the Reverse Stock Split.
The following tables set forth the minimum capital ratios required by
federal regulations with respect to the Company and required by federal
regulations and the 1995 Formal Agreement with respect to the Bank, the
Company's and the Bank's actual ratios at December 31, 1996 and the Company's
and the Bank's capital ratios as adjusted to give effect to the estimated net
proceeds of the Public Offering and the Private Offering to be $6.6 million,
in the event $8.0 million (minimum) is sold and $7.6 million, if $9.0 million
(maximum) is sold. Solely for purposes of the following tables, it is assumed
that $2.5 million of the net proceeds of the Rights Offering will be
contributed to the Bank. See "Reasons for the Public Offering and the Private
Offering and Use of Proceeds." Ratios do not reflect unrealized losses on
investment securities available-for-sale.
<TABLE>
<CAPTION>
THE COMPANY
AT DECEMBER 31, 1996
-----------------------------------------
AS ADJUSTED(1)
---------------
REQUIRED(2) ACTUAL EXCESS MINIMUM MAXIMUM
----------- ------ ------ ------- -------
<S> <C> <C> <C> <C> <C>
Tier 1 risk-based capital ratio... 4.00% 6.96% 2.96% 15.72% 16.97%
Total risk-based capital ratio.... 8.00% 8.25% 0.25% 17.00% 18.25%
Leverage capital ratio(3)......... 4.00% 4.68% 0.68% 10.30% 11.10%
</TABLE>
<TABLE>
<CAPTION>
THE BANK
AT DECEMBER 31, 1996
--------------------------------------------
AS ADJUSTED(4)
EXCESS ---------------
REQUIRED(2) ACTUAL (DEFICIT) MINIMUM MAXIMUM
----------- ------ --------- ------- -------
<S> <C> <C> <C> <C> <C>
Tier 1 risk-based capital ra-
tio........................... 4.00% 6.95% 2.95 % 10.41% 10.41%
Total risk-based capital ratio. 8.00% 8.24% 0.24 % 11.69% 11.69%
Leverage capital ratio(3)...... 4.00% 4.67% 0.67 % 6.88% 6.88%
Formal Agreement--leverage cap-
ital ratio(2)................. 6.50% 4.67% (1.83)% 6.88% 6.88%
Formal Agreement--Tier 1 risk-
based capital ratio(2)........ 10.00% 6.95% (3.05)% 10.41% 10.41%
</TABLE>
- --------
(1) Assumes the investment of such funds in 20% risk-weighted (investment
securities) other than increases to the investment in the Bank.
(2) The Bank's minimum Tier 1 risk-based capital and leverage capital
requirements are based on the provisions of the 1995 Formal Agreement,
which became effective on December 14, 1995.
(3) The regulatory leverage capital ratio represents the ratio Tier 1 capital
at December 31, 1996 to average total assets during the three-month period
then ended.
(4) Assumes the investment of such funds in 100% risk-weighted assets (loans).
57
<PAGE>
MARKET PRICE OF COMMON STOCK AND DIVIDENDS
The Common Stock is included for quotation on the Small Cap tier of the
Nasdaq Stock Market. The following table sets forth on a per share basis,
without giving effect to the Reverse Stock Split, the high and low sales
prices for the periods indicated, as reported by the Nasdaq Stock Market.
<TABLE>
<CAPTION>
QUARTER HIGH LOW
------- ----- -----
<C> <S> <C> <C>
1994 Second Quarter............................................. $4.50 $3.50
Third Quarter.............................................. 5.25 4.00
Fourth Quarter............................................. 4.88 2.63
1995 First Quarter.............................................. 3.75 2.06
Second Quarter............................................. 4.00 3.50
Third Quarter.............................................. 4.00 2.75
Fourth Quarter............................................. 3.50 1.25
1996 First Quarter.............................................. 2.06 1.25
Second Quarter............................................. 2.38 1.50
Third Quarter.............................................. 1.88 1.13
Fourth Quarter............................................. 1.25 1.00
</TABLE>
On March 11, 1997, the Nasdaq Stock Market, Inc. moved the Company's Common
Stock from the Nasdaq National Market tier to the Nasdaq Small Cap tier. On
March 31, 1997, the Company had approximately 677 shareholders of record of
its Common Stock. This number does not include beneficial owners whose shares
are held by brokers, banks and other nominees. On April 23, 1997, the last
reported sale price of the Common Stock was $1.50 per share.
The Company has not paid a cash dividend on the Common Stock since July 1990
and there can be no assurance that the Company will generate earnings in the
future which would permit the declaration of dividends. The Company is
prohibited by the terms of the 1995 MOU from declaring or paying a dividend
without prior notice to the Reserve Bank, which may prohibit the payment of
dividends. In addition, the source of any such dividends is likely to be
dividends from the Bank. The Bank is also limited in the amount of dividends
which it may distribute according to the terms of the 1995 Formal Agreement.
Pursuant to the 1995 Formal Agreement, the Board of Directors of the Bank may
declare or pay dividends only: (i) when the Bank is in compliance with 12
U.S.C. Sections 56, 60, and 1831o(d)(1); (ii) when the Bank is in compliance
with the capital program developed pursuant to the 1995 Formal Agreement;
(iii) when such dividend payment is consistent with the capital levels
specified in paragraph (1) of the 1995 Formal Agreement; and (iv) with prior
written approval of the OCC. See "Regulation." Further, it is anticipated that
for the foreseeable future any earnings which may be generated will be
retained for the purpose of increasing the Company's capital and reserves to
facilitate growth.
58
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following table presents selected consolidated financial and other data
of the Company for each of the years in the five-year period ended December
31, 1996. The information below should be read in conjunction with, and is
qualified in its entirety by, the more detailed information included elsewhere
in this Prospectus including the Company's Audited Consolidated Financial
Statements and notes thereto.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------------------------------
1996 1995 1994 1993 1992
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Interest income........ $ 8,757 $ 11,634 $ 20,900 $ 20,612 $ 22,577
Interest expense....... 3,079 3,979 5,526 5,920 7,621
---------- ---------- ---------- ---------- ----------
Net interest income.... 5,678 7,655 15,374 14,692 14,956
Provision for credit
losses................ -- 2,307 7,330 2,000 3,050
---------- ---------- ---------- ---------- ----------
Net interest income
after provision for
credit losses......... 5,678 5,348 8,044 12,692 11,906
Other operating (loss)
income................ 502 (1,315) (2,857) 1,474 2,140
Other operating
expense(1)............ 8,003 11,233 13,714 14,058 17,014
---------- ---------- ---------- ---------- ----------
(Loss) income before
income tax benefit and
cumulative effect of
change in accounting
principle............. (1,823) (7,200) (8,527) 108 (2,968)
Income tax benefit..... 579 -- -- -- --
---------- ---------- ---------- ---------- ----------
Net (loss) income
before cumulative
effect of change in
accounting principle.. (1,244) (7,200) (8,527) 108 (2,968)
Cumulative effect of
change in accounting
principle............. -- -- -- 63 --
---------- ---------- ---------- ---------- ----------
Net (loss) income...... $ (1,244) $ (7,200) $ (8,527) $ 171 $ (2,968)
========== ========== ========== ========== ==========
PER SHARE DATA:
Net (loss) income fully
diluted(2)............ $ (0.40) $ (2.34) $ (2.79) $ 0.05 $ (0.98)
Net (loss) income fully
diluted(3)............ (3.67) (21.26) (25.37) 0.49 (8.89)
Book value (period
ending)(4)............ 1.57 1.95 3.35 7.29 7.12
Book value (period
ending)(3)............ 14.31 17.75 30.44 66.28 64.69
Weighted average shares
outstanding(2)........ 3,078,146 3,078,146 3,055,584 3,041,268 3,035,379
Weighted average shares
outstanding(3)........ 338,630 338,630 336,148 334,573 333,925
AVERAGE BALANCE SHEET
DATA:
Federal funds sold..... $ 19,572 $ 16,034 $ 7,739 $ 11,822 $ 17,067
Securities............. 17,398 26,681 79,146 93,914 61,026
Short-term investments. -- 174 45 595 2,657
Loans receivable....... 69,975 95,771 140,079 159,680 192,546
Allowance for credit
losses................ 3,407 3,504 8,172 7,573 8,167
---------- ---------- ---------- ---------- ----------
Loans, net............. 66,568 92,267 131,907 152,107 184,379
---------- ---------- ---------- ---------- ----------
Total assets........... 112,303 149,399 245,555 291,166 294,406
Noninterest-bearing
demand deposits....... 36,518 52,246 77,445 89,605 78,607
Total deposits......... 104,118 134,218 212,755 251,934 246,369
Shareholders' equity... 5,500 9,033 19,086 21,713 24,643
SELECTED PERFORMANCE
RATIOS:
(Loss) return on
average assets........ (1.11)% (4.82)% (3.47)% 0.06% (1.01)%
(Loss) return on
average shareholders'
equity................ (22.61)% (79.71)% (44.68)% 0.79% (12.04)%
Average shareholders'
equity to average
assets................ 4.90 % 6.05 % 7.77 % 7.46% 8.37 %
Other core operating
expenses to average
assets(5)............. 6.24 % 7.52 % 5.58 % 4.83% 5.78 %
Net yield on interest-
earning assets........ 5.31 % 5.52 % 6.77 % 5.56% 5.53 %
Ratio of earnings to
fixed charges(6)...... -- -- -- 1.02% --
</TABLE>
59
<PAGE>
<TABLE>
<CAPTION>
AT DECEMBER 31,
---------------------------------------------------
1996 1995 1994 1993 1992
--------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
CAPITAL RATIOS:
Company:
Tier 1 risk-based........ 6.96% 6.96% 9.84% 11.94% 9.85%
Total risk-based......... 8.25% 8.25% 11.11% 13.25% 11.12%
Leverage................. 4.68% 4.68% 5.65% 7.11% 7.39%
Bank:
Tier 1 risk-based........ 6.95% 6.95% 9.80% 11.65% 9.57%
Total risk-based......... 8.24% 8.24% 11.06% 12.95% 10.84%
Leverage................. 4.67% 4.67% 5.62% 6.93% 7.18%
ASSET QUALITY:
Nonaccrual loans......... $ 928 $ 573 $ 3,426 $ 7,780 $ 6,316
Troubled debt
restructurings.......... 5,016 5,167 5,582 5,584 5,043
Loans contractually past
due 90 or more days
with respect to either
principal or interest
and still accruing in-
terest.................. 300 221 1,507 2,502 47
-------- -------- --------- --------- ---------
Total nonperforming
loans................. 6,244 5,961 10,515 15,866 11,406
Other real estate
owned(7)................ 556 581 1,529 6,175 5,613
-------- -------- --------- --------- ---------
Total nonperforming as-
sets.................... 6,800 6,542 12,044 22,041 17,019
ASSET QUALITY RATIOS:
Nonaccrual loans to to-
tal assets.............. 0.8% 0.4% 1.5% 2.6% 1.8%
Nonaccrual assets to to-
tal assets(8)........... 1.4% 0.9% 2.1% 4.6% 3.4%
Allowance for credit
losses to nonaccrual
loans................... 319.9% 664.0% 89.4% 86.1% 95.1%
Allowance for credit
losses to nonaccrual
assets(8)............... 200.1% 329.7% 61.8% 48.0% 50.4%
Classified assets to al-
lowance for credit
losses plus sharehold-
ers' equity............. 106.2% 79.1% 149.2% 139.4% 156.7%
Classified assets to al-
lowance for credit
losses plus sharehold-
ers' equity(9).......... 43.9% 29.5% 112.8% 122.5% 139.1%
</TABLE>
- --------
(1) Includes a legal settlement of $1.0 million for the year ended December
31, 1996. (See "Business--Legal Proceedings--Other Litigation.")
(2) The weighted average number of shares of Common Stock outstanding for the
years ended December 31, 1996, 1995 and 1994 was used to compute loss per
share data as the use of average shares outstanding including Common
Stock equivalents would be antidilutive. The weighted average number of
shares used to compute fully diluted earnings per share in 1993 and 1992
was 3,171,250 and 3,035,660, respectively. The weighted average number of
shares outstanding used to compute (loss) income per share does not give
effect to the proposed 9.09 to one reverse stock split.
(3) Pro forma after giving effect to the Reverse Stock Split.
(4) Book value per share numbers are based on the number of shares
outstanding at period end and does not give effect to outstanding options
and warrants to purchase Common Stock or to the Reverse Stock Split.
(5) Other core operating expenses equals other operating expenses excluding
legal settlement of $1.0 million for the year ended December 31, 1996.
(See "Business--Legal Proceedings--Other Litigation.")
(6) The ratio of earnings to fixed charges were computed by dividing (loss)
income before income tax benefit and cumulative effect of change in
accounting principle plus fixed charges, by fixed charges. Fixed charges
represent total interest expense. Except for the year ended December 31,
1993, earnings were inadequate to cover fixed charges by $1.8 million,
$7.2 million, $8.5 million and $3.0 million for the years ended December
31, 1996, 1995, 1994 and 1992, respectively.
(7) Includes OREO acquired by the Bank through legal foreclosure or deed-in-
lieu of foreclosures and loans classified as in-substance foreclosures.
(8) Nonaccrual assets are comprised of nonaccrual loans plus OREO.
(9) Excludes one loan, a trouble debt restructuring with a principal balance
of $4.9 million at December 31, 1996, 1995, 1994, 1993 and 1992. This
loan is secured by a first deed of trust on a personal residence which,
as of December 1996, had an appraised value of $10.0 million.
60
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following presents management's discussion and analysis of the
consolidated financial condition and operating results of the Company for the
years ended December 31, 1996, 1995 and 1994. The discussion should be read in
conjunction with the Company's consolidated financial statements. Averages
presented in the tables are daily average balances unless otherwise stated.
This Prospectus includes forward looking statements concerning the Company
and the Bank. The forward looking statements are made pursuant to the "safe
harbor" provisions of the Private Securities Litigation Reform Act of 1995.
See "Risk Factors." References to the "Consolidated Financial Statements" are
to the consolidated financial statements contained in the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 1996, incorporated
herein by reference and made a part hereof.
GENERAL
During the 1990's the Bank experienced a continued decline in loans,
deposits and total assets in response to prolonged operating losses and an
effort to maintain capital levels above regulatory minimums. These prolonged
operating losses were the result of a deteriorating real estate market,
combined with certain internal deficiencies noted by the Company's and the
Bank's primary regulators. The volume of outstanding loans declined from the
second quarter of 1991 due to the ongoing recession affecting the Bank's
primary market area, combined with scheduled loan amortizations and
management's planned restructuring of the balance sheet. This restructuring
plan emphasized the reduction of criticized and classified assets along with
non-strategic loan relationships. In addition, the Bank's restructuring plan
called for a reduction of high rate ("money desk") deposits which originate
from institutional investors nationwide. These deposits, under this planned
restructuring, represent a non-strategic relationship and accordingly
contributed significantly to the recent decline of the Bank's deposits. The
planned run-off of deposits was designed to improve the core deposit base and
reduce potentially volatile liabilities. As a result, the balance sheet was
reduced for liquidity purposes as well as to achieve compliance with the
regulatory capital requirements. Although management does not presently intend
to further reduce the balance sheet, and anticipates that the additional
capital raised as a result of the Public Offering and the Private Offering
will be used to support an increase in assets in the post-recessionary
environment, no assurances can be given that management will be successful in
such efforts.
In addition to the planned restructuring discussed above, management
believes that a portion of the reduction in deposits was attributable to
depositors seeking higher yields on their funds than the Bank was offering as
a result of the lower interest rate environment. Further, deposit reductions
were also attributable to customers moving their banking relationships to
other institutions when the Bank restructured its balance sheet, as well as to
the public's reaction to adverse publicity about the Bank's losses and
regulatory agreements. The Company has taken steps to improve the public's
perception of the Banks' financial condition, including marketing campaigns
and enhanced business development efforts designed to generate core deposit
growth followed by a renewed expansion of total banking relationships. No
assurances can be given, however, that such efforts will be successful.
Loans receivable decreased from $115.3 million at December 31, 1994 to $82.0
million at December 31, 1995, and to $62.5 million at December 31, 1996. Total
deposits decreased from $207.8 million at December 31, 1994 to $120.2 million
at December 31, 1995 and to $103.9 million at December 31, 1996. Similarly,
total assets decreased from $233.0 million at December 31, 1994 to $132.0
million at December 31, 1995 and to $109.4 million at December 31, 1996. See
"Business--Loan Portfolio," "--Investment Portfolio" and "--Deposits."
61
<PAGE>
The Bank's decline in loans, deposits and total assets had an adverse effect
on results of operations over the same period. The net loss for the year ended
December 31, 1994 was $8.5 million or a $25.37 loss per share (pro forma after
giving effect to the Reverse Stock Split), compared to $7.2 million or a
$21.26 loss per share (pro forma after giving effect to the Reverse Stock
Split) in 1995. The net loss for the year ended December 31, 1994 was
primarily attributable to a significant provision for credit losses
accompanied by increased losses on investment securities and real estate. The
net loss for the year ended December 31, 1995 was the result of significant
decreases in net interest income as a consequence of the decline of interest
earning assets and continued losses relating to loans and investment
securities, which were compounded by minimal decreases in other operating
expense.
The net loss for the year ended December 31, 1996 was $1.2 million or a
$3.67 loss per share (pro forma after giving effect to the Reverse Stock
Split), an 83% reduction from 1995. The significant improvement over 1995 was
due to a significant decrease in the provision for credit losses and reduced
other operating expenses. However, customer-related fee income has decreased
since 1994 as a result of reduced mortgage and deposit activities.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated the increase or
decrease of certain items in the statements of income as compared to the prior
periods:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31
----------------------------------------------------------------------
INCREASE INCREASE
(DECREASE) (DECREASE)
---------------- ----------------
1996 1995 AMOUNT PERCENT 1995 1994 AMOUNT PERCENT
------- ------- ------- ------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Total interest income... $ 8,757 $11,634 $(2,877) (25)% $11,634 $20,900 $(9,266) (44)%
Total interest expense.. 3,079 3,979 (900) (23)% 3,979 5,526 (1,547) (28)%
------- ------- ------- ------- ------- -------
Net interest income..... 5,678 7,655 (1,977) (26)% 7,655 15,374 (7,719) (50)%
Provision for credit
losses................. -- 2,307 (2,307) (100)% 2,307 7,330 (5,023) (69)%
------- ------- ------- ------- ------- -------
Net interest income
after provision for
credit losses.......... 5,678 5,348 330 6 % 5,348 8,044 (2,696) (34)%
Other operating (loss)
income................. 502 (1,315) 1,817 138 % (1,315) (2,857) 1,542 54 %
Other operating
expense(1)............. 8,003 11,233 (3,230) (29)% 11,233 13,714 (2,481) (18)%
------- ------- ------- ------- ------- -------
(Loss) income before
income tax benefit..... (1,823) (7,200) 5,377 (75)% (7,200) (8,527) 1,327 16 %
Income tax benefit...... 579 -- 579 -- % -- -- -- --
------- ------- ------- ------- ------- -------
Net (loss) income....... $(1,244) $(7,200) $ 5,956 (83)% $(7,200) $(8,527) $ 1,327 16 %
======= ======= ======= ======= ======= =======
</TABLE>
- --------
(1) Includes a legal settlement of $1.0 million for the year ended December
31, 1996.
NET INTEREST INCOME
The Bank's earnings depend largely upon the difference between the income
received from its loan and investment portfolios and the interest paid on its
liabilities, primarily interest paid on deposits. This difference is net
interest income. Net interest income represents the Bank's most significant
source of earnings. The Bank's ability to generate profitable levels of net
interest income is largely dependent on its ability to maintain sound asset
quality and appropriate levels of capital and liquidity. The Bank's inability
to maintain strong asset quality, capital or liquidity may adversely affect
(i) the ability to accommodate desirable borrowing customers, thereby
inhibiting growth in quality higher-yielding earning assets, (ii) the ability
to attract comparatively stable, lower-cost deposits, and (iii) the costs of
wholesale funding sources.
Net interest income for the year ended December 31, 1996 was $5.7 million, a
decrease of $2.0 million from $7.7 million for 1995. This decrease was
primarily due to the decreased volume of interest-earning assets and the
decreased volume of interest-bearing liabilities.
62
<PAGE>
Net interest income for the year ended December 31, 1995 was $7.7 million
compared to $15.4 million for the year ended December 31, 1994. This decrease
is primarily attributable to decreases in the volume of interest-earning
assets resulting from declining loan balances, and the sale of securities
during the year ended December 31, 1995 and during the fourth quarter of the
year ended December 31, 1994. In addition, net interest income for the year
ended December 31, 1994 included the accretion of discounts of $3.9 million
related to the 1993 purchase of $20.8 million of loans from the FDIC. Further,
net interest income for the year ended December 31, 1994 included the
accretion of a deferred gain of $544,000 from the sale of a prime rate based
floor component of an interest rate collar contract which expired in June
1994. See "Note 7 to the Consolidated Financial Statements."
Net interest income, when expressed as a percentage of average total
interest-earning assets, is referred to as the net yield on interest-earning
assets. The Bank's net yield on interest-earning assets is affected by changes
in the yields earned on assets and rates paid on liabilities, referred to as
rate changes. The difference between the yield earned on assets and rates paid
on liabilities is referred to as the interest rate spread. Interest rates
charged on the Bank's loans are affected principally by the demand for such
loans, the supply of money available for lending purposes and other
competitive factors. These factors are in turn affected by general economic
conditions and other factors beyond the Company's control, such as federal
economic policies, the general supply of money in the economy, legislative tax
policies, governmental budgetary matters, and the action of the Federal
Reserve Board.
The average yield on interest-earning assets was 8.19% for the year ended
December 31, 1996, a decrease of 20 basis points from the average yield of
8.39% during 1995. During this period, the rates paid on interest-bearing
liabilities decreased 14 basis points to 4.48% from 4.62% for 1995. As a
result, the net yield on interest-earning assets decreased 21 basis points to
5.31% during the year ended December 31, 1996 from 5.52% during 1995.
The average yield on interest-earning assets during the year ended December
31, 1995 was 8.39%, a decrease of 82 basis points from the average yield of
9.21% during the year ended December 31, 1994. This was primarily the result
of a significant reduction in volume during 1995 of higher yielding loans.
During this period, the rates paid on interest-bearing liabilities increased
84 basis points to 4.62% from 3.78% for the year ended December 31, 1994 due
to the increased rates paid on time deposits. As a result, the net yield on
interest-earning assets decreased from 6.77% during the year ended December
31, 1994 to 5.52% during the year ended December 31, 1995.
Average interest-earning assets decreased $31.8 million to $106.9 million
during 1996 from $138.7 million during 1995. Average interest-bearing
liabilities decreased $17.4 million to $68.7 million during 1996 from
$86.1 million during 1995. Average interest-earning assets decreased $88.3
million to $138.7 million during the year ended December 31, 1995 from $227.0
million during the year ended December 31, 1994. Average interest- bearing
liabilities decreased $60.1 million to $86.1 million during the year ended
December 31, 1995, from $146.2 million during the year ended December 31,
1994. These declines were the result of management's efforts to shrink the
balance sheet in order to maintain capital levels above regulatory minimums,
in response to prolonged operating losses which eroded shareholders' equity.
Average loan volume has continued to decline, decreasing to $70.0 million
during the year ended December 31, 1996, compared to $95.8 million during 1995
and $140.1 million for 1994. The volume of outstanding loans has continued to
declined from the second quarter of 1991 due to (i) the ongoing recession
affecting the Company's primary market area; (ii) scheduled loan
amortizations; and (iii) management's planned restructuring of the loan
portfolio to reduce criticized and classified assets and non-strategic loan
relationships. Management believes that a lower volume of loans will continue
to adversely affect the Bank's net interest income, interest rate spread and
net yield on earning assets during the foreseeable future, until such time as
the Public Offering and the Private Offering are consummated and the Bank has
the capital to increase its lending.
63
<PAGE>
AVERAGE BALANCES AND INTEREST RATES
The following tables summarize average balances and for interest-earning
assets and interest-bearing liabilities the amounts earned or paid and the
yield or rates for the periods indicated. The average balances in the following
tables and elsewhere in this Prospectus have been calculated on the basis of
the daily account balances:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------
1996 1995
-------------------------------- --------------------------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST YIELD/RATE(1) BALANCE INTEREST YIELD/RATE(1)
-------- -------- ------------- -------- -------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS:
Investment
securities(1)......... $ 17,398 $ 990 5.69% $ 26,855 $ 1402 5.22%
Federal funds sold..... 19,572 1,024 5.23% 16,034 933 5.82%
Loans receivable(2)(3). 69,975 6,743 9.64% 95,771 9,299 9.71%
-------- ------ -------- -------
Total interest-earning
assets................ 106,945 8,757 8.19% 138,660 11,634 8.39%
NONINTEREST-EARNING
ASSETS:
Cash and due from
banks................. 5,878 9,403
Other assets........... 2,887 4,840
Less: Allowance for
credit losses......... (3,407) (3,504)
-------- --------
Total Assets........... $112,303 $149,399
======== ========
INTEREST-BEARING
LIABILITIES:
Deposits:
Demand................. $ 5,914 76 1.29% $ 7,341 137 1.87%
Money market and
savings............... 21,556 634 2.94% 29,001 1,002 3.46%
Time deposits under
$100,000.............. 32,665 1,925 5.89% 36,754 2,188 5.95%
Time deposits over
$100,000.............. 7,465 419 5.61% 8,876 542 6.11%
Federal funds purchased
and securities sold
under agreements to
repurchase............ 1,140 25 2.19% 4,154 110 2.65%
-------- ------ -------- -------
Total interest-bearing
liabilities........... 68,740 3,079 4.48% 86,126 3,979 4.62%
------ -------
NONINTEREST-BEARING
LIABILITIES:
Demand deposit......... 36,518 52,246
Other.................. 1,545 1,994
SHAREHOLDERS' EQUITY.... 5,500 9,033
-------- --------
Total liabilities and
shareholders' equity.. $112,303 $149,399
======== ========
Net interest income.... $5,678 $ 7,655
====== =======
Interest Rate Spread... 3.71% 3.77%
Net yield on interest-
earning assets(4)..... 5.31% 5.52%
</TABLE>
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------
1994
-------------------------------------
AVERAGE AVERAGE
BALANCE INTEREST YIELD/RATE
----------- ---------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS:
Investment securities(1)...... $ 79,191 $ 4,418 5.58%
Federal funds sold............ 7,739 333 4.30%
Loans receivable(2)(3)........ 140,079 16,149 11.53%
----------- ----------
Total interest-earning assets. 227,009 20,900 9.21%
NONINTEREST-EARNING ASSETS:
Cash and due from banks....... 16,203
Other assets.................. 10,515
Less: Allowance for credit
losses....................... (8,172)
-----------
Total Assets.................. $ 245,555
===========
INTEREST-BEARING LIABILITIES:
Deposits:
Demand........................ $ 9,493 144 1.52%
Money market and savings...... 39,852 1,274 3.20%
Time deposits under $100,000.. 74,484 3,309 4.44%
Time deposits over $100,000... 11,481 471 4.11%
Federal funds purchased and
securities sold under
agreements to repurchase..... 10,863 328 3.02%
----------- ----------
Total interest-bearing
liabilities.................. 146,173 5,526 3.78%
----------
NONINTEREST-BEARING
LIABILITIES:
Demand deposit................ 77,445
Other......................... 2,851
SHAREHOLDERS' EQUITY........... 19,086
-----------
Total liabilities and
shareholders' equity......... $ 245,555
===========
Net interest income........... $ 15,374
==========
Interest Rate Spread.......... 5.43%
Net yield on interest-earning
assets(4).................... 6.77%
</TABLE>
Footnotes on following page.
64
<PAGE>
- --------
(1) The average balance of tax-exempt securities held by the Bank and, in
turn, the earnings thereon have been included together with taxable
securities for the period indicated because of utilized operating loss
carryforwards.
(2) The average balance of nonperforming loans has been included in loans
receivable.
(3) Yields and amounts earned on loans include loan fees of $24,000, $150,000
and $121,000 for the years ended December 31, 1996, 1995 and 1994,
respectively.
(4) Computed on a tax equivalent basis. If customer service expense was
classified as interest expense and deducted in computing net interest
income, net yield on interest-earning assets would have been 4.98%, 5.17%
and 6.58%, respectively, for the years ended December 31, 1996, 1995 and
1994.
The Bank's net yield on interest-earning assets remains high in comparison
with the interest rate spread due to the continued significance of
noninterest-bearing demand deposits relative to total funding sources.
Noninterest-bearing demand deposits totaled $34.8 million at December 31,
1996, representing 33.5% of total deposits, compared to $44.6 million and
$87.4 million, representing 37.1% and 42.1% of total deposits at December 31,
1995 and 1994, respectively. Of these noninterest-bearing demand deposits,
$8.8 million or 8.1% of total assets were represented by real estate title and
escrow company deposits at December 31, 1996, compared to $9.8 million and
$17.6 million or 7.5% and 7.6% of total assets at December 31, 1995 and 1994,
respectively. While these deposits are noninterest-bearing, they are not cost-
free funds. Customer service expense, primarily costs related to external
accounting, data processing and courier services provided to title and escrow
company depositors, are incurred by the Bank to the extent that certain
average noninterest-bearing deposits are maintained by such depositors, and
such deposit relationships are determined to be profitable. Customer service
expense is classified as other operating expense. If customer service expenses
related to escrow customers were classified as interest expense, the Bank's
reported net interest income for the years ended December 31, 1996, 1995 and
1994 would be reduced by $349,000, $489,000 and $423,000, respectively.
Similarly, this would create identical reductions in other operating expense.
The net yield on interest-earning assets for the years ended December 31,
1996, 1995 and 1994 would have decreased 32.6 basis points, 35.3 basis points
and 18.6 basis points, respectively.
65
<PAGE>
RATE/VOLUME ANALYSIS OF NET INTEREST INCOME
The following table represents the extent to which changes in interest rates
and changes in the volume of interest-earning assets and interest-bearing
liabilities have affected the Bank's interest income and expense during the
periods indicated. Information is provided for each major component of
interest-earning assets and interest-bearing liabilities with respect to (i)
changes attributable to changes in volume, (ii) changes attributable to
changes in rate, and (iii) the net change. The changes due to simultaneous
rate and volume changes have been allocated to rate and volume changes in
proportion to the relationship between their absolute dollar amounts.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996 YEAR ENDED DECEMBER 31, 1995
COMPARED TO YEAR ENDED COMPARED TO YEAR ENDED
DECEMBER 31, 1995 DECEMBER 31, 1994
-------------------------------- --------------------------------
INCREASE (DECREASE) INCREASE (DECREASE)
-------------------------------- --------------------------------
NET NET
VOLUME RATE CHANGE VOLUME RATE CHANGE
---------- -------- ---------- ---------- --------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
INTEREST EARNED ON:
Loans receivable(1).... $(2,505) $ (51) $(2,556) $(5,109) $(1,743) $(6,852)
Investment
Securities(2)......... (545) 133 (412) (2,895) (119) (3,014)
Federal funds sold..... 206 (115) 91 357 243 600
---------- -------- ---------- --------- --------- ---------
Total.................. (2,844) (33) (2,877) (7,647) (1,619) (9,266)
---------- -------- ---------- --------- --------- ---------
INTEREST PAID ON:
Demand deposits........ (27) (34) (61) (33) 26 (7)
Money market and
savings deposits...... (257) (111) (368) (347) 74 (273)
Time deposits under
$100,000.............. (244) (19) (263) (1,675) 556 (1,119)
Time deposits over
$100,000.............. (86) (37) (123) (107) 177 70
Federal funds purchased
and securities sold
under agreements to
repurchase............ (80) (5) (85) (203) (15) (218)
---------- -------- ---------- --------- --------- ---------
Total.................. (694) (206) (900) (2,365) 818 (1,547)
---------- -------- ---------- --------- --------- ---------
Net interest income.... $(2,150) $ 173 $ (1,977) $ (5,282) $ (2,437) $(7,719)
========== ======== ========== ========= ========= =========
</TABLE>
- --------
(1) Table does not include interest income that would have been earned on
nonaccrual loans.
(2) The average balance of tax-exempt securities held by the Bank and, in
turn, the earnings differentials thereon have been included together with
taxable securities for the period indicated because of utilized NOLs.
Effects of Nonperforming Loans on Net Interest Income. Foregone interest
income attributable to nonperforming loans totaled $171,000, $160,000 and $1.2
million for the years ended 1996, 1995 and 1994, respectively. This resulted
in a reduction in yield on average gross loans outstanding of 24 basis points,
17 basis points and 83 basis points for the years ended December 31, 1996,
1995 and 1994, respectively. Although the Bank sold a large portion of the
nonperforming loans in February 1995, to the extent that additional loans are
identified as nonperforming in future periods, operating results will continue
to be adversely affected.
Each month the Bank reviews the allowance for credit losses and determines
the provision for credit losses, if needed. As a result of management's
periodic analysis of the adequacy of the allowance for credit losses, there
was no provision for credit losses for the year ended December 31, 1996,
compared to a provision of $2.3 million for the year ended December 30, 1995.
The Bank's allowance for credit losses as a percentage of nonperforming assets
decreased to 43.7% at December 31, 1996, from 63.8% at December 31, 1995, due
to loan charge-offs of $836,000, net of recoveries of loans previously
charged-off of 464,000.
66
<PAGE>
OTHER OPERATING INCOME
The following table sets forth for the periods indicated the various
components of the Bank's other operating income:
<TABLE>
<CAPTION>
FOR THE YEARS FOR THE YEARS
ENDED DECEMBER 31, ENDED DECEMBER 31,
-------------------------------------- -----------------------------------------
INCREASE (DECREASE) INCREASE (DECREASE)
---------------------- -----------------------
1996 1995 AMOUNT PERCENT 1995 1994 AMOUNT PERCENT
----- ------- ---------- ---------- ------- ------- ----------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
OTHER OPERATING (LOSSES)
INCOME:
Securities
transactions:
Net (loss) gain on sale
of trading securities. $ -- $ -- $ -- -- $ -- $ (112) $ 112 100 %
Net (loss) gain on sale
of securities
available-for-sale.... (3) (1,233) 1,230 100 % (1,233) (1,327) 94 7 %
Loss on termination of
interest rate swap.... -- (1,294) 1,294 100 % (1,294) -- (1,294) --
FEE INCOME:
International services. 124 224 (100) (45)% 224 435 (211) (49)%
Investment services.... 73 254 (181) (71)% 254 283 (29) (10)%
Deposit and other
customer services..... 308 737 (429) (58)% 737 696 41 6 %
OTHER:
Other income-
shareholders'
insurance claims...... -- 730 (730) (100)% 730 -- 730 --
Loss on OREO........... -- (733) 733 100 % (733) (894) 161 18 %
Loss on other assets... -- -- -- -- -- (1,087) 1,087 100 %
Lower-of-cost-or-market
adjustment on loans
held for sale......... -- -- -- -- -- (851) 851 100 %
----- ------- ---------- -------- ------- ------- ----------- -------
Total other operating
(losses) income....... $ 502 $(1,315) $ 1,817 138 % $(1,315) $(2,857) $ 1,542 54 %
===== ======= ========== ======== ======= ======= =========== =======
</TABLE>
As set forth in the accompanying consolidated statements of operations, the
Bank's principal sources of other operating income is fee income related to
international, investment, deposit and other customer services. In addition,
other operating income also includes the results of activity related to
transactions involving the Bank's securities portfolio and results of activity
related to other transactions primarily involving OREO, loans and other
assets.
