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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE YEAR ENDED DECEMBER 31, 1996 COMMISSION FILE NUMBER 0-15982
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
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (310) 277-2265
NO SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, NO PAR VALUE
(TITLE OF CLASS)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. [X] Yes [_] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of the
registrant, based upon the closing sale price of its Common Stock as reported
by the National Association of Securities Dealers Automated Quotation System
on March 14, 1997, was approximately $6,049,000.
The number of shares of Common Stock, no par value, of the registrant
outstanding as of March 14, 1997 was 3,078,146.
DOCUMENTS INCORPORATED BY REFERENCE:
Certain portions of the Company's Proxy Statement to be filed with the
Commission pursuant to Rule 14a-6 under the Securities Exchange Act of 1934 in
connection with the Company's 1997 Annual Meeting of Shareholders are
incorporated by reference in Part III, Items 10-13 of this Annual Report on
Form 10-K.
THIS REPORT INCLUDES A TOTAL OF 86 PAGES
INDEX TO EXHIBITS ON PAGE E-1
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NATIONAL MERCANTILE BANCORP
TABLE OF CONTENTS AND
CROSS REFERENCE SHEET
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
PAGE(S) IN
FORM 10-K
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PART I
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<C> <S> <C>
Item 1. Business.................................................. 1
Item 2. Properties................................................ 14
Item 3. Legal Proceedings......................................... 14
Item 4. Submission of Matters to a Vote of Security Holders....... 15
PART II
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Item 5. Market for the Registrant's Common Stock and Related
Stockholder Matters...................................... 15
Item 6. Selected Financial Data................................... 16
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations...................... 18
Item 8. Financial Statements and Supplementary Data............... 54
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure...................... 54
PART III
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Item 10. Directors and Executive Officers of the Registrant*....... 54
Item 11. Executive Compensation*................................... 54
Item 12. Security Ownership of Certain Beneficial Owners and
Management*.............................................. 54
Item 13. Certain Relationships and Related Transactions*........... 54
PART IV
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Item 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K.................................................. 55
Signatures.......................................................... 56
Financial Statements F-1
Exhibit Index....................................................... E-1
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* Incorporated by reference to National Mercantile Bancorp's Proxy Statement
to be filed with the Commission pursuant to Rule 14a-6 under the Securities
Exchange Act of 1934 in connection with the Company's 1997 Annual Meeting of
Shareholders.
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PART I
ITEM 1. BUSINESS
Certain matters discussed in this Annual Report may constitute forward-looking
statements within the meaning of the Private Securities Litigation Reform Act
of 1995 (the "Reform Act") and as such may involve risks and uncertainties.
These forward-looking statements relate to, among other things, expectations
of the business environment in which the Company operates, projections of
future performance, perceived opportunities in the market and statements
regarding the Company's mission and vision. The Company's actual results,
performance, or achievements may differ significantly from the results,
performance, or achievements expressed or implied in such forward-looking
statements. For discussion of the factors that might cause such a difference,
see "Item 1. Business--Factors that May Affect Future Results."
NATIONAL MERCANTILE BANCORP
National Mercantile Bancorp (the "Company") is a corporation which was
organized under the laws of the State of California on January 17, 1983 and is
registered as a bank holding company under the Bank Holding Company Act of
1956, as amended (the "BHC Act"). The Company's principal asset is the capital
stock of Mercantile National Bank (the "Bank"), which became its wholly-owned
subsidiary on May 31, 1984. The Company's principal business is to serve as a
holding company for the Bank, and for other banking or banking-related
subsidiaries which the Company may establish or acquire. On February 6, 1986,
the Federal Reserve Bank of San Francisco ("Reserve Bank") approved the
Company to engage in lending activities. The Reserve Bank as part of its
regulatory oversite may conduct examinations of the Company and its
subsidiaries.
Due to the deterioration in the Company's financial condition and
operations, the bank regulatory authorities designated the Company for special
supervisory attention. Following a regulatory examination in late 1990 and
early 1991, the Company entered into a Memorandum of Understanding (the "1991
MOU") with the Reserve Bank. The Reserve Bank's examination of the Company as
of June 30, 1993 found the Company to be in substantial compliance with all
provisions of the 1991 MOU, but determined that the Company continued to
require supervisory attention. As a result of the Reserve Bank's examination
of the Company as of March 31, 1995, the Company entered into a Memorandum of
Understanding (the "1995 MOU") with the Reserve Bank on October 26, 1995,
which supersedes and replaces the 1991 MOU. For additional information
concerning the 1995 MOU, see "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations--Regulatory Agreements."
As a legal entity separate and distinct from its subsidiary, the Company's
principal source of funds is, and will continue to be, dividends paid to the
Company by the Bank. Legal limitations are imposed on the amount of dividends
that may be paid and loans that may be made by the Bank to the Company (see
Note 14 of the accompanying Notes to Consolidated Financial Statements).
Pursuant to 1995 MOU with the Reserve Bank the Company agreed to not pay any
dividends without the prior written approval of the Reserve Bank. (See "Item
7. Management's Discussion and Analysis of Financial Condition and Results of
Operations--Capital Resources and Liquidity, and Regulatory Agreements.")
MERCANTILE NATIONAL BANK
GENERAL
The Bank was organized on October 29, 1981, as a national banking
association and obtained a Certificate of Authority to commence the business
of banking from the Office of the Comptroller of the Currency (the "OCC")
effective March 22, 1982. As a result of certain deficiencies noted in the
Bank by the OCC during examinations conducted during 1990 and 1991, the Bank
entered into a formal regulatory agreement with the OCC on July 26, 1991 (the
"1991 Formal Agreement"). The 1991 Formal Agreement was superseded and
replaced in its entirety by an agreement dated December 14, 1995 (the "1995
Formal Agreement"). For additional information concerning the 1995 Formal
Agreement, see "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations--Regulatory Agreements."
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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 service area, a four mile radius from
its headquarters. 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 hospitals/medical centers and
numerous health-service related companies in West Los Angeles. The Bank also
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. The Bank's primary business activities are to
generate deposits and loans. In addition, the Bank provides investment and
specialized deposit services, handling the needs of large deposit clients.
OPERATING STRATEGY
The operating strategy of the Bank will be to continue building upon the
Bank's established market niches of business and private banking and
entertainment. The Bank also plans a market expansion 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.
Business Banking Division
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, on-
line banking and investment services.
Private Banking Division
Products sold by the Private Banking Division include personal lines of
credit, investment services, term loans, professional practice development
loans, cash management services, on-line 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.
Health Services. The Bank has served the medical community in its primary
service area for a number of years. Based on its proximity to several major
hospital/medical centers and numerous health service-related companies, the
Bank plans to expand its focus in the medical community. The Bank is located
in the center of one of the major medical markets in Los Angeles.
Technology/Multimedia Division
Products sold by the Technology/Multimedia Division will 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 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. The Bank anticipates that in
lending to 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 products. 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.
Acquisitions
Part of the Company's business strategy following the planned capital
raising activities is to acquire other financial service-related companies
including "in-market" acquisitions with banks of similar size and market
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presence. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations--Capital Resources and Liquidity, and
Regulatory Agreements." 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.
COMPETITION
The banking business in California generally, and in the Bank's primary
service area 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, as well
as with non-bank financial institutions, including savings and loan
associations, credit unions, thrift and loan companies, mortgage companies,
commercial finance lenders, and providers of money market accounts. 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
service area offer certain services, such as trust services, which are not
offered directly by the Bank and, by virtue of their greater total
capitalization, such banks have substantially higher lending limits than the
Bank.
To compete with other financial institutions in its primary service area,
the Bank relies principally upon personal contact by its officers, directors
and employees and providing, through third parties, specialized services such
as messenger services and escrow accounting services. For clients whose loan
demands exceed the Bank's legal lending limit, the Bank has arranged for such
loans on a participation basis with other banks. The Bank also assists clients
requiring other services not offered by the Bank in obtaining such services
from other providers.
PLANS TO RAISE ADDITIONAL CAPITAL
The Company plans to raise additional capital through the sale of preferred
stock. (For information concerning the Company's plans relating to capital
raising activities, see "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations--Capital Resources and
Liquidity, and Regulatory Agreements.")
MONETARY POLICY
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 clients and securities held in the Bank's investment
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 policies of various governmental
regulatory authorities, particularly the Board of Governors of the Federal
Reserve System (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
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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 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
"Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations."
RECENT LEGISLATION
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 (FDICIA)
PROMPT CORRECTIVE ACTION AND OTHER ENFORCEMENT MECHANISMS. Federal law
requires each federal banking agency to take prompt corrective action to
resolve the problems of insured depository institutions, including but not
limited to those that fall below one or more prescribed minimum capital
ratios. In accordance with federal law, each federal banking agency has
promulgated regulations defining the following five categories in which an
insured depository institution will be placed, based on the level of its
capital ratios: well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized and critically undercapitalized. An insured
depository institution will be classified in the following categories based,
in part, on the capital measures indicated below:
<TABLE>
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"WELL CAPITALIZED" "ADEQUATELY CAPITALIZED"
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Total risk-based capital of 10%; Total risk-based capital of 8%;
Tier 1 risk-based capital of 6%; and Tier 1 risk-based capital of 4%; and
Leverage ratio of 5%. Leverage ratio of 4%.
"UNDERCAPITALIZED" "SIGNIFICANTLY UNDERCAPITALIZED"
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Total risk-based capital less than 8%; Total risk-based capital less than 6%;
Tier 1 risk-based capital less than 4%; or Tier 1 risk-based capital less than 3%; or
Leverage ratio less than 4%. Leverage ratio less than 3%.
"CRITICALLY UNDERCAPITALIZED"
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Tangible equity to total assets less than 2%.
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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 1995 Formal Agreement. (See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Capital Resources and Liquidity, and 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
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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) 1831(o)); and (d) the types and levels of activities in which the
institution will engage; (ii) is based on realistic assumptions and is likely
to succeed in restoring the depository institution's capital; and (iii) would
not appreciably increase the risk (including credit risk, interest-rate risk,
and other types of risk) to which the institution is exposed. In addition,
each company controlling an undercapitalized depository institution must
guarantee that the institution will comply with the capital plan until the
depository institution has been adequately capitalized on average during each
of four consecutive calendar quarters and must otherwise provide appropriate
assurances of performance. The aggregate liability of such guarantee is
limited to the lesser of (a) an amount equal to 5% of the depository
institution's total assets at the time the institution became undercapitalized
or (b) the amount which is necessary to bring the institution into compliance
with all capital standards applicable to such institution as of the time the
institution fails to comply with its capital restoration plan. Finally, the
appropriate federal banking agency may impose any of the additional
restrictions or sanctions that it may impose on significantly undercapitalized
institutions if it determines that such action will further the purpose of the
prompt 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.
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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
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 Federal Deposit Insurance Corporation
(the "FDIC") has adopted final regulations implementing a risk-based premium
system required by federal law. On November 14, 1995, the FDIC issued
regulations that establish a new assessment-rate schedule ranging from 0 cents
per $100 of deposits to 27 cents per $100 of deposits applicable to members of
the Bank Insurance Fund ("BIF"). To determine the risk-based assessment for
each institution, the FDIC will categorize an institution as well capitalized,
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 also will 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).
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The BIF assessment rates are set forth below for institutions based on their
risk-based assessment categorization.
Assessment Rates Effective January 1, 1996*
<TABLE>
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GROUP A GROUP B GROUP C
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Well Capitalized.................................. 0 3 17
Adequately Capitalized............................ 3 10 24
Undercapitalized.................................. 10 24 27
</TABLE>
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* 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 was 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%).
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 BHC Act 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
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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.
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 as part of its
regulatory oversight 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 1995 MOU with the Reserve Bank on
October 26, 1995. The 1995 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 Item 7.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--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.
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
8
<PAGE>
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 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.
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 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
Securities Exchange Act of 1934 as amended, (the "Exchange Act"). Accordingly,
the Company is subject to certain rules and regulations promulgated by the
Securities and Exchange Commission (the "Commission"), including, among other
things, the periodic reporting requirements, the proxy solicitation 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 the 1995
Formal Agreement with the OCC dated December 14, 1995, which imposes certain
affirmative obligations and material restrictions on the Bank. See
9
<PAGE>
Item 7. "Management's Discussion and Analysis of Financial Condition and
Results of Operations--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.
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 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
10
<PAGE>
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 1995 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 1995 Formal Agreement. A capital plan was filed with the
OCC on February 8, 1996.
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% of assets classified doubtful; (c) 15%
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) 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.
11
<PAGE>
In March 1994, the federal Interagency Task Force on Fair Lending issued a
policy statement on discrimination in lending. The policy statement describes
the three methods that federal agencies will use to prove discrimination:
overt evidence of discrimination, evidence of disparate treatment and evidence
of disparate impact.
In connection with its assessment of CRA performance, the 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, are, and
will continue to be, primarily dividends paid by the Bank. In addition, under
the 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
12
<PAGE>
affiliates from borrowing from the Bank unless the loans are secured by
marketable obligations of designated amounts. Further, such secured loans and
investments by the Bank to or in the Company or to or in any other affiliate
is limited to 10% of the Bank's capital stock and surplus (as defined by
federal regulations) and such secured loans and investments are limited, in
the aggregate, to 20% of the Bank's capital stock and surplus (as defined by
federal regulations). California law also imposes certain restrictions with
respect to transactions involving the Company and other controlling persons of
the Bank. Additional restrictions on transactions with affiliates may be
imposed on the Bank under the prompt corrective action provisions of federal
law. See "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.
EMPLOYEES
As of March 14, 1997, the Company had 6 officers but no employees while the
Bank had 41 full-time equivalent employees including 3 of the Company's
officers. The Company and the Bank believe that the Bank's employee relations
with its employees are good and it has not encountered a strike or material
work stoppage.
FACTORS THAT MAY AFFECT FUTURE RESULTS
The following discusses certain factors which may affect the Company's
financial results and operations and should be considered in evaluating the
Company.
Economic Conditions and Geographic Concentration. The Company's operations
are located in Southern California. As a result of the geographic
concentration, the Company's results depend largely upon economic conditions
in these areas, which have been relatively volatile over the last several
years. While the Southern California economy recently has exhibited positive
economic and employment trends, there is no assurance that such trends will
continue. A deterioration in economic conditions could have material adverse
impact on the quality of the Company's loan portfolio and the demand for its
products and services.
Interest Rates. The Company anticipates that interest rate levels will
remain generally constant in 1997, but if interest rates vary substantially
from present levels, the Company's results may differ materially from the
results currently anticipated. Changes in interest rates will influence the
growth of loans, investments and deposits and affect the rates received on
loans and investment securities and paid on deposits.
Government Regulation and Monetary Policy. The banking industry is subject
to extensive federal and state supervision and regulation. Significant new
laws or changes in, or repeals of, existing laws may cause the Company's
results to differ materially. Further, federal monetary policy, particularly
as implemented through the Federal Reserve System, significantly affects
credit conditions for the Company, primarily through open market operations in
United States government securities, the discount rate for bank borrowings and
bank reserve requirements, and a material change in these conditions would be
likely to have a material impact on the Company's results.
Competition. The banking and financial services business in the Company's
market areas are highly competitive. The increasingly competitive environment
is a result primarily of changes in regulation, changes in technology and
product delivery systems, and the accelerating pace of consolidation among
financial services providers. The results of the Company may differ if
circumstances affecting the nature or level of competition change.
13
<PAGE>
Credit Quality. A significant source of risk arises from the possibility
that losses will be sustained because borrowers, guarantors and related
parties may fail to perform in accordance with the terms of their loans. The
Company has adopted underwriting and credit monitoring procedures and credit
policies, including the establishment and review of the allowance for credit
losses, that management believes are appropriate to minimize this risk by
assessing the likelihood of nonperformance, tracking loan performance and
diversifying the Company's credit portfolio. Such policies and procedures,
however, may not prevent unexpected losses that could materially adversely
affect the Company's results.
Other Risks. From time to time, the Company details other risks with respect
to its business and/or financial results in its filings with the Commission.
ITEM 2. 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 a Lease
Restructure Agreement with its landlord, which modified the Bank's future
lease obligations by substantially reducing its rent expense. As a result of
the modifications to the leases (the "Lease Modification"), the Bank reduced
its space under its leases from approximately 42,400 square feet to 23,883
square feet. Further, the Lease Modification resulted in a decrease in 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. Such reduction
equals approximately $4.3 million during the first five years under the Lease
Modification. The effective rent for the period November 1, 2000 to October
31, 2004 will be $2.83 per square foot or $67,607 per month. The rent is
subject to annual adjustments for changes 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, and the Company issued the
landlord a seven-year warrant to purchase up to 9.9% of the shares of capital
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.
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.
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to routine litigation involving various aspects of
its business. As of March 14, 1997, 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.
