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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE YEAR ENDED DECEMBER 31, 1997 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 to principal executive (Zip Code)
offices)
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 registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K. / /
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 February 13, 1998, was approximately $4,223,732.
The number of shares of Common Stock, no par value, of the registrant
outstanding as of February 13, 1998 was 677,048.
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 1998 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 73 PAGES
INDEX TO EXHIBITS ON PAGE E-1
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NATIONAL MERCANTILE BANCORP
TABLE OF CONTENTS
FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
PAGE(S) IN
FORM
10-K
PART I
- ------
ITEM 1. BUSINESS ................................................... 1
ITEM 2. PROPERTIES .................................................. 7
ITEM 3. LEGAL PROCEEDINGS .......................................... 7
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ......... 7
PART II
- -------
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
SHAREHOLDER MATTERS ......................................... 7
ITEM 6. SELECTED FINANCIAL DATA ..................................... 9
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS ................................... 11
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ................. 43
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE ................................... 43
PART III
- --------
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT .......... 43
ITEM 11. EXECUTIVE COMPENSATION ..................................... 43
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT ................................................. 43
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ............. 43
PART IV
- -------
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K .................................................... 44
SIGNATURES ............................................................. 45
Financial Statements .................................................... F-1
Exhibit Index .......................................................... E-1
<PAGE>
PART I
ITEM 1. BUSINESS
Certain matters discussed in this Form 10-K may constitute
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995 (the "Reform Act") and as such may involve
risks and uncertainties. These forward-looking statements relate to, among
other things, expectations of the business environment in which the Company
operates, projections of future performance, perceived opportunities in the
market and statements regarding the Company's mission and vision. The
Company's actual results, performance, or achievements may differ
significantly from the results, performance, or achievements expressed or
implied in such forward-looking statements. For discussion of the factors
that might cause such a difference, see "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations--Cautionary
Statement for Purposes of the `Safe Harbor' Provisions of the Private
Securities Litigation Reform Act of 1995".
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.
Because the Bank comprises substantially all of the business of the Company,
references to the "Company" reflect the consolidated activities of the
Company and Bank. On February 6, 1986, the Federal Reserve Bank of San
Francisco (the "Reserve Bank") approved the Company to engage in lending
activities. The Reserve Bank as part of its regulatory oversight may conduct
examinations of the Company and its subsidiaries.
As a legal entity separate and distinct from its subsidiary, the
Company's principal source of funds is currently interest earned from its
loans and investments. 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 Item 14. "Exhibits, Financial Statement Schedules and Reports
on Form 8K--Notes to Consolidated Financial Statements for the Three years
ended December 31, 1997--Note 14--Availability of Funds from Bank".
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. 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. The Bank's primary business
activities are to generate deposits and loans. In addition, the Bank provides
investment and specialized deposit services in order to accommodate the
needs of large deposit clients.
COMPETITION
The banking business is highly competitive. The Bank's primary service
area 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, savings and loan
associations, credit unions, and thrift and loan companies, as well as with
non-depository institutions, including mortgage companies, commercial finance
lenders and providers of money market mutual funds. Non-depository
institutions can be expected to increase the extent to which they act as
financial intermediaries. Large institutional users and sources of credit
may also increase the extent to which they interact directly, meeting
business credit needs outside the banking system. Furthermore, the
geographic constraints on portions of the financial services industry can be
expected to continue to erode. 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
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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.
MONETARY POLICY
The earnings of the Bank are affected not only by general economic
conditions, but also by the policies of various governmental regulatory
authorities in the U.S. and abroad. In particular, the Board of Governors of
the Federal Reserve System (Federal Reserve Board) exerts a substantial
influence on interest rates and credit conditions, primarily through open
market operations in U.S. government securities, varying the discount rate on
member bank borrowings and setting reserve requirements against deposits.
Federal Reserve Board's monetary policies have had a significant effect on
the operating results of financial institutions in the past and are expected
to continue to do so in the future.
SUPERVISION AND REGULATION
Bank holding companies, banks and their non-bank affiliates are
extensively regulated under both federal and state law. The following is not
intended to be an exhaustive description of the statutes and regulations
applicable to the Company's or the Bank's business. The description of
statutory and regulatory provisions is qualified in its entirety by reference
to the particular statutory or regulatory provisions.
Moreover, major new legislation and other regulatory changes affecting
the Company, the Bank, banking and the financial services industry in general
have occurred in the last several years and can be expected to occur in the
future. The nature, timing and impact of new and amended laws and regulations
cannot be accurately predicted.
BANK HOLDING COMPANIES
Bank holding companies are regulated under the BHC Act and are
supervised by the Federal Reserve Board. Under the BHC Act, the Company
files reports of its operations with the Federal Reserve Board and is subject
to examination by it.
The BHC Act requires, among other things, the Federal Reserve Board's
prior approval whenever a bank holding company proposes to (i) acquire all or
substantially all the assets of a bank, (ii) acquire direct or indirect
ownership or control of more than 5% of the voting shares of a bank, or (iii)
merge or consolidate with another bank holding company. In 1996, legislation
was approved that will substantially streamline the application process for
well-capitalized and well-managed bank holding companies.
In September 1994, the Riegle-Neal Interstate Banking and Branch
Efficiency Act (the Riegle-Neal Act) was enacted. Under the Riegle-Neal Act,
interstate banking is allowed in three different forms:
- Effective September 1995, a bank owned by a holding company may acquire
a subsidiary bank anywhere in the United States.
- Effective September 1995, a bank owned by a holding company may act as
an agent in accepting deposits or servicing loans for any other bank or
savings or loan owned by the holding company.
- Effective June 1, 1997, a bank itself may establish a branch in another
state, but only if the bank's home state permits interstate mergers and
branches, and the other state has not passed a law to prohibit
interstate mergers or branches.
Interstate bank subsidiaries and branch banks are subject to
concentration limits, Community Reinvestment Act requirements, bank
supervisory controls and other restrictions of the Riegle-Neal Act or of
state law.
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California law permits bank holding companies in other states to acquire
California banks and bank holding companies, provided the acquiring company's
home state has enacted "reciprocal" legislation that expressly authorizes
California bank holding companies to acquire banks or bank holding companies
in that state on terms and conditions substantially no more restrictive than
those applicable to such an acquisition in California by a bank holding
company from the other state.
The BHC Act also prohibits a bank holding company, with certain
exceptions, from acquiring more than 5% of the voting shares of any company
that is not a bank and from engaging in any activities without the Federal
Reserve Board's prior approval other than (1) managing or controlling banks
and other subsidiaries authorized by the BHC Act, or (2) furnishing services
to, or performing services for, its subsidiaries. The BHC Act authorizes the
Federal Reserve Board to approve the ownership of shares in any company, the
activities of which have been determined to be so closely related to banking
or to managing or controlling banks as to be a proper incident thereto.
Consistent with its "source of strength" policy (see "Capital Adequacy
Requirements," below), the Federal Reserve Board has stated that, as a matter
of prudent banking, a bank holding company generally should not pay cash
dividends unless its net income available to common shareholders has been
sufficient to fully fund the dividends, and the prospective rate of earnings
retention appears consistent with the company's capital needs, asset quality
and overall financial condition.
A bank holding company and its subsidiaries are prohibited from engaging
in certain tie-in arrangements in connection with the extension of credit.
The Federal Reserve Board may, among other things, issue
cease-and-desist orders with respect to activities of bank holding companies
and nonbanking subsidiaries that represent unsafe or unsound practices or
violate a law, administrative order or written agreement with a federal
banking regulator. The Federal Reserve Board can also assess civil money
penalties against companies or individuals who violate the BHC Act or other
federal laws or regulations, order termination of nonbanking activities by
nonbanking subsidiaries of bank holding companies and order termination of
ownership and control of a nonbanking subsidiary by a bank holding company.
NATIONAL BANKS
The Bank is a national bank and, as such, is subject to supervision and
examination by the OCC and requirements and restrictions under federal and
state law, including requirements to maintain reserves against deposits,
restrictions on the types and amounts of loans that may be granted and
limitations on the types of investments that may be made and services that
may be offered. Various consumer laws and regulations also affect the Bank's
operations. These laws primarily protect depositors and other customers of
the Bank, rather than the Company and its shareholders.
"Brokered deposits" are deposits obtained by a bank from a "deposit
broker" or that pay above-market rates of interest. Because the Bank is
categorized as a well capitalized financial institution, the Bank can accept
brokered deposits without the prior approval of the Federal Deposit Insurance
Corporation ("FDIC"). Currently, the Bank is not utilizing brokered deposits.
The Company's principal asset is its investment in the Bank. The Bank's
ability to pay dividends to the Company is limited by certain statutes and
regulations. OCC approval is required for a national bank to pay a dividend
if the total of all dividends declared in any calendar year exceeds the total
of the bank's net profits (as defined) for that year combined with its
retained net profits for the preceding two calendar years, less any required
transfer to surplus or a fund for the retirement of any preferred stock. A
national bank may not pay any dividend that exceeds its retained net profits
then on hand after deducting its loan losses and bad debts, as defined by the
OCC. At December 31, 1997 the Bank did not have funds available for the
payment of cash dividends. The OCC and the Federal Reserve Board have also
issued banking circulars emphasizing that the level of cash dividends should
bear a direct correlation to the level of a national bank's current and
expected earnings stream, the bank's need to maintain an adequate capital
base and other factors. National banks that are not in compliance with
regulatory capital requirements generally are not permitted to pay dividends.
The Bank is in compliance with such
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requirements. The OCC also can prohibit a national bank from engaging in an
unsafe or unsound practice in its business. Depending on the bank's
financial condition, payment of dividends could be deemed to constitute an
unsafe or unsound practice. Except under certain circumstances and with
prior regulatory approval, a bank may not pay a dividend if, after so doing,
it would be undercapitalized. The Bank's ability to pay dividends in the
future is, and could be, further influenced by regulatory policies or
agreements and by capital guidelines.
The Bank's ability to make funds available to the Company is also
subject to restrictions imposed by federal law on the Bank's ability to
extend credit to the Company to purchase assets from it, to issue a
guarantee, acceptance or letter of credit on its behalf (including an
endorsement or standby letter of credit), to invest in its stock or
securities, or to take such stock or securities as collateral for loans to
any borrower. Such extensions of credit and issuances generally must be
secured and are generally limited, with respect to the Company, to 10% of the
Bank's capital stock and surplus.
The Bank is insured by the FDIC and therefore is subject to its
regulations. Among other things, the Federal Deposit Insurance Corporation
Improvement Act of 1991 ("FDICIA") provided authority for special assessments
against insured deposits and required the FDIC to develop a general
risk-based assessment system. During 1995, the Bank Insurance Fund reached
its targeted level of 1.25% of estimated insured deposits. The FDIC reduced
the minimum assessment rate for well capitalized banks to $2,000 per year for
1996. Beginning January 1, 1997, the FDIC collects an assessment against
Bank Insurance Fund-assessable deposits to be paid to the Financing
Corporation of approximately 1.29 basis points on total deposits, as defined.
Banks and bank holding companies are also subject to the Community
Reinvestment Act of 1977, as amended ("CRA"). CRA requires the Bank to
ascertain and meet the credit needs of the communities it serves, including
low-and moderate-income neighborhoods. The Bank's compliance with CRA is
reviewed and evaluated by the OCC, which assigns the Bank a publicly
available CRA rating at the conclusion of the examination. Further, an
assessment of CRA compliance is also required in connection with applications
for OCC approval of certain activities, including establishing or relocating
a branch office that accepts deposits or merging or consolidating with, or
acquiring the assets or assuming the liabilities of, a federally regulated
financial institution. An unfavorable rating may be the basis for OCC
denial of such an application, or approval may be conditioned upon
improvement of the applicant's CRA record. In the case of a bank holding
company applying for approval to acquire a bank or other bank holding
company, the Federal Reserve Board will assess the CRA record of each
subsidiary bank of the applicant, and such records may be the basis for
denying the application.
At the conclusion of the most recently completed CRA compliance
examination, conducted in 1996, the OCC assigned the Bank a rating of
"Satisfactory," the second highest of four possible ratings. From time to
time, banking legislation has been proposed that would require consideration
of the Bank's CRA rating in connection with applications by the Company or
the Bank to the Federal Reserve Board or the OCC for permission to engage in
additional lines of business. The Company cannot predict whether such
legislation will be adopted, or its effect upon the Bank and the Company if
adopted. In April 1995, the federal regulatory agencies issued a
comprehensive revision to the rules governing CRA compliance. In assigning a
CRA rating to a bank, the new regulations place greater emphasis on
measurements of performance in the area of lending (specifically, the bank's
home mortgage, small business, small farm and community development loans),
investment (the bank's community development investments) and service (the
bank's community development services and the availability of its retail
banking services), although examiners are still given a degree of flexibility
in taking into account unique characteristics and needs of the bank's
community and its capacity and constraints in meeting such needs. The new
regulations also require increased collection and reporting of data regarding
certain kinds of loans. Although the regulation became generally effective
on July 1, 1995, various provisions have different effective dates, and the
new CRA evaluation criteria will go into effect for examinations beginning on
July 1, 1997. Although management cannot predict the impact of the
substantial changes in the new rules on the Bank's CRA rating, it will
continue to take steps to comply with the requirements in all respects.
In 1995, the OCC adopted regulations under FDICIA incorporating
guidelines establishing standards for safety and soundness, including
operational and managerial standards relating to internal controls and
information systems, internal audit systems, loan documentation, credit
underwriting, interest rate exposure, assets growth and
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compensation, fees and benefits, as well as prohibiting compensation deemed
excessive. If the OCC finds that a bank has failed to meet any applicable
standard, it may require the institution to submit an acceptable plan to
achieve compliance and, if the bank fails to comply, the OCC must, by order,
require it to correct the deficiency. The guidelines are general in nature
and are not expected to require material changes in the Bank's operations.
Banking agencies have recently adopted final regulations which mandate
that regulators take into consideration concentrations of credit risk and
risks from non-traditional activities, as well as an institution's ability to
manage those risks, when determining the adequacy of an institution's
capital. This evaluation will be made as a part of the institution's regular
safety and soundness examination. Banking agencies also have recently
adopted final regulations requiring regulators to consider interest rate risk
(when the interest rate sensitivity of an institution's assets does not match
the sensitivity of its liabilities or its off-balance-sheet position) in the
evaluation of a bank's capital adequacy. Concurrently, banking agencies have
proposed a methodology for evaluating interest rate risk. After gaining
experience with the proposed measurement process, those banking agencies
intend to propose further regulations to establish an explicit risk-based
capital charge for interest rate risk.
The OCC has enforcement powers with respect to national banks for
violations of federal laws or regulations that are similar to the powers of
the Federal Reserve Board with respect to bank holding companies and
nonbanking subsidiaries. See "Bank Holding Companies," above.
CAPITAL ADEQUACY REQUIREMENTS
Both the Federal Reserve Board and the OCC have adopted similar, but not
identical, "risk-based" and "leverage" capital adequacy guidelines for bank
holding companies and national banks, respectively. Under the risk-based
capital guidelines, different categories of assets are assigned different
risk weights, ranging form zero percent for risk-free assets (e.g., cash) to
100% for relatively high-risk assets (e.g., commercial loans). These risk
weights are multiplied by corresponding asset balances to determine a
risk-adjusted asset base. Certain off-balance sheet items (e.g., standby
letters of credit) are added to the risk-adjusted asset base. The minimum
required ratio of total capital to risk-weighted assets for both bank holding
companies and national banks is presently 8%. At least half of the total
capital is required to be "Tier 1 capital," consisting principally of common
shareholders' equity, a limited amount of perpetual preferred stock and
minority interests in the equity. The remainder (Tier 2 capital) may consist
of a limited amount of subordinated debt, certain hybrid capital instruments
and other debt securities, preferred stock and a limited amount of the
general loan-loss allowance. As of December 31, 1997, the Company had a
ratio of total capital to risk-weighted assets (total risk-based capital
ratio) of 18.25% and a ratio of Tier 1 capital to risk-weighted assets (Tier
1 risk-based capital ratio) of 16.98%, while the Bank had a total risk-based
capital ratio of 11.63% and a Tier 1 risk-based capital ratio of 10.36%.
The minimum Tier 1 leverage ratio, consisting of Tier 1 capital to
average adjusted total assets, is 3% for bank holding companies and national
banks that have the highest regulatory examination rating and are not
contemplating significant growth or expansion. All other bank holding
companies and national banks are expected to maintain a ratio of at least 1%
to 2% or more above the stated minimum. As of December 31, 1997, the Company
had a Tier 1 leverage ratio of 10.43%, and the Bank's Tier 1 leverage ratio
was 6.48%.
The OCC has adopted regulations under FDICIA establishing capital
categories for national banks and prompt corrective actions for
undercapitalized institutions. The regulations create five capital
categories: well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized and critically undercapitalized. The
following table shows the minimum total risk-based capital, Tier 1 risk-based
capital and Tier 1 leverage ratios, which must be satisfied for a bank to be
classified as well capitalized, adequately capitalized or under-capitalized,
respectively, together with the Company's and Bank's ratios at December 31,
1997:
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<TABLE>
<CAPTION>
Total Tier 1 Tier 1
risk-based risk-based leverage
capital ratio capital ratio ratio
------------- ------------- --------
<S> <C> <C> <C>
Actual:
National Mercantile Bancorp ......... 18.25% 16.98% 10.43%
Mercantile National Bank. ........... 11.63% 10.36% 6.48%
Minimum:
Well capitalized (1) ................ 10.00% 6.00% 5.00%
Adequately capitalized .............. 8.00% 4.00% 4.00% (2)
Undercapitalized .................... 6.00% 4.00% 3.00%
</TABLE>
(1) A bank may not be classified as well capitalized if it is subject to a
specific agreement with OCC to meet and maintain a specific level of
capital.
(2) 3% for institutions having a composite rating of 1 in the most recent
OCC examination.
If any one or more of a bank's ratios are below the minimum ratios required
to be classified as undercapitalized, it will be classified as significantly
undercapitalized or, if in addition, its ratio of tangible equity to total
assets is 2% or less, it will be classified as critically undercapitalized. A
bank may be reclassified by the OCC to the next level below that determined by
the criteria described above if the OCC finds that it is in an unsafe or
unsound condition or if it has received a less-than-satisfactory rating for any
of the categories of asset quality, management, earnings or liquidity in its
most recent examination and the deficiency has not been corrected, except that
a bank cannot be reclassified as critically undercapitalized for such reasons.
Under FDICIA and its implementing regulations, the OCC may subject national
banks to a broad range of restrictions and regulatory requirements. A national
bank may not pay management fees to any person having control of the
institution, nor, except under certain circumstances and with prior regulatory
approval, make any capital distribution if, after doing so, it would be
undercapitalized. Undercapitalized banks are subject to increased monitoring
by the OCC, are restricted in their asset growth, must obtain regulatory
approval for certain corporate activities, such as acquisitions, new branches
and new lines of business, and, in most cases, must submit to the OCC a plan to
bring their capital levels to the minimum required in order to be classified as
adequately capitalized. The OCC may not approve a capital restoration plan
unless each company that controls the bank guarantees that the bank will comply
with it. Significantly and critically undercapitalized banks are subject to
additional mandatory and discretionary restrictions and, in the case of
critically undercapitalized institutions, must be placed into conservatorship
or receivership unless the OCC and the FDIC agree otherwise.
Under Federal Reserve Board policy, a bank holding company is expected
to act as a source of financial strength to its subsidiary banks and to
commit resources to support each such bank. In addition, a bank holding
company is required to guarantee that its subsidiary bank will comply with
any capital restoration plan required under FDICIA. The amount of such a
guarantee is limited to the lesser of (i) 5% of the bank's total assets at
the time it became undercapitalized, or (ii) the amount which is necessary
(or would have been necessary) to bring the bank into compliance with all
applicable capital standards as of the time the bank fails to comply with the
capital restoration plan. A holding company guarantee of a capital
restoration plan results in a priority claim to the holding company's assets
ahead of its other unsecured creditors and shareholders that is enforceable
even in the event of the holding company's bankruptcy or the subsidiary
bank's insolvency.
EMPLOYEES
As of February 13, 1998, the Company had 6 officers but no employees
while the Bank had 43 full-time equivalent employees including 6 of the
Company's officers. The Company and the Bank believe that the Bank's
relations with its employees are good and it has not encountered a strike or
material work stoppage.
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ITEM 2. PROPERTIES
The Bank leases space in an office building at 1840 Century Park East, Los
Angeles, California. The Bank leases approximately 23,883 square feet under
its lease at an effective rent per square foot of approximately $2.33 or
$55,666 per month for the period November 1, 1995 to 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. The rent is subject to annual
adjustments for changes in property taxes and operating costs.
Under the provisions of the lease agreement, the Bank 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 $5.00 per common share which has
been adjusted for the 9:09 to 1 reverse stock split completed June 20, 1997
and the 100% common stock dividend paid on February 13, 1998, and an exercise
price of $10.00 per share of preferred stock (with such stock being
convertible into 2 shares of common stock). The Company also granted the
landlord registration rights with respect to capital stock 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. Based on present knowledge, management is of the opinion
that the final outcome of such lawsuits will not have a material adverse
effect upon the Company.
The Company is not aware of any material proceedings to which any
director, officer or affiliate of the Company, any owner of record or
beneficially of more than 5% of the voting securities of the Company, or any
associate of any such director, officer or security holder is a party adverse
to the Company or has a material interest adverse to the Company.
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, 1997.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS
Until March 10, 1997, the common stock, no par value ("Common Stock") of
the Company was traded on the NASDAQ national tier of the NASDAQ stock
market. Since that date the Common Stock has traded in the over-the-counter
market on the Nasdaq SmallCap tier of the Nasdaq Stock Market ("NASDAQ
SmallCap Market"), under the symbol MBLA. The 6.5% noncumulative convertible
preferred stock ("Preferred Stock") of the Company has traded in the NASDAQ
SmallCap Market since issuance on June 30, 1997. The following table shows
the high and low trade prices of the Company's Common Stock and Preferred
Stock for each quarter of 1996 and 1997 as quoted by the NASDAQ.
Additionally, there may have been transactions at prices other than those
shown during that time.
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<TABLE>
<CAPTION>
Common Stock Preferred
Quarter Ended: High Low High Low
-------------- ---- --- ---- ---
<S> <C> <C> <C> <C>
March 31, 1996............................. 9.36 5.68 n/a n/a
June 30, 1996.............................. 10.82 6.82 n/a n/a
September 30, 1996......................... 8.54 5.14 n/a n/a
December 31, 1996.......................... 5.68 4.55 n/a n/a
March 31, 1997............................. 9.66 4.83 n/a n/a
June 30, 1997.............................. 8.24 5.68 n/a n/a
September 30, 1997......................... 7.25 5.75 14.50 12.75
December 31, 1997.......................... 7.88 6.00 14.69 13.50
</TABLE>
The prices of the Common Stock stated above have been restated to
reflect both the 9:09 to 1 reverse stock split effective June 20, 1997 and
the 100% common stock dividend paid on February 13, 1998. The 100% common
stock dividend was accounted for as a 2 for 1 stock split.
At February 13, 1998, the closing trade price for the Company's Common
Stock and Preferred Stock as quoted by Nasdaq was approximately $6.75 and
$14.25 per share, respectively. At February 13, 1998, the Company had
approximately 243 registered shareholders of record for its Common Stock and
approximately 30 registered shareholders of record for its Preferred Stock.
The actual number of shareholders for the Common Stock and Preferred Stock is
higher as many of the Company's shareholders hold their shares in "street"
name as a single holder. At February 13, 1998, approximately 62% and 70% of
the Common Stock and Preferred Stock, respectively, was held in street name.
The Company has not paid a cash dividend on the Common Stock since July
1990, nor a cash dividend on the Preferred Stock since its issuance on June
30, 1997 (dividends are not required to be paid on the preferred stock until
October 31, 1999), and there can be no assurance that the Company will
generate earnings in the future which would permit the declaration of cash
dividends. The Company is prohibited from declaring or paying a cash dividend
until 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. Based on the retained earnings of
the Company and the Company's assets and liabilities as of December 31, 1997,
it is unlikely the Company will be able to legally pay dividends for the
foreseeable future. Further, it is anticipated that for the foreseeable
future any earnings that may be generated will be retained for the purpose of
increasing the Company's capital and reserves to facilitate growth.
Page 8
<PAGE>
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, 1997. The information below should be read in conjunction with,
and is qualified in its entirety by, the more detailed information included
elsewhere including the Company's Audited Consolidated Financial Statements
and Notes thereto.
ITEM 6a. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
1997 (7) 1996 1995 1994 1993
-------- ------ ------- ------- -------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Interest income.............................................. $8,600 $8,757 $11,634 $20,900 $20,612
Interest expense............................................. 2,856 3,079 3,979 5,526 5,920
------- ------- -------- -------- --------
Net interest income.......................................... 5,744 5,678 7,655 15,374 14,692
Provision for credit losses.................................. - - 2,307 7,330 2,000
------- ------- -------- -------- --------
Net interest income after provision for credit losses........ 5,744 5,678 5,348 8,044 12,692
Other operating income (loss)................................ 486 502 (1,315) (2,857) 1,474
Other operating expense (1).................................. 6,098 8,003 11,233 13,714 14,058
------- ------- -------- -------- --------
Income (loss) before income tax benefit and cumulative
effect of change in accounting principle................... 132 (1,823) (7,200) (8,527) 108
Income tax benefit........................................... - 579 - - -
------- ------- -------- -------- --------
Net income (loss) before cumulative effect of change in
accounting principle........................................ 132 (1,244) (7,200) (8,527) 108
Cumulative effect of change in accounting principle.......... - - - - 63
------- ------- -------- -------- --------
Net income (loss)............................................ $132 $(1,244) $(7,200) $(8,527) $171
------- ------- -------- -------- --------
------- ------- -------- -------- --------
PER SHARE DATA:
Net income (loss) basic (2).................................. $0.20 $(1.84) $(10.63) $(12.68) $0.26
Net income (loss) diluted (2)................................ 0.08 (1.84) (10.63) (12.68) 0.25
Book value (period end) (3).................................. 5.02 7.14 8.86 15.23 33.13
Weighted average common shares outstanding (2):.............. 677,202 677,260 677,260 672,296 669,146
BALANCE SHEET DATA - AT PERIOD END:
Assets...................................................... $119,405 $109,416 $131,992 $232,979 $303,120
Securities................................................... 40,478 18,630 20,417 62,056 83,674
Loans receivable............................................. 61,252 62,547 82,012 115,284 161,791
Interest-earning assets...................................... 113,880 104,177 123,429 208,634 283,064
Deposits..................................................... 97,388 103,854 120,243 207,815 268,846
Shareholders' equity......................................... 12,440 4,845 6,011 10,308 22,199
AVERAGE BALANCE SHEET DATA - AVERAGE BALANCES:
Assets....................................................... $107,801 $112,303 $149,399 $245,555 $291,166
Securities................................................... 29,768 17,398 26,681 79,146 93,914
Loans receivable............................................. 59,336 69,975 95,771 140,079 159,680
Interest-earning assets...................................... 102,007 106,945 138,660 227,009 266,011
Deposits..................................................... 96,445 104,118 134,218 212,755 251,934
Shareholders' equity......................................... 8,541 5,500 9,033 19,086 21,713
</TABLE>
Page 9
<PAGE>
ITEM 6b.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------
1997 (7) 1996 1995 1994 1993
-------- ------ ------- ------- -------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
SELECTED PERFORMANCE RATIOS:
Return (loss) on average assets..................... 0.12% -1.11% -4.82% -3.47% 0.06%
Return (loss) on average shareholders' equity....... 1.55% -22.61% -79.71% -44.68% 0.79%
Average shareholders' equity to average assets...... 7.92% 4.90% 6.05% 7.77% 7.46%
Net interest spread................................. 4.05% 3.71% 3.77% 5.43% 4.44%
Net yield on interest-earning assets................ 5.63% 5.31% 5.52% 6.77% 5.56%
CAPITAL RATIOS:
Company:
Tier 1 risk-based.................................. 16.98% 6.96% 6.96% 9.84% 11.94%
Total risk-based................................... 18.25% 8.25% 8.25% 11.11% 13.25%
Leverage........................................... 10.43% 4.68% 4.68% 5.65% 7.11%
Bank:
Tier 1 risk-based.................................. 10.36% 6.95% 6.95% 9.80% 11.65%
Total risk-based................................... 11.63% 8.24% 8.24% 11.06% 12.95%
Leverage........................................... 6.48% 4.67% 4.67% 5.62% 6.93%
ASSET QUALITY:
Nonaccrual loans.................................... $1,201 $928 $573 $3,426 $7,780
Troubled debt restructurings (4).................... 5,422 5,016 5,167 5,582 5,584
Loans contractually past due ninety days or
more with respect to either principal or
interest and still accruing interest............... - 300 221 1,507 2,502
------ ------ ------ ------ ------
Total nonperforming loans.......................... 6,623 6,244 5,961 10,515 15,866
Other real estate owned (5)......................... 777 556 581 1,529 6,175
------ ------ ------ ------ ------
Total nonperforming assets.......................... $7,400 $6,800 $6,542 $12,044 $22,041
------ ------ ------ ------ ------
------ ------ ------ ------ ------
ASSETS QUALITY RATIOS:
Nonaccrual loans to loans receivable................ 2.0% 1.5% 0.7% 3.0% 4.8%
Nonaccrual assets to total assets (6)............... 1.7% 1.4% 0.9% 2.1% 4.6%
Allowance for credit losses to loans receivable..... 3.3% 4.7% 4.6% 2.7% 4.1%
Allowance for credit losses to nonaccrual loans..... 168.4% 319.9% 664.0% 89.4% 86.1%
Net charge-offs to average loans receivable......... 1.6% 1.2% 1.6% 7.8% 0.8%
</TABLE>
- -----------------------
(1) Includes a legal settlement of $1.0 million for the year ended
December 31, 1996.