Other operating income for the year ended December 31, 1996 was $502,000
compared to losses of $1.3 million for 1995. This resulted primarily from the
absence of losses on securities transactions during 1996. Fee income decreased
$710,000 or 58% during the year ended December 31, 1996 compared to the year
ended December 31, 1995 primarily due to volume decreases in international,
investment, deposit and other customer services. The international services
department was closed in December 1995, resulting in reduced letter of credit
and foreign exchange functions during 1996.
During 1996 the Bank restructured its investment service division by forming
a strategic alliance with an investment brokerage firm. This strategic
alliance enables the Bank to provide a wide array of products at a reduced
overhead cost. Management expects that this alliance will allow fees from
these services to increase without a corresponding increase in overhead
expenses experienced in prior years. In addition, the Bank is currently
reviewing the fee structure of its deposit related services to ensure such
services are competitively priced and, as a result of this review, expects
fees from these services to increase in the future.
Other operating income during the year ended December 31, 1995 resulted in a
loss of $1.3 million, representing a decrease of $1.5 million or 54% from a
loss of $2.9 million during the year ended December 31, 1994. With respect to
securities transactions during 1995, the Bank sold $46.9 million of investment
securities available for sale and terminated a related interest rate swap
contract. These transactions caused the Bank to realize a net loss of $1.2
million on the sale of securities and a loss of $1.3 million on the
termination of the interest rate swap contract during the year ended December
31, 1995. During the year ended December 31, 1994, losses on sales of
securities were $1.4 million, primarily the result of transactions during the
fourth quarter of that year. In the fourth quarter of 1994, the Bank sold
approximately $30.0 million of investment securities and realized a loss of
$1.3 million. The loss on sale of trading securities totaled $112,000 for the
year ended December 31, 1994. Activity in trading securities ceased during
1994, and management does not intend to engage in this activity in the
foreseeable future.
67
<PAGE>
Other income for the year ended December 31, 1995 included $730,000 in
income from insurance proceeds resulting from the settlement of a lawsuit. In
addition during the year ended December 31, 1994 other income included a loss
of $1.1 million on the write-down of a movie library received as collateral
for a loan.
OTHER OPERATING EXPENSES
The following table sets forth for the periods indicated the various
components of the Company's other operating expense:
<TABLE>
<CAPTION>
FOR THE YEARS FOR THE YEARS
ENDED INCREASE ENDED INCREASE
DECEMBER 31, (DECEASE) DECEMBER 31, (DECREASE)
-------------- ---------------- --------------- ----------------
1996 1995 AMOUNT PERCENT 1995 1994 AMOUNT PERCENT
------ ------- ------- ------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
OTHER OPERATING EX-
PENSES:
Salaries and related
benefits.............. $2,718 $ 3,878 $(1,160) (30)% $ 3,878 $ 5,088 $(1,210) (24)%
Severance costs........ -- 141 (141) (100)% 141 333 (192) (58)%
Net occupancy.......... 793 1,468 (675) (46)% 1,468 1,832 (364) (20)%
Furniture and
equipment............. 298 385 (87) (23)% 385 539 (154) (29)%
Printing and
communications........ 211 270 (59) (22)% 270 420 (150) (36)%
Insurance and
regulatory
assessments........... 629 971 (342) (35)% 971 1,203 (232) (19)%
Customer services...... 607 853 (246) (29)% 853 837 16 2 %
Computer data
processing............ 359 413 (54) (13)% 413 495 (82) (17)%
Legal settlement....... 1,000 -- 1,000 -- -- -- -- --
Legal services......... 503 749 (246) (33)% 749 768 (19) (2)%
Other professional
services.............. 640 1,546 (906) (59)% 1,546 1,406 140 10 %
Other real estate owned
expenses.............. 39 41 (2) (5)% 41 87 (46) (53)%
Promotion and other
expenses.............. 206 518 (312) (60)% 518 706 (188) (27)%
------ ------- ------- ---- ------- ------- ------- ---
Total other operating
expenses.............. $8,003 $11,233 $(3,230) (29)% $11,233 $13,714 $(2,481) (18)%
====== ======= ======= ==== ======= ======= ======= ===
</TABLE>
During the year ended December 31, 1996, other operating expenses was $8.0
million, a 29% decrease from the year ended December 31, 1995. This $3.2
million decrease was the result of management's continuing efforts to reduce
operating expenses, and is primarily attributable to the reduction in salaries
and related expenses of $1.2 million, the reduction in occupancy expenses of
$675,000 and the reduction in other professional services of $906,000. In
1995, the Bank negotiated with its landlord a restructuring of its lease for
the Bank's premises. This restructuring of the Bank's lease represents an
annual savings of approximately $850,000 over the five years ending December
31, 2000, and significantly contributed to the reductions in net occupancy
expense achieved during the year ended December 31, 1996. See "Business--
Properties." In addition, the decreases in compensation expense and other
professional services are due to reductions in staff and changes in management
during the year ended December 31, 1996.
Other operating expenses for the year ended December 31, 1996 includes a
litigation settlement of $1.0 million resulting from a settlement agreement
reached in relation to counterclaims filed against the Bank by underwriters
for Lloyd's ("Lloyd's Underwriters") and certain other parties. See
"Business--Legal Proceedings." Other operating expenses, excluding the $1.0
million legal settlement, decreased to $7.0 million for the year ended
December 31, 1996, representing a $4.2 million or 38% decrease when compared
to the year ended December 31, 1995. Other operating expenses for the year
ended December 31, 1996 includes $145,000 for consulting services directly
related to efforts associated with the federal income tax refund. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Income Taxes."
68
<PAGE>
In conjunction with the Bank's execution of the Lease Restructuring
Agreement, the Company issued to its landlord a seven-year warrant to purchase
shares of the Company's Common Stock and granted the landlord registration
rights with respect to any shares purchased by the landlord pursuant to such
warrant. See "Business --Properties" and "Description of Capital Stock--
Registration Rights."
Other operating expenses decreased 18.1% to $11.2 million for the year ended
December 31, 1995 as compared to $13.7 million for the year ended December 31,
1994. This decrease was primarily due to management's efforts to continue to
reduce operating expenses in response to the Bank's shrinking asset base.
Compensation expense decreased $1.2 million or 24% to $3.9 million for the
year ended December 31, 1995 compared to $5.1 million for the year ended
December 31, 1994.
Virtually all other categories of other operating expenses decreased or
remained level during the year ended December 31, 1995 compared to the year
ended December 31, 1994 except for other professional services which increased
$140,000 or 10%. This increase in other professional services was attributable
to expanded accounting and auditing services and the use of other outside
consultants to supplement management. During 1996, the Bank has reduced its
utilization of outside consultants through the addition of executive
management and streamlining operating functions. As a result, management
expects that fees paid to outside consultants will continue to decrease.
PROVISION FOR CREDIT LOSSES
Provisions for credit losses are charged to earnings to bring the total
allowance for credit losses to a level deemed appropriate by management based
on such factors as historical experience, the volume and type of lending
conducted by the Bank, the amount of nonperforming loans, regulatory policies,
generally accepted accounting principles, general economic conditions, and
other factors related to the collectability of loans in the Bank's portfolio.
Each month the Bank reviews the allowance for credit losses and makes
additional transfers to the allowance, as needed. As a result of management's
periodic analysis of the allowance for credit losses, there was no provision
for credit losses for the year ended December 31, 1996, compared to a
provision of $2.3 million for 1995. No provision was made for credit losses
for the year ended December 31, 1996. The Bank's allowance for credit losses
as a percentage of nonperforming assets decreased to 43.7% at December 31,
1996 from 58.2% at December 31, 1995 due to loan charge offs of $836,000, net
of recoveries of loans previously charged-off of $464,000.
The provision for credit losses for the year ended December 31, 1995 was
$2.3 million compared to $7.3 million for the year ended December 31, 1994.
The provision for credit losses during the year ended December 31, 1994 was
primarily due to the $20.8 million loan portfolio purchased from the FDIC
during 1993. At the time of purchase, the Bank had recorded an allowance for
credit losses of $4.0 million. This allowance was subsequently reclassified as
a purchase discount and accreted over the term of the related loans.
Concurrent with this reclassification in 1994, the Bank added $4.1 million to
the provision for credit losses to absorb losses from this portfolio. Charge-
offs related to the $20.8 million of purchased loans totaled $4.0 million
during the year ended December 31, 1994. From December 31, 1994 through
December 31, 1996, the Bank has charged off $1.3 million related to this
purchased portfolio.
To improve asset quality and future profitability, in February 1995, the
Bank sold loans with an outstanding principal balance of $13.5 million,
realizing net proceeds of $6.6 million. This loan portfolio consisted of
criticized and/or nonperforming loans and loans that were previously charged-
off. At December 31, 1994, the loans sold in February 1995 were carried based
on the ultimate sales price net of, lower of cost or market adjustment of
$851,000, charge-offs totaling $2.0 million, and loans that were previously
charged-off totaling $4.0 million.
69
<PAGE>
The decrease in the provision for credit losses during 1995 resulted from
the decrease in loan balances, the sale of loans, improved collections and
reduced net charge-offs in 1995. As of December 31, 1996, the Company believes
based on its periodic analysis that the allowance for credit losses was
adequate.
INCOME TAXES
The Company utilized all available financial statement income tax benefits
in 1991, therefore, the cumulative losses through December 31, 1996, resulted
in income tax carryforwards for the Company. The Company has recognized losses
for financial statement purposes which have not yet been recognized on an
income tax return. At December 31, 1996, the Company had $22.3 and $11.8
million of NOL carryforwards for federal and state income tax purposes,
respectively. The federal NOL carryforwards expire beginning in 2007 through
2011 and the state NOL carryforwards expire beginning in 1997 through 2001.
The Company filed a loss carryback claim in 1995, and during 1996 realized a
tax benefit for federal income tax purposes and received refund received of
approximately $579,000 (including $43,000 in interest) related to a carryback
of a portion of the Company's NOLs previously unrecognized.
Federal income tax laws permit the Company to carry back NOLs three years to
offset taxable income in those periods, if any, and forward fifteen years to
offset taxable income in those future periods. Under special circumstances,
losses may be carried back up to ten years. California Franchise Tax laws do
not provide for the carryback of such losses and generally permit one-half of
net operating losses to be carried forward five years. See "Certain Federal
Income Tax Consequences."
LIQUIDITY AND LIABILITY MANAGEMENT
Liquidity management for banks requires that funds be available to pay
anticipated deposit withdrawals and maturing financial obligations promptly
and fully in accordance with their terms. Over a very short time frame,
maturing assets provide only a limited portion of the funds required to pay
maturing liabilities. The balance of the funds required is generally provided
by payments on loans, sale of loans, liquidation of assets and the acquisition
of additional deposit liabilities.
Market and public confidence in the financial strength of the Bank and
financial institutions in general will largely determine the Bank's access to
appropriate levels of liquidity. This confidence is significantly dependent on
the Bank's ability to maintain continued sound asset credit quality and
appropriate levels of capital resources.
Management has defined liquidity as the ability of the Bank to meet
anticipated customer demands for funds under credit commitments and deposit
withdrawals at a reasonable cost and on a timely basis. Management measures
the Bank's liquidity position by giving consideration to both on- and off-
balance sheet sources of and demands for funds. Management believes this
method provides a comprehensive measure of the Bank's net liquidity position.
Liquidity includes cash and due from banks, federal funds sold and
investment securities. Sources of liquidity include loan repayments, deposits
and borrowings under informal overnight federal fund lines available from
correspondent banks. In addition to volatile noninterest-bearing demand and
interest rate-sensitive deposits, the Bank's principal demand for liquidity is
anticipated fundings under credit commitments to customers.
To meet liquidity needs, the Bank maintains a portion of its funds in cash
deposits in other banks, Federal funds sold and investment securities. As of
December 31, 1996, the Bank's liquidity ratio was 44.8%, defined as $23.0
million in Federal funds sold, $18.4 million in investment securities and $5.1
million in cash and due from banks, as a percentage of deposits.
In response to the 1995 Formal Agreement, the Bank's Board of Directors
adopted revised measurement guidelines for management of the Bank's liquidity
position (the "liquidity guidelines"), including limitations on
70
<PAGE>
the maximum acceptable ratios as follows: (i) loan-to-deposit ratio of 85%;
(ii) amounts of purchased funds as a percentage of aggregate funding sources,
comprised of purchased funds, deposits, and borrowings from customers under
retail repurchase agreements ("purchased funds ratio") of 20%; (iii) pledged
investment securities as a percentage of the total investment securities
portfolio ("pledged securities ratio") of 75%; and (iv) money desk deposits,
in the aggregate and as a percentage of total deposits of 40% and time
certificates of deposit of $100,000 or more to total deposits of 15%. For this
purpose, purchased funds include borrowings from securities dealers under
wholesale repurchase agreements, borrowings from correspondent banks under
overnight federal fund lines and brokered deposits. The liquidity guidelines
further establish a minimum net liquidity position to be maintained by the
Bank. The Bank was in compliance with these guidelines throughout the years
ended December 31, 1996 and 1995.
As described above, maintaining appropriate levels of capital is an
important factor in determining the availability of critical sources of
liquidity. Accordingly, the liquidity guidelines also require that the Bank
maintain a minimum level of total regulatory capital in excess of the minimum
level required under the Federal Reserve Board's guidelines.
Management and the Interest Rate Risk Committee of the Board of Directors
seek to maintain a stable net liquidity position while optimizing operating
results, as reflected in net interest income, the net yield on earning assets
and the cost of interest-bearing liabilities in particular. The Board meets
monthly to review the Bank's current and projected net liquidity position and
to review actions taken by management at its weekly Interest Rate Risk
Committee meetings in order to achieve this liquidity objective.
The Company's consolidated statements of cash flows included in the
accompanying consolidated financial statements present certain information
about cash flows from operating, investing and financing activities. The
Bank's principal cash flows relate to investing and financing activities,
rather than operating activities. While the statements present the net cash
flows for the periods indicated from lending and deposit activities, they do
not reflect certain important aspects of the Bank's liquidity described above,
including (i) anticipated liquidity requirements under outstanding credit
commitments to customers, (ii) intraperiod volatility of deposits,
particularly fluctuations in the volume of commercial customers' noninterest-
bearing demand deposits, and (iii) unused borrowings available under federal
funds lines, repurchase agreements, and other arrangements. As such,
management believes that the measurements provided in the liquidity guidelines
discussed above are generally more indicative of the Bank's overall liquidity
position. The Bank's principal source of operating cash flows is net interest
income.
INTEREST RATE MATURITIES OF ASSETS AND FUNDING SOURCES
The careful planning of asset and liability maturities and the matching of
interest rates to correspond with this maturity matching is an integral part
of the active management of an institution's net yield. To the extent
maturities of assets and liabilities do not match in a changing interest rate
environment, net yields may be affected. Even with perfectly matched repricing
of assets and liabilities, risks remain in the form of prepayment of assets
and timing lags in adjusting certain assets and liabilities that have varying
sensitivities to market interest rates. In its overall attempt to match assets
and liabilities, management takes into account rates and maturities to be
offered in connection with its certificates of deposit and offers variable
rate loans.
The matching of assets and liabilities may be analyzed by examining the
extent to which such assets and liabilities are "interest rate sensitive" and
by monitoring an institution's interest rate sensitivity "gap." An asset or
liability is said to be interest rate sensitive within a specific time period
if it will mature to reprice within that time period. The interest rate
sensitivity gap is defined as the difference between the amount of interest-
earning assets maturing or repricing within a specific time period and the
amount of interest-bearing liabilities maturing or repricing within that time
period. A gap is considered positive when the amount of interest rate
sensitive assets exceeds the amount of interest rate sensitive liabilities. A
gap is considered negative when the amount of interest rate sensitive
liabilities exceeds the amount of interest rate sensitive assets. During a
period of rising interest
71
<PAGE>
rates, therefore, a negative gap would theoretically tend to adversely affect
net interest income, while a positive gap would tend to result in an increase
in net interest income. Conversely, during a period of falling interest rates,
a negative gap position would theoretically tend to result in an increase in
net interest income while a positive gap would tend to affect net interest
income adversely.
INTEREST RATE SENSITIVITY
The following table sets forth the amounts of interest-earning assets and
interest-bearing liabilities outstanding at December 31, 1996 which are
anticipated by the Bank, based upon certain assumptions, to reprice or mature
in each of the future time periods shown. Except as stated below, the amount
of assets and liabilities shown which reprice or mature during a particular
period were determined in accordance with the earlier of term to repricing or
the contractual maturity of the asset or liability. The table is intended to
provide an approximation of the projected repricing of assets and liabilities
at December 31, 1996, on the basis of contractual maturities, anticipated
prepayments, and scheduled rate adjustments within a three-month period and
subsequent selected time intervals. Money market and demand deposits and
savings accounts are all assumed to reprice immediately, and so are allocated
to the shortest period (three months or less) for purposes of the table.
<TABLE>
<CAPTION>
AT DECEMBER 31, 1996
-----------------------------------------------------------
DUE IN DUE AFTER
WITHIN THREE TO ONE YEAR
THREE TWELVE TO FIVE DUE AFTER NOT RATE
MONTHS MONTHS YEARS FIVE YEARS SENSITIVE TOTAL
------- -------- --------- ---------- --------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS:
Federal funds sold..... $23,000 $ -- $ -- $ -- $ -- $ 23,000
Investment securities.. -- -- 15,398 3,232 -- 18,630
Loans receivable....... 37,050 15,572 7,913 2,012 -- 62,547
------- ------- ------- ------- -------- --------
Total.................. 60,050 15,572 23,311 5,244 -- 104,177
NONINTEREST-EARNING
ASSETS:
Cash and due from
banks................. -- -- -- -- 5,113 5,113
Other real estate
owned................. -- -- -- -- 556 556
All other assets....... -- -- -- -- 2,539 2,539
Allowance for credit
losses................ -- -- -- -- (2,969) (2,969)
------- ------- ------- ------- -------- --------
Total assets........... 60,050 15,572 23,311 5,244 5,239 109,416
INTEREST-BEARING
LIABILITIES:
Demand deposits, money
market and savings.... 28,454 28,454
Time deposits.......... 10,934 22,346 7,368 40,648
------- ------- ------- ------- -------- --------
Total.................. 39,388 22,346 7,368 -- -- 69,102
------- ------- ------- ------- -------- --------
NONINTEREST-BEARING
LIABILITIES:
Noninterest-bearing
deposits.............. -- -- -- -- 34,752 34,752
Other liabilities...... -- -- -- -- 717 717
Shareholders' equity... -- -- -- -- 4,845 4,845
------- ------- ------- ------- -------- --------
Total liabilities and
shareholders equity.... 39,388 22,346 7,368 40,314 109,416
------- ------- ------- ------- -------- --------
Interest rate
sensitivity gap........ $20,662 $(6,774) $15,943 $ 5,244 $(35,075) $ --
======= ======= ======= ======= ======== ========
Cumulative interest rate
sensitivity gap........ $20,662 $13,888 $29,831 $35,075 $ -- $ --
======= ======= ======= ======= ======== ========
Cumulative interest rate
sensitivity gap ratio
based on cumulative
earning assets......... 34% 18% 30% 34%
</TABLE>
At December 31, 1996, the Bank had net repriceable assets (a "positive" gap)
as measured at one year of 18% of total assets. The net repriceable assets
over a five-year time horizon totaled approximately $5.2 million or 4.8% of
total assets. A positive gap implies that the Bank is asset sensitive, and
therefore subject to a decline
72
<PAGE>
in net interest income as interest rates decline. In a relatively stable
interest rate environment that follows a period of rising interest rates,
variable rate liabilities will continue to reprice upward while variable rate
assets, particularly those indexed to the prime rate, remain relatively
constant, thereby narrowing net interest margin. As interest rates decline,
variable rate assets reprice at lower rates immediately, while the variable
rate liabilities reprice gradually, resulting in a narrowing of the net
interest margin. During a period of rising interest rates, this positive gap
would tend to result in an increase in net interest income.
Although certain assets and liabilities are assumed to have similar
maturities or periods to repricing, they may actually react in different
degrees to changes in market interest rates. Also, the interest rates on
certain types of assets and liabilities may fluctuate in advance of changes in
market interest rates, while interest rates on other types may lag behind
changes in market rates. Further, in the event of a significant change in
interest rates, prepayment and early withdrawal levels would likely deviate
materially from those assumed in calculating the foregoing table. Finally, the
ability of many borrowers to service their adjustable-rate loans may decrease
in the event of a significant interest rate increase. Since interest rate
changes do not affect all categories of assets and liabilities equally or
simultaneously, a cumulative gap analysis alone cannot be used to evaluate the
Bank's interest rate sensitivity position.
CAPITAL RESOURCES
The Company's shareholders' equity at December 31, 1996 decreased to $4.8
million from $6.0 million at December 31, 1995, and $10.3 million at December
31, 1994. The decrease in 1996 is attributable to the net loss of $1.2 million
and the decrease in unrealized losses on securities available for sale of
$78,000. The decrease in 1995 is attributed to the year's net loss of $7.2
million, net of a decrease in unrealized losses on the securities available-
for-sale of $2.9 million.
The ability of the Company and the Bank to achieve and maintain appropriate
levels of capital resources is substantially dependent on their ability to
attract capital, such as through the Public Offering and the Private Offering,
and to support earning assets and sustain profitability on an ongoing basis.
The Bank's goal for 1997 is to achieve profitability by improving asset
quality through the reduction of nonperforming loans and operating expenses
and growth in interest earning assets. Although the Company and the Bank have
taken steps toward these goals, there can be no assurances that operating
losses will not continue.
The Bank is currently operating under the 1995 Formal Agreement with the
OCC. To the extent significant losses continue and capital continues to erode,
the Bank could fall into the "undercapitalized" category. In such event, the
Bank would be even more closely monitored by the federal regulators, and could
be subject to other restrictions. See "The Company--Regulatory Agreements" and
"Regulation--Supervision and Regulation--Capital Standards."
REGULATORY CAPITAL OF THE COMPANY AND THE BANK
The Federal Reserve Board and the OCC have issued guidelines to implement
risk-based capital requirements. The risk-based capital ratio of the Company
and the Bank are calculated under the guidelines by dividing their respective
qualifying total capital by their respective total risk-weighted assets. The
Company's qualifying total capital and total risk-weighted assets are
determined on a fully consolidated basis. A bank holding company's total
qualifying capital is comprised of the sum of core capital elements ("Tier 1
capital") and supplementary capital elements ("Tier 2 capital") minus certain
specified deductions (collectively, the "deductions"), if any. Tier 1 capital
consists primarily of common stock and retained earnings. Tier 2 capital is
comprised of the allowance for credit losses limited to 1.25% of total risk
weighted assets. Total risk-based capital is Tier 1 plus Tier 2 capital;
however, at least 50% of total capital must be composed of Tier 1 capital. The
capital standards specify that assets, including certain off-balance sheet
items be assigned risk weights based on credit and liquidity risk which range
from 0% risk weight for cash to 100% risk weight for commercial loans and
certain other assets. The leverage ratio is Tier 1 capital to adjusted average
assets. The Tier 1 capital ratio is
73
<PAGE>
Tier 1 capital to risk weighted assets. The total risk-based capital ratio is
Tier 1 plus Tier 2 capital to risk weighted assets.
The FDIC Improvement Act requires that for banks to be considered "well
capitalized," they must maintain a leverage ratio of 5.0%, a Tier 1 capital
ratio of 6.0% and a risk-based capital ratio of 10.0% and not be under a
written agreement or capital directive. Banks will be considered "adequately
capitalized" if they maintain a leverage ratio of 4.0%, a Tier 1 risk-based
capital ratio of 4.0%, and a total risk-based capital ratio of 8.0%.
Pursuant to the 1995 Formal Agreement, the Bank is required to achieve and
thereafter maintain a Tier 1 risk-based capital ratio of at least 10.0% and a
leverage capital ratio of at least 6.5%. At December 31, 1996, the Bank was
not in compliance with the 1995 Formal Agreement with respect to these ratios.
The Bank's Tier 1 risk-based capital and leverage capital ratios at December
31, 1996, were 6.95% and 4.67%, respectively. Accordingly, the Bank may be
subject to further regulatory enforcement action by the OCC. Pursuant to the
1995 Formal Agreement, a capital plan was filed by the Bank with the OCC on
February 8, 1996. See "The Company--Regulatory Agreements."
The following tables set forth the minimum capital ratios required by
federal regulations with respect to the Company and by federal regulations and
the 1995 Formal Agreement with respect to the Bank and the Company's and
Banks' actual ratios as of December 31, 1996.
<TABLE>
<CAPTION>
COMPANY AT DECEMBER 31, 1996
------------------------------------------------
REQUIRED ACTUAL EXCESS
------------ ------------ --------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- ------ ----- ---------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Tier 1 risk-based capital
ratio....................... $2,828 4.00% $4,921 6.96% $ 2,093 2.96 %
Total risk-based capital
ratio....................... 5,657 8.00% 5,831 8.25% 174 0.25 %
Leverage capital ratio(2).... 4,210 4.00% 4,921 4.68% 711 0.68 %
<CAPTION>
BANK AT DECEMBER 31, 1996
------------------------------------------------
REQUIRED ACTUAL EXCESS(DEFICIENCY)
------------ ------------ --------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- ------ ----- ---------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Tier 1 risk-based capital
ratio....................... $2,828 4.00% $4,911 6.95% $ 2,083 2.95 %
Total-risk-based capital
ratio....................... 5,657 8.00% 5,820 8.24% 163 0.24 %
Leverage capital ratio(2).... 4,210 4.00% 4,911 4.67% 701 0.67 %
Formal Agreement-leverage
capital ratio(1)............ 6,841 6.50% 4,911 4.67% (1,930) (1.83)%
Formal Agreement-Tier 1 risk
based capital ratio(1)...... 7,071 10.00% 4,911 6.95% (2,160) (3.05)%
</TABLE>
- --------
(1) The Bank's minimum Tier 1 risk-based capital and leverage capital
requirements are based on the provisions of the 1995 Formal Agreement,
which became effective on December 14, 1995.
(2) The regulatory leverage capital ratio represents the ratio of Tier 1
capital at December 31, 1996 to average total assets during the three-
month period then ended.
The significant losses incurred during the years ended December 31, 1995 and
1994 eroded the Bank's capital. These losses were primarily a result of
increased provisions for credit losses, losses on securities, losses on OREO
and other assets, and reductions in interest-earning assets without a
corresponding reduction in operating expenses. Although the Bank was able to
decrease the level of nonperforming assets at December 31, 1996 and 1995, it
suffered significant credit losses during the year ended December 31, 1995
related to the high level of nonperforming loans from previous years. To the
extent that the level of nonperforming loans increases and results in
increased provisions for credit losses and loan charge-offs or adversely
affects the level of income from those loans, the Bank's ability to generate
adequate future earnings will be negatively affected.
74
<PAGE>
RECENT ACCOUNTING DEVELOPMENTS
In June 1996, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities," which 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. SFAS No. 125 distinguishes transfers of financial assets that are
sales from transfers that are secured borrowings. 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. The Company has not completed its analysis of the impact SFAS
No. 125 may have on the financial condition and results of operations of the
Company.
In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation," which establishes financial accounting and reporting standards
for stock-based employee compensation plans. Those plans include all
arrangements by which employees receive shares of stock or other equity
instruments of the employer or the employer incurs liabilities to employees in
amounts based on the price of the employer's stock. Examples are stock
purchase plans, stock options, restricted stock awards and stock appreciation
rights. This statements also applies to transactions in which an entity issues
its equity instruments to acquire goods or services from non-employees. Those
transactions must be accounted for, or at least disclosed in the case of stock
options, based on the fair value of the consideration received or the fair
value of the equity instruments issued, whichever is more reliably measurable.
The accounting requirements of SFAS No. 123 are effective for financial
statements for fiscal years beginning after December 15, 1995, or for an
earlier fiscal year for which SFAS No. 123 is initially adopted for
recognizing compensation cost. The statement permits a company to choose
either a new fair value-based method or the current APB Opinion 25 intrinsic
value-based method of accounting for its stock-based compensation
arrangements. The statement requires pro forma disclosures of net earnings and
earnings per share computed as if the fair value-based method had been applied
in financial statements of companies that continue to follow current practice
in accounting for such arrangements under APB Opinion 25. The Company has
chosen not to adopt the fair value provisions of SFAS No. 123 and will
continue accounting for stock compensation awards at their intrinsic value at
the grant date, and will adopt the disclosure requirements of SFAS No. 123.
BUSINESS
MARKET AREA
The Bank, through a single site location, operates primarily in the west
side of the city of Los Angeles, California. The Bank's market area for its
established niche markets of business and private banking and entertainment
banking can be defined geographically to include a radius of four miles from
the Bank. In implementing its planned extension into the technology/multimedia
market, the Bank will be offering specific products tailored to that industry
to prospective clients in a wider geographic area that includes Los Angeles,
Ventura and Orange Counties.
COMPETITION
The banking business in California generally, and in the Bank's primary
market specifically, is highly competitive with respect to both loans and
deposits, and is dominated by a relatively small number of major banks which
have many offices operating over a wide geographical area. The Bank competes
for loans and deposits primarily with other commercial banks, including many
that are much larger than the Bank, as well as with non-bank financial
institutions, including savings and loan associations, credit unions, thrift
and loan companies, mortgage companies, commercial finance lenders, offerors
of money market accounts, and other financial and non-financial institutions.
Among the advantages certain of those institutions have over the Bank is their
ability to finance wide-ranging and effective advertising campaigns and to
allocate their investment resources to regions of highest yield and demand. In
addition, many of the major commercial banks operating in the Bank's primary
market offer certain services, such as trust services, which are not currently
offered directly by the Bank and, by virtue of their greater total
capitalization, such banks have substantially higher lending limits than the
Bank.
75
<PAGE>
To compete with other financial institutions in its primary market, the Bank
relies principally upon personal contact by its officers, directors and
employees and providing, through third parties, specialized services such as
courier services and escrow accounting services. For customers whose loan
demands exceed the Bank's legal lending limits, the Bank has arranged for such
loans on a participation basis with other banks. The Bank also assists
customers requiring other services not offered by the Bank in obtaining such
services from other providers.
LOAN PORTFOLIO
The following table presents the Company's loan portfolio as of the dates
indicated:
<TABLE>
<CAPTION>
AT DECEMBER 31,
---------------------------------------------------
1996 1995 1994
---------------- ---------------- -----------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------- ------- ------- ------- -------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Loan portfolio composition:
Real estate construction
and land development...... $ 3,441 5% $ 4,185 5% $ 948 1%
Commercial loans:
Secured by one to four
family residential
properties.............. 6,233 10% 9,637 12% 18,398 16%
Secured by multifamily
residential properties.. 2,879 5% 2,876 3% 2,368 2%
Secured by commercial
real properties......... 26,629 42% 28,734 35% 32,061 28%
Other--secured and
unsecured............... 16,508 26% 27,393 33% 43,385 37%
Home equity lines of
credit.................... 581 1% 3,983 5% 2,867 2%
Consumer installment and
unsecured loans to
individuals............... 6,545 11% 5,435 7% 15,691 14%
------- --- ------- --- -------- ---
Gross loans outstanding.... 62,816 100% 82,243 100% 115,718 100%
Deferred net loan
origination fees,
purchased loan discount
and gains on termination
of interest rate hedging
contracts................. (269) (231) (434)
------- ------- --------
Loans receivable........... $62,547 $82,012 $115,284
======= ======= ========
</TABLE>
The Bank's real estate construction and land development loans are primarily
interim loans made by the Bank to finance construction of commercial and
single family residential property. These loans are typically short-term. The
Bank does not make loans for speculative or tract housing construction or for
acquisition and development of raw land.
The Bank's commercial loans secured by real estate consist primarily of
loans made based on the borrower's cash flow and which are secured by deeds of
trust on commercial and residential property to provide another source of
repayment in the event of default. It is the Bank's policy generally to
restrict real estate loans to no more than a range of 65% to 70% of the lower
of the Bank's appraised value or the purchase price of the property, depending
on the type of property and its utilization. The Bank offers both fixed and
floating rate loans. Maturities on such loans are generally restricted to five
years (on an amortization ranging from fifteen to twenty-five years with a
balloon payment due at maturity).
The Bank's other secured and unsecured commercial loans are made for the
purpose of providing working capital, financing the purchase of equipment or
for other business purposes. Included in this category are both secured and
unsecured loans consisting of revolving lines of credit, term loans for
equipment and short-term working capital lines of credit. Collateral for the
secured loans in this category is generally represented by accounts
receivable, inventory, equipment, real estate, marketable securities and other
assets, such as the cash surrender value of life insurance contracts. The
Bank's policy pertaining to collateral support for such loans generally
requires the filing of Uniform Commercial Code forms with the appropriate
state agency, deeds of trust, purchase money interests and proper assignments
of documents as required.
76
<PAGE>
Other Secured Commercial Loans. The Bank underwrites its commercial loans on
the basis of the borrower's cash flow and ability to service debt from cash
flow and earnings rather than on the basis of the underlying collateral value,
and seeks to structure such loans to have more than one source of repayment.
The borrower is required to provide the Bank with sufficient information to
allow a loan decision to be made and to assess the value of the proposed
collateral. This generally includes three years of financial statements,
projected cash flows, current financial information on any and all guarantors,
and other reports such as a current business plan, that show trends in the
current assets and projects the impact of the proposed financing. While most
loans do not exceed one year, except for equipment and real estate loans,
those in excess of one year have covenants which generally require financial
reporting and other financial performance.
Other Unsecured Commercial Loans. This category, which includes term loans
and lines of credit, represents a smaller portion of the portfolio, and is a
customary product provided for the Bank's business clients. The Bank's
underwriting guidelines include low levels of existing debt of the borrower,
working capital sufficient to cover the loan and a history of earnings and
cash flow. Lines of credit are generally required to be unused for a
continuous 30 day period to demonstrate the borrower's ability to have
sufficient funds to carry its operations on an annual basis. These lines are
generally used for short-term cash needs and do not represent permanent
working capital requirements. Generally, these loans do not exceed the lesser
of 50% to 100% of the borrower's verified liquid assets, or 10% to 20% of the
borrower's tangible net worth.