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
14
<PAGE>
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 through the Offerings or 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 of the $1.0 million on a discounted lump sum basis, which payment
was made, thereby concluding and completing the settlement.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There was no submission of matters to a vote of shareholders during the
fourth quarter of the year ended December 31, 1996.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The common stock of the Company was traded, until March 10, 1997, in the
over-the-counter market on The Nasdaq National Market tier of the Nasdaq Stock
Market, under the symbol MBLA. The following table shows the high and low
trade prices of the Company's common stock for each quarter of 1995 and 1996
as quoted by the National Association of Securities Dealers Automated
Quotation System ("Nasdaq"). Additionally, there may have been transactions at
prices other than those shown during that time.
<TABLE>
<CAPTION>
QUARTER ENDED: HIGH LOW
-------------- ----- -----
<S> <C> <C>
March 31, 1995................................................... $3.75 $2.06
June 30, 1995.................................................... 4.00 3.50
September 30, 1995............................................... 4.00 2.75
December 31, 1995................................................ 3.50 1.25
March 31, 1996................................................... 2.06 1.25
June 30, 1996.................................................... 2.38 1.50
September 30, 1996............................................... 1.88 1.13
December 31, 1996................................................ 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. At
March 14, 1997, the closing trade price for the Company's common stock as
quoted by Nasdaq was $2.06 per share. At March 14, 1997, the Company had 268
registered shareholders of record.
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
15
<PAGE>
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; (iv) when the Company has sufficient retained
earnings as set forth in the Retained Earnings Test under California General
Corporation Law. The Retained Earnings Test is defined as the Company's
retained earnings (determined on a consolidated basis according to generally
accepted accounting principles) or, if after giving effect to such
distribution, all of the Company's assets equal 1.25 times the Company's
liabilities and (v) 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.
ITEM 6. SELECTED 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)............ $ (.40) $ (2.34) $ (2.79) $ 0.05 $ (0.98)
Book value (period
ending)(3)............ 1.57 1.95 3.35 7.29 7.12
Weighted average shares
outstanding(2)........ 3,078,146 3,078,146 3,055,584 3,041,268 3,035,379
BALANCE SHEET DATA--AT
PERIOD END:
Assets................. $ 109,416 $ 131,992 $ 232,979 $ 303,120 $ 351,638
Securities............. 18,630 20,417 62,056 62,022 --
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
demand................ 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
</TABLE>
16
<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>
AVERAGE BALANCE SHEET
DATA--AVERAGE BALANCES:
Federal funds sold...... $ 19,572 $ 16,034 $ 7,739 $ 11,822 $ 17,067
Investment securities... 17,398 26,681 79,148 93,916 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(4).............. 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(5)....... -- -- -- 1.02% --
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 ninety 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(6)............... 556 581 1,529 6,175 5,613
--------- --------- --------- --------- ---------
Total nonperforming
assets................. 6,800 6,542 12,044 22,041 17,019
ASSET QUALITY RATIOS:
Nonaccrual loans to
total assets........... 0.8% 0.4% 1.5% 2.6% 1.8%
Nonaccrual assets to
total assets(7)........ 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(7).............. 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(8).............. 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.
(3) 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.
(4) 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.")
17
<PAGE>
(5) 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.
(6) Includes OREO acquired by the Bank through legal foreclosure and/or deed-
in-lieu of foreclosure and loans classified as in-substance foreclosures.
(7) Nonaccrual assets are comprised of nonaccrual loans plus OREO.
(8) 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 single-family residence which, as
of December 1996, had an appraised value of $10.0 million.
For further discussion of regulatory capital requirements applicable to the
Company and the Bank, see "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations--Capital Resources and
Regulatory Agreements."
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Certain statements under this caption constitute "forward-looking
statements" under the Reform Act which involve risks and uncertainties. The
Company's actual results may differ significantly from the results discussed
in such forward-looking statements. Factors that might cause such a difference
include but are not limited to economic conditions, competition in the
geographic and business areas in which the Company conducts its operations,
fluctuations in interest rates, credit quality and government regulation. For
additional information concerning these factors, see "Item 1. Business--
Factors That May Affect Future Results."
OVERVIEW
The Company's net loss for the year ended December 31, 1996, was $1.2
million or $.40 per share as compared to a net loss of $7.2 million or $2.34
per share for the year ended December 31, 1995. Declining loan balances
continued to negatively impact the Company's loan interest income, while sales
of securities during 1995 resulted in decreased interest income from
securities. Other operating expenses decreased 29% (including the settlement
of a lawsuit for $1.0 million) during the year ended December 31, 1996, as
compared to the year ended December 31, 1995. The net loss for the year ended
December 31, 1995, was $7.2 million or $2.34 per share as compared to a net
loss of $8.5 million or $2.79 per share for the year ended December 31, 1994.
The net losses for 1995 and 1994 were primarily attributed to increased
provisions for credit losses and the realized losses from the sale of
investment securities available-for-sale.
Net interest income for the year ended December 31, 1996, was $5.7 million,
compared to $7.7 million for the year ended December 31, 1995. This decrease
was primarily due to the decreased volumes of interest-bearing assets and
interest-bearing liabilities, which resulted from management's planned
restructuring of the balance sheet. This restructuring plan emphasized the
reduction of criticized and classified assets and non-strategic relationships
pertaining to both loans and deposits. Investment securities were sold in
order to facilitate this planned reduction of deposits and to bolster
liquidity.
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 created by 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 8 to the Consolidated Financial Statements."
18
<PAGE>
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 the corresponding period
in 1995. 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 as a result of no provision for credit losses for the year
ended December 31, 1996 and 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 the year ended December 31, 1993. At the time of purchase in 1993, 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.
Total assets of the Company at December 31, 1996, were $109.4 million, a
decrease of $22.6 million or 17.1% from total assets at December 31, 1995, of
$132.0 million. The decrease was due to a $1.8 million decrease in securities,
a $19.5 million decrease in loans receivables and a $2.2 million decrease in
cash and cash equivalents. At the same time, customer deposits decreased by
$16.3 million or 13.6% to $103.9 million at December 31, 1996, from $120.2
million at December 31, 1995. Total assets of the Company at December 31,
1995, were $132.0 million compared to $233.0 million at December 31, 1994.
As a part of the Company's capital plan for the Bank and its restructuring
of the organization to return to profitability, the Company reduced the Bank's
asset size through sales of securities available-for-sale, reduced classified
assets through the sales of loans and OREO, and reduced operating expenses
through consolidating functions and reduction of personnel. The restructuring
of the Bank began during the third quarter of 1994 and the Bank continues to
improve the quality of its assets, minimize its interest-rate risk, generate
fee income, and reduce overhead expenses in efforts to return to
profitability. However, should a reduction in asset size continue to occur
without corresponding reductions in operating expenses, interest income from
the reduced earning asset base may not cover operating expenses.
RESULTS OF OPERATIONS
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.
The Bank analyzes its earnings performance using, among other measures, the
interest rate spread and net yield on earning assets. The interest rate spread
represents the difference between the interest yield received on earning
assets and the interest rate paid on interest-bearing liabilities. 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. 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
19
<PAGE>
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. Table 1
presents the average yield on each category of earning assets, average rate
paid on each category of interest-bearing liability, and the resulting
interest rate spread and net yield on earning assets for each year in the
three-year period ended December 31, 1996. Yields on tax-exempt investment
securities presented in Table 1 have not been adjusted to a fully taxable
equivalent to recognize the income tax savings and to facilitate comparison of
taxable and tax-exempt assets because of utilized operating loss
carryforwards.
1996 COMPARED TO 1995. 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 the
year ended December 31, 1995. This decrease was primarily due to the decreased
volume of interest-earning assets and the decreased volume of interest-bearing
liabilities.
The average yield on interest-earning assets was 8.19% during the year ended
December 31, 1996, a decrease of 20 basis points from the average yield of
8.39% during the year ended December 31, 1995. During this period, the rates
paid on interest-bearing liabilities decreased 14 basis points to 4.48% from
4.62% for the year ended December 31, 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 the year ended December 31, 1995.
Average interest-earning assets decreased $31.8 million to $106.9 million
during the year ended December 31, 1996, from $138.7 million during the year
ended December 31, 1995. Average interest-bearing liabilities decreased $17.4
million to $68.7 million during the year ended December 31, 1996, from $86.1
million during the year ended December 31, 1995. These reductions were the
result of management's restructuring plan which emphasized the reduction of
criticized and classified assets and non-strategic loan and deposit
relationships. This planned restructuring was borne by management's intention
to improve liquidity and 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 the
same period in 1995. The volume of outstanding loans has continued to decline
due to (i) the ongoing recession affecting the Company's primary service 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 affect adversely the Bank's net interest income,
interest rate spread, and net yield on earning assets during the foreseeable
future. See "Capital Resources and Liquidity."
1995 COMPARED TO 1994. Net interest income for the year ended December 31,
1995, was $7.7 million, as compared to $15.4 million for the year ended
December 31, 1994. The decrease is primarily attributable to declining loan
balances, the sale of securities during 1995, and the fourth quarter of 1994.
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 $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.
20
<PAGE>
Loan interest income in 1994 included the accretion of deferred gain from
the Company's prime-based interest rate floor contract and the accretion of
discount on the purchased loans, discussed below. The net yield on earning
assets and the net interest rate spread for 1995 were 5.52% and 3.77%,
respectively, as compared to 6.77% and 5.43%, respectively, for 1994,
including the effect of the accretion of deferred gain and discounts. This
also is reflected in the decreased net interest income for 1995.
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 December 31, 1996, 1995, and 1994, respectively.
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.
FUTURE EFFECTS OF CONTINUED DECLINE IN LOAN VOLUME. Loan volume continued to
decline during 1996, decreasing to $62.5 million at December 31, 1996, from
$82.0 million at December 31, 1995. Average balances for 1996 totaled $70.0
million compared to $95.8 million for 1995. The volume of outstanding loans
has continued to decline since the second quarter of 1991, due to the ongoing
recession affecting the Company's primary market area, the planned
restructuring, and lack of effective marketing efforts. Management believes
that a lower volume of loans will continue to affect adversely the Company's
net interest income, interest rate spread, and net yield on earning assets
during the foreseeable future. See "Capital Resources and Liquidity."
COMPARISON OF NET YIELD AND INTEREST RATE SPREAD. 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, representing 37.1% of total
deposits at December 31, 1995. Of these noninterest-bearing demand deposits,
$8.8 million or 8.0% 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.
21
<PAGE>
TABLE 1
AVERAGE BALANCE SHEETS AND
ANALYSIS OF NET INTEREST INCOME
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1996 DECEMBER 31, 1995 DECEMBER 31, 1994
-------------------------- -------------------------- --------------------------
INTEREST AVERAGE INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
AMOUNT EXPENSE RATE AMOUNT EXPENSE RATE AMOUNT EXPENSE RATE
-------- -------- ------- -------- -------- ------- -------- -------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Assets:
Federal funds sold and
securities purchased
under agreements to
resell................. $ 19,572 $1,024 5.23% $ 16,034 $ 933 5.82% $ 7,739 $ 333 4.30%
Interest-bearing
deposits in other
financial institutions. -- -- -- 174 7 4.02% 45 3 6.67%
Securities held to
maturity: U.S. Treasury
and agency, corporate
and other securities... 888 62 6.98% -- -- -- 11,673 610 5.23%
Securities available for
sale:
U.S. Treasury and
agency, corporate and
other securities...... 16,510 928 5.62% 26,636 1,383 5.19% 64,252 3,625 5.64%
Tax-exempt municipal
securities............ -- -- -- 45 12 26.67% 326 50 14.89%
Trading securities...... -- -- -- -- -- -- 2,895 130 4.49%
Loans receivable(1) (2). 69,975 6,743 9.64% 95,771 9,299 9.71% 140,079 16,149 11.53%
-------- ------ -------- ------- -------- -------
Total interest earning
assets................ $106,945 $8,757 8.19% $138,660 $11,634 8.39% $227,009 $20,900 9.21%
====== ======= =======
Noninterest earning
assets:
Cash and due from
banks-- demand........ 5,878 9,403 16,203
Other assets........... 2,887 4,840 10,515
Allowance for credit
losses................ (3,407) (3,504) (8,172)
-------- -------- --------
Total assets........... $112,303 $149,399 $245,555
======== ======== ========
</TABLE>
22
<PAGE>
TABLE 1 (CONTINUED)
AVERAGE BALANCE SHEETS AND
ANALYSIS OF NET INTEREST INCOME
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1996 DECEMBER 31, 1995 DECEMBER 31, 1994
-------------------------- -------------------------- --------------------------
INTEREST AVERAGE INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
AMOUNT EXPENSE RATE AMOUNT EXPENSE RATE AMOUNT EXPENSE RATE
-------- -------- ------- -------- -------- ------- -------- -------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Liabilities and
shareholders' equity:
Interest-bearing
deposits:
Demand................. $ 5,914 $ 76 1.29% $ 7,341 $ 137 1.87% $ 9,493 $ 144 1.52%
Money market and
savings................ 21,556 634 2.94% 29,001 1,002 3.46% 39,852 1,274 3.20%
Time certificates of
deposit:
$100,000 or more..... 7,465 419 5.61% 8,876 542 6.11% 11,481 471 4.11%
Under $100,000....... 32,665 1,925 5.89% 36,754 2,188 5.95 74,484 3,309 4.44%
-------- ------ -------- ------ -------- -------
Total time
certificates of
deposit................ 40,130 2,344 5.84% 45,630 2,730 5.98% 85,965 3,780 4.40%
-------- ------ -------- ------ -------- -------
Total interest-bearing
deposits............... 67,600 3,054 4.52% 81,972 3,869 4.72% 135,310 5,198 3.84%
Federal funds purchased
and securities sold
under agreements to
repurchase.............. 1,140 25 2.19% 4,154 110 2.65% 10,863 328 3.02%
-------- ------ -------- ------ -------- -------
Total interest-bearing
liabilities............ $ 68,740 $3,079 4.48% $ 86,126 $3,979 4.62% $146,173 $ 5,526 3.78%
====== ==== ====== =======
Noninterest-bearing
liabilities:
Noninterest-bearing
demand deposits........ 36,518 52,246 77,445
Other liabilities...... 1,545 1,994 2,851
Shareholders' equity.... 5,500 9,033 19,086
-------- -------- --------
Total liabilities and
shareholder's equity.... $112,303 $149,399 $245,555
======== ======== ========
Net interest income
(spread) $5,678 3.71% $7,655 3.77% $15,374 5.43%
====== ====== =======
Excess of interest
earning assets over
interest-bearing
liabilities............. $ 38,206 $ 52,534 $ 80,836
Net yield on earning
assets (2)............. 5.31% 5.52% 6.77%
Loans as a percent of
total deposits ("loan-
to-deposit ratio")...... 67.2% 71.4% 65.8%
</TABLE>
- -----
(1) The average balance of nonperforming loans has been included in loans
receivable.
(2) 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.
23
<PAGE>
TABLE 2
INCREASE (DECREASE) IN INTEREST INCOME/EXPENSE DUE TO CHANGE IN
AVERAGE VOLUME AND AVERAGE RATE(1)
<TABLE>
<CAPTION>
1996 VS 1995 1995 VS 1994 1994 VS 1993
----------------------- ------------------------- ------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL VOLUME RATE TOTAL
------- ----- ------- ------- ------- ------- ------- ------ -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest Income:
Federal funds sold and
securities purchased
under agreements to
resell.................. $ 206 $(115) $ 91 $ 357 $ 243 $ 600 $ (178) $ 136 $ (42)
Interest-bearing
deposits in other
financial institutions.. (7) -- (7) 9 (5) 4 (30) 1 (29)
Securities held-to-
maturity:
U.S. Treasury and
agency, corporate and
other securities....... -- 62 62 (610) -- (610) (3,765) (271) (4,036)
Tax-exempt municipal
securities............. -- -- -- -- -- -- (50) -- (50)
Securities available-
for-sale:
U.S. Treasury and
agency, corporate and
other securities....... (526) 71 (455) (2,122) (119) (2,241) 3,067 244 3,311
Tax-exempt municipal
securities............. (12) -- (12) (42) 5 (37) (15) 20 5
Trading securities...... -- -- -- (130) -- (130) (132) 45 (87)
Loans receivable (2).... (2,505) (51) (2,556) (5,109) (1,743) (6,852) (1,980) 3,196 1,216
------- ----- ------- ------- ------- ------- ------- ------ -------
Total interest-earning
assets................. $(2,844) $ (33) $(2,877) $(7,647) $(1,619) $(9,266) $(3,083) $3,371 $ 288
======= ===== ======= ======= ======= ======= ======= ====== =======
Interest Expense:
Interest-bearing
deposits:
Demand................. $ (27) $ (34) $ (61) $ (33) $ 26 $ (7) $ (53) $ 26 $ (27)
Money market and
savings................ (257) (111) (368) (347) 74 (273) (234) 207 (27)
Time certificates of
deposit:
$100,000 or more...... (86) (37) (123) (107) 177 70 (169) 78 (91)
Under $100,000........ (244) (19) (263) (1,675) 556 (1,119) (474) 249 (225)
------- ----- ------- ------- ------- ------- ------- ------ -------
Total time certificates
of deposit............. (330) (56) (386) (1,782) 733 (1,049) (643) 327 (316)
------- ----- ------- ------- ------- ------- ------- ------ -------
Total interest-bearing
deposits................ (614) (201) (815) (2,162) 833 (1,329) (930) 560 (370)
Federal funds purchased
and securities sold
under agreements to
repurchase.............. (80) (5) (85) (203) (15) (218) (115) 91 (24)
------- ----- ------- ------- ------- ------- ------- ------ -------
Total interest-bearing
liabilities............ $ (694) $(206) $ (900) $(2,365) $ 818 $(1,547) $(1,045) $ 651 $ (394)
======= ===== ======= ======= ======= ======= ======= ====== =======
Net interest income..... $(2,150) $ 173 $ 1,977 $(5,282) $(2,437) $(7,719) $(2,038) $2,720 $ 682
======= ===== ======= ======= ======= ======= ======= ====== =======
</TABLE>
- ----
(1) The change in interest income or interest expense that is attributable to
both changes in average balance and average rate has been allocated to the
changes due to (i) average balance and (ii) average rate in proportion to
the relationship of the absolute amounts of the changes in each.