(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
diluted 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 diluted earnings per share in
1997 and 1993 was 1,629,796 and 697,744, respectively.
(3) Book value per share numbers are based on the number of shares
outstanding at period end (including the assumed conversion of 900,000
shares of Preferred Stock into 1,800,000 shares of Common Stock at
December 31, 1997) and does not give effect to outstanding options and
warrants to purchase Common Stock.
(4) Includes one loan, a trouble debt restructuring with a principal
balance of $5.4 million at December 31, 1997 and $4.9 million at
December 31, 1996, 1995, 1994 and 1993. This loan is secured by a
first deed of trust on a single-family residence which, as of January
1998, had an appraised value of $10.0 million.
(5) Includes OREO acquired by the Bank through legal foreclosure and/or
deed-in-lieu of foreclosure.
(6) Nonaccrual assets are comprised of nonaccrual loans plus OREO.
(7) On June 30, 1997 the Company completed the sale of 900,000 shares of
Preferred Stock through a private offering and rights offering in which
the Company raised net proceeds of $7.35 million ("Capital Offerings").
Page 10
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
National Mercantile Bancorp (the "Company") is the holding company for
Mercantile National Bank (the "Bank"). In light of the fact that the Bank
constitutes substantially all of the business of the Company, references to the
Company in this Item 7 reflect the consolidated activities of the Company and
the Bank.
OVERVIEW
The operating results for 1997 reflected a reversal of trends recently
experienced by the Company over the past several years. This reversal was
evident by the Company's growth in assets during the second half of 1997
along with net income of $344,000 during this same period, which offset
declining asset trends and net losses of $212,000 during the first six months
of 1997. The 1997 results were the culmination of management's plan to
restructure the balance sheet and reduce operating expenses over the past
three years combined with the Capital Offerings completed on June 30, 1997.
The Company recorded net income for the year ended December 31, 1997 of
$132,000 or $0.08 diluted earnings per share, compared with a net loss for
the year ended December 31, 1996 of $1.2 million or $1.84 loss per share.
The operating results for 1997 reflect the first year in which the Company
has recorded net income since 1993. The improvement in earnings during 1997
compared to 1996 was the result of a reduction in other operating expense of
$1.9 million and to a lesser extent an increase in the net interest margin
brought about by the investment of $7.35 million of net proceeds raised in
the Capital Offerings completed on June 30, 1997.
Total assets increased during the second half of 1997 reversing a
decreasing asset trend which began during 1991. At December 31, 1997, the
Company's total assets increased by $10.0 million or 9.1% to $119.4 million
from $109.4 million at December 31, 1996. This increase was funded primarily
by the net proceeds of $7.35 million raised in the Capital Offerings and an
increase in other borrowings and securities sold under agreements to
repurchase of $8.5 million. Partially offsetting these increases was a
decrease of $6.5 million in deposits, compared to 1996.
Substantially all asset growth was in the investment securities
portfolio. Investment securities increased to $40.5 million at December 31,
1997 from $18.6 million at December 31, 1996. This increase was primarily
due to the purchase of $33.0 million of U.S. government and federal agency
securities partially offset by sales and maturities of similar securities
totaling $11.3 million. Net unrealized gains on securities
available-for-sale at December 31, 1997 was $38,000 compared with losses of
$76,000 at December 31, 1996. In addition, during 1997 the Company purchased
stock in the Federal Home Loan Bank and Pacific Coast Bankers Bank totaling
$413,000.
Loans receivable at December 31, 1997 remained relatively unchanged at
$61.3 million compared to $62.6 million at December 31, 1996. Loans secured
by real estate decreased to 56% of total loans outstanding at December 31,
1997 compared to 64% at December 31, 1996.
The allowance for credit losses was $2.0 million or 3.3% of loans
receivable at December 31, 1997 compared to $3.0 million or 4.8% of loans
receivable at December 31, 1996. This decrease is the result of net loan
charge-offs of $946,000 during 1997.
Nonaccrual loans increased to $1.2 million at December 31, 1997 or 2.0%
of loans receivable compared to $928,000 or 1.5% at December 31, 1996. Other
real estate owned totaled $777,000 at year end 1997, an increase of $221,000
from $556,000 a year earlier.
Based on its review of the loan portfolio, management considers the
allowance for credit losses to be adequate. However, credit quality will be
influenced by underlying trends in the economic cycle, particularly for
Southern California, among other factors, which are beyond management's
control. Consequently, no assurances can be given that the Company will not
sustain loan losses, in any particular period, that are sizable in relation
to the allowance for credit losses. Additionally, subsequent evaluations of
the loan portfolio, in light of factors then
Page 11
<PAGE>
prevailing, by the Company and its regulators may indicate a requirement for
increases in the allowance for credit losses through charges to the provision
for credit losses.
On June 30, 1997, the Company completed the sale of 900,000 shares of
Preferred Stock in the Capital Offerings in which the Company raised net
proceeds of $7.35 million. The primary purpose of the Capital Offerings was
to enable the Company to downstream capital into the Bank in order to comply
with the requirements of the formal agreement ("Formal Agreement") and the
Memorandum of Understanding ("MOU") entered into between the Bank and the
Office of the Comptroller of the Currency (the "OCC") dated December 14, 1995
and the Company and the Federal Reserve Bank of San Francisco ("the FRB")
dated October 26, 1995, respectively. As of September 4, 1997 and November
18, 1997 the MOU and Formal Agreement, respectively, were terminated by the
FRB and OCC, respectively. The Company contributed $2.5 million in capital
to the Bank on June 30, 1997. The remaining portion of the net proceeds have
been retained for general corporate purposes to facilitate the implementation
of the business strategies of the Company.
As the year 2000 approaches, a critical issue has emerged regarding how
existing application software programs and operating systems can accommodate
this date value. In brief, many existing application software products in
the marketplace were designed to only accommodate a two digit date position
which represents the year (e.g., '95' is stored on the system and represents
the year 1995). As a result, the year 1999 (i.e., '99') could be the maximum
date value these systems will be able to accurately process. Management is
in the process of working with its data processing vendors to assure that the
Bank is prepared for the year 2000 and has developed a detailed project plan
to address the possible exposures related to the impact on its computer
systems as well as those of its vendors/partners and key clients. Critical
financial information and operational systems have been assessed and a time
and action plan has been developed to ensure testing of systems modifications
by December 31, 1998. The financial impact of making the required systems
changes is not expected to be material to the Company's consolidated
financial position, results of operations or cash flows.
Table 1
Operations Summary
<TABLE>
<CAPTION>
Year Increase Year Increase
Ended (Decrease) Ended (Decrease) Year ended December 31,
------------ ------------ --------------------------
1997 Amount % 1996 Amount % 1995 1994 1993
----- ------ --- ----- ----- --- ---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income . . . . . . . . . . . . . . . . $8,600 $(157) (1.8%) $8,757 $(2,877) (24.7%) $11,634 $20,900 $20,612
Interest expense. . . . . . . . . . . . . . . . 2,856 (223) (7.2%) 3,079 (900) (22.6%) 3,979 5,526 5,920
------ ------ ----- ------ ------- ------ ------- ------- -------
Net interest income 5,744 66 1.2% 5,678 (1,977) (25.8%) 7,655 15,374 14,692
Provision for credit losses . . . . . . . . . . - - - - (2,307) (100.0%) 2,307 7,330 2,000
Other operating income. . . . . . . . . . . . . 486 (16) (3.2%) 502 1,817 (138.2%) (1,315) (2,857) 1,474
Other operating expense . . . . . . . . . . . . 6,098 (1,905) (23.8%) 8,003 (3,230) 11,233 (2,198) 13,714 14,058
------ ------ ----- ------ ------- ------ ------- ------- -------
Income (loss) before income taxes and
cumulative effect of change in
accounting principle. . . . . . . . . . . . . 132 1,955 (107.2%) (1,823) 5,377 (74.7%) (7,200) (8,527) 108
Income tax benefit. . . . . . . . . . . . . . . - 579 (100.0%) (579) (579) 0.0% - - -
Income (loss) before cumulative effect
of change in accounting principle . . . . . . 132 1,376 (110.6%) (1,244) 5,956 (82.7%) (7,200) (8,527) 108
Cumulative effect of change of
accounting principle. . . . . . . . . . . . . - - 0.0% - - 0.0% - - 63
------ ------ ----- ------ ------- ------ ------- ------- -------
Net income (loss) . . . . . . . . . . . . . . $132 $1,376 (110.6%) $(1,244) $5,956 (82.7%) $(7,200) $(8,527) $171
------ ------ ----- ------ ------- ------ ------- ------- -------
------ ------ ----- ------ ------- ------ ------- ------- -------
</TABLE>
RESULTS OF OPERATIONS
NET INTEREST INCOME
The Company'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 Company's most significant
source of earnings. The Company'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 Company's
inability to maintain strong asset quality, capital or liquidity may adversely
affect (i) the ability to accommodate desirable borrowing customers, thereby
Page 12
<PAGE>
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.
1997 COMPARED TO 1996.
Net interest income remained virtually unchanged during 1997 compared to 1996
totaling $5.7 million for each year. However, the components of net interest
income changed during 1997, reflecting an increase in interest income from
securities offset by a corresponding decrease in interest income from loans,
compared to 1996. Average earning assets decreased during 1997 to $102.0
million compared to $106.9 million during 1996. This $4.9 million or 4.6%
decrease in average earning assets was primarily the result of a $10.6 million
reduction in average loans receivable which was partially offset by the
investment of $7.35 million of net proceeds raised form the Capital Offerings
combined with an increase in other borrowings and securities sold under
agreements to repurchase. During the first half of 1997, the Company's average
earning assets decreased primarily due to the reduction of the Company's
deposits. However, this trend reversed during the second half of 1997, as the
Company began to experience growth of its average earning assets created by the
net proceeds of the Capital Offerings and an increase in borrowings. The
average yield on interest-earning assets was 8.43% during the year ended
December 31, 1997, an increase of 24 basis points from the average yield of
8.19% during the year ended December 31, 1996, primarily as a result of
increased volume and yield of investment securities. During 1997, the rates
paid on interest-bearing liabilities decreased 10 basis points to 4.38% from
4.48% for 1996. As a result, the net yield on interest-earning assets
increased 32 basis points to 5.63% during the year ended December 31, 1997,
from 5.31% during the year ended December 31, 1996.
Average loans receivable decreased to $59.3 million in 1997 from $70.0
million in 1996, a decrease of $10.7 million or 15.3%. The majority of this
decrease was reflected by the payoffs and maturities of loans primarily secured
by real estate. The decrease in real estate loans was partially offset by the
growth of the commercial loan portfolio due to the Company's emphasis in this
area. The Company's loan portfolio continued to experience a decrease during
1997 consistent with the past several years. However, this trend reversed
during the fourth quarter of 1997 when the Company experienced an increase in
loans receivable.
Average total investment securities increased to $29.8 million during 1997
from $17.4 million during 1996. This increase was primarily driven by the net
proceeds of the Capital Offerings, reduction in the Company's liquidity needs
as a result of the termination of the Formal Agreement and MOU and an increase
in the Company's borrowings. The average yield on investment securities
increased to 6.52% during 1997 compared to 5.69% during 1996, representing an
83 basis point or 14.6% increase. During 1997 and 1996, the Company disposed
of its lower yielding investment securities and reinvested the proceeds into
higher yielding investment securities, resulting in the increased yields during
1997. These investment transactions were consistent with the Company's
strategy to restructure its balance sheet.
Average noninterest-bearing deposits decreased to $33.0 million during 1997
from $36.5 million during 1996, a decrease of $3.5 million or 9.7%. Similarly,
average interest-bearing deposits decreased to $63.5 million during 1997 from
$67.6 million during 1996, a decrease of $4.1 million or 6.0%. The decreases
occurred primarily during the first six months of 1997, prior to the completion
of the Capital Offerings and during the time in which the Company was subject
to regulatory enforcement actions, specifically the Formal Agreement and MOU.
However, during the last six months of 1997, average deposits increased as a
result of increased marketing efforts.
Average securities sold under agreements to repurchase increased to $1.6
million during 1997 compared to $1.1 million during 1996. This $497,000 or
43.6% increase facilitated the growth of investment securities during 1997 and,
to a lesser extent, offset the decrease in average deposits during 1997. In
addition, the Company borrowed $3.5 million from the Federal Home Loan Bank
("FHLB") at the end of the fourth quarter of 1997, which accounted for the
increase in other borrowings from 1996.
Page 13
<PAGE>
TABLE 2
RATIOS TO AVERAGE ASSETS
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Net interest income . . . . . . . . . . . . . . 5.33% 5.06% 5.12% 6.26% 5.05%
Other Operating income (loss) . . . . . . . . . 0.45% 0.45% (0.88%) (1.16%) 0.51%
Provision for credit losses . . . . . . . . . . 0.00% 0.00% (1.54%) (2.99%) (0.69%)
Other operating expense . . . . . . . . . . . . (5.66%) (7.13%) (7.52%) (5.58%) (4.83%)
------ ------ ------- ------ -------
Income (loss) before income taxes and
cumulative effect of change in
accounting principle . . . . . . . . . . . . . 0.12% 1.62% (4.82%) (3.47%) 0.04%
------ ------ ------- ------ -------
Net income (loss) before cumulative effect
of change in accounting principle. . . . . . . 0.12% (1.11%) (4.82%) (3.47%) 0.04%
------ ------ ------- ------ -------
Net income (loss). . . . . . . . . . . . . . . 0.12% (1.11%) (4.82%) (3.47%) 0.06%
------ ------ ------- ------ -------
------ ------ ------- ------ -------
</TABLE>
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 that emphasized the reduction of
criticized and classified assets and nonstrategic 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 that eroded shareholders' equity.
Average loan volume 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 during
1996 due to scheduled loan amortizations and management's planned restructuring
of the loan portfolio to reduce criticized and classified assets and non-
strategic loan relationships.
COMPARISON OF NET YIELD AND INTEREST RATE SPREAD
The Company 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 or net
interest margin. The Company'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 Company's loans are
affected principally by the demand for such loans, the supply of money
available for lending purposes, and other competitive factors. These factors
are in turn affected by general economic conditions and other factors beyond the
Page 14
<PAGE>
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 3 presents information
concerning the change in interest income and interest expense attributable to
changes in average volume and average rate. Table 4 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, 1997. Yields on tax-exempt investment securities presented in Table 4 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 net operating loss carryforwards.
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. Average noninterest-
bearing demand deposits totaled $33.0 million during 1997, representing 34.2%
of average deposits, compared to $36.5 million, representing 35.1% of average
deposits during 1996. Of these noninterest-bearing demand deposits during
1997, $9.8 million or 29.6% of average deposits were represented by real estate
title and escrow company deposits, compared to $8.8 million or 24.0% of average
deposits during 1996. While these deposits are noninterest-bearing, they are
not cost-free funds. Customer service expenses, 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.
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, 1997, 1996, and 1995, would be reduced by $282,000, $349,000 and $489,000,
respectively. Similarly, this would create identical reductions in other
operating expense. The net yield on interest-earning assets for the years
ended December 31, 1997, 1996, and 1995, would have decreased 28 basis points,
33 basis points, and 35 basis points, respectively.
Page 15
<PAGE>
Table 3
Increase (Decrease) in Interest Income/Expense Due to Change in
Average Volume and Average Rate (1)
<TABLE>
<CAPTION>
1997 vs 1996 1996 vs 1995 1995 vs 1994
------------------------------ ----------------------------- ------------------------------
Increase Increase Increase
(Decrease) due to: Net (Decrease) due to: Net (Decrease) due to: Net
------------------- Increase ------------------ Increase ------------------ Increase
Volume Rate (Decrease) Volume Rate (Decrease) Volume Rate (Decrease)
---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest Income:
Federal funds sold................. $ (35) $ 37 $(314) $206 $(115) $ 91 $ 357 $243 $600
Interest-bearing deposits with
other financial institutions...... - 3 3 (7) - (7) 9 (5) 4
Securities held-to-maturity:
U.S. Government and federal
agency, and other securities..... 1,192 (60) 1,132 - 62 62 - - -
Tax-exempt municipal securities... - - - - -
Securities available-for-sale:
U.S. Government and federal
agency, and other securities..... (264) 82 (182) (526) 71 (455) (2,122) (119) (2,241)
Tax-exempt municipal securities.. - - - (12) - (12) (42) 5 (37)
Loans receivable (2).............. (1,025) 229 (796) (2,505) (51) (2,556) (5,109) (1,743) (6,852)
------ ---- ----- ------- ---- ------- ------- ------- -------
Total interest-earning assets.... $ (448) $291 $(157) $(2,844) $(33) $(2,877) $(7,517) $(1,619) $(9,136)
------ ---- ----- ------- ---- ------- ------- ------- -------
------ ---- ----- ------- ---- ------- ------- ------- -------
Interest Expense:
Interest-bearing deposits:
Demand............................ $ 17 $ (3) $ 14 $ (27) $(34) $ (61) $ (33) $26 $ (7)
Money market and savings.......... (6) 6 - (257) (111) (368) (347) 74 (273)
Time certificates of deposit:
$100,000 or more................ 49 (4) 45 (86) (37) (123) (107) 177 70
Under $100,000.................. (363) 6 (357) (244) (19) (263) (1,675) 556 (1,119)
------ ---- ----- ------- ---- ------- ------- ------- --------
Total time certificates of
deposit.......................... (314) 2 (312) (330) (56) (386) (1,782) 733 (1,049)
------ ---- ----- ------- ---- ------- ------- ------- --------
Total interest-bearing deposits... (303) 5 (298) (614) (201) (815) (2,162) 833 (1,329)
Other borrowed funds.............. - 7 7
Securities sold under agreements
to repurchase and other
borrowings...................... 11 57 68 (80) (5) (85) (203) (15) (218)
Total interest-bearing
liabilities.................... $ (292) $ 69 $(223) $ (694) $(206) $ (900) $(2,365) $ 818 $ (1,547)
------ ---- ----- ------- ---- ------- ------- ------- --------
Net interest income $ (156) $222 $ 66 $(2,150) $173 $(1,977) $(5,152) $(2,437) $ (7,589)
------ ---- ----- ------- ---- ------- ------- ------- --------
------ ---- ----- ------- ---- ------- ------- ------- --------
</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 changes in each.
(2) Table does not include interest income that would have been earned on
nonaccrual loans.
Page 16
<PAGE>
TABLE 4
AVERAGE BALANCE SHEET AND
ANALYSIS OF NET INTEREST INCOME
<TABLE>
<CAPTION>
Year ended Year ended Year ended
December 31, 1997 December 31, 1996 December 31, 1995
--------------------------- --------------------------- --------------------------
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.... $ 12,862 $ 710 5.52% $19,572 $ 1,024 5.23% $ 16,034 $ 933 5.82%
Interest-bearing deposits with other
financial institutions.................. 41 3 7.33% - - - 174 7 4.02%
Securities held to maturity: U.S.
Treasury and agency, corporate and
other securities........................ 17,960 1,194 6.65% 888 62 6.98% - - -
Securities available for sale:
U.S. Treasury and agency, corporate
and other securities................... 11,808 746 6.32% 16,510 928 5.62% 26,636 1,383 5.19%
Tax-exempt municipal securities......... - - - - - - 45 12 26.67%
Loans receivable (1) (2)................. 59,336 5,947 10.02% 69,975 6,743 9.64% 95,771 9,299 9.71%
-------- ------ -------- ------- -------- -------
Total interest earning assets........... 102,007 $8,600 8.43% 106,945 $ 8,757 8.19% 138,660 $11,634 8.39%
------ ------- -------
------ ------- -------
Noninterest earning assets:
Cash and due from banks - demand........ 4,957 5,878 9,403
Other assets............................ 3,491 2,887 4,840
Allowance for credit losses............. (2,654) (3,407) (3,504)
-------- -------- --------
Total assets............................ $107,801 $112,303 $149,399
-------- -------- --------
-------- -------- --------
</TABLE>
Page 17
<PAGE>
TABLE 4 (CONTINUED)
AVERAGE BALANCE SHEET AND
ANALYSIS OF NET INTEREST INCOME
<TABLE>
<CAPTION>
Year ended Year ended Year ended
December 31, 1997 December 31, 1996 December 31, 1995
--------------------------- --------------------------- --------------------------
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.................................. $ 7,239 $ 90 1.24% $ 5,914 $ 76 1.29% $ 7,341 $ 137 1.87%
Money market and savings................ 21,359 634 2.97% 21,556 634 2.94% 29,001 1,002 3.46%
Time certificates of deposit:
$100,000 or more....................... 8,341 464 5.56% 7,465 419 5.61% 8,876 542 6.11%
Under $100,000......................... 26,518 1,568 5.91% 32,665 1,925 5.89% 36,754 2,188 5.95%
-------- ------ -------- ------- ------- ------
Total time certificates of deposit...... 34,859 2,032 5.83% 40,130 2,344 5.84% 45,630 2,730 5.98%
-------- ------ -------- ------- ------- ------
Total interest-bearing deposits......... 63,457 2,756 4.34% 67,600 3,054 4.52% 81,972 3,869 4.72%
Other borrowed funds..................... 143 7 4.89% -- -- -- -- -- --
Federal funds purchased and securities
sold under agreements to repurchase..... 1,637 93 5.68% 1,140 25 2.19% 4,154 110 2.65%
-------- ------ -------- ------- ------- ------
Total interest-bearing liabilities...... 65,237 $2,856 4.38% 68,740 $ 3,079 4.48% 86,126 $3,979 4.62%
------ ------- ------
------ ------- ------
Noninterest-bearing liabilities:
Noninterest bearing demand deposits..... 32,988 36,518 52,246
Other liabilities....................... 1,035 1,545 1,994
Shareholders' equity..................... 8,541 5,500 9,033
-------- -------- ------
Total liabilities and shareholders'
equity.................................. $107,801 $112,303 $149,399
-------- -------- --------
-------- -------- --------
Net interest income (spread)............. $5,744 4.05% $ 5,678 3.71% $7,655 3.77%
------ -------- ------
------ -------- ------
Net yield on earning assets (2)......... 5.63% 5.31% 5.52%
</TABLE>
- ---------------------
(1) The average balance of nonperforming loans has been included in loans
receivable.
(2) Yields and amounts earned on loans receivable include loan fees of
$130,000, $24,000 and $150,000 for the years ended December 31, 1997, 1996 and
1995 respectively.
Page 18
<PAGE>
PROVISION FOR CREDIT LOSSES
Provisions for credit losses charged to operations reflect management's
judgment of the adequacy of the allowance for credit losses and is determined
through periodic analysis of the loan portfolio. This analysis includes a
detailed review of the classification and categorization of problem and
potential problem loans and loans to be charged off; an assessment of the
overall quality and collectibility of the portfolio; and consideration of the
loan loss experience, trends in problem loan concentrations of credit risk,
as well as current and expected future economic conditions (particularly
Southern California). Reports produced internally are provided to the Board
of Directors. For 1997 and 1996, the Company did not record a provision for
credit losses compared to a provision of $2.3 million for 1995. In 1997, net
charge offs totaled $946,000 compared to $836,000 in 1996 and $1.6 million in
1995.
The combination of the leveling-off of net charge offs, a change in the
risk profile of the loan portfolio, the continued reduction in problem loans,
and the improvement of the Southern California economy allowed the Company
not to record any provision for credit losses in 1997 and 1996. However,
credit quality will be influenced by underlying trends in the economic cycle,
particularly in Southern California, among other factors, which are beyond
management's control. Consequently, no assurances can be given that the
Company will not sustain loan losses, in any particular period, that are
sizable in relation to the allowance for credit losses. Additionally,
subsequent evaluation of the loan portfolio, in light of factors then
prevailing, by the Company and its regulators may indicate a requirement for
increases in the allowance for credit losses through charges to the provision
for credit losses. See "Cautionary Statement for Purposes of the `Safe
Harbor' Provisions of the Private Securities Litigation Reform Act of 1995",
below.
OTHER OPERATING INCOME
Other operating income decreased by $16,000 or 3.2% to $486,000 in 1997
compared to $502,000 in 1996. Other operating income increased in 1996 by $1.8
million or 138.2% from a loss of $1.3 million in 1995 resulting from the
absence of significant losses from securities transactions which occurred
during 1995. A breakdown of other operating income by category is reflected
below:
TABLE 5
OTHER OPERATING INCOME
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------------------------------------
INCREASE INCREASE
(DECREASE) (DECREASE)
---------------- ---------------
1997 AMOUNT % 1996 AMOUNT % 1995
---- ------ ------ ---- ------ --- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
OTHER OPERATING (LOSSES) INCOME:
Securities transactions:
Net gain (loss) on sale of securities available-
for-sale............................................. $(37) $(34) (1133%) $ (3) $1,230 100% $(1,233)
Loss on termination of interest swap................. - - - - 1,294 100% (1,294)
FEE INCOME:
International services............................... 128 4 3.23% 124 (100) (45%) 224
Investment services.................................. 18 (55) (75%) 73 (181) (71%) 254
Deposit and other customer services.................. 377 69 22.40% 308 (429) (58%) 737
OTHER:
Other income-shareholder's insurance claim........... - - - - (730) (100%) 730
Loss on other real estate owned...................... - - - - 733 100% (733)
---- ---- ---- ---- ------ ---- -------
Total other operating (loss) income................. $486 $(16) (3%) $502 $1,817 138% $(1,315)
---- ---- ---- ---- ------ ---- -------
---- ---- ---- ---- ------ ---- -------
</TABLE>
Page 19
<PAGE>
SECURITIES TRANSACTIONS
During 1997, the Company continued to restructure 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, 1997, the Company sold $3.9
million of investment securities available-for-sale, realizing a net loss of
$37,000 compared to a net loss of $3,300 in 1996 and a net loss of $1.2
million in 1995. The losses realized in 1997 and 1996 resulted from the
Company's sale of low yielding securities for reinvestment into higher
yielding assets. During 1995, the Bank sold $46.9 million of investment
securities available for sale, and terminated a related interest rate swap
contract, 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 net unrealized gains on securities available-for-sale increased by
$114,000 to $38,000 at December 31, 1997, compared to losses of $76,000 at
December 31, 1996.