Home equity lines of credit loans provide the borrower a line of credit of
up to 80% of the appraised value of their residential real estate net of any
senior mortgages. This line of credit is secured by a mortgage on the
borrower's property and can be drawn upon at any time.
Consumer loans are made for the purpose of financing automobiles, various
types of consumer goods, and other personal purposes. Consumer loans generally
provide for the monthly payment of principal and interest. Most of the Bank's
consumer loans are secured by the personal property being purchased.
The loan portfolio decreased by $19.5 million to $62.5 at December 31, 1996,
from $82.0 million at December 31, 1995, or by 20.9%. See "Business Effects on
Nonperforming Loans and Net Interest Income." The table above indicates that
the loan portfolio mix at December 31, 1996 had a larger portion of loans
secured by real estate, representing approximately 63% of gross loans
outstanding as compared to 60% at December 31, 1995. Other secured and
unsecured commercial loans represented 26% of the portfolio at December 31,
1996, a decline from 33% at December 31, 1995. Loans secured by commercial
real properties increased as a percentage of the portfolio to 42% at December
31, 1996 from 35% at December 31, 1995 due to the reduced portfolio size.
The loan portfolio decreased to $82.0 million at December 31, 1995 from
$115.3 million at December 31, 1994, or by 28.9%. The above table indicates
that the loan portfolio mix at December 31, 1995, had a larger portion of
loans secured by real estate, representing approximately 60% of gross loans
outstanding as compared to 49% at December 31, 1994. Other secured and
unsecured commercial loans represented 33% of the loan portfolio at December
31, 1995, a decline from 37% at December 31, 1994, and consumer loans to
individuals represented 7% at December 31, 1995, a decline from 14% at
December 31, 1994.
MATURITIES AND RATE SENSITIVITY OF LOANS
The following table sets forth the maturity distribution of the Bank's loans
outstanding at December 31, 1996. At that date, the Bank had no loans with a
maturity greater than 30 years, other than loans totaling approximately
$496,000 which have no stated maturity, although most such loans do not have a
maturity greater than nine years. In addition, the table shows the
distribution of such loans between those loans with predetermined (fixed)
interest rates and those with variable (floating) interest rates. Floating
rates generally fluctuate with changes in various prime rates. As of December
31, 1996, over 74% of the Bank's loan portfolio
77
<PAGE>
were floating interest rate loans. Nonperforming loans are included in this
schedule based on nominal maturities, even though the Bank may be unable to
collect such loans at their maturity date.
<TABLE>
<CAPTION>
AT DECEMBER 31, 1996
-------------------------------------------
OVER ONE YEAR
ONE YEAR OR BUT LESS THAN OVER FIVE
LESS(1) FIVE YEARS YEARS TOTAL
----------- ------------- --------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Loan portfolio composition:
Real estate construction and land
development....................... $ -- $ 3,441 $ -- $ 3,441
Commercial loans:
Secured by one to four family
residential properties.......... 6,001 189 43 6,233
Secured by multifamily
residential properties.......... -- 707 2,172 2,879
Secured by commercial real
properties...................... 7,686 14,360 4,584 26,629
Other--secured and unsecured..... 9,723 4,873 1,642 16,239
Home equity lines of credit........ 80 465 36 581
Consumer installment and unsecured
loans to individuals.............. 1,883 4,010 651 6,545
------- ------- ------ -------
Total loans.................... $25,373 $28,045 $9,128 $62,547
======= ======= ====== =======
Loans with variable (floating)
interest rates.................... $46,442 $ 22 $ -- $46,464
Loans with predetermined (fixed)
interest rates.................... 6,180 7,891 2,012 16,083
------- ------- ------ -------
Total.......................... $52,622 $ 7,913 $2,012 $62,547
======= ======= ====== =======
</TABLE>
- --------
(1) All loans due on demand, having no stated repayment schedule or maturity,
and overdrafts are reported as due in one year or less.
ASSET QUALITY
The risk of nonpayment of loans is an inherent feature of the banking
business. That risk varies with the type and purpose of the loan, the
collateral which is utilized to secure payment, and ultimately, the
creditworthiness of the borrower. To minimize this credit risk, the Bank
requires that all loans of $100,000 to $750,000 be approved by an officer's
loan committee. Larger loans must be approved by the loan committee of the
Board of Directors.
The Bank has implemented an enhanced process by which it reviews and manages
the credit quality of the loan portfolio. An officers' loan committee has been
established with the Bank's senior officers serving as voting members. The
ongoing credit control process includes a stringent risk rating system,
enhanced underwriting criteria, early identification of problem credits, and
regular monitoring of classified assets graded as "criticized" by the Bank's
internal grading system. The Bank also maintains a program of quarterly review
of loans by an independent outside loan review consultant. Loans are graded
from "pass" to "loss," depending on credit quality. Loans in the "pass"
category are generally performing in accordance with their terms, and are to
companies which have profit records, adequate capital for normal operations
and cash flow sufficient to service the loan. When a loan shows signs of
potential weakness that may affect repayment of the loan or the collateral,
the loan is reclassified "specially mentioned." A loan which has further
deterioration and exhibits defined weaknesses in the borrower's capacity to
repay is reclassified "substandard." When loan repayment is questionable or
not supported by collateral, the loan is labeled "doubtful," reserves are
established to offset the estimated risk and when loans decline further, the
partial or anticipated loss is charged off.
CLASSIFIED ASSETS
Classified assets are assets that have defined weaknesses in the borrower's
ability to repay the loan or in the underlying collateral, and are assigned a
loan grading of "substandard", "doubtful" or "loss" in accordance with the
Bank's grading policy described above. Classified assets include nonperforming
assets.
78
<PAGE>
Asset quality of the Bank improved as evidenced by the decrease in
classified assets from December 31, 1994. The table below summarizes the
Bank's classified assets at the dates indicated:
<TABLE>
<CAPTION>
AT DECEMBER 31,
------------------------
1996 1995 1994
------- ------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Substandard......................................... $ 6,891 $ 7,025 $ 17,796
Doubtful............................................ 852 150 620
------- ------- --------
Classified loans.................................... 7,743 7,175 18,416
OREO................................................ 556 581 1,529
------- ------- --------
TOTAL............................................... $ 8,299 $ 7,756 $ 19,945
======= ======= ========
</TABLE>
Classified loans increased to $7.7 million at December 31, 1996 from $7.2
million at December 31, 1995. Classified loans decreased during the year ended
December 31, 1995 by $11.2 million from $18.4 million at December 31, 1994.
Loans held for sale at December 31, 1994, which were sold in February 1995,
further augmented a reduction in classified loans.
At December 31, 1996, $6.2 million or 75% of classified assets were
represented by loans to three borrowers in excess of $500,000 as follows: i)
two loans totaling $806,000 secured by real estate; ii) a loan of $550,000 to
an individual secured by a single family home; and iii) a loan of $4.9 million
to an individual on a single family home with an appraised value as of
December 1996 of $10.0 million. This $4.9 million loan is currently performing
in accordance with its restructured terms and is carried as a troubled debt
restructuring (TDR) due to its below market interest rate.
NONPERFORMING ASSETS
Nonperforming assets consist of nonperforming loans and OREO. Nonperforming
loans are those loans which have (i) been placed on nonaccrual status, (ii)
been subject to troubled debt restructurings, or (iii) become contractually
past due 90 days or more with respect to principal or interest and have not
been restructured or placed on nonaccrual status.
The following table sets forth information regarding the Bank's
nonperforming assets at the dates indicated:
<TABLE>
<CAPTION>
AT DECEMBER 31,
--------------------------
1996 1995 1994
------- ------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Nonaccrual loans................................ $ 928 $ 573 $ 3,426
Troubled debt restructurings.................... 5,016 5,167 5,582
Loans contractually past due 90 days or more
with respect to either principal or interest
and still accruing interest.................... 300 221 1,507
------- ------- --------
Nonperforming loans........................... 6,244 5,961 10,515
Other real estate owned......................... 556 581 1,529
------- ------- --------
Total nonperforming assets...................... $ 6,800 $ 6,542 $ 12,044
======= ======= ========
Allowance for credit losses to nonaccrual loans. 319.9% 664.0% 89.4%
Allowance for credit losses to nonaccrual
assets(1)...................................... 200.1% 329.7% 61.8%
Allowance for credit losses to nonperforming
loans.......................................... 47.5% 63.8% 29.1%
Allowance for credit losses to nonperforming
assets......................................... 43.7% 58.2% 25.4%
Total nonperforming assets to total assets...... 6.2% 5.0% 5.2%
</TABLE>
- --------
(1) Nonaccrual assets are comprised of nonaccrual loans plus OREO.
79
<PAGE>
NONACCRUAL LOANS
Nonaccrual loans are those for which management has discontinued accrual of
interest because there exists reasonable doubt as to the full and timely
collection of either principal or interest.
When a loan is placed on nonaccrual status, all interest previously accrued
but uncollected is reversed against current period operating results. Income
on such loans is then recognized only to the extent that cash is received and
where the ultimate collection of the carrying amount of the loan is probable,
after giving consideration to the borrower's current financial condition,
historical repayment performance and other factors. Accrual of interest is
resumed only when (i) principal and interest are brought fully current and
(ii) such loans are either considered, in management's judgment, to be fully
collectible or otherwise become well secured and in the process of collection.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations--Net Interest Income" for a discussion of the effects on
operating results of nonperforming loans. At December 31, 1996 a single
nonaccrual loan with an outstanding principal balance of $550,000, or 59.3% of
total nonaccrual loans was secured by residential real estate. Troubled debt
restructured loans are those for which the Company has, for reasons related to
borrowers' financial difficulties, granted concessions to borrowers (including
reductions of either interest or principal) that it would not otherwise
consider, whether or not such loans are secured or guaranteed by others.
Troubled debt restructurings occurring after January 1, 1995 are included in
impaired loans and accounted for as described below.
The FASB issued SFAS No. 114 "Accounting by Creditors for Impairment of a
Loan" which was amended by SFAS No. 118, "Accounting by Creditors for
Impairment of a Loan--Income Recognition and Disclosures", which eliminates
the provisions of SFAS No. 114 regarding how a creditor should report income
on an impaired loan and clarifies certain disclosure requirements. SFAS No.
114 prescribes the recognition criterion for loan impairment and the
measurement methods for certain impaired loans and loans whose terms are
modified in troubled debt restructurings. SFAS No. 114 states that a loan is
impaired when it is probable that a creditor will be unable to collect all
principal and interest amounts due according to the contractual terms of the
loan agreement. A creditor is required to measure impairment by discounting
expected future cash flows at the loan's effective interest rate, by reference
to an observable market price, or by determining the fair value of the
collateral for a collateral dependent asset. Due to the size and nature of the
Bank's loan portfolio, impaired loans are determined by a periodic evaluation
on an individual loan basis. Impaired loans are characterized as loans where
it is probable that the Bank will be unable to collect the principal and
interest amounts due according to their terms.
At December 31, 1996, the Bank had classified $1.6 million of its loans as
impaired under SFAS No. 114, for which the related specific reserves of
$710,000. The average recorded investment in, and the amount of interest
income recognized on impaired loans for the year ended December 31, 1996, were
$7.8 million and $700,000, respectively. Of the loans considered to be
impaired at December 31, 1996, $4.9 million or 68% was represented by one
loan, a troubled debt restructuring.
Foregone interest income attributable to nonperforming loans amounted to
$171,000, $160,000 and $1.2 million for the years ended December 31, 1996,
1995 and 1994. See "Effects of Nonperforming Loans and Net Interest Income."
This resulted in a reduction in yield on average loans receivable of 24 basis
points, 17 basis points and 83 basis points for the years ended December 31,
1996, 1995 and 1994, respectively. Although the Bank sold a large portion of
the nonperforming loans in February 1995, to the extent that additional loans
are identified as nonperforming in future periods, operating results will
continue to be adversely affected.
TROUBLED DEBT RESTRUCTURINGS
Included within nonperforming loans are troubled debt restructurings
("TDR"). TDR is defined in Statements of Financial Accounting Standards No. 15
and No. 114 as a loan for which the Bank has, for economic or legal reasons
related to a borrower's financial difficulties, granted a concession to the
borrower it would not otherwise consider, including modifications of loan
terms to alleviate the burden of the borrower's near-term cash flow
requirements in order to help the borrower to improve its financial condition
and eventual ability to repay the loan. At December 31, 1996, a single TDR
loan represented $4.9 million of the total
80
<PAGE>
$5.0 million of TDRs. This loan is secured by a first deed of trust on
residential real property which, as of December 1996, had an appraised value
of $10.0 million. This loan is currently performing in accordance with its
restructured terms and the property is currently on the market for sale. No
assurance can be given that the property will sell for its appraised value.
OTHER REAL ESTATE OWNED
When appropriate or necessary to protect the Bank's interests, real estate
pledged as collateral on a loan may be acquired by the Bank through
foreclosure or a deed in lieu of foreclosure. Real property acquired in this
manner by the Bank is known as "other real estate owned" ("OREO"). OREO is
carried on the books of the Bank as an asset, at the lesser of the Bank's
recorded investment or the fair value. The Bank periodically revalues OREO
properties and charges other expenses for any further write-downs. OREO
represents an additional category of "nonperforming assets." OREO at December
31, 1996 consisted of two properties totaling $556,000 representing two
undeveloped commercially zoned parcels and one residential parcel. The Bank is
currently marketing the properties for sale. No assurances can be given that
the remaining properties will be sold at 100% of the value at which the
properties were carried by the Bank at December 31, 1996.
LOAN DELINQUENCIES
The following table sets forth the principal balance of loan delinquencies
as of the dates indicated:
<TABLE>
<CAPTION>
AT DECEMBER 31, 1996
--------------------------
30-59 60-89 90 OR
DAYS DAYS MORE DAYS
------ ------ ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Real estate construction and land development....... $ -- $ -- $ --
Commercial loans:
Secured by one to four family residential
properties....................................... 330 -- 550
Secured by multifamily residential properties..... -- -- --
Secured by commercial real properties............. 39 41 257
Other--secured and unsecured...................... 539 224 342
Home equity lines of credit.........................
Consumer installment and unsecured loans to
individuals........................................ 6 4 9
------ ------ --------
Total delinquent loans.............................. $ 914 $ 269 $ 1,158
====== ====== ========
Delinquent loans as a percentage of loans
receivable......................................... 1.5% 0.4% 1.9%
</TABLE>
<TABLE>
<CAPTION>
AT DECEMBER 31, 1995 AT DECEMBER 31, 1994
-------------------------- -------------------------
30-59 60-89 90 OR 30-59 60-89 90 OR
DAYS DAYS MORE DAYS DAYS DAYS MORE DAYS
------ ------ ---------- ------ ------ ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Real estate construction
and land development..... $ -- $ -- $ -- $ 189 $ -- $ --
Commercial loans:
Secured by one to four
family residential
properties............. -- -- 576 336 108 683
Secured by multifamily
residential properties. -- -- -- -- -- 365
Secured by commercial
real properties........ -- 129 -- -- 621 1,340
Other--secured and
unsecured.............. 100 84 22 1,166 1,572 1,965
Home equity lines of
credit................... 74 -- 189 349 38 580
Consumer installment and
unsecured loans to
individuals.............. 43 31 7 437 140 --
------ ------ ------ ------ ------ ------
Total delinquent loans.... $ 217 $ 244 $ 794 $2,477 $2,479 $4,933
====== ====== ====== ====== ====== ======
Delinquent loans as a
percentage of loans
receivable............... 0.3% 0.3% 1.0% 2.0% 2.0% 4.0%
</TABLE>
81
<PAGE>
ALLOWANCE FOR CREDIT LOSSES
The Bank maintains an allowance for credit losses to provide for potential
losses in the loan portfolio. Additions to the allowance are made by charges
to operating expenses in the form of a provision for credit losses. All loans
which are judged to be uncollectible are charged against the allowance while
recoveries are credited to the allowance. The Bank has a process by which it
reviews and manages the credit quality of the loan portfolio. The ongoing
credit control process includes a stringent risk rating system, enhanced
underwriting criteria, early identification of problem credits, regular
monitoring of any classified assets graded as "criticized" by the Bank's
internal grading system and an independent outside loan review process. The
loan approval process is also tied to the risk rating system. The Classified
Asset Committee ("CAC") meets on a monthly basis to review, monitor and take
corrective action upon all criticized assets and review the adequacy of the
allowance for credit losses. The results of the CAC's meetings are reviewed by
the officers and directors loan committees monthly.
The calculation of the adequacy of the allowance for credit losses is based
on a variety of factors, including loan classifications and underlying cash
flow and collateral values. On a quarterly basis, management engages an
outside loan review firm to augment the preparation of the analysis of the
allowance for credit losses which utilizes both a migration factor and
specific loss reserves to determine the level necessary to allow for potential
credit losses. Migration analysis is a method by which specific charge-offs
are related to the prior life of the same loan compared to the total loan
pools in which the loan was graded. This method allows for management to use
historical trends that are relative to the Bank's portfolio rather than use
outside factors that may not take into consideration trends relative to the
specific loan portfolio. In addition, this analysis takes into consideration
other trends that are qualitative relative to the Bank's marketplace,
demographic trends, amount and trends in nonperforming assets and
concentration factors.
The Board of Directors reviews the adequacy of the allowance for credit
losses on a quarterly basis. Management utilizes its judgement in conjunction
with the analysis prepared by the outside loan review firm to determine the
provision for credit losses and establish the allowance for credit losses. In
addition, regulatory agencies, as an integral part of their examination
process, periodically review the Bank's allowance for credit losses. Such
agencies may require the Bank to recognize additions to the allowance based
upon their judgement of the information available to them at the time of their
examination. Following the OCC's March 1996 examination of the Bank, the OCC
accepted the Bank's allowance for credit losses.
82
<PAGE>
ANALYSIS OF CHANGES IN THE ALLOWANCE FOR CREDIT LOSSES
The following table sets forth information regarding the activity in the
Bank's accounting for credit losses for the periods indicated:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
--------------------------
1996 1995 1994
------- ------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Balance at beginning of period..................... $ 3,805 $ 3,063 $ 6,697
Loans charged-off:
Real estate construction and land development...... -- -- 45
Commercial loans:
Secured by one to four family residential
properties...................................... 9 120 2,215
Secured by multifamily residential properties.... -- -- 702
Secured by commercial real properties............ -- -- 1,407
Other -- secured and unsecured................... 1,183 1,913 6,781
Home equity lines of credit........................ -- -- 257
Consumer installment and unsecured loans to
individuals....................................... 108 599 2,810
------- ------- --------
Total loan charge-offs......................... 1,300 2,632 14,217
Recoveries of loans previously charged-off:
Real estate construction and land development...... -- 200 --
Commercial loans:
Secured by one to four family residential
properties...................................... 26 11 288
Other -- secured and unsecured................... 398 588 2,205
Home equity lines of credit........................ -- -- 38
Consumer installment and unsecured loans to
individuals....................................... 40 268 722
------- ------- --------
Total recoveries of loans previously charged-
off........................................... 464 1,067 3,253
Net loan charge-offs............................... 836 1,565 10,964
Provision for credit losses........................ -- 2,307 7,330
------- ------- --------
Balance at end of period........................... $ 2,969 $ 3,805 $ 3,063
======= ======= ========
Allowance for credit losses as a percent of annual
net loan
charge-offs during the period..................... 228.38% 243.13% 27.94%
Provision for credit losses as a percent of net
loan
charge-offs during the period..................... -- 147.41% 66.86%
Net loan charge-offs as a percent of average loans
receivable
during the period................................. 1.19% 1.63% 7.83%
Recoveries of loans previously charged-off as a
percent of loans
charged-off in the previous year.................. 17.6% 7.50% 133.60%
</TABLE>
LOAN CHARGE-OFFS AND RECOVERIES
Management regularly monitors the loan portfolio in order to promptly
identify loans that may become nonperforming and conducts an ongoing
evaluation of the Bank's exposure to potential losses arising from such loans,
as discussed above. Loan losses are fully or partially charged against the
allowance for credit losses when, in management's judgment, the full
collectibility of a loan's principal is in doubt. However, there is no precise
method of predicting specific losses which ultimately may be charged against
the allowance in future periods.
Loan charge-offs for the year ended December 31, 1996 were $1.3 million,
primarily related to two loans in the commercial--other secured and unsecured
portfolio pertaining to the international division and purchased lease
financing contracts.
Loan charge-offs for the year ended December 31, 1995 of $2.6 million
included $1.7 million for loans purchased in 1993 from the FDIC ("FDIC Loans")
and $700,000 for loans generated by the international division. This decrease
from 1994 was predominantly the consequence of declining loan balances from
the sale of loans.
83
<PAGE>
Charge-offs for the year ended December 31, 1994 of $14.2 million were
primarily the result of charge-offs totaling $6.0 million of allocated
allowance for credit losses related to the portfolio of loans sold in February
1995. In addition, upon the determination that these loans were to be sold,
the Bank recorded a lower of cost or market adjustment of $851,000 during 1994
to adjust the carrying value of the loans to their estimated ultimate sales
price. These loans had an outstanding principal balance of $13.5 million and
were identified as criticized and/or nonperforming. In addition, charge-offs
related to the FDIC Loans which were not subsequently sold totaled
$3.3 million. Charge-offs during 1994 affecting the Bank's commercial--other
secured and unsecured loan portfolio of $6.8 million were comprised of $4.0
million of loans sold in February 1995, $1.7 million of business banking and
entertainment related lending and $1.1 million of FDIC Loans. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Provision for Credit Losses."
Recoveries of loans previously charged-off amounted to $464,000 for the year
ended December 31, 1996 and were primarily the result of recoveries related to
the FDIC Loans and to business banking and entertainment related lending. The
majority of these loans were grouped in the commercial--other secured and
unsecured category.
Recoveries of loans previously charged-off for the year ended December 31,
1995 of $1.1 million included $700,000 of business banking and entertainment
related lending and $150,000 of FDIC Loans. Recoveries pertaining to the
commercial--other secured and unsecured loan portfolio included $400,000 of
business banking and entertainment related lending and $100,000 of FDIC Loans.
Recoveries of loans previously charged-off for the year ended December 31,
1994 of $3.3 million included $750,000 representing the proceeds of loans sold
which were previously charged-off, $1.2 million of entertainment related
loans, $900,000 of business banking and consumer loans and $350,000 of FDIC
Loans. Recoveries during 1994 pertaining to the commercial--other secured and
unsecured portfolio included $1.1 million of business banking and
entertainment related loans and $600,000 of loans sold in 1994 previously
charged-off.
ALLOCATION OF ALLOWANCE FOR CREDIT LOSSES
Management believes based on its periodic analysis that the allowance for
credit losses at December 31, 1996 was adequate to absorb estimated losses in
the existing portfolio, including commitments under commercial and standby
letters of credit. However, no assurance can be given on how continued
weaknesses in the real estate market or future changes in economic conditions
might affect the Bank's principal market area and may result in increased
losses in the Bank's loan portfolio.
The allocation of the allowance for credit losses to specific loan
categories presented below should not be interpreted as an indication that
loan charge-offs will occur in these amounts or proportions, or as an
indication of future charge-off trends. In addition, the portion of the
allowance allocated to each loan category does not represent the total amount
available for future losses that may occur within such categories, since the
total allowance is applicable to the entire portfolio. Consistent with the
Bank's recent charge-off experience, it is anticipated that the major
component of future charge-offs will be attributed to the commercial--other
secured and unsecured loan portfolio. However, no assurance can be made that
actual charge-offs will occur consistent with historical trends or in
accordance with the allocation of allowance for credit losses presented below.
84
<PAGE>
The Bank's current practice is to make specific allocations of the allowance
for credit losses to criticized and classified loans, and unspecified
allocations to each loan category based on management's risk assessment. The
following table presents the composition of the Bank's allocation of the
allowance for credit losses to specific loan categories designated by
management for this purpose for the periods indicated:
<TABLE>
<CAPTION>
AT DECEMBER 31,
-------------------------
1996 1995 1994
------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Real estate construction and land development....... $ 42 $ 11 $ 17
Commercial loans:
Secured by one to four family residential
properties....................................... 479 205 77
Secured by multifamily residential properties..... 41 25 51
Secured by commercial real properties............. 590 454 674
Other--secured and unsecured...................... 1,642 2,521 1,645
Home equity lines of credit......................... 13 64 18
Consumer installment and unsecured loans to
individuals........................................ 161 523 578
------- ------- -------
Allowance allocable to loans receivable............. 2,968 3,803 3,060
Commitments to extend credit under standby and
commercial letters of credit....................... 1 2 3
------- ------- -------
Total allowance for credit losses............... $ 2,969 $ 3,805 $ 3,063
======= ======= =======
Allowance for credit losses allocable as a percent
of loans receivable................................ 4.75% 4.64% 2.66%
</TABLE>
INDUSTRY CONCENTRATIONS OF LOANS AND OTHER RISK ELEMENTS
The following table presents information about the Company's loans
outstanding to entertainment-related customers at the dates indicated:
<TABLE>
<CAPTION>
AT DECEMBER 31,
--------------------------
1996 1995 1994
------- ------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Entertainment industry-related loans(1):
Loans for single productions of motion picture
and television feature films................. $ -- $ 1,739 $ 5,662
Other loans to entertainment-related
enterprises, such as television and film
production or distribution................... 1,158 3,020 4,814
Loans to individuals involved primarily in the
entertainment industry....................... 2,516 1,663 5,633
Loans to business management, legal and
accounting firms, including their principals
and employees, serving primarily the
entertainment industry....................... 2,791 2,930 5,048
------- ------- --------
Total entertainment industry-related
loans(2)................................... $ 6,465 $ 9,352 $ 21,157
======= ======= ========
Percent of loans receivable................. 10.3% 11.4% 18.4%
</TABLE>
- --------
(1) Included are loans secured by liens on residential and commercial real
property amounting to $3.0 million, $1.2 million and $1.3 million at
December 31, 1996, 1995 and 1994, respectively.
(2) Includes nonperforming loans of $400,000 at December 31, 1995.
In addition to the Bank's concentration in loans secured by real estate, the
Bank is a provider of banking services to the entertainment industry in
Southern California. Management believes that the varying nature of customers
represented by the composition of loans within this group indicates reasonable
diversification. In addition, loans for the production of independently
produced motion picture and television feature films are supported, during
production, by performance bonds from highly rated insurers and either
distribution commitments from major studios or, in the case of smaller
studios, standby letters of credit from large commercial banks. Management
therefore believes that this concentration does not represent an undue
concentration of credit risk.
85
<PAGE>
INVESTMENT PORTFOLIO
In order to maintain a reserve of readily saleable assets to meet the Bank's
liquidity and loan requirements, the Bank purchases United States government
and agency securities and other investments. In addition, sales of "Federal
funds" (short-term loans to other banks) are regularly utilized. Placement of
funds in certificates of deposit with other financial institutions may be made
as alternative investments pending utilization of funds for loans or other
purposes.
Securities may be pledged to meet security requirements imposed as
collateral for retail (customer) repurchase agreements, FRB discount lines and
other deposits. At December 31, 1996, the carrying values of securities
pledged were $4.0 million.
At December 31, 1996, the Bank's investment portfolio consisted of U.S.
government and agency securities, mortgage-backed securities including CMOs,
and municipal securities. The Bank's policy is to stagger the maturities of
its investments to meet overall liquidity requirements of the Bank. The Bank's
current policy is to invest only in securities with maturities of generally
less than ten years.
ESTIMATED FAIR VALUE OF INVESTMENT SECURITIES
AND DEBT SECURITIES
The following tables summarize the amounts and distribution of the Bank's
investment securities as of the dates indicated and the weighted average yield
as of December 31, 1996.
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------------------------
1996 1995 1994
------------------------ --------------- ---------------
WEIGHTED
BOOK MARKET AVERAGE BOOK MARKET BOOK MARKET
VALUE VALUE YIELD VALUE VALUE VALUE VALUE
------- ------- -------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Securities held-to-
maturity:
U.S. government and
agency securities:
One to five years...... $14,395 $14,355 6.67% -- -- -- --
======= ======= ==== ======= ======= ======= =======
Securities available-
for-sale:
U.S. government and
agency securities:
Within one year........ $ -- $ -- -- $ 4,013 $ 4,009 $12,000 $11,949
One to five years...... 1,000 1,004 6.05% 6,798 6,749 9,043 8,480
Over five years........ -- -- -- -- -- 11,151 10,586
------- ------- ---- ------- ------- ------- -------
Total U.S. government
and agency
securities........... $ 1,000 $ 1,004 6.05% $10,811 $10,758 $32,194 $31,015
------- ------- ---- ------- ------- ------- -------
Mortgage-backed
securities:
Within one year........ -- -- -- -- -- -- --
One to five years...... -- -- -- -- -- -- --
Over five years........ 3,079 2,999 5.73% 6,002 5,971 7,362 7,109
------- ------- ---- ------- ------- ------- -------
Total mortgage-backed
securities........... 3,079 2,999 5.73% 6,002 5,971 7,362 7,109
------- ------- ---- ------- ------- ------- -------
CMO and REMICS:
Within one year........ -- -- -- -- -- -- --
One to five years...... -- -- -- -- -- 2,042 1,952
Over five years........ -- -- -- 3,443 3,373 22,843 21,188
------- ------- ---- ------- ------- ------- -------
Total CMO and Remics.. -- -- -- 3,443 3,373 24,885 23,140
------- ------- ---- ------- ------- ------- -------
FRB stock:
Over five years........ 233 233 6.00% 315 315 573 573
Municipal securities:
Over five years........ -- -- -- -- -- 99 84
Interest rate swap..... -- -- -- -- -- -- 135
------- ------- ---- ------- ------- ------- -------
$ 4,312 $ 4,236 5.82% $20,571 $20,417 $65,113 $62,056
======= ======= ==== ======= ======= ======= =======
</TABLE>
86
<PAGE>
Actual maturities may differ from contractual maturities to the extent that
borrowers have the right to call or repay obligations with or without call or
repayment penalties. As of December, 1996, the only securities held by the
Bank where the aggregate book value of the Bank's investment in securities of
a single issuer exceeded ten percent (10%) of the Bank's shareholders' equity
were issued by U.S. government agencies.
DEPOSITS
Deposits are the Bank's primary source of funds. During the year ended
December, 1996, the Bank had an average deposit mix of 39% in time deposits,
26% in interest-bearing demand, money market and savings deposits and 35% in
noninterest-bearing demand deposits. The Bank's net interest income is
enhanced by its percentage of noninterest-bearing deposits.
The Bank's deposits are obtained from a cross section of the communities it
serves. No material portion of the Bank's deposits has been obtained from or
is dependent upon any one person or industry. The Bank's business is not
seasonal in nature. The Bank accepts deposits in excess of $100,000 from
customers. Those deposits are priced to remain competitive. The Bank is not
dependent upon funds from sources outside the United States.
The following table summarizes the distribution of average deposits for the
periods indicated:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------------
1996 1995 1994
-------------- -------------- --------------
AVERAGE % OF AVERAGE % OF AVERAGE % OF
BALANCE TOTAL BALANCE TOTAL BALANCE TOTAL
-------- ----- -------- ----- -------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Noninterest-bearing demand
deposits:
Real estate title and escrow
company customers........... $ 9,280 9% $ 10,932 8% $ 18,949 9%
All other noninterest-bearing
demand...................... 27,238 26% 41,313 31% 58,496 28%
Interest-bearing demand, money
market and savings............ 27,470 26% 36,342 27% 49,345 23%
Time certificates of deposit:
Money desk operation......... 27,014 26% 33,806 25% 74,657 35%
All other:
$100,000 or more........... 5,302 5% 6,506 5% 6,141 3%
Under $100,000............. 7,814 8% 5,318 4% 5,167 2%
-------- --- -------- --- -------- ---
Total time certificates of
deposit................... 40,130 39% 45,630 34% 85,965 40%
-------- --- -------- --- -------- ---
Total deposits............. $104,118 100% $134,217 100% $212,755 100%
======== === ======== === ======== ===
</TABLE>
As indicated above, the Bank experienced a 22.4% decline in average total
deposits for the year ended December 31, 1996 from average total deposits
during the year ended December 31, 1995 and a 37% decline during the year
ended December 31, 1995 from the same period in 1994. The decline in deposits
occurred throughout all the deposit categories as the mix of deposits for the
years ended December 31, 1996 and 1995, did not significantly change from the
year ended December 31, 1994 except for the decrease in money desk operations,
which was consistent with management's restructuring plan.
The Bank's wholesale institutional funds acquisition operation ("money
desk") was established in June 1990. The money desk solicits time certificates
of deposit from institutional investors nationwide, including other banks,
savings and loans, credit unions, trust companies, and pension funds beyond
the Bank's primary market area. Although management believed that deposits
gathered through the money desk are less costly and provide
87
<PAGE>
greater capacity for overall deposit growth than brokered deposits, the rates
paid on certificates of deposits gathered through this vehicle are higher than
those offered in the local market. At December 31, 1996, money desk deposits
totaled $27.3 million or 26.3% of total deposits. This represents a 15.5% and
54.3% decrease, respectively, from levels at December 31, 1995 and 1994 of
$32.3 million and $59.8 million, respectively.
The Bank's customers are principally commercial in nature and attracted
primarily on the basis of personal relationships and service quality. A
portion of those customers maintain deposit accounts having balances
significantly in excess of current federal deposit insurance limits. At
December 31, 1996, 1995 and 1994, 41.7%, 45.1% and 40.9%, respectively, of
total deposits, excluding time certificates of deposit attributable to the
money desk, were held in accounts with balances of $100,000 or more.
While time certificates of deposit in the aggregate do not exhibit the daily
volatility that characterizes commercial customers' noninterest-bearing demand
deposits, the stability of time certificates of deposit is dependent, in
significant part, on such depositors' perceptions of the Bank's financial
strength. Management believes that the Bank's ability to compete for potential
customers' deposits has been hampered to some extent by concerns arising from
the Bank's reported net losses.
TIME DEPOSITS OF $100,000 OR MORE
The following table indicates the maturity schedule of the Bank's
certificates of deposit of $100,000 or more as of the dates indicated:
<TABLE>
<CAPTION>
AT DECEMBER 31, 1996
-----------------------
MONEY ALL
DESK OTHER TOTAL
------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Aggregate maturities of time certificates of deposit
In three months or less.............................. $ 206 $ 5,390 $ 5,596
After three months but within six months........... 300 667 967
After six months but within twelve months.......... 1,335 803 2,138
After twelve months................................ 513 -- 513
------- ------- -------
Total time certificates of deposit of $100,000 or
more............................................ $ 2,354 $ 6,860 $ 9,214
======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
AT DECEMBER 31, 1995 AT DECEMBER 31, 1994
-------------------- ---------------------
MONEY ALL MONEY ALL
DESK OTHER TOTAL DESK OTHER TOTAL
------ ------ ------ ------ ------ -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Aggregate maturities of time
certificates of deposit
In three months or less......... $ 400 $4,196 $4,596 $1,300 $4,358 $ 5,658
After three months but within
six months..................... 300 958 1,258 400 1,902 2,302
After six months but within
twelve months.................. 1,392 900 2,292 2,231 1,770 4,001
After twelve months............. 405 0 405 -- 300 300
------ ------ ------ ------ ------ -------
Total time certificates of
deposit of $100,000 or more.. $2,497 $6,054 $8,551 $3,931 $8,330 $12,261
====== ====== ====== ====== ====== =======
</TABLE>
As indicated in the table above, time certificates of deposit of $100,000 or
more from money desk operations represented a less significant source of
funding at December 31, 1996 than at December 31, 1995. In general, deposits
of more than $100,000 are considered to be more volatile than fully insured
deposits in denominations of less than $100,000. At December 31, 1996, 22.7%
of total time certificates of deposit were represented by accounts
individually in excess of $100,000 as compared to 18.2% and 16.1% at December
31, 1995 and 1994.