(2) Table does not include interest income that would have been earned on
nonaccrual loans.
24
<PAGE>
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.
1996 COMPARED TO 1995. 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 the corresponding period in 1995.
Due to loan charge-offs of $836,000, net of recoveries of loans previously
charged-off of $464,000, 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.
1995 COMPARED TO 1994. 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 the year ended December 31, 1993. At the time
of purchase in 1993, 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. Since 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.
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.
OTHER OPERATING INCOME
Securities Transactions
1996 COMPARED TO 1995. During 1996, the Company restructured its investment
portfolio in an effort to increase yield, reduce volatility to unexpected
market changes, and stagger maturities to meet overall liquidity requirements.
Accordingly, during the year ended December 31, 1996, the Company sold $10.5
million of investment securities available-for-sale, realizing a net loss of
$3,300. The net loss on sale of $46.9 million of investment securities
available-for-sale-for the year ended December 31, 1995, was $1.2 million. The
net unrealized losses on securities available-for-sale decreased by $78,000 to
$76,000 at December 31, 1996, primarily as a result of the sale of securities
previously discussed. The net realized losses on securities available-for-sale
decreased $2.9 million to $154,000 for the year ended December 31, 1995.
1995 COMPARED TO 1994. The Company continued to reduce asset size through
restructuring the securities portfolio during 1995, including the sale of
securities available-for-sale that were funded by high rate deposits to
minimize future interest-rate risk and decrease volatile liability dependency.
During 1995, the Bank sold $46.9 million of investment securities available
for sale, and terminated a related interest rate swap contract,
25
<PAGE>
realizing 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. The 1994
losses on sales of securities were $1.4 million, resulting primarily from
transactions occurring mainly in the fourth quarter of that year. The net
unrealized loss on securities available-for-sale decreased by $2.9 million
during the year ended December 31, 1995, primarily as a result of the sales of
securities and realization of related losses, as compared to an increase of
$3.5 million in net unrealized losses on securities available for sale during
the year ended December 31, 1994.
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.
The Bank's plan is to minimize its securities available-for-sale portfolio
through sales and maturities and to allocate future purchases of securities to
the held-to-maturity portfolio in order to provide a source of liquidity and
maintain appropriate levels of pledged collateral for retail customers
repurchase agreements and other deposits as required.
Activity in trading securities ceased during 1994 and management does not
intend to engage in this activity in the foreseeable future.
As discussed further under "Repurchase Agreements", the Company pledges
certain securities as collateral for retail (customer) repurchase agreements
FRB discount lines, and other deposits, as required. At December 31, 1996,
total securities pledged amounted to $4.0 million. The Company may pledge
additional securities as collateral for borrowings against wholesale (dealer)
repurchase agreements to the extent such agreements become necessary to meet
future liquidity needs.
Fee and Other Income
As set forth in the accompanying consolidated statements of operations, the
Company's principal sources of recurring other operating income currently are
letters of credit and foreign exchange services, investment services, and
deposit-related and other customer services. As set forth in the accompanying
consolidated statements of operations, the Bank's principal sources of fee and
other income is income related to international, investment, deposit, and
other customer services. In addition, other operating income also includes the
results of activities related to transactions involving the Bank's securities
portfolio and the result of activities related to transactions primarily
involving OREO, loans, and other assets.
1996 COMPARED TO 1995. Fee income decreased $710,000 or 58.4% 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 and reduced operating expenses.
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.
1995 COMPARED TO 1994. Fee and 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
26
<PAGE>
as collateral for a loan. Income from international services decreased by
48.5% for the year ended December 31, 1995, as compared to the year ended
December 31, 1994. The international department was closed in December 1995.
To improve asset quality, the Bank sold in February, 1995, loans amounting
to $6.6 million, net, which 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 sales price net of the lower
of cost of market adjustment of $851,000.
OTHER OPERATING EXPENSE
1996 COMPARED TO 1995. During the year ended December 31, 1996, other
operating expense was $8.0 million, a 29% (including the settlement of a
lawsuit for $1.0 million) 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
expense 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 is due to reductions in staff and changes in
management during the year ended December 31, 1996.
Other operating expense for the year ended December 31, 1996 includes a
litigation settlement of $1.0 million 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 expense, excluding the $1.0 million 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 expense 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."
In conjunction with the Bank's execution of the Lease Restructuring
Agreement, the Company issued to its landlord (or its assignee) 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."
1995 COMPARED TO 1994. Other operating expenses decreased 18.1% for the year
ended December 31, 1995, as compared to the year ended December 31, 1994. The
decrease was due primarily to management's efforts to continue to reduce
operating expenses. Compensation expense decreased $1.2 million or 23.8% for
the year ended December 31, 1995, as compared to the year ended December 31,
1994.
Other operating expenses decreased in all categories, except for customer
service expenses, which increased $16,000 or 1.9%, and other professional
services which increased $140,000 or 10.0%. The increase in customer services
expenses were attributable to increased data processing costs associated with
escrow account customers, and the increase in other professional services were
attributable to accounting and auditing fees and the use of outside
consultants to supplement management.
As of December 31, 1995, the Bank entered into a Lease Restructure Agreement
with its landlord, which modified the Bank's future lease obligations by
substantially reducing its rent expense. As a result of the Lease Restructure
Agreement, the Bank reduced its space under its leases from approximately
42,400 square feet to 23,883 square feet. Further, the Lease Restructure
Agreement resulted in a decrease in 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
27
<PAGE>
October 31, 2000. The effective rent for the period November 1, 2000, to
October 31, 2004, will be $2.83 per square foot or $67,607 per month, and 1996
is the base year for increases in property taxes and operating costs,
resulting in a further decline of operating expenses and a limit on annual
increases. For the year 1996, pass-through expenses, or operating costs
normally charged to the tenant, were zero. The restructuring of the Bank's
leases represents an annual savings of $852,000 over the next five years.
Under the provisions 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 to the
landlord a seven-year warrant to purchase up to 9.9% of the shares of the
Company's capital stock at $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 any shares purchased by the landlord (or its assignee)
pursuant to the Warrant.
FINANCIAL CONDITION
LOAN PORTFOLIO COMPOSITION AND CREDIT RISK
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.
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
28
<PAGE>
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 borrower's verified liquid
assets, or 10% to 20% of the borrower's tangible net worth.
Home equity lines of credit loans are made pursuant to which the borrower is
granted 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 $62.6 million at December
31, 1996, from $82.0 million at December 31, 1995. Table 3 below 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. 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. Other secured and unsecured commercial loans represented 26%
of the portfolio at December 31, 1996, a decline from 33% at December 31,
1995.
The loan portfolio decreased by 33.3 million to $82.0 million at December
31, 1995 from $115.3 million at December 31, 1994. Table 3 below 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. Consumer loans to
individuals represented 7% of the loan portfolio at December 31, 1995, a
decline from 14% at December 31, 1994.
TABLE 3
LOAN PORTFOLIO COMPOSITION
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
---------------- ---------------- ----------------- ----------------- -----------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------- ------- ------- ------- -------- ------- -------- ------- -------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Loan Portfolio
Composition:
Real estate
construction and land
development........... $ 3,441 5% $ 4,185 5% $ 948 1% $ 1,676 1% $ 5,407 3%
Commercial loans:
Secured by one-to-four
family residential
properties........... 6,233 10% 9,637 12% 18,398 16% 20,098 12% 27,801 16%
Secured by multifamily
residential
properties........... 2,879 5% 2,876 3% 2,368 2% 4,985 3% 8,651 5%
Secured by commercial
real properties...... 26,629 42% 28,734 35% 32,061 28% 40,330 25% 46,772 27%
Other--secured and
unsecured............ 16,508 26% 27,393 33% 43,385 37% 67,614 41% 62,973 36%
Home equity lines of
credit................ 581 1% 3,983 5% 2,867 2% 7,122 3% 8,030 5%
Consumer installment
and unsecured loans to
individuals........... 6,545 11% 5,435 7% 15,691 14% 21,124 15% 16,761 8%
------- --- ------- --- -------- --- -------- --- -------- ---
Gross loans
outstanding......... 62,816 100% 82,243 100% 115,718 100% 162,949 100% 176,395 100%
Deferred net loan
origination fees,
purchased loan
discount and gains on
termination of
interest rate swap and
cap agreements........ (269) (231) (434) (1,158) (659)
------- ------- -------- -------- --------
Loans receivable....... $62,547 $82,012 $115,284 $161,791 $175,736
======= ======= ======== ======== ========
</TABLE>
29
<PAGE>
EXPOSURE TO ECONOMIC CONDITIONS AND FLUCTUATIONS IN VALUE OF REAL ESTATE
COLLATERAL. 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 credit losses.
At December 31, 1996, approximately 63% of the Bank's aggregate principal
amount of loans were secured by real estate collateral. Of that total,
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 collateral and approximately 5% were
secured by real estate construction and land development projects. 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.
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 officers'
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
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 has expanded the role of an outside loan review firm to
include a migration analysis on its loan portfolio on a quarterly basis, and
has established an underwriting department to standardize loan write-ups,
enhance portfolio quality, and allow officers time to service their clients
and prospects.
The ongoing credit control process includes a stringent risk rating system
and regular monitoring of classified assets graded as "criticized" by the
Bank's internal grading system. Under the Bank's internal grading system,
loans are graded from "pass" to "loss," depending on credit quality. Loans in
the "pass" category generally perform 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 as "special mentioned." A loan which has further
deterioration and exhibits defined weaknesses in the borrower's capacity to
repay is reclassified as "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.
ALLOWANCE FOR CREDIT LOSSES. 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 loan review process. The loan approval process is
also tied to the risk rating system. The Classified Asset Committee ("CAC")
meets on a
30
<PAGE>
monthly basis to review, monitor, take corrective action upon all criticized
assets, and review the adequacy of the allowance for credit losses. This
Committee is currently chaired by the President and CEO, with the results of
the CAC's meetings 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 judgment in conjunction
with the analysis prepared by an 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 judgment of the information available to them at the time of their
examination. Following the OCC March 1996 examination of the Bank, the OCC
accepted the Bank's allowance for credit losses.
Management believes 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.
Table 4 presents, for the five-year period ended December 31, 1996, the
composition of the Company's allocation of the allowance for credit losses to
specific loan categories designated by management for this purpose. 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. This allocation should
not be interpreted as an indication that loan charge-offs will occur in the
future 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.
31
<PAGE>
TABLE 4
ALLOCATION OF ALLOWANCE FOR CREDIT LOSSES
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------
1996 1995 1994 1993 1992
------ ------ ------ ------ ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Allocation of the Allowance for Credit
Losses:
Real estate construction and land
development........................... $ 42 $ 11 $ 17 $ 30 $ 299
Commercial loans:
Secured by one-to-four family
residential properties.............. 479 205 77 499 475
Secured by multifamily residential
properties.......................... 41 25 51 472 358
Secured by commercial real
properties.......................... 590 454 674 1,422 1,219
Other--secured and unsecured......... 1,642 2,521 1,645 3,130 2,808
Home equity lines of credit............ 13 64 18 149 137
Consumer instalment and unsecured loans
to individuals........................ 161 523 578 988 697
------ ------ ------ ------ ------
Allowance allocable to loans
receivable.......................... 2,968 3,803 3,060 6,690 5,993
Commitments to extend credit under
standby and commercial letters of
credit................................ 1 2 3 7 16
------ ------ ------ ------ ------
Total allowance for credit losses...... $2,969 $3,805 $3,063 $6,697 $6,009
====== ====== ====== ====== ======
Allowance for credit losses allocable
as a percent of loans receivable...... 4.75% 4.64% 2.66% 4.14% 3.42%
</TABLE>
LOAN CHARGE-OFFS AND RECOVERIES. Management regularly monitors the loan
portfolio to identify promptly loans that may become nonperforming and
conducts an ongoing evaluation of the Company's exposure to potential losses
arising from such loans, as discussed above. Credit losses are fully or
partially charged against the allowance for credit losses when, in
management's judgment, the full collectability 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 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.
Charge-offs for the year ended December 31, 1994 of $14.2 million were
primarily attributable to $6.0 million of charge-offs related to the portfolio
of loans sold in February 1995. These loans had an outstanding principal
balance of $13.5 million and were identified as criticized and/or non-
performing. In addition, charge-offs related to the FDIC Loans in 1993 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 in the commercial--other secured and unsecured
category.
32
<PAGE>
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 related to the 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
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 for business banking and consumer loans and $350,000 for the
FDIC Loans. Recoveries during 1994 pertaining to the commercial--other secured
and unsecured loan portfolio primarily included $1.1 million of business
banking and entertainment related loans and $600,000 of loans sold in 1994
previously charged off.
TABLE 5
ANALYSIS OF CHANGES IN THE ALLOWANCE FOR CREDIT LOSSES
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1996 1995 1994 1993 1992
------ ------ ------- ------ ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Balance, beginning of period......... $3,805 $3,063 $ 6,697 $6,009 $8,381
Loans charged off:
Real estate construction and land
development....................... -- -- 45 558 971
Commercial loans:
Secured by one-to-four family
residential properties.......... 9 120 2,215 72 36
Secured by multifamily residen-
tial properties................. -- -- 702 -- 65
Secured by commercial real prop-
erties.......................... -- -- 1,407 581 519
Other--secured and unsecured..... 1,183 1,913 6,781 774 4,504
Home equity lines of credit........ -- -- 257 -- 153
Consumer instalment and unsecured
loans to individuals.............. 108 599 2,810 450 261
------ ------ ------- ------ ------
Total loan charge-offs............. 1,300 2,632 14,217 2,435 6,509
Recoveries of loans previously
charged off:
Real estate construction land de-
velopment......................... -- 200 -- 4 2
Commercial Loans:
Secured by one-to-four family
residential properties.......... 26 11 288 7 9
Other--secured and unsecured..... 398 588 2,205 945 1,056
Home equity lines of credit........ -- -- 38 38 8
Consumer instalment and unsecured
loans to individuals.............. 40 268 722 129 12
------ ------ ------- ------ ------
Total recoveries of loans previ-
ously charged off................. 464 1,067 3,253 1,123 1,087
------ ------ ------- ------ ------
Net loan charge-offs................. 836 1,565 10,964 1,312 5,422
Provision for credit losses.......... -- 2,307 7,330 2,000 3,050
------ ------ ------- ------ ------
Balance, end of period............... $2,969 $3,805 $ 3,063 $6,697 $6,009
====== ====== ======= ====== ======
Allowance for credit losses as a per-
cent of average annual net loan
charge-offs during the three-year
period.............................. 66.6% 82.5% 51.9% 132.6% 86.5%
Provision for credit losses as a per-
cent of net loan charge-offs during
the period.......................... -- 147.41% 66.86% 152.44% 56.25%
Net loan charge-offs as a percent of
average gross loans
outstanding during the period....... 1.19% 1.63% 7.83% 0.82% 2.82%
Recoveries of loans previously
charged off as a percent of loans
charged off in the previous year.... 17.6% 7.5% 133.6% 17.3% 11.7%
</TABLE>
33
<PAGE>
REAL ESTATE-RELATED AND ENTERTAINMENT INDUSTRY LENDING. In addition to the
Company's concentration in loans secured by real estate, the Company is a
provider of banking services to the entertainment industry in southern
California. Table 6 presents information about the Company's loans outstanding
to entertainment-related customers at December 31, 1996, 1995 and 1994. The
concentration of loans to the entertainment-related industry at December 31,
1996, decreased to $6.5 million or 10.3% of the total portfolio, as compared
to $9.4 million, or 11.4% at December 31, 1995 and $21.2 million, or 18.4% at
December 31, 1994. The amounts presented in Table 6 also include loans to
customers in this industry group which are secured by real estate, which
represent 46.2% of the total entertainment industry loans at December 31,
1996, compared to 12.8% at December 31, 1995, and 6.1% at December 31, 1994.
Management believes that the varying nature of customers represented within
this group, as set forth in Table 6, indicates reasonable diversification. In
addition, loans for the production of independently produced motion picture
and television feature films presented in Table 6, 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.
The following table presents information about the Company's loans
outstanding to entertainment-related customers at the dates indicated:
TABLE 6
INDUSTRY CONCENTRATIONS OF LOANS
The following table presents information about the Company's loans
outstanding to entertainment-related customers at the date indicated:
<TABLE>
<CAPTION>
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.