FEE AND OTHER INCOME
Fee income related to international, investment and deposit services
increased by $18,000 or 3.6% to $523,000 during the year ended December 31,
1997, compared to fee income of $505,000 in 1996. This increase is primarily
due to an increased effort to market deposit services combined with a focus
on the realization of such fees during a period that the Company experienced
an overall decrease in the deposit base. Fee income related to investment
services decreased significantly as a result of a restructuring of the means
by which the services are delivered, described below. During 1996 fee income
related to international, investment and deposit services decreased $710,000
or 58.4% to $505,000 from $1.2 million in 1995. The international services
department was closed in December 1995, resulting in reduced letter of credit
and foreign exchange functions during 1996.
Other income for the year ended December 31, 1995, included $730,000 of
income from insurance proceeds resulting from the settlement of a lawsuit,
offset by losses on other real estate owned of $733,000.
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 continue to provide a wide array of
products at significantly reduced overhead costs. In addition, the Bank has
reviewed the fee structure of its deposit-related services and has made the
necessary changes to ensure such services are competitively priced beginning
in 1998.
OTHER OPERATING EXPENSE
Other operating expense totaled $6.1 million in 1997, a decrease of $1.9
million from 1996 which was down $3.2 million from 1995. A breakdown of
other operating expense by category is reflected below:
Page 20
<PAGE>
TABLE 6
OTHER OPERATING EXPENSES
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------------------------------------
INCREASE INCREASE
(DECREASE) (DECREASE)
---------------- ---------------
1997 AMOUNT % 1996 AMOUNT % 1995
---- ------ ------ ---- ------ --- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
OTHER OPERATING EXPENSES:
Salaries and related benefits...................... $2,887 $ 169 6% $2,718 $(1,160) (30%) $ 3,878
Severance costs.................................... - - - - (141) (100%) 141
Net occupancy...................................... 806 13 2% 793 (675) (46%) 1,468
Furniture and equipment............................ 200 (98) (33%) 298 (87) (23%) 385
Printing and communications........................ 229 18 9% 211 (59) (22%) 270
Insurance and regulatory assessments............... 516 (113) (18%) 629 (342) (35%) 971
Customer services.................................. 537 (70) (12%) 607 (246) (29%) 853
Computer data processing........................... 292 (67) (19%) 359 (54) (13%) 413
Legal settlement................................... - - - 1,000 1,000 - -
Legal services..................................... 172 (331) (66%) 503 (246) (33%) 749
Other professional services........................ 225 (415) (65%) 640 (906) (59%) 1,546
Other real estate owned expenses................... 21 (18) (46%) 39 (2) (5%) 41
Promotion and other expenses....................... 213 7 3% 206 (312) (60%) 518
------ ------- ---- ------ ------- --- -------
Total other operating expenses.................... $6,098 $(1,905) (24%) $8,003 $(3,230) (29%) $11,233
------ ------- ---- ------ ------- --- -------
------ ------- ---- ------ ------- --- -------
</TABLE>
The primary reason for the 23.8% reduction of other operating expense during
1997 compared to 1996 is attributable to the $1.0 million legal settlement
recognized during 1996, discussed below. Salaries and related benefits
increased $169,000 to $2.9 million during 1997 compared to $2.7 million in
1996. This increase in salaries and related benefits during 1997 was the
result of the Bank's efforts to expand its loan and deposit production staff
in response to the recapitalization completed in June 1997. However,
significant other operating expense reductions were achieved in 1997 compared
to 1996 in the areas of insurance and regulatory assessments, legal services,
and other professional services. These reductions were the result of
management's continued efforts to reduce operating expenses.
During the year ended 1996, other operating expense was $8.0 million
(including the settlement of a lawsuit for $1.0 million), a 28.8% decrease
from 1995. This $3.2 million decrease was primarily attributable to the
reduction in salaries and related expenses of $1.2 million, along with the
reductions in occupancy expense, insurance and regulatory assessments, and
other professional services. 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 1996. See "Item 2
Properties." In addition, the decreases in compensation expense and other
professional services is due to reductions in staff and changes in management
during 1996.
Other operating expense during 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. In addition, 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."
Page 21
<PAGE>
INCOME TAXES
The Company accounts for income taxes under Statement of Financial Accounting
Standards ("SFAS") No. 109. Under this standard, financial statement tax
benefit associated with income tax net operating loss carryforwards ("NOL's")
and future tax deductions for expenses already incurred for financial statement
purposes but not yet deducted for tax return purposes (deferred tax assets) are
allowed to be recognized when there is a more likely than not expectation that
such benefits will actually be utilized. At December 31, 1997, the Company had
$10,190,000 of these deferred tax assets and placed a valuation allowance
against 100% of the asset.
The Company's deferred tax asset consists primarily of federal and state
NOL's which total $22.3 and $11.1 million respectively. Federal income tax laws
permit the Company to carry back NOL's three years (two years after 1997) to
offset taxable income in those periods, if any, and forward fifteen years
(twenty years after 1997) 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. The federal NOL's expire beginning in 2007 through 2011 and the
state carryforwards expire beginning in 1998 through 2002.
No income tax provision was recorded during 1997 due to the utilization of
previously unrecognized tax benefits to offset current period tax liability.
During the year ended December 31, 1996 the Company recognized a tax benefit
for federal income tax purposes of approximately $579,000 (including $43,000 in
interest) related to a refund of prior years taxes from the carryback of a
portion of the Company's NOL's for which a tax benefit had not been previously
recognized. No income tax benefit was recorded for 1995, due to the uncertainty
with respect to the ultimate realization of such benefit.
Additionally, federal and state income tax laws provide that, following an
ownership change of a corporation with a net operating loss, a net unrealized
built-in loss, or tax credit carryovers, the amount of annual post-ownership
change taxable income that can be offset by pre-ownership change NOLs or
recognized built-in losses generally cannot exceed a prescribed annual
limitation. The annual limitation generally equals the product of the fair
market value of the corporation immediately before the ownership change
(subject to certain adjustments) and the federal long-term tax-exempt rate
prescribed monthly by the Internal Revenue Service. If such limitations were
to apply to the Company, the ability of the Company to reduce the valuation
allowance that is currently placed against the deferred tax asset could be
severely limited.
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The Company wishes to take advantage of the "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995 as to "forward looking"
statements in this Form 10-K which are not historical facts. The Company
cautions readers that the following important factors could affect the
Company's business and cause actual results to differ materially from those
expressed in any forward looking statement made by, or on behalf of, the
Company.
- ECONOMIC CONDITIONS. The Company's results are strongly influenced by
general economic conditions in its market area, Southern California, and
a deterioration in these conditions could have a material adverse impact
on the quality of the Bank's loan portfolio and the demand for its
products and services. In particular, changes in economic conditions in
the real estate and entertainment industries may affect the Company's
performance.
- INTEREST RATES. Management anticipates that interest rate levels will
remain generally constant in 1998, but if interest rates vary
substantially from present levels, this may cause the Company's results
to differ materially.
Page 22
<PAGE>
- GOVERNMENT REGULATION AND MONETARY POLICY. All forward-looking
statements presume a continuation of the existing regulatory environment
and U.S. Government monetary policies. The banking industry is subject
to extensive federal and state regulations, and significant new laws or
changes in, or repeals of, existing laws may cause results to differ
materially. Further, federal monetary policy, particularly as
implemented through the Federal Reserve System, significantly affects
credit conditions for the Bank, primarily through open market operations
in U.S. government securities, the discount rate for member bank
borrowing and bank reserve requirements, and a material change in these
conditions would be likely to have an impact on results.
- COMPETITION. The Bank competes with numerous other domestic and foreign
financial institutions and non-depository financial intermediaries.
Results may differ if circumstances affecting the nature or level of
competitive change, such as the merger of competing financial
institutions or the acquisition of California institutions by
out-of-state companies.
- CREDIT QUALITY. A significant source of risk arises form 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 Bank 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 Bank's credit portfolio, but such
policies and procedures may not prevent unexpected losses that could
adversely affect the Company's results.
- OTHER RISKS. From time to time, the Company details other risks to its
business and/or its financial results in its filings with the Securities
and Exchange Commission.
While management believes that its assumptions regarding these and other
factors on which forward-looking statements are based are reasonable, such
assumptions are necessarily speculative in nature, and actual outcomes can be
expected to differ to some degree. Consequently, there can be no assurance
that the results described in such forward-looking statements will, in fact, be
achieved.
FINANCIAL CONDITION
CAPITAL
On June 30, 1997, the Company completed the sale of 900,000 shares of
Preferred Stock through the Capital Offerings in which the Company raised net
proceeds of $7.35 million. The primary purpose of the offerings was to enable
the Company to downstream capital into the Bank in order to comply with the
requirements of the Formal Agreement and the MOU entered into between the Bank
and the OCC, and between the Company and the FRB, respectively. The Company
contributed $2.5 million in capital to the Bank on June 30, 1997. The
remaining portion of the net proceeds have been retained for general corporate
purposes to facilitate the implementation of the business strategies of the
Company.
Primarily a result of the Capital Offerings and the positive operating
results during 1997, Tier 1 capital, which is comprised of shareholders' equity
and certain regulatory adjustments, of the Company and Bank increased to $12.4
million and $7.4 million, respectively, at December 1997 compared to Tier 1
capital of $4.9 million for both the Company and Bank at December 31, 1996.
The following table sets forth the regulatory standards for well capitalized
institutions, and the capital ratios for the Company and the Bank as of
December 31, 1997, 1996 and 1995.
Page 23
<PAGE>
TABLE 7
REGULATORY CAPITAL INFORMATION
OF THE COMPANY AND BANK
<TABLE>
<CAPTION>
Well Capitalized December 31,
---------------------------------------
Standards 1997 1996 1995
---------------- --------- --------- ---------
<S> <C> <C> <C> <C>
COMPANY:
Tier 1 leverage......................................... 5.00% 10.43% 4.68% 4.68%
Tier 1 risk-based capital............................... 6.00% 16.98% 6.96% 6.96%
Total risk-based capital................................ 10.00% 18.25% 8.25% 8.25%
BANK:
Tier 1 leverage......................................... 5.00% 6.48% 4.67% 4.67%
Tier 1 risk-based capital............................... 6.00% 10.36% 6.95% 6.95%
Total risk-based capital................................ 10.00% 11.63% 8.24% 8.24%
</TABLE>
RESTRICTIONS ON DIVIDENDS
As a result of the offerings and the contribution of $2.5 million in capital
into the Bank, the Company (parent company only) had cash and investment
securities of approximately $3.9 million at December 31, 1997. Despite this
fact, the Company is currently prohibited from paying cash dividends by state
law.
As a California corporation, the Company may not make a distribution to its
shareholders (which includes a payment of dividends but not stock dividends)
unless the Company has sufficient retained earnings under the Retained Earnings
Test. The Retained Earnings Test is defined as the Company's retained earnings
(determined on a consolidated basis according to generally accepted accounting
principles) or if, immediately after giving effect to the distribution, all of
the Company's assets equal 1.25 times the Company's liabilities (the "Retained
Earnings Test"). The Company's accumulated deficit of $19.6 million as of
December 31, 1997 requires the Company to record cumulative net earnings in
excess of $19.6 million before a dividend can be paid under the Retained
Earnings Test. If assets equal 1.25 times liabilities subsequent to a
distribution, the Company may pay a dividend prior to recording cumulative
earnings of $19.6 million, however, it is not anticipated that the Company will
ever achieve capital levels to meet this prong of the test. At the present
time, the Company does not meet the Retained Earnings Test and no assurance can
be made as to when, if ever, such test will be met. The terms of the Preferred
Stock provide that dividends on the Preferred Stock may be paid commencing June
30, 1999. Notwithstanding the foregoing, the Company may not pay dividends
unless the Bank is in full compliance with federal regulatory capital
requirements, the Company is permitted by the FRB to pay dividends and the
Company meets the Retained Earnings Test. Dividends on the Preferred Stock
will not accumulate.
LIQUIDITY MANAGEMENT
The objective of liquidity management is the ability to maintain cash flow
adequate to fund the Company's operations and meet obligations and other
commitments on a timely and cost effective basis. The Company manages to this
objective through the selection of asset and liability maturity mixes that it
believes best meet the needs of the Company. The Company's liquidity position
is enhanced by its ability to raise additional funds as needed in the money
markets.
The Company's deposit base provides the majority of the Company's funding
requirements. This relatively stable and low-cost source of funds has, along
with shareholders' equity, provided 97.4% and 97.6% of funding for average
total assets in 1997 and 1996, respectively.
The remaining funding of average total assets is primarily provided by sales
of securities under repurchase agreements. This funding source averaged $1.6
million and $1.1 million during 1997 and 1996, respectively. Additionally, the
Bank increased its funding from other borrowings at the end of 1997,
specifically Federal Home
Page 24
<PAGE>
Loan Bank ("FHLB") advances, which averaged $143,000 during 1997. The
Company was not a member of the FHLB during 1996.
Liquidity is also provided by reductions in assets such as federal funds sold
and securities which may be immediately converted to cash at minimal cost. The
aggregate of federal funds sold averaged $12.9 million during 1997, down $6.7
million, or 34.3% from $19.6 million during 1996. This decrease resulted from
the Company's decision to maintain a substantially lower level of liquidity due
to the completion of the Capital Offerings, the stabilization in deposits, the
Company's improved operating performance and the termination of the Formal
Agreement and MOU during 1997.
Liquidity is also provided by the portfolio of available-for-sale securities
which total $25.8 million at December 31, 1997. In addition, the unpledged
portion of securities at December 31, 1997 totaled $22.2 million and would be
available as collateral for borrowing. Maturing loans also provide liquidity,
of which $22.4 million of the Bank's loans are scheduled to mature in 1998.
ASSET LIABILITY MANAGEMENT
The principal objectives of asset/liability management are to maximize the
net yield on earning assets or net interest margin subject to margin volatility
and liquidity constraints. Margin volatility results when the rate reset (or
repricing) characteristics of assets are materially different from those of the
Company's liabilities. Liquidity risk results from the mismatching of asset
and liability cash flows. Management chooses asset/liability strategies that
promote stable earnings and reliable funding. Interest rate risk and funding
positions are kept within limits established by the Company's board of
directors to ensure that risk-taking is not excessive and that liquidity is
properly managed.
The Company has established three measurement processes to quantify and
manage exposure to interest rate risk: net interest income simulation
modeling, gap analysis, and present value of equity analysis. Net interest
income simulations, provided to the Company by an outside firm, are used to
identify the direction and severity of interest rate risk exposure across a
twelve month forecast horizon. Gap analysis provides insight into structural
mismatches of assets and liability repricing characteristics. Present value of
equity calculations also provided to the Company by an outside firm are used to
estimate the theoretical price sensitivity of shareholder equity to changes in
interest rates.
Table 8 compares the Company's interest rate gap position as of December 31,
1997 and 1996. Generally, an asset sensitive gap indicates that net interest
margin will improve during a period of rising interest rates.
The gap report shows that the Company's cumulative one year interest rate
sensitivity gap decreased to $110,000 at December 31, 1997 from $13.9 million
at December 31, 1996. This change resulted from the Company's efforts to lower
its exposure to decreases in net interest income due to a rapid decline in
interest rates. The Company has increased its investment securities portfolio
that reprice after one year to $38.5 million at December 31, 1997 compared to
$18.6 million at December 31, 1996. However, a majority of the Company's
investment securities portfolio contains securities with an optional principal
redemption feature allowing the issuer to "call" the security at specified
dates. This call option is generally exercised when rates decrease - see
"Investment Securities" below. Because the Company is unable to estimate the
extent to which such investment securities will be called, the repricing of
such securities in Table 8 is based on final maturity date. Due to the nature
of the Company's liabilities which reprice within one year, during a period of
slowly rising or falling interest rates it is not expected that rates paid on
these liabilities will change to the same degree as the Company's assets since
rates paid on the Company's base of interest checking, savings and money market
deposit accounts historically have not increased or decreased proportionately
with changes in interest rates.
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 Company's interest rate sensitivity position. To
supplement traditional gap analysis, the Company uses simulation modeling to
estimate the potential effects of
Page 25
<PAGE>
changing interest rates. This process allows
the Company to fully explore the complex relationships within the gap over time
and various interest rate scenarios.
At December 31, 1997 and 1996, the Company's distribution of rate-sensitive
assets and liabilities was as follows:
TABLE 8
RATE-SENSITIVE ASSETS AND LIABILITIES
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-----------------------------------------------------------------
MATURING OR REPRICING IN
-----------------------------------------------------------------
LESS AFTER THREE AFTER ONE
THAN MONTHS YEAR
THREE BUT WITHIN BUT WITHIN AFTER NOT RATE
MONTHS ONE YEAR 5 YEARS 5 YEARS SENSITIVE TOTAL
------- ----------- ---------- ------- --------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Rate-Sensitive Assets:
Interest-bearing deposits with other
financial institutions..................... $ - $ 250 $ - $ - $ - $ 250
Federal Funds sold and securities
purchased under agreements to resell....... 11,900 - - - - 11,900
Securities held-to-maturity................. - 2,000 12,000 - - 14,000
Securities available-for-sale............... - - 13,946 11,886 - 25,832
Equity investment-FRB & PCBB................ - - - 646 - 646
Loans receivable............................ 26,258 19,520 13,325 2,149 - 61,252
------- ------- ------- ------- ------- --------
Total rate-sensitive assets................ 38,158 21,770 39,271 14,681 - 113,880
Rate-Sensitive Liabilities: (1)
Interest bearing Deposits:
Interest-bearing demand, money
market and savings......................... 30,601 - - - - 30,601
Time certificates of deposit............... 8,112 12,555 10,721 - - 31,388
Federal funds purchased and securities
sold under agreements to repurchase........ 50 5,000 - - - 5,050
Other borrowings............................ - 3,500 - - - 3,500
------- ------- ------- ------- ------- --------
Total rate-sensitive liabilities........... 38,763 21,055 10,721 - - 70,539
Interest rate-sensitivity gap............... (605) 715 28,550 14,681 - 43,341
------- ------- ------- ------- ------- --------
------- ------- ------- ------- ------- --------
Cumulative interest rate-sensitivity gap.... $ (605) $ 110 $28,660 $43,341 43,341
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Cumulative ratio of rate sensitive assets
to rate-sensitive liabilities.............. 98% 100% 141% 161%
------- ------- ------- -------
------- ------- ------- -------
</TABLE>
(1) Customer deposits which are subject to immediate withdrawal are presented
as repricing within three months or less.
The distribution of other time deposits is based on scheduled maturities.
Page 26
<PAGE>
TABLE 8
RATE-SENSITIVE ASSETS AND LIABILITIES
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-----------------------------------------------------------------
MATURING OR REPRICING IN
-----------------------------------------------------------------
LESS AFTER THREE AFTER ONE
THAN MONTHS YEAR
THREE BUT WITHIN BUT WITHIN AFTER NOT RATE
MONTHS ONE YEAR 5 YEARS 5 YEARS SENSITIVE TOTAL
------- ----------- ---------- ------- --------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Rate-Sensitive Assets:
Interest-bearing deposits with other
financial institutions.................... $ - $ - $ - $ - $ - $ -
Federal Funds sold and securities
purchased under agreements to resell...... 23,000 - - - - 23,000
Securities held-to-maturity................ - - 14,395 - - 14,395
Securities held-for-sale................... - - 1,003 2,999 - 4,002
Equity investment-FRB & PCBB............... - - - 233 - 233
Loans receivable........................... 37,050 15,572 7,913 2,012 - 62,547
------- ------- ------- ------ ------ --------
Total rate-sensitive assets............... 60,050 15,572 23,311 5,244 - 104,177
Rate-Sensitive Liabilities: (1)
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....... - - - - - -
Other borrowings........................... - - - - - -
------- ------- ------- ------ ------ --------
Total rate-sensitive liabilities.......... 39,388 22,346 7,368 - - 69,102
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 35,075
------- ------- ------- ------ ------
------- ------- ------- ------ ------
Cumulative ratio of rate sensitive assets
to rate-sensitive liabilities............. 152% 122% 143% 151%
------- ------- ------- ------
------- ------- ------- ------
</TABLE>
(1) Customer deposits which are subject to immediate withdrawal are presented
as repricing within three months or less.
The distribution of other time deposits is based on scheduled maturities.
INVESTMENT SECURITIES
The Company classifies its securities as held-to-maturity or available-for-
sale. Securities which the Company has the ability and intent to hold to
maturity are classified as held-to-maturity securities. All other securities
are classified as available-for-sale.
HELD-TO-MATURITY
Held-to-maturity securities at December 31, 1997 totaled $14.0 million
compared to $14.4 million at December 31, 1996. The average expected maturity
of held-to-maturity securities was 1.04 years at December 31, 1997.
AVAILABLE-FOR-SALE SECURITIES
At December 31, 1997, securities available-for-sale totaled $25.8 million,
an increase of $21.8 million from $4.0 million at December 31, 1996. This
increase was due to the investment of the net proceeds from the Capital
Page 27
<PAGE>
Offerings and utilization of the Company's excess liquidity position for
investment purposes during 1997. The average expected maturity of total
available-for-sale securities at December 31, 1997 was 2.44 years.
As illustrated in Table 9 below, the Company's investment portfolio
generally consisted of U.S. government and federal agency securities and
mortgage-backed securities including CMOs, at December 31, 1997 and 1996. The
Company's policy is to stagger the maturities of its investments to meet
overall liquidity requirements of the Company. Table 10 below sets forth
information concerning the maturity of and weighted average yield on the
Company's investment portfolio.
TABLE 9
ESTIMATED FAIR VALUES OF AND UNREALIZED
GAINS AND LOSSES ON INVESTMENT SECURITIES
AND DEBT SECURITIES
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997 AT DECEMBER 31, 1996
---------------------------------------------- --------------------------------------------
TOTAL GROSS GROSS ESTIMATED TOTAL GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSS VALUE COST GAINS LOSS VALUE
--------- ---------- ---------- --------- --------- ---------- ---------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Securities held-to-maturity:
U.S. government and federal
agency securities................ $14,000 $ 10 $ - $14,010 $14,395 $ - $40 $14,355
------- ---- --- ------- ------- --- --- -------
------- ---- --- ------- ------- --- --- -------
Securities available-for-sale:
U.S. Treasury securities.......... $ 1,002 $ 3 $ - $ 1,005 $ - $ - $ - $ -
FNMA-issued mortgage
pass through certificates........ 4,327 22 - 4,349 - - - -
U.S. government and federal
agency securities................ 15,488 34 - 15,522 1,000 3 - 1,003
CMO's and REMIC's issued by U.S.
government and federal agencies.. 4,977 (21) - 4,956 3,078 - 79 2,999
------- ---- --- ------- ------- --- --- -------
$25,794 $ 38 $ - $25,832 $ 4,078 $ 3 $79 $ 4,002
------- ---- --- ------- ------- --- --- -------
------- ---- --- ------- ------- --- --- -------
</TABLE>
Page 28
<PAGE>
TABLE 10
MATURITIES OF AND WEIGHTED AVERAGE YIELDS ON
INVESTMENT SECURITIES AND DEBT SECURITIES
<TABLE>
<CAPTION>
Carrying amount of investment securities maturing:
----------------------------------------------------------------------------------------------
After one but After five but
Within one year within five years within ten years After ten 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............... $2,000 5.86% $12,000 6.72% $ - - $ - - $14,000 6.60%
------ ------- ------- ------ -------- ------- -------- ----- -------- -------
$2,000 5.86% $12,000 6.72% $ - - $ - - $14,000 6.60%
------ ------- ------- ------ -------- ------- -------- ----- -------- -------
------ ------- ------- ------ -------- ------- -------- ----- -------- -------
Securities available-for-sale:
U.S Treasury..................... $ - - $1,005 5.85% $ - - $ - - $ 1,005 5.85%
FHLMC/FNMA-issued mortgage
pass-through certificates....... - - 923 6.45% 3,426 6.59% - - 4,349 6.56%
Other government-sponsored
agency securities............... - - 12,018 6.59% 3,504 6.96% - - 15,522 6.67%
CMO's and REMIC's issued by
U.S. government-sponsored
agencies........................ - - - 3,499 6.69% $1,457 6.96% 4,956 6.77%
------ ------- ------- ------ -------- ------- -------- ----- -------- -------
$ - - $13,946 6.53% $10,429 6.75% $1,457 6.96% $25,832 6.64%
------ ------- ------- ------ -------- ------- -------- ----- -------- -------
------ ------- ------- ------ -------- ------- -------- ----- -------- -------
</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, 1997, the only securities held by the Company where the
aggregate book value of the Company's investment in securities of a single
issuer exceeded ten percent (10%) of the Bank's shareholders' equity were
issued by U.S. government and federal agencies.
Investment securities included in Table 10 above include securities issued by
Federal Home Loan Bank ("FHLB"), Federal National Mortgage Association ("FNMA")
and Federal Home Loan Mortgage Corporation ("FHLMC"). The majority of these
securities contain a optional principal redemption feature (commonly referred
to as a "call"), whereby the issuer, at their option, may redeem in whole at
par the then outstanding bonds on specified redemption dates. Generally, these
securities are called by the issuer when the prevailing market rates at the
call date are below the market rates at the date of issue, allowing the issuer
to replace such borrowings at a lower cost. Investment securities containing
such call features totaled $29.5 million at December 31, 1997. Table 11 below
summarizes the Company's callable investment securities in both the available-
for-sale and held-to-maturity portfolios at December 31, 1997 indicating the
next call period and call frequency.
Page 29
<PAGE>
TABLE 11
INVESTMENT SECURITIES WITH OPTIONAL PRINCIPAL REDEMPTION
AT DECEMBER 31, 1997
<TABLE>
<CAPTION>
Call Period as of December 31, 1997:
----------------------------------------
Weighted Weighted Within Three Six months
Call Average Average Three To Six To
Issuer Frequency Yield Maturity Months Months One Year Total
- -------------------- ------------------------ ---------- ---------- ---------- ---------- ------------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
FHLMC Less than 3 Months 6.510% 3.90 $ 3,000 $ - $ - $ 3,000
FHLB 3 Months 6.422% 2.84 10,489 - - 10,489
FHLB 6 Months 6.777% 4.48 4,999 3,000 5,500 13,499
FNMA 6 Months 6.851% 4.47 2,499 2,499
---------- ---------- ---------- ---------- ------------- -------
6.637% 3.83 $18,488 $3,000 $ 7,999 $29,487
---------- ---------- ---------- ---------- ------------- -------
---------- ---------- ---------- ---------- ------------- -------
</TABLE>
OTHER SECURITIES
The Company owns stock in the Federal Reserve Bank, Federal Home Loan Bank
and Pacific Coast Bankers Bank. These investments are carried at cost and
totaled $646,000 and $233,000 at December 31, 1997 and 1996, respectively.