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REPURCHASE AGREEMENTS
The Bank has borrowed funds from investment banking firms (dealers) and
customers pursuant to sales of securities under repurchase agreements. Those
repurchase agreements provide for the Bank's sale of investment securities to
dealers or customers with simultaneous agreement to repurchase identical
securities on specified dates at specified prices. The initial price paid to
the Bank under such wholesale (dealer) and retail (customer) repurchase
agreements is less than the fair market value of the investment securities
sold, and the Bank may be required to pledge or deliver additional securities
if the fair market value of the investment securities sold declines below the
price initially paid to the Bank for those securities. Borrowings under
repurchase agreements are collateralized by U.S. Treasury or government agency
securities and mortgage pass-through certificates guaranteed or issued by the
Government National Mortgage Corporation, Federal National Mortgage
Association, and Federal Home Loan Mortgage Corporation.
The Bank's borrowings under wholesale (dealer) repurchase agreements have
not represented a significant source of liquidity. However, there remain
market and credit risks associated with repurchase agreements. In the event of
sudden short-term market interest rate increases, the costs of this funding
source could increase concurrent with a decline in the fair value of the
underlying investment securities. As a result, the Bank would be required to
deliver additional securities, thereby reducing the amount of investment
securities otherwise available for collateralized borrowings.
Wholesale (dealer) repurchase agreements involve credit risk to the extent
that the fair value of underlying investment securities exceeds the amount
advanced to the Bank under the related repurchase agreement. Securities
subject to such repurchase agreements are held in the name of the Bank by the
dealers who arrange the transactions. In the event the dealer defaults and the
Bank is unable to obtain the collateralizing investment securities, the Bank's
risk of loss is the amount of any such excess fair market value. The Bank's
wholesale (dealer) repurchase agreements are primarily overnight transactions.
As a result, management believes that the credit risks associated with this
funding source are limited.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
The following table summarizes securities under agreements to repurchase
along with weighted average interest rate, maturity and average and maximum
balance outstanding for the periods indicated:
<TABLE>
<CAPTION>
AT OR FOR THE YEAR ENDED
DECEMBER 31,
--------------------------
1996 1995 1994
-------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Balance......................................... $ -- $ 4,497 $ 12,572
Weighted average interest rate.................. -- % 2.18% 2.47%
Weighted average maturity (days)................ -- 7 5
Average balance for the period.................. $ 1,140 $ 4,093 $ 10,685
Weighted average interest rate for the period... 2.20% 2.61% 2.96%
Maximum balance outstanding at any month-end
during the period.............................. $ 1,546 $ 7,031 $ 15,127
</TABLE>
OFF-BALANCE-SHEET CREDIT COMMITMENTS AND CONTINGENT OBLIGATIONS
The Bank is a party to financial instruments with off-balance-sheet credit
risk in the normal course of business to meet the financing needs of its
customers. In addition to undisbursed commitments to extend credit under loan
facilities, these instruments include conditional obligations under standby
and commercial letters of credit. The Bank's exposure to credit loss in the
event of nonperformance by customers is represented by the contractual amount
of the instruments.
Standby letters of credit are conditional commitments issued by the Bank to
secure the financial performance of a customer to a third party and are
primarily issued to support private borrowing arrangements.
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<PAGE>
The credit risk involved in issuing letters of credit is essentially the same
as that involved in extending loan facilities to customers. The Bank uses the
same credit underwriting policies in accepting such contingent obligations as
it does for loan facilities. When deemed necessary, the Bank holds appropriate
collateral supporting those commitments. The nature of collateral obtained
varies and may include deposits held in financial institutions and real
properties.
Management does not anticipate any material losses as a result of
commitments under letters of credit. A portion of the allowance for credit
losses has been allocated to these contingent obligations. Losses, if any, are
charged against the allowance for credit losses. At December 31, 1996 and
1995, standby letters of credit amounted to $175,000 and $413,000,
respectively, and there were no commercial letters of credit outstanding.
Undisbursed commitments under revocable and irrevocable loan facilities
amounted to $7.9 million and $11.6 million at December 31, 1996 and 1995,
respectively. Many of these commitments are expected to expire without being
drawn upon and, as such, the total commitment amounts do not necessarily
represent future cash requirements.
EMPLOYEES
As of December 31, 1996, the Company had 5 officers but no employees while
the Bank had 44 full-time equivalent employees including 3 of the Company's
officers. The Company and the Bank believe that the Bank's employee relations
are satisfactory.
PROPERTIES
The Bank leases space in an office building at 1840 Century Park East, Los
Angeles, California. As of December 31, 1995, the Bank entered into the Lease
Restructuring Agreement with its landlord which restructured the Bank's future
obligations under its then existing leases. As a result, the Bank reduced its
leased space from approximately 42,400 square feet to 23,883 square feet and
decreased the effective rent per square foot from approximately $4.00 to $2.33
or $55,666 per month for the period November 1, 1995 to October 31, 2000. The
effective rent per square foot for the period November 1, 2000 to October 31,
2004 will be $2.83 per square foot or $67,607 per month. The Lease
Restructuring Agreement provides that the lease obligation will expire on
October 31, 2004. The rent is subject to annual adjustments for increases in
property taxes and operating costs.
In connection with the Bank's execution of the Lease Restructuring
Agreement, the Company issued to its landlord the Warrant. See "Risk Factors--
Requirement of Shareholder Approval of Reverse Stock Split." In addition, the
Company granted the landlord certain registration rights with respect to
shares of capital stock subject to the Warrant. See "Description of Capital
Stock--Registration Rights."
The Company does not directly own or lease any property. Its administrative
offices are located at the Bank's headquarters at 1840 Century Park East, Los
Angeles, California 90067.
LEGAL PROCEEDINGS
The Company is a party to routine litigation involving various aspects of
its business. As of the date of this Prospectus, except as described below,
none of the pending litigation, in the opinion of management, will have a
material adverse impact on the consolidated financial condition of the
Company.
Derivative and Class Action
On or about October 7, 1992, an action (the "Class Action") was commenced by
two of the Company's shareholders, Messrs. Berlin and Zlotnick, in the United
States District Court for the Eastern District of Pennsylvania and later
transferred to the United States District Court of California (the "Court"),
against the Company and the following former and current directors, officers
or employees of the Company: Messrs. Ladd, Thornburg, Hughes, Tomich, Bell,
Guldeman, Smith, Brewer, Wolfen, Winner, Thomson, Hickey, Grahm, and Domyan
and Ms. Romero and Ms. Thornton.
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<PAGE>
The complaint was a derivative and class action case, which purported to
assert various violations of the Securities Exchange Act of 1934 and state
common law claims for violation of the directors' alleged duty of candor,
common law negligent misrepresentation and breach of fiduciary duty, and waste
of corporate assets, on behalf of the Company and a class of purchasers of the
Company's stock during the period October 7, 1989 through July 12, 1994 and
persons who owned shares of the Company on the record dates and who were
eligible to vote at the 1990, 1991 and 1992 Annual Meetings of Shareholders of
the Company. The plaintiffs sought declaratory and injunctive relief,
consequential and punitive damages in an unspecified amount and attorneys'
fees.
On December 22, 1994, a stipulation of settlement (the "Stipulation") was
entered by the Court. According to the Stipulation, all claims in the action
were settled, discharged and dismissed with prejudice. The monetary portion of
the settlement (approximately $1.6 million) was funded solely by the Company's
insurer. None of the defendants were required to pay any portion of the
settlement. In addition, the Company was required to issue 169,800 warrants to
the class of plaintiffs to purchase shares of Common Stock of the Company. The
exercise price of the warrants is $3.55 ($32.27 giving effect to the Reverse
Stock Split). The warrants are exercisable during a three-year period which
commenced June 2, 1996. Also, pursuant to the Court's order, in the two-year
period after the approval of the proposed settlement, which approval was
obtained in June 1996, plaintiffs will have the right to two new directors on
the Company's board of directors. One new member was scheduled to be chosen
during the first year after the effective date of the settlement, June 2, 1995
(the "Effective Date"). A second new member would be chosen during the second
year after the Effective Date. Both of the new directors would be independent
of the present or former directors of the Company. Robert E. Gipson, a Company
candidate, was approved by the plaintiff's counsel. The Company plans to
continue to seek (and will consider candidates suggested by plaintiff's
counsel) qualified candidates to serve as directors of the Company. Upon the
approval of one more candidate by the plaintiff's counsel, the Company's
obligation under the Stipulation to add two (2) new members to the Board of
Directors will be satisfied.
Other Litigation
In February 1995, counterclaims were filed against the Bank in an action
commenced by British & Commonwealth Merchant Bank ("BCMB"), as agent for
itself and the Bank, in England against Lloyd's Underwriters and certain other
parties (collectively, "Lloyd's"). The Bank and BCMB claimed that Lloyd's owed
them a further $120,659 of insurance proceeds relating to a claim filed by
BCMB (for itself and the Bank) for approximately $7.8 million under policies
insuring repayment of a loan from the Bank and BCMB to Performance Guarantees,
Inc. for production of a film entitled "Barr Sinister." On or about November
1991, Lloyd's paid approximately $7.8 million in insurance proceeds, which
Lloyd's sought to recover a half each from the Bank and BCMB. In its
counterclaim, Lloyd's contended that the Leading Underwriter lacked authority
to issue the insurance policies and endorsements on behalf of all of the
insurers under which payment was made and secondly, that material
misrepresentations were made to the Leading Underwriter as to the likely
budget for the film and that if the Leading Underwriter had known the true
position he would not have accepted the film under the relevant policies.
Lloyd's position, therefore, was that such payment should be returned to
Lloyd's.
The Bank reached an agreement with Lloyd's for the settlement of the Bank's
claim against Lloyd's and Lloyd's counterclaims against the Bank. The Bank
entered into the settlement not as a result of the Bank's conclusions as to
the merits of Lloyd's counterclaims against the Bank, but solely as a matter
of resolving those counterclaims in connection with the Bank's effort to
recapitalize.
The settlement was originally conditioned on the recapitalization of the
Bank on or before March 31, 1997, and, in light of that condition, "tolling"
agreements were entered into with various third parties to preserve the Bank's
ability to institute, if necessary, further proceedings against those third
parties for potential losses that may have arisen from the continuation of
Lloyd's counterclaims, if the settlement had not been concluded. The
settlement agreement originally provided that the Bank would pay $500,000 to
Lloyd's on the earlier of the seventh day following the completion of the
Bank's recapitalization or on March 31, 1997 and an additional $500,000 on the
second anniversary of that payment. The agreement also provided that BCMB will
release the Bank from any claim that BCMB might have against the bank should
BCMB suffer loss in connection with Lloyd's counterclaims against BCMB in the
continuing litigation. Prior to December 31, 1996, the Company and all
affected parties agreed to a single payment of the settlement on a discounted
lump sum basis, which payment was made, concluding and completing the
settlement.
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<PAGE>
REGULATION
SUPERVISION AND REGULATION
The Company
The Company, as a registered bank holding company, is subject to regulation
under the BHC Act, and as such, is required to file with the Reserve Bank
quarterly and annual reports and such additional information as the Reserve
Bank may require pursuant to the BHC Act. The Reserve Bank may conduct
examinations of the Company and its subsidiaries. As a result of such an
examination of the Company by the Reserve Bank in 1995, the Company entered
into the MOU with the Reserve Bank on October 26, 1995. The MOU imposes
certain affirmative obligations and material restrictions on the Company which
will most likely impede asset growth and preclude dividend payments in the
foreseeable future. As a result of its examination by the Reserve Bank, the
Company is required to have new appointments of senior executive officers and
directors reviewed by the Reserve Bank prior to their appointment to such a
position. See "The Company--Regulatory Agreements."
The Reserve Bank may require that the Company terminate an activity or
control of or liquidate or divest certain nonbank subsidiaries or affiliates
when the Reserve Bank believes the activity or the control of the subsidiary
or affiliate constitutes a serious risk to the financial safety, soundness or
stability of any of its banking subsidiaries and is inconsistent with sound
banking principles or the purposes of the BHC Act or the Financial
Institutions Supervisory Act of 1966, as amended. The Reserve Bank 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 Reserve Bank prior to purchasing or redeeming its
equity securities.
Under the BHC Act 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 "Regulation--Supervision and Regulation--Capital Standards."
The Company is required to obtain the prior approval of the Reserve Bank for
the acquisition of more than five percent (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 Reserve Bank is also required
for the merger or consolidation of the Company with another bank holding
company.
The Company is prohibited by the BHC Act, except in certain statutorily
prescribed instances, from acquiring direct or indirect ownership or control
of more than five percent (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 may,
subject to the prior approval of the Reserve Bank, engage in any, or acquire
shares of companies engaged in, activities that are deemed by the Reserve Bank
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 Reserve Bank
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 Reserve Bank 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, 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
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<PAGE>
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 "Business--Supervision
and Regulation--Prompt Corrective Action and Other Enforcement Mechanisms."
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 BHC Act, the decision, which is not binding on federal
courts outside the Fifth Circuit, was 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.
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.
Finally, the Company's shares of Common Stock are registered pursuant to the
Exchange Act. Accordingly, the Company is subject to certain rules and
regulations promulgated by the Commission, including, among other things, the
periodic reporting requirements, the proxy solicitations rules and the short-
swing profit rules under Sections 13, 14 and 16 of the Exchange Act,
respectively.
The Bank
The Bank, as a national banking association, is subject to primary
supervision, periodic examination and regulation by the OCC. If, as a result
of an examination of a bank, the OCC 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 OCC. 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, and to remove officers and directors. The FDIC has similar
enforcement authority, in addition to its authority to terminate the Bank's
deposit insurance, in the absence of action by the OCC and upon a finding that
a bank is in an unsafe or unsound condition, is engaging in unsafe or unsound
activities, or that its conduct poses a risk to the deposit insurance fund or
may prejudice the interest of its depositors. The Bank entered into a Formal
Agreement with the OCC dated December 14, 1995, which imposes certain
affirmative obligations and material restrictions on the Bank. See
"Management's Discussion and Analysis Of Financial Condition and Results Of
Operations--Capital Resources" and "The Company--Regulatory Agreements."
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 "Premiums for Deposit Insurance." The Bank is also
subject to certain regulations of the Federal Reserve Board and applicable
provisions of California law, insofar as they do not conflict with or are not
preempted by federal banking law.
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<PAGE>
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 and disclosure
obligations to depositors and borrowers.
Capital Standards
The Federal Reserve Board, the OCC 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.
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 include 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, the Federal Reserve Board and the
OCC require banking organizations to maintain a minimum amount of Tier 1
capital to total assets. 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 is 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
ratio 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.
Under the "prompt corrective action" regulations (discussed below)
implemented pursuant to the Federal Deposit Insurance Corporation Improvement
Act of 1991 ("FDICIA"), the Bank will be considered "adequately capitalized"
if it has a ratio of qualifying total capital to risk-weighted assets of 8%,
Tier 1 capital to risk-weighted assets of 4% and a leverage ratio of 4% or
greater. To be considered "well capitalized" the Company and the Bank must
have a ratio of qualifying total capital to risk-weighted assets of 10%, Tier
1 capital to risk-weighted assets of 6% and a leverage ratio of 5% or greater
as well as not be subject to any order or directive. Under certain
circumstances, the Reserve Bank or the OCC may require an "adequately
capitalized" institution to comply with certain mandatory or discretionary
supervisory actions as if the Company or the Bank were undercapitalized. See
"Regulation--Effects of Governmental Policies and Recent Legislation--Federal
Deposit Insurance Corporation Improvement Act of 1991--Prompt Corrective Act."
Although the Company and the Bank are each considered to be adequately
capitalized, in accordance with the Formal Agreement, the Bank must maintain a
Tier 1 risk-based capital ratio of at least 10% and a leverage capital ratio
of at least 6.5%. At December 31, 1996, the Bank's Tier 1 risk-based capital
ratio was 6.95% and the leverage capital ratio was 4.67%, both of which were
not in compliance with the Formal Agreement. A capital plan was filed with the
OCC on February 8, 1996.
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<PAGE>
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 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, 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, or (ii) ten percent (10%) of Tier 1 capital.
The amount of any deferred tax in excess of this limit would be excluded from
Tier 1 capital and total assets and regulatory capital calculations.
Future changes in regulations or practices could further reduce the amount
of capital recognized for purposes of capital adequacy. Such a change could
affect the ability of the Bank to grow and could restrict the amount of
profits, if any, available for the payment of dividends.
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 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.
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In connection with its assessment of CRA performance, the OCC assigns a
rating of "outstanding," "satisfactory," "needs to improve," or "substantial
noncompliance." Based on an examination conducted during the third quarter of
1996, the Bank was rated "satisfactory."
Potential and Existing Enforcement Actions
Commercial banking organizations, such as the Bank, and their institution-
affiliated parties, such as the Company, are subject to potential enforcement
actions by the Reserve Bank, the FDIC and the OCC for any 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 FDICIA. 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.
Restrictions on Transfers of Funds to the Company by the Bank
The Company is a legal entity separate and distinct from the Bank. At
present, substantially all of the Company's revenues, including funds
available for the payments of dividends and other operating expenses, depend
upon and will continue to depend upon, the receipt of dividends paid by the
Bank. The Company's ability to pay cash dividends is limited by state law.
There are statutory and regulatory limitations on the amount of dividends
which may be paid to the Company by the Bank. The prior approval of the OCC is
required if the total of all dividends declared by a national bank in any
calendar year exceeds the bank's net profits for that year combined with its
retained net profits for the preceding two years, less any transfers to
surplus or a fund for the retirement of any preferred stock. At December 31,
1996, the Bank did not have funds available for the payment of cash dividends.
At present, substantially all of the Company's revenues, including funds
available for the payment of dividends and other operating expenses, is, and
will continue to be, primarily dividends paid by the Bank. In addition, under
the 1995 Formal Agreement, the Bank is prohibited from paying cash dividends
without the prior approval of the OCC.
The OCC also has authority to prohibit the Bank from engaging in what, in
the OCC's opinion, constitutes an unsafe or unsound practice in conducting its
business. Depending upon the financial condition of the bank in question and
other factors, it is possible that the OCC could assert that the payment of
dividends or other payments is an unsafe or unsound practice under the
circumstances. Further, the OCC 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 could limit the amount of dividends
which the Bank or the Company may pay. See "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.
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
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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 "Supervision and
Regulation--Prompt Corrective Regulatory Action and Other Enforcement
Mechanisms."
Compliance with Environmental Regulation
Management of the Company and its subsidiaries is unaware of any material
effect upon the Company's and the Company's subsidiaries' capital
expenditures, earnings or competitive position as a result of compliance with
federal, state and local provisions which have been enacted or adopted
regulating the discharge of materials into the environment or otherwise
relating to the protection of the environment. Based on current federal, state
and local environmental laws and regulations, the Company does not intend to
make any material capital expenditures for environmental control facilities
for either the remainder of its current fiscal year or its succeeding fiscal
year.
EFFECT OF GOVERNMENTAL POLICIES AND RECENT LEGISLATION
Government Fiscal and Monetary Policies
Banking is a business which depends in large part 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
comprise a major portion of the Company's earnings. These rates are highly
sensitive to many factors that are beyond the control of 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 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
institutions. Proposals to change the laws and regulations governing the
operations and taxation of banks, bank holding companies and other financial
institutions are frequently made in Congress, in the California legislature
and before various bank regulatory and other professional agencies. The
likelihood of any major changes and the impact such changes might have on the
Company are impossible to predict. Certain of the potentially significant
changes which have been enacted, and proposals which have been made recently,
are discussed below. Recent and proposed accounting changes are discussed in
"Business--Recent Accounting Developments."
The following discussion of statutes and regulations is only a summary and
does not purport to be complete. This discussion is qualified in its entirety
by reference to such statutes and regulations. No assurance can be given that
such statutes or regulations will not change in the future.
Federal Deposit Insurance Corporation Improvement Act of 1991
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
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<PAGE>
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:
"Well capitalized" "Adequately capitalized"
---------------- ----------------------
Total risk-based capital of 10%; Total risk-based capital of 8%;
Tier 1 risk-based capital of 6%; Tier 1 risk-based capital of 4%;
and Leverage ratio of 5%. and 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%; Tier 1 risk-based capital less than 3%;
or Leverage ratio less than 4%. or Leverage ratio less than 3%
"Critically undercapitalized"
---------------------------
Tangible equity to total assets
less than 2%.
As of December 31, 1996, the Company and Bank were deemed to be adequately
capitalized based upon their capital ratios, however, the Bank was not in
compliance with the Tier 1 risk-based capital ratio and the leverage capital
ratio requirements of the Formal Agreement. See "The Company--Regulatory
Agreements."
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.
Federal 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 under Section 38 of the FDICIA (12
U.S.C. (S) 1831o); 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
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undercapitalized institutions if it determines that such action will further
the purpose of the prompt corrective 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 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 "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 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
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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 BIF. To determine the risk-based assessment
for each institution, the FDIC will categorize an institution as well
capitalized, adequately capitalized or undercapitalized based on its capital
ratios 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.
On September 30, 1996, Congress passed the Budget Act which capitalized the
Savings Association Insurance Fund (SAIF) through a special assessment on
SAIF-insured deposits and required banks to 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, 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%).
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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 to be
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 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.
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SHAREHOLDINGS OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information as of the date of this
Prospectus (pre Reverse Stock Split) regarding the beneficial ownership of the
Company's Common Stock by each person known to the Company to be the
beneficial owner of more than five percent (5%) of the outstanding Common
Stock of the Company and by each person who is currently serving as a director
or executive officer of the Company and by all directors and executive
officers of the Company as a group.
<TABLE>
<CAPTION>
NUMBER OF SHARES
BENEFICIALLY PERCENT
BENEFICIAL OWNER OWNED(1) OF CLASS(1)
---------------- ---------------- -----------
<S> <C> <C>
9830 Investments No. 1, Ltd, a California
limited partnership........................... 287,615 9.3%
Robert E. Gipson............................... 1,000 *
Alan Grahm..................................... 80,993 2.6%
A. Thomas Hickey (2)........................... 13,000 *
Howard P. Ladd................................. 57,827 1.9%
Scott A. Montgomery (3)........................ 4,000 *
Robert E. Thompson............................. 625 *
Joseph W. Kiley III............................ 0 *
All directors and executive officers as a group
(8 persons)................................... 157,445(4) 5.1%
</TABLE>
- --------
* Less than 1%
(1) Under the rules of the SEC, shares not actually outstanding are deemed to
be beneficially owned by an individual if such individual has the right to
acquire the shares within 60 days. Pursuant to such SEC Rules, shares
deemed beneficially owned by virtue of an individual's right to acquire
them are also treated as outstanding when calculating the percent of the
class owned by such individual and when determining the percent owned by
any group in which the individual is included.
(2) Includes 12,000 shares (pre Reverse Stock Split) which may be purchased by
Mr. Hickey upon exercise of a currently exercisable option.
(3) Excludes 200,000 shares (pre Reverse Stock Split) which may be purchased
by Mr. Montgomery upon exercise of an option which becomes exercisable on
June 20, 1997.
(4) Includes 12,000 shares (pre Reverse Stock Split) which may be purchased
upon exercise of currently exercisable options or upon exercise of options
that will become exercisable within 60 days.
The Conrad Company has agreed, subject to certain conditions, to purchase a
minimum of $2.25 million, and a maximum of $4.95 million, of Preferred Stock.
Assuming those conditions are satisfied and $9.0 million of Preferred Stock is
sold in the Public Offering and the Private Offering, if the Conrad Company
purchases 2,045,455 shares (or 225,000 shares after the Reverse Stock Split),
the minimum amount of Preferred Stock it has agreed to purchase, it would own
25% of the outstanding Preferred Stock (or 18.2% of Common Stock on an as
converted basis) and if the Conrad Company purchases 4,500,000 shares (or
495,000 shares after the Reverse Stock Split), the maximum amount of Preferred
Stock it has agreed to purchase, it would own 55% of the outstanding Preferred
Stock (or 40.0% of the Common Stock on an as converted basis).
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DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth certain information as of the date of this
Prospectus regarding the directors and executive officers of the Company and
the Bank.
<TABLE>
<CAPTION>
NAME AGE POSITION WITH THE COMPANY AND THE BANK
---- --- --------------------------------------
<S> <C> <C>
Robert E. Gipson.... 50 Director
Alan Grahm.......... 74 Director
A. Thomas Hickey.... 56 Director and Secretary
Joseph W. Kiley III. 41 Director, Executive Vice President and Chief Financial Officer
Howard P. Ladd...... 76 Chairman of the Board of Directors; President and Chief
Executive Officer of the Company
Scott A. Montgomery. 55 Director of the Company and the Bank; Executive Vice
President and Chief Administrative Officer of the Company
and President and Chief Executive Officer of the Bank
Robert E. Thomson... 55 Vice Chair of the Board of Directors
Carol A. Ward....... 42 Executive Vice President and Administrator of Operations
of the Bank
</TABLE>
ROBERT E. GIPSON is Principal of the law firm of Gipson Hoffman & Pancione,
A.P.C. and has served in that capacity for more than five years. He has also
been President of Corporate Management Group, Inc., a financial management
company, since 1988. Mr. Gipson was elected a director of the Company and the
Bank by the Board of Directors in October of 1996. Mr. Gipson is a trustee of
Meyers Sheppard Investment Trust.
ALAN GRAHM has served as Chairman of the Board of Trade Zone Connection
(formerly Associated Sales), an import company, for more than five years. He
has also been the owner of Bonny Doon Vineyards since 1981. Mr. Grahm has been
a director of the Company since 1983 and a director of the Bank since 1982.
A. THOMAS HICKEY has been President and Chief Executive Officer of Tea
Garden Products, Inc., a manufacturer and distributor of consumer products,
from 1992 to 1995 and from June 1996 to the present. From November 1995 until
June 1996 Mr. Hickey was a private investor. Mr. Hickey was also Vice Chairman
of Continental Airlines from 1990 to 1992. Mr. Hickey has been a director of
the Company and the Bank since 1991.
JOSEPH W. KILEY III has served as Executive Vice President and Chief
Financial Officer of the Company and the Bank since August 1996. Prior
thereto, from July 1992 to August 1996, he was Executive Vice President and
Chief Financial Officer of Hancock Savings Bank, FSB, in Los Angeles. From
June 1990 to June 1992 Mr. Kiley served as Executive Vice President--
Operations and Chief Financial Officer of Compensation Resource Group, Inc., a
benefits consulting company, in Pasadena, California. Mr. Kiley has been a
director of the Company and the Bank since April 1996.
HOWARD P. LADD serves as Chairman of the Board of Directors of the Company
and the Bank. He has been a director of the Company since 1983 and of the Bank
since 1982. He has also served as President and Chief Executive Officer of the
Company since August 1995. Mr. Ladd was Chairman of the Board of Concord
Technology Development ("Concord Technology"), an information systems company,
from 1991 to 1995. Prior to forming Concord Technology (formerly Concord Media
Systems) in 1991, Mr. Ladd was Chairman of Ladd Electronics since 1989.
SCOTT A. MONTGOMERY has served as President and Chief Executive Officer of
the Bank since November 1995 and as Executive Vice President and Chief
Administrative Officer of the Company since June 1996. Prior thereto, from
September 1990 to September 1994, he was President and Chief Operating Officer
of Cupertino National Bank, Cupertino, California. From September 1994 until
November 1995, Mr. Montgomery was a consultant for various banks. Mr.
Montgomery has also been Vice Chairman of the Board of Tracy Federal Bank
F.S.B., Tracy, California since March 1995. Mr. Montgomery has been a director
of the Company and the Bank since 1995.
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ROBERT E. THOMSON is serving as of Counsel at Jekel & Howard since August
1996. Mr. Thomson was an Executive Consultant from November 1995 until August
1996. He has been an Executive Consultant to Sterling Forest Corporation
("Sterling"), a real estate development company, since August 1994, and served
as Chairman of the Board and Chief Executive Officer of Sterling from January
1989 to August 1994. Mr. Thomson has served as a director of the Company since
1983 and of the Bank since 1982 and has served as Vice Chairman of the Company
and the Bank since June 1991. He also served as Interim Chief Executive
Officer of the Bank from June to October, 1991 and as Interim President and
Chief Executive Officer of the Bank from August to November 1995.
CAROL WARD has served as Executive Vice President and Administrator of
Operations of the Bank since July 1996. Prior thereto, from January 1996 to
July 1996, she served as a consultant to financial institutions. From November
1993 to January 1996, Ms. Ward served as Vice President and General Auditor,
and as Executive Vice President and Chief Operating Officer of Ventura County
National Bancorp in Oxnard, California. From March 1990 to November 1993 she
was Vice President and Director of Risk Management and Senior Vice President
and General Auditor at Community Bank in Pasadena, California.
DESCRIPTION OF CAPITAL STOCK
The Company's Articles of Incorporation, as amended, authorize the issuance
of 10,000,000 shares of no par value Common Stock and 1,000,000 shares of
preferred stock. As of the date of this Prospectus, there were 3,078,146
shares of the Common Stock and no shares of preferred stock issued and
outstanding. At the Annual Meeting of the Company scheduled to occur on June
18, 1997, the shareholders of the Company are being asked to approve the
Restatement to reduce the number of outstanding shares of Common Stock and to
effectuate an 9.09 to 1 reverse stock split. The Restatement will also reflect
the terms of the Preferred Stock to be issued in the Public Offering and the
Private Offering and, if approved, will reflect the reduction in the number of
outstanding shares of Common Stock. Consummation of the Public Offering and
the Private Offering is conditioned upon approval of the Restatement by the
shareholders of the Company.
COMMON STOCK
Holders of Common Stock are entitled to cast one vote for each share held of
record and to cumulate votes for the election of directors, subject to the
preferential rights of any outstanding class of Preferred Stock, to receive
such dividends as may be declared by the Board of Directors out of legally
available funds and to share ratably in any distribution of the Company's
assets after payment of all debts and other liabilities, upon liquidation,
dissolution or winding up of the Company. Common shareholders do not have
preemptive rights or other rights to subscribe for additional shares, and the
Common Stock is not subject to conversion or redemption. The outstanding
shares of Common Stock are, and the shares of Common Stock into which shares
of Preferred Stock to be issued in the Public Offering and the Private
Offering may be converted, will be, upon delivery and payment therefor in
accordance with the terms of the Public Offering and the Private Offering,
fully paid and nonassessable.
PREFERRED STOCK
Under the Company's Articles of Incorporation, the Board of Directors of the
Company has the authority to establish for the 1,000,000 authorized shares of
preferred stock (i) voting rights, if any; (ii) the rate of dividend, the
priority of payment thereof, and the right to cumulation thereof, if any;
(iii) redemption terms and conditions; and (iv) the right of conversion, if
any. No shares of preferred stock are currently outstanding.
The Preferred Stock, upon issuance in the Public Offering and the Private
Offering against full payment of the purchase price therefor, will be fully
paid and nonassessable, and will have the terms as described below. The rights
of holders of shares of Preferred Stock will be subordinate to the rights of
general creditors and there is no sinking fund with respect to the Preferred
Stock nor any other obligation of the Company to redeem or retire the
Preferred Stock. Unless redeemed by the Company or converted, the Preferred
Stock will be perpetual. The Private Purchasers and Standby Purchasers have
certain additional rights with respect to their shares of Preferred Stock. See
"The Private Offering."
104
<PAGE>
Dividends
The terms of the Preferred Stock provide that dividends may be paid
commencing two years after the Date of Issuance. Holders of shares of
Preferred Stock will be entitled to receive, if, when and as declared by the
Board of Directors of the Company out of assets of the Company legally
available for payment, non-cumulative cash dividends, payable quarterly on the
day of January, April, July, and October in each year, with respect to the
three months then ending, at the rate of 6.5% per share per annum, before any
distribution by way of dividend or otherwise shall be declared or paid upon,
or set apart for, the shares of Common Stock or any other class of shares of
the Company ranking junior to the Preferred Stock with respect to the payment
of dividends or upon liquidation, dissolution or winding up of the Company
("Junior Stock"). Each such dividend will be payable to holders of record as
they appear on the books of the Company on or about the fifteenth day of the
month preceding the payment dates thereof, as shall be fixed by the Board of
Directors of the Company. The amount of dividends payable for each quarterly
dividend period shall be computed by dividing by four the dividend due on the
basis of the 6.5% annual rate. Dividends payable on the Preferred Stock for
any period shorter than a full three months shall be computed on the basis of
30-day month and a 360-day year. Notwithstanding the foregoing, the Company
may not pay dividends following such date unless the Bank is in full
compliance with federal regulatory capital requirements, the Company and the
Bank are permitted to pay dividends by their regulators and the Company meets
the Retained Earnings Test. The ability of the Company to pay dividends on the
Preferred Stock will depend on the Company's ability to obtain funds for such
purpose from the Bank. The Company has no funds otherwise available for the
payment of dividends. Both the Bank's ability to pay dividends to the Company
and the Company's ability to pay dividends on the Preferred Stock are subject
to significant regulatory restrictions. The Company cannot assess at this time
its ability to pay dividends in the immediate future. See "Risk Factors--
Restrictions on Preferred Stock Dividends" and "The Company--Regulatory
Agreements." Dividends on the Preferred Stock will not accumulate.
No dividend (other than dividends or distributions paid in shares of, or
options, warrants or rights to subscribe for or purchase shares of, such class
or series of stock ranking on parity with the Preferred Stock as to dividends)
may be paid upon, or declared or set apart for, any class or series of stock
ranking on a parity with the Preferred Stock as to dividends, for any dividend
period, prior to two years after the Date of Issuance, and thereafter, unless
there shall be or have been declared on the Preferred Stock dividends for the
then current quarterly period coinciding with or ending before such quarterly
period, ratably in proportion to the respective annual dividend rates fixed
therefor. Except with respect to the foregoing, for a period of two years
after the Date of Issuance and thereafter, whenever full quarterly dividends
are in arrears for the Preferred Stock for a current dividend period, the
Company may not declare or pay or set aside for payment dividends or make any
other distributions (other than dividends or distributions paid in shares of,
or options, warrants or rights to subscribe for or purchase shares of Junior
Stock or Parity Stock (as defined below)) (i) on any Junior Stock or (ii) on
any shares of stock ranking on a parity (whether as to dividends or upon
liquidation, dissolution or winding up) with the Preferred Stock ("Parity
Stock"). In addition, the Company may not redeem or purchase or otherwise
acquire for consideration shares of any Junior Stock or Parity Stock unless in
exchange for shares of Junior Stock or Parity Stock. Dividends on the
Preferred Stock are not cumulative.