Nonperforming Assets
Nonperforming assets consist of nonperforming loans and other real estate
owned. 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 ninety days with respect to principal or
interest, and have not been restructured or placed on nonaccrual status, as
described below. Other real estate owned consists of real properties securing
loans of which the Bank has taken title in partial or complete satisfaction of
the loan. Information about nonperforming assets is presented in Table 7.
34
<PAGE>
TABLE 7
NONPERFORMING ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------
1996 1995 1994 1993 1992
------ ------ ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
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 ninety
or more days with respect to
either principal or interest and
still accruing interest........... 300 221 1,507 2,502 47
------ ------ ------- ------- -------
Nonperforming loans................ 6,244 5,961 10,515 15,866 11,406
Other real estate owned............ 556 581 1,529 6,175 5,613
------ ------ ------- ------- -------
Total nonperforming assets......... $6,800 $6,542 $12,044 $22,041 $17,019
====== ====== ======= ======= =======
Allowance for credit losses as a
percent of nonaccrual loans........ 319.9% 664.0% 89.4% 86.1% 95.1%
Allowance for credit losses as a
percent of
nonperforming loans............... 47.5% 63.8% 29.1% 42.2% 52.7%
Total nonperforming assets as a
percent of loans receivable........ 10.9% 8.0% 10.4% 13.6% 9.7%
Total nonperforming assets as a
percent of total
shareholders' equity.............. 140.4% 108.8% 116.8% 99.3% 78.8%
</TABLE>
At December 31, 1996, total nonperforming assets were $6.8 million
representing a $258,000 increase from the level at December 31, 1995. The
balance at December 31, 1996 was 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 loans
represented 10.0% of loans receivable at December 31, 1996. One loan, a
troubled debt restructure, represents $4.9 million of the total $6.8 million
of nonperforming assets. This $4.9 million loan is currently performing in
accordance with its restructured terms and is secured by a first deed of trust
on a single family residence with an appraised value as of December 1996 of
$10.0 million.
At December 31, 1995, nonperforming assets totaled $6.5 million or 8.0% of
total loans outstanding, representing a $5.5 million decrease from the level
at December 31, 1994. The decrease in nonperforming assets was due primarily
to improved collection procedures and the sales of loans and OREO in 1995. One
loan, classified as a Troubled Debt Restructuring at December 31, 1995 as
described above, represented $4.9 million of the total of $6.5 million.
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 "Net Interest Income" for a discussion of the effects on
operating results of nonperforming loans.)
Nonaccrual loans at December 31, 1996, increased to $928,000 from $573,000
at December 31, 1995 and decreased significantly from $3.4 million at December
31, 1994.
The Financial Accounting Standards Board ("FASB") issued Statement of
Accounting Standards ("SFAS") 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
35
<PAGE>
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. 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. 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.
At December 31, 1996, the Bank had classified $7.2 million of its loans as
impaired under SFAS No. 114, for which the related allowance for credit losses
was $800,000. The average recorded investment in, and the amount of interest
income recognized on those impaired loans during 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. Due to the size and nature of the Bank's
loan portfolio, impaired loans are determined based on a periodic evaluation
on an individual loan basis.
Foregone interest income attributable to nonperforming loans amounted to
$171,000 for the year ended December 31, 1996 and $160,000 for the same period
in 1995. See "Effects of Nonperforming Loans and Net Interest Income." This
resulted in a reduction in yield on average loans receivable of 24 basis
points and 17 basis points for the years ended December 31, 1996 and 1995,
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 assets are
troubled debt restructurings ("TDR"). TDR is defined in Statement of Financial
Accounting Standards No. 15 and No. 114 (see discussion above) as a loan for
which the Company 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 $5.0 million of TDRs. This loan is secured by a first deed of trust on
residential real property which, at 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.
Loans for which the Company had modified the terms by reductions in interest
rates to below-market rates for loans with similar credit risk characteristics
or extensions of maturity dates are presented in Table 3.
LOANS CONTRACTUALLY PAST DUE NINETY OR MORE DAYS. Loans contractually past
due ninety or more days are those loans which have become contractually past
due at least 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 have collateral
having a realizable value in excess of the amount of principal and accrued
interest outstanding and/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.
Loans contractually past due ninety or more days increased to $300,000 at
December 31, 1996, from $221,000 at December 31, 1995, and $1.5 million at
December 31, 1994.
OTHER REAL ESTATE OWNED ("OREO"). 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
36
<PAGE>
foreclosure. Real property acquired in this manner by the Bank is known as
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 "non-performing 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.
OREO at December 31, 1996 decreased to $556,000, from $581,000 at December
31, 1995, and $1.5 million at December 31, 1994. There were no losses on OREO
in 1996.
POTENTIAL NONPERFORMING LOANS. At December 31, 1996, management identified
potential nonperforming loans as presented in Table 8. Potential nonperforming
loans are those which are not already considered as nonperforming, as defined
above, but where information about possible cash flow causes management to
have doubts as to the ability of such borrowers to comply with the present
loan repayment terms and which may result in the designation of such loans as
nonperforming. Management is unable to predict the extent to which potential
nonperforming loans may ultimately be designated nonperforming, since, as
discussed below, those events are largely dependent on future conditions
outside the Company's control. Further deterioration of residential and
commercial real estate values may continue to affect adversely the Company's
level of nonperforming loans and provisions for credit losses. At December 31,
1996, potential nonperforming loans decreased to $409,000 from $1.6 million at
December 31, 1995.
The significant losses incurred during 1996, 1995 and 1994 reduced the
Company's capital. These losses were primarily a result of increased
provisions for credit losses, losses on securities, OREO and other assets,
legal settlements and reductions in interest earning assets without a
corresponding reduction in operating expenses. To the extent that such
nonperforming loan levels increase and result in increased provisions for
credit losses and loan charge-offs or adversely affect the level of income
from those loans, the Company's ability to generate adequate future earnings
will be negatively affected. (See "Net Interest Income.")
TABLE 8
POTENTIAL NONPERFORMING LOANS
<TABLE>
<CAPTION>
AT DECEMBER
31, 1996
--------------
AMOUNT PERCENT
------ -------
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Commercial Loans
Secured by commercial real properties..................... $207 51%
Other--secured and unsecured.............................. 44 11%
Home equity lines of credit................................ -- 0%
Consumer installment and other loans....................... 158 38%
---- ---
$409 100%
==== ===
</TABLE>
Loan Delinquencies
Total loan delinquencies increased to $2.0 million, or 3.2% of loans
receivable at December 31, 1996, from $1.2 million, or 1.6% of loans
receivable at December 31, 1995, and declined $7.9 million or 79.8% from
$9.9 million or 8.6% of loans receivable at December 31, 1994.
Credit Administration and Regulatory Oversight
As the Bank's principal regulator, the OCC examines and evaluates the
financial condition, operations, and policies and procedures of nationally
chartered banks on a regular basis as part of its legally prescribed oversight
responsibilities. The OCC conducted a general loan portfolio examination of
the Bank in early 1991 which
37
<PAGE>
identified deficiencies in the Bank's loan underwriting and administration
policies and procedures. As discussed under "Regulatory Agreements," the OCC
determined the Bank required special supervisory attention. To implement this
determination, the OCC and the Bank entered into a formal regulatory agreement
on July 26, 1991. This agreement was amended and superseded in its entirety on
December 14, 1995, by the 1995 Formal Agreement.
In response to the 1995 Formal Agreement, the Bank retained qualified
management and strengthened credit policies designed to minimize the level of
losses and nonperforming loans. 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 Officers Loan Committee reviews delinquencies and
documentation exceptions, as well as, 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 has expanded
the role of an outside loan review firm to include a migration analysis on its
loan portfolio on a quarterly basis; and has established an underwriting
department to standardize loan write-ups, enhance portfolio quality and allow
officers time to service their clients and prospects
Off-Balance Sheet Credit Commitments and Contingent Obligations
The Company 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 clients. In addition to undisbursed commitments to extend credit under
loan facilities, these instruments include conditional obligations under
standby and commercial letters of credit. The Company'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 Company
to secure the financial performance of a client to a third party and are
primarily issued to support private borrowing arrangements. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan facilities to clients. The Company uses the same credit
underwriting policies in accepting such contingent obligations as it does for
loan facilities. When deemed necessary, the Company 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, as presented in
Table 4. 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 $8.0 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 (see "Liquidity").
INVESTMENT PORTFOLIO
In order to maintain a resource 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.
38
<PAGE>
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.
As illustrated in Table 9 below, the Bank's investment portfolio generally
consisted of U.S. Government and Agency securities, mortgage-backed securities
including CMOs, and municipal securities at December 31, 1996 and 1995. 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 as shown
in Table 10 below.
TABLE 9
ESTIMATED FAIR VALUES OF AND UNREALIZED
GAINS AND LOSSES ON INVESTMENT SECURITIES
AND DEBT SECURITIES
<TABLE>
<CAPTION>
AT DECEMBER 31, 1996 AT DECEMBER 31, 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-matu-
rity:
Other government spon-
sored agency securi-
ties................... $14,395 $-- $40 $14,355 $ -- $-- $ -- $ --
======= === === ======= ======= === ==== =======
Securities available-
for-sale:
U.S. Treasury securi-
ties................... $ -- $-- $-- $ -- $ 1,010 $-- $ -- $ 1,010
GNMA-guaranteed mortgage
pass-through certifi-
cates.................. -- -- -- -- 119 1 -- 120
FHLMC-issued mortgage
pass-through certifi-
cates.................. -- -- -- -- 6,001 11 41 5,971
Other government-spon-
sored agency securi-
ties................... 1,000 3 -- 1,003 9,683 -- 55 9,628
CMO's and REMIC'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>
39
<PAGE>
TABLE 10
MATURITIES OF AND WEIGHTED AVERAGE YIELDS ON
INVESTMENT SECURITIES AND DEBT SECURITIES
<TABLE>
<CAPTION>
DECEMBER 31, 1996
--------------------------------------------------------------------
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-matu-
rity:
Other government-spon-
sored agency securi-
ties................... $ -- -- $14,395 6.67% $-- -- $ -- -- $14,395 6.67%
==== ======= === ====== ======= ====
Securities available-
for-sale:
Other government spon-
sored agency securi-
ties................... $ -- -- $ 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>
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 31, 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 AND OTHER SOURCES OF FUNDS
As indicated in Table 11, the Bank experienced a 22.4% decline in average
total deposits during 1996 compared to 1995. The decline in deposits occurred
throughout various deposit categories as the mix of deposits during 1996 did
not significantly change from 1995 except for the decrease in money desk
operations, which was consistent with management's restructuring plan.
See "Net Interest Income" and "Other Operating Expense" for a discussion of
the effects of these events on recent or prospective operating results.
40
<PAGE>
TABLE 11
FUNDING COMPOSITION AND LIQUIDITY TRENDS
(BALANCES ARE PERIOD AVERAGES)
<TABLE>
<CAPTION>
THREE-MONTH PERIOD ENDED YEAR ENDED DECEMBER 31,
-------------------------------------------------------- -------------------------------------------
DECEMBER SEPTEMBER JUNE 30, MARCH 31,
31, 1996 30, 1996 1996 1996 1996 1995 1994
------------ ------------ ------------- ------------- ------------- ------------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Noninterest-bearing
demand deposits:
Real estate title
and escrow company
customers......... $ 8,419 9% $ 8,506 9% $ 11,809 11% $ 8,385 7% $ 9,280 9% $ 10,932 8% $ 18,949 8%
All other
noninterest-
bearing demand.... 28,181 29% 25,458 25% 25,149 24% 30,194 26% 27,238 26% 41,313 30% 58,496 26%
Interest-bearing
demand, money
market and
savings........... 26,587 27% 27,326 27% 26,389 25% 29,635 25% 27,470 26% 36,342 26% 49,345 22%
Time certificates
of deposit:
Money desk
operation......... 22,729 23% 24,939 25% 28,030 26% 32,358 28% 27,014 26% 33,806 24% 74,657 33%
All other:
$100,000 or more.. 5,487 5% 4,865 5% 5,167 5% 5,688 5% 5,302 5% 6,506 5% 6,141 3%
Under $100,000.... 6,726 7% 7,442 8% 8,290 8% 8,889 8% 7,814 7% 5,318 4% 5,167 3%
------------ ------------ ------------- ------------- ------------- ------------- -------------
Total time
certificates of
deposit.......... $34,942 35% $37,246 38% $ 41,487 39% $ 46,935 41% $ 40,130 38% $ 45,630 33% $ 85,965 39%
------------ ------------ ------------- ------------- ------------- ------------- -------------
Total deposits.. 98,129 100% 98,536 99% 104,834 99% 115,149 99% 104,118 99% 134,217 97% 212,755 95%
Federal funds
purchased.......... -- -- -- -- -- -- -- -- -- -- -- -- 179 --
Securities sold
under agreements
to repurchase..... 357 0% 1,346 1% 1,517 1% 1,344 1% 1,140 1% 4,154 3% 10,685 5%
------------ ------------ ------------- ------------- ------------- ------------- -------------
Total funding
liabilities...... $98,486 100% $99,882 100% $106,351 100% $116,493 100% $105,258 100% $138,371 100% $223,619 100%
============ ============ ============= ============= ============= ============= =============
Average loan-to-
deposit ratio..... 64.6% 67.8% 68.7% 67.5% 67.2% 71.4% 65.8%
Average purchased
funds ratio....... 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.1%
Period-end pledged
securities ratio.. 21.5% 61.3% 61.7% 57.6% 21.5% 88.1% 94.9%
</TABLE>
41
<PAGE>
As indicated in Table 12, time certificates of deposit of $100,000 or more
from money desk operations represented a slightly less significant source of
funding during 1996 than in 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 of $40.6 million were represented by accounts
individually in excess of $100,000 as compared to 18.2% of total time
certificates of deposit of $47.1 million at December 31, 1995. Time
certificates of deposit from the money desk operation comprised 25.5% of time
certificates of deposit in excess of $100,000 in 1996 as compared to 29.2% in
1995.
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
clients' deposits during 1996 was hampered by the Company's reported net
losses and the need to raise additional capital.
The Bank's customers are principally commercial in nature and are 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 and 1995, 41.7% and 45.1%, 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.
TABLE 12
MATURITIES OF TIME CERTIFICATES OF DEPOSIT
$100,000 OR MORE
<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 0 513
------ ------ ------
Total time certificates of deposit $100,000 or more..... $2,354 $6,860 $9,214
====== ====== ======
<CAPTION>
DECEMBER 31, 1995
--------------------
MONEY ALL
DESK OTHER TOTAL
------ ------ ------
(DOLLARS IN
THOUSANDS)
<S> <C> <C> <C>
Aggregate maturities of time certificates of deposit:
In three months or less................................... $ 400 $4,196 $4,596
After three months but within six months.................. 300 958 1,258
After six months but within twelve months................. 1,392 900 2,292
After twelve months....................................... 405 -- 405
------ ------ ------
Total time certificates of deposit $100,000 or more..... $2,497 $6,054 $8,551
====== ====== ======
</TABLE>
MONEY DESK DEPOSITS. The Bank's wholesale institutional funds acquisition
operation ("money desk") was established in September 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 traditional market area, comprised of the west
side of the City of Los Angeles.
Although management believes that deposits gathered through the money desk
are less costly and provide greater capacity for overall deposit growth than
brokered deposits, the rates paid on certificates of deposits
42
<PAGE>
gathered through this vehicle are higher than those offered in the local
market. The Banks focus will be to attract deposits from its traditional local
market area. However, the Banks policy is to activate the money desk operation
as necessary, if the Banks liquidity falls below specified levels. Brokered
deposits will not be solicited through the money desk.
OTHER LIQUIDITY SOURCES
Management continues to seek additional sources of liquidity. Additional
sources of liquidity available to the Bank are securities available-for-sale
and federal funds sold which may be immediately converted into cash at a
minimal cost. Management intends to use these additional sources of liquidity
to the extent necessary.
Pursuant to FDICIA, the use of brokered deposits is limited to institutions
categorized as "well-capitalized" and, upon the issuance of a waiver by the
FDIC, to "adequately capitalized" institutions. As a result of the 1995 Formal
Agreement, the Bank is presently considered only adequately capitalized under
the FDIC regulations and cannot avail itself of brokered deposits as a source
of liquidity.
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 Banks sale of
investment securities to dealers or customers with simultaneous agreement to
repurchase identical securities on specified dates and 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 Banks borrowings under repurchase agreements are summarized in Table 13.
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
rates 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 Banks
risk of loss is the amount of any such excess fair market value. The Banks
wholesale (dealer) repurchase agreements are primarily overnight transactions.
As a result, management believes that the credit risks associated with this
funding source are substantially limited.