LOAN PORTFOLIO
The Company's lending activities are predominantly in Southern California.
The Company has no foreign loans.
LOANS BY TYPE
The loan portfolio decreased by $1.3 million to $61.3 million at December 31,
1997 compared to $62.6 million at December 31, 1996. Table 12 below indicates
that the loan portfolio composition at December 31, 1997 had a decreased
portion of loans secured by real estate, representing approximately 56% of
total loans outstanding as compared to 64% at December 31, 1996. Loans secured
by commercial real properties decreased as a percentage of total loans
outstanding to 36% at December 31, 1997 from 42% at December 31, 1996 due to
loan payoffs and scheduled maturities. Other secured and unsecured commercial
loans represented 35% of total loans outstanding at December 31, 1997, an
increase from 26% at December 31, 1996 as a result of the Company's increased
emphasis in this area.
The loan portfolio decreased by $19.4 million to $62.6 million at December
31, 1996 compared to $82.0 million at December 31, 1995. Table 12 below
indicates that the loan portfolio mix at December 31, 1996 had a larger portion
of loans secured by real estate, representing approximately 64% of total loans
outstanding as compared to 60% at December 31, 1995. Other secured and
unsecured commercial loans represented 26% of total loans outstanding at
December 31, 1996, a decline from 33% at December 31, 1995. Consumer loans to
individuals represented 10% of total loans outstanding at December 31, 1996, an
increase from 7% at December 31, 1995.
Page 30
<PAGE>
TABLE 12
LOAN PORTFOLIO COMPOSITION
<TABLE>
<CAPTION>
December 31,
----------------------------------------------------------------------------------
1997 1996 1995
---------------------- ----------------------- -----------------------
Amount Percent Amount Percent Amount Percent
-------- --------- -------- --------- -------- ---------
<S> <C> <C> <C> <C> <C> <C>
(Dollars in thousands)
Loan Portfolio Composition:
Real estate construction and land
development............................ $ 3,148 5% $ 3,441 6% $ 4,185 5%
Commercial loans:
Secured by one to four family
residential properties................ 6,545 11% 6,233 10% 9,637 12%
Secured by multifamily
residential properties................ 2,494 4% 2,879 5% 2,876 3%
Secured by commercial real
properties............................ 22,324 36% 26,629 42% 28,734 35%
Other - secured and
unsecured............................. 21,264 35% 16,508 26% 27,393 33%
Home equity lines of credit............. 252 0% 581 1% 3,983 5%
Consumer installment and
unsecured loans to individuals......... 5,508 9% 6,545 10% 5,435 7%
-------- --------- -------- --------- -------- ---------
Total loans outstanding 61,535 100% 62,816 100% 82,243 100%
Deferred net loan origination
fees, purchased loan discount
and gains on termination of
interest rate swap and cap
agreements............................. (283) (269) (231)
-------- -------- --------
Loans receivable, net................... $61,252 $62,547 $82,012
-------- -------- --------
-------- -------- --------
</TABLE>
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 13 presents information about the Company's loans outstanding
to entertainment-related customers at December 31, 1997, 1996, and 1995. The
concentration of loans to the entertainment-related industry at December 31,
1997, decreased to $6.3 million or 10.2% of the total portfolio, as compared to
$6.5 million, or 10.3% at December 31, 1996 and $9.4 million, or 11.4% at
December 31, 1995.
Management believes that the varying nature of customers represented within
this group, as set forth in Table 13, indicates reasonable diversification. In
addition, loans for the production of independently produced motion picture and
television feature films presented in Table 13, 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.
Page 31
<PAGE>
TABLE 13
INDUSTRY CONCENTRATIONS OF LOANS
<TABLE>
<CAPTION>
December 31,
--------------------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
(Dollars in thousands)
Entertainment industry-related loans (1):
Loans for single productions of motion picture and television
feature films........................................................ $ 2,221 $ - $ 1,739
Other loans to entertainment-related enterprises, such as television
and film production or distribution.................................. 1,068 1,158 3,020
Loans to individuals involved primarily in the
entertainment industry................................................ 1,487 2,516 1,663
Loans to business management, legal and accounting firms,
including their principals and employees, serving primarily the
entertainmemt industry............................................... 1,479 2,791 2,930
-------- -------- --------
Total entertainment industry-related loans (2)........................ $ 6,255 $ 6,465 $ 9,352
-------- -------- --------
-------- -------- --------
Percent of total loans outstanding.................................... 10.2% 10.3% 11.4%
</TABLE>
- ---------------
(1) Included are loans secured by liens on residential and commercial real
property amounting to $3.0 million and $1.2 million at December 31, 1996
and 1995, respectively.
(2) Includes nonperformimg loans of $400,000 at December 31, 1995.
LOAN MATURITY AND RATE COMPOSITION
Floating rate or adjustable rate loans comprised 66.3% of total loans
outstanding at December 31, 1997 and 74.3% at December 31, 1996. Total loans
at December 31, 1997 were comprised of 36.4% due in one year or less, 50.0% due
in 1--5 years and 13.6% due after 5 years.
The loan maturities shown in Table 14 below are based on contractual
maturities. As is customary in the banking industry, loans that meet sound
underwriting criteria can be renewed by mutual agreement between the Company
and the borrower. Because the Company is unable to estimate the extent to
which its borrowers will renew their loans the table is based on contractual
maturities.
Page 32
<PAGE>
TABLE 14
LOAN MATURITIES
<TABLE>
<CAPTION>
At December 31, 1997
-----------------------------------------
Interest rates Interest rates
are floating are fixed or
or adjustable predetermined Total
---------------- -------------- ---------
<S> <C> <C> <C>
(Dollars in thousands)
Aggregate maturities of total loans outstanding:
Real estate construction and development:
In one year or less................................ $ 321 $ - $ 321
After one year but within five years............... 2,827 - 2,827
After five years................................... - - -
Commercial secured by real estate
In one year or less................................ 5,218 1,060 6,278
After one year but within five years............... 8,387 9,972 18,359
After five years................................... 4,163 2,563 6,726
Commecial other secured and unsecured
In one year or less................................ 10,073 2,773 12,846
After one year but within five years............... 4,205 3,032 7,237
After five years................................... 1,181 - 1,181
Other -
In one year or less................................ 2,309 632 2,941
After one year but within five years............... 1,814 554 2,368
After five years................................... 295 156 451
---------- --------- ---------
Total loans outstanding $40,793 $20,742 $61,535
---------- --------- ---------
---------- --------- ---------
</TABLE>
CREDIT RISK MANAGEMENT
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 $250,000 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 a 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
determine the level of the allowance for credit losses.
The ongoing credit control process includes a risk rating system and regular
monitoring of classified and criticized assets as graded 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
provided 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.
Page 33
<PAGE>
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 15.
TABLE 15
NONPERFORMING ASSETS
<TABLE>
<CAPTION>
December 31,
-----------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- ------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Nonaccrual loans.............................$ 1,201 $ 928 $ 573 $ 3,426 $ 7,780
Troubled debt restructurings................. 5,422 5,016 5,167 5,582 5,584
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
-------- -------- -------- ------- --------
Nonperforming loans.......................... 6,623 6,244 5,961 10,515 15,866
Other real estate owned...................... 777 556 581 1,529 6,175
-------- -------- -------- ------- --------
Total nonperforming assets...................$ 7,400 $ 6,800 $ 6,542 $12,044 $ 22,041
-------- -------- -------- ------- --------
-------- -------- -------- ------- --------
Allowance for credit losses as a percent
of nonaccrual loans........................ 168.4% 319.9% 664.0% 89.4% 86.1%
Allowance for credit losses as a percent
of nonperforming loans..................... 30.5% 47.5% 63.8% 29.1% 42.2%
Total nonperforming assets as a percent
of loans receivable........................ 12.1% 10.9% 8.0% 10.4% 13.6%
Total nonperforming assets as a percent
of total shareholders' equity.............. 59.5% 140.4% 108.8% 116.8% 99.3%
</TABLE>
At December 31, 1997, nonperforming assets totaled $7.4 million or 12.1%
of total loans outstanding, representing a $600,000 increase from $6.8
million at December 31, 1996. The increase in nonperforming assets was due
primarily to the refinancing of an existing loan representing a troubled debt
restructuring from $4.9 million to $5.4 million as a result of the Bank
consenting to increase the loan balance due by the amount of the past due
real estate property taxes in order to protect its security interest. In
addition, as a result of this refinancing, the Bank realized an increased
yield which now approximates market. At December 31, 1997 this loan was
performing in accordance with its refinanced terms and is secured by a first
deed of trust on a single family residence with an appraised value as of
January 1998 of $10.0 million.
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 assets
represented 10.9% of total loans outstanding at December 31, 1996. One loan,
a troubled debt restructure, represents $4.9 million of the total $6.8
million of nonperforming assets.
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. It is the
Bank's policy that a loan will be placed on nonaccrual status if either
principal or interest payments are past due in excess of ninety days unless
the loan is both well secured and in process of collection, or if full
collection of interest or principal becomes uncertain, regardless of the time
period involved.
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,
Page 34
<PAGE>
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, 1997, increased to $1.2 million from
$928,000 at December 31, 1996. Nonaccrual loans at December 31, 1997 were
comprised primarily of entertainment and Small Business Administration
("SBA") loans. The additional interest income that would have been recorded
from nonaccrual loans, if the loans had not been on nonaccrual status was
$177,000, $171,000 and $160,000 for the years ended December 31, 1997, 1996
and 1995, respectively. Interest payments received on nonaccrual loans are
applied to principal unless there is no doubt as to ultimate full repayment
of principal, in which case, the interest payment is recognized as interest
income. Interest income not recognized on nonaccrual loans reduced the net
yield on earning assets by 17, 16, and 12 basis points for the years ended
December 31, 1997, 1996, and 1995, respectively.
TROUBLED DEBT RESTRUCTURINGS. Included within nonperforming assets are
troubled debt restructurings ("TDR"). TDR is defined in SFAS Nos. 15 and
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,
1997, a single TDR loan represented $5.35 million of the total $5.40 million
of TDRs. This loan is secured by a first deed of trust on residential real
property which, at January 1998, had an appraised value of $10.0 million. At
December 31, 1997 this loan was performing in accordance with its
restructured terms and the property is currently being marketed 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 15.
LOANS CONTRACTUALLY PAST DUE 90 OR MORE DAYS. Loans contractually past
due 90 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 90 or more days and still accruing interest
decreased to zero at December 31, 1997, from $300,000 at December 31, 1996.
The Financial Accounting Standards Board ("FASB") issued SFAS No. 114
"Accounting by Creditors for Impairment of a Loan" which was amended by
SFAS No. 118, "Accounting by Creditors for Impairment of a Loan--Income
Recognition and Disclosures", which eliminates the provisions of SFAS No.
114 regarding how a creditor should report income on an impaired loan and
clarifies certain disclosure requirements. SFAS No. 114 prescribes the
recognition criterion for loan impairment and the measurement methods for
certain impaired loans and loans whose terms are modified in troubled debt
restructurings. 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.
Page 35
<PAGE>
At December 31, 1997, the Bank had classified $6.6 million of its loans
as impaired under SFAS No. 114, for which the related specific reserves was
$15,000. The average recorded investment in, and the amount of interest
income recognized on those impaired loans during the year ended December 31,
1997, were $6.4 million and $539,000 respectively. Of the loans considered to
be impaired at December 31, 1997, $5.35 million or 81% of impaired loans 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
$177,000 for the year ended December 31, 1997 and $171,000 for the same
period in 1996. This resulted in a reduction in yield on average loans
receivable of 30 basis points and 24 basis points for the years ended
December 31, 1997 and 1996, 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.
POTENTIAL NONPERFORMING LOANS. At December 31, 1997, management could
not identify any significant amounts of loans about which it had serious
doubts as to the ability of the borrowers to comply with the present loan
payment terms in the future, beyond the loans disclosed above as past due,
nonaccrual or restructured. If economic conditions change, adversely or
otherwise, or if additional facts on borrowers' financial condition come to
light, then the amount of potential problem loans may change, possibly
significantly.
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
quarterly 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 quarterly.
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 periodic basis (three times per year),
management engages an outside loan review firm to review the Bank's loan
portfolio, risk grade accuracy and the reasonableness of loan evaluations.
Annually, this outside loan review team analyzes the Bank's methodology for
calculating the ALLL based on the Bank's loss histories and policies. The
Bank uses a migration analysis as part of its ALLL evaluation which 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 to determine
the provision for credit losses and establish the allowance for credit
losses. Management believes that the allowance for credit losses at December
31, 1997, 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 16 presents, for the five-year period ended December 31, 1997, the
composition of the Company's allocation of the allowance for credit losses to
specific loan categories designated by management for this purpose.
Page 36
<PAGE>
The Bank's current practice is to make specific allocations of the
allowance for credit losses to criticized and classified loans, and
unspecified allocations to each loan category based on management's risk
assessment. 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.
TABLE 16
ALLOCATION OF ALLOWANCE FOR CREDIT LOSSES
<TABLE>
<CAPTION>
December 31,
--------------------------------------------------------------------------------------------------
1997 %(1) 1996 %(1) 1995 %(1) 1994 %(1) 1993 %(1)
-------- ------- -------- ------ ------ ------- ------ ------ ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Allocation of the Allowance
for Credit Losses:
Real Estate construction and
land development..............$ 63 5% $ 42 6% $ 11 5% 17 1% $ 30 1%
Commercial loans:
Secured by one to four family
residential properties........ 154 11% 479 10% 205 12% 77 16% 499 12%
Secured by multifamily
residential properties........ 49 4% 41 5% 25 3% 51 2% 472 3%
Secured by commercial real
properties.................... 512 36% 590 42% 454 35% 674 28% 1,422 25%
Other - secured and unsecured. 1,055 35% 1,642 26% 2,521 33% 1,645 37% 3,130 41%
Home equity lines of credit..... 2 0% 13 1% 64 5% 18 2% 149 3%
Consumer installment and unsecured
loans to individuals (1)...... 187 9% 161 10% 523 7% 578 14% 988 15%
------- ------- ------ ------ ------ ------ ------ ------ ------ -----
Allowance allocable to loans
receivable.................... 2,022 100% 2,968 100% 3,803 100% 3,060 100% 6,690 100%
Commitments to extend credit
under standby and commercial
letters of credit............. 1 - 1 - 2 - 3 - 7 -
------- ------- ------ ------ ------ ------ ------ ------ ------ -----
Total allowance for credit
losses........................$ 2,023 100% $2,969 100% $3,805 100% $3,063 100% $6,697 100%
------- ------- ------ ------ ------ ------ ------ ------ ------ -----
------- ------- ------ ------ ------ ------ ------ ------ ------ -----
</TABLE>
_______________
(1) Percentage of loans in each category to total loans.
LOAN CHARGE-OFFS AND RECOVERIES
Management regularly monitors the loan portfolio to identify 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, 1997 of $1.3 million
were primarily attributable to loans secured by residential properties,
commercial--other secured and unsecured loans, and consumer loans pertaining
to loans purchased in 1993 from the FDIC ("FDIC loans") and to a lesser
extent the SBA portfolio.
Loan charge-offs for the year ended December 31, 1996 were $1.3 million,
primarily related to two loans in the commercial--other secured and unsecured
portfolio pertaining to the international division and purchased lease
financing contracts.
Loan charge-offs for the year ended December 31, 1995 of $2.6 million
included $1.7 million of 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.
Recoveries of loans previously charged-off amounted to $369,000 and
$464,000 for the years ended December 31, 1997 and 1996, respectively, and
were primarily the result of recoveries of business banking and entertainment
related loans. The majority of these loans were in the commercial--other
secured and unsecured category.
Recoveries of loans previously charged-off for the year ended December
31, 1995 of $1.1 million included $700,000 of business banking and
entertainment related lending and $150,000 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.
Page 37
<PAGE>
TABLE 17
ANALYSIS OF CHANGES IN ALLOWANCE FOR CREDIT LOSSES
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
1997 1996 1995 1994 1993
------ ------ ------ ------ ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Balance, beginning of period........................... $2,969 $3,805 $3,063 $6,697 $6,009
Loan charged off:
Real estate construction and land development......... - - - 45 558
Commercial loans:
Secured by one to four family residential properties. 310 9 120 2,215 72
Secured by multifamily residential properties........ 256 - - 702 -
Secured by commercial real properties................ 56 - - 1,407 581
Other - secured and unsecured........................ 350 1,183 1,913 6,781 774
Home equity lines of credit........................... - - - 257 -
Consumer installment and unsecured loans to
individuals (1)...................................... 343 108 599 2,810 450
------ ------ ------ ------ ------
Total loan charge-offs................................ 1,315 1,300 2,632 14,217 2,435
Recoveries of loans previously charged off:
Real estate construction and land development......... - - 200 - 4
Commercial loans:
Secured by one to four family residential properties. 71 26 11 288 7
Secured by commercial real properties................ 4 - - - -
Other - secured and unsecured........................ 202 398 588 2,205 945
Home equity lines of credit........................... - - - 38 38
Consumer installment and unsecured loans to
individuals (1)...................................... 92 40 268 722 129
------ ------ ------ ------ ------
Total recoveries of loans previously charged off..... 369 464 1,067 3,253 1,123
------ ------ ------ ------ ------
Net charge-offs...................................... 946 836 1,565 10,964 1,312
Provision for credit losses.......................... - - 2,307 7,330 2,000
------ ------ ------ ------ ------
Balance, end of period............................... $2,023 $2,969 $3,805 $3,063 $6,697
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Net loan charge-offs as a percentage of allowance
for credit losses.................................. 46.76% 28.16% 41.13% 357.95% 19.59%
Provision for credit losses as a percent of net
loan charge-offs during period...................... - - 147.41% 66.86% 152.44%
Net loans charge-offs as a percent of average
gross loans outstanding during the period........... 1.54% 1.19% 1.63% 7.83% 0.82%
Recoveries of loans previously charged off
as a percent of loans charged off in the
previous year....................................... 28.38% 17.60% 7.50% 133.60% 17.30%
</TABLE>
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.
Page 38
<PAGE>
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 16. Losses, if any, are charged against the allowance for credit
losses. At December 31, 1997 and 1996, standby letters of credit amounted to
$600,000 and $175,000, respectively, and there were no commercial letters of
credit outstanding.
Undisbursed commitments under revocable and irrevocable loan facilities
amounted to $9.4 million and $7.9 million at December 31, 1997 and 1996,
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.
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 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 "nonperforming
assets." OREO at December 31, 1997 consisted of three properties totaling
$777,000 representing two undeveloped commercially zoned parcels, one
residential parcel and a single-family residence. The single-family residence
closed escrow during January 1998. While the Bank is currently marketing the
remaining properties for sale, no assurances can be given that they will be
sold at 100% of the value at which the properties were carried by the Bank at
December 31, 1997.
OREO at December 31, 1997 increased to $777,000, from $556,000 at December
31, 1996.
Page 39
<PAGE>
DEPOSITS
As indicated in Table 18, the Bank experienced a 7.4% decline in average
total deposits during 1997 compared to 1996. The decline in deposits occurred
throughout various deposit categories causing the overall mix of deposits
during 1997 to remain relatively consistent with 1996, except for the
disproportionate decrease in money desk deposits, which was consistent with
management's restructuring plan.
TABLE 18
DEPOSIT COMPOSITION
(BALANCES ARE AVERAGES)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------
1997 1996 1995
---------------- ----------------- -----------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Noninterest-bearing demand
deposits:
Real estate title and
escrow company customers.... $ 9,764 10% $ 9,280 9% $ 10,933 8%
Other noninterest-bearing
demand...................... 23,224 24% 27,238 26% 41,313 31%
Interest-bearing demand,
money market and savings.... 28,598 30% 27,470 26% 36,342 27%
Time certificates of deposit:
Money Desk.................. 23,789 25% 27,014 26% 33,806 25%
Other:
$100,000 or more............ 5,320 6% 5,302 5% 6,506 5%
Under $100,000.............. 5,750 6% 7,814 8% 5,318 4%
---------------- ----------------- -----------------
Total time certificates of
deposit..................... 34,859 36% 40,130 39% 45,630 34%
---------------- ----------------- -----------------
Total Deposits.............. $ 96,445 100% $104,118 100% $ 134,218 100%
---------------- ----------------- -----------------
---------------- ----------------- -----------------
</TABLE>
As indicated in Table 19, time certificates of deposit of $100,000 or more
from money desk (wholesale institutional funds) operations represented a more
significant source of funding during 1997 than in 1996. At December 31, 1997,
39.5% of total time certificates of deposit of $31.4 million were represented
by accounts individually in excess of $100,000 as compared to 22.7% of total
time certificates of deposit of $40.6 million at December 31, 1996. Time
certificates of deposit in excess of $100,000 from the money desk operation
comprised 51.3% of total time certificates of deposit in excess of $100,000
in 1997 as compared to 25.5% in 1996.
Page 40
<PAGE>
TABLE 19
MATURITIES OF TIME CERTIFICATES OF DEPOSIT
$100,000 OR MORE
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997
------------------------------------
MONEY ALL
DESK OTHER TOTAL
------ ------ -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Aggregate maturities of time certificates of deposit:
In three months or less.............................. $ 108 $4,472 $4,580
After three months but within six months............. - 746 746
After six months but within twelve months............ 805 822 1,627
After twelve months.................................. 5,449 - 5,449
------ ------ -------
Total time certificates of deposit $100,000 or more. $6,362 $6,040 $12,402
------ ------ -------
------ ------ -------
</TABLE>
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997
------------------------------------
MONEY ALL
DESK OTHER TOTAL
------ ------ -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Aggregate maturities of time certificates of deposit:
In three months or less.............................. $206 $5,390 $5,596
After three months but within six months............. 300 667 967
After six months but within twelve months............ 1,335 803 2,138
After twelve months.................................. 513 - 513
------ ------ -------
Total time certificates of deposit $100,000 or more. $2,354 $6,860 $9,214
------ ------ -------
------ ------ -------
</TABLE>
BORROWED FUNDS
Borrowings and related weighted average rates are summarized below in Table
20.
TABLE 20
BORROWED FUNDS
<TABLE>
<CAPTION>
1997 1996 1995
----------------------------- ----------------------------- -----------------------------
BALANCES AT AVERAGE AVERAGE BALANCES AT AVERAGE AVERAGE BALANCES AT AVERAGE AVERAGE
YEAR-END BALANCE RATE YEAR-END BALANCE RATE YEAR-END BALANCE RATE
----------- ------- ------- ----------- ------- ------- ----------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Securities sold under
repurchase agreements...... $ 5,050 $ 1,637 5.68% - - - $4,497 $4,154 2.65%
Other borrowings............ 3,500 143 4.89% - - - - - -
</TABLE>
The maximum amount of securities sold with agreements to repurchase at any
month end was $5.0 million, $1.5 million and $7.0 million during 1997, 1996
and 1995, respectively.
The maximum amount of other borrowings at any month end was $3.5 million
during 1997. The Bank did not utilize other borrowings during 1996 and 1995.
At December 31, 1997, the total balance of borrowed funds are scheduled to
mature during 1998.
Page 41
<PAGE>
REGULATORY AGREEMENTS
FORMAL AGREEMENT AND MEMORANDUM OF UNDERSTANDING
The Bank entered into the Formal Agreement with the OCC on December 14, 1995
which superceded and replaced a similar agreement entered into in 1991.
Effective November 18, 1997 the OCC terminated the Formal Agreement. Prior to
its termination, the Bank was required to maintain stipulated regulatory
capital levels, appoint a new chief financial officer, make certain
determinations as to the reasonableness of any salary, consulting fee, expense
reimbursement or other type of compensation, review the need for, and the
reasonableness of, all existing consulting, employment and severance contracts,
prepare a written analysis of any new products or services, maintain the Bank's
liquidity at a level sufficient to sustain current and anticipated operations,
develop a three year capital plan and strategic plan, and improve the Bank's
loan administration.
The Company entered into a Memorandum of Understanding ("MOU") on October 26,
1995 with the FRB which superceded and replaced a similar agreement entered
into in 1991. Effective September 4, 1997 the MOU was terminated by the FRB.
Prior to its termination, the MOU prohibited the Company from paying dividends
without prior approval of the FRB, required the submission of a plan to
increase the Bank's capital ratios, required the Company to conduct a review of
the senior and executive management of the Company and the Bank, prohibited the
incurrence or renewal of debt without the FRB's approval, restricted cash
expenditures in excess of $10,000 in any month and prohibited the Company from
making acquisitions or divestitures or engaging in new lines of business
without the FRB's approval.
RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the FASB issued SFAS No. 128 "Earnings Per Share" which
specifies the computation, presentation, and disclosure requirements for
earnings per share ("EPS") for entities with publicly held common stock or
potential common stock. SFAS No. 128 eliminates both "primary" and "fully
diluted" EPS, and requires the computation and disclosures of "basic" EPS and
"diluted" EPS. SFAS No. 128 is effective for financial statements for both
interim and annual periods ending after December 15, 1997, and earlier
application is not permitted. EPS disclosures presented herein have been
calculated in accordance with SFAS No. 128. See "Notes to Consolidated
Financial Statements - Summary of Significant Accounting Policies - Earnings
(Loss) Per Share".
The FASB recently issued SFAS No. 129, "Disclosure of Information about
Capital Structure," SFAS No. 130, "REPORTING COMPREHENSIVE INCOME" and SFAS No.
131, "DISCLOSURE ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION." SFAS
No. 129 applies to all entities that issue any securities other than ordinary
common stock and continues the existing requirements to disclose the pertinent
rights and privileges of all securities. SFAS No. 130 provides guidance for
reporting and display of comprehensive income and its components in the
financial statements and SFAS No. 131 establishes standards for the way that
public entities report information about operating segments in annual financial
statements and requires that those entities report selected information about
operating segments in interim financial reports issued to shareholders. These
Statements are effective for fiscal years beginning after December 15, 1997.
The Company will incorporate these disclosures at the time these pronouncements
are adopted.
Page 42
<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 1998 Annual Meeting of
Shareholders (the "1998 Proxy Statement"), and such information either shall
be (i) deemed to be incorporated herein by reference to that portion of the
1998 Proxy Statement, if filed with the Securities and Exchange Commission
pursuant to Regulation 14A not later than 120 days after the end of the
Company'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 1998
Proxy Statement, and such information either shall be (i) deemed to be
incorporated herein by reference to those portions of the 1998 Proxy Statement,
if filed with the Securities and Exchange Commission pursuant to Regulation 14A
not later than 120 days after the end of the Company'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 1998 Proxy Statement, and such
information either shall be (i) deemed to be incorporated herein by reference
to that portion of the 1998 Proxy Statement, if filed with the Securities and
Exchange Commission pursuant to Regulation 14A not later than 120 days after
the end of the Company'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 1998 Proxy Statement, and such
information either shall be (i) deemed to be incorporated herein by reference
to that portion of the 1998 Proxy Statement, if filed with the Securities and
Exchange Commission pursuant to Regulation 14A not later than 120 days after
the end of the Company's most recently completed fiscal year, or (ii) included
in an amendment to this report filed with the Commission on Form 10-K/A.
Page 43
<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
PAGE
----
Independent Auditors' Report. . . . . . . . . . . . . . . . . . . . . . F-1
Consolidated Balance Sheets at December 1997 and 1996 . . . . . . . . . F-2
Consolidated Statements of Operations for the
years ended December 31, 1997, 1996, and 1995. . . . . . . . . . . . . F-3
Consolidated Statements of Changes in Shareholders'
Equity for the years ended December 31, 1997, 1996 and 1995. . . . . . F-4
Consolidated Statements of Cash Flows for the years
ended December 31, 1997, 1996 and 1995 . . . . . . . . . . . . . . . . F-5
Notes to Consolidated Financial Statements for the
three years ended December 31, 1997. . . . . . . . . . . . . . . . . . F-6
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.