Liquidation Rights
The Preferred Stock will be entitled to, prior to any distribution to
holders of the Company's other capital stock, $10.00 per share upon any
liquidation, dissolution or winding up of the Company, plus an amount equal to
any declared but unpaid dividends (the "Liquidation Amount"). In the event of
either an involuntary or a voluntary liquidation or dissolution of the Company
payment shall be made to the holders of shares of Preferred Stock in an amount
equal to the Liquidation Amount before any payment shall be made or any assets
distributed to the holders of the Common Stock or any other class or series of
capital stock of the Company ranking junior to the Preferred Stock with
respect to payment upon dissolution or liquidation of the Company. If upon any
liquidation or dissolution of the Company the assets available for
distribution shall be insufficient to pay the holders of all outstanding
shares of Preferred Stock and any other class or series of capital stock
ranking on a parity with the Preferred Stock as to payments upon dissolution
or liquidation of the Company the full amounts to which they respectively
shall be entitled, then such assets or the proceeds thereof shall be
distributed among such holders ratably in accordance with the respective
amounts which would be payable on such shares if all
105
<PAGE>
amounts payable thereon were paid in full. After the payment of such amounts,
the Preferred Stock will not be entitled to any further payment. The
liquidation rights of the Preferred Stock will be subordinate to all
indebtedness of the Company.
At any time, in the event of the merger or consolidation of the Company into
or with another company or the merger or consolidation of any other company
into or with the Company or a plan of exchange between the Company and any
other company (in which consolidation or merger or plan of exchange any
shareholders of the Company receive distributions of cash or securities or
other property) or the sale, transfer or other disposition of all or
substantially all of the assets of the Company, then, such transaction shall
be deemed, solely for purposes of determining the amounts to be received by
the holders of the Preferred Stock in such merger, consolidation, plan of
exchange, sale, transfer or other disposition, and for purposes of determining
the priority of receipt of such amounts as between the holders of the
Preferred Stock and the holders of other classes or series of capital stock,
to be a liquidation or dissolution of the Company.
Conversion
Each share of the Preferred Stock will be immediately convertible at the
option of the holder thereof at the initial rate of one share of Common Stock
for each share of Preferred Stock based on an initial conversion price of
$10.00 per share which shall be subject to adjustment for any stock dividend
or stock split or other recapitalization involving the Common Stock or the
consolidation or merger of the Company or the sale of all or substantially all
of the Company's assets. No adjustment or allowance will be made for dividends
on shares of Preferred Stock surrendered for conversion whether declared or
otherwise. To exercise the conversion privilege with respect to any shares of
Preferred Stock, the holder thereof shall surrender the certificate or
certificates therefor to the transfer agent of the Company for the Preferred
Stock, duly endorsed to the Company in blank for transfer, accompanied by
written notice of election to convert such shares of Preferred Stock or a
portion thereof executed on the form set forth on such certificates or on such
other form as may be provided from time to time by the Company. As soon as
practicable after the surrender of such certificates, the Company shall cause
to be issued and delivered to or on the order of the holder of the
certificates thus surrendered, a certificate or certificates for the number of
full shares of Common Stock issuable upon the conversion of such shares. No
fractional shares of Common Stock shall be issued upon conversion, but,
instead of any fraction of a share which would otherwise be issuable, the
Company shall pay a cash adjustment in respect of such fraction in an amount
equal to the same fraction of the market price (as defined in the Restatement)
per share of Common Stock as of the close of business on the day of
conversion. Such conversion shall be deemed to have been effected on the date
on which the certificates for such shares of Preferred Stock have been
surrendered as provided above, and the person in whose name any certificate or
certificates for shares of Common Stock are issuable upon such conversion
shall be deemed to have become on such date the holder of record of the shares
represented thereby.
In the event the Company shall (i) declare a dividend upon the Common Stock
payable in Common Stock (other than a dividend declared to effect a
subdivision of the outstanding shares of Common Stock) or Convertible
Securities, or in any rights or options to purchase Common Stock or
Convertible Securities, or (ii) declare any other dividend or make any other
distribution upon the Common Stock payable otherwise than out of earnings or
earned surplus, then thereafter each holder of shares of Preferred Stock upon
the conversion thereof will be entitled to receive the number of shares of
Common Stock into which such shares of Preferred Stock have been converted,
and, in addition and without payment therefor, each dividend described in
clause (i) above and each dividend or distribution described in clause (ii)
above which such holder would have received by way of dividends or
distributions if continuously since such holder became the record holder of
such shares of Preferred Stock such holder (i) had been the record holder of
the number of shares of Common Stock then received, and (ii) had retained all
dividends or distributions in stock or securities (including Common Stock or
Convertible Securities, and any rights or options to purchase any Common Stock
or Convertible Securities) payable in respect of such Common Stock or in
respect to any stock or securities paid as dividends or distributions and
originating directly or indirectly from such Common Stock. For the purposes of
the foregoing, a dividend or distribution other than in cash shall be
considered payable out of earnings or earned surplus only to the extent that
such earnings or earned surplus are charged an amount equal to the fair value
of such dividend or distribution as determined by the Board of Directors of
the Company.
106
<PAGE>
Voting Rights
The Preferred Stock will vote together with the Common Stock on all matters
submitted to a vote of the holders of the Common Stock, with voting power
equal to the number of shares of Common Stock into which the Preferred Stock
is then convertible. In addition, the Preferred Stock will have the right to
vote as a separate class with respect to (a) the authorization of any
additional shares of Preferred Stock or the authorization or issuance of any
class or series of the Company's capital stock which would rank senior to or
on a parity with the Preferred Stock as to distribution of (i) assets upon the
liquidation or dissolution, voluntary or involuntary, of the Company or
(ii) dividends, (b) any other action to amend, alter or repeal any provisions
of the Restatement so as to adversely affect the rights, preferences and
privileges of the Preferred Stock or the holders thereof or waive any of the
rights granted to the holders of the Preferred Stock, (c) any action to amend,
alter or repeal any of the provisions of the Restatement, or the bylaws, of
the Company with respect to the election of directors by cumulative voting or
(d) the issuance of any authorized shares of Preferred Stock except in
connection with the Public Offering and the Private Offering or the Warrant.
Except as required by law, the Preferred Stock will not have special voting
rights in the event of a default on the payment of dividends.
Preemptive Rights
Rights Holders and the Standby Purchasers who receive shares of Preferred
Stock in the Public Offering shall not have any preemptive right to acquire
any unissued shares of any stock of the Company, now or hereafter authorized,
or any other securities of the Company, whether or not convertible into shares
of stock of the Company or carrying a right to subscribe to or acquire any
such shares of stock. Pursuant to the terms of the Private Offering, the
Private Purchasers shall have a right of first refusal, under certain
circumstances, to acquire additional shares of capital stock of the Company
upon the same terms and conditions pursuant to which the Company may propose
to offer shares of its capital stock for sale in the future. See "The Private
Offering--Certain Covenants--Right of First Refusal."
Redemption at Option of the Company
The Preferred Stock will be redeemable by the Company, in whole or in part,
at the option of the Company at any time after three years from the Date of
Issuance (the "Beginning Redemption Date"), to the extent the Company has
funds legally available therefor and upon approval of the Board of Governors
of the Federal Reserve System, at a redemption price per share in cash equal
to 105% of the original purchase price of $10.00 per share, plus declared but
unpaid dividends. The applicable percentage of the original purchase price
will decline by one percentage point every anniversary of the Beginning
Redemption Date thereafter until five years after the Beginning Redemption
Date, and thereafter the Preferred Stock may be redeemed at 100% of the
original purchase price per share, plus declared but unpaid dividends. If less
than all of the outstanding shares of Preferred Stock are to be redeemed, the
Company will select the shares to be redeemed by lot, pro rata (as nearly may
be), or in such other equitable manner as the Board of Directors of the
Company may determine.
In no event shall the Company redeem less than all the outstanding shares of
the Preferred Stock, unless dividends for the then current dividend period
(without accumulation of any accrued and unpaid dividends for prior dividend
periods unless previously declared and without interest) to the date fixed for
redemption shall have been declared and paid or set apart for payment on all
outstanding shares of Preferred Stock; provided, however, that the foregoing
shall not prevent, if otherwise permitted, the purchase or acquisition by the
Company of shares of Preferred Stock pursuant to a tender or exchange offer
made on the same terms to holders of all the outstanding shares of Preferred
Stock and mailed to the holders of record of all such outstanding shares at
such holders' addresses as the same appear on the books of the Company; and
provided further that if some, but less than all, of the shares of Preferred
Stock are to be purchased or otherwise acquired pursuant to such a tender or
exchange offer and the number of such shares so tendered exceeds the number of
shares so to be purchased or otherwise acquired by the Company, the shares of
Preferred Stock so tendered shall be purchased or otherwise acquired by the
Company on a pro rata basis (with adjustments to eliminate fractions)
according to the number of such shares duly tendered by each holder so
tendering shares of Preferred Stock for such purchase or
107
<PAGE>
exchange. If less than all of the outstanding shares of Preferred Stock are to
be redeemed, the Company will select the shares to be redeemed by lot, pro
rata (as nearly may be), or in such other equitable manner as the Board of
Directors of the Company may determine.
Notice of such redemption shall be given by first-class mail, postage paid,
mailed not less than 15 nor more than 60 days prior to the Redemption Date, to
each record holder of the shares to be redeemed, at such holder's address as
the same appears on the books of the Company. Each such notice shall state:
(i) the date as of which the redemption shall occur; (ii) the total number of
shares of Preferred Stock to be redeemed and, if fewer than all the shares
held by such holder are to be redeemed, the number of such shares to be
redeemed from such holder; (iii) the Redemption Price; (iv) that the shares of
Preferred Stock called for redemption may be converted at any time prior to
the date fixed for redemption; (v) the applicable conversion price or rate;
(vi) the place or places where certificates for such shares are to be
surrendered for payment of the Redemption Price; and (vii) that dividends on
the shares to be redeemed will cease to accrue on such Redemption Date.
There is no sinking fund requirement for redemption of the Preferred Stock.
U.S. Stock Transfer Corporation, Glendale, California is the transfer agent
and registrar for the Common Stock.
REGISTRATION RIGHTS
Landlord Rights. In connection with the Bank's execution of the Lease
Restructuring Agreement, the Company issued to the Bank's landlord (the
"Landlord") a warrant to purchase up to 9.9% of the value of the outstanding
shares of Company capital stock (the "Warrant") and granted to the Landlord
certain registration rights with respect to shares of capital stock subject to
the Warrant (the "Warrant Shares"). Until the earlier of December 31, 1997 or
the occurrence of a recapitalization which results in a change in the
Company's ability to use its federal and state NOLs of approximately $22.3
million and $11.8 million, respectively (an "Ownership Change"), the holders
of the Warrant Shares may require the Company to use its best efforts to
effect one registration of the Warrant Shares under the Securities Act. The
Company is required to pay the expenses of such registration. In the
alternative, the Company may elect to purchase the number of Warrant Shares
for which registration has been demanded. In addition, until such time as the
Company shall have filed a "shelf" registration statement with respect to the
Warrant Shares (as described below), the holder of the Warrant Shares is
entitled to an unlimited number of demands for registration provided that it
shall pay the registration expenses.
After the earlier of an Ownership Change or January 1, 1998, the holder of
the Warrant Shares is entitled to request that the Company use its best
efforts to file a registration statement within ninety (90) days pursuant to
Rule 415 under the Securities Act (a "Shelf Registration Statement") and to
keep such registration statement continuously effective until all the Warrant
Shares included therein have been sold.
In the event that the Company proposes to register any of its securities
under the Securities Act prior to the time the Company shall have filed the
Shelf Registration Statement, the holder of the Warrant Shares is entitled to
include the Warrant Shares in such registration, subject to certain
limitations.
Class Action Plaintiff Rights. In connection with the Class Action, the
Company issued 169,800 warrants (the "Class Action Warrants") to the
plaintiffs to purchase shares of Common Stock of the Company. The exercise
price of the Class Action Warrant is $3.55 ($32.27 giving effect to the
Reverse Stock Split). The Company must file a registration statement under the
Securities Act before such holders may exercise such Class Action Warrants.
REGISTRATION RIGHTS OF THE CONRAD COMPANY AND WILDWOOD ENTERPRISES
Pursuant to the terms of the Registration Rights Agreement between the
Conrad Company and the Company, the Conrad Company is entitled to two requests
that the Company register, and the Company is
108
<PAGE>
obligated to file registration statements under the Securities Act covering,
shares of Common Stock owned by Conrad Company at the time of the request (the
"Registrable Securities"). Conrad Company also has the right to request that
the Company include the Registrable Securities in any registration statement
proposed to be filed by the Company for its own account and/or upon the
request or for the account of any securityholder, subject to certain
limitations with respect to the number of Registrable Securities that may be
included. Pursuant to a Registration Rights Agreement between Wildwood
Enterprises and the Company, Wildwood Enterprises has the right to request
that the Company include the securities of the Company held by Wildwood
Enterprises in any registration statement proposed to be filed by the Company
upon the request or for the account of any securityholder, subject to certain
limitations with respect to the number of securities that may be included. The
Company does not believe that costs incurred in connection with such
registration will be material.
LEGAL MATTERS
The validity of the securities offered hereby will be passed upon for the
Company by Manatt, Phelps & Phillips, LLP, Los Angeles, California. Muldoon,
Murphy & Faucette, Washington, D.C. is acting as counsel for Sandler O'Neill
in connection with certain legal matters related to the securities offered
hereby.
EXPERTS
The consolidated financial statements incorporated in this prospectus by
reference from the Company's Annual Report on Form 10-K as of December 31,
1996 and for each of the three years in the period ended December 31, 1996
have been audited by Deloitte & Touche LLP, independent auditors, as stated in
their report (which expresses an unqualified opinion and includes an
explanatory paragraph relating to the Company's ability to continue as a going
concern), which is incorporated by reference herein, and have been so
incorporated in reliance upon the report of such firm given upon their
authority as experts in accounting and auditing.
109
<PAGE>
INDEX TO
CONSOLIDATED FINANCIAL STATEMENTS
NATIONAL MERCANTILE BANCORP
CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Auditors............................................ F-1
Consolidated Balance Sheets as of December 31, 1996 and December 31, 1995. F-2
Consolidated Statements of Operations for the years ended December 31,
1996, December 31, 1995 and December 31, 1994............................ F-3
Consolidated Statements of Changes in Shareholders' Equity for the years
ended December 31, 1996, December 31, 1995 and December 31, 1994......... F-4
Consolidated Statements of Cash Flows for the years ended December 31,
1996, December 31, 1995 and December 31, 1994............................ F-5
Notes to Consolidated Financial Statements................................ F-6
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors
National Mercantile Bancorp
Los Angeles, California
We have audited the accompanying consolidated balance sheets of National
Mercantile Bancorp and subsidiary (the "Company") as of December 31, 1996 and
1995 and the related consolidated statements of operations, changes in
shareholders' equity and cash flows for each of the years in the three-year
period ended December 31, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits 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 misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of National Mercantile Bancorp
and subsidiary as of December 31, 1996 and 1995 and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 1996, in conformity with generally accepted accounting
principles.
The accompanying 1996 consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in
Note 2 to the consolidated financial statements, the Company and its wholly
owned subsidiary, Mercantile National Bank (the "Bank"), are operating under
regulatory agreements with the Federal Reserve Bank of San Francisco and the
Office of the Comptroller of the Currency ("OCC"), respectively, that require
them to meet prescribed requirements. At December 31, 1996, the Bank did not
meet the leverage and tier-one risk-based capital requirements under the
regulatory agreements. If the Company or the Bank are unable to comply with
the terms of the agreements, they may be subject to further regulatory
enforcement actions. These matters raise substantial doubt about the Company's
ability to continue as a going concern. Management's plans concerning these
matters are also described in Note 2. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
[LOGO OF DELOITTE & TOUCHE LLP]
Los Angeles, California
March 7, 1997
F-2
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1995
<TABLE>
<CAPTION>
1996 1995
-------- --------
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
ASSETS
Cash and due from banks-demand............................. $ 5,113 $ 9,272
Federal funds sold and securities purchased under
agreements to resell...................................... 23,000 21,000
-------- --------
Cash and cash equivalents................................. 28,113 30,272
Securities available-for-sale, at fair value; aggregate
amortized cost of $4,078 and $20,256 at December 31, 1996
and 1995, respectively.................................... 4,002 20,102
Securities held-to-maturity, at amortized cost; aggregate
market value of $14,355 at December 31, 1996.............. 14,395 --
Federal Reserve Bank stock................................. 233 315
Loans receivable........................................... 62,547 82,012
Allowance for credit losses............................... (2,969) (3,805)
-------- --------
Net loans receivable..................................... 59,578 78,207
Premises and equipment, net................................ 943 1,126
Other real estate owned.................................... 556 581
Accrued interest receivable and other assets............... 1,596 1,389
-------- --------
Total Assets........................................... $109,416 $131,992
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing demand............................... $ 34,752 $ 44,579
Interest-bearing demand.................................. 7,292 7,737
Money market accounts.................................... 15,512 18,901
Savings.................................................. 5,650 1,927
Time certificates of deposit:
$100,000 and over...................................... 9,214 8,551
Under $100,000......................................... 31,434 38,548
-------- --------
Total deposits......................................... 103,854 120,243
Securities sold under agreements to repurchase............. -- 4,497
Accrued interest payable and other liabilities............. 717 1,241
-------- --------
Total liabilities...................................... 104,571 125,981
-------- --------
Shareholders' equity:
Preferred stock, no par value; authorized 1,000,000
shares.................................................. -- --
Common stock, no par value; authorized 10,000,000
shares; issued and outstanding 3,078,146 at December 31,
1996 and 1995........................................... 24,614 24,614
Accumulated deficit...................................... (19,693) (18,449)
Net unrealized loss on securities available-for-sale..... (76) (154)
-------- --------
Total shareholders' equity............................. 4,845 6,011
-------- --------
Total Liabilities and Shareholders' Equity............. $109,416 $131,992
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
1996 1995 1994
------- ------- -------
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Interest income:
Loans, including fees............................. $ 6,743 $ 9,299 $16,149
Securities held-to-maturity....................... 62 -- 610
Securities available-for-sale..................... 928 1,395 3,675
Trading securities................................ -- -- 130
Federal funds sold and securities purchased under
agreements to resell............................. 1,024 933 333
Interest-bearing deposits with other financial
institutions..................................... -- 7 3
------- ------- -------
Total interest income......................... 8,757 11,634 20,900
Interest expense:
Interest-bearing demand........................... 76 137 144
Money market and savings.......................... 634 1,002 1,274
Time certificates of deposit:
$100,000 and over............................... 419 542 471
Under $100,000.................................. 1,925 2,188 3,309
------- ------- -------
Total interest expense on deposits............ 3,054 3,869 5,198
Federal funds purchased and securities sold under
agreements to repurchase......................... 25 110 328
------- ------- -------
Total interest expense........................ 3,079 3,979 5,526
------- ------- -------
Net interest income.......................... 5,678 7,655 15,374
Provision for credit losses......................... -- 2,307 7,330
------- ------- -------
Net interest income after provision for credit
losses........................................... 5,678 5,348 8,044
Other operating income (losses):
Net loss on sale of trading securities............ -- -- (112)
Net loss on sale of securities available-for-sale. (3) (1,233) (1,327)
Loss on termination of interest-rate swap......... -- (1,294) --
International services............................ 124 224 435
Investment services............................... 73 254 283
Deposit-related and other customer services....... 308 737 696
Other income-shareholders' insurance claims....... -- 730 --
Loss on other real estate owned................... -- (733) (894)
Loss on sale of other assets...................... -- -- (1,087)
Lower-of-cost-or-market adjustment on loans held
for sale......................................... -- -- (851)
------- ------- -------
Total other operating income (losses)......... 502 (1,315) (2,857)
Other operating expenses:
Salaries and related benefits..................... 2,718 3,878 5,088
Severance costs................................... -- 141 333
Net occupancy..................................... 793 1,468 1,832
Furniture and equipment........................... 298 385 539
Printing and communications....................... 211 270 420
Insurance and regulatory assessments.............. 629 971 1,203
Customer services................................. 607 853 837
Computer data processing.......................... 359 413 495
Legal Settlement.................................. 1,000 -- --
Legal services.................................... 503 749 768
Other professional services....................... 640 1,546 1,406
Other real estate owned expenses.................. 39 41 87
Promotion and other expenses...................... 206 518 706
------- ------- -------
Total other operating expenses................ 8,003 11,233 13,714
------- ------- -------
Net loss before income tax benefit................ (1,823) (7,200) (8,527)
Income tax benefit.................................. (579) -- --
------- ------- -------
Net loss.......................................... $(1,244) $(7,200) $(8,527)
======= ======= =======
Net loss per share................................ $ (0.40) $ (2.34) $ (2.79)
======= ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
NET
UNREALIZED
GAIN (LOSS)
COMMON STOCK ON SECURITIES
PREFERRED ----------------- ACCUMULATED AVAILABLE-
STOCK SHARES AMOUNT DEFICIT FOR-SALE TOTAL
--------- --------- ------- ----------- ------------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Balance at January 1,
1994................... -- 3,044,446 $24,525 $ (2,722) $ 396 $22,199
Stock options
exercised............. 33,700 89 89
Net unrealized loss on
securities available-
for-sale.............. (3,453) (3,453)
Net income............. (8,527) (8,527)
--- --------- ------- -------- ------- -------
Balance at December 31,
1994.................... -- 3,078,146 24,614 (11,249) (3,057) 10,308
Decrease in net
unrealized loss on
securities available-
for-sale.............. 2,903 2,903
Net loss............... (7,200) (7,200)
--- --------- ------- -------- ------- -------
Balance at December 31,
1995.................... -- 3,078,146 24,614 (18,449) (154) 6,011
Decrease in net
unrealized loss on
securities available-
for-sale.............. 78 78
Net loss............... (1,244) (1,244)
--- --------- ------- -------- ------- -------
Balance at December 31,
1996.................... -- 3,078,146 $24,614 $(19,693) $ (76) $ 4,845
=== ========= ======= ======== ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Net cash flows from operating activities:
Net loss...................................... $ (1,244) $ (7,200) $ (8,527)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Accretion of sublease loss.................... -- (458) (386)
Depreciation and amortization................. 194 365 468
Gain on sale of fixed assets.................. (1) -- --
Provision for credit losses................... -- 2,307 7,330
Provision for OREO............................ -- 733 411
Lower of cost or market adjustment on loans
held-for-sale................................ -- -- 851
Net loss on sale of securities available-for-
sale......................................... 3 1,233 1,327
Net amortization of premiums on securities
held-to-maturity............................. -- -- 19
Net amortization of premiums on securities
held-for-sale................................ 57 57 177
Net accretion of discounts on loans purchased. (9) (163) (4,196)
Accretion of deferred gains, net of
amortization of premiums on interest-rate
hedging contracts terminated................. -- -- (588)
Loss on sale of other assets.................. -- -- 1,087
Net loss on sale of OREO...................... -- -- 483
Net decrease in trading securities............ -- -- 9,992
(Increase) decrease in accrued interest
receivable and other assets.................. (201) 723 906
Decrease in accrued interest payable and other
liabilities.................................. (524) (287) (409)
-------- -------- ---------
Net cash provided by (used in) operating
activities................................. (1,725) (2,690) 8,945
Cash flows from investing activities:
Net decrease (increase) in interest-bearing
deposits with other financial institutions... -- 195 (96)
Purchase of securities held-to-maturity....... (14,395) -- (11,964)
Proceeds from repayments and maturities of
securities held-to-maturity.................. -- -- 8,000
Purchase of securities available-for-sale..... (1,000) (8,013) (151,752)
Proceeds from sales of securities available-
for-sale..................................... 10,632 46,862 154,040
Proceeds from repayments and maturities of
securities available-for-sale................ 6,568 4,276 8,326
Proceeds from sale of loans................... -- 6,599 --
Net decrease in loans......................... 18,638 31,870 30,533
Purchase of OREO.............................. (43)
Proceeds from sale of OREO.................... 62 215 4,637
Proceeds from sale of other assets............ -- -- 372
Net purchases of premises and equipment....... (10) (105) (320)
-------- -------- ---------
Net cash provided by investing activities... 20,452 81,899 41,776
Cash flows from financing activities:
Net decrease in demand deposits, money market
and savings accounts......................... (9,938) (58,649) (40,690)
Net decrease in time certificates of deposit.. (6,451) (28,923) (20,341)
Net decrease in funds payable on purchase of
securities not yet settled................... -- -- (973)
Net (decrease) increase in securities sold
under agreements to repurchase and federal
funds purchased.............................. (4,497) (8,075) 4,549
Net proceeds from exercise of stock options... -- -- 89
-------- -------- ---------
Net cash used in financing activities....... (20,886) (95,647) (57,366)
-------- -------- ---------
Net decrease in cash and cash equivalents....... (2,159) (16,438) (6,645)
Cash and cash equivalents, January 1............ 30,272 46,710 53,355
-------- -------- ---------
Cash and cash equivalents, December 31.......... $ 28,113 $ 30,272 $ 46,710
======== ======== =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 AND 1994
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business and Basis of Presentation
The consolidated financial statements include the accounts of National
Mercantile Bancorp (the "Company") and its wholly owned subsidiary, Mercantile
National Bank (the "Bank"). All significant intercompany transactions and
balances have been eliminated. The Bank is the Company's only subsidiary. The
Bank operates as a commercial bank in the Los Angeles area. The accounting and
reporting policies of the Company and the Bank conform with generally accepted
accounting principles and general practice within the banking industry.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash
and due from banks-demand, federal funds sold and securities purchased under
agreements to resell. Cash flows from interest-rate swap agreements and collar
and floor contracts that are accounted for as hedges of loans and investments
available-for-sale are reflected in cash flows from operating activities,
rather than cash flows from investing activities.
Investments in Debt Securities
Investments in debt securities are classified into three categories based on
the Company's intent at acquisition date. The categories are: (1) held-to-
maturity, (2) available-for-sale, and (3) trading securities.
Debt securities available-for-sale are carried at estimated fair value.
Unrealized holding gains and losses are excluded from earnings and reported in
a separate component of shareholders' equity until realized. Because the Bank
has net operating loss carryforwards, no tax benefit has been recorded from
the unrealized loss.
Gains or losses on sales of securities are determined using the specific
identification method. Securities transferred from one category to another are
transferred at estimated fair value.
Loans
Loans are reported at the principal amounts outstanding, net of (i) deferred
net loan origination fees, (ii) purchased discounts, (iii) deferred net gains
on sales or terminations of interest-rate swap agreements and collar contracts
accounted for as hedges of loans, and (iv) the allowance for credit losses.
Nonaccrual loans are those for which management has discontinued accrual of
interest because (i) there exists reasonable doubt as to the full and timely
collection of either principal or interest, or (ii) such loans have become
contractually past due ninety days with respect to principal or interest.
Interest accruals may be continued for loans that have become contractually
past due ninety days when such loans are well secured and in the process of
collection and, accordingly, management has determined such loans to be fully
collectible as to both principal and interest.
For this purpose, loans are considered well secured if they are
collateralized by property having a realizable value in excess of the amount
of principal and accrued interest outstanding or are guaranteed by a
financially capable party. Loans are considered to be in the process of
collection if collection of the loan is proceeding in due course either
through legal action or through other collection efforts which management
reasonably expects to result in repayment of the loan or its restoration to a
current status in the near future.
When a loan is placed on nonaccrual status, all interest previously accrued
but uncollected is reversed against current period operating results. Income
on such loans is then recognized only to the extent that cash is received and
where the ultimate collection of the carrying amount of the loan is probable,
after giving
F-7
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
consideration to borrowers' current financial condition, historical repayment
performance and other factors. Accrual of interest is resumed only when (i)
principal and interest are brought fully current and (ii) such loans are
either considered, in management's judgment, to be fully collectible or
otherwise become well secured and in the process of collection.
Troubled debt restructured loans are those for which the Company has, for
reasons related to borrowers' financial difficulties, granted concessions to
borrowers (including reductions of either interest or principal) that it would
not otherwise consider, whether or not such loans are secured or guaranteed by
others. Troubled debt restructurings occurring after January 1, 1995 are
included in impaired loans and accounted for as described below.
Loan Origination and Credit-Related Fees
Nonrefundable fees and direct costs associated with the origination or
purchase of loans are deferred and netted against outstanding loan balances.
Deferred net fees and costs are recognized in interest income over the loan
term using a method which generally produces a level yield on the net
investment in the loan.
Nonrefundable fees associated with the issuance of loan commitments are
deferred and recognized over the life of the loan as an adjustment of yield.
Fees for commitments which expire unexercised are recognized in other
operating income upon the expiration of the commitment. Fees received for
standby letters of credit written are recognized as other operating income
over the term of the related commitment.
Allowance for Credit Losses
The Company's allowance for credit losses is maintained at a level
considered by management to be adequate to absorb estimated losses inherent in
the existing portfolio, including commitments under commercial and standby
letters of credit. The allowance for credit losses is increased by the
provision for credit losses charged against operating results and decreased by
the amount of net loan charge-offs. Impaired loans, characterized as loans
where it is probable that the Bank will be unable to collect the principal and
interest amounts due according to their contractual terms, are determined by a
periodic evaluation on an individual loan basis. Losses for secured loans that
are individually evaluated are measured at the fair value of the collateral.
Credit losses are fully or partially charged against the allowance for credit
losses when, in management's judgment, the full collectibility of a loan's
principal is in doubt.
In evaluating the adequacy of the allowance for credit losses, management
estimates the amount of the potential risk of loss for each loan that has been
identified as having below-standard credit risk. Those estimates give
consideration to economic conditions and their effects on the borrower's
industry; borrower's financial data and management capabilities; and current
valuations of collateral where appropriate. An allowance for loan loss is
further allocated for all loans not so identified based upon the risk
characteristics of particular categories of loans and historical loss
experience in the portfolio, adjusted, as appropriate, for the estimated
effects of current economic conditions. Additional allowances are allocated on
the basis of credit risk concentrations in the portfolio and commitments and
contingent obligations under off-balance sheet commercial and standby letters
of credit.
Other Real Estate Owned
Other Real Estate Owned ("OREO") includes real property acquired in full or
partial satisfaction of loans through foreclosure, including direct
foreclosure or deed in lieu of foreclosure.
Foreclosed property is recognized at the property's estimated fair value at
the date of foreclosure, with any excess of the net investment in the loan
over the property's fair value charged against the allowance for credit
losses.
F-8
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
OREO is classified as held for sale and carried at the lower of estimated
fair value or cost. Subsequent write-downs of OREO resulting from declining
fair values are recorded in the periods in which they become known. Costs of
holding OREO are reflected in other operating expense as incurred.
Premises and Equipment, Net
Premises and equipment are presented at cost less accumulated amortization
and depreciation. Depreciation of furniture, fixtures and equipment is
determined using the straight-line method over the estimated useful lives of
the related assets, which range from 3 to 7 years. Leasehold improvements are
amortized using the straight-line method over the term of the related leases
or the service lives of the improvements, whichever is shorter.
Income Taxes
The Company and the Bank file consolidated federal and combined state income
tax returns on a calendar year basis.
Deferred tax assets and liabilities are recognized for the expected future
tax consequences of existing differences between financial reporting and tax
reporting bases of assets and liabilities, as well as for operating losses and
tax credit carryforwards using enacted tax laws and rates. Deferred tax
expense represents the net change in deferred tax asset or liability balance
during the year. This amount, together with income taxes currently payable or
refundable in the current year, represents the total tax expense or benefit
for the year.
Loss per Share
Loss per share is computed using the weighted average number of common
shares outstanding during the period. The weighted average number of common
shares outstanding for the years ended December 31, 1996, 1995 and 1994 was
3,078,146, 3,078,146, and 3,055,584, respectively. Loss per share computations
exclude common share equivalents, since the effect would be to reduce the loss
per share amount.
Interest-Rate Swap Agreements and Hedging Contracts
During 1994 and 1995, the Company entered into interest-rate swap agreements
as a means of moderating the impact of changes in the prime interest rate on
income from loans and investment securities. The differential to be received
(paid) in interest-rate swap agreements is recognized in interest income from
loans or investments over the life of the related agreements. Upon termination
of a swap agreement, the Company recognizes the remaining interest
differential to be received (paid) and unrealized gain or loss to income or
expense in the period the swap is terminated.
The Company does not use interest-rate swaps for trading purposes. Interest-
rate swap agreements used to hedge the available-for-sale investment
securities are carried at fair value and the unrealized gain or loss is
included with the unrealized gain or loss on its investment securities
available-for-sale as a separate component of equity. Interest-rate swaps used
to hedge the loan portfolio are carried off balance sheet.
The Company did not enter into any interest-rate swap or other derivative
agreements during 1996. There were no such agreements outstanding as of
December 31, 1996 and 1995.
Fair Value of Financial Instruments
Estimated fair value amounts have been determined using available market
information and appropriate valuation methodologies. Considerable judgment is
required to interpret market data and to develop the estimates of fair value.
Accordingly, the estimates of fair value in the financial statements are not
necessarily indicative of the amounts the Company could realize in a current
market exchange. The use of different market assumptions and estimation
methodologies may have a material effect on the estimated fair value amounts.
F-9
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
Recent Accounting Pronouncements
On January 1, 1996, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of." This Statement requires
that long-lived assets, certain identifiable intangibles, and goodwill related
to those assets to be held and used, or disposed of, be reviewed for
impairment based on the fair value of the asset. Furthermore, this statement
requires that certain long-lived assets and identifiable intangibles to be
disposed of, be reported at the lower of carrying amount or fair value less
cost to sell. The Company has determined that the impact of this Statement on
its operations and financial position is not material for the year ended
December 31, 1996.
SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123")
establishes financial accounting and reporting standards for stock-based
employee compensation plans. Those plans include all arrangements by which
employees receive shares of stock or other equity instruments of the employer
or the employer incur liabilities to employees in amounts based on the price
of the employer's stock. Examples are stock purchase plans, stock options,
restricted stock awards, and stock appreciation rights. This statement also
applies to transactions in which any entity issues its equity instruments to
acquire goods or services from non-employees. Those transactions must be
accounted for, or at least disclosed in the case of stock options, based on
the fair value of the consideration received or the fair value of the equity
instruments issued, whichever is more reliably measurable. The accounting
requirements of SFAS No. 123 are effective for financial statements for fiscal
years beginning after December 15, 1995, or for an earlier fiscal year for
which SFAS No. 123 is initially adopted for recognizing compensation cost. The
statement permits a company to choose either a new fair value-based method or
the current APB Opinion 25 intrinsic value-based method of accounting for its
stock-based compensation arrangements. The statement requires pro forma
disclosures of net earnings and earnings per share computed as if the fair
value-based method had been applied in financial statements of companies that
continue to follow current practice in accounting for such arrangements under
APB Opinion 25. The Company has chosen not to adopt the fair value provisions
of SFAS No. 123 and will continue accounting for stock compensation awards at
the intrinsic value at the grant date. See Note 12 for the disclosure
requirements of SFAS No 123.
In June 1996, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities." This Statement provides accounting and
reporting standards for transfers and servicing of financial assets and
extinguishments of liabilities, and is applied prospectively to financial
statements for fiscal years beginning after December 31, 1996. In 1996, the
FASB also issued SFAS No. 127, "Deferral of the Effective Date of Certain
Provisions of FASB Statement No. 125," which defers for one year the effective
date of certain provisions within SFAS No. 125. The Company does not believe
the impact on its operations and financial position will be material upon
adoption of SFAS No. 125 or SFAS No. 127.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Reclassifications
Certain items in the 1995 and 1994 financial statements have been
reclassified to conform to the 1996 presentation.
F-10
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
NOTE 2--REGULATORY MATTERS
Going Concern
The accompanying consolidated financial statements have been prepared on a
going-concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. As shown in the
financial statements, the Company incurred net losses of $1.2 million, $7.2
million and $8.5 million during the years ended December 31, 1996, 1995 and
1994, respectively. At December 31, 1996, the Bank was not in compliance with
the minimum capital requirements prescribed by the formal agreement that the
Bank entered into with the Office of the Comptroller of the Currency (OCC) in
December 1995. The formal agreement and regulatory capital requirements are
described below. If the Bank is unable to meet the minimum capital
requirements of the formal agreement, one or more regulatory sanctions may
result, such as a cease and desist order, the imposition of civil money
penalties against the Bank and its directors and executive officers or the
removal of one or more directors or executive officers.
These factors, among others, raise substantial doubt about the Company's
ability to continue as a going concern. The financial statements do not
include the adjustments, if any, that might have been required had the outcome
of the uncertainty been known, or any adjustments relating to the
recoverability of recorded asset amounts or the amount of liabilities that may
be necessary should the Company be unable to continue as a going concern. The
Company's continuation as a going concern is dependent on the Bank's ability
to comply with the terms of the formal agreement (the most significant of
which is the raising of capital), maintain sufficient liquidity, and
ultimately, return to profitable operations. Management has taken steps to
raise additional capital to comply with the formal agreement as described in
Note 19--Subsequent Event.
Management's Plans
Although the Bank incurred significant losses which have reduced capital,
management's primary focus is to return the Bank to profitability.
Management's plans for 1997 are to continue to improve the quality of assets,
continue to reduce operating expenses, and increase revenues through increased
volume of fee-based services and increased loans. Management's attainment of
these objectives is dependent on the economic developments in its principal
market area. An improvement in the southern California economy will negate the
impact the recession has had on the Bank's borrowers and stimulate growth.
Conversely, further declines in the southern California economy could continue
to negatively impact the Company's ability to attain those planned objectives.
In addition, the Company has neither adequate cash flow nor the financial
flexibility to enable it to act as a source of financial strength to the Bank.
Management has taken steps to raise additional capital to comply with the 1995
Formal Agreement as described in Note 19--Subsequent Event.
Regulatory Agreements
The Bank's principal regulator is the OCC. At periodic intervals, the OCC
examines and evaluates the financial condition, operations, and policies and
procedures of nationally chartered banks, such as the Bank, as part of its
legally prescribed oversight responsibilities. Based on its examinations, the
OCC can direct a national bank to adjust its financial statements in
accordance with the examination's findings. In view of the increasingly
uncertain regulatory environment in which banks now operate, the extent, if
any, to which future OCC examinations may ultimately result in adjustments to
the financial statements cannot presently be determined.
The OCC conducted examinations of the Bank in late 1990 and early 1991 which
identified deficiencies in the Bank's loan underwriting and administration
policies and procedures. Information derived from these examinations resulted
in significant increases in loans identified as nonperforming in 1991 and
concurrent increases in the 1991 provisions for credit losses, charge-offs of
nonperforming loans and the allowance for credit losses. These developments
caused the OCC to determine that the Bank required special supervisory
attention. In order to implement this determination, the OCC and the Bank
entered into a formal regulatory agreement on July 26, 1991 ("1991 Formal
Agreement").
F-11
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
The OCC and the Bank have entered into a Formal Agreement dated December 14,
1995 ("1995 Formal Agreement"), which supersedes and replaces in its entirety
the 1991 Formal Agreement. The 1995 Formal Agreement provides that the Bank
must (a) achieve and maintain (i) a capital leverage ratio equal to at least
6.5% and (ii) a Tier 1 capital to risk weighted assets ratio equal to at least
10.0%; (b) provide quarterly progress reports to the OCC; (c) employ a Chief
Financial Officer after approval by the OCC; (d) not pay directors fees; (e)
review all management fees, consulting contracts and severance plans; (f)
analyze new products and services; (g) maintain sufficient liquidity; (h)
develop a three-year capital plan; (i) develop a strategic plan; and
(j) implement a written loan administration program. During 1996, the Bank
submitted to the OCC a three-year capital plan, a strategic plan and a loan
administration program.
The Bank's capital leverage ratio at December 31, 1996 was 4.67%, and the
Bank's Tier 1 capital to risk weighted assets ratio was 6.95%, both of which
were not in compliance with the 1995 Formal Agreement. Although the Bank did
not meet the minimum 6.5% and 10%, respectively, required for these ratios by
the 1995 Formal Agreement, management believed at December 31, 1996, it was in
compliance with a substantial portion of the 1995 Formal Agreement and was
making significant progress toward achieving full compliance with the
remaining requirements.
As required under and to comply with the reporting provisions of the 1995
Formal Agreement, the Bank reports quarterly on the status of its progress to
the OCC. The Bank has developed a detailed tracking system for determining and
reporting compliance with the 1995 Formal Agreement.
The Company entered into a Memorandum of Understanding ("1995 MOU") on
October 26, 1995 with the Federal Reserve Bank of San Francisco ("FRB"). This
MOU replaces the Memorandum of Understanding entered into by the Company and
the FRB in 1991 (the "1991 MOU"). The 1995 MOU prohibits the Company from
paying dividends without prior approval of the FRB, requires the submission of
a plan to increase the Bank's capital ratios to comply with the 1995 Formal
Agreement, requires the Company to conduct a review of the senior and
executive management of the Company and the Bank, prohibits the incurrence or
renewal of debt without the FRB's approval, restricts cash expenditures in
excess of $10,000 in any month, and prohibits the Company from making
acquisitions or divestitures or engaging in new lines of business without the
FRB's approval.
The 1995 Formal Agreement will impair the ability of the Bank to declare and
pay dividends to the Company since the Bank currently needs to retain any
earnings to augment its capital. As dividends from the Bank are the principal
source of income to the Company, and because the payment of dividends by the
Company is subject to prior approval of the FRB, it is unlikely that the
Company will declare and pay dividends in the foreseeable future.
Absent sales of equity securities or subordinated debt by the Company,
capital will increase only through the retention of earnings.
Regulatory Capital Requirements
The Federal Reserve Board and the OCC have issued guidelines (the
"guidelines") regarding risk-based capital requirements. The guidelines
provide detailed definitions of regulatory capital and assign different
weights to various assets and credit equivalent amounts of off-balance sheet
financial instruments, depending upon the perceived degree of credit risk to
which they expose such entities. Each banking organization is required to
maintain a specified minimum ratio of capital to the total of such risk-
adjusted assets and off-balance sheet financial instruments.
The Company and the Bank are subject to various capital requirements
administered by the federal banking regulatory agencies. Failure to meet
minimum capital requirements can initiate certain mandatory--and possibly
additional discretionary--actions by regulators that, if undertaken, could
have a direct material effect on the
F-12
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
Company's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Company and Bank must
meet specific capital guidelines that involve quantitative measures of assets,
liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices. The capital amounts and classification are
also subject to qualitative judgment by the regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios which
have impacted by the 1995 Formal Agreement (set forth in the table below) of
total and Tier 1 capital (primarily common stock and retained earnings less
goodwill) to risk-weighted assets, and of Tier 1 capital to average assets.
At December 31, 1996, the most recent notification from the OCC categorized
the Bank as adequately capitalized under regulatory framework for prompt
corrective action. Under this framework, the Bank's capital levels do not
allow the acceptance of brokered deposits without prior approval. At December
31, 1996, brokered deposits were 0.38% of total deposits. Management expects
that this limitation will not have a significant impact. To be categorized as
adequately capitalized the Bank must maintain minimum total risk-based, Tier 1
risk-based, Tier 1 leverage ratios as set forth in the following table. There
are no conditions or events since that notification which management believes
have changed the Bank's category except as discussed below regarding the 1995
Formal Agreement.
On December 14, 1995, the Bank entered into the 1995 Formal Agreement with
the OCC, pursuant to which the Bank is required to achieve and maintain, (i) a
capital leverage ratio equal to at least 6.5% and (ii) a Tier 1 capital to
risk weighted assets ratio equal to at least 10.0%. The Bank's capital
leverage and Tier 1 capital to risk weighted assets ratios at December 31,
1996, were 4.67% and 6.95%, respectively. At December 31, 1996, the Bank was
not in compliance with maintaining a capital leverage ratio of 6.5% or a Tier
1 capital to risk weighted assets ratio of 10% pursuant to the 1995 Formal
Agreement.
The actual capital ratios of the Company and the Bank at December 31:
<TABLE>
<CAPTION>
TO BE
CATEGORIZED
AS
ADEQUATELY
CAPITALIZED
UNDER PROMPT
FOR CAPITAL CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION
------------ ------------------ ------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- --------- -------- ------ -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1996:
Total Capital to Risk Weighted
Assets
Company....................... $5,831 8.25% $ 5,657 * 8.0% N/A
Bank.......................... $5,820 8.24% $ 5,657 * 8.0% $5,657 *8.0%
Tier 1 Capital to Risk Weighted
Assets
Company....................... $4,921 6.96% $ 2,828 * 4.0% N/A
Bank.......................... $4,911 6.95% $ 7,071 *10.0% $2,828 *4.0%
Tier 1 Capital to Average Assets
Company....................... $4,921 4.68% $ 4,210 * 4.0% N/A
Bank.......................... $4,911 4.67% $ 6,841 * 6.5% $4,210 *4.0%
As of December 31, 1995:
Total Capital to Risk Weighted
Assets
Company....................... $7,306 8.25% $ 7,085 * 8.0% N/A
Bank.......................... $7,297 8.24% $ 7,085 * 8.0% $7,085 *8.0%
Tier 1 Capital to Risk Weighted
Assets
Company....................... $6,166 6.96% $ 3,542 * 4.0% N/A
Bank.......................... $6,157 6.95% $ 8,856 *10.0% $3,542 *4.0%
Tier 1 Capital to Average Assets
Company....................... $6,166 4.68% $ 5,271 * 4.0% N/A
Bank.......................... $6,157 4.67% $ 8,565 * 6.5% $5,271 *4.0%
</TABLE>
F-13
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
NOTE 3--AVERAGE FEDERAL RESERVE REQUIREMENTS
All depository institutions which are member banks are required to maintain
reserves on deposits representing transaction accounts in the form of balances
with the Federal Reserve Bank. The average reserve requirements for the Bank
were $657,000 and $1,462,000 for the years ended December 31, 1996 and 1995,
respectively. Neither the Company nor the Bank is required to maintain
compensating balances to assure credit availability under existing borrowing
arrangements.
NOTE 4--SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL
The Company enters into purchases of securities under agreements to resell
("reverse repurchase agreements") with primary dealers, as designated by the
Federal Reserve Bank of New York, only. Amounts advanced under these
agreements represent short-term invested cash included in cash and cash
equivalents in the balance sheet. Securities subject to reverse repurchase
agreements are held in the name of the Company by the dealers who arrange the
transactions.
Overnight reverse repurchase agreements contain no provisions to ensure that
the fair value of the underlying securities remains sufficient to prevent loss
to the Company in the event of default by the counterparty. With respect to
agreements having terms in excess of one day, in the event that the fair value
of securities decreases below the carrying amount of the related reverse
repurchase agreements, the counterparties are required to designate an
equivalent amount of additional securities in the name of the Company.
Reverse repurchase agreements relating to mortgage-backed securities and
U.S. Treasury and government agency securities represent agreements to resell
the same securities.
There were no reverse repurchase agreements outstanding during 1996 and
1995.
NOTE 5--INVESTMENTS IN DEBT SECURITIES
The following is a summary of gains and losses on securities available-for-
sale and interest income on securities held-to-maturity and available for
sale:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
----------------------
1996 1995 1994
---- ------- -------
(DOLLARS IN
THOUSANDS)
<S> <C> <C> <C>
Gains and Losses:
Securities available-for-sale:
Gross realized gains............................... $ 17 $ 67 $ 25
Gross realized losses.............................. (20) (1,300) (1,352)
---- ------- -------
Net realized losses.................................. $ (3) $(1,233) $(1,327)
==== ======= =======
Interest Income:
Securities held-to-maturity:
Tax-exempt......................................... -- -- --
Taxable............................................ 62 -- 610
---- ------- -------
Securities available-for-sale:
Tax-exempt......................................... -- 12 50
Taxable............................................ 928 1,383 3,625
---- ------- -------
$928 $ 1,395 $ 3,675
==== ======= =======
</TABLE>
F-14
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
At December 31, 1996, a portion of the Company's investment securities
portfolio was pledged (excluding the Federal Reserve Bank stock) as collateral
for retail (customer) repurchase agreements, FRB discount lines and other
deposits. Securities pledged for FRB discount lines, and other deposits,
totaled $3.0 million and $1.0 million, respectively. (Also see Note 10--
Securities Sold Under Agreements to Repurchase.)
In 1994, investment securities with an amortized cost of $12.9 million and
fair value of $12.5 million were transferred from the held-to-maturity
category to the available-for-sale category for regulatory capital and
liquidity purposes. From the date of the transfer, these securities and all
securities purchased through September 1996 were classified as available-for-
sale. During the fourth quarter of 1996, the Bank purchased $14.4 million of
securities which were classified as held-to-maturity.
The Company regularly monitors its investment portfolio for any
deterioration in the issuer's creditworthiness expected to continue for a
prolonged period of time which may result in a permanent impairment of the
security's value. In such a circumstance, any permanent decline in value is
charged against earnings.
The amortized cost, gross unrealized gains, gross unrealized losses, and
estimated fair values of the Company's investment in debt securities held-to-
maturity and available-for-sale at December 31, 1996 and 1995, are presented
below.
<TABLE>
<CAPTION>
1996 1995
----------------------------------------- -----------------------------------------
TOTAL GROSS GROSS ESTIMATED TOTAL GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE
--------- ---------- ---------- --------- --------- ---------- ---------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Securities held-to-
maturity:
Other government
sponsored agency
securities........... $14,395 $-- $ 40 $14,355 $ -- $-- $-- $ --
======= ==== ==== ======= ======= ==== ==== =======
Securities available-
for-sale:
U.S. Treasury
securities........... $ -- $-- $-- $ -- $ 1,010 $-- $-- $ 1,010
GNMA-guaranteed
mortgage pass-through
certificates......... -- -- -- -- 119 1 -- 120
FHLMC-issued mortgage
pass-through
certificates......... -- -- -- -- 6,001 11 41 5,971
Other government-
sponsored agency
securities........... 1,000 3 -- 1,003 9,683 -- 55 9,628
CMO's and REMICS's
issued by U.S.
government agencies.. 3,078 -- 79 2,999 3,443 -- 70 3,373
------- ---- ---- ------- ------- ---- ---- -------
$ 4,078 $ 3 $ 79 $ 4,002 $20,256 $ 12 $166 $20,102
======= ==== ==== ======= ======= ==== ==== =======
</TABLE>
F-15
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
The following is a summary of the contractual maturities of the Company's
investment in debt securities held-to-maturity and available-for-sale at
December 31, 1996. Actual maturities may differ from contractual maturities to
the extent that borrowers have the right to call or repay obligations with or
without call or repayment penalties.
<TABLE>
<CAPTION>
CARRYING AMOUNT OF INVESTMENT SECURITIES MATURING:
--------------------------------------------------------------------
AFTER ONE BUT AFTER FIVE
WITHIN ONE WITHIN FIVE BUT WITHIN AFTER TEN
YEAR YEARS TEN YEARS YEARS
------------ ------------- ------------ ------------
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD TOTAL YIELD
------ ----- ------- ----- ------ ----- ------ ----- ------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Securities held-to-
maturity:
Other government-
sponsored agency
securities............ $ -- -- $14,395 6.67% $-- -- $ -- -- $14,395 6.67%
===== ======= ==== ====== ======= ====
Securities available-
for-sale:
Other government
sponsored agency
securities............. $ -- -- $ 1,003 6.05% $-- -- $ -- -- $ 1,003 6.05%
CMO's and REMIC's issued
by
U.S. government-
sponsored agencies..... -- -- -- -- -- -- 2,999 5.73% 2,999 5.73%
----- --- ------- ---- ---- --- ------ ---- ------- ----
$ -- -- $ 1,003 6.05% $-- -- $2,999 5.73% $ 4,002 5.81%
===== ======= ==== ====== =======
</TABLE>
NOTE 6--LOANS
The following is a summary of the major categories of loans outstanding at
December 31, 1996 and 1995:
<TABLE>
<CAPTION>
1996 1995
------- -------
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Real estate construction and land development................. $ 3,441 $ 4,185
Commercial loans:
Secured by one to four family residential properties........ 6,233 9,637
Secured by multifamily residential properties............... 2,879 2,876
Secured by commercial real properties....................... 26,629 28,734
Other, secured and unsecured................................ 16,508 27,393
Home equity lines of credit................................... 581 3,983
Consumer installment and unsecured loans to individuals....... 6,545 5,435
------- -------
62,816 82,243
Deferred net loan origination fees............................ (269) (231)
------- -------
$62,547 $82,012
======= =======
Weighted average yield for loans at December 31............... 9.34% 9.46%
</TABLE>
F-16
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
The following is a summary of activity in the allowance for credit losses
for the years ended December 31, 1996, 1995 and 1994:
<TABLE>
<CAPTION>
1996 1995 1994
------- ------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Balance, beginning of year.................... $ 3,805 $ 3,063 $ 6,697
Provisions for credit losses.................. -- 2,307 7,330
Loans charged off............................. (1,300) (2,632) (14,217)
Recoveries of loans previously charged off.... 464 1,067 3,253
------- ------- --------
Balance, end of year.......................... $ 2,969 $ 3,805 $ 3,063
======= ======= ========
</TABLE>
At December 31, 1996 and 1995, the Bank had classified $1.6 million and $3.3
million of its loans as impaired, as determined in accordance with SFAS No.
114, with specific reserves of $710,000 and $450,000, respectively. In
addition, $5.6 million and $5.3 million of the Bank's loans are classified as
impaired with no related specific loss reserve at December 31, 1996 and 1995,
respectively. The average recorded investment and interest income recognized
on impaired loans during the years ended December 31, 1996 and 1995 was $7.8
million and $9.9 million, and $0.7 and $0.8 million, respectively.
In September 1993, the Bank purchased $20.8 million in performing loans from
the FDIC, acting as receiver for a bank in Los Angeles. The purchase price was
$16.8 million, net of an allowance for credit losses established by the Bank
at the time of purchase. During 1994, the allowance for credit losses that was
established at the time of purchase was reclassified to a purchase discount on
loans. The total net discount of $4.0 million, net of premiums of $300,000, is
being accreted into interest income over the term of the related loans. The
effect of these adjustments resulted in additional interest income of
approximately $3.9 million for the year ended December 31, 1994, for which the
Bank recorded additional provisions for credit losses.
The allowance for credit losses is an estimate involving both subjective and
objective factors and its measurement is inherently uncertain, pending the
outcome of future events. Management's determination of the adequacy of the
allowance is based on an evaluation of the loan portfolio, previous loan loss
experience, current economic conditions, volume, growth and composition of the
portfolio, the value of collateral and other relevant factors. The ongoing
recession, which was more prolonged and severe in southern California than
elsewhere in the country, continued to have an adverse impact on the credit
risk profile and performance of the Bank's loan portfolio in 1996.
Deterioration of cash flows, profit margins and declining real estate market
values have negatively affected many borrowers' operating cash flows and
ability to service debt. Although management believes the level of the
allowance as of December 31, 1996 is adequate to absorb losses inherent in the
loan portfolio, additional deterioration in the economy of the Bank's lending
area could result in levels of credit losses that could not be reasonably
predicted at that date.
The following is a summary of nonperforming loans at December 31, 1996 and
1995, respectively.
<TABLE>
<CAPTION>
1996 1995
------ ------
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Nonaccrual loans........................................... $ 928 $ 573
Troubled debt restructurings............................... 5,016 5,167
Loans contractually past due ninety or more days with
respect to either principal or interest and still accruing
interest.................................................. 300 221
------ ------
$6,244 $5,961
====== ======
</TABLE>
F-17
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
Interest foregone on nonperforming loans outstanding during the years ended
December 31, 1996, 1995 and 1994 was $171,000, $160,000 and $1,164,000,
respectively.
The ability of the Company's borrowers to honor their contracts is
substantially dependent upon economic conditions and real estate market values
throughout the Company's market area. At December 31, 1996, loans aggregating
$39.8 million were collateralized by liens on residential and commercial real
properties. While the Company's loan portfolio is generally diversified with
regard to the industries represented, at December 31, 1996, the Company's
loans to businesses and individuals engaged in entertainment industry-related
activities amounted to $6.5 million, including $3.0 million of such loans
which are collateralized by real property.
The Company did not extend credit to any directors and business enterprises
in which they have interests during 1996 or 1995.
NOTE 7--PREMISES AND EQUIPMENT AND LEASE COMMITMENTS
The following is a summary of the major components of premises and equipment
at December 31, 1996 and 1995.
<TABLE>
<CAPTION>
1996 1995
------- -------
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Leasehold improvements.................................. $ 1,680 $ 1,680
Furniture, fixtures and equipment....................... 3,208 3,418
------- -------
4,888 5,098
Less accumulated amortization and depreciation.......... (3,945) (3,972)
------- -------
$ 943 $ 1,126
======= =======
</TABLE>
Rent amortization and depreciation expense, and rental income for the years
ended December 31, 1996, 1995 and 1994 are summarized below.
<TABLE>
<CAPTION>
1996 1995 1994
---- ------ ------
(DOLLARS IN
THOUSANDS)
<S> <C> <C> <C>
Rent expense........................................ $668 $1,939 $2,155
Sublease income..................................... (16) (246) (293)
Accretion of sublease loans......................... -- (457) (386)
---- ------ ------
Net rent expense.................................. 652 1,236 1,476
Amortization of leasehold improvements.............. 77 135 107
Other occupancy expense............................. 64 97 249
---- ------ ------
Total occupancy expense........................... $793 $1,468 $1,832
==== ====== ======
Depreciation expense................................ $117 $ 220 $ 333
Other furniture and equipment expense............... 181 165 206
---- ------ ------
Total furniture and equipment expense............. $298 $ 385 $ 539
==== ====== ======
</TABLE>
The Bank has leased, under lease agreements, modified by a Lease Restructure
Agreement as of December 31, 1995, 23,883 square feet of office space in west
Los Angeles. The leases expire in October 2004. The leases are subject to
annual adjustments for increases in property taxes and operating costs. Under
the provision of the Lease Restructure Agreement, the Bank assigned its
interests in its subleases to the landlord. In conjunction with the execution
of the Lease Restructure Agreement, the Company has issued the landlord a
F-18
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
seven-year warrant to purchase up to 9.9% of the shares of common stock of the
Company at an exercise price of $1.50 per share (or such lower price as
provided in the Warrant Agreement). The Company also granted the landlord
registration rights with respect to shares purchased by the landlord (or its
assignee) pursuant to the Warrant. No value has been assigned to those
warrants for disclosure purposes in the Consolidated Financial Statements.
Minimum annual rental commitments under these leases at December 31, 1996
are summarized below.
<TABLE>
<CAPTION>
(DOLLARS
IN
THOUSANDS)
----------
<S> <C>
Year Ended December 31,
1997.............................. $ 668
1998.............................. 668
1999.............................. 668
2000.............................. 692
2001 and thereafter............... 3,110
------
$5,806
======
</TABLE>
NOTE 8--OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS
The Company is a party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of its customers
and to reduce the impact on the Company's operating results of fluctuations in
market or managed index interest rates. These financial instruments include
commitments to extend credit, conditional obligations under standby letters of
credit, and interest-rate swap agreements and collar contracts.
These financial instruments involve, to varying degrees, elements of credit
and interest-rate risk in excess of the amounts recognized in the balance
sheet. The contract or notional amounts of those instruments reflect the
extent of the Company's involvement in those financial instruments. With
respect to irrevocable commitments to extend credit and standby letters of
credit, the Company's exposure to credit loss in the event of nonperformance
by customers is represented by the contractual amount of those instruments,
less the realizable value of any collateral held. For interest-rate swap and
collar transactions, notional amounts do not represent exposure to credit
loss.
Commitments to extend credit are agreements to lend to a customer provided
there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Many of these commitments are expected to
expire without being drawn upon. As such, the total commitment amounts do not
necessarily represent future cash requirements.
The Company uses the same credit underwriting policies in granting or
accepting such commitments or contingent obligations as it does for on-
balance-sheet instruments, evaluating customers' creditworthiness
individually. The amount of collateral obtained, if deemed necessary by the
Company upon extension of credit, is based on management's credit evaluation
of the counterparty. The nature of collateral obtained varies and may include
deposits held in financial institutions; marketable securities; accounts
receivable, inventory, and plant and equipment; and residential or income-
producing commercial real properties.
Standby letters of credit written are conditional commitments issued by the
Company to guarantee the financial 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
F-19
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
involved in extending loan facilities to customers. When deemed necessary, the
Company holds appropriate collateral supporting those commitments. Management
does not anticipate any material losses as a result of these transactions.
Losses, if any, from standby letters of credit are charged against the
allowance for credit losses.
Undisbursed commitments under revocable and irrevocable loan facilities
amounted to $7.9 million and $11.6 million at December 31, 1996 and 1995,
respectively. Contingent obligations under standby letters of credit totaled
$175,000 and $413,000 at December 31, 1996 and 1995, respectively. At December
31, 1996, $175,000 of standby letters of credit was collateralized by either
cash or property; substantially all standby letters of credit expire within
one year and one such obligation for $100,000 extends to the year 2001.
Interest-rate swap transactions involve the exchange of fixed and floating
rate interest payment obligations without the exchange of the underlying
notional (principal) amounts. The Company minimizes the credit risk associated
with interest-rate swap agreements by performing normal credit reviews of and
establishing transaction limits with counterparties. While the notional
amounts are often used to indicate the extent of involvement with these
transactions, the amounts potentially subject to credit risk are much less.
In December 1994, the Bank entered into an interest-rate swap contract.
Under the terms of the agreement the Bank received a floating three-month U.S.
Libor rate, initial rate of 6.8%, and paid an 8.2% fixed rate. The payments
were calculated on a $30 million notional amount based on a three-year term to
be paid semi annually. The swap was intended to hedge the market value
fluctuations of a portion of the available-for-sale securities portfolio, and
was terminated early in the second quarter of 1995. The Bank realized a loss
of $1,294,000 on the early termination of the swap.
In October 1993, the Bank entered into an interest-rate swap contract. Under
the terms of the agreement, the Bank received 6.0% fixed and paid floating-
rate prime for 21 months on a $10 million notional amount. The swap expired in
August, 1995.
During 1994, the Company recognized $544,000 in interest income from loans
which represented the accretion of a deferred gain resulting from the sale of
a prime rate based floor component of an interest-rate collar contract that
expired in June 1994. The twenty-four month collar contract had a notional
amount of $100 million and provided for the Company's payment of the daily
average New York bank prime interest rate above 10 percent (the cap rate) and
the receipt of the prime interest rate below 8.5 percent (the floor rate).
The Company did not enter into any interest-rate swap or other derivative
agreements during 1996. There were no such agreements outstanding as of
December 31, 1996 and 1995.
NOTE 9--LITIGATION
Because of the nature of their activities, the Company and the Bank are
subject to pending and threatened legal actions which arise out of the normal
course of business. In the opinion of management, based upon opinions of legal
counsel, the disposition of all suits will not have a material adverse effect
on the consolidated financial position or results of operations of the
Company.
During 1992, an action was commenced by two of the Company's shareholders
against the Company and various directors, officers and employees of the
Company. The complaint was a derivative and class action case, which purported
to assert various violations of the Securities Exchange Act of 1934 and state
common law.
On December 22, 1994, the parties to the action filed a stipulation of
settlement (the Stipulation) with the Court. According to the Stipulation, all
claims in the action were settled, discharged and dismissed with
F-20
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
prejudice. The monetary portion of the settlement (approximately $1.6 million)
was funded solely by the Company's insurer. None of the defendants is to be
required to pay any portion of the settlement. In addition, the Company was
required to issue 169,800 warrants to the class of plaintiffs to purchase
shares of Common Stock of the Company. The exercise price of the warrants is
$3.55 and are exercisable during a three-year period which commenced June 2,
1996. Also pursuant to the Court's order, in the two-year period after the
approval of the proposed settlement, which approval was obtained in June 1996,
plaintiffs will have the right to two new directors on the Company's board of
directors. One new member was scheduled to be chosen during the first year
after the effective date of the settlement, June 2, 1995 (the "Effective
Date"). A second new member would be chosen during the second year after the
Effective Date. Both of the new directors would be independent of the present
or former directors of the Company. Robert E. Gipson, a Company candidate, was
approved by the plaintiff's counsel. The Company plans to continue to seek
(and will consider candidates suggested by plaintiff's counsel) qualified
candidates to serve as directors of the Company. Upon the approval of one more
candidate by the plaintiff's counsel, the Company's obligation under the
Stipulation to add two (2) new members to the Board of Directors will be
satisfied.
Other Litigation
In February 1995, counterclaims were filed against the Bank in an action
commenced by British & Commonwealth Merchant Bank ("BCMB"), as agent for
itself and the Bank, in England against Lloyd's Underwriters and certain other
parties (collectively, "Lloyd's"). The Bank and BCMB claimed that Lloyd's owed
them a further $120,659 of insurance proceeds relating to a claim filed by
BCMB (for itself and the Bank) for approximately $7.8 million under policies
insuring repayment of a loan from the Bank and BCMB to Performance Guarantees,
Inc. for production of a film entitled "Barr Sinister." On or about November
1991, Lloyd's paid approximately $7.8 million in insurance proceeds, which
Lloyd's sought to recover a half each from the Bank and BCMB. In its
counterclaim, Lloyd's contended that the Leading Underwriter lacked authority
to issue the insurance policies and endorsements on behalf of all of the
insurers under which payment was made and secondly, that material
misrepresentations were made to the Leading Underwriter as to the likely
budget for the film and that if the Leading Underwriter had known the true
position he would not have accepted the film under the relevant policies.
Lloyd's position, therefore, was that such payment should be returned to
Lloyd's.
The Bank reached an agreement with Lloyd's for the settlement of the Bank's
claim against Lloyd's and Lloyd's counterclaims against the Bank. The Bank
entered into the settlement not as a result of the Bank's conclusions as to
the merits of Lloyd's counterclaims against the Bank, but solely as a matter
of resolving those counterclaims in connection with the Bank's effort to
recapitalize.
The settlement was originally conditioned on the recapitalization of the
Bank on or before May 5, 1997, and, in light of that condition, "tolling"
agreements were entered into with various third parties to preserve the Bank's
ability to institute, if necessary, further proceedings against those third
parties for potential losses that may have arisen from the continuation of
Lloyd's counterclaims, if the settlement had not been concluded. The
settlement agreement originally provided that the Bank would pay $500,000 to
Lloyd's on the earlier of the seventh day following the completion of the
Bank's recapitalization through the Offerings or May 5, 1997 and an additional
$500,000 on the second anniversary of that payment. The agreement also
provided that BCMB will release the Bank from any claim that BCMB might have
against the Bank should BCMB suffer loss in connection with Lloyd's
counterclaims against BCMB in the continuing litigation. Prior to December 31,
1996, the Company and all affected parties agreed to a single payment of the
settlement on a discounted lump-sum basis, which payment was made.
F-21
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
NOTE 10--SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
The Company enters into sales of securities under agreements to repurchase
("repurchase agreements"). Repurchase agreements are treated as financings
with the related investment securities and obligations to repurchase those
securities reported in the balance sheet as assets and liabilities,
respectively.
As part of its money management services offered to customers, the Company
offers retail repurchase agreements secured by U.S. Treasury and government
agency securities for the short-term investment of funds. Those securities may
be obtained by the Company pursuant to reverse repurchase agreements (see Note
4). Securities subject to repurchase agreements are retained by the Company's
custodian under written agreements that recognize the customers' interests in
the securities.
For wholesale (dealer) repurchase agreements, investment securities subject
to such agreements are delivered to the dealers who arrange the transactions.
The dealers may have sold, loaned or otherwise disposed of such securities to
other parties in the normal course of operations and have agreed to resell to
the Company identical securities at the repurchase agreements' maturities. The
Company may be required to deliver additional securities if the fair value of
the investment securities sold declines below the price initially paid to the
Company for those securities.
Presented below is information about repurchase agreements at December 31,
1995. During 1996 and 1995, no material amount of repurchase agreements were
outstanding with any individual dealer.
<TABLE>
<CAPTION>
DECEMBER 31, 1995
--------------------------
UNDERLYING REPURCHASE
SECURITIES LIABILITY
---------- ---------------
ESTIMATED INTEREST
MATURITY/TYPE OF ASSET FAIR VALUE AMOUNT RATE
- ---------------------- ---------- ------ --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
2 to 30 days:
FHLMC-issued mortgage pass-through certificates...... $4,544 $2,882 1.86%
Other government agency securities................... 2,999 1,615 2.74%
------ ------
$7,543 $4,497
====== ======
</TABLE>
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
--------------
1996 1995
------ ------
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Weighted average interest rate at the end of the year........... -- 2.18%
Maximum amount outstanding at any month-end during the year..... $1,546 $7,031
Average balance outstanding during the year..................... $1,140 $4,093
Weighted average interest rate for the year..................... 2.20% 2.61%
</TABLE>
NOTE 11--INCOME TAXES
The Company filed a loss carryback claim in 1995 and during the year ended
December 31, 1996 realized a tax benefit for federal income tax purposes and
received a refund of approximately $579,000 (including $43,000 in interest)
related to a carryback of a portion of the NOLs previously unrecognized.