TABLE 13
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
<TABLE>
<CAPTION>
1996 1995
------ ------
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Balance at December 31......................................... $ -- $4,497
Weighted average interest rate at December 31.................. -- 2.18%
Weighted average maturity at December 31 (days)................ -- 7
Average balance during the year ended December 31.............. $1,140 $4,093
Weighted average interest rate during the year ended December
31............................................................ 2.20% 2.61%
Maximum balance outstanding at any month-end during the year
ended December 31............................................. $1,546 $7,031
</TABLE>
43
<PAGE>
INTEREST-RATE RISK MANAGEMENT
Interest-rate risk management focuses on controlling changes in net interest
income that result from fluctuating market interest rates as they impact the
rates earned and paid on interest earning assets and interest-bearing
liabilities whose interest rates are subject to change prior to their
maturity. Net interest income is subject to fluctuations arising from changes
in market interest rates to the extent that the yields on various categories
of earning assets respond differently to such changes as compared to interest
rate-sensitive funding sources.
As part of the Bank's efforts to manage interest-rate risk, the Interest
Rate Risk Committee of the Board of Directors meets monthly to review the
exposure of earnings to potential changes in market interest rates.
HEDGING CONTRACTS. The Company's ability to manage interest-rate risk using
an on-balance sheet approach (such as offering loan and deposit products with
varying terms and pricing characteristics) is limited by competitive factors
and customer options. As a result, the Company's previous management of
interest-rate risk used off-balance sheet techniques, including interest-rate
swap agreements and collar and floor contracts. Interest-rate swap
transactions involve the exchange of fixed and floating rate interest payment
obligations without the exchange of the underlying notional (principal)
amounts. In exchange for a premium, interest rate collar and floor contracts
provide for the purchaser's (seller's) receipt (payment) of interest on the
notional amount of the contract to the extent that a specified index interest
rate declines below (rises above) a fixed rate established in the contract.
In December 1994, the Bank entered into an interest-rate swap contract.
Under the terms of the agreement the Bank received a floating U.S. Libor rate,
initial rate of 6.8%, and paid an 8.2% fixed rate. Payments were calculated on
a $30 million notional amount based on a three year term to be paid semi
annually. The original expiration of the contract was March 31, 1995, and was
subsequently extended to July 31, 1995. The swap was intended to hedge the
market value fluctuations of investment securities available-for-sale and was
therefore recorded at its fair value at December 31, 1994. The unrealized gain
of $135,000 at December 31, 1994 was recorded with the unrealized gain/loss on
securities available-for-sale. The swap was terminated in 1995 with a realized
loss of $1.3 million.
The interest-rate swap agreements and floor contract were entered into to
reduce the effects on loan interest income and net interest income from
potential changes in interest rates generally and the prime interest rate in
particular. As illustrated in Table 14 below, at December 31, 1996 the
Company's loan portfolio included $46.5 million of loans having interest rates
that float, primarily with changes in the prime interest rate, representing
74.3% of total loans outstanding at that date. The Company does not plan to
utilize hedging contracts in the foreseeable future.
The Company and the Bank did not have any open contracts at December 31,
1996.
TABLE 14
MATURITIES AND SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES
<TABLE>
<CAPTION>
AT DECEMBER 31, 1996
------------------------------------
INTEREST
INTEREST RATES RATES ARE
ARE FLOATING FIXED OR
OR ADJUSTABLE PREDETERMINED TOTAL
-------------- ------------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Aggregate maturities of net loan balances
which are due (1):
In one year or less.................... $46,442 $ 6,180 $52,622
After one year but within five years... 22 7,891 7,913
After five years....................... -- 2,012 2,012
------- ------- -------
Total.................................... $46,464 $16,083 $62,547
======= ======= =======
</TABLE>
- --------
(1) Scheduled repayments are reported in the maturity category in which the
payments are due, based on the loans' contractual terms, without regard to
any potential renewals (rollovers) of such loans. The Company may renew
loans upon their maturity, pursuant to credit underwriting guidelines
established for all extensions of credit (see "Credit Portfolio
Composition and Credit Risk").
44
<PAGE>
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 or 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 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.
Table 15 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.
At December, 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 in net interest income as interest rates decline. In a
relatively stable interest rate environment that follows a rise in interest
rates, variable rate liabilities will continue to reprice upward while
variable rate assets, particularly those indexed to 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.
45
<PAGE>
TABLE 15
INTEREST RATE MATURITIES OR REPRICING
OF ASSETS AND FUNDING SOURCES
<TABLE>
<CAPTION>
AT DECEMBER 31, 1996
------------------------------------------------------------
LESS AFTER THREE AFTER ONE
THAN MONTHS BUT YEAR
THREE WITHIN ONE BUT WITHIN AFTER NOT RATE
MONTHS YEAR 5 YEARS 5 YEARS SENSITIVE TOTAL
------- ----------- ---------- ------- --------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Assets:
Federal Funds sold and
securities purchased
under agreements to
resell................. $23,000 $ -- $ -- $ -- $ -- $ 23,000
Securities held-to-
maturity............... -- -- 14,395 -- 14,395
Securities available-
for-sale............... -- -- 1,003 2,999 -- 4,002
Federal Reserve Bank
stock.................. -- -- -- 233 -- 233
Loans receivable........ 37,050 15,572 7,913 2,012 -- 62,547
------- ------- ------- ------- -------- --------
Total earning
assets............. 60,050 15,572 23,311 5,244 -- 104,177
Non-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
Liabilities &
Shareholders' Equity:
Interest bearing
Deposits:
Interest-bearing demand,
money market and
savings................ 28,454 -- -- -- -- 28,454
Time certificates of
deposit................ 10,934 22,346 7,368 -- -- 40,648
Federal funds purchased
and securities sold
under agreements to
repurchase............. -- -- -- -- -- --
------- ------- ------- ------- -------- --------
Total Interest bearing
liabilities.......... 39,388 22,346 7,368 -- -- 69,102
Non-Interest bearing
liabilities:
Non-Interest bearing
deposits............. -- -- -- -- 34,752 34,752
Other liabilities..... -- -- -- -- 717 717
Shareholders' equity.. -- -- -- -- 4,845 4,845
------- ------- ------- ------- -------- --------
Total Liabilities &
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 rate
sensitivity gap as a
percent of cumulative
earning assets......... 34% 18% 30% 34%
======= ======= ======= =======
</TABLE>
46
<PAGE>
INCOME TAXES
The Company utilized all available financial statement income tax benefits
in 1991, therefore, the cumulative losses through December 31, 1995, 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 $24.7 million of
financial statement net operating loss carryforwards ("NOL") for federal and
state income tax purposes, respectively, and $22.3 million and $13.0 million
of income tax NOL for federal and state income tax purposes, respectively.
Future losses will not result in income tax benefits to the Company until it
generates sufficient taxable income to utilize the present net operating loss
carryforwards. The Company has maximized its carryback potential for federal
income tax purposes. The federal NOLs expire beginning in 2007 through 2011
and the state NOLs expire beginning in 1997 through 2001.
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 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 10 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.
CAPITAL RESOURCES AND LIQUIDITY
Capital Resources
The Company's shareholders' equity at December 31, 1996, decreased to $4.9
million from $6.0 million at December 31, 1995. The decrease is attributed to
the current years net loss of $1.2 million net of a decrease in unrealized
losses on the securities available-for-sale of $78,000.
The ability of the Company and the Bank to maintain appropriate levels of
capital resources is substantially dependent on their ability to support
earning assets and sustain profitability. The Company's plan for 1997 is to
further improve operations to achieve profitability by increasing interest-
earning assets, improving asset quality by reducing nonperforming loans,
continuing to reduce operating expenses, and augmenting capital through the
offerings of capital stock as described below.
Plans to Raise Additional Capital
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, as amended, 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 the
Carl Pohlad and Wildwood Enterprises, Inc. Profit Sharing Plan and Trust and
one of the beneficiaries thereunder (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
47
<PAGE>
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 minimum proceeds of $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 1986, 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 Company believes that
the Minimum Condition will be satisfied.
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. See Item 1
"Business--Operating Strategy" and Item 7 Management's "Discussion and
Analysis of Financial Condition and Results of Operations--Regulatory
Agreements." The Company anticipates that the net proceeds contributed to the
Bank will be invested in earning assets. Proceeds retained by the Company will
be used for general corporate purposes, including possible strategic
acquisitions. The Company has no current understandings or agreements, is not
presently negotiating any such acquisitions and is not able to effect any
acquisitions due to regulatory constraints. 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. See
Item 7 "Management Discussion and Analysis of Financial Conditions and Results
of Operations--Regulatory Agreements."
The Bank is currently operating under the 1995 Formal Agreement dated
December 14, 1995 with the OCC. To the extent significant losses continue and
capital continues to decline, the Bank could fall into an "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 Item 1.
"Business--Federal Deposit Insurance Corporation Improvement Act of 1991" for
additional information.
Liquidity
THE BANK. 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.
48
<PAGE>
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 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%, (iv) money desk deposits, as
discussed further below, 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% (See "Regulatory Agreements"). 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 1996. (See Item 8. "CONSOLIDATED
FINANCIAL STATEMENTS.")
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 FRB's guidelines (see "Capital Resources").
Management and the Interest Rate Risk Committee of the Board of Directors of
the Bank 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 (see
"Net Interest Income and Interest Rate Risk"). The Committee meets monthly to
review the Banks current and projected net liquidity position and to review
actions taken by management at its weekly Interest Rate Risk Committee
meetings 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
Company's principal cash flows relate to investing and financing activities of
the Bank, rather than operating activities. While the statement presents the
periods' net cash flows from lending and deposit activities, it does 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. See "Net Interest Income" for a discussion of the impact of recent
trends and events on this source of operating cash flows during the three-year
period ended December 31, 1996.
49
<PAGE>
THE COMPANY. The Company's liquidity is limited. The Company is relying on
equity sales and dividends from the Bank as sources of liquidity. Dividends
from subsidiaries ordinarily provide a source of liquidity to a bank holding
company. The Bank is prohibited from paying cash dividends without the prior
written consent of the OCC and Reserve Bank.
During 1996, the Company did not receive dividends.
The Company anticipates cash expenditures during 1997 to consist of
operating expenses. A cash shortfall is anticipated unless additional cash can
be raised. (See "Regulatory Agreement").
REGULATORY CAPITAL REQUIREMENTS
RISK-BASED CAPITAL GUIDELINES
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 comprised of Tier 1 capital.
The capital standards specify that assets, including certain off-balance 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 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 risk-based capital ratio focuses principally on broad categories of
credit risk. The ratio does not take into account many other factors that can
affect the Company's or the Bank's financial condition. Those factors include
interest-rate risk, liquidity risks, the levels and quality of earnings,
investment or loan portfolio concentrations, the quality of loans and
investments, the effectiveness of lending and investment policies, and
management's overall ability to monitor and control financial and operating
risks. In addition to evaluating capital ratios, an overall assessment of
capital adequacy will take into account each of those other factors,
including, in particular, the level of nonperforming and potential
nonperforming loans. For these reasons, the final supervisory judgment on a
banking organization's capital adequacy may differ from the conclusions that
may be drawn solely from the entity's risk-based capital ratio. Accordingly,
the FRB and OCC generally expect bank holding companies and national banks to
operate with risk-based capital ratios above the minimums required.
CAPITAL LEVERAGE RATIO STANDARDS
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%.
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%. As set forth in Table 16,
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
50
<PAGE>
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. Accordingly, the Bank may be
subject to further regulatory enforcement action by the OCC. A Capital Plan
was filed with the OCC on February 8, 1996. See "Regulatory Agreements."
TABLE 16
REGULATORY CAPITAL INFORMATION
OF THE COMPANY AND THE BANK
<TABLE>
<CAPTION>
AT DECEMBER 31, 1996 AT DECEMBER 31, 1995
------------------------------- -------------------------------
COMPANY BANK COMPANY BANK
-------------- --------------- -------------- ---------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
-------- ----- -------- ----- -------- ----- -------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Risk-based capital (3):
Tier 1 capital......... $ 4,921 6.96% $ 4,911 6.95 % $ 6,166 6.96% $ 6,157 6.95 %
Tier 1 capital minimum
requirement (1)....... 2,828 4.00% 7,071 10.00 % 3,542 4.00% 8,856 10.00 %
-------- ---- -------- ----- -------- ---- -------- -----
Excess (Deficiency).... $ 2,093 2.96% $ (2,160) (3.05)% $ 2,624 2.96% $ (2,699) (3.05)%
======== ==== ======== ===== ======== ==== ======== =====
Total capital........... $ 5,831 8.25% $ 5,820 8.23 % $ 7,306 8.25% $ 7,297 8.24 %
Total capital minimum
requirement............ 5,657 8.00% 5,657 8.00 % 7,085 8.00% 7,085 8.00 %
-------- ---- -------- ----- -------- ---- -------- -----
Excess................. $ 174 0.25% $ 163 0.23 % $ 221 0.25% $ 212 0.24 %
======== ==== ======== ===== ======== ==== ======== =====
Total risk-weighted
assets................. $ 70,170 $ 70,710 $ 88,558 $ 88,558
Capital Leverage Ratio
Standard (2) (3)
Tier 1 capital......... $ 4,921 4.68% $ 4,911 4.67 % $ 6,166 4.68% $ 6,157 4.67 %
Tier 1 capital minimum
requirement (1)....... 4,210 4.00% 6,841 6.50 % 5,271 4.00% 8,565 6.5 %
-------- ---- -------- ----- -------- ---- -------- -----
Excess (Deficiency).... $ 711 0.68% $ (1,930) (1.83)% $ 895 0.68% $ (2,408) (1.83)%
======== ==== ======== ===== ======== ==== ======== =====
Average total assets, as
adjusted, during three-
month periods ended
December 31,........... $105,249 $105,249 $131,764 $131,764
</TABLE>
- --------
(1) The Bank's minimum Tier 1 capital to risk weighted assets and Tier 1
capital leverage requirements are based on the provisions of the 1995
Formal Agreement, which became effective on December 14, 1995.
(2) The regulatory capital leverage ratio represents the ratio of Tier 1
capital at December 31, 1996 and December 31, 1995 to average total assets
during the three-month period then ended.
(3) Tier 1 capital excludes any unrealized gains or losses recorded under
Statement of Financial Accounting Standards No. 115.
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 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. 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 after 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%.
51
<PAGE>
Subsequent to the 1991 Formal Agreement and 1991 MOU (described 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, 1995, the Company's cumulative
net losses amounted to $22.4 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
conducted 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 after 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. 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 1995 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 Offerings, it will be in substantial
compliance with all requirements of the 1995 Formal Agreement. See Item 7.
"Management Discussion and Analysis of Financial Condition and Results of
Operations--Capital Resources and Liquidity." 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 may 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.
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 with the
Reserve Bank, which supersedes and replaces the 1991 MOU.
52
<PAGE>
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.
The Company believes that, following the completion of the Offerings, 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 lift the 1995 MOU. See
Capital Resources and Liquidity.
Management expects that, until lifted, 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.
Recent Accounting Developments
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 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.
No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities" ("SFAS No. 125"), 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.
53
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements required by this Item are included
herewith as a separate section of this Report, commencing on page F-1. The
supplementary data pursuant to Item 8 is included in "Note 18--Quarterly
Financial Data (unaudited)"--of the Notes to Consolidated Financial
Statements" on page F-28.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this item will appear under the captions
"Proposal 1: Nomination and Election of Directors," "Directors and Executive
Officers," and "Section 16(a) Beneficial Ownership Reporting Compliance" in
the Company's definitive proxy statement for the 1995 and 1996 Annual Meetings
of Shareholders (the "1996 Proxy Statement"), and such information either
shall be (i) deemed to be incorporated herein by reference to that portion of
the 1996 Proxy Statement, if filed with the Securities and Exchange Commission
pursuant to Regulation 14A not later than 120 days after the end of the
Corporation's most recently completed fiscal year, or (ii) included in an
amendment to this report filed with the Commission on Form 10-K/A.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item will appear under the captions
"Directors and Executive Officers--Compensation of Directors," "Directors and
Executive Officers--Executive Compensation," "Report of the Compensation
Committee on Executive Compensation", "Directors and Executive Officers--Stock
Option Grants," "Directors and Executive Officers--Option Exercises and
Holdings," "Directors and Executive Officers--Compensation Committee
Interlocks and Insider Participation." and "Performance Graph" in the 1996
Proxy Statement, and such information either shall be (i) deemed to be
incorporated herein by reference to those portions of the 1996 Proxy
Statement, if filed with the Securities and Exchange Commission pursuant to
Regulation 14A not later than 120 days after the end of the Corporation's most
recently completed fiscal year, or (ii) included in amendment to this report
filed with the Commission on Form 10-K/A.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item will appear under the captions
"Outstanding Securities and Voting Rights" and "Security Ownership of
Principal Shareholders and Management" in the 1996 Proxy Statement, and such
information either shall be (i) deemed to be incorporated herein by reference
to that portion of the 1996 Proxy Statement, if filed with the Securities and
Exchange Commission pursuant to Regulation 14A not later than 120 days after
the end of the Corporation's most recently completed fiscal year, or (ii)
included in an amendment to this report filed with the Commission on Form 10-
K/A.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item will appear under the caption "Certain
Relationships and Related Transactions" in the 1996 Proxy Statement, and such
information either shall be (i) deemed to be incorporated herein by reference
to that portion of the 1996 Proxy Statement, if filed with the Securities and
Exchange Commission pursuant to Regulation 14A not later than 120 days after
the end of the Corporation's most recently completed fiscal year, or (ii)
included in an amendment to this report filed with the Commission on Form 10-
K/A.