Page 44
<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/ SCOTT A. MONTGOMERY
--------------------------
Scott A. Montgomery
Chief Executive Officer
By /s/ JOSEPH W. KILEY III
--------------------------
Joseph W. Kiley III
Chief Financial Officer
Date: March 11, 1998
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/ ROBERT E. GIPSON
- ------------------------------------
Robert E. Gipson Chairman of the Board March 11, 1998
/s/ ROBERT E. THOMSON
- ------------------------------------
Robert E. Thomson Vice Chair March 11, 1998
/s/ DONALD E. BENSON
- ------------------------------------
Donald E. Benson Director March 11, 1998
/s/ ALAN GRAHM
- ------------------------------------
Alan Grahm Director March 11, 1998
/s/ JOSEPH W. KILEY, III
- ------------------------------------
Joseph W. Kiley, III Director and Chief
Financial Officer March 11, 1998
/s/ SCOTT A. MONTGOMERY
- ------------------------------------
Scott A. Montgomery Director and Chief
Executive Officer March 11, 1998
/s/ DION G. MORROW
- ------------------------------------
Dion G. Morrow Director March 11, 1998
</TABLE>
Page 45
<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, 1997 and
1996 and the related consolidated statements of operations, changes in
shareholders' equity and cash flows for each of the years in the three-year
period ended December 31, 1997. These 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, 1997 and 1996 and the results of their operations
and their cash flows for each of the years in the three-year period ended
December 31, 1997, in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Los Angeles, California
January 23, 1998
F-1
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
1997 1996
---------- ----------
(Dollars in thousands)
<S> <C> <C>
ASSETS
Cash and due from banks-demand. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 4,186 $ 5,113
Federal funds sold and securities purchased under agreements to resell . . . . . . . . . . . . . . . . 11,900 23,000
---------- ----------
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,086 28,113
Interest-bearing deposits with other financial institutions . . . . . . . . . . . . . . . . . . . . . . 250 -
Securities available-for-sale, at fair value; aggregate amortized cost of $25,794 and
$4,078 at December 31, 1997 and 1996, respectively . . . . . . . . . . . . . . . . . . . . . . . . . 25,832 4,002
Securities held-to-maturity, at amortized cost; aggregate market value of $14,010 and
$14,355 at December 31, 1997 and 1996, respectively. . . . . . . . . . . . . . . . . . . . . . . . . 14,000 14,395
FRB and other stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 646 233
Loans receivable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61,252 62,547
Allowance for credit losses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,023) (2,969)
---------- ----------
Net loans receivable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59,229 59,578
Premises and equipment, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 785 943
Other real estate owned, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 777 556
Accrued interest receivable and other assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,800 1,596
---------- ----------
Total Assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 119,405 $ 109,416
---------- ----------
---------- ----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 35,399 $ 34,752
Interest-bearing demand. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,431 7,292
Money market accounts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19,646 15,512
Savings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,524 5,650
Time certificates of deposit:
$100,000 or more. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,402 9,214
Under $100,000. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18,986 31,434
---------- ----------
Total deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97,388 103,854
Securities sold under agreements to repurchase. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,050 -
Other borrowed funds. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,500 -
Accrued interest payable and other liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,027 717
---------- ----------
Total liabilities.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106,965 104,571
Shareholders' equity:
Preferred stock, 6.5% noncumulative convertible preferred stock; $10.00 stated value,
authorized 1,000,000 shares; issued and outstanding 900,000 and 0
at December 31, 1997 and 1996, respectively . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,350 -
Common stock, no par value; authorized 10,000,000 shares; issued and outstanding
677,144 and 677,260 at December 31, 1997 and 1996, respectively . . . . . . . . . . . . . . . . . 24,613 24,614
Accumulated deficit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (19,561) (19,693)
Net unrealized gain (loss) on securities available-for-sale. . . . . . . . . . . . . . . . . . . . . 38 (76)
---------- ----------
Total shareholders' equity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,440 4,845
---------- ----------
Total Liabilities and Shareholders' equity. . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 119,405 $ 109,416
---------- ----------
---------- ----------
</TABLE>
See accompanying notes to consolidated financial statements.
F-2
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
(Dollars in thousands, except per share data)
<S> <C> <C> <C>
Interest income:
Loans, including fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,947 $ 6,743 $ 9,299
Securities held-to-maturity . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,194 62 -
Securities available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . 746 928 1,395
Federal funds sold and securities purchased under agreements to resell. . . . . . . 710 1,024 933
Interest-bearing deposits with other financial institutions . . . . . . . . . . . . 3 - 7
--------- --------- ---------
Total interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,600 8,757 11,634
Interest expense:
Interest-bearing demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90 76 137
Money market and savings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 634 634 1,002
Time certificate of deposits:
$100,000 or more . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 464 419 542
Under $100,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,568 1,925 2,188
--------- --------- ---------
Total interest expense on deposits. . . . . . . . . . . . . . . . . . . . . . 2,756 3,054 3,869
Federal funds purchased and securities sold under agreements to repurchase. . . . . 93 25 110
Other borrowed funds. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 - -
--------- --------- ---------
Total interest expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,856 3,079 3,979
--------- --------- ---------
Net interest income before provision for credit losses. . . . . . . . . . . . 5,744 5,678 7,655
Provision for credit losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - - 2,307
--------- --------- ---------
Net interest income after provision for credit losses . . . . . . . . . . . . . . . 5,744 5,678 5,348
Other operating income (losses):
Net loss on sale of securities available-for-sale . . . . . . . . . . . . . . . . . (37) (3) (1,233)
Loss on termination of interest-rate swap . . . . . . . . . . . . . . . . . . . . . - - (1,294)
International services. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128 124 224
Investment division . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 73 254
Deposit-related and other customer services . . . . . . . . . . . . . . . . . . . . 377 308 737
Other income-shareholders' insurance claim. . . . . . . . . . . . . . . . . . . . . - - 730
Loss on other real estate owned . . . . . . . . . . . . . . . . . . . . . . . . . . - - (733)
--------- --------- ---------
Total other operating income (loss) . . . . . . . . . . . . . . . . . . . . . 486 502 (1,315)
Other operating expenses:
Salaries and related benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,887 2,718 3,878
Severance costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - - 141
Net occupancy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 806 793 1,468
Furniture and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200 298 385
Printing and communications . . . . . . . . . . . . . . . . . . . . . . . . . . . . 229 211 270
Insurance and regulatory assessments. . . . . . . . . . . . . . . . . . . . . . . . 516 629 971
Customer services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 537 607 853
Computer data processing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 292 359 413
Legal settlement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - 1,000 -
Legal services. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 172 503 749
Other professional services . . . . . . . . . . . . . . . . . . . . . . . . . . . . 225 640 1,546
Other real estate owned expenses. . . . . . . . . . . . . . . . . . . . . . . . . . 21 39 41
Promotion and other expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . . 213 206 518
--------- --------- ---------
Total other operating expenses. . . . . . . . . . . . . . . . . . . . . . . . 6,098 8,003 11,233
--------- --------- ---------
Net income (loss) before income tax benefit . . . . . . . . . . . . . . . . . . . . 132 (1,823) (7,200)
Income tax benefit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - (579) -
--------- --------- ---------
Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 132 $ (1,244) $ (7,200)
--------- --------- ---------
--------- --------- ---------
Earnings (loss) per share:
Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.20 $ (1.84) $ (10.63)
--------- --------- ---------
--------- --------- ---------
Diluted. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.08 $ (1.84) $ (10.63)
--------- --------- ---------
--------- --------- ---------
</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, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
Net
Unrealized
Gain (Loss)
Preferred Stock Common Stock on Securities
Accumulated Available-
Shares Amount Shares Amount Deficit for-sale Total
-------- --------- ---------- -------- ------------- ------------- --------
(Dollars in thousands except share data)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1995 . . . . . . . . . $ 3,078,146 $ 24,614 $ (11,249) $ (3,057) $ 10,308
Net unrealized gain 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
Net unrealized gain 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
9.09 to 1 reverse stock split
effective June 20, 1997. . . . . . . . (2,739,516)
Return of fractional common
shares due to reverse stock
split. . . . . . . . . . . . . . . . . (58) (1) (1)
Net unrealized gain on securities
available-for-sale . . . . . . . . . . 114 114
Issuance of 6.5% noncumulative
convertible preferred stock,
$10.00 stated value, net . . . . . . . 900,000 7,350 7,350
100 % stock dividend declared on
January 8, 1998. . . . . . . . . . . . 338,572
Net income. . . . . . . . . . . . . . . . 132 132
-------- --------- ---------- -------- ------------ ------------- --------
Balance at December 31, 1997.. . . . . . . . 900,000 $ 7,350 677,144 $ 24,613 $ (19,561) $ 38 $ 12,440
-------- --------- ---------- -------- ------------ ------------- --------
-------- --------- ---------- -------- ------------ ------------- --------
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOW
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
(Dollars in thousands)
<S> <C> <C> <C>
Net cash flow from operating activities:
Net income (loss). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 132 $ (1,244) $ (7,200)
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:
Accretion of sublease loss . . . . . . . . . . . . . . . . . . . . . . . . . . . - - (458)
Depreciation and amortization. . . . . . . . . . . . . . . . . . . . . . . . . . 179 194 365
Gain on sale of fixed assets . . . . . . . . . . . . . . . . . . . . . . . . . . - (1) -
Provision for credit losses. . . . . . . . . . . . . . . . . . . . . . . . . . . - - 2,307
Provision for other real estate owned. . . . . . . . . . . . . . . . . . . . . . - - 733
Net loss on sale of securities available-for-sale. . . . . . . . . . . . . . . . 37 3 1,233
Net amortization of (discounts) premiums on securities . . . . . . . . . . . . . (28) 57 57
Net accretion of discounts on loans purchased. . . . . . . . . . . . . . . . . . (36) (9) (163)
(Increase) decrease in accrued interest receivable and other assets. . . . . . . (204) (201) 723
Increase (decrease) in accrued interest payable and other liabilities. . . . . . 310 (524) (287)
--------- --------- ---------
Net cash provided by (used in) operating activities . . . . . . . . . . . . 390 (1,725) (2,690)
Cash flows from investing activities:
Net (increase) decrease in interest-bearing deposits with other financial
institutions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (250) - 195
Purchase of securities held-to-maturity. . . . . . . . . . . . . . . . . . . . . (6,972) (14,395) -
Purchase of securities available-for-sale. . . . . . . . . . . . . . . . . . . . (26,428) (1,000) (8,013)
Proceeds from sales of securities available-for-sale . . . . . . . . . . . . . . 3,836 10,632 46,862
Proceeds from repayments and maturities of securities available-for-sale . . . . 421 6,568 4,276
Proceeds from repayments and maturities of secutiries-held-to-maturity . . . . . 7,400 - -
Proceeds from sale of loans. . . . . . . . . . . . . . . . . . . . . . . . . . . - - 6,599
Loan originations and principal collections, net . . . . . . . . . . . . . . . . 164 18,638 31,870
Purchase of other real estate owned. . . . . . . . . . . . . . . . . . . . . . . - (43) -
Proceeds from sale of other real estate owned. . . . . . . . . . . . . . . . . . - 62 215
Net purchases of premises and equipment. . . . . . . . . . . . . . . . . . . . . (21) (10) (105)
--------- --------- ---------
Net cash (used in) provided by investing activities.. . . . . . . . . . . . (21,850) 20,452 81,899
Cash flows from financing activities:
Net increase (decrease) in demand deposits, money market and savings accounts. . 2,794 (9,938) (58,649)
Net decrease in time certificates of deposit . . . . . . . . . . . . . . . . . . (9,260) (6,451) (28,923)
Net increase (decrease) in securities sold under agreements to repurchase
and federal funds purchased.. . . . . . . . . . . . . . . . . . . . . . . . 5,050 (4,497) (8,075)
Net increase in other borrowed funds. . . . . . . . . . . . . . . . . . . . . . 3,500 - -
Payment for fractional shares of common stock. . . . . . . . . . . . . . . . . . (1) - -
Net proceeds from issuance of 900,000 shares of preferred stock. . . . . . . . . 7,350 - -
--------- --------- ---------
Net cash provided by (used in) financing activities.. . . . . . . . . . . . 9,433 (20,886) (95,647)
--------- --------- ---------
Net decrease in cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . (12,027) (2,159) (16,438)
Cash and cash equivalents, January 1. . . . . . . . . . . . . . . . . . . . . . . . . 28,113 30,272 46,710
--------- --------- ---------
Cash and cash equivalents, December 31. . . . . . . . . . . . . . . . . . . . . . . . $ 16,086 $ 28,113 $ 30,272
--------- --------- ---------
--------- --------- ---------
</TABLE>
See accompanying notes to consolidated financial statements
F-5
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
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 held-to-maturity are carried at amortized cost. 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.
LOANS
Loans are generally carried at principal amounts outstanding less unearned
income. Unearned income includes deferred unamortized fees net of direct
incremental loam origination costs. Interest income is accrued as earned. Net
deferred fees are accreted into interest income using the interest method or
straight line method if not materially different as described below.
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.
F-6
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
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 borrowers' current financial condition, historical
repayment performance and other factors.
The Company considers a loan to be impaired when it is probable that it
will be unable to collect all amounts due according to the contractual terms of
the loan agreement. Once a loan is determined to be impaired, the impairment is
measured based on the present value of the expected future cash flows discounted
at the loan's effective interest rate, except that as a practical expedient, the
impairment is measured by using the loan's observable market price or the fair
value of the collateral if the loan is collateral dependent.
When the measurement of the impaired loan is less than the recorded amount
of the loan, an impairment is recognized by creating a valuation allowance with
a corresponding charge to the provision for credit losses or by adjusting an
existing valuation allowance for the impaired loan with a corresponding charge
or credit to the provision for credit losses.
The Company's policy is to record cash receipts received on impaired loans
first as reductions to principal and then to interest income.
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
Provisions for credit losses charged to operations reflect management's
judgment of the adequacy of the allowance for credit losses and are determined
through periodic analysis of the loan portfolio. This analysis includes a
detailed review of the classification and categorization of problem and
potential problem loans and loans to be charged off; an assessment of the
overall quality and collectibility of the portfolio; and consideration of the
loan loss experience, trends in problem loan concentrations of credit risk, as
well as current and expected future economic conditions (particularly Southern
California).
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 initially 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, 1997, 1996 AND 1995
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.
EARNINGS (LOSS) PER SHARE
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128 "Earnings Per
Share" which specifies the computation, presentation, and disclosure
requirements for earnings per share ("EPS") for entities with publicly held
common stock or potential common stock. SFAS No. 128 eliminates both "primary"
and "fully diluted" EPS, and requires the computation and disclosures of "basic"
EPS and "diluted" EPS. SFAS No. 128 shall be effective for financial statements
for both interim and annual periods ending after December 15, 1997, and earlier
application is not permitted. EPS disclosures presented herein have been
calculated in accordance with SFAS No. 128.
F-8
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
Basic earnings (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 used in computing basic earnings (loss) per
share for the years ended December 31, 1997, 1996 and 1995 was 677,202, 677,260,
and 677,260, respectively. The weighted average number of common shares and
common shares equivalents outstanding used in computing diluted earnings per
share for the year ended December 31, 1997 was 1,629,796. Loss per share
computations, for 1996 and 1995, exclude common share equivalents, since the
effect would be to reduce the loss per share amount. All periods presented were
restated to reflect the 9:09 to 1 reverse stock split effective June 20, 1997
and the 100% common stock dividend declared January 8, 1998 to be paid February
13, 1998. The 100% stock dividend was accounted for as a 2 for 1 stock split.
The following table is a reconciliation of income (loss) and shares used in the
computation of basic and diluted earnings per share:
<TABLE>
<CAPTION>
Net Income Per share
(loss) Shares amount
---------- ---------- ----------
(in thousands)
<S> <C> <C> <C>
FOR THE YEAR ENDED 1997:
Basic EPS. . . . . . . . . . . . . . . . $ 132 677,202 $ 0.20
----------
----------
Effect of dilutive securities:
Options and warrants. . . . . . . . 40,265
Convertible preferred stock . . . . 912,329
---------- ----------
Diluted EPS. . . . . . . . . . . . . . . $ 132 1,629,796 $ 0.08
---------- ---------- ----------
---------- ---------- ----------
FOR THE YEAR ENDED 1996:
Basic and diluted EPS. . . . . . . . . . $ (1,244) 677,260 $ (1.84)
---------- ---------- ----------
---------- ---------- ----------
FOR THE YEAR ENDED 1995:
Basic and diluted EPS. . . . . . . . . . $ (7,200) 677,260 $ (10.63)
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
On January 8, 1998, subsequent to year end 1997, a 100% stock dividend was
declared by the Board of Directors for shareholders of record on February 4,
1998. The stock dividend is payable on February 13, 1998. The stock dividend
will be accounted for as a 2 for 1 stock split and all related share data in the
consolidated financial statements reflect the effect of the stock dividend for
all periods presented.
INTEREST-RATE SWAP AGREEMENTS AND HEDGING CONTRACTS
During 1994, 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.
F-9
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
The Company did not enter into any interest-rate swap or other derivative
agreements during 1997, 1996 and 1995. There were no such agreements outstanding
as of December 31, 1997 and 1996.
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.
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.
STOCK OPTIONS
Prior to January 1, 1996 the Company accounted for its stock option plans
in accordance with the provisions of Accounting Principles Board ("APB") Opinion
No. 25, Accounting for Stock Issued to Employees, and related interpretations.
As such, compensation expense would be recorded on the date of grant only if the
current market price of the underlying stock exceeded the exercise price. On
January 1, 1996 the Company adopted SFAS No. 123, Accounting for Stock-Based
Compensation, which permits entities to recognize as expense over the vesting
period, the fair value of all stock-based awards on the date of grant.
Alternatively, SFAS No. 123 also allows entities to continue to apply the
provisions of APB Opinion No. 25 and provide pro forma net income and pro forma
earnings per share disclosures for employee stock option grants made in 1995 and
future years as if the fair-value-based method defined in SFAS No. 123 had been
applied. The Company has elected to continue to apply the provisions of APB
Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123.
RECLASSIFICATIONS
Certain items in the 1996 and 1995 financial statements have been
reclassified to conform to the 1997 presentation.
NEW ACCOUNTING PRONOUNCEMENTS
The FASB recently issued SFAS No. 129, "Disclosure of Information about
Capital Structure," SFAS No. 130, "REPORTING COMPREHENSIVE INCOME" and SFAS No.
131, "DISCLOSURE ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION." SFAS
No. 129 applies to all entities that issue any securities other than ordinary
common stock and continues the existing requirements to disclose the pertinent
rights and privileges of all securities. SFAS No. 130 provides guidance for
reporting and display of comprehensive income and its components in the
financial statements and SFAS No. 131 establishes standards for the way that
public entities report information about operating segments in annual and
interim financial statements. These statements are effective for fiscal years
beginning after December 15, 1997. The Company will incorporate these
disclosures into its financial statements and notes thereto at the time these
pronouncements are adopted.
F-10
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
NOTE 2--REGULATORY MATTERS
The Bank entered into a Formal Agreement with the Office of the Comptroller
of the Currency ("OCC") on December 14, 1995 (the "Formal Agreement").
Effective November 18, 1997 the OCC terminated the Formal Agreement. Prior to
its termination the Bank was required to maintain certain regulatory capital
levels, appoint a new chief financial officer, make certain determinations as to
the reasonableness of any salary, consulting fee, expense reimbursement or other
type of compensation, review the need for, and the reasonableness of, all
existing consulting, employment and severance contracts, prepare a written
analysis of any new products or services, maintain the Bank's liquidity at a
level sufficient to sustain current and anticipated operations, develop a
three-year capital plan and strategic plan, and improve the Bank's loan
administration.
The Company entered into a Memorandum of Understanding ("MOU") on October
26, 1995 with the Federal Reserve Bank of San Francisco (the "FRB"). Effective
September 4, 1997 the MOU was terminated by the FRB. Prior to its termination,
the MOU prohibited the Company from paying dividends without prior approval of
the FRB, required the submission of a plan to increase the Bank's capital
ratios, required the Company to conduct a review of the senior and executive
management of the Company and the Bank, prohibited the incurrence or renewal of
debt without the FRB's approval, restricted cash expenditures in excess of
$10,000 in any month and prohibited the Company from making acquisitions or
divestitures or engaging in new lines of business without the FRB's approval.
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 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 (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, 1997, the most recent notification from the OCC categorized
the Bank as well capitalized under the regulatory framework for prompt
corrective action. At December 31, 1996, the OCC categorized the Bank as
adequately capitalized. Under this framework, the Bank's current capital levels
allow the acceptance of brokered deposits without prior approval. At December
31, 1997, brokered deposits were 0.3% of total deposits. There are no conditions
or events since the most recent notification which management believes have
changed the Bank's category.
F-11
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
The actual and required capital ratios of the Company and the Bank at
December 31:
<TABLE>
<CAPTION>
TO BE CATEGORIZED
AS WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION
-------------------- -------------------- --------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------- -------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1997
(Dollars in thousands)
Total Capital to Risk Weighted Assets
Company.. . . . . . . . . . . . . . . . . . . $13,329 18.25% $ 5,844 > =8.0% n/a
Bank. . . . . . . . . . . . . . . . . . . . . 8,296 11.63% 5,705 > =8.0% $ 7,132 > =10.0%
Tier 1 Capital to Risk Weighted Assets
Company.. . . . . . . . . . . . . . . . . . . 12,402 16.98% 2,922 > =4.0% n/a
Bank. . . . . . . . . . . . . . . . . . . . . 7,390 10.36% 2,853 > =4.0% 4,279 > =6.0%
Tier 1 Capital to Average Assets
Company.. . . . . . . . . . . . . . . . . . . 12,402 10.43% 4,756 > =4.0% n/a
Bank. . . . . . . . . . . . . . . . . . . . . 7,390 6.48% 4,559 > =4.0% 5,699 > =5.0%
As of December 31, 1996
Total Capital to Risk Weighted Assets
Company . . . . . . . . . . . . . . . . . . . 5,831 8.25% 5,657 > =8.0% n/a
Bank. . . . . . . . . . . . . . . . . . . . . 5,820 8.24% 5,657 > =8.0% 7,071 > =10.0%
Tier 1 Capital to Risk Weighted Assets
Company . . . . . . . . . . . . . . . . . . . 4,921 6.96% 2,828 > =4.0% n/a
Bank. . . . . . . . . . . . . . . . . . . . . 4,911 6.95% 7,071 > =10.0% (1) 4,243 > =6.0%
Tier 1 Capital to Average Assets
Company . . . . . . . . . . . . . . . . . . . 4,921 4.68% 4,210 > =4.0% n/a
Bank. . . . . . . . . . . . . . . . . . . . . 4,911 4.67% 6,841 > =6.5% (1) 5,262 > =5.0%
</TABLE>
(1) Ratio required by the Formal Agreement, terminated September 4, 1997.
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 $667,000 and $657,000 for the years ended December 31, 1997 and 1996,
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
consolidated balance sheets. Securities subject to reverse repurchase agreements
are held in the name of the Company or Bank 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
F-12
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
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 1997 and
1996.
NOTE 5--INVESTMENT SECURITIES
The following is a summary of realized 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,
---------------------------------
1997 1996 1995
--------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Gains and Losses:
Securities available-for-sale:
Gross realized gains. . . . . . $ 3 $ 17 $ 67
Gross realized losses . . . . . (40) (20) (1,300)
--------- --------- ---------
Net realized losses. . . . . . . . . $ (37) $ (3) $ (1,233)
--------- --------- ---------
--------- --------- ---------
Interest Income:
Securities held-to-maturity:
Tax-exempt. . . . . . . . . . . $ - $ - $ -
Taxable . . . . . . . . . . . . 1,194 62 -
--------- --------- ---------
$ 1,194 $ 62 $ -
--------- --------- ---------
--------- --------- ---------
Securities available-for-sale:
Tax-exempt. . . . . . . . . . . $ - $ - $ 12
Taxable . . . . . . . . . . . . 746 928 1,383
--------- --------- ---------
$ 746 $ 928 $ 1,395
--------- --------- ---------
--------- --------- ---------
</TABLE>
At December 31, 1997, a portion of the Company's investment securities
portfolio was pledged as collateral for retail (customer) repurchase agreements,
institutional repurchase agreements, FHLB borrowings, FRB discount lines and
other deposits. Securities pledged for these purposes totaled $17.6 million.
(Also see Note 10--Borrowed Funds.)
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.
F-13
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
The amortized cost, gross unrealized gains, gross unrealized losses, and
estimated fair values of the Company's investment securities held-to-maturity
and available-for-sale at December 31, 1997 and 1996, are presented below:
<TABLE>
<CAPTION>
1997 1996
--------------------------------------------- ---------------------------------------------
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 . . . . . . $ 14,000 $ 10 $ - $ 14,010 $ 14,395 $ - $ 40 $ 14,355
--------- ---------- ---------- --------- --------- ---------- ---------- ---------
Securities available-for-sale:
U.S. Treasury securities . . . . $ 1,002 $ 3 $ - $ 1,005 $ $ - $ - $ -
FNMA-issued mortgage pass-
through certificates. . . . . 4,327 22 - 4,349 - - - -
Other government-sponsored
agency securities . . . . . . 15,488 34 - 15,522 1,000 3 - 1,003
CMO's and REMIC's issued by U.S.
government sponsored agencies 4,977 (21) - 4,956 3,078 - 79 2,999
--------- ---------- ---------- --------- --------- ---------- ---------- ---------
$ 25,794 $ 38 $ - $ 25,832 $ 4,078 $ 3 $ 79 $ 4,002
--------- ---------- ---------- --------- --------- ---------- ---------- ---------
--------- ---------- ---------- --------- --------- ---------- ---------- ---------
</TABLE>
The carrying value and estimated fair values of investment securities at
December 31, 1997 by contractual maturity, are shown below:
<TABLE>
<CAPTION>
CARRYING AMOUNT OF INVESTMENT SECURITIES MATURING:
------------------------------------------------------------------------------------------------
AFTER ONE BUT AFTER FIVE BUT
WITHIN ONE YEAR WITHIN FIVE YEARS WITHIN TEN YEARS AFTER TEN 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. . . . . . $2,000 5.86% $12,000 6.72% $ - - $ - - $14,000 6.60%
------ ------- ------- ------- ------- ------- ------- ------- ------- -------
------ ------- ------- ------- ------- ------- ------- ------- ------- -------
Securities available-for-sale:
U.S. Treasury securities . . . $ - - $ 1,005 5.85% $ - - $ - - $ 1,005 5.85%
FHLMC/FNMA-issued mortgage
pass-through certificates. . - - 923 6.45% 3,426 6.59% - - 4,349 6.56%
Other government sponsored
agency securities. . . . . . - - 12,018 6.59% 3,504 6.96% - - 15,522 6.67%
CMO's and REMIC's issued by
U.S. government sponsored
agencies . . . . . . . . . . - - - - 3,499 6.69% 1,457 6.96% 4,956 6.77%
------ ------- ------- ------- ------- ------- ------- ------- ------- -------
$ - - $13,946 6.53% $10,429 6.75% $ 1,457 6.96% $25,832 6.64%
------ ------- ------- ------- ------- ------- ------- ------- ------- -------
------ ------- ------- ------- ------- ------- ------- ------- ------- -------
</TABLE>
The Company owns stock in the Federal Reserve Bank, Federal Home Loan Bank
and Pacific Coast Bankers Bank. These investments are carried at cost and
totaled $646,000 and $233,000 at December 31, 1997 and 1996, respectively.