No income tax provision was recorded at 1995 and 1994, due to the
utilization of all available financial statement income tax benefits in 1991.
F-22
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
A reconciliation of the amounts computed by applying the federal statutory
rate of 35% for 1996, 1995 and 1994 to the loss or income before tax benefits
and the effective tax rate follows:
<TABLE>
<CAPTION>
1996 1995 1994
----------- ------------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Tax provision (benefit) at
statutory rate................... $(638) (35)% $(2,545) (35)% $(2,960) (35)%
Increase (reduction) in taxes
resulting from:
Tax-exempt income on state and
municipal securities and loans.. -- -- $ (67) (1)% (527) (6)%
Valuation reserve................ -- -- $ 2,302 31.7 % 3,671 43 %
Other, net....................... 59 3 % $ 310 4.3 % (184) (2)%
----- ---- ------- ---- ------- ---
$(579) (32)% $ -- -- % $ -- -- %
===== ==== ======= ==== ======= ===
</TABLE>
The major components of the net deferred tax asset at December 31, 1996 and
1995 are as follows:
<TABLE>
<CAPTION>
1996 1995
-------- -------
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Deferred tax assets:
Net operating losses....................................... $ 9,143 $ 8,514
Loan loss reserves......................................... -- 1,014
Sublease loss.............................................. -- 9
Accrued expenses........................................... 234 126
Alternative minimum tax credits............................ 218 218
Bad debt expense........................................... 455 --
Nonaccrual interest........................................ 108 --
Other...................................................... 18 180
-------- -------
Total deferred tax assets.................................. 10,176 10,061
-------- -------
Deferred tax liabilities:
State taxes................................................ (1) 583
Depreciation............................................... 88 --
Loan Fees.................................................. (36) 2
-------- -------
Total deferred tax liabilities............................. 51 585
-------- -------
Net deferred tax asset....................................... 10,125 9,476
Valuation allowance.......................................... (10,125) (9,476)
-------- -------
Deferred tax asset, net of valuation allowance............... $ -- $ --
======== =======
</TABLE>
Management believes that the temporary differences resulting in the ending
deferred tax asset are expected to reverse within the next three to five
years. These temporary differences will generate deductions which will be
available to offset future taxable income in the period that these differences
reverse. To the extent that these reversing timing differences are in excess
of taxable income, they will generate additional operating loss carryforwards.
For tax purposes at December 31, 1996, the Company had federal net operating
loss carryforwards of $22.3 million, which begin to expire in the year 2007.
The Bank has California net operating loss carryforwards of $11.8 million, of
which $1.2 million expire in the year 1997, $686,000 expire in 1998 and the
remaining
F-23
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
expiring thereafter. Future losses will not result in income tax benefits to
the Company until it generates sufficient taxable income to exhaust the
present net operating loss carryforward. In addition, the Bank has an AMT
credit carryforward of $218,000 which carryforward indefinitely.
NOTE 12--BENEFIT PLANS
Stock Option Plans. The Company has three stock option plans established in
1983, 1990 and 1994, respectively (together, the "Plans"). The Plans offer
executives and other key employees an opportunity to purchase shares of the
Company's common stock. The Plans provide for both nonqualified and incentive
stock options and specify a maximum ten-year term for each option granted.
Options are granted at exercise prices not less than the fair market value of
the stock at the date of grant and are exercisable as determined by the Board
of Directors.
Stock appreciation rights entitling the holder to exercise an option by
taking any appreciation over the option exercise price in stock or, with the
consent of the Board of Directors Stock Option Committee, in cash, also may be
granted under the 1990 plan. A stock associated option is exercisable, and is
exercisable only for such period as the Stock Option Committee may determine.
As of December 31, 1996, 200,000 appreciation rights had been granted under
the 1990 plan.
At December 31, 1996, 10,300 option shares were vested and exercisable under
the Plans. The remaining shares under option become exercisable as follows:
1997--218,938; 1998--18,937; 1999--18,937; and 2000--12,063. Following is a
summary of changes in stock options under the Plans.
<TABLE>
<CAPTION>
OPTION
PRICE
RANGE PER
SHARE
-----------
<S> <C> <C>
Outstanding, January 1, 1994........................ 318,044 $2.50-$5.00
Granted........................................... 55,000 $4.00
Canceled.......................................... (65,123) $2.50-$5.00
Exercised......................................... (33,700) $2.50-$3.00
--------
Outstanding, December 31, 1994...................... 274,221 $2.87-$5.00
Granted........................................... 80,000 $3.13-$3.63
Canceled.......................................... (53,296) $2.87-$5.00
--------
Outstanding, December 31, 1995...................... 300,925 $3.00-$5.00
Granted........................................... 269,750 $1.06-$1.88
Canceled.......................................... (291,500) $1.38-$4.00
--------
Outstanding, December 31, 1996...................... 279,175 $1.06-$1.88
========
</TABLE>
On February 28, 1992 the Board of Directors granted an option to purchase
12,000 shares of the Company's common stock to a director of the Company at a
price of $2.87 per share. As of December 31, 1996 all 12,000 shares were
vested and exercisable.
On January 18, 1991 and June 26, 1992 the Board of Directors granted an
option to purchase 12,000 shares of the Company's common stock each to two
directors at $4.50 and $2.25, respectively. These options expired unexercised
on March 28, 1995 and October 8, 1995, respectively.
The estimated fair value of options granted during 1996 and 1995 was $0.63
and $1.60 per share, respectively. The Company applies Accounting Principles
Board Opinion No. 25 and related Interpretations in
F-24
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
accounting for its stock option and purchase plans. Accordingly, no
compensation cost has been recognized for its stock option plan. Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," encourages, but does not require, companies to record
compensation cost for stock-based employee compensation plans at fair value.
The company has chosen to continue to account for stock-based compensation
using the intrinsic value method prescribed in Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees," and related
Interpretations. Accordingly, compensation cost for stock options is measured
as the excess, if any, of the quoted market price of the Company's stock at
the date of the grant over the amount an employee must pay to acquire the
stock.
Had compensation cost for the Company's stock option plan been determined
based on the fair value at the grant dates for awards under the plan
consistent with the method of SFAS No. 123, the Company's net loss for the
years ended December 31, 1996 and 1995 would have been increased by $23,000
and $6,000, respectively. The net loss per share would not have changed for
1996 or 1995.
The fair values of options granted under the Company's fixed stock option
plan during 1996 and 1995 were estimated on the date of grant using the Black-
Scholes option-pricing model with the following weighted-average assumptions
used: no dividend yield, expected volatility of 81%, risk-free interest rate
of 6.3%, and expected lives of 10 years.
Defined Contribution Retirement Plan. The Company maintains a Defined
Contribution Retirement Plan under section 401(k) of the Internal Revenue
Code. Employees are eligible to participate following six months of continuous
employment. Under the plan, employee contributions were partially matched by
the Company through August 31, 1995. The plan remains in force for employee
contributions only. Such matching becomes vested when the employee reaches
three years of service. Plan expense was $16,000 and $33,000 in 1995 and 1994,
respectively.
NOTE 13--PARENT COMPANY INFORMATION
The following financial information presents the balance sheets of the
Company on a parent-only basis as of December 31, 1996 and 1995, and the
related statements of operations and cash flows for each of the years in the
three-year period ended December 31, 1996.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1996 1995
-------- --------
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Cash with the Bank......................................... $ 11 $ 9
Investment in the Bank..................................... 4,834 6,002
-------- --------
Total Assets............................................. $ 4,845 $ 6,011
======== ========
Liabilities................................................ $ -- $ --
Shareholders' equity:
Common stock............................................. 24,614 24,614
Accumulated deficit...................................... (19,693) (18,449)
Net unrealized (loss) gain on securities available-for-
sale.................................................... (76) (154)
-------- --------
Total shareholders' equity............................... 4,845 6,011
-------- --------
Total liabilities and shareholders' equity................. $ 4,845 $ 6,011
======== ========
</TABLE>
F-25
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER
31,
-------------------------
1996 1995 1994
------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Interest income...................................... $ 2 $ 2 $ 18
Other income......................................... -- 730 --
------- ------- -------
Total operating income............................... 2 732 18
Other operating expense.............................. 145 85 87
------- ------- -------
Loss before equity in undistributed net loss of the
Bank.............................................. (143) 647 (69)
Equity in undistributed net loss of the Bank......... (1,680) (7,847) (8,458)
------- ------- -------
Net loss before provision for income tax benefit..... $(1,823) $(7,200) $(8,527)
Income tax benefit................................... (579) -- --
------- ------- -------
Net loss............................................. $(1,244) $(7,200) $(8,527)
======= ======= =======
STATEMENTS OF CASH FLOWS
<CAPTION>
YEARS ENDED DECEMBER
31,
-------------------------
1996 1995 1994
------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss............................................ $(1,244) $(7,200) $(8,527)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Equity in undistributed net loss of the Bank Other,
net............................................... 1,680 7,847 8,458
Other, net......................................... -- -- 1
------- ------- -------
Net cash provided by (used in) operating
activities....................................... 436 647 (68)
Cash flows from investing activities:
Investment in Bank.................................. (434) (700) (500)
------- ------- -------
Net cash used in investing activities.............. (434) (700) (500)
Cash flows from financing activities:
Net proceeds from issuance of common stock.......... -- -- 89
------- ------- -------
Net cash provided by financing activities.......... -- -- 89
------- ------- -------
Net increase (decrease) in cash and cash equivalents. 2 (53) (479)
Cash and cash equivalents, beginning of year......... 9 62 541
------- ------- -------
Cash and cash equivalents, end of year............... $ 11 $ 9 $ 62
======= ======= =======
</TABLE>
F-26
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
NOTE 14--AVAILABILITY OF FUNDS FROM BANK
The Company is a legal entity separate and distinct from the Bank. At
present, substantially all of the Company's revenues come from interest earned
on deposits held in the Bank (see Note 13). Management believes the Company's
cash balance plus interest revenues, on a separate-entity basis, are adequate
to cover its modest level of operating expenses.
The prior approval of the OCC is required if the total of all dividends
declared by a national bank in any calendar year exceeds the Bank's net income
for that year combined with its retained net income for the preceding two
years, less any required transfers to surplus. As a result of these
limitations and net losses incurred by the Bank, the Bank could not have
declared dividends to the Company at December 31, 1996 without the prior
approval of the OCC.
The OCC also has authority under the Financial Institutions Supervisory Act
to prohibit the Bank from engaging in activities that the OCC regards as
unsafe or unsound in conducting its business. It is possible that, depending
upon the financial condition of the Bank and other factors, the OCC could
assert that the payment of dividends or other payments is, under some
circumstances, considered to be an unsafe or unsound practice. Further, future
cash dividends by the Bank to the Company will depend upon management's
assessment of the Bank's future capital requirements (see Note 2).
In addition, federal law restricts the Bank's extension of credit to, or the
issuance of a guarantee or letter of credit on behalf of, the Company.
Investments in stock or other securities of the Company are similarly
restricted as is the taking of such securities as collateral for loans.
Restrictions prevent the Company from borrowing from the Bank unless the loans
are secured by designated amounts of marketable obligations. Further, secured
loans to and investments in the Company or its affiliates by the Bank are
limited to 10% of the Bank's capital stock and surplus (as defined by federal
regulations) and are limited, in the aggregate, to 20% of the Bank's
contributed capital (as defined by federal regulations).
NOTE 15--SUPPLEMENTAL CASH FLOW INFORMATION
The following information supplements the statements of cash flows:
<TABLE>
<CAPTION>
1996 1995 1994
------ ------ -------
(DOLLARS IN
THOUSANDS)
<S> <C> <C> <C>
Interest paid........................................... $3,147 $4,294 $ 5,628
Income tax refunds...................................... 579 77 35
Non-Cash Investing and Financing Transactions:
Real estate loans transferred to OREO................. -- -- 2,285
Loans transferred to other assets..................... -- -- 1,459
Loans transferred to loans held-for-sale.............. -- -- 7,450
Loans made in conjunction with the sale of OREO....... -- -- 1,400
Securities held-to-maturity transferred to available-
for-sale............................................. -- -- 15,605
Unrealized gain (loss) on securities available-for-
sale................................................. 78 2,903 (3,453)
</TABLE>
NOTE 16--SEVERANCE COSTS
In connection with the Company's restructuring of the Bank to reduce
operating expenses, employees were terminated, resulting in severance costs of
$141,000 and $333,000 for the years ended December 31, 1995 and 1994,
respectively. Included in the total 1994 cost was $132,000 related to the
employment agreement of a former senior officer of the Bank which was
terminated by mutual agreement.
F-27
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
NOTE 17--DISCLOSURES ABOUT THE FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of financial instruments at December 31, 1996 and
1995, are presented below.
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1995
---------------- ----------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- ------- -------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Financial Assets:
Cash and cash equivalents.................. $28,113 $28,113 $30,272 $30,272
Securities available-for-sale.............. 4,002 4,002 20,102 20,102
Securities held-to-maturity................ 14,395 14,355 -- --
Loans, net of allowance for credit losses.. 59,578 59,450 78,207 76,496
Financial Liabilities:
Demand deposits, money market and savings.. 63,206 63,206 73,144 73,144
Time certificates of deposit............... 40,648 41,015 47,099 46,965
Securities sold under agreement to
repurchase................................ -- -- 4,497 4,497
Off Balance Sheet Financial Instruments:
Commercial and standby letters of credit... -- 175 -- 413
</TABLE>
The estimated fair value amounts have been determined using pertinent
information available to management as of December 31, 1996 and 1995.
Considerable judgment is required to interpret this information and develop
the estimates of fair value. Although management is not aware of any factors
which would significantly affect the estimated fair value amounts, such
amounts have not been comprehensively revalued for purposes of these financial
statements since that date and, therefore, current estimates of fair value may
differ significantly from the amounts presented therein.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practical to estimate
that value.
Cash, cash equivalents and interest-bearing deposits: For those short-term
investments, the carrying amount is a reasonable estimation of fair value,
except for securities purchased under agreements to resell, for which fair
value is based on quoted market prices.
Trading and debt securities: For securities held for trading purposes, debt
securities held-to-maturity and available-for-sale, fair values are based on
dealer quotes or quoted market prices, if available. If a quoted market price
is not available, fair value is estimated using quoted market prices for
similar securities.
Loans: Variable rate loans have carrying amounts that approximate fair
value. The fair value of fixed rate loans is estimated by discounting the
future cash flows using the current rates at which similar loans would be made
to borrowers with similar credit ratings and for the same remaining
maturities. In computing the estimated fair value for all loans, estimated
future cash flows have been reduced by specific and general reserves for loan
losses.
It was not practicable to estimate the fair value of nonaccrual loans of
approximately $900,000 at December 31, 1996, and $600,000 at December 31,
1995, because it is not practicable to reasonably assess the credit adjustment
that would be applied in the marketplace for such loans.
Demand deposits and time certificates of deposit: The fair value of demand
deposits, money market accounts and savings deposits is the amount payable on
demand at the reporting date. The fair value of fixed-maturity certificates of
deposit is estimated using the rates currently offered for deposits of similar
maturities.
F-28
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
Securities sold under agreements to repurchase: The carrying value for this
short-term debt is a reasonable approximation of its fair value.
Commercial and standby letters of credit: The fair value of standby and
commercial letters of credit is based on fees currently charged for similar
agreements.
NOTE 18--QUARTERLY FINANCIAL DATA (UNAUDITED)
Quarterly financial information for the years ended December 31, 1996 and
1995 is presented below.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
---------------------------------------------
JUNE
MARCH 31, 30, SEPTEMBER 30, DECEMBER 31,
1996 1996 1996 1996
--------- ------- ------------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Interest income.................. $ 2,345 $ 2,228 $ 2,121 $ 2,063
Interest expense................. 892 781 718 688
------- ------- ------- -------
Net interest income............ 1,453 1,447 1,403 1,375
Net loss on sale of securities
available-for-sale.............. (1) -- -- (2)
Other operating income........... 169 116 124 96
Other operating expense.......... (1,757) (2,839) (1,709) (1,698)
------- ------- ------- -------
Net loss before income tax
benefit......................... $ (136) $(1,276) $ (182) $ (229)
Income tax benefit............... -- (579) -- --
------- ------- ------- -------
Net loss......................... $ (136) $ (697) $ (182) $ (229)
======= ======= ======= =======
Net loss per share............... $ (0.04) $ (0.23) $ (0.06) $ (0.07)
======= ======= ======= =======
<CAPTION>
THREE MONTHS ENDED
---------------------------------------------
JUNE
MARCH 31, 30, SEPTEMBER 30, DECEMBER 31,
1995 1995 1995 1995
--------- ------- ------------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Interest income.................. $ 3,458 $ 3,064 $ 2,871 $ 2,241
Interest expense................. 1,190 988 857 944
------- ------- ------- -------
Net interest income............ 2,268 2,076 2,014 1,297
Provision for credit losses...... (146) (381) (1,720) (60)
Net loss on securities available-
for-sale........................ (1,156) (47) (6) (24)
Loss on termination of interest-
rate swap....................... -- (1,294) -- --
Loss on other real estate owned.. -- (169) -- (564)
Other operating income........... 371 1,151 204 219
Other operating expense.......... (3,037) (3,089) (3,013) (2,094)
------- ------- ------- -------
Net loss......................... $(1,700) $(1,753) $(2,521) $(1,226)
======= ======= ======= =======
Net loss per share............... $ (0.55) $ (0.57) $ (0.82) $ (0.40)
======= ======= ======= =======
</TABLE>
F-29
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
NOTE 19--SUBSEQUENT EVENT
On February 10, 1997, the Company filed with the Securities and Exchange
Commission ("Commission") a Registration Statement on Form S-2 pursuant to the
Securities Act of 1933 with respect to a proposed rights offering (the "Rights
Offering") to its shareholders and certain qualified investors. The Rights
Offering provides for the purchase of a minimum of $2.5 million to a maximum
of $6.5 million of 6.5% noncumulative convertible preferred stock ("Preferred
Stock") with a $10.00 stated value, for a subscription price per share
currently undetermined. In connection with the Rights Offering, the Company
plans to offer to qualified institutional investors a minimum of $1.0 million
to a maximum of $2.5 million of Preferred Stock. The maximum available to
qualified institutional investors is subject to a reduction based on the level
of shareholder participation.
In addition the Company entered into private purchase agreements with two
investors, Conrad Company, a bank holding company which is controlled by Carl
Pohlad, and Wildwood Enterprises, Inc. Profit Sharing Plan and Trust (the
"Private Offering"). The Private Offering provides for the acquisition of a
minimum of $2.5 million to a maximum of $5.5 million of Preferred Stock at a
purchase price per share of the lower of $1.10 ($10.00 after the reverse stock
split discussed below) or the subscription price in the Rights Offering. The
Preferred Shares available in the Private Offering are subject to a reduction
based on the level of shareholder participation. The minimum amount to be
raised in the Rights Offering and the Private Offering (collectively the
"Offerings") will be $8.0 million consisting of $5.5 million in the Private
Offering and $2.5 million in the Rights Offering by qualified institutional
investors assuming no rights are exercised by the shareholders. The maximum
amount to be raised in the Offerings will be $9.0 million, consisting of $6.5
million in the Rights Offering and $2.5 million in the Private Offering
assuming 100% of the rights are exercised by the shareholders. However, the
maximum amount raised of $9.0 million may be achieved should the level of
shareholder participation exceed 18.2%.
The completion of the Offerings is conditioned upon (i) the receipt by the
Company of proceeds of at least $5.5 million, (ii) shareholder approval of a
9.09 to 1 reverse stock split, (iii) shareholder approval of a limitation on
the acquisition by any person (other than persons to whom the Company is
contractually obligated on or before the date of the Offerings to transfer up
to 4.9% of the Preferred Stock) of the Preferred Stock or Common Stock if such
acquisition would cause that person's aggregate ownership to be equal to or in
excess of 4.5% (or 4.9% as described above) of the shares of the Company's
stock, as the term is defined, and such ownership is determined, under Section
382 of the Internal Revenue Code of 1996, as amended, (a "4.5% Holder") and a
restriction on the acquisition, sale, assignment or transfer of Common Stock
held by any current 4.5% Holder of the Company, (iv) shareholder approval of
the terms and conditions of the Preferred Stock, and (v) approval by the
Federal Reserve Board of an application filed by Conrad Company to acquire
more than 4.9% of the voting stock of the Company.
The primary purposes of the Offerings are to enable the Company to
downstream sufficient capital to the Bank to comply with the requirements of
the 1995 Formal Agreement and the 1995 MOU and to facilitate the
implementation of the Company's and Bank's operating strategies. Proceeds from
the Offerings will not be used to pay dividends on the Preferred Stock.
Notwithstanding the foregoing, the Company may not pay dividends unless the
Bank is in full compliance with federal regulatory capital requirements, the
Company and the Bank are permitted to pay dividends by their regulators and
the Company has adequate retained earnings in accordance with California law.
At present, the Company is prohibited by the terms of the 1995 MOU from
declaring or paying a dividend without prior approval of the Reserve Bank and
does not have adequate retained earnings to declare a dividend in compliance
with California law.
F-30
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NO PERSON HAS BEEN AUTHORIZED IN CONNECTION WITH ANY OFFERING MADE HEREBY TO
GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATION OTHER THAN AS CONTAINED IN
THIS PROSPECTUS, AND IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST
NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY NATIONAL MERCANTILE BANCORP OR
SANDLER O'NEILL. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OFFERED HEREBY TO ANY PERSON OR
BY ANYONE IN ANY JURISDICTION IN WHICH IT IS UNLAWFUL TO MAKE SUCH OFFER OR
SOLICITATION. NEITHER THE DELIVERY OF THE PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL UNDER ANY CIRCUMSTANCES CREATE ANY IMPLICATION THAT THE
INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE
HEREOF.
----------------
TABLE OF CONTENTS
----------------
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Available Information..................................................... 4
Documents Incorporated by Reference....................................... 4
Prospectus Summary........................................................ 5
Summary Selected Consolidated Financial and Other Data.................... 17
Summary of Recent Developments............................................ 19
Risk Factors.............................................................. 21
The Company............................................................... 29
The Private Offering...................................................... 37
The Rights Offering....................................................... 40
Certain Federal Income Tax Consequences................................... 51
Standby Purchasers........................................................ 54
Reasons for the Public Offering and the Private Offering and Use of
Proceeds................................................................. 56
Dilution.................................................................. 56
Capitalization............................................................ 57
Market Price of Common Stock and Dividends................................ 58
Selected Consolidated Financial Data...................................... 59
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 61
Business.................................................................. 75
Estimated Fair Value of Investment Securities and Debt Securities......... 86
Regulation................................................................ 92
Shareholdings of Certain Beneficial Owners and Management................. 102
Directors and Executive Officers.......................................... 103
Description of Capital Stock.............................................. 104
Legal Matters............................................................. 109
Experts................................................................... 109
Index to Financial Statements............................................. F-1
</TABLE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
[LOGO OF NATIONAL MERCANTILE BANCORP]
NATIONAL MERCANTILE BANCORP
6.5% NONCUMULATIVE
CONVERTIBLE PREFERRED STOCK
$2.5 MILLION (MINIMUM)
$8.0 MILLION (MAXIMUM)
----------------
PROSPECTUS
----------------
MAY 13, 1997
Sandler O'Neill & Partners, l.p.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The expenses to be paid by the Registrant in connection with the offering
described in this Registration Statement, other than underwriting discounts
and commissions, are as follows (all amounts are estimated except the SEC,
Nasdaq and NASD filing fees):
<TABLE>
<S> <C>
SEC filing fee................................................. $ 2,425
Nasdaq listing fees............................................ 3,250
NASD filing fee................................................ 1,300
Printing and engraving fees.................................... 100,000
Accounting fees and expenses................................... 412,000
Legal fees and expenses........................................ 505,000
Blue sky fees and expenses..................................... 27,000
Transfer agent and registrar's fees and expenses............... 5,000
Subscription agent fees and expenses........................... 5,000
Information agent fees and expenses............................ 12,000
Miscellaneous.................................................. 28,000
----------
Total...................................................... $1,100,975
==========
</TABLE>
ITEM 15. INDEMNIFICATION OF OFFICERS AND DIRECTORS
Article X of the Registrant's Articles of Incorporation, as amended,
provides that the liability of the directors of the corporation for monetary
damages shall be eliminated to the fullest extent permissible under California
law. Article XI of the Registrant's Articles of Incorporation, as amended,
provides that the corporation is authorized to provide for the indemnification
of agents (as defined in Section 317 of the California General Corporation
Law) in excess of that expressly permitted by such Section 317, subject to the
limitations set forth in the General Corporation Law of California, for breach
of duty to the corporation and its stockholders through bylaw provisions or
through agreements, or both.
Article V of the Registrant's amended Bylaws provides as follows:
ARTICLE VI
Indemnification
Section 5.01. Definitions. For the purposes of this Article, "agent"
includes any person who is or was a director, officer, employee, or other
agent of the Corporation, or is or was serving at the request of the
Corporation as a director, officer, employee or agent of the Corporation, or
is or was serving at the request of the Corporation as a director, officer,
employee or agent of a foreign or domestic corporation, partnership, joint
venture, trust or other enterprise, or was a director, officer, employee or
agent of a foreign or domestic corporation which was a predecessor corporation
of the Corporation or of another enterprise at the request of such predecessor
corporation; "proceeding" includes any threatened, pending or completed action
or proceeding, whether civil, criminal, administrative or investigative; and
"expenses" includes without limitation attorneys' fees and any expenses of
establishing a right to indemnification under Section 5.04 or Section 5.05(c)
of these Bylaws.
II-1
<PAGE>
Section 5.02. Indemnification in Actions by Third Parties. The Corporation
shall have the power to indemnify any person who was or is a party or is
threatened to be made a party to any proceeding (other than an action by, or
in the right of, the Corporation) by reason of the fact that such person is or
was an agent of the Corporation, against expenses, judgments, fines,
settlements, and other amounts actually and reasonably incurred in connection
with such proceeding if he acted in good faith and in a manner he reasonably
believed to be in the best interests of the Corporation and, in the case of a
criminal proceeding, had no reasonable cause to believe the conduct of such
person was unlawful. The termination of any proceeding by judgment, order,
settlement, conviction, or upon a plea of nolo contendere or its equivalent
shall not, of itself, create a presumption that the person did not act in good
faith and in a manner he reasonably believed to be in the best interests of
the Corporation or that he had reasonable cause to believe that his conduct
was unlawful.
Section 5.03. Indemnification in Actions by or in the Right of the
Corporation. The Corporation shall have the power to indemnify any person who
was or is a party or is threatened to be made a party to any threatened,
pending, or completed action by, or in the right of, the Corporation to
procure a judgment in its favor by reason of the fact that such person is or
was an agent of the Corporation against expenses actually and reasonably
incurred in connection with the defense or settlement of such action if he
acted in good faith, in a manner he believed to be in the best interests of
the Corporation, and with such care, including reasonable inquiry, as an
ordinarily prudent person in a like position would use under similar
circumstances. No indemnification shall be made under this Section:
(A) in respect of any claim, issue, or matter as to which such person shall
have been adjudged to be liable to the Corporation in the performance of his
duty to the Corporation, unless and only to the extent that the court in which
such action was brought shall determine upon application that, in view of all
the circumstances of the case, he is fairly and reasonably entitled to
indemnity for the expenses which such court shall determine;
(B) of amounts paid in settling or otherwise disposing of a threatened or
pending action, with or without court approval; or
(C) of expenses incurred in defending a threatened or pending action which
is settled or otherwise disposed of without court approval.
Section 5.04. Indemnification Against Expenses. To the extent that an agent
of the Corporation has been successful on the merits in defense of any
proceeding referred to in Section 5.02 or 5.03 of these Bylaws or in defense
of any claim, issue or matter therein, he shall be indemnified against his
expenses actually and reasonably incurred in connection therewith.
Section 5.05. Required Determinations. Except as provided in Section 5.04 of
these Bylaws, any indemnification under this Article shall be made by the
Corporation only if authorized in the specific case, upon a determination that
indemnification of the agent is proper under the circumstances because the
agent has met the applicable standard of conduct set forth in Section 5.02 or
5.03 of these Bylaws by:
(A) a majority vote of a quorum consisting of directors who are not parties
to such proceeding;
(B) approval of the shareholders, with the shares owned by the person to be
indemnified not being entitled to vote thereon; or
(C) the court in which such proceeding is or was pending upon application
made by the Corporation or the agent or the attorney or other person rendering
services in connection with the defense, whether or not such application by
the agent, attorney or other person is opposed by the Corporation.
Section 5.06. Advance of Expenses. Expenses incurred in defending any
proceeding may be advanced by the Corporation before the final disposition of
such proceeding upon receipt of an undertaking by or on behalf of the agent or
repay such amount unless it shall be determined ultimately that the agent is
not entitled to be indemnified as authorized in this Article.
II-2
<PAGE>
Section 5.07. Other Indemnification. No provision made by the Corporation to
indemnify the directors or officers of the Corporation, or a subsidiary of the
Corporation for the defense of any proceeding, whether contained in the
Articles of Incorporation, Bylaws, a resolution of the shareholders or
directors, an agreement or otherwise, shall be valid unless consistent with
Section 317 of the California General Corporation Law. Nothing contained in
this Article shall affect any right to indemnification to which persons other
than such directors and officers may be entitled by contract or otherwise.
Section 5.08. Forms of Indemnification Not Permitted. No indemnification or
advance shall be made under this Article, except as provided in Section 5.04
or Section 5.05(c) of these Bylaws in any circumstance where it appears:
(A) that it would be inconsistent with a provision of the Articles of
Incorporation, Bylaws, a resolution of the shareholders or an agreement in
effect at the time of the accrual of the alleged cause of action asserted in
the proceeding in which the expenses were incurred or other amounts were paid,
which prohibits or otherwise limits indemnification; or
(B) that it would be inconsistent with any condition expressly imposed by a
court in approving a settlement.
Section 5.09. Insurance. The Corporation shall have the power to buy and
maintain insurance on behalf of any agent of the Corporation against any
liability asserted against or incurred by the agent in such capacity or
arising out of the agent's status as such whether or not the Corporation would
have the power to indemnify the agent against such liability under the
provisions of this Article.
Section 5.10. Nonapplicability to Fiduciaries of Employee Benefit
Plans. This Article does not apply to any proceeding against any trustee,
investment manager or other fiduciary of an employee benefit plan in his
capacity as such, even though he may also be an agent of the Corporation as
defined in Section 5.01 of these Bylaws. Nothing contained in this Article
shall limit any right to indemnification to which such trustee, investment
manager or other fiduciary may be entitled by contract or otherwise which
shall be enforceable to the extent permitted by applicable law other than
Section 317 of the California General Corporation Law.
ITEM 16. EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <S>
1.1 Form of Agency Agreement**
3.1 Articles of Incorporation of the Company, as amended(1)
3.2 Amended and Restated Bylaws of the Company(3)
3.3 Form of Amended and Restated Articles of Incorporation**
4.1 Subscription Right Certificate**
5. Opinion of Manatt, Phelps & Phillips, LLP**
8. Tax opinion of Manatt, Phelps & Phillips, LLP**
10.1 Memorandum of Understanding dated October 25, 1991 between the
Federal Reserve Bank of San Francisco and the Company(2)
10.2 Memorandum of Understanding dated October 26, 1995 between the
Federal Reserve Bank of San Francisco and the Company(6)
10.3 Formal Agreement dated July 26, 1991 between the Office of the
Comptroller of the Currency and Mercantile National Bank(2)
10.4 Amendment to the Agreement by and between Mercantile National Bank
and the Office of the Comptroller of the Currency dated December 14,
1995(6)
10.5 Employment Agreement, dated June 21, 1996 between Mercantile National
Bank and Scott A. Montgomery(9)
10.6 Financial Institution Services Agreement dated April 8, 1993 between
Mercantile National Bank and Linsco/Private Ledger(4)
10.7 Form of Indemnity Agreement between the Company and its directors(1)
Form of Indemnity Agreement between the Company and its executive
10.8 officers(1)
10.9 First Floor Lease at 1840 Century Park East, Los Angeles, California,
dated as of December 21, 1982 between Northrop Corporation and
Mercantile National Bank(3)
</TABLE>
II-3
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <S>
10.10 Second Floor Lease at 1840 Century Park East, Los Angeles, California,
dated as of December 21, 1982 between Northrop Corporation and
Mercantile National Bank for space at 1840 Century Park East, Los
Angeles, California, as amended by Amendment to Second Floor Lease
dated as of June 7, 1986, and as amended by Second Amendment to
Second Floor Lease dated as of December 18, 1992 between California
State Teachers' Retirement System and Mercantile National Bank(3)
10.11 Lease Restructure Agreement dated December 31, 1995 by and between
California State Teachers' Retirement System and Mercantile National
Bank(6)
10.12 Warrant Agreement dated December 31, 1995 by and between National
Mercantile Bancorp and California State Teachers' Retirement System(6)
10.13 Registration Rights Agreement dated December 31, 1995 by and between
the Company and California State Teachers' Retirement System(6)
10.14 National Mercantile Bancorp 1983 Stock Option Plan, as amended March
22, 1991(2)
10.15 Form of Stock Option Agreement under the 1983 Stock Option Plan(3)
10.16 National Mercantile Bancorp 1990 Stock Option Plan(7)
10.17 Form of Stock Option Agreement under the 1990 Stock Option Plan(3)
10.18 National Mercantile Bancorp 1994 Stock Option Plan(8)
10.19 Form of Stock Option Agreement under the 1994 Stock Option Plan(5)
10.20 Form of Severance Agreement between the Company, Mercantile National
Bank and some of its officers(9)
10.21 Form of Stay Bonus Agreement between the Company, Mercantile National
Bank and some of its officers(10)
10.22 Private Purchase Agreement (Conrad)**
10.23 Private Purchase Agreement (Wildwood)**
10.24 Form of Standby Purchase Agreement**
10.25 Registration Rights Agreement (Conrad)**
10.26 Form of Registration Rights Agreement (Wildwood)**
10.27 Form of First Amendment to Letter Agreement (Conrad)**
10.28 Form of First Amendment to Letter Agreement (Wildwood)**
11. Statement regarding computation of per share earnings (see "Note 1--
Summary of Significant Accounting Policies--Income (Loss) Per
Share"--of the "Notes to the Consolidated Financial Statements" in
"Item 8. Financial Statements" in this Annual Report on Form 10-K)
22. Subsidiaries of the Registrant**
23.1 Consent of Deloitte & Touche LLP+
23.2 Consent of Manatt, Phelps & Phillips, LLP (included in Exhibit 5)**
24. Power of Attorney (see page II-10)
99.1 Instructions as to Use of Subscription Right Certificates**
99.2 Form of Letter to Shareholders**
99.3 Form of Letter to Nominee Holders**
99.4 Form of Nominee Holder Oversubscription Certification**
99.5 Form of Letter from Nominee Holders to Beneficial Owners**
99.6 Form of Special Notice to Shareholders whose addresses are outside the
United States and Canada**
99.7 Form of Notice of Guaranteed Delivery**
99.8 DTC Participant Oversubscription Exercise Form**
99.9 Form of Information Agent Agreement**
99.10 Form of Subscription Agent Agreement*
</TABLE>
- --------
+ Included in this amendment.