54
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents have been filed as part of this report:
1. Financial Statements
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report............................................ F-1
Consolidated Balance Sheets at December 1996 and 1995................... F-2
Consolidated Statements of Operations for the years ended December 31,
1996, 1995, and 1994................................................... F-3
Consolidated Statements of Changes in Shareholders' Equity for the years
ended December 31, 1996, 1995 and 1994................................. F-4
Consolidated Statements of Cash Flows for the years ended December 31,
1996, 1995 and 1994.................................................... F-5
Notes to Consolidated Financial Statements for the three years ended De-
cember 31, 1996........................................................ F-6
</TABLE>
2. Financial Statement Schedules
None.
(b) Reports on Form 8-K
None.
(c) Exhibits
See Index to Exhibits on page E-1 of this Report on Form 10-K
(d) See Item 14(a) above.
55
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
NATIONAL MERCANTILE BANCORP
(Registrant)
By /s/ HOWARD P. LADD
-------------------------------------
Howard P. Ladd
Chief Executive Officer
By /s/ JOSEPH W. KILEY III
-------------------------------------
Joseph W. Kiley III
Chief Financial Officer
Date: March 31, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ HOWARD P. LADD Chairman of the Board March 31, 1997
- ------------------------------------ and Chief Executive Officer
Howard P. Ladd
/s/ ROBERT E. THOMSON Vice Chair March 31, 1997
- ------------------------------------
Robert E. Thomson
/s/ ROBERT E. GIPSON Director March 31, 1997
- ------------------------------------
Robert E. Gipson
/s/ ALAN GRAHM Director March 31, 1997
- ------------------------------------
Alan Grahm
/s/ A. THOMAS HICKEY Director and Secretary March 31, 1997
- ------------------------------------
A. Thomas Hickey
/s/ SCOTT A. MONTGOMERY Director March 31, 1997
- ------------------------------------
Scott A. Montgomery
</TABLE>
56
<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.
DELOITTE & TOUCHE LLP
Los Angeles, California
March 7, 1997
F-1
<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-2
<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-3
<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-4
<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-5
<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-6
<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-7
<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 were
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-8
<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-9
<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-10
<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-11
<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 that 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
ACTUAL FOR CAPITAL ADEQUACY PURPOSES UNDER PROMPT CORRECTIVE 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 (greater than or equal to) 8.0% N/A
Bank..................... $5,820 8.24% $5,657 (greater than or equal to) 8.0% $5,657 (greater than or equal to) 8.0%
Tier 1 Capital to Risk
Weighted Assets
Company.................. $4,921 6.96% $2,828 (greater than or equal to) 4.0% N/A
Bank..................... $4,911 6.95% $7,071 (greater than or equal to) 10.0% $2,828 (greater than or equal to) 4.0%
Tier 1 Capital to Average
Assets
Company.................. $4,921 4.68% $4,210 (greater than or equal to) 4.0% N/A
Bank..................... $4,911 4.67% $6,841 (greater than or equal to) 6.5% $4,210 (greater than or equal to) 4.0%
As of December 31, 1995:
Total Capital to Risk
Weighted Assets
Company.................. $7,306 8.25% $7,085 (greater than or equal to) 8.0% N/A
Bank..................... $7,297 8.24% $7,085 (greater than or equal to) 8.0% $7,085 (greater than or equal to) 8.0%
Tier 1 Capital to Risk
Weighted Assets
Company.................. $6,166 6.96% $3,542 (greater than or equal to) 4.0% N/A
Bank..................... $6,157 6.95% $8,856 (greater than or equal to) 10.0% $3,542 (greater than or equal to) 4.0%
Tier 1 Capital to Average
Assets
Company.................. $6,166 4.68% $5,271 (greater than or equal to) 4.0% N/A
Bank..................... $6,157 4.67% $8,565 (greater than or equal to) 6.5% $5,271 (greater than or equal to) 4.0%
</TABLE>
F-12
<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-13
<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-14
<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-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 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-16
<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-17
<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-18
<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-19
<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 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 through the Offerings or 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.
F-20
<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-21
<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-22
<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-23
<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 no 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 value 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-24
<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-25
<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-26
<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-27
<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-28
<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-29
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NO.
-------
<C> <S>
3.1 Articles of Incorporation dated January 17, 1983, as amended by
Certificate of Amendment of Articles of Incorporation dated May 8,
1984, and as amended by Certificate of Amendment of Articles of
Incorporation dated March 7, 1989(1)
3.2 Bylaws of the Company, as amended, restated as of December 18, 1992(2)
10.1 CEO Term Sheet dated November 1, 1995 between Mercantile National Bank
and Scott A. Montgomery(2)
10.2 Employment Agreement and Addendum dated June 21, 1996 between
Mercantile National Bank and Scott A. Montgomery(7)
10.3 Letter Agreement dated June 5, 1996 between Mercantile National Bank
and John Kendall Whiting(4)
10.4 Letter Agreement dated June 5, 1996 between Mercantile National Bank
and Carol A. Ward(4)
10.5 Employment Agreement and Addendum dated July 17, 1996 between
Mercantile National Bank and Joseph W. Kiley III (filed as an Exhibit
to the Company's Report on Form 10-Q for the quarter ended September
30, 1996 and incorporated herein by reference)
10.6 Form of Indemnity Agreement between the Company and its directors(1)
10.7 Form of Indemnity Agreement between the Company and its executive
officers(1)
10.8 Warrant Agreement dated April 30, 1996 between the Company and U.S.
Stock Transfer Corporation(4)
10.9 Settlement Agreement dated December 17, 1996 by and between Mercantile
National Bank and Lloyd's Underwriters, BCMB and Company
Underwriters(8)
10.10 Financial Advisor Agreement dated December 1, 1996 by and between
Sandler O'Neill & Partners, L.P. and the Company(5)
10.28 Settlement Agreement dated December 17, 1996
10.29 Settlement Agreement dated December 17, 1996
11. Statement regarding computation of per share earnings (see "Note 1--
Summary of Significant Accounting Policies--Loss Per Shares"--of the
"Notes to the Consolidated Financial Statements" commencing on page F-
6, included in this Report)
21. Subsidiaries of the Registrant(5)
23. Consent of Deloitte & Touche LLP, Independent Auditors(5)
27. Financial Data Schedule(5)
</TABLE>
- -------
(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, 1992 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, 1995 and incorporated herein by reference
(4) Filed as an exhibit to Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1996 and incorporated herein by reference.
(5) Included in this Report
E-1
<PAGE>
[LETTERHEAD OF RICHARDS BUTLER INTERNATIONAL LAW FIRM]
Clyde & Co
51 Eastcheap
London EC3M 1JP
your ref RV/YJ/92-01029
LeBoeuf, Lamb, Greene & MacRae
Sixth Floor
1 Minster Lane
London EC3R AA 27th January 1997
your ref 4/00018
Davies Arnold Cooper
6-8 Bouvene Street
London EC4Y 8DD
your ref 1710.6
our ref DGW/CMH/93-18760
BY FAX AND BY HAND
Dear Sirs
BARR SINISTER
We refer to the Settlement Agreement between our respective clients dated
17th December 1996 ("the Agreement").
We hereby confirm the agreement reached between our respective clients that the
Agreement be varied and, specifically:
(a) that the payment to your respective clients on 28 January of US$
929,397 (for value 31st December 1996 being the date when it was paid
by our clients to this firm), plus interest of US$2,899.40 accrued
since that date while it was being held by this firm, will constitute
full and final satisfaction of the obligations of our clients pursuant
to clauses 2(a) and (b) of the Agreement (it being accepted that the
value of the payment being made is equivalent to that of the payments
provided for in clauses 2(a) and (b) once interest discounts are
applied to reflect the timing of the respective payments); and
<PAGE>
Clyde & Co
LeBoeuf, Lamb, Greene & Macrae
Davies Arnold Cooper / page 2 of 2
27th January 1997
(b) that the conditions in clause 1(a) and (b) of the Agreement will be
deemed to be fulfilled following the payment and that the remaining
provisions of the Agreement take effect from the date of that payment.
Please countersign this letter to confirm your acceptance of the above and to
confirm your acknowledgment, on behalf of your clients, that the payment will be
made by our clients in reliance on the agreement reflected above. For the
avoidance of doubt, this letter is confidential to the parties and clause 8 of
the Agreement shall apply to this letter.
Yours faithfully
/s/ Richards Butler
- -------------------------------
Richards Butler
/s/ Clyde & Co
- -------------------------------
Clyde & Co
/s/ LeBoeuf
- -------------------------------
LeBoeuf, Lamb, Greene & MacRae
/s/ Davies Arnold Cooper
- -------------------------------
Davies Arnold Cooper
<PAGE>
This Agreement is made the l7th day of December 1996 between:
1. Mercantile National Bank Inc ("MNB") a Bank incorporated in California with
a place of business at 1840 Century Park East, Los Angeles, California
90067-2103 USA
2. Victor William Broad (on his own behalf and on behalf of all the other
Lloyd's underwriters subscribing to the contracts which were the subject
matter of the proceedings referred to below) of Syndicate 370, Lloyd's, 1
Lime Street, London EC3
3. Eagle Star Insurance Company Limited whose registered office is at 60 St
Mary Axe, London EC3A 8JQ
4. Star Assurance Company Limited whose registered office is at 60 St Mary Axe,
London EC3A 8JQ
5. St. Paul Fire and Marine Insurance Company (UK) Limited whose registered
office is at St Pauls House, 27 Camperdown Street, London E1 8DS
6. Sphere Drake Insurance PLC whose registered office is at 52-54 Leadenhall
Street, London EC3A 2BJ
7. Scor (UK) Reinsurance Company Limited whose registered office is at 52 Lime
Street, London EC3M 7BS
8. Orion Insurance Company Limited whose registered office is at Orion House,
Bouverie Road, West Folkstone, Kent CT20 2RW
9. Prudential Assurance Co Limited whose registered office is at 142 Holborn
Bars, London EC1N 2NH
<PAGE>
- 2 -
10. Guardian Royal Exchange (UK) Limited whose registered office is at Royal
Exchange, London EC3V 8JQ
11. Union America Insurance Company Limited whose registered office is at 77
Gracechurch Street, London EC3V OAS
12. Munich Reinsurance Company a Company incorporated under the laws of Germany
whose principal place of business is Koniginstraze, Postfach 401320, D-800
Munich 40, Germany
13. Albingia Versicherungen, a Company incorporated under the laws of Germany
whose principal place of business is Ballindamn 39 (Europahans), 2000
Hamburg l, Germany
14. Sovereign Insurance (UK) Limited whose registered office is at 10 Trinity
Square, London EC3P 3AX
15. Tokio Marine and Fire Insurance Company Limited whose registered office is
at 1O Trinity Square, London EC3P 3AX
16. Taisho Marine & Fire Insurance Company (Europe) Limited whose registered
office is at 10 Trinity Square, London EC3P 3AX
17. Uni Storebrant Insurance Company (UK) Limited whose registered office is at
Suite 2/1/D Plantation House, 5-8 Mincing Lane, London EC3 7EE
18. Wasa International (UK) Insurance Company Limited whose registered office
is at 3 Quays, Tower Hill, London EC3R 6DA
19. Dominic Adams of Maycroft House, Mill Hill, Herne Bay, Kent CT6 7EB.
<PAGE>
- 3 -
20. V.W. Broad Agency c/o Sphere Drake Underwriting Limited, 52 Leadenhall
Street, London, EC3A 2BJ.
WHEREAS:
1. British & Commonwealth Merchant Bank Plc (in administration)("BCMB") (and
now known as BCMB Corporation Limited (in administration)) commenced
proceedings on behalf of itself and as agent for MNB against the second to
eighteenth parties to this Agreement ("the Defendant Insurers") in the
Commercial Court, Queen's Bench Division of the High Court of Justice (1992
Folio No. 2684) on 11 September 1992.
2. In their Defences to the aforementioned claim, the Defendant Insurers deny
all liability. Further, the Defendant Insurers have served Counterclaims
against BCMB and MNB and have joined MNB to the proceedings as a Defendant
to those counterclaims.
3. In its Defences to Counterclaim, MNB denies all liability.
4. All the parties hereto wish to compromise the Defendant Insurers'
Counterclaims against MNB and to compromise MNB's half share of BCMB's
original claim against the Defendant Insurers on the terms hereinafter set
out.
5. Subject to the effect of certain terms of the agreement set cut below,
BCMB's claim against the Defendant Insurers will continue to subsist
following the completion of this agreement and the Defendant Insurers'
Counterclaims against BCMB will also so continue to subsist.
6. The Names of the Lloyd's Syndicates subscribing to the contracts which are
the subject of the proceedings
<PAGE>
-4-
described in paragraph 1 above have assigned certain of their rights in
respect of these contracts, upon the terms of a Reinsurance and Run-Off
Contract dated 3rd September 1996 to Equitas Reinsurance Ltd, which has
itself assigned certain of its rights to Equitas Limited upon the terms of
a Retrocession Agreement dated 3rd September 1996.
NOW IT IS HEREBY AGREED AS FOLLOWS:-
1. This Agreement is conditional upon:-
(a) the recapitalisation of MNB being completed on or before 31 March
1997.
(b) the payment described in paragraph 2(a) below being made.
Upon the fulfilment of conditions 1(a) and 1(b) above, the following
provisions of this Agreement shall take effect (except for Clauses 4 and 8
below which take effect from the date of this Agreement and will remain in
effect after the date of fulfilment). If conditions l(a) and l(b) are not
fulfilled, this Agreement (including Clauses 4 & 8) shall be null and void.
2. (a) MNB shall pay US$ 500,000 to the Defendant Insurers for value on or
before noon UK time 7 days after the completion of the
recapitalisation referred to in clause 1 above ("the payment date").
Payment will be made by three bank wire transfers to the accounts and
in the amounts specified in Schedule 1 to this Agreement and such
payment will constitute a good discharge of MNB's obligations under
this sub-clause.
<PAGE>
- 5 -
(b) MNB shall pay a further US$ 500,000 to the Defendant Insurers two
years after the payment date. The mode and effect of payment will be
as in (a) above.
(c) Subject to the terms of this Agreement, the payments in (a) and (b)
above will be in full and final settlement of one half of the
Defendant Insurers' Counterclaims in these proceedings which
constitute the entirety of their claims against MNB. The Defendant
Insurers, Dominic Adams and the V.W. Broad Agency and each of them
accordingly hereby release MNB from any and all claims that they
presently have against them, or which may hereafter arise out of
anything done or omitted to be done prior to the date hereof (whether
known or unknown, suspected or unsuspected), insofar as the same
arise out of or in connection with these proceedings or the subject
matter thereof or any aspect of the Barr Sinister film project
(including, without limitation, the completion guarantee, insurance
cover and/or cut-through endorsements).
(d) MNB hereby releases the Defendant Insurers, Dominic Adams and the V.W.
Broad Agency, from one half of the original sum claimed by BCMB on
behalf of itself and MNB in the Points of Claim in these proceedings.
MNB hereby further releases the Defendant Insurers, Dominic Adams and
the V.W. Broad Agency, from any and all other claims that they
presently have against them or which may hereafter arise out of
anything done or omitted to be done prior to the date hereof (whether
known or unknown, suspected or unsuspected), insofar as the same arise
out of or in connection with these proceedings or the subject matter
thereof or any aspect of the Barr Sinister film project (including,
<PAGE>
- 6 -
without limitation, the completion guarantee, the insurance cover
and/or cut-through endorsements).
3. (a) The parties to this Agreement by their solicitors shall
contemporaneously with the execution of this Agreement sign respective
consent orders in the terms of Schedule 2 hereto discontinuing the
Counterclaims against MNB with no order as to costs. The signed
consent orders shall be held by MNB's solicitors pending the payment
of funds by MNB on the payment date referred to in clause 2(a) above
to the order of the parties signing the consent orders and MNB's
solicitors shall let the Defendant Insurers solicitors have copies of
the conformed Order. On confirmation of receipt of payment by the
recipients of such funds, MNB's solicitors shall forthwith lodge the
signed consent orders at the High Court for sealing.
(b) The Defendant Insurers shall within 21 days of the payment provided
for by Clause 2(a) above apply for leave and use all reasonable
endeavours to obtain leave to amend their Defences and Counterclaims
in these proceedings:
(i) to remove the claims against MNB; and
(ii) to amend the claim against BCMB to reflect the fact that they are
suing BCMB for half of the Counterclaim (in the way illustrated
by Schedules 3(A)-(C) to this Agreement). Pursuant to such
amendments, the total sum claimed against BCMB alone will be
US$3,898,814.70 plus interest and costs.
(c) MNB shall within 21 days of the payment provided by clause 2(a)
procure the amendment of the Points of
<PAGE>
- 7 -
Claim by BCMB to reflect the release of the Defendant Insurers from
one half of the original sum claimed by BCMB on behalf of MNB and
itself in the Points of Claim (in the way illustrated by Schedule 4 to
this Agreement).