F-14
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
NOTE 6--LOANS RECEIVABLE
The following is a summary of the major categories of loans receivable
outstanding at December 31, 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
--------- --------
(Dollars in thousands)
<S> <C> <C>
Real estate construction and land development. . . . . . . . . . . . . $ 3,148 $ 3,441
Commercial loans:
Secured by one to four family residential properties. . . . . . . 6,545 6,233
Secured by multifamily residential properties . . . . . . . . . . 2,494 2,879
Secured by commercial real properties . . . . . . . . . . . . . . 22,324 26,629
Other, secured and unsecured. . . . . . . . . . . . . . . . . . . 21,264 16,508
Home equity lines of credit. . . . . . . . . . . . . . . . . . . . . . 252 581
Consumer installment and unsecured loans to individuals. . . . . . . . 5,508 6,545
--------- --------
61,535 62,816
Deferred net loan origination fees. . . . . . . . . . . . . . . . (283) (269)
--------- --------
$ 61,252 $ 62,547
--------- --------
--------- --------
Weighted average yield for loans at December 31 . . . . . . . . . 9.69% 9.34%
</TABLE>
The following is a summary of activity in the allowance for credit losses
for the years ended December 31, 1997, 1996 and 1995:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C>
Balance, beginning of year. . . . . . . . . . $ 2,969 $ 3,805 $ 3,063
Provision for credit losses . . . . . . . . . - - 2,307
Loans charged off.. . . . . . . . . . . . . . (1,315) (1,300) (2,632)
Recoveries of loans previously charged off. . 369 464 1,067
------ ------- -------
Balance, end of year. . . . . . . . . . . . . $ 2,023 $ 2,969 $ 3,805
------ ------- -------
------ ------- -------
</TABLE>
At December 31, 1997 and 1996, the Bank had classified $0.2 million and
$1.6 million, respectively, of its loans as impaired with specific reserves of
$15,000 and $710,000, respectively. In addition, $6.4 million and $5.6 million
of the Bank's loans are classified as impaired with no related specific loss
reserve at December 31, 1997 and 1996, respectively. The average recorded
investment and interest income recognized on impaired loans during the years
ended December 31, 1997, 1996, and 1995 was $6.4 million, $7.8 million, and $9.9
million, and $0.5, $0.7 million and $0.8 million, respectively.
F-15
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
The following is a summary of nonperforming loans at December 31, 1997, 1996,
respectively.
<TABLE>
<CAPTION>
1997 1996
-------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Nonaccrual loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,201 $ 928
Troubled debt restructurings. . . . . . . . . . . . . . . . . . . . . . . . 5,422 5,016
Loans contractually past due ninety or more days with respect
to either principal or interest and still accruing interest. . . . . . - 300
------- -------
$ 6,623 $ 6,244
------- -------
------- -------
</TABLE>
Interest foregone on nonperforming loans outstanding during the years ended
December 31, 1997, 1996 and 1995 was $177,000, $171,000 and $160,000,
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, 1997, loans aggregating
$34.5 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, 1997, the Company's loans
to businesses and individuals engaged in entertainment industry-related
activities amounted to $6.3 million, none of which are collateralized by real
property.
In the normal course of business, the Bank may make loans to officers and
directors as well as loans to companies and individuals affiliated with or
guaranteed by officers and directors of the Company and the Bank. Such loans
are made in the ordinary course of business at rates and terms no more favorable
than those offered to other customers with a similar credit standing. The
aggregate dollar amounts of these loans were $1,133,000 and $191,000 at December
31, 1997 and 1996, respectively. During 1997 there were $1.0 million of
advances and $58,000 of repayments. Interest income recognized on these loans
amounted to $16,000, $22,000 and $27,000 during 1997, 1996 and 1995,
respectively. At December 31, 1997, none of these loans were on nonaccrual
status. Based on analysis of information presently known to management about the
loans to officers and directors and their affiliates, management believes all
have the ability to comply with the present loan repayment terms.
NOTE 7--PREMISES AND EQUIPMENT AND LEASE COMMITMENTS
The following is a summary of the major components of premises and
equipment at December 31, 1997 and 1996.
<TABLE>
<CAPTION>
1997 1996
------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Leasehold improvements . . . . . . . . . . . . . . . . $ 1,680 $ 1,680
Furniture, fixtures and equipment. . . . . . . . . . . 3,229 3,208
------- -------
4,909 4,888
Less accumulated amortization and depreciation . . . . (4,124) (3,945)
------- -------
$ 785 $ 943
------- -------
------- -------
</TABLE>
F-16
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
Rent amortization and depreciation expense, and rental income for the years
ended December 31, 1997, 1996 and 1995 are summarized below.
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Rent expense . . . . . . . . . . . . . . . . $ 650 $ 668 $ 1,939
Sublease income. . . . . . . . . . . . . . . - (16) (246)
Accretion of sublease loans. . . . . . . . . - - (457)
------- ------- -------
Net rent expense. . . . . . . . . . . . 650 652 1,236
Amortization of leasehold improvements . . . 93 77 135
Other occupancy expense. . . . . . . . . . . 63 64 97
------- ------- -------
Total occupancy expense . . . . . . . . $ 806 $ 793 $ 1,468
------- ------- -------
------- ------- -------
Depreciation expense . . . . . . . . . . . . $ 85 $ 117 $ 220
Other furniture and equipment expense. . . . 115 181 165
------- ------- -------
Total furniture and equipment expense . $ 200 $ 298 $ 385
------- ------- -------
------- ------- -------
</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
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 the landlord a seven-year warrant
to purchase up to 9.9% of the shares of common stock of the Company at a current
exercise price of $5.00 per share and 9.9% of the shares of preferred stock of
the Company at a current exercise price of $10.00 per share. The Company also
granted the landlord registration rights with respect to shares purchased by the
landlord (or its assignee) pursuant to the Warrant Agreement. 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, 1997
are summarized below.
<TABLE>
<CAPTION>
(DOLLARS IN
THOUSANDS)
----------
<S> <C>
Year Ended December 31,
1998 . . . . . . . . . . . . . . . . . . . . $ 668
1999 . . . . . . . . . . . . . . . . . . . . 668
2000 . . . . . . . . . . . . . . . . . . . . 692
2001 . . . . . . . . . . . . . . . . . . . . 692
2002 and thereafter. . . . . . . . . . . . . 2,418
----------
$ 5,138
----------
----------
</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
F-17
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
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 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 $9.4 million and $7.9 million at December 31, 1997 and 1996,
respectively. Contingent obligations under standby letters of credit totaled
$600,000 and $175,000 at December 31, 1997 and 1996, respectively. At December
31, 1997, $100,000 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 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.
F-18
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
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.
The Company did not enter into any interest-rate swap or other derivative
agreements during 1997 and 1996. There were no such agreements outstanding as of
December 31, 1997 and 1996.
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.
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.
NOTE 10--BORROWED FUNDS
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.
F-19
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
As part of its money management services offered to customers, the Company
offers retail repurchase agreements secured by U.S. government and federal
agency securities for the short-term investment of funds. 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.
The maximum amount of securities sold with agreements to repurchase at any
month end was $5.0 million, $1.5 million and $7.0 million during 1997, 1996 and
1995, respectively.
Other borrowings is comprised of Federal Home Loan Bank advances, secured
by U.S. government and agency securities, and mature on June 29, 1998 with a
fixed rate of 5.79%. The maximum amount of other borrowings outstanding at any
month end was $3.5 million during 1997. The Bank did not utilize other
borrowings during 1996 and 1995.
The following summarizes borrowed funds and weighted average rates.
<TABLE>
<CAPTION>
1997 1996 1995
------------------------------- ------------------------------- -----------------------------
BALANCES AT AVERAGE AVERAGE BALANCES AT AVERAGE AVERAGE BALANCES AT AVERAGE AVERAGE
YEAR-END BALANCE RATE YEAR-END BALANCE RATE YEAR-END BALANCE RATE
----------- ------- ------- ----------- ------- ------- ----------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Securities sold under
repurchase agreements. . . $ 5,050 $ 1,637 5.68% $ - $ - - $ 4,497 $ 4,154 2.65%
Other borrowings. . . . . . . 3,500 143 4.89% - - - - - -
</TABLE>
NOTE 11--INCOME TAXES
No income tax provision was recorded during 1997 due to the utilization of
previously unrecognized tax benefits to offset the current period tax liability.
During the year ended December 31, 1996 the Company recognized a tax benefit for
federal income tax purposes of approximately $579,000 (including $43,000 in
interest) related to a refund of prior year taxes from the carryback of a
portion of the NOL's for which tax benefit had not previously been recognized.
No income tax benefit was recorded for 1995, due to the uncertainty with respect
to the ultimate realization of such benefit.
A reconciliation of the amounts computed by applying the federal statutory
rate of 35% for 1997, 1996 and 1995 to the loss or income before tax benefits
and the effective tax rate follows:
F-20
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
----------------- ----------------- ------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Tax provision (benefit) at statuory rate . . . . . . . . . . . . $ 46 35.0% $ (638) (35.0%) $(2,545) (35.0%)
Increase (reduction) in taxes resulting from:
Tax-exempt income on state municipal securities and loans . - - (67) (1.0%)
Valuation allowance on deferred tax asset . . . . . . . . . (47) (35.6%) - 2,302 31.7%
Other, net. . . . . . . . . . . . . . . . . . . . . . . . . 1 0.6% 59 3.0% 310 4.3%
------- ------- ------- ------- ------- -------
$ - - $ (579) (32.0%) $ - -
------- ------- ------- ------- ------- -------
------- ------- ------- ------- ------- -------
</TABLE>
The major components of the net deferred tax asset at December 31, 1997 and 1996
are as follows:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Deferred tax assets:
Net operating losses. . . . . . . . . . . . . . $ 9,013 $ 9,143
OREO reserves . . . . . . . . . . . . . . . . . 448 434
Accrued expenses. . . . . . . . . . . . . . . . 222 234
Alternative minimum tax credits . . . . . . . . 218 218
Bad debt expense. . . . . . . . . . . . . . . . 230 455
Nonaccrual interest . . . . . . . . . . . . . . 36 108
Other . . . . . . . . . . . . . . . . . . . . . 19 18
-------- --------
Total deferred tax liabilities. . . . . . . . . 10,186 10,610
-------- --------
Deferred tax liabilities:
State taxes . . . . . . . . . . . . . . . . . . (1) (1)
Depreciation. . . . . . . . . . . . . . . . . . 58 88
Loan Fees . . . . . . . . . . . . . . . . . . . (61) (36)
-------- --------
Total deferred tax liabilities. . . . . . . . . (4) 51
-------- --------
Net deferred tax asset . . . . . . . . . . . . . . . 10,190 10,559
Valuation allowance. . . . . . . . . . . . . . . . . (10,190) (10,559)
-------- --------
Deferred tax asset, net of valuation allowance . . . $ - $ -
-------- --------
-------- --------
</TABLE>
Management believes that the temporary differences resulting in the ending
deferred tax asset (exclusive of net operating losses) 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. A valuation allowance has been placed against 100%
of the net deferred tax asset due to the uncertainty as to its ultimate
realization.
For tax purposes at December 31, 1997, the Company had federal net
operating loss carryforwards of $22.3 million, which begin to expire in the year
2007. The Company has California net operating loss carryforwards of $11.1
million, of which $686,000 expire in 1998, $5.5 million expire in 1999 and the
remaining expire thereafter. In addition, the Company has an Alternate Minimum
Tax credit at December 31, 1997 of $218,000 which may be carried forward
indefinitely.
NOTE 12--BENEFIT PLANS
F-21
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
STOCK OPTION PLANS. The Company has four stock option plans established in
1983, 1990, 1994, and 1996 (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 only for
such period as the Stock Option Committee may determine. As of December 31,
1997, 200,000 appreciation rights had been granted under the 1990 plan.
At December 31, 1997, 47,764 option shares were vested and exercisable
under the Plans. The remaining shares under option become exercisable as
follows: 1998--42,513; 1999--42,482; and 2000--33,669. Following is a summary of
changes in stock options under the Plans.
<TABLE>
<CAPTION>
OPTION PRICE
RANGE PER
SHARE
-----------------------------
<S> <C> <C> <C> <C>
Outstanding, January 1, 1995 . . . 60,335 $ 13.04 - $ 22.73
Granted . . . . . . . . . . . 17,602 14.23 - 16.50
Cancelled . . . . . . . . . . (11,726) 13.04 - 22.73
Exercised . . . . . . . . . . -
--------
Outstanding, December 31, 1995 . . 66,211 13.64 - 22.73
Granted . . . . . . . . . . . 59,350 4.82 - 8.52
Cancelled . . . . . . . . . . (64,137) 6.27 - 22.73
Exercised . . . . . . . . . . - -
--------
Outstanding, December 31, 1996 . . 61,424 4.82 - 8.52
Granted . . . . . . . . . . . 111,258 5.00 - 7.96
Cancelled . . . . . . . . . . (6,254) 5.75 - 8.52
Exercised . . . . . . . . . . - -
--------
Outstanding, December 31, 1997 . . 166,428 $ 4.82 - $ 8.52
--------
--------
</TABLE>
On June 19, 1997 the Board of Directors granted an option to purchase
1,100 shares of the Company's common stock to an outside director of the
Company at a price of $7.23 per share. As of December 31, 1997 none of the
1,100 shares were vested nor exercisable.
The estimated fair value of options granted during 1997 and 1996 was
$7.63 and $2.86 per share, respectively. The Company applies Accounting
Principles Board Opinion No. 25 and related Interpretations in accounting for
its stock option and purchase plans. Accordingly, no compensation cost has
been recognized for its stock option plans. SFAS No. 123, "Accounting for
Stock-Based Compensation," encourages, but does not require, companies to
record compensation cost for stock-based employee compensation plans at fair
value. 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 income for
the year ended December 31, 1997 would have been decreased by $57,000. The
Company's net loss for the year ended December 31, 1996 would have been
increased by $23,000. Basic and diluted earnings per share would have
decreased by $.05 for 1997. Basic and diluted loss per share would not have
changed for 1996.
F-22
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
The fair values of options granted under the Company's fixed stock option
plan during 1997 and 1996 were estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions used: 1997-no dividend yield, expected volatility of 73%, risk-free
interest rate of 5.74%, and an expected life of 10 years; 1996-no dividend
yield, expected volatility of 81%, risk-free interest rate of 6.3% and an
expected life 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 in 1995.
NOTE 13--PARENT COMPANY INFORMATION
The following financial information presents the statements of condition of
the Company on a parent-only basis as of December 31, 1997 and 1996, and the
related statements of operations and cash flows for each of the years in the
three-year period ended December 31, 1997.
STATEMENTS OF CONDITION
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1997 1996
---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Cash with Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 29 $ 11
Federal Funds. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,900 -
Securities held-to-maturity. . . . . . . . . . . . . . . . . . . . . . 2,000 -
Loan receivable. . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,036 -
Investment in the Bank . . . . . . . . . . . . . . . . . . . . . . . . 7,428 4,834
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 -
----------- -----------
Total Assets. . . . . . . . . . . . . . . . . . . . . . . . . . . $ 12,440 $ 4,845
----------- -----------
----------- -----------
Liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ - $ -
Shareholders' equity:
Common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24,613 24,614
Preferred stock. . . . . . . . . . . . . . . . . . . . . . . . . . . 7,350 -
Accumulated deficit. . . . . . . . . . . . . . . . . . . . . . . . . (19,561) (19,693)
Net unrealized (loss) gain on securities available-for-sale. . . . . 38 (76)
----------- -----------
Total shareholders' equity . . . . . . . . . . . . . . . . . . . . . 12,440 4,845
----------- -----------
Total liabilities and shareholder's equity . . . . . . . . . . . . . $ 12,440 $ 4,845
----------- -----------
----------- -----------
</TABLE>
F-23
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 1997, 1996 AND 1995
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Years ended December 31,
---------------------------------
1997 1996 1995
-------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C>
Interest income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 151 $ 2 $ 2
Other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 - 730
-------- -------- -------
Total operating income . . . . . . . . . . . . . . . . . . . . . . . . . . 152 2 732
Other operating expense. . . . . . . . . . . . . . . . . . . . . . . . . . - 145 85
-------- -------- -------
Income (loss) before equity in undistributed net loss of the Bank . . . 152 (143) 647
Equity in undistributed net loss of the Bank . . . . . . . . . . . . . . . (20) (1,680) (7,847)
-------- -------- -------
Net income (loss) before income tax benefit . . . . . . . . . . . . . . . 132 (1,823) (7,200)
Income tax benefit . . . . . . . . . . . . . . . . . . . . . . . . . . . . - (579) -
-------- -------- -------
Net income (loss). . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 132 $ (1,244) $ (7,200)
-------- -------- -------
-------- -------- -------
</TABLE>
STATEMENTS OF CASH FLOW
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
-------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 132 $ (1,244) $ (7,200)
Adjustment to reconcile net loss to net cash provided by (used in)
operating activities.:
Equity in undistributed net loss (income) of the Bank, net. . . . . . 20 1,680 7,847
Other, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (47) - -
-------- -------- --------
105 436 647
Cash flows from investing activities:
Investment in Bank. . . . . . . . . . . . . . . . . . . . . . . . . . . (2,500) (434) (700)
Purchase of securities held-to maturity . . . . . . . . . . . . . . . . (2,000) - -
Purchase of loans participated. . . . . . . . . . . . . . . . . . . . . (1,036) - -
-------- -------- --------
Net cash used in investing activities . . . . . . . . . . . . . . . . (5,536) (434) (700)
Cash flows from financing activities:
Net proceeds from issuance of Preferred Stock . . . . . . . . . . . . . 7,350 - -
Other, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1) - -
-------- -------- --------
Net cash provided by financing activities . . . . . . . . . . . . . . 7,349 - -
-------- -------- --------
Net increase (decrease) in cash and cash equivalents . . . . . . . . . . . 1,918 2 (53)
Cash and cash equivalents, beginning of the year . . . . . . . . . . . . . 11 9 62
-------- -------- --------
Cash and cash equivalents, end of the year . . . . . . . . . . . . . . . . $ 1,929 $ 11 $ 9
-------- -------- --------
-------- -------- --------
</TABLE>
F-24
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
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, investments and loans (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 in prior years, the Bank could not have declared
dividends to the Company at December 31, 1997 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>
1997 1996 1995
------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C>
Interest paid. . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,825 $ 3,147 $ 4,294
Income tax refund. . . . . . . . . . . . . . . . . . . . . . . . - 579 77
Non-Cash Investing and Financing Transactions:
Unrealized gain on securities available-for-sale. . . . . . . 114 78 2,903
Transfers to OREO from loans receivable, net . . . . . . . . . . 221 - -
</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 for the year ended December 31, 1995.
F-25
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
NOTE 17--DISCLOSURES ABOUT THE FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of financial instruments at December 31, 1997 and
1996, are presented below.
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1996
--------------------- --------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
--------- --------- --------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Financial Assets:
Cash, cash equivalents and certificates of deposit. . . . $ 16,336 $ 16,336 $ 28,113 $ 28,113
Securities available-for-sale . . . . . . . . . . . . . . 25,832 25,832 4,002 4,002
Securities held-to-maturity . . . . . . . . . . . . . . . 14,000 14,010 14,395 14,355
Loans, net of allowance for credit losses . . . . . . . . 59,229 59,478 59,578 59,450
Financial Liabilities:
Demand deposits, money market and savings . . . . . . . . 66,000 66,000 63,206 63,206
Time certificates of deposit. . . . . . . . . . . . . . . 31,388 31,938 40,648 41,015
Securities sold under agreement to repurchase . . . . . . 5,050 5,050 - -
Other borrowed funds. . . . . . . . . . . . . . . . . . . 3,500 3,500 - -
Off-Balance-Sheet Financial Instruments:
Commercial and standby letters of credit. . . . . . . . . - 600 - 175
</TABLE>
The estimated fair value amounts have been determined using pertinent
information available to management as of December 31, 1997 and 1996.
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.
INVESTMENT SECURITIES: For securities held for trading purposes,
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 $1.2 million at December 31, 1997, and $900,000 at December 31,
1996, because it is not practicable to reasonably assess the credit adjustment
that would be applied in the marketplace for such loans.
F-26
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
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.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE: The carrying value for this
short-term debt is a reasonable approximation of its fair value.
OTHER BORROWED FUNDS: 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.
F-27
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
NOTE 18--QUARTERLY FINANCIAL DATA (UNAUDITED)
Quarterly financial information for the years ended December 31, 1997 and
1996 is presented below.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------------------------
MARCH 31, JUNE 30, SEPT. 30 DEC. 31
1997 1997 1997 1997
-------- -------- -------- --------
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Interest income . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,015 $ 1,996 $ 2,228 $ 2,361
Interest expense. . . . . . . . . . . . . . . . . . . . . . . . . 711 654 704 787
-------- -------- -------- --------
Net interest income. . . . . . . . . . . . . . . . . . . . . . 1,304 1,342 1,524 1,574
Net loss on sale of securities available-for-sale . . . . . . . . - - (12) (25)
Other operating income. . . . . . . . . . . . . . . . . . . . . . 118 110 119 176
-------- -------- -------- --------
Other operating expense . . . . . . . . . . . . . . . . . . . . . (1,557) (1,529) (1,537) (1,475)
Net income (loss) before income tax benefit . . . . . . . . . . . (135) (77) 94 250
Income tax benefit. . . . . . . . . . . . . . . . . . . . . . . . - - - -
-------- -------- -------- --------
Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . $ (135) $ (77) $ 94 $ 250
-------- -------- -------- --------
-------- -------- -------- --------
Basic earnings (loss) per share . . . . . . . . . . . . . . . . . $ (0.20) $ (0.11) $ 0.14 $ 0.37
Diluted earnings (loss) per share . . . . . . . . . . . . . . . . $ (0.20) $ (0.11) $ 0.04 $ 0.10
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------------------------
MARCH 31, JUNE 30, SEPT. 30 DEC. 31
1997 1997 1997 1997
-------- -------- -------- --------
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
<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 income (loss) before income tax benefit . . . . . . . . . . . (136) (1,276) (182) (229)
Income tax benefit. . . . . . . . . . . . . . . . . . . . . . . . - (579) - -
-------- -------- -------- --------
Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . $(136) $(697) $(182) $(229)
-------- -------- -------- --------
-------- -------- -------- --------
Basic earnings (loss) per share . . . . . . . . . . . . . . . . . $(0.18) $(1.06) $(0.28) $(0.32)
Diluted earnings (loss) per share . . . . . . . . . . . . . . . . $(0.18) $(1.06) $(0.28) $(0.32)
</TABLE>
F-28
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NO.
- -------
<S> <C>
3.1 Amended and Restated Articles of Incorporation, dated June 20, 1997 *
3.2 Bylaws of the Company, as amended, restated as of December 18, 1992
(1)
10.1 Employment Agreement and Addendum dated June 21, 1996 between
Mercantile National Bank and Scott A. Montgomery (2)
10.2 Amendment No. 2 to Employment Agreement dated December 20, 1996
between Mercantile National Bank and Scott A. Montgomery *
10.3 Letter Agreement dated June 5, 1996 between Mercantile National Bank
and Carol A. Ward (2)
10.4 Letter Agreement dated July 17, 1996 between Mercantile National Bank
and Joseph W. Kiley III (3)
10.5 Form of Indemnity Agreement between the Company and its directors (4)
10.6 First Floor Lease at 1840 Century Park East, Los Angeles, California,
dated as of December 21, 1982 between Northrop Corporation and
Mercantile National Bank (1)
10.7 Second Floor Lease at 1840 Century Park East, Los Angeles, California,
dated as of December 21, 1982 between Northrop Corporation and
Mercantile National Bank for space at 1840 Century Park East, Los
Angeles, California, as amended by Amendment to Second Floor Lease
dated as of June 7, 1986, and as amended by Second Amendment to Second
Floor Lease dated as of December 18, 1992 between California State
Teachers' Retirement System and Mercantile National Bank (1)
10.8 Lease Restructure Agreement dated December 31, 1995 by and between
California State Teachers' Retirement System and Mercantile National
Bank (5)
10.9 Warrant Agreement dated December 31, 1995 by and between the Company
and California State Teachers' Retirement System (5)
10.10 Registration Rights Agreement dated December 31, 1995 by and between
the Company and California State Teachers' Retirement System (5)
10.11 Warrant Agreement dated April 30, 1996 between the Company and U.S.
Stock Transfer Corporation (2)
10.12 National Mercantile Bancorp 1983 Stock Option Plan, as amended March
22, 1991 (6)
10.13 Form of Stock Option Agreement under the 1983 Stock Option Plan (1)
10.14 National Mercantile Bancorp 1990 Stock Option Plan (7)
10.15 Form of Stock Option Agreement under the 1990 Stock Option Plan (1)
10.16 National Mercantile Bancorp 1994 Stock Option Plan (8)
10.17 Form of Stock Option Agreement under the 1994 Stock Option Plan (9)
10.18 National Mercantile Bancorp 1996 Stock Incentive Plan (10)
E-1
<PAGE>
10.19 Form of Stock Option Agreement under the 1996 Stock Incentive Plan
(10)
10.20 Registration Rights Agreement between the Company and Conrad Company
(11)
10.21 Registration Rights Agreement between the Company and Wildwood
Enterprises Inc. Profit Sharing Plan and Trust (11)
10.22 Bank Service Agreement dated April 21, 1997 between RH Investment
Corporation and Mercantile National Bank *
10.23 Investment Management Agreement dated December 1, 1997 between
Mercantile National Bank and Windsor Financial Group, Inc *
11. Statement regarding computation of per share earnings (see "Note
1--Summary of Significant Accounting Policies--Earnings (Loss) Per
Share"--of the "Notes to the Consolidated Financial Statements" in
Item 8. Financial Statements in this Annual Report on Form 10-K)
21. Subsidiaries of the Registrant (12)
23. Consent of Deloitte & Touche LLP, Independent Auditors *
27. Financial Data Schedule *
</TABLE>
____________
* Included in this Report
<TABLE>
<S> <C>
(1) 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.
(2) Filed as an exhibit to the Company's Report on Form 10-Q for the quarter
ended June 30, 1996 and incorporated herein by reference.
(3) 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.
(4) Filed as an exhibit to Company's Annual Report on Form 10-K for the year
ended December 31, 1990 and incorporated herein by reference.
(5) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
year ended December 31, 1995 and incorporated herein by reference.
(6) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
year ended December 31, 1991 and incorporated herein by reference.
(7) Filed as an exhibit to the Company's Proxy Statement dated May 24, 1990 and
incorporated herein by reference.
(8) Filed as an exhibit to the Company's Proxy Statement dated April 18, 1994
and incorporated herein by reference.
(9) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
year ended December 31, 1994 and incorporated herein by reference.
(10) Filed as an exhibit to the Company's Registration Statement on Form S-8
dated August 7, 1997 and incorporated herein by reference.
(11) Filed as an exhibit to the Company's Registration Statement on Form S-2
dated February 10, 1997 and amendments thereto and incorporated herein by
reference.
(12) Filed as an exhibit to the Company's annual report on Form 10-K for the
year ended December 31, 1996 and incorporated herein by reference.
</TABLE>
E-2
<PAGE>
AMENDED AND RESTATED
ARTICLES OF INCORPORATION
OF
NATIONAL MERCANTILE BANCORP
A CALIFORNIA CORPORATION
The undersigned certify that:
1. They are the president and chief executive officer and chief financial
officer, respectively, of National Mercantile Bancorp, a California
Corporation.