** Previously filed.
(1) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
year ended December 31, 1990 and incorporated herein by reference.
(2) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
year ended December 31, 1991 and incorporated herein by reference.
II-4
<PAGE>
(3) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
year ended December 31, 1992 and incorporated herein by reference.
(4) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
year ended December 31, 1993 and incorporated herein by reference.
(5) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
year ended December 31, 1994 and incorporated herein by reference.
(6) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
year ended December 31, 1995 and incorporated herein by reference.
(7) Filed as an exhibit to the Company's Proxy Statement dated May 24, 1990
and incorporated herein by reference.
(8) Filed as an exhibit to the Company's Proxy Statement dated April 18, 1994
and incorporated herein by reference.
(9) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1995 and incorporated herein by reference.
(10) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for
the quarter ended September 30, 1995.
ITEM 17. UNDERTAKINGS
The undersigned registrant hereby undertakes as follows:
1. To file, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement:
i. To include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933;
ii. To reflect in the prospectus any facts or events arising after the
effective date of the registration statement (or the most post-effective
amendment thereof) which, individually or in the aggregate, represent a
fundamental change in the information set forth in the registration
statement. Notwithstanding the foregoing, any increase or decrease in
volume of securities offered (if the total dollar value of securities
offered would not exceed that which was registered) and any deviation from
the low or high end of the estimated maximum offering range may be
reflected in the form of prospectus filed with the Commission pursuant to
Rule 424(b) if, in the aggregate, the changes in volume and price represent
no more than a 20% change in the maximum aggregate offering price set forth
in the "Calculation of Registration Fee" table in the effective
registration statement;
iii. To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or any
material change to such information in the registration statement;
PROVIDED, HOWEVER, that paragraphs 1(i) and 1(ii) do not apply if the
registration statement is on Form S-3 or Form S-8, and the information
required to be included in a post-effective amendment by those paragraphs is
contained in the periodic reports filed with or furnished to the Commission by
the registrant pursuant to Section 13 or Section 15(d) of the Securities
Exchange Act of 1934, as amended, that are incorporated by reference to the
registration statement.
2. That, for the purposes of determining any liability under the Securities
Act of 1933, each such post-effective amendment shall be deemed to be a new
registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial
bona fide offering thereof.
3. To remove from registration by means of a post-effective amendment any of
the securities being registered which remain unsold at the termination of the
offering.
4. That, for purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed as part of
the registration statement in reliance upon Rule 430A and contained in a form
of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or
497(h) under the Securities Act of 1933 shall be deemed to be part of the
registration statement as of the time it was declared effective.
II-5
<PAGE>
5. That, for the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of prospectus
shall be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities
Act of 1933 and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment of the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act of 1933 and will be governed by the final adjudication of such
issue.
6. To supplement the prospectus, after the expiration of the subscription
period, to set forth the results of the subscription offer, the transactions
by the underwriters during the subscription period, the amount of unsubscribed
securities to be purchased by the underwriters, and the terms of any
subsequent reoffering thereof. If any public offering by the underwriters is
to be made on terms differing from those set forth on the cover page of the
prospectus, a post-effective amendment will be filed to set forth the terms of
such offering.
7. To deliver or cause to be delivered with the prospectus, to each person
to whom the prospectus is sent or given, the latest annual report to
securityholders that is incorporated by reference in the prospectus and
furnished pursuant to and meeting the requirements of Rule 14a-3 or Rule 14c-3
under the Securities Exchange Act of 1934; and, where interim financial
information required to be presented by Article 3 of Regulation S-X are not
set forth in the prospectus, to deliver, or cause to be delivered to each
person to whom the prospectus is sent or given, the latest quarterly report
that is specifically incorporated by reference in the prospectus to provide
such interim financial information.
II-6
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-2 and has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in Los Angeles, State of California, on May 15, 1997.
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Scott A. Montgomery and Robert E. Thomson his
or her true and lawful attorneys-in-fact and agents, each with full power of
substitution and resubstitution, for him or her and in his or her name, place
and stead, in any and all capacities, to sign any and all amendments to this
Registration Statement, and to file the same, with the Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents full power and
authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises, as fully to all intents and
purposes as he or she might or could do in person, hereby ratifying and
confirming all that such attorneys-in-fact and agents, or their substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
NATIONAL MERCANTILE BANCORP
By: /s/ Howard P. Ladd
----------------------------------
Howard P. Ladd
Chairman of the Board
By: /s/ Joseph W. Kiley III
----------------------------------
Joseph W. Kiley III
Chief Financial Officer
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the date indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ Howard P. Ladd Chairman, President and May 15, 1997
____________________________________ Chief Executive Officer
Howard P. Ladd
/s/ Scott A. Montgomery Executive Vice President May 15, 1997
____________________________________ and Director
Scott A. Montgomery
/s/ Joseph W. Kiley III Executive Vice President, May 15, 1997
____________________________________ Chief Financial Officer
Joseph W. Kiley III and Director
/s/ Alan Grahm Director May 15, 1997
____________________________________
Alan Grahm
/s/ A. Thomas Hickey Director May 15, 1997
____________________________________
A. Thomas Hickey
/s/ Robert E. Thomson Director May 15, 1997
____________________________________
Robert E. Thomson
/s/ Robert E. Gipson Director May 15, 1997
____________________________________
Robert E. Gipson
</TABLE>
II-7
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NO. DESCRIPTION PAGE
------- ----------- ------------
<C> <S> <C>
1.1 Form of Agency Agreement**
3.1 Articles of Incorporation of the Company, as amended(1)
3.2 Amended and Restated Bylaws of the Company(3)
Form of Amended and Restated Articles of
3.3 Incorporation**
4.1 Subscription Right Certificate**
5. Opinion of Manatt, Phelps & Phillips, LLP+
8. Tax opinion of Manatt, Phelps & Phillips, LLP**
10.1 Memorandum of Understanding dated October 25, 1991
between the Federal Reserve Bank of San Francisco and
the Company(2)
10.2 Memorandum of Understanding dated October 26, 1995
between the Federal Reserve Bank of San Francisco and
the Company(6)
10.3 Formal Agreement dated July 26, 1991 between the Office
of the Comptroller of the Currency and Mercantile
National Bank(2)
10.4 Amendment to the Agreement by and between Mercantile
National Bank and the Office of the Comptroller of the
Currency dated December 14, 1995(6)
10.5 Employment Agreement, dated June 21, 1996 between
Mercantile National Bank and Scott A. Montgomery(9)
10.6 Financial Institution Services Agreement dated April 8,
1993 between Mercantile National Bank and
Linsco/Private Ledger(4)
10.7 Form of Indemnity Agreement between the Company and its
directors(1)
Form of Indemnity Agreement between the Company and its
10.8 executive officers(1)
10.9 First Floor Lease at 1840 Century Park East, Los
Angeles, California, dated as of December 21, 1982
between Northrop Corporation and Mercantile National
Bank(3)
10.10 Second Floor Lease at 1840 Century Park East, Los
Angeles, California, dated as of December 21, 1982
between Northrop Corporation and Mercantile National
Bank for space at 1840 Century Park East, Los Angeles,
California, as amended by Amendment to Second Floor
Lease dated as of June 7, 1986, and as amended by
Second Amendment to Second Floor Lease dated as of
December 18, 1992 between California State Teachers'
Retirement System and Mercantile National Bank(3)
10.11 Lease Restructure Agreement dated December 31, 1995 by
and between California State Teachers' Retirement
System and Mercantile National Bank(6)
10.12 Warrant Agreement dated December 31, 1995 by and
between National Mercantile Bancorp and California
State Teachers' Retirement System(6)
10.13 Registration Rights Agreement dated December 31, 1995
by and between the Company and California State
Teachers' Retirement System(6)
10.14 National Mercantile Bancorp 1983 Stock Option Plan, as
amended March 22, 1991(2)
10.15 Form of Stock Option Agreement under the 1983 Stock
Option Plan(3)
10.16 National Mercantile Bancorp 1990 Stock Option Plan(7)
10.17 Form of Stock Option Agreement under the 1990 Stock
Option Plan(3)
10.18 National Mercantile Bancorp 1994 Stock Option Plan(8)
10.19 Form of Stock Option Agreement under the 1994 Stock
Option Plan(5)
10.20 Form of Severance Agreement between the Company,
Mercantile National Bank and some of its officers(9)
10.21 Form of Stay Bonus Agreement between the Company,
Mercantile National Bank and some of its officers(10)
10.22 Private Purchase Agreement (Conrad)**
10.23 Private Purchase Agreement (Wildwood)**
10.24 Form of Standby Purchase Agreement**
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NO. DESCRIPTION PAGE
------- ----------- ------------
<C> <S> <C>
10.25 Registration Rights Agreement (Conrad)**
10.26 Form of Registration Rights Agreement (Wildwood)**
10.27 Form of First Amendment to Letter Agreement (Conrad)**
10.28 Form of First Amendment to Letter Agreement
(Wildwood)**
11. Statement regarding computation of per share earnings
(see "Note 1--Summary of Significant Accounting
Policies--Income (Loss) Per Share"--of the "Notes to
the Consolidated Financial Statements" in "Item 8.
Financial Statements" in this Annual Report on Form
10-K)
22. Subsidiaries of the Registrant**
23.1 Consent of Deloitte & Touche LLP**
23.2 Consent of Manatt, Phelps & Phillips, LLP (included in
Exhibit 5)**
24. Power of Attorney (see page II-10)
99.1 Instructions as to Use of Subscription Right
Certificates**
99.2 Form of Letter to Shareholders**
99.3 Form of Letter to Nominee Holders**
99.4 Form of Nominee Holder Oversubscription Certification**
99.5 Form of Letter from Nominee Holders to Beneficial
Owners**
99.6 Form of Special Notice to Shareholders whose addresses
are outside the United States and Canada**
99.7 Form of Notice of Guaranteed Delivery**
99.8 DTC Participant Oversubscription Exercise Form**
99.9 Form of Information Agent Agreement**
99.10 Form of Subscription Agent Agreement**
</TABLE>
- --------
** Previously filed.
(1) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
year ended December 31, 1990 and incorporated herein by reference.
(2) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
year ended December 31, 1991 and incorporated herein by reference.
(3) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
year ended December 31, 1992 and incorporated herein by reference.
(4) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
year ended December 31, 1993 and incorporated herein by reference.
(5) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
year ended December 31, 1994 and incorporated herein by reference.
(6) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
year ended December 31, 1995 and incorporated herein by reference.
(7) Filed as an exhibit to the Company's Proxy Statement dated May 24, 1990
and incorporated herein by reference.
(8) Filed as an exhibit to the Company's Proxy Statement dated April 18, 1994
and incorporated herein by reference.
(9) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1995 and incorporated herein by reference.
(10) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for
the quarter ended September 30, 1995.
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+ +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
PROSPECTUS
[LOGO OF NATIONAL MERCANTILE BANCORP]
NATIONAL MERCANTILE BANCORP
6.5% NONCUMULATIVE CONVERTIBLE PREFERRED STOCK, $10.00 STATED VALUE
$2.5 MILLION (MINIMUM)
$8.0 MILLION (MAXIMUM)
-----------
National Mercantile Bancorp (the "Company") is hereby distributing to holders
of the Company's common stock, no par value (the "Common Stock"), of record at
the close of business on May 5, 1997 (the "Record Date"), nontransferable
rights (the "Rights") to subscribe for and purchase up to $5.5 million (550,000
shares) of its 6.5% noncumulative convertible preferred stock, $10.00 stated
value (the "Preferred Stock"), at a price of $10.00 per share (the
"Subscription Price"), subject to reduction by the Company under certain
circumstances (the "Rights Offering"). Shareholders will receive one Right for
each share of Common Stock (after giving effect to the Reverse Stock Split
described below) held as of the Record Date. Holders of Rights (the "Rights
Holders") may exercise their Rights until 5:00 p.m., Pacific Time, on June 13,
1997, unless extended by the Company (the "Expiration Time"). Each Right
entitles the Rights Holder to subscribe for 1.624 shares (the "Underlying
Preferred Shares") of Preferred Stock (the "Basic Subscription Privilege") at
the Subscription Price. Each share of the Preferred Stock will be immediately
convertible at the option of the holder thereof at the initial rate of one
share of Common Stock for each share of Preferred Stock based on an initial
conversion price of $10.00 per share, subject to adjustment. See "Description
of Capital Stock."
The Company has not shown a profit in each of the past three years and is
unable to assess at this time whether it will return to profitability during
1997. The Company cannot assess at this time its ability to pay dividends in
the immediate future.
(continued on next page)
THE PURCHASE OF PREFERRED STOCK IN THE PUBLIC OFFERING INVOLVES A
SIGNIFICANT DEGREE OF INVESTMENT RISK. RIGHTS HOLDERS AND STANDBY
PURCHASERS ARE URGED TO READ AND CAREFULLY CONSIDER THE INFORMATION
SET FORTH UNDER THE HEADING "RISK FACTORS" ON PAGE 21.
THE SECURITIES OFFERED HEREBY ARE NOT SAVINGS OR DEPOSIT ACCOUNTS AND ARE
NOT INSURED OR GUARANTEED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION
OR ANY OTHER GOVERNMENTAL AGENCY.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION (THE "COMMISSION") OR ANY STATE SECURITIES COMMISSIONER
NOR HAS THE COMMISSION OR ANY STATE SECURITIES COMMISSIONER PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
<TABLE>
- -----------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------
<CAPTION>
SUBSCRIPTION UNDERWRITERS' PROCEEDS
PRICE COMMISSIONS(1) TO COMPANY(2)
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share
Total Minimum.................................... $10.00 $250,000 $6,650,000
Total Maximum.................................... $10.00 $372,500 $7,527,500
- -----------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------
</TABLE>
(1) Sandler O'Neill & Partners, L.P. ("Sandler O'Neill") will receive 3% of the
aggregate purchase price of the shares of Preferred Stock sold in the
Rights Offering (except for Rights exercised in Arizona) and 5% of the
aggregate value of funds committed by Standby Purchasers. Sandler O'Neill
will receive 1.5% of the aggregate value of funds committed in the Private
Offering. The Company has agreed to reimburse Sandler O'Neill for its
reasonable out-of-pocket expenses, including fees of legal counsel, and has
agreed to indemnify Sandler O'Neill against certain liabilities under the
securities laws.
(2) Before deducting expenses of the Public Offering and the Private Offering
payable by the Company estimated at $1.1 million.
-----------
Sandler O'Neill & Partners, l.p.
-----------
The date of this Prospectus is May 13, 1997
<PAGE>
(continued from previous page)
Pursuant to a private offering exemption from the registration requirements
of the Securities Act of 1933, as amended (the "Securities Act"), the Company
entered into purchase agreements (the "Private Purchase Agreements") with two
purchasers (collectively, the "Private Purchasers"). The Private Purchasers
have severally agreed, subject to certain conditions, to purchase and the
Company has agreed to sell (the "Private Offering"), in the aggregate, up to
$5.5 million (550,000 shares) (the "Maximum Private Offering") of Preferred
Stock at a purchase price (the "Private Purchasers Price") equal to $1.10 per
share (equal to $10.00 after giving effect to a 9.09 to 1 reverse stock split
of the Common Stock (the "Reverse Stock Split") that the Company plans to
effect prior to the closing of the Public Offering and the Private Offering
and after obtaining shareholder approval), subject to reduction under certain
circumstances. The Company has guaranteed the availability of an aggregate
minimum of $2.5 million (250,000 shares) of Preferred Stock to the Private
Purchasers at the Private Purchasers Price (the "Private Purchasers Minimum
Obligation") irrespective of the number of shares available after the exercise
of the Basic Subscription Privilege. The offer and sale of shares pursuant to
the Private Purchase Agreements is hereinafter referred to as the "Private
Offering." See "The Private Offering."
Each Rights Holder who fully exercises the Basic Subscription Privilege will
be eligible to subscribe for 0.376 shares of Preferred Stock (the "Excess
Underlying Preferred Shares"), for each Right held, which remain available
after the exercise of the Basic Subscription Privilege and giving effect to
the Private Offering, subject to availability, proration and reduction by the
Company under certain circumstances (the "Oversubscription Privilege"). A
Rights Holder's election to exercise the Oversubscription Privilege must be
made at the time the Basic Subscription Privilege is exercised. Once a Rights
Holder has exercised the Basic Subscription Privilege or the Oversubscription
Privilege, such exercise may not be revoked. The maximum amount of Preferred
Stock available to Rights Holders under the Basic Subscription Privilege and
the Oversubscription Privilege is $5.5 million.
The Company anticipates that it will enter into purchase agreements (the
"Standby Purchase Agreements") pursuant to which certain institutional
investors (the "Standby Purchasers") would severally agree, subject to certain
conditions, to purchase $2.5 million (250,000 shares) of Preferred Stock at
the Subscription Price (the "Maximum Standby Offering"), to the extent
available after the exercise of the Basic Subscription Privilege, the
consummation of the Private Offering and the exercise of the Oversubscription
Privilege (the "Standby Purchaser Offering"). Such Standby Purchasers are
expected to require the Company to sell an aggregate minimum of $1.0 million
(100,000 shares) of Preferred Stock at the Subscription Price even if a
sufficient number of shares of Preferred Stock is not available after the
exercise of the Basic Subscription Privilege, the consummation of the Private
Offering and the exercise of the Oversubscription Privilege (the "Minimum
Standby Obligation"). See "The Standby Purchasers." The Rights Offering and
the Standby Purchaser Offering may sometimes be referred to collectively as
the "Public Offering."
The minimum amount to be raised in the Public Offering and the Private
Offering will be $8.0 million (assuming no rights are exercised in the Rights
Offering), consisting of $5.5 million (550,000 shares) of Preferred Stock
purchased by the Private Purchasers and $2.5 million (250,000 shares) of
Preferred Stock purchased by the Standby Purchasers. The maximum amount to be
raised in the Public Offering and the Private Offering will be $9.0 million,
consisting of $5.5 million (550,000 shares) pursuant to the Rights Offering,
$2.5 million (250,000 shares) of Preferred Stock purchased by the Private
Purchasers and $1.0 million (100,000 shares) of Preferred Stock purchased by
the Standby Purchasers. The maximum amount which could be raised in the Public
Offering will be $8.0 million, consisting of $5.5 million (550,000 shares) of
Preferred Stock pursuant to the Rights Offering and $2.5 million (250,000
shares) of Preferred Stock pursuant to the Maximum Standby Offering.
The number of Underlying Preferred Shares issuable by the Company as a
result of exercises of the Basic Subscription Privilege and the
Oversubscription Privilege in the aggregate or to any Rights Holder, the
Private Purchasers or the Standby Purchasers may be limited by the Company, if
necessary, with certain exceptions, in its sole
judgment and discretion, to reduce the risk that certain tax benefits will be
subject to limitation under Section 382 of the Internal Revenue Code of 1986,
as amended (the "Code"), or the risk of any other adverse tax consequences to
the Company, either at the time of the Public Offering and the Private
Offering or at any subsequent time. See "The Rights Offering--Limitations--Tax
Limitation." The number of shares issuable by the Company to the Private
Purchasers also may be limited by the Company pursuant to the terms of the
Private Purchase Agreements. See "The Private Offering."
2
<PAGE>
THE COMPLETION OF THE PUBLIC OFFERING AND THE PRIVATE OFFERING IS SUBJECT TO
CERTAIN CONDITIONS INCLUDING, BUT NOT LIMITED TO, THE RECEIPT BY THE COMPANY
OF MINIMUM PROCEEDS OF $5.5 MILLION (THE "MINIMUM CONDITION"). EVEN IF THE
PRIVATE OFFERING IS NOT CONSUMMATED, THE PUBLIC OFFERING COULD CLOSE AND THE
MINIMUM CONDITION SATISFIED IF THE RIGHTS HOLDERS SUBSCRIBE FOR AT LEAST $3.0
MILLION OF PREFERRED STOCK AND THE STANDBY PURCHASERS PURCHASE $2.5 MILLION OF
PREFERRED STOCK. IN THE EVENT THE MINIMUM CONDITION IS NOT ACHIEVED, ANY FUNDS
THAT HAVE BEEN DEPOSITED WITH THE SUBSCRIPTION AGENT WILL BE RETURNED
PROMPTLY, WITHOUT INTEREST. SEE "THE PRIVATE OFFERING--CONDITIONS TO CLOSING;
AMENDMENT AND TERMINATION" AND "THE RIGHTS OFFERING--MINIMUM CONDITION."
The Rights will not be transferable. There will be no trading market for the
Rights. The Company intends to apply to the National Association of Securities
Dealers Automated Quotation ("Nasdaq") Stock Market ("Nasdaq Stock Market")
for quotation of the Preferred Stock on the Small Cap tier Nasdaq Stock Market
under the trading symbol "MBLAP" if there are an adequate number of publicly
held shares of Preferred Stock to meet the requirements of Nasdaq. No
assurance can be given that there will be an adequate number of publicly held
shares or that a market will develop for the Preferred Stock. On April 23, the
last reported trade price of the Common Stock as quoted on the Small Cap tier
of the Nasdaq Stock Market under the symbol "MBLA" was $1.50. See "Market
Price for Common Stock and Dividends."
3
<PAGE>
or deduction promptly after the Expiration Time
and after all prorations and adjustments
contemplated by the Public Offering and the
Private Offering have been effected.
Oversubscription Privileges are not transferable.
If 45.5% of the Basic Subscription Privilege is
exercised by the Rights Holders, and assuming
$5.5 million of Preferred Stock is sold pursuant
to the Private Offering, participation in the
Oversubscription Privilege will not be available
to the Rights Holders.
Standby Purchasers..........
The Company anticipates that it will enter into
the Standby Purchase Agreements prior to the
commencement of the Rights Offering pursuant to
which certain institutional investors will
severally agree to acquire from the Company a
portion of any shares of Preferred Stock
remaining after the exercise of the Basic
Subscription Privilege, the consummation of the
Private Offering and the exercise of the
Oversubscription Privilege Rights subject to a
maximum standby purchase commitment. The Standby
Purchase Agreements are expected to require that
the Company sell an aggregate minimum of $1.0
million (100,000 shares) of Preferred Stock at
the Subscription Price even if sufficient shares
of Preferred Stock are not available after
issuance of all shares of Preferred Stock
subscribed for by the exercise of the Basic
Subscription Privilege, the consummation of the
Private Offering and the exercise of the
Oversubscription Privilege (the "Minimum Standby
Obligation"). In any such case, the Company will
issue sufficient new shares to satisfy such
Minimum Standby Obligation. The number of shares
issuable to any Standby Purchasers may be limited
by the Company, if necessary, with certain
exceptions, in the sole judgment and discretion
of the Company, to reduce the risk that certain
tax benefits will be subject to limitation under
Section 382 or the risk of any other adverse tax
consequence to the Company, either at the time of
the Public Offering and the Private Offering or
at any subsequent time. See "The Rights
Offering--Tax Limitation" and "Standby
Purchasers." Purchases by Standby Purchasers
pursuant to the Standby Purchase Agreements also
will be subject to limitations based on certain
regulatory requirements. See "The Rights
Offering--Regulatory Limitation" and "Standby
Purchasers." The Standby Purchasers (or their
transferees) will not be able to offer or sell
the shares of Preferred Stock (or shares of
Common Stock into which such shares of Preferred
Stock are convertible) acquired in the Public
Offering in the State of California. This
condition will continue to apply until such time
as it is removed by the State of California. See
"Standby Purchasers."
Reasons for the Public
Offering and the Private
Offering...................
The Board of Directors decided to conduct both
the Private Offering and the Public Offering (i)
to minimize the dilutive effect of the Private
Offering and the Standby Purchaser Offering to
current shareholders, (ii) to ensure, through the
Private Offering, that the Company would obtain
sufficient capital to meet bank regulatory re-
quirements and (iii) to finance the Company's
business strategy in the event the Company's
shareholders chose not to participate in the
Rights Offering.
Transferability of Rights... THE RIGHTS ARE NOT TRANSFERABLE.
May 5, 1997
Record Date.................
Subscription Price..........
$10.00 per share. Shares purchased by the Private
Purchasers will be purchased at the Subscription
Price. Shares purchased by Standby Purchasers
pursuant to the Standby Purchase Agreements shall
be at the Subscription Price. See "The Private
Offering--Subscription Price."
Expiration Time.............
The Rights will expire if not exercised prior to
5:00 p.m., Pacific Time, on June 13, 1997, unless
extended in the sole discretion of the Company.
The number and length of any such extensions will
be set at the time of any such extension. See
"The Rights Offering-- Expiration Time." RIGHTS
NOT EXERCISED PRIOR TO THE EXPIRATION TIME WILL
EXPIRE AND BECOME WORTHLESS.
10
<PAGE>
Preferred Stock
Outstanding................ No shares of Preferred Stock are currently out-
standing. Giving effect to the Private Purchasers
Maximum Offering and the Maximum Standby Offer-
ing, a minimum of 800,000 shares of Preferred
Stock will be outstanding after the completion of
the Public Offering and the Private Offering.
Giving effect to the exercise in full of the Ba-
sic Subscription Privilege, the Private Purchas-
ers Minimum Obligation and the Minimum Standby
Obligation, a maximum of 900,000 shares of Pre-
ferred Stock will be outstanding after the com-
pletion of the Public Offering and the Private
Offering. Rights Holders may experience substan-
tial dilution of their equity ownership interest
and voting power in the Company if they do not
exercise the Basic Subscription Privilege and the
Oversubscription Privilege. Even if Rights Hold-
ers exercise their Basic Subscription Privilege
and Oversubscription Privilege in full, they will
experience dilution due to the Private Purchasers
Minimum Obligation and the Minimum Standby Obli-
gation. See "Risk Factors--Dilution of Ownership
Interest," "Dilution," and "Business--Legal
Proceedings."
Subscription Agent.......... U.S. Stock Transfer Corporation
Information Agent........... Kissel-Blake Inc.
Financial Advisor........... The Company and Sandler O'Neill have entered into
an agreement pursuant to which Sandler O'Neill is
acting as the Company's financial advisor in con-
nection with the Public Offering and the Private
Offering. The Company has agreed to pay certain
fees to, and expenses of, Sandler O'Neill for its
services in the Public Offering and the Private
Offering. See "The Rights Offering--Financial Ad-
visor."
Procedure for Exercising
Rights................ The Basic Subscription Privilege and the
Oversubscription Privilege may be exercised by
properly completing the Subscription Right Cer-
tificate distributed to each Rights Holder and
forwarding it (or following the Guaranteed Deliv-
ery Procedures, as defined below) with payment of
the Subscription Price for each Underlying Share
subscribed for pursuant to the Basic Subscription
Privilege and the Oversubscription Privilege, to
the Subscription Agent, which must receive such
Subscription Right Certificate or Notice of Guar-
anteed Delivery and payment at or prior to the
Expiration Time. If Subscription Right Certifi-
cates are sent by mail, Rights Holders are urged
to use insured, registered mail, return receipt
requested. See "The Rights Offering--Method of
Subscription."
If the aggregate Subscription Price paid by an
exercising Rights Holder is insufficient to pur-
chase the number of Underlying Preferred Shares
that the Rights Holder indicates are being sub-
scribed for, or if no number of Underlying Pre-
ferred Shares to be purchased is specified, then
the Rights Holder will be deemed to have exer-
cised the Basic Subscription Privilege to pur-
chase Underlying Preferred Shares to the full ex-
tent of the payment price tendered. If the aggre-
gate Subscription Price paid by an exercising
Rights Holder exceeds the amount necessary to
purchase the number of Underlying Preferred
Shares for which the Rights Holder has indicated
an intention to subscribe, then the Rights Holder
will be deemed to have exercised the
Oversubscription Privilege to the full extent of
the excess payment tendered.
11
<PAGE>
Adjustment of Conversion Ratio
Section 305 of the Code renders taxable certain actual or constructive
distributions of stock with respect to stock and convertible securities.
Regulations promulgated under Section 305 provide that an adjustment in the
conversion ratio of convertible preferred stock made pursuant to a bona fide,
reasonable formula which has the effect of preventing dilution of the interest
of the holders of such stock will not be considered to result in a taxable
dividend under Section 301 of the Code. Any adjustment in the conversion ratio
of the Preferred Stock to reflect taxable distributions on the Common Stock
would be treated as a constructive distribution of stock to the holders of
Preferred Stock and would be taxable as a dividend to the extent of current or
accumulated earnings and profits of the Company. The amount of the dividend to
a holder of Preferred Stock resulting from such an adjustment would be
measured by the fair market value of the additional Common Stock (or fraction
thereof) that would be obtainable as a result of adjustment of the conversion
price. Because the adjustments to the conversion price could occur more than
three years after the date of a taxable stock dividend, there can be no
assurance and none is hereby given that an adjustment to the conversion ratio
of the Preferred Stock will not result in a taxable dividend under Section
301.
GENERAL BACK UP WITHHOLDING AND REPORTING REQUIREMENTS
Under Section 3406 of the Code and applicable Treasury regulations, a holder
of Preferred Stock may be subject to backup withholding tax at the rate of 31%
with respect to dividends paid on or the proceeds of a sale or redemption of
Preferred Stock, as the case may be. The payor will be required to deduct and
withhold the tax if (a) the payee fails to furnish a taxpayer identification
number ("TIN") to the payor or fails to certify under the penalty of perjury
that such TIN is correct, (b) the IRS notifies the payor that the TIN
furnished by the payee is incorrect, (c) there has been a notified payee under
reporting with respect to interest, dividends or original issue discount
described in Section 3406(c) of the Code, or (d) there has been a failure of
the payee to certify under the penalty of perjury that the payees is not
subject to withholding under Section 3406(a)(1)(C) of the Code. As a result,
if any one of the events discussed above occurs, the payor will be required to
withhold a tax equal to 20% from any payment of dividends or proceeds made
with respect to the Preferred Stock unless an exemption applies under
applicable law and is established in a manner acceptable to the payor. Reports
will be made annually or otherwise as may be required to the IRS and to the
holders of record that are not excepted from such reporting requirements with
respect to distributions on the Preferred Stock. Such reporting will be made
on IRS Form 1099 or on such other form as may be prescribed under the rules
issued by the IRS.
STANDBY PURCHASERS
Prior to the commencement of the Rights Offering, the Company will seek to
enter into Standby Purchase Agreements pursuant to which certain institutional
investors as Standby Purchasers will severally agree, subject in each case to
a maximum standby commitment and to certain conditions, to purchase up to $2.5
million (250,000 shares) of Preferred Stock at the Subscription Price to the
extent available after exercise of the Basic Subscription Privilege, the sale
of shares in the Private Offering and the exercise of the Oversubscription
Privilege. The Company expects that the Standby Purchasers will require the
Company to sell, and the Standby Purchasers will purchase, an aggregate
minimum of $1.0 million (100,000 shares) of Preferred Stock if a sufficient
number of shares of Preferred Stock is not available after the exercise of the
Basic Subscription Privilege, the sale of shares in the Private Offering and
the Oversubscription Privilege. The obligations of the Standby Purchasers will
not be subject to the purchase of any minimum number of shares pursuant to the
exercise of the Rights, but are subject to certain conditions, including that
the Public Offering shall have been conducted substantially in the manner
described in the Prospectus for the Public Offering.
The Company anticipates that each Standby Purchase Agreement will provide
that it may be terminated by the Standby Purchaser only upon the occurrence of
any of the following events: (i) a material adverse change in the Company's
financial condition prior to the expiration of the Public Offering from that
existing at December 31, 1996 (except as disclosed in the Prospectus) ; (ii) a
suspension in the trading in the Common
54
<PAGE>
Stock, a general suspension of trading or establishment of limited or minimum
prices on the Nasdaq Stock Market, any banking moratorium, any suspension of
payments with respect to banks in the United States or a declaration of war or
a national emergency by the United States; (iii) under any circumstances which
would result in the Standby Purchaser, individually or together with any other
person or entity, being required to register as a depository institution
holding company under federal or state laws or regulations, or to submit an
application, or notice, to a federal bank regulatory authority to acquire or
retain control of a depository institution or depository institution holding
company; or (iv) if the Public Offering, including sales of Preferred Stock to
Standby Purchasers, is not completed by June 30, 1997 through no fault of the
Standby Purchaser.
If the Company believes that the number of Underlying Preferred Shares
issuable by the Company pursuant to the Standby Purchase Agreements, both in
the aggregate and to any individual purchaser, will have an adverse effect
upon the Company's ability to utilize the NOL carryforwards, then the Company
may reduce the number of shares issuable to the Standby Purchasers, either pro
rata or individually to each Standby Purchaser whose purchase of Preferred
Stock may create such an adverse effect. Such reduction will be made to the
minimum extent necessary, with certain exceptions, in the sole opinion and
discretion of the Company after consultation with its tax advisor, to
accomplish avoidance of such adverse effect. Based on current circumstances,
the Company does not anticipate that it will have to reduce the number of
shares issued to Standby Purchasers to avoid an adverse effect upon the
Company's ability to utilize such federal income tax benefits. See "Risk
Factors--Possible Loss of Tax Benefit."
The Department of Corporations of the State of California (the "Department")
has advised the Company that the permit to be granted for the Public Offering
will provide that the Standby Purchasers (or their transferees) may not offer
or sell, in the State of California, any of the shares of Preferred Stock (or
shares of Common Stock into which such shares of Preferred Stock are
convertible) which the Standby Purchasers acquire in the Public Offering. The
condition will continue to apply until such time as the Company files, and the
Department approves, an application to remove such condition. The Company
understands that one of the factors the Department considered in placing this
condition was that the Company had not shown a net profit in the last several
years. The Company intends to file an application with the Department to
remove such condition as soon as practicable after such time as the Company's
results of operations for a fiscal year reflect a net profit. A Standby
Purchaser also may seek to qualify an offer or sale by a Standby Purchaser
with the Department.
55
<PAGE>
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in this Post-Effective Amendment
No. 1 to the Registration Statement No. 333-21455 of National Mercantile Bancorp
on Form S-2/A of our report dated March 7, 1997 (which expresses an unqualified
opinion and includes an explanatory paragraph relating National Mercantile
Bancorp and Subsidiary's ability to continue as a going concern) appearing in
and incorporated by reference in the Annual Report on Form 10-K of National
Mercantile Bancorp for the year ended December 31, 1996, and to the reference to
us under the heading of "Experts" in the Prospectus, which is a part of this
Registration Statement.
DELOITTE & TOUCHE LLP
Los Angeles, California
May 15, 1997