4. MNB on the one hand, and each of the Defendant Insurers, Dominic Adams and
the V.W. Broad Agency on the other hand, irrevocably and unconditionally
covenant with each other that, save for the purposes of enforcing the
provisions of this Agreement, they will not institute or pursue against the
other any claim whatsoever (whether known or unknown, suspected or
unsuspected) insofar as the same arise out of or in connection with these
proceedings or the subject matter thereof or any aspect of the Barr
Sinister film project (including, without limitation, the completion
guarantee, the insurance cover and/or cut-through endorsements).
5. Each of the Defendant Insurers agree with MNB that they will not sue BCMB
for more than one half of the principal amount of the Counterclaim (US
$3,898,814.70 excluding interest and costs) . Each of the Defendant
Insurers agree with MNB that they will only seek to recover from BCMB such
costs as have been incurred by them in:
(a) Defending the claim brought by BCMB on behalf of itself and not MNB;
and
(b) pursuing the Counterclaim against BCMB and not MNB.
6. The Defendant Insurers and MNB agree that they will each bear their own
costs in relation to the matters arising between them in these proceedings
and this settlement.
<PAGE>
- 8 -
7. The terms of this settlement are without prejudice to any of the Defendant
Insurers' arguments, other than against MNB, including arguments as to the
validity or otherwise of policy nos OLH 9490 and OLH 9491 (referred to in
the Points of Claim to these proceedings as "the First Excess Policy" and
"the Second Excess Policy").
8. Each of the parties hereto agree that the terms of this Agreement and of
the discussions leading to this Agreement shall be and remain confidential
to the parties, their legal and financial advisers and their reinsurers
save to the extent that:
(a) They may be compelled by applicable law to disclose the same; and
(b) MNB may disclose the same to actual or potential investors in MNB and
applicable regulatory authorities; and
(c) The Defendant Insurers and BCMB shall be at liberty to bring to the
attention of the Court the costs provisions (Clauses 5 & 6) only in
this Agreement on any issue of costs arising between them.
(d) The Defendant Insurers or MNB may be at liberty to disclose this
Agreement on any questions concerning its validity or enforceability.
9. Each of the parties hereto warrants that it has not assigned, encumbered or
otherwise disposed of any claim against any of the other parties, other
than as described in preamble 6 to this Agreement.
10. If any term or provision in this Agreement shall in whole or in part be
held to any extent to be illegal or
<PAGE>
- 9 -
unenforceable under any enactment or rule of law, that term or provision or
part shall to that extent be deemed not to form part of this Agreement and
the enforceability of the remainder of this Agreement shall not be
affected.
11. The signatories to this Agreement each hereby warrant that they are
authorised to sign this Agreement on behalf of their clients. This
Agreement:
(a) shall be binding upon and shall enure for the benefit of the
successors of the parties hereto but shall not be assignable (except
to successor entities by way of merger consolidation or asset
disposition) and;
(b) may be executed in any number of counterparts and all such
counterparts taken together shall be deemed to constitute one and the
same instrument.
12. a) In the event MNB goes into liquidation after conditions 1(a) and (b)
above have been fulfilled but before paying the Defendant Insurers the
sums due in accordance with clause 2(b) of this Agreement, MNB admit,
for the purposes of the liquidation, the balance of the debt due under
this Agreement, namely the sum of US$ 500,000.
b) This Agreement is without prejudice to the Defendant Insurers' rights
to seek to prove in MNB's liquidation for the full amount of their
Counterclaim against MNB (US$3,898,814.70) including interest and
costs in the event that MNB goes into liquidation before paying the
Defendant Insurers any of the sums due in accordance with either
clauses 2(a) or 2(b) of this Agreement. If the Defendant Insurers have
received any sums from MNB prior to the liquidation, they agree that
they will deduct these sums from the US$3,898,814.70,
<PAGE>
- 10 -
including interest and costs and seek to prove only for the balance.
c) The Defendant Insurers' rights under sub-paragraph (b) above may be
exercised as an alternative to their rights of enforcement under this
Agreement.
13. This Agreement shall be governed by and construed in all respects in
accordance with English law and the parties hereto submit to the exclusive
jurisdiction of the English Court in relation to any matters arising under
this Agreement.
14. Neither MNB, its directors and officers nor its legal or financial
advisers, including those advisers who have been or who are participating
in the negotiations or in the preparation or execution of this Agreement
are aware, after diligent enquiry, of MNB violating any laws applicable to
the validity and enforceability of this Agreement. Nor are they aware of
any other matters which may render this Agreement invalid or unenforceable
or, which may violate any applicable law.
IN WITNESS OF which this Agreement has been duly executed on the date first
above written
Signed by Clyde & Co
on behalf of all of those Lloyds
Underwriters subscribing to
the Lineslips No. 9SH 9388 & OLH 9482
(The First Defendant), Dominic Adams and
the V.W. Broad Agency
/s/ Clyde & Co.
- -------------------------
Signed by LeBoeuf Lamb Greene & Macrae
on behalf of Eagle Star Insurance Company
Limited and Star Assurance Company Limited
and Munich Reinsurance Company
(The Second and Third and Eleventh Defendants)
/s/ LeBouef
- -------------------------
<PAGE>
- 11 -
Signed by Davies Arnold Cooper
on behalf of St Paul Fire and Marine
Insurance Company (UK) Ltd, Sphere Drake
Insurance Plc, Scor (UK) Reinsurance Co Ltd,
Orion Insurance Co Ltd, Prudential Assurance
Co Ltd, Guardian Royal Exchange (UK) Ltd,
Union America Insurance Co Ltd, Munich
Reinsurance Company, Albingia Versicherungen,
Sovereign Insurance (UK) Ltd, Tokio Marine &
Fire Insurance Co Ltd, Taisho Marine & Fire
Insurance Co (Europe) Ltd, Uni Storebrant
Insurance Co (UK) Ltd and Wasa International
(UK) Insurance Co Ltd.
(The Fourth to Tenth and Twelfth to Seventeenth Defendants)
/s/ Davies Arnold Cooper
- ------------------------------
Signed by Richards Butler
on behalf of Mercantile National Bank Inc
(The Second Defendant to Counterclaim)
/s/ Richards Butler
- ------------------------------
<PAGE>
This Agreement is made the 17th day of December 1996 between BCMB Corporation
Limited (in administration)(formerly British and Commonwealth Merchant Bank plc
(in administration)) ("BCMB") of Saddler's House, 44 Gutter Lane, London EC2V
6HL and Mercantile National Bank Inc ("MNB") of 1840 Century Park East, Los
Angeles, CA 90067 USA.
WHEREAS:
1. BCMB commenced proceedings on behalf of itself and MNB against seventeen
Lloyd's of London and Company insurers ("the Defendant Insurers") in the
Commercial Court, Queen's Bench Division of the High Court of Justice,(1992
Folio No. 2684) on 11 September 1992.
2. In their Defences to the aforementioned claim, the Defendant Insurers deny
all liability. Further, the Defendant Insurers have served Counterclaims
against BCMB and MNB and have joined MNB to the proceedings as a Defendant
to those counterclaims.
3. In their Defences to Counterclaim, BCMB and MNB deny all liability.
However, MNB and the Defendant Insurers have agreed a compromise of the
Defendant Insurers' counterclaims against MNB and a compromise of MNB's
half share of BCMB's original claim against the Defendant Insurers on the
terms set out in the aforementioned Agreement ("the Insurers' Agreement").
Insofar as the provisions of the Insurers' Agreement affect the
continuation of the proceedings between BCMB and the Defendant Insurers,
such effect is recorded in the letter agreement between BCMB and the
Defendant Insurers a draft of which is annexed as schedule 1 hereto ("the
Letter Agreement").
4. Subject to the effect of certain terms of the Letter Agreement, BCMB's
claim against the Defendant Insurers will continue to subsist following the
completion of this Agreement ("the BCMB Agreement") and the Defendant
Insurers' Counterclaims against BCMB will also so continue.
5. BCMB and MNB have reached the agreement set out below for the purposes:-
<PAGE>
(a) of clarifying the relationship between BCMB and MNB which exists
pursuant to their joint participation in the loan to Performance
Guarantees Inc ("PGI") and Brault Holdings in respect of the film Barr
Sinister and as set out in the Loan Agreement and Security Agreement
dated 11 July 1990 between such parties ("the Loan Agreement") and the
agency letter between BCMB and MNB dated 11 July 1990 ("the agency
letter");
(b) of ensuring that the Insurers' Agreement eliminates any future
exposure for MNB in respect of the Barr Sinister project; and
(c) of ensuring that BCMB's potential liability to the Defendant Insurers
is restricted to one half of the current claim by the Defendant
Insurers against BCMB and MNB (i.e. US$3,898,814.70 plus interest plus
costs (with such costs being limited in accordance with the provisions
of the Letter Agreement)).
(d) Of ensuring that MNB will have no interest in or entitlement to any
sum ultimately awarded or agreed to be paid to BCMB by the Defendant
Insurers or any of them.
NOW IT IS HEREBY AGREED AS FOLLOWS:-
1. The BCMB Agreement is conditional upon the fulfilment of the conditions
referred to in Clause 1 of the Insurers' Agreement. Upon the fulfilment of
such conditions (in respect of which MNB will notify BCMB within 7 days
thereof), the following provisions of the BCMB Agreement shall take effect
(except for clauses 4 and 5 below which take effect from the date of the
BCMB Agreement and will remain in effect after the date of fulfilment). If
such conditions are not fulfilled then the BCMB Agreement (including
clauses 4 and 5) shall be null and void.
2. In consideration of MNB securing an agreement with the Defendant Insurers
in the terms of the Insurers' Agreement, BCMB:-
(a) within 14 days of the date of fulfilment of the conditions referred to
in Clause 1 of the Insurers' Agreement, shall seek leave to amend the
Points of Claim in this action in the manner set out at schedule 2
hereto so as to enable MNB to comply with its obligation under Clause
3(c) of the Insurers' Agreement;
2
<PAGE>
(b) subject to paragraph 3 hereof hereby releases MNB from responsibility
for payment of any part of BCMB's costs of pursuing any claim
whatsoever arising out of or in connection with any aspect of the Barr
Sinister film project (including, specifically, but without
limitation, responsibility for payment of any part of BCMB's costs of
pursuing the original claim against the Defendant Insurers);
(c) hereby releases MNB from any liability for and covenants not to sue
MNB in respect of any part of the claim for US $3,898,814.70 plus
interest plus costs which will, subject to the terms of the Letter
Agreement, continue to be made by the Defendant Insurers against BCMB
after the completion of the BCMB Agreement.
(d) hereby releases MNB from responsibility for any costs or expenses
incurred by BCMB in defending any claim whatsoever arising out of or
in connection with any aspect of the Barr Sinister film project
(including, specifically, but without limitation, responsibility for
any costs or expenses incurred by BCMB in defending the Defendant
Insurers' counterclaims).
3. Within 7 days of the fulfilment of the conditions referred to in clause 1
of the Insurers' Agreement, MNB's solicitors, Richards Butler and BCMB's
solicitors, Denton Hall, will sign a joint bank instruction releasing to
Denton Hall for the account of BCMB the sum of (Pounds) 13,758 plus
interest which is currently held in a joint account in the name of those
two firms.
4. Each of the parties hereto irrevocably and unconditionally covenants with
each other that, save for the purposes of enforcing the provisions of the
BCMB Agreement, they will not institute or pursue against the other any
claim whatsoever (whether known or unknown, suspected or unsuspected)
insofar as the same arises out of or in connection with the proceedings
referred to in the above Recitals or the subject matter thereof or any
aspect of the Barr Sinister film project (including, without limitation,
the Loan Agreement, the completion guarantee, the agency letter, the
insurance cover and/or cut-through endorsements).
3
<PAGE>
5. Each of the parties hereto agree that the terms of the BCMB Agreement (and
of the Insurers' Agreement) and of the discussions leading to the BCMB
Agreement shall be and remain confidential to the parties and their legal
and financial advisers save to the extent that they may be compelled by
applicable law or regulation to disclose the same and save that MNB may
disclose the same to actual or potential investors in MNB or to applicable
regulatory authorities
6. If any term or provision in the BCMB Agreement shall in whole or in part be
held to any extent to be illegal or unenforceable under any enactment or
rule of law, that term or provision or part shall to that extent be deemed
not to form part of the BCMB Agreement and the enforceability of the
remainder of the BCMB Agreement shall not be affected.
7. The signatories to the BCMB Agreement each hereby warrant that they are
authorised to sign the BCMB Agreement and thereby to bind their principal
to the terms hereof.
8. The Administrators of BCMB shall not incur any personal liability of any
kind under, or by virtue of, the BCMB Agreement and/or the Letter
Agreement, nor in relation to any related matter or claim, whether in
contract, tort or restitution or by reference to any other remedy or right,
in any jurisdiction or forum.
9. The BCMB Agreement:
(a) shall be binding upon and shall enure for the benefit of the
successors of the parties hereto but shall not be assignable (except,
to successor entities by way of merger consolidation or asset
disposition) and;
(b) may be executed in any number of counterparts and all such
counterparts taken together shall be deemed to constitute one and the
same instrument.
9. The BCMB Agreement shall be governed by and construed in all respects in
accordance with English law and the parties hereto submit to the non-
exclusive
4
<PAGE>
jurisdiction of the English Court in relation to any matters arising under
the BCMB Agreement.
Signed by Denton Hall on behalf of) /s/ Denton Hall
BCMB Corporation Limited )
(In Administration) )
)
Signed by Richard Butler )
on behalf of Mercantile )
National Bank Inc )
)
5
<PAGE>
SCHEDULE 1
DRAFT LETTER FROM DENTON HALL TO THE DEFENDANT INSURERS
SOLICITORS
WITHOUT PREJUDICE
& SUBJECT TO CONTRACT
[Date]
Dear Sirs
We confirm that out clients, British Commonwealth and Mercantile Bank (BCMB)
agree:
1 To consent to the amendments to the Points of Counterclaim in Commerical
Court action 1992 Folio No. 2684 ("the Original Action") made by the first
to seventeenth defendants ("the Defendant Insurers") as appear in the
attached drafts at Annex 1 to this letter.
2 In accordance with Mercantile National Bank's instructions to BCMB, to
amend their Points of Claim in the Original Action as per the attached
draft at Annex 2 to this letter.
3 They will not thereafter seek to pursue the Defendant Insurers, Dominic
Adams or the V. W. Broad Agency for any sums in excess of US (Pounds)
60,329.42 plus interest and costs as per paragraph 4 below.
4 In the event of Judgment on costs in favour of BCMB, BCMB will not seek to
obtain more than the following:
<PAGE>
Costs Incurred Up To The Date Of This Agreement
- -----------------------------------------------
(i) 50% of such costs as have been incurred by BCMB in pursuing the claim on
its own behalf and on behalf of MNB.
(ii) 100% of the total costs incurred by BCMB in defending on its own behalf
the Counterclaim by the Defendant Insurers.
Costs Incurred After The Date Of This Agreement
- -----------------------------------------------
(iii) 100% of such costs as are hereafter incurred by BCMB in pursuing the claim
on its own behalf.
(iv) 100% of such costs as are hereafter incurred by BCMB in defending the
Counterclaim on its own behalf.
The Defendant Insurers agree that they will:
5a Amend their Points of Counterclaim as per the drafts at Annex 1.
b Consent to the amendments to BCMB's Points of Claim as appear in Annex 2.
c Not pursue BCMB for sums in excess of US$3,898,814.70 (being one half of
the combined total of the principal sums claimed by the Defendant Insurers
by way of their Counterclaims at the date hereof) plus interest and costs
as per sub-paragraph d. below.
d In the event of a Judgment on costs in favour of the Defendant Insurers,
the Defendant Insurers will not seek to obtain more than the following:-
PAGE 2
<PAGE>
Costs Incurred Up To The Date Of This Agreement
- -----------------------------------------------
(i) 50% of their total costs of defending the claim brought by BCMB on its own
behalf and on behalf of MNB.
(ii) 100% of such of their total costs in pursuing the Counterclaim as are
solely attributable to the Counterclaim against BCMB, plus 50% of such of
their total costs as are common to the Counterclaims against both BCMB and
MNB.
Costs Incurred After The Date Of This Agreement
- -----------------------------------------------
(iii) 100% of such costs as are hereafter incurred by the Defendant Insurers in
defending the claim pursued by BCMB alone.
(iv) 100% of such costs as are hereafter incurred in pursuing the Counterclaim
against BCMB alone.
The Defendant Insurers and BCMB shall be at liberty to bring to the attention of
the Court the terms of the costs provisions (clauses 5 and 6) in the Agreement
between MNB and the Defendant Insurers on the issue of costs.
The obligations of the parties arising from this letter will only come into
effect once condition 2(a) of the Agreement between MNB and the Defendant
Insurers, Dominic Adams and the V. W. Broad Agency has been fulfilled. MNB and
the Defendant Insurers solicitors shall immediately notify BCMB's solicitors
once condition 2(a) has been fulfilled. Within 21 days thereafter, BCMB and the
Defendant Insurers shall seek to amend their respective pleadings in accordance
with paragraphs 2 and 5a above.