2. The Articles of Incorporation of this corporation are amended and restated
to read as set forth in EXHIBIT A attached hereto.
3. The attached amendment and restatement of the Articles of Incorporation has
been duly approved by the board of directors.
4. The attached amendment and restatement of the Articles of Incorporation has
been duly approved by the required vote of shareholders in accordance with
Section 902, California Corporation Code. The total number of outstanding
shares of the class of common stock entitled to vote with respect to the
amendment was 3,078,146. There are no other amendment equaled or exceeded
the vote required. The percentage vote required was more than 50%.
Articles IV, V, VI, VII, VII and IX have not been amended or repealed,
which amendment or repeal would have required the affirmative vote of the
holders of not less than two-thirds (2/3) of the total voting power of all
outstanding shares of the voting stock of National Mercantile Bancorp.
We further declare under penalty of perjury under the laws of the State of
California that the matters set forth in this certificate are true and correct
of our own knowledge.
DATE: June 24, 1997 By /s/ SCOTT A. MONTGOMERY
----------------------------- -------------------------------------
Scott A. Montgomery
President and Chief Executive Officer
By /s/ JOSEPH W. KILEY, III
-------------------------------------
Joseph W. Kiley, III
Executive Vice President & CFO
<PAGE>
EXHIBIT A
AMENDED AND RESTATED
ARTICLES OF INCORPORATION
OF
NATIONAL MERCANTILE BANCORP
A CALIFORNIA CORPORATION
I
The name of the Corporation shall be:
NATIONAL MERCANTILE BANCORP
II
The purpose of the Corporation is to engage in any lawful act or
activity for which a corporation may be organized under the General Corporation
Law of California other than the banking business, the trust company business or
the practice of a profession permitted to be incorporated by the California
Corporations Code.
III
The liability of the directors of the corporation for monetary damages
shall be eliminated to the fullest extent permissible under California law.
IV
The Corporation is authorized to issue two (2) classes of shares to
be designated respectively common and preferred. The number of common shares
authorized is Ten Million (10,000,000). The number of preferred shares
authorized is One Million (1,000,000). The preferred shares may be issued in
one or more series. The Board of Directors is authorized to fix the number of
any such series of preferred shares and to determine the designation of any
such series. The Board of Directors is further authorized to determine or
alter the rights, preferences, privileges, and restrictions granted to or
imposed upon any wholly unissued series of preferred shares and, within the
limits and restrictions stated in any resolution or resolutions of the Board
of Directors originally fixing the number of shares constituting any series,
to increase or decrease (but not below the number of shares of such series
then outstanding) the number of shares of any such series subsequent to the
issuance of shares of that series.
2
<PAGE>
V
Elections shall be by written ballot.
VI
The affirmative vote of the holders of not less than two-thirds (2/3)
of the total voting power of all outstanding shares of voting stock of this
Corporation shall be required for the approval of any proposal (1) that this
Corporation merge or consolidate with any other corporation if such other
corporation and its affiliates singly or in the aggregate are directly or
indirectly the beneficial owners of more than twenty percent (20%) of the total
voting power of all outstanding shares of the voting stock of this Corporation
(such other corporation being herein referred to as a "Related Corporation"), or
(2) that this Corporation sell or exchange all or substantially all of its
assets or business to or with such Related Corporation, or (3) that this
Corporation issue or deliver any stock or other securities of its issue in
exchange or payment for any properties or assets of such Related Corporation or
securities issued by such Related Corporation or in a merger of any affiliate of
this Corporation with or into such Related Corporation or any of its affiliates,
if to effect such transaction the approval of shareholders of this Corporation
is required by law; provided, however, that the foregoing shall not apply to any
such merger, consolidation, sale or exchange, or issuance or delivery of stock
or other securities which was (i) approved by resolution of the Board of
Directors adopted by the affirmative vote of not less than two-thirds (2/3) of
the then authorized number of directors, or (ii) approved by resolution of the
Board of Directors prior to the acquisition of the beneficial ownership of more
than twenty percent (20%) of the total voting power of all outstanding shares of
the voting stock of this Corporation by such Related Corporation and its
affiliates, nor shall it apply to any such transaction solely between this
Corporation and another corporation fifty percent (50%) or more of the voting
stock of which is owned by this Corporation. For the purposes hereof, an
"affiliate" is any person (including a corporation, partnership, trust, estate
or individual) who directly, or indirectly through one or more intermediaries,
controls or is controlled by, or is under common control with the person
specified; "control" means the possession, directly or indirectly, of the power
to direct or cause the direction of the management and policies of a person,
whether through the ownership of voting securities, by contract, or otherwise;
and in computing the percentage of outstanding voting stock beneficially owned
by any person the shares outstanding and the shares owned shall be determined as
of the record date fixed to determine the shareholders entitled to vote with
respect to such proposal. The shareholder vote, if any, required for mergers,
consolidations, sales or exchanges of assets or issuances of stock or other
securities not expressly provided for in this Article, shall be such as may be
required by applicable law.
VII
No action shall be taken by the shareholders except at an annual or
special meeting of shareholders.
3
<PAGE>
VIII
If at any time the Corporation has a variable board, the shareholders
of the Corporation may not change the exact number of directors within the
limits specified in the bylaws, except by the vote of the holders of not less
than two-thirds (2/3) of the total voting power of all outstanding shares of
voting stock of the Corporation.
After the issuance of shares, any action by the shareholders to
specify or change the fixed number of directors (if the Corporation does not
have a variable board) or the maximum or minimum number of directors (if the
Corporation has a variable board) or to change from a fixed to a variable board
or vice versa shall not be made, repealed, altered, amended or rescinded except
by the vote of the holders of not less than two-thirds (2/3) of the total voting
power of all outstanding shares of voting stock of the Corporation; provided,
however, that a bylaw reducing the fixed number or the minimum number of
directors to a number less than five (5) cannot be adopted if the votes cast
against its adoption at a meeting are equal to more than sixteen and two-thirds
percent (16-2/3%) of the outstanding shares entitled to vote.
IX
The Corporation reserves the right to amend, alter, change or repeal
any provision contained in these Articles of Incorporation, in the manner now or
hereafter prescribed by statute, and all rights conferred on shareholders herein
are granted subject to this reservation. Notwithstanding the foregoing, the
provisions set forth in Articles IV, V, VI, VII, VIII and this Article IX may
not be repealed or amended in any respect unless such repeal or amendment is
approved by the affirmative vote of the holders of not less than two-thirds
(2/3) of the total voting power of all outstanding shares of voting stock of
this Corporation.
X
Upon filing with the Secretary of State of the State of California of
these Amended and Restated Articles of Incorporation, every 9.09 outstanding
shares of common shares prior to the filing of these Articles shall be combined
and converted into one (1) share of newly issued common shares (the "Reverse
Stock Split"). The number of authorized shares of common shares ("Common
Stock") shall remain as 10,000,000.
4
<PAGE>
XI
Pursuant to the authority conferred upon the Board of Directors by
Article IV of these Amended and Restated Articles of Incorporation (and with the
approval of more than a majority of the outstanding shares of Common Stock), the
preferred shares (the "Preferred Stock") shall consist of 990,000 shares of
Series A Noncumulative Convertible Perpetual Preferred Stock (the "Series A
Preferred Stock") and 10,000 shares undesignated as to series. The shares of
Common Stock and Preferred Stock are referred to herein collectively as the
"capital stock".
(A) VOTING PRIVILEGES OF SERIES A PREFERRED STOCK.
(1) GENERAL. Each holder of Series A Preferred Stock shall have that
number of votes on all matters submitted to the shareholders that is equal to
the number of shares of Common Stock into which such holder's shares of Series A
Preferred Stock are then convertible, as hereinafter provided.
(2) ADDITIONAL CLASS VOTES BY SERIES A PREFERRED STOCK. In addition to
any class votes required by the California General Corporation Law, without the
affirmative vote or written consent of the holders (acting together as a class)
of a majority of the shares of Series A Preferred Stock at the time outstanding,
the Corporation shall not:
(a) authorize any additional shares of Series A Preferred Stock, or
authorize or issue any shares of capital stock having priority over Series
A Preferred Stock or ranking on a parity therewith as to the payment or
distribution of (i) assets upon the liquidation or dissolution, voluntary
or involuntary, of the Corporation, or (ii) dividends; or
(b) amend, alter or repeal any of the provisions of the Amended and
Restated Articles of Incorporation of the Corporation or adopt any
Certificate of Determination of Rights and Preferences with respect to any
class or series of capital stock so as to adversely affect the rights,
preferences and privileges relating to Series A Preferred Stock or the
holders thereof or waive any of the rights granted to the holders of the
Series A Preferred Stock by the Amended and Restated Articles of
Incorporation of the Corporation; or
(c) amend, alter or repeal any of the provisions of the Amended and
Restated Articles of Incorporation, or the bylaws, of the Corporation
with respect to the election of directors by cumulative voting; or
(d) issue any authorized shares of Series A Preferred Stock except in
connection with (i) an offering of rights to holders of Common Stock
to purchase shares of the Series A Preferred Stock (the "Rights
Offering") consummated on or before June 30, 1997, (ii) an offering of
shares of the Series A Preferred Stock to certain institutional
investors for purchase (the "Standby Purchaser Offering") consummated
on or before June 30, 1997, (iii) a sale of shares of Series A Preferred
Stock to certain private purchasers (the "Private Purchaser Offering")
consummated on or before June 30,
5
<PAGE>
1997, and (iv) the exercise of a warrant to purchase shares of the
Series A Preferred Stock pursuant to a certain Warrant Agreement dated
December 31, 1995, between the Corporation and California State Teachers'
Retirement System. The Rights Offering, the Private Purchasers Offering
and the Standby Purchasers Offering are referred to collectively as the
"Offerings."
(B) DIVIDENDS.
(1) Unless otherwise prohibited by law, the Series A Preferred Stock shall
be entitled to receive non-cumulative cash dividends at the annual rate of 6.5%
of the Liquidation Amount (as defined in Paragraph C below) per share, payable
quarterly on the first day of January, April, July and October in each year,
commencing October 1, 1999, with respect to the three months then ending, before
any distribution by way of dividend or otherwise shall be declared or paid upon,
or set apart for, the shares of Common Stock or any other class of shares of the
Corporation ranking junior to the Series A Preferred Stock with respect to the
payment of dividends or upon liquidation, dissolution or winding up of the
Corporation (the "Junior Stock"). Each such dividend will be payable to holders
of record as they appear on the books of the Corporation on or about the
fifteenth day of the month preceding the payment dates thereof, as shall be
fixed by the Board of Directors of the Corporation. The amount of dividends
payable for each quarterly dividend period shall be computed by dividing by four
the dividend due on the basis of the 6.5% annual rate. Dividends payable on the
Series A Preferred Stock for any period shorter than a full three months shall
be computed on the basis of 30-day months and a 360-day year.
(2) No dividend (other than dividends or distributions paid in shares of,
or options, warrants or rights to subscribe for or purchase shares of, such
class or series of stock ranking on parity with the Series A Preferred Stock as
to dividends) may be paid upon, or declared or set apart for, any class or
series of stock ranking on a parity with the Series A Preferred Stock as to
dividends, for any dividend period, prior to October 1, 1999, and thereafter,
unless there shall be or have been declared on the Series A Preferred Stock
dividends for the then current quarterly period coinciding with or ending before
such quarterly period, ratably in proportion to the respective annual dividend
rates fixed therefor.
(3) No dividend (other than dividends or distributions paid in shares of,
or options, warrants or rights to subscribe for or purchase shares of, Junior
Stock and other than as provided in subparagraph (2) of this paragraph (B))
shall be declared or paid or set aside for payment or other distribution
declared or made upon any Junior Stock or any capital stock ranking on a parity
with the Series A Preferred Stock as to dividends or upon liquidation or
dissolution (the "Parity Stock"), nor shall any Junior Stock or Parity Stock be
redeemed, purchased or otherwise be acquired for any consideration (or any
monies to be paid to or made available for a sinking fund for the redemption of
any shares of Junior Stock or Parity Stock) by the Corporation (except by
conversion into or exchange for Junior Stock or Parity Stock), in each case,
prior to October 1, 1999, and thereafter, unless full dividends on all
outstanding shares of Series A Preferred Stock shall have been paid for
6
<PAGE>
the then current dividend period or declared and a sum sufficient for the
payment thereof set aside for such payment.
(C) OTHER TERMS OF THE SERIES A PREFERRED STOCK.
(1) LIQUIDATION PREFERENCE. In the event of an involuntary or voluntary
liquidation or dissolution of the Corporation at any time, the holders of shares
of Series A Preferred Stock shall be entitled to receive out of the assets of
the Corporation an amount equal to $10.00 per share (appropriately adjusted to
reflect stock splits, stock dividends, reorganizations, consolidations and
similar changes hereafter effected) (the "Liquidation Amount"), plus dividends
declared and unpaid thereon, if any. In the event of either an involuntary or a
voluntary liquidation or dissolution of the Corporation payment shall be made to
the holders of shares of Series A Preferred Stock in the amounts herein fixed
before any payment shall be made or any assets distributed to the holders of the
Common Stock or any other class or series of capital stock of the Corporation
ranking junior to the Series A Preferred Stock with respect to payment upon
dissolution or liquidation of the Corporation. If upon any liquidation or
dissolution of the Corporation the assets available for distribution shall be
insufficient to pay the holders of all outstanding shares of Series A Preferred
Stock and any other class or series of capital stock ranking on a parity with
the Series A Preferred Stock as to payments upon dissolution or liquidation of
the Corporation the full amounts to which they respectively shall be entitled,
then such assets or the proceeds thereof shall be distributed among such holders
ratably in accordance with the respective amounts which would be payable on such
shares if all amounts payable thereon were paid in full.
At any time, in the event of the merger or consolidation of the Corporation
into or with another Corporation or the merger or consolidation of any other
Corporation into or with the Corporation or a plan of exchange between the
Corporation and any other Corporation (in which consolidation or merger or plan
of exchange any shareholders of the Corporation receive distributions of cash or
securities or other property) or the sale, transfer or other disposition of all
or substantially all of the assets of the Corporation, then, such transaction
shall be deemed, solely for purposes of determining the amounts to be received
by the holders of the Series A Preferred Stock in such merger, consolidation,
plan of exchange, sale, transfer or other disposition, and for purposes of
determining the priority of receipt of such amounts as between the holders of
the Series A Preferred Stock and the holders of other classes or series of
capital stock, to be a liquidation or dissolution of the Corporation.
Nothing hereinabove set forth shall affect in any way the right of each
holder of shares of Series A Preferred Stock to convert such shares at any time
and from time to time in accordance with subparagraph (3) below.
(2) REDEMPTION.
(a) The shares of Series A Preferred Stock shall not be redeemable by the
Corporation prior to July 1, 2000. On and after July 1, 2000, the
Corporation, at its sole option,
7
<PAGE>
may redeem shares of Series A Preferred Stock, in whole or in part, at
any time or from time to time, to the extent the Corporation has funds
legally available therefor, at the redemption prices set forth below
(expressed as a percentage of the Liquidation Amount) and upon the
approval of the Board of Governors of the Federal Reserve System. If
less than all of the outstanding shares of Series A Preferred Stock
are to be redeemed, the Corporation will select the shares to be
redeemed by lot, pro rata (as nearly may be), or in such other
equitable manner as the Board of Directors of the Corporation may
determine.
If redeemed during the twelve-month period beginning July 1
<TABLE>
<CAPTION>
Year Price Per Share
---- ---------------
<S> <C>
2000 ....................... 105%
2001 ....................... 104%
2002 ....................... 103%
2003 ....................... 102%
2004 ....................... 101%
</TABLE>
at the price indicated above, and from and after July 1, 2005, at the
price per share of 100% of the Liquidation Amount, plus in each case
declared and unpaid dividends thereon to the date fixed for redemption
(the total sum so payable on any such redemption being herein referred
to as the "redemption price").
(b) In no event shall the Corporation redeem less than all the outstanding
shares of Series A Preferred Stock, unless dividends for the
then-current dividend period (without accumulation of any accrued and
unpaid dividends for prior dividend periods unless previously declared
and without interest) to the date fixed for redemption shall have been
declared and paid or set apart for payment on all outstanding shares
of Series A Preferred Stock; provided, however, that the foregoing
shall not prevent, if otherwise permitted, the purchase or acquisition
by the Corporation of shares of Series A Preferred Stock pursuant to a
tender or exchange offer made on the same terms to holders of all the
outstanding shares of Series A Preferred Stock and mailed to the
holders of record of all such outstanding shares at such holders'
addresses as the same appear on the books of the Corporation; and
provided further that if some, but less than all, of the shares of
Series A Preferred Stock are to be purchased or otherwise acquired
pursuant to such a tender or exchange offer and the number of such
shares so tendered exceeds the number of shares so to be purchased or
otherwise acquired by the Corporation, the shares of Series A
Preferred Stock so tendered shall be purchased or otherwise acquired
by the Corporation on a pro rata basis (with adjustments to eliminate
fractions) according to the number of such shares duly
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<PAGE>
tendered by each holder so tendering shares of Series A Preferred
Stock for such purchase or exchange.
(c) Notice of any redemption pursuant to this subparagraph (2) shall be
mailed at least 30, but not more than 60, days in advance of the date
designated for such redemption (herein called the "redemption date")
to the holders of record of shares of Series A Preferred Stock so to
be redeemed at their respective addresses as the same shall appear on
the books of the Corporation. To facilitate the redemption of shares
of Series A Preferred Stock, the Board of Directors may fix a record
date for the determination of holders of shares of Series A Preferred
Stock to be redeemed not more than 60 days prior to the redemption
date. Each such notice shall state: (i) the redemption date; (ii) the
number of shares of Series A Preferred Stock to be redeemed and, if
less than all the shares held by such holder are to be redeemed, the
number of such shares to be redeemed from such holder; (iii) the
redemption price; (iv) that the shares of Series A Preferred Stock
called for redemption may be converted at any time prior to the date
fixed for redemption; (v) the applicable conversion price or rate;
(vi) the place or places where certificates for such shares are to be
surrendered for payment of the redemption price; and (vii) that
dividends on the shares to be redeemed will cease to accrue on such
redemption date. If less than all the shares represented by any such
surrendered certificate are redeemed, a new certificate shall be
issued representing the unredeemed shares.
(d) The Corporation shall, on or prior to the date fixed for redemption of
any shares, but not earlier than 45 days prior to the date fixed for
redemption, deposit with its transfer agent or other redemption agent
selected by the Board of Directors, as a trust fund, a sum sufficient
to redeem the shares called for redemption, with irrevocable
instructions and authority to such transfer agent or other redemption
agent to give or complete the notice of redemption thereof and to pay
to the respective holders of such shares, as evidenced by a list of
such holders certified by an officer of the Corporation, the
redemption price upon surrender of their respective share
certificates. Such deposit shall be deemed to constitute full payment
of such shares to their holders; and from and after the date of such
deposit, notwithstanding that any certificates for such shares shall
not have been surrendered for cancellation, the shares represented
thereby shall no longer be deemed outstanding, rights to receive
dividends and distributions shall cease to accrue from and after the
redemption date, and all rights of the holders of the Series A
Preferred Stock called for redemption, as shareholders of the
Corporation with respect to such shares, shall cease and terminate,
except the right to receive the redemption price, without interest,
upon the surrender of their respective certificates, and except the
right to convert their shares into Common Stock as provided in
subparagraph (3) of this paragraph (C), until the close of business on
the redemption date. In case the holders of any shares shall not,
within six years after such deposit, claim the amount deposited for
redemption thereof, such transfer agent or other redemption agent
shall, upon demand, pay over
9
<PAGE>
to the Corporation the balance of such amount so deposited. Thereupon,
such transfer agent or other redemption agent shall be relieved of all
responsibility to the holders thereof and the sole right of such
holders shall be as general creditors of the Corporation. To the
extent that shares of Series A Preferred Stock called for redemption
are converted into Common Stock prior to the date fixed for
redemption, the amount deposited by the Corporation to redeem such
shares shall immediately be returned to the Corporation. Any interest
accrued on any funds so deposited shall belong to the Corporation, and
shall be paid to it from time to time on demand.
(e) Redemption of any shares of Series A Preferred Stock is subject to the
prior approval of any federal regulatory agency with jurisdiction over
such matters.
(3) CONVERSION RIGHT. At the option of the holders thereof, the shares of
Series A Preferred Stock shall be convertible, at the office of the Corporation
(or at such other office or offices, if any, as the Board of Directors may
designate), into fully paid and nonassessable shares (calculated as to each
conversion to the nearest 1/100th of a share) of Common Stock of the
Corporation, at the conversion price, determined as hereinafter provided, in
effect at the time of conversion, each share of Series A Preferred Stock being
deemed to have a value of $10.00 for the purpose of such conversion. The price
at which shares of Common Stock shall be delivered upon conversion (herein
called the "conversion price") shall be initially $10.00 per share of Common
Stock (I.E., at an initial conversion rate of one share of Common Stock for each
share of Series A Preferred Stock); PROVIDED, HOWEVER, that such initial
conversion price shall be subject to adjustment from time to time in certain
instances as hereinafter provided. In the case of the call for redemption of
any shares of Series A Preferred Stock, such right of conversion shall cease and
terminate as to the shares designated for redemption on the day such shares are
actually redeemed by the Corporation. The following provisions shall govern
such right of conversion:
(a) To convert shares of Series A Preferred Stock into shares of Common
Stock of the Corporation, the holder thereof shall surrender at any
office hereinabove mentioned the certificate or certificates therefor,
duly endorsed to the Corporation or in blank, and give written notice
to the Corporation at such office that such holder elects to convert
such shares. Shares of Series A Preferred Stock shall be deemed to
have been converted immediately prior to the close of business on the
day of the surrender of such shares for conversion as herein provided,
and the person entitled to receive the shares of Common Stock of the
Corporation issuable upon such conversion shall be treated for all
purposes as the record holder of such shares of Common Stock at such
time. As promptly as practicable on or after the conversion date, the
Corporation shall issue and deliver or cause to be issued and
delivered at such office a certificate or certificates for the number
of shares of Common Stock of the Corporation issuable upon such
conversion.
(b) The conversion price shall be subject to adjustment from time to time
as hereinafter provided. Upon each adjustment of the conversion price
each holder of shares of
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<PAGE>
Series A Preferred Stock shall thereafter be entitled to receive the
number of shares of Common Stock of the Corporation obtained by
multiplying the conversion price in effect immediately prior to such
adjustment by the number of shares issuable pursuant to conversion
immediately prior to such adjustment and dividing the product thereof
by the conversion price resulting from such adjustment.
(c) In case the Corporation shall (i) declare a dividend upon the Common
Stock payable in Common Stock (other than a dividend declared to
effect a subdivision of the outstanding shares of Common Stock, as
described in subparagraph (d) below) or Convertible Securities, or in
any rights or options to purchase Common Stock or Convertible
Securities, or (ii) declare any other dividend or make any other
distribution upon the Common Stock payable otherwise than out of
earnings or earned surplus, then thereafter each holder of shares of
Series A Preferred Stock upon the conversion thereof will be entitled
to receive the number of shares of Common Stock into which such shares
of Series A Preferred Stock have been converted, and, in addition and
without payment therefor, each dividend described in clause (i) above
and each dividend or distribution described in clause (ii) above which
such holder would have received by way of dividends or distributions
if continuously since such holder became the record holder of such
shares of Series A Preferred Stock such holder (i) had been the record
holder of the number of shares of Common Stock then received, and (ii)
had retained all dividends or distributions in stock or securities
(including Common Stock or Convertible Securities, and any rights or
options to purchase any Common Stock or Convertible Securities)
payable in respect of such Common Stock or in respect to any stock or
securities paid as dividends or distributions and originating directly
or indirectly from such Common Stock. For the purposes of the
foregoing a dividend or distribution other than in cash shall be
considered payable out of earnings or earned surplus only to the
extent that such earnings or earned surplus are charged an amount
equal to the fair value of such dividend or distribution as determined
by the Board of Directors of the Corporation.
(d) In case the Corporation shall at any time subdivide its outstanding
shares of Common Stock into a greater number of shares, the conversion
price in effect immediately prior to such subdivision shall be
proportionately reduced, and conversely, in case the outstanding
shares of Common Stock of the Corporation shall be combined into a
smaller number of shares (other than the Reverse Stock Split), the
conversion price in effect immediately prior to such combination shall
be proportionately increased.
(e) If any capital reorganization or reclassification of the capital stock
of the Corporation, or consolidation or merger of the Corporation with
another Corporation, or the sale of all or substantially all of its
assets to another Corporation shall be effected in such a way that
holders of Common Stock shall be entitled to receive stock, securities
or assets with respect to or in exchange for Common Stock, then, as a
condition of such reorganization, reclassification, consolidation,
merger or sale, and subject to
11
<PAGE>
subparagraph (1) above, lawful and adequate provision shall be made
whereby the holders of Series A Preferred Stock shall thereafter have
the right to receive upon the basis and upon the terms and conditions
specified herein and in lieu of the shares of the Common Stock of the
Corporation immediately theretofore receivable upon the conversion of
Series A Preferred Stock, such shares of stock, securities or assets
as may be issued or payable with respect to or in exchange for a
number of outstanding shares of such Common Stock equal to the number
of shares of such stock immediately theretofore receivable upon the
conversion of Series A Preferred Stock had such reorganization,
reclassification, consolidation, merger or sale not taken place, plus
all declared dividends unpaid and accumulated or accrued thereon to
the date of such reorganization, reclassification, consolidation,
merger or sale, and in any such case appropriate provision shall be
made with respect to the rights and interests of the holders of Series
A Preferred Stock to the end that the provisions hereof (including
without limitation provisions for adjustments of the conversion price
and of the number of shares receivable upon the conversion of Series A
Preferred Stock) shall thereafter be applicable, as nearly as may be
in relation to any shares of stock, securities or assets thereafter
receivable upon the conversion of Series A Preferred Stock. The
Corporation shall not effect any such consolidation, merger or sale,
unless prior to the consummation thereof the successor Corporation (if
other than the Corporation) resulting from such consolidation or
merger or the Corporation purchasing such assets shall assume by
written instrument executed and mailed to the registered holders of
Series A Preferred Stock, at the last addresses of such holders
appearing on the books of the Corporation, the obligation to deliver
to such holders such shares of stock, securities or assets as, in
accordance with the foregoing provisions, such holders may be entitled
to receive.
(f) Upon any adjustment of the conversion price, then and in each case the
Corporation shall give written notice thereof, by first-class mail,
postage prepaid, addressed to the registered holders of Series A
Preferred Stock, at the addresses of such holders as shown on the
books of the Corporation, which notice shall state the conversion
price resulting from such adjustment and the increase or decrease, if
any, in the number of shares receivable at such price upon the
conversion of Series A Preferred Stock, setting forth in reasonable
detail the method of calculation and the facts upon which such
calculation is based.