The solicitors for Mercantile National Bank, the Defendant Insurers, Mr. Adams
and V. W. Broad Agency have countersigned this letter and the Annexes attached
indicating their clients' agreement to the terms set out in this letter.
PAGE 3
<PAGE>
Yours faithfully
Denton Hall (Solicitors for BCMB)
We confirm the above
- ---------------------------------------
Signed by Clyde & Co (Solicitors for all those Lloyd's
Underwriters subscribing to the Lineslips No. 9SH 9388
& OLH 9482 (The First Defendant) and Mr. Adams, and the
V. W. Broad Agency)
- ---------------------------------------
Signed by LeBoeuf, Lamb, Greene & MacRae (Solicitors
for Eagle Star Insurance Company Limited, Star Assurance
Company Limited and Munich Reinsurance Company (The
Second, Third and Eleventh Defendants))
- ---------------------------------------
Signed by Davies Arnold Cooper (Solicitors for St Paul
Fire and Marine Insurance Company (UK) Ltd, Sphere
Drake Insurance Plc, Scor (UK) Reinsurance Co Ltd,
Orion Insurance Co Ltd, Prudential Assurance Co Ltd, Guardian
Royal Exchange (UK) Ltd, Union America Insurance Co Ltd,
Munich Reinsurance Company, Albingia Versicherungen,
Sovereign Insurance (UK) Ltd, Tokio Marine & Fire Insurance
Co Ltd, Taisho Marine & Fire Insurance Co (Europe) Ltd, Uni
Storebrant Insurance Co (UK) Ltd and Wasa International (UK)
Insurance Co Ltd (The Fourth to Tenth and Twelfth to Seventeenth
Defendants))
- ---------------------------------------
Signed by Richards Butler (solicitors for Mercantile National Bank)
PAGE 4
<PAGE>
[LETTERHEAD OF SANDLER O'NEILL]
December 1, 1996
Board of Directors
National Mercantile Bancorp
1840 Century Park East
Los Angeles, CA 90067-2103
Attention: Mr. Scott A. Montgomery
President and Chief Executive Officer
-------------------------------------
Ladies and Gentlemen:
Sandler O'Neill & Partners, L.P. ("Sandler O'Neill"), is pleased to act as
exclusive financial advisor to the Board of Directors and Senior Management of
National Mercantile Bancorp and its wholly-owned subsidiary, Mercantile National
Bank (together, the "Company"), in connection with the Company's proposed offer
and sale of certain newly issued shares of Series A Noncumulative Convertible
Preferred Stock ("Preferred Stock") of the Company in order to enhance the
Company's capital base (the "Offering"). The Offering would involve a rights
offering to the Company's shareholders as of a specified record date (the
"Rights Offering") in combination with a private offering the Conrad Company and
Wildwood Enterprises, Inc. Profit Sharing Plan (the "Private Offering") and
purchase commitments for unsubscribed shares by certain standby investors (the
"Standby Purchasers") pursuant to standby purchase agreements (the "Standby
Purchaser Offering"). The Rights Offering and the Standby Purchaser Offering
are sometimes collectively referred to herein as the "Public Offering". This
letter is to confirm the terms and conditions of our engagement.
ADVISORY SERVICES
- -----------------
Sandler O'Neill will act as financial advisor to the Company and will work
with the Company's management, counsel, accountants and other advisors in
connection with the Offering. We anticipate that our activities would include,
as appropriate, the following:
1. Assisting management in structuring the Offering;
<PAGE>
Board of Directors
National Mercantile Bancorp
December 1, 1996
Page 2
2. Advising the Company on the financial and market impact of the
proposed Offering;
3. Advising and assisting management in making presentations to the
Company's Board of Directors regarding the Offering;
4. Assisting the Company in establishing an appropriate price for the
shares of Preferred Stock to be issued in the Offering;
5. Reviewing all offering documents, including the Prospectus and related
offering materials (it being understood that preparation and filing of
such documents will be the responsibility of the Company and its
counsel);
6. Identifying prospective standby purchasers in the Standing Purchaser
Offering and assisting in the negotiation of standby purchase
agreements with such standby purchasers;
7. Assisting the Company's management in preparing for meetings with
existing shareholders and other potential investors in the Offering;
and
8. Providing such other general advice and assistance as may be requested
to promote the successful completion of the Offering.
FEES
- ----
For its services hereunder, the Company agrees to pay Sandler O'Neill the
fees set forth below:
(a) A fee of 1.5% of the aggregate value of funds committed in the Private
Offering;
(b) A fee of 3.0% of the aggregate purchase price of the shares of
Preferred Stock sold in the Public Offering pursuant to the exercise
of subscription rights; and
(c) A fee of 5% of the aggregate value of funds committed by Standby
Purchasers in the Standby Purchaser Offering who execute standby
---------------------------------
purchase agreements acceptable to the Company.
-------------------------
The above fee structure is subject to a minimum fee of $250,000.
<PAGE>
Board of Directors
National Mercantile Bancorp
December 1, 1996
Page 3
If (i) Sandler O'Neill's engagement hereunder is terminated for any of the
reasons provided for under the section of this letter captioned "Definitive
Agreement," or (ii) the Offering is terminated by the Company, no fee shall be
payable by the Company to Sandler O'Neill hereunder, however, the Company shall
reimburse Sandler O'Neill for its reasonable out-of-pocket expenses, including
legal fees, in accordance with the provisions of the section of this letter
captioned "Costs and Expenses."
If the Offering is completed, fees payable to Sandler O'Neill hereunder
shall be payable in cash at the time of the closing of the Offering.
COSTS AND EXPENSES
- ------------------
In addition to any fees that may be payable to Sandler O'Neill hereunder
and the expenses to be borne by the Company pursuant to the following paragraph,
the Company agrees to reimburse Sandler O'Neill, upon request made from time to
time, for its reasonable out-of-pocket expenses incurred in connection with its
engagement hereunder up to an aggregate amount of $125,000, inclusive of costs
---------
and expenses paid, or to be paid, under the letter agreement between the
Company and Sandler O'Neill dated February 28, 1996 (the "Letter Agreement"),
but including, without limitation, fees and disbursements of its legal counsel,
advertising, promotional, and travel expenses, regardless of whether the
Offering is consummated; provided, however, that Sandler O'Neill shall document
-------- -------
such expenses to the reasonable satisfaction of the Company. The provisions of
this paragraph are not intended to apply to or in any way impair the
indemnification provisions of this letter.
As is customary, the Company will bear all other expenses incurred in
connection with the Offering, including, without limitation, (i) the cost of
obtaining all securities and bank regulatory approvals, including any required
NASD filing fees; (ii) the cost of printing and distributing the offering
materials; (iii) the costs of blue sky qualification (including fees and
expenses of blue sky counsel in an amount not to exceed $15,000) of the
Preferred Stock in the various states; (iv) listing fees; and (v) all fees and
disbursements of the Company's counsel, accountants, agents and other advisors.
In the event Sandler O'Neill incurs any such fees and expenses on behalf of the
Company, the Company will reimburse Sandler O'Neill for such fees and expenses
whether or not the Offering is consummated; provided, however, that Sandler
-------- -------
O'Neill shall not incur any substantial expenses on behalf of the Company
pursuant to this paragraph without the prior approval of the Company.
<PAGE>
Board of Directors
National Mercantile Bancorp
December 1, 1996
Page 4
DUE DILIGENCE REVIEW
- --------------------
Sandler O'Neill's obligation to perform the services contemplated by this
letter shall be subject to the satisfactory completion of such investigation and
inquiries relating to the Company and its directors, officers, agents and
employees as Sandler O'Neill and its counsel in their sole discretion may deem
appropriate under the circumstances. In this regard, the Company agrees that,
at its expense, it will make available to Sandler O'Neill all information which
Sandler O'Neill requests, and will allow Sandler O'Neill the opportunity to
discuss with the Company's management the financial condition, business and
operations of the Company. The Company acknowledges that Sandler O'Neill will
rely upon the accuracy and completeness of all information received from the
Company and its directors, officers, employees, agents, independent accountants
and counsel.
BLUE SKY MATTERS
- ----------------
The Company agrees that if Sandler O'Neill's counsel does not serve as
counsel with respect to blue sky matters in connection with the Offering, the
Company will cause the counsel performing such services to prepare a Blue Sky
Memorandum related to the Offering including Sandler O'Neill's participation
therein and shall furnish Sandler O'Neill a copy thereof addressed to Sandler
O'Neill or upon which such counsel shall state Sandler O'Neill may rely.
CONFIDENTIALITY
- ---------------
Other than as otherwise required by law or regulation, Sandler O'Neill
agrees that it will not disclose any information furnished by the Company to
Sandler O'Neill in connection with its engagement hereunder (the "Confidential
Information"). As used in this paragraph, the term "Confidential Information"
shall not include information which (a) has been made public by a person other
than Sandler O'Neill, (b) is known to Sandler O'Neill on a non-confidential
basis prior to its disclosure to Sandler O'Neill, (c) has been or is disclosed
to Sandler O'Neill on a non-confidential basis by a third party who is not
otherwise known to Sandler O'Neill to be bound by a duty of confidentiality to
the Company, (d) which the Company has agreed may be disclosed, (e) which
Sandler O'Neill is required to disclose pursuant to a subpoena or order of the
court or other tribunal or agency, or pursuant to law or regulation, or (f) in
connection with litigation to which Sandler O'Neill is or is threatened to be
made a party.
<PAGE>
Board of Directors
National Mercantile Bancorp
December 1, 1996
Page 5
INDEMNIFICATION
- ---------------
The Company agrees to indemnify and hold Sandler O'Neill and its affiliates
and their respective partners, directors, officers, employees, agents and
controlling persons within the meaning of Section 15 of the Securities Act of
1933 or Section 20 of the Securities Exchange Act of 1934 (Sandler O'Neill and
each such person being an "Indemnified Party") harmless from and against any and
all losses, claims, damages and liabilities, joint or several, to which such
Indemnified Party may become subject under applicable federal or state law, or
otherwise (including in settlement of any litigation) related to or arising out
of the Offering, or the engagement of Sandler O'Neill pursuant to, and the
performance by Sandler O'Neill of the services contemplated by, this letter, and
will reimburse any Indemnified Party for all expenses (including reasonable
legal fees and expenses) as they are incurred, including expenses incurred in
connection with the investigation of, preparation for or defense of any pending
or threatened claim or any action or proceeding arising therefrom, whether or
not such Indemnified Party is a party. The Company will not be liable under the
foregoing indemnification provision to the extent that any such loss, claim,
damage, liability or expense is found in the final judgement by a court of
competent jurisdiction to have resulted primarily from Sandler O'Neill's bad
faith or gross negligence.
The Company shall be entitled to assume the defense of any action for which
indemnification is sought hereunder with counsel of its choice at its expense
(in which case it shall not thereafter be responsible for the fees and expenses
of any separate counsel retained by Sandler O'Neill or any other Indemnified
Party except as set forth below); provided, however, that such counsel shall be
-------- -------
satisfactory to Sandler O'Neill. Notwithstanding the Company's election to
assume the defense of such action, if, in the sole judgment of Sandler O'Neill
or any other Indemnified Party, it is advisable for Sandler O'Neill or any other
Indemnified Party to be represented by separate counsel, Sandler O'Neill or any
other Indemnified Party shall have the right to employ counsel to represent
Sandler O'Neill or any other Indemnified Party for liability arising form any
claim in respect of which indemnity may be sought by Sandler O'Neill or any
other Indemnified Party, in which event the reasonable fees and expenses of such
separate counsel shall be borne by the Company and reimbursed to Sandler
O'Neill or any other Indemnified Party as incurred. It is expressly understood
that the Company shall only be obligated to pay for one separate counsel (in
addition to any required local counsel) in any one action or proceeding or group
of related actions or proceedings for all Indemnified Parties collectively. The
Company will not be liable under this letter agreement for any amount paid by
Sandler O'Neill or any other Indemnified Party to settle any claims or actions
if the settlement is entered into without the Company's consent, which shall not
be unreasonably withheld.
In the event Sandler O'Neill appears as a witness in any action brought
against the Company in which an Indemnified Party is not named as a defendant,
the Company agrees to reimburse Sandler O'Neill for all reasonable expenses
incurred and time expended by it in connection with its appearing as a witness.
<PAGE>
Board of Directors
National Mercantile Bancorp
December 1, 1996
Page 6
If the foregoing indemnification is unavailable for any reason, the Company
agrees to contribute to such losses, claims, damages, liabilities and expenses
in the proportion that its financial interest in the Offering bears to that of
Sandler O'Neill.
The Company agrees to notify Sandler O'Neill promptly of the assertion
against it or any other person of any claim or the commencement of any action or
proceeding relating to any transaction contemplated by this agreement.
DEFINITIVE AGREEMENT
- --------------------
Sandler O'Neill and the Company agree that (a) except as set forth in
clause (b) of this sentence, the foregoing represents the general intention of
the Company and Sandler O'Neill and will supercede the provisions set forth in
the Letter Agreement unless otherwise stated herein, with respect to the
services to be provided by Sandler O'Neill in connection with the Offering,
which will serve as a basis for Sandler O'Neill to proceed with its activities,
and (b) the only legal and binding obligations of the Company and Sandler
O'Neill with respect to the subject matter hereof shall be (1) the Company's
obligation to reimburse costs and expenses pursuant to the section captioned
"Costs and Expenses," (2) those set forth under the captions "Confidentiality"
and "Indemnification," and (3) as set forth in a duly negotiated and executed
definitive Agency Agreement to be entered into prior to the commencement of the
Offering relating to the services of Sandler O'Neill in connection with the
Offering. Such Agency Agreement shall be in form and content satisfactory to
Sandler O'Neill and the Company and their respective counsel and shall contain
standard indemnification provisions consistent herewith.
Sandler O'Neill's execution of such Agency Agreement shall also be subject
to (i) Sandler O'Neill's satisfaction with its investigation of the Company's
business, financial condition and results of operations, (ii) preparation of
offering materials that are reasonably satisfactory to Sandler O'Neill and its
counsel, (iii) compliance with all relevant legal and regulatory requirements to
the reasonable satisfaction of Sandler O'Neill's counsel, and (iv) market
conditions at the time of the proposed offering.
TERMINATION OF ENGAGEMENT
- -------------------------
Sandler O'Neill's engagement hereunder may be terminated by the Company or
by Sandler O'Neill at any time upon 30 days written notice to that effect, it
being understood that (1) the obligation of the Company to reimburse costs and
expenses pursuant to the section captioned "Costs and Expenses" and (2) the
obligations of the Company and Sandler O'Neill set forth under the captions
"Confidentiality" and "Indemnification" will survive any such termination.
<PAGE>
Board of Directors
National Mercantile Bancorp
December 1, 1996
Page 7
JURISDICTION
- ------------
This agreement shall be governed by, and construed in accordance with, the
laws of the State of New York applicable to contracts executed in and to be
performed in the state, without regard to conflicts of laws principles.
Please confirm that the foregoing correctly sets forth our agreement by
signing and returning to Sandler O'Neill the duplicate copy of this letter
enclosed herewith.
Very truly yours,
Sandler O'Neill & Partners, L.P.
By: Sandler O'Neill & Partners Corp.,
the sole general partner.
By: /s/ Catherine A. Lawton
--------------------------
Catherine A. Lawton
Vice President
Accepted and agreed to as of
the date first written above:
National Mercantile Bancorp
By: ________________________
Title: ________________________
Date: ________________________
<PAGE>
EXHIBIT 21
Subsidiaries of the Registrant
Mercantile National Bank
1840 Century Park East
Los Angeles, California 90067
<PAGE>
EXHIBIT 23
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statements No.
33-23303 and 33-94828 of National Mercantile Bancorp on Form S-8 of our report
dated March 7, 1997, appearing in this Annual Report on Form 10-K of National
Mercantile Bancorp for the year ended December 31, 1996.
DELOITTE & TOUCHE LLP
Los Angeles, California
March 27, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 5,113
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 23,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 4,002
<INVESTMENTS-CARRYING> 14,395
<INVESTMENTS-MARKET> 0
<LOANS> 62,547
<ALLOWANCE> 2,969
<TOTAL-ASSETS> 109,416
<DEPOSITS> 103,854
<SHORT-TERM> 0
<LIABILITIES-OTHER> 717
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0
0
<COMMON> 24,614
<OTHER-SE> (19,769)
<TOTAL-LIABILITIES-AND-EQUITY> 109,416
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<INTEREST-TOTAL> 8,757
<INTEREST-DEPOSIT> 3,054
<INTEREST-EXPENSE> 3,079
<INTEREST-INCOME-NET> 5,678
<LOAN-LOSSES> 0
<SECURITIES-GAINS> (3)
<EXPENSE-OTHER> 8,003
<INCOME-PRETAX> (1,823)
<INCOME-PRE-EXTRAORDINARY> (1,823)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,244)
<EPS-PRIMARY> (.40)
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<YIELD-ACTUAL> 5.45
<LOANS-NON> 928
<LOANS-PAST> 300
<LOANS-TROUBLED> 5,016
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