12
<PAGE>
(g) In case at any time:
(i) the Corporation shall pay any dividend payable in stock upon
its Common Stock or make any distribution (other than regular
cash dividends) to the holders of its Common Stock;
(ii) the Corporation shall offer for subscription pro rata to the
holders of its Common Stock any additional shares of stock of
any class or other rights;
(iii) there shall be any capital reorganization, or reclassification
of the capital stock of the Corporation, or consolidation or
merger of the Corporation with, or sale of all or substantially
all of its assets to, another Corporation; or
(iv) there shall be a voluntary or involuntary dissolution,
liquidation or winding up of the Corporation;
then, in any one or more of said cases, the Corporation shall give
written notice, by first-class mail, postage prepaid, addressed to the
registered holders of Series A Preferred Stock at the addresses of
such holders as shown on the books of the Corporation, of the date on
which (i) the books of the Corporation shall close or a record shall
be taken for such dividend, distribution or subscription rights, or
(ii) such reorganization, reclassification, consolidation, merger,
sale, dissolution, liquidation or winding up shall take place, as the
case may be. Such notice also shall specify the date as of which the
holders of Common Stock of record shall participate in such dividend,
distribution or subscription rights, or shall be entitled to exchange
their Common Stock for securities or other property deliverable upon
such reorganization, reclassification, consolidation, merger, sale,
dissolution, liquidation, or winding up, as the case may be. Such
written notice shall be given at least 20 days prior to the action in
question and not less than 20 days prior to the record date or the
date on which the Corporation's transfer books are closed in respect
thereto.
(h) As used in this paragraph (3) the term "Common Stock" shall mean and
include the Corporation's presently authorized Common Stock and also
shall include any capital stock of any class of the Corporation
hereafter authorized which shall not be limited to a fixed sum or
percentage in respect of the rights of the holders thereof to
participate in dividends or in the distribution of assets upon the
voluntary or involuntary liquidation, dissolution or winding up of the
Corporation, provided that the shares receivable pursuant to
conversion of shares of Series A Preferred Stock shall include shares
designated as Common Stock of the Corporation as of the date of
issuance of such shares of Series A Preferred Stock, or, in case of
any reclassification of the outstanding shares thereof, the stock,
securities or assets provided for in subparagraph (e) above.
13
<PAGE>
(i) No fractional shares of Common Stock shall be issued upon conversion,
but, instead of any fraction of a share which would otherwise be
issuable, the Corporation shall pay a cash adjustment in respect of
such fraction in an amount equal to the same fraction of the market
price per share of Common Stock as of the close of business on the day
of conversion. "Market price" shall mean if the Common Stock is
traded on a securities exchange or on the Nasdaq Stock Market, the
closing price of the Common Stock on such exchange or the Nasdaq Stock
Market, or, if the Common Stock is otherwise traded in the
over-the-counter market, the closing bid price, in each case averaged
over a period of 20 consecutive business days prior to the date as of
which "market price" is being determined. If at any time the Common
Stock is not traded on an exchange or the Nasdaq Stock Market, or
otherwise traded in the over-the-counter market, the "market price"
shall be deemed to be the higher of (i) the book value thereof as
determined by any firm of independent public accountants of recognized
standing selected by the Board of Directors of the Corporation as of
the last day of any month ending within 60 days preceding the date as
of which the determination is to be made, or (ii) the fair value
thereof determined in good faith by the Board of Directors of the
Corporation as of a date which is within 15 days of the date as of
which the determination it to be made.
XII
Each holder of Common Stock shall have one vote on all matters
submitted to the shareholders for each share of Common Stock standing in the
name of such holder on the books of the Corporation. Except as otherwise
provided herein, and except as otherwise required by law, the shares of capital
stock of the Corporation shall vote as a single class on all matters submitted
to the shareholders.
XIII
TRANSFER RESTRICTIONS
(A) GENERAL. The shares of capital stock may not be transferred by any
person (the "Initial Transferor") in any manner to any extent to any other
person (other than persons to whom the Corporation is contractually obligated on
or before the date of issuance of the Series A Preferred Stock in the Offerings
to transfer up to 4.9% of the Corporation's stock) if such other person is or
would become by reason of the transfer a beneficial owner of more than 4.5% (or
4.9% as described above) of the Corporation's stock (a "Prohibited Transferee"),
as the term "stock" is defined and such ownership is determined under Section
382 of the Internal Revenue Code of 1986, as amended, and regulations thereunder
(collectively "Section 382"). For purposes of this provision, transfers to a
Prohibited Transferee shall include transfers directly with or through trusts,
estates, corporations, partnerships or other entities as defined under Internal
Revenue Code Regulation Section 1.382-3(a), and attribution through such
entities shall be determined pursuant to Section 382.
14
<PAGE>
(B) PROHIBITED STOCK. Transfers made in violation of paragraph (A) of
this Article XIII shall not be effective to transfer ownership of the shares of
Preferred Stock or Common Stock subject thereto ("Prohibited Stock").
(1) Upon the transfer of Prohibited Stock, the Corporation shall have
thirty (30) days from discovery of such prohibited transfer to demand
the transfer of the Prohibited Stock from the Prohibited Transferee to
the agent designated by the Board of Directors (the "Agent").
Further, the Agent shall demand the transfer of any distributions
received on such Prohibited Stock by the Prohibited Transferee.
Discovery shall be deemed to have been made pursuant to provisions of
Section 382 regarding discovery of ownership changes. If a Prohibited
Transferee shall refuse or fail upon demand by the Corporation to
transfer such Prohibited Stock and distributions received thereon, the
Corporation shall take all necessary action at law or equity to compel
such transfer as soon as possible.
(2) Upon transfer by the Prohibited Transferee of the Prohibited Stock,
together with distributions received thereon, the Agent shall sell
such Prohibited Stock as soon as practicable thereafter in an arm's
length transaction and in a manner consistent with the restriction set
forth in this paragraph upon the refusal by the Prohibited Transferee.
Proceeds from such sale shall not inure to the benefit of the
Corporation or the Agent but shall be remitted to the Prohibited
Transferee in an amount not to exceed the amount paid by the
Prohibited Transferee for such Prohibited Stock, or, if the transfer
made in violation of this paragraph was by gift, inheritance or
similar transfer, the fair market value of such shares at the time of
receipt of such shares by the Prohibited Transferee. For purposes of
the foregoing, the fair market value per share of the Prohibited Stock
shall not be less than: (i) the average of the highest and lowest
selling price at the time of receipt of such shares by the Prohibited
Transferee or if there were no sales on such date, then not less than
the mean between the bid and asked price on such date, if the
Prohibited Stock was listed on a national securities exchange or
quoted on the Nasdaq Stock Market on such date; (ii) the mean between
the bid and asked price on such date or, if there was no bid and asked
price on such date, then on the next prior business day on which there
was a bid and asked price if the Prohibited Stock was traded
otherwise than on a national securities exchange or the Nasdaq Stock
Market on such date; or (iii) as determined by the Board of Directors.
(3) Any sale of Prohibited Stock by a Prohibited Transferee received in
violation of this Article XIII shall be deemed to have been made
solely by the Agent, and the Agent shall demand of the Prohibited
Transferee the proceeds from such sale together with distributions
received from such Prohibited Stock. Such demand shall be made within
thirty (30) days of discovery (as that term is described in paragraph
(B) of this Article XIII) by the Agent of the transfer of the
Prohibited Stock to the Prohibited Transferee. If the Prohibited
Transferee shall refuse or fail upon demand by the
15
<PAGE>
Agent to surrender such proceeds and distributions, the Agent shall
take all necessary action at law or in equity to compel the transfer
of such proceeds and distributions. The Agent, at its discretion, may
make demand of such proceeds in the amount net of the amount which the
Prohibited Transferee would have received from the Agent had the Agent
rather than the Prohibited Transferee sold such Prohibited Stock.
(4) Any proceeds received by the Agent as a result of the sale of the
Prohibited Stock, whether by the Agent or by the Prohibited
Transferee, and the distributions received on such Prohibited Stock,
shall be transferred to the Initial Transferor, less any amounts
remitted to or retained by the Prohibited Transferee as otherwise
described in Article XIII. If such Initial Transferor cannot be
determined by the Agent within ninety (90) days after receipt by the
Agent of such proceeds and distributions, the Agent may pay any such
amounts due the Initial Transferor into a court or governmental
agency, if applicable law permits, and otherwise must irrevocably
transfer such amounts to a charity designated by the Agent. In no
event shall amounts due to such Initial Transferor inure to the
benefit of the Agent, but such amounts may be used to reimburse the
Agent, if any, for reasonable expenses incurred in attempting to
identify the Initial Transferor.
(5) The Board of Directors is expressly empowered to waive application of
this Article XIII to any specific transaction, provided that such
waiver is by resolution of the Board of Directors duly considered and
approved by at least a majority of the Board of Directors prior to any
such transfer of stock described within this Article XIII.
(C) LEGEND. Certificates representing shares of the capital stock shall,
upon issuance, bear the following legend:
THE AMENDED AND RESTATED ARTICLES OF INCORPORATION OF NATIONAL
MERCANTILE BANCORP (THE "COMPANY") PROHIBIT THE TRANSFER OF THE SHARES
OR INTERESTS REPRESENTED BY THIS CERTIFICATE TO ANY PERSON IF SUCH
PERSON IS OR WOULD BECOME BY REASON OF SUCH TRANSFER THE BENEFICIAL
OWNER OF MORE THAN 4.5% (OR 4.9% IF THE TRANSFEREE IS A PERSON TO WHOM
THE COMPANY IS CONTRACTUALLY OBLIGATED ON OR BEFORE THE DATE OF
ISSUANCE OF THESE SHARES OR INTERESTS TO TRANSFER UP TO 4.9% OF THE
COMPANY'S STOCK) OF THE COMPANY'S STOCK, AS THE TERM "STOCK" IS
DEFINED, AND SUCH OWNERSHIP IS DETERMINED, UNDER SECTION 382 OF THE
INTERNAL REVENUE CODE OF 1986, AS AMENDED.
(D) TERMINATION. This Article XIII shall have no applicability and shall
be of no force and effect, notwithstanding notations to the contrary on any
certificates evidencing ownership of any
16
<PAGE>
securities of the Corporation, (i) on or after July 1, 2000 or (ii) upon the
occurrence of any transaction in which holders of all outstanding shares of
capital stock receive, or are offered the opportunity to receive, cash, stock or
other property for all such shares and upon the consummation of which the
acquiror will own at least a majority of the outstanding shares of capital
stock.
XIV
This corporation is authorized to provide indemnification of agents
(as defined in Section 317 of the General Corporation Law of California) for
breach of duty to the corporation and its shareholders through bylaw provisions
or through agreements with the agents, or both, in excess of the
indemnification otherwise permitted by Section 317 of the General Corporation
Law of California, subject to any limitations on indemnification under the
General Corporation Law of California which cannot be waived.
17
<PAGE>
AMENDMENT NO. 2 TO EMPLOYMENT AGREEMENT
This AMENDMENT No. 2 TO EMPLOYMENT AGREEMENT ("Second Amendment") is
made as of the 20th day of December, 1996 between Mercantile National Bank (the
"Bank"), a national banking association organized and existing under the laws of
the United States, and Scott A. Montgomery, an individual ("Montgomery") and
amends that certain Employment Agreement dated June 21, 1996 between the Bank
and Montgomery as amended by that certain Addendum dated June 21, 1996
(collectively, the "Employment Agreement").
RECITAL
WHEREAS, the Bank and Montgomery desire to amend the Employment
Agreement to reflect the following terms and conditions.
NOW, THEREFORE, Bank and Montgomery hereby agree as follows:
1. Section 3.4 of the Agreement shall be deleted in its entirety and
replaced with the following:
Bancorp has granted to Montgomery options to purchase 200,000
shares of Bancorp common stock (the "Stock Options") under the
National Mercantile Bancorp 1990 Stock Option Plan (the "1990
Plan") on December 20, 1996. The terms and conditions of such
Stock Options shall be set forth in a separate option agreement.
Such Granted Stock Options shall be deemed incentive options to
the maximum extent permitted by law and the 1990 Plan. Such
stock option agreement, which must be executed by Montgomery and
Bancorp, shall include, among others, the following terms and
conditions:
2. The term "Non-Qualified Stock Options" used in subsection 3.4.2,
3.4.3, 3.4.4 and 3.4.5, shall be deleted and replaced with the term
"Granted Stock Options" and the word "Non-Qualified" used in
subsections 3.4.6 and 3.4.7 shall be deleted and replaced with the
term "Granted."
3. The first phrase of the second sentence of Section 3.4.4 shall be
deleted in its entirety and replaced with the following:
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<PAGE>
Bancorp shall adopt the 1996 Stock Incentive Plan to
authorize 500,000 (pre Reverse Stock Split shares contemplated by
the Board of Directors to occur in connection with the
Recapitalization) additional shares (the "1996 Plan") and submit
the 1996 Plan for approval at the next annual or special
shareholders meeting. Bancorp's Board of Directors shall
recommend and solicit approval of the 1996 Plan. Subject to such
approval,
4. Subsection 3.4.4(g) shall be amended by adding the following:
(i) For purposes of this Agreement, any adjustments
contemplated by Section 3.4.4 hereof to occur after a
Recapitalization shall be required to occur only once and with
respect only to the first such Recapitalization to occur on or
before December 31, 1999.
5. Subsection 3.4.4(h) is deleted in its entirety and replaced with
the following:
(h) Montgomery acknowledges that at present there are not
sufficient shares available under the National Mercantile Bancorp
1990 or 1994 Stock Option Plans (collectively, the "Plans") to
grant Montgomery the Additional Options (or the Option and Tandem
SAR referred to in paragraph 3.5), and that shareholder approval
for the 1996 Plan providing for additional shares is required.
Bancorp agrees to adopt the 1996 Plan and to submit the 1996 Plan
to the shareholders of Bancorp for approval at the next annual
or special shareholders meeting. Bancorp's Board of Directors
shall recommend and solicit approval of the 1996 Plan.
6. Subsection 3.4.5 shall be amended by adding the words "or the
1996 Plan, as the case may be" immediately before the period.
7. A new sentence shall be added to the end of subsection 3.4.6 as
follows:
In no event shall Montgomery be permitted to exercise any options
granted by the Company to him, and, as a result hereof, hold more
than 4.9% of the Company's capital stock at any time during the
period commencing on the date
2
<PAGE>
hereof and continuing for a period of three years following the
Recapitalization.
8. Section 3.5 shall be amended by deleting the first sentence and
replacing it with the following:
Pursuant to a separate stock rights agreement, and subject to
shareholder approval of the 1996 Plan, Bancorp shall grant to
Montgomery a non-qualified stock option ("Option") and tandem
stock appreciation right ("Tandem SAR") with respect of 75,000
shares of Bancorp Common Stock (the "Option and Tandem SAR")
under the 1996 Plan.
9. Subsections 3.4.4(e) and 3.5.5 shall be amended by deleting all
references to the 1990 Plan and replacing such references with "1996
Plan".
10. Subsection 3.5.6 shall be deleted in its entirety and replaced
with the following:
3.5.6 Montgomery acknowledges that at present there are not
sufficient shares available under the Plans to grant Montgomery
the Option and Tandem SAR (or the Additional Options referred to
in paragraph 3.4.4), and that shareholder approval for the 1996
Plan providing for additional shares is required. Bancorp agrees
to adopt the 1996 Plan and to submit the amendment to the
shareholders of Bancorp for approval at the next annual or
special shareholders meeting. Bancorp's Board of Directors shall
recommend and solicit approval of the 1996 Plan.
11. Subsection 3.5.7 shall be amended by deleting the words "the 1990
Plan" and adding the words "the 1996 Plan."
12. Montgomery acknowledges that on December 20, 1996 the Stock
Option Committee of the Board of Directors cancelled the grant of
options of 200,000 shares of Common Stock to Montgomery on June 21,
1996 and granted Montgomery options of 200,000 shares of Common Stock
at $1.25 per share.
3
<PAGE>
13. All other terms and conditions contained in the Employment
Agreement shall remain in full force and effect.
MERCANTILE NATIONAL BANK
By /s/ HOWARD P. LADD
-------------------------------------
Howard P. Ladd
Chairman
By /s/ SCOTT A. MONTGOMERY
-------------------------------------
Scott A. Montgomery
Agreed as to the obligations of National Mercantile Bancorp specified in the
foregoing Agreement.
NATIONAL MERCANTILE BANCORP
By /s/ HOWARD P. LADD
-------------------------------------
Howard P. Ladd
Chairman, President & CEO
4
<PAGE>
14. INTERPRETATION AND CONSTRUCTION. The interpretation and
construction of this Agreement b the Committee shall be final, binding
and conclusive. The section headings in this Agreement are for
conveniences of reference only and shall not be deemed part of, or
germane to the interpretation or construction of, this Agreement.
NATIONAL MERCANTILE BANCORP
By /s/ HOWARD P. LADD
-------------------------------------
Howard P. Ladd
Chairman of the Board
By /s/ SCOTT A. MONTGOMERY
-------------------------------------
Scott A. Montgomery
Optionee
By her signature below, the spouse of the Optionee agrees to be bound by all of
the terms and conditions of the foregoing Agreement.
By /s/ ELAINE BELL MONTGOMERY
-------------------------------------
Elaine Bell Montgomery
5
<PAGE>
BANK SERVICE AGREEMENT
Agreement ("Agreement") made this, the 21st day of April, 1997, between R H
Investment Corporation, Inc. (hereinafter referred to as "RHI") and Mercantile
National Bank (hereinafter referred to as "Bank").
W I T N E S S E T H:
WHEREAS, the Bank desires to make a broad array of securities and
investment services available to its Customers (hereinafter referred to as
"Customers"); and
WHEREAS, RHI desires to provide the Bank's Customers with such securities
and investment services.
NOW, THEREFORE, in consideration of the mutual covenants hereinafter set
forth, and other good and valuable consideration, the receipt of which is hereby
acknowledged, the parties covenant and agree as follows:
1. The Bank and RHI each agree that they will share with the other such
information regarding the Customer, as may be reasonably necessary to carry
out the intent of this Agreement.
2. SERVICES TO BE PERFORMED BY RHI - RHI may accept, establish, and maintain
securities and other investment accounts for Customers of the Bank in
conformity with its policies, as may be changed from time to time by RHI,
and in accordance with all applicable rules, regulations, laws, and
procedures, including those pursuant to the Securities Exchange Act of
1934, and the National Association of Securities Dealers, Inc., and such
other regulatory authorities as to which RHI may be subject.
a.) RHI will cause to be prepared, printed, and mailed; monthly statements
and confirmations to the accounts, as shown on the books and records
of RHI.
b.) RHI will comply with any, and all, prospectus delivery requirements
relating to options or other securities.
c.) RHI will maintain books and records of all transactions executed
through it, in accordance with any applicable rules, regulations or
laws, in conformity with industry standards.
d.) RHI will provide any required information pursuant to federal, state
or local tax laws, rules, or regulations, as may be in effect from
time to time, and shall be responsible for causing the withholding of
dividend payments as may be required, pursuant to federal law.
e.) RHI will comply with Bank policy pertaining to the Investment Services
Division and all applicable bank regulatory guidelines for retail non
deposit investment sales.
f.) RHI will provide the Bank with all necessary material and forms
required for its Customers to open and maintain securities and other
investment accounts with RHI, and RHI shall be responsible for the
compliance of such items with all applicable laws, rules or
regulations.
f.) RHI will designate, which designation may be changed form time to time
by RHI, an individual to whom the Bank may address inquiries about the
implementation and
<PAGE>
maintenance of this agreement, and such accounts as shall be opened
pursuant hereto.
g.) RHI reserves the right, at its sole discretion, to accept or reject
any accounts for any Customer of the Bank, any order from any such
Customer of the Bank, whether said Customer has an existing account
with RHI or not, and to terminate any account previously accepted by
RHI for such Customer. RHI agrees that it will not act unreasonably
in exercising such discretion.
h.) ORDERS - RHI shall be responsible for screening orders prior to
execution, acceptance or rejection of such orders, errors in execution
and settlement of Customer contracts;
i.) RESTRICTED SECURITIES - RHI shall be responsible for its own
compliance with, and the obtaining of, information on any sale of
restricted/control stock.
3. SERVICES TO BE PROVIDED BY THE BANK - The bank will use its best efforts,
with its Customers, to promote, develop, and maintain accounts with RHI.
The Bank will render all reasonable assistance to its Customers, as shall
be necessary in order to open accounts on their behalf with RHI.
a.) The Bank shall make available to its Customers appropriate new account
forms and such documentation as shall be necessary to open and
maintain accounts with RHI. The Bank will render all reasonable
assistance to its Customers as shall be necessary in order to open
accounts on their behalf with RHI.
b.) The Bank will perform only such clerical and ministerial functions as
shall be necessary to open and operate accounts on behalf of its
Customers, unless those Bank employees, performing more than clerical
or ministerial functions, are duly qualified and registered with RHI
as registered representatives, pursuant to the appropriate regulatory
requirements.
c.) Bank agrees that no employee of the bank shall receive commission
related compensation for any brokerage activities unless such employee
is duly licensed and registered with RHI.
d.) The Bank shall clearly identify RHI as the entity performing all such
brokerage services, and will further advise its Customers that such
services are being provided by RHI on a fully disclosed basis.
4. REPRESENTATIONS AND WARRANTIES OF RHI - RHI represents and warrants as
follows:
a.) RHI is a member, in good standing, of the National Association of
Securities Dealers, Inc.
b.) RHI is and, during the term of this Agreement, will remain duly
licensed and in good standing as a broker/dealer under applicable
federal and state laws and regulations.
c.) RHI has the requisite authority, in conformity with all applicable
laws and regulations, to enter into and perform the services
contemplated by this Agreement.
d.) RHI is in compliance with and, during the term of this Agreement, will
remain in compliance with the capital and financial reporting
requirements of each national securities exchange or association of
which it is a member, the Securities and Exchange Commission, and in
each state in which it is licensed.
e.) RHI will keep confidential any information not otherwise generally
available to the public, which it may acquire as a result of this
Agreement regarding the business and affairs of the Bank. RHI will
treat the names of account holders and Customers as confidential, and
shall not provide such names to third parties, other than its
corporate affiliates, as shall be
<PAGE>
reasonably necessary to implement this Agreement, except as authorized
in writing, by the Bank, or the Customer, or as required by applicable
statutes, rules or regulations. The provisions of this paragraph
shall survive the termination of this Agreement.
f.) RHI has full legal right, power and authority to enter into and
perform this Agreement, and this Agreement has been duly authorized,
executed and delivered by RHI and constitutes a legal, valid and
binding Agreement of RHI.
g.) RHI is authorized to contact the customer directly to service the
accounts and activities contemplated by this Agreement.
5. REPRESENTATIONS AND WARRANTIES OF BANK - Bank represents and warrants as
follows:
a.) The Bank has full legal right, power, and authority to enter into and
perform this Agreement, and that this Agreement has been duly
authorized, executed, and delivered by the Bank, and constitutes a
legal, valid and binding obligation of the Bank. The Bank has all of
the requisite authority and conformity, with applicable law and
regulations, to enter into this Agreement.
b.) The Bank is entering into this Agreement pursuant to an exemption from
registration as a broker/dealer, as provided by Rule 3b-9, promulgated
pursuant to the Securities Exchange Act of 1934, as amended. It will
continue to qualify for such exemption, or it will be duly registered
as a broker/dealer throughout the term of this Agreement.
c.) The Bank is, and will remain, in compliance with all applicable laws,
rules and regulations that may apply to it from time to time by any
state blue sky law, banking laws, or other applicable requirements of
regulatory bodies or agencies having jurisdiction.
d.) The Bank shall not permit any activity on its behalf, or by its
employees, insofar as such acts may relate to this Agreement, which is
not in compliance with all applicable laws, rules, and regulations of
federal, state and local law.
e.) The Bank shall keep confidential any information not otherwise
generally available to the public, which it may acquire as a result of
this Agreement regarding the business affairs of RHI, which
requirement shall survive the termination of this Agreement.
6. DESIGNATION OF ACCOUNTS - RHI shall maintain, on its books and records, a
notation of each account opened with a Customer of the Bank. Not less than
annually, RHI will forward to the Bank, a list of all such accounts which
have been opened with Customers of the Bank, and the Bank, within thirty
days of receipt of such list, shall verify to RHI the accuracy of such
list. The purpose of the preparation and verification of this list is for
the Bank to be able to verify that it is being paid the fees to which it is
entitled, pursuant to this Agreement, and for RHI to verify that the
persons or entities with whom it is dealing are, in fact, Customers of the
Bank.
7. SUPERVISORY RESPONSIBILITY
a.) EMPLOYEES - The Bank shall have the sole and exclusive responsibility
for supervising activities of its employees involved in carrying out
the functions encompassed in this Agreement. RHI shall have the sole
and exclusive responsibility for supervising the activities of its
employees involved in the activities encompassed by this Agreement.
In the event that there are employees who are dually employed by the
Bank and RHI, the Bank shall have supervisory responsibility for the
employees' bank related activities and RHI shall have supervisory
responsibility for the employees' securities related activities.
<PAGE>
b.) CUSTOMERS - RHI shall have sole responsibility for complying with the
requirements of knowing Customers with whom it is dealing, knowing
their investment objectives and rendering investment advice to such
Customers, to the extent that such investment advice may be given.
8. INDEMNIFICATION - RHI shall indemnify and hold Bank harmless against any
losses, claims, damages, liabilities or expenses (which shall include, but
not be limited to, all costs of defense and investigation, and all
reasonable attorney's fees), to which the bank may be subject, insofar as
such losses, claims, damages, liabilities or expenses arise out of, or are
based upon, any of the following:
a.) The gross negligence or willful misconduct of RHI or its employees to
perform any of its obligations under this agreement or any act or
omission in connection herewith..
b.) The failure of RHI to perform its obligations under this Agreement,
including the provisions of the Independent Registered Representative
Agreement for each bank employee registered with RHI;
c.) The loss of securities or cash after receipt by RHI, prior to receipt
of securities or cash by the Bank from RHI;
d.) The operation of margin accounts in a manner not in conformity with
applicable laws, provided that such lack of conformity is not the
result of the failure by the Bank to follow instructions of RHI, as
provided herein;
e.) Failure of RHI to remain a duly licensed broker/dealer in good
standing under applicable law;
f.) Failure of the forms and materials, provided by RHI in connection to
the services contemplated hereunder, to comply with any applicable
securities laws, regulations and rules;
g.) Failure of any marketing materials, which RHI approves, to comply with
any applicable securities laws, regulations and rules;
h.) Failure of RHI to comply with Bank policy pertaining to the Investment
Services Division and all applicable bank regulatory guidelines for
retail non deposit investment sales.
9. The Bank shall indemnify and hold RHI harmless against any losses, claims,
damages, liabilities or expenses (which shall include, but not be limited
to, all costs of defense and investigation, and all attorney's fees) to
which RHI may become subject, insofar as such losses, claims, damages,
liabilities, or expenses arise out of, or are based upon, any of the
following:
a.) The gross negligence or willful misconduct of the Bank or its
employees to perform any of its obligations under this agreement or
any act or omission in connection herewith.
b.) Failure of the Bank and/or its employee/representative to
satisfactorily perform its obligations under this Agreement and the
Independent Registered Representative Agreement;
The parties agree that upon receipt of any claim or notice of any action
prompt written notice of such claim or action shall be communicated to all
parties to this Agreement. Upon assumption by any party of the defense of
a claim or action by counsel reasonable acceptable to the indemnified party
within the scope of its indemnity, such party shall not thereafter be
responsible for legal, accounting or paralegal expenses of the indemnified
party. Any indemnified party may at its own expense retain
<PAGE>
counsel and the indemnifying party and its counsel shall reasonably keep
informed any such additional counsel selected by an indemnified party.
10. FEES AND COMMISSIONS;
a.) RHI will distribute fifty percent (50%) of "net commissions" to the
Bank received by it on all transactions of RHI at a Bank branch in
connection with existing and future customers through the Bank. Such
fees shall be paid on a monthly basis and shall include fees and
commissions generated by transactions in branch office customer
accounts payable to and received by RHI. RHI shall exercise
reasonable and diligent efforts to collect all fees and commissions
due it in connection with such transactions. "NET COMMISSIONS" for
purposes of this agreement is defined to include commissions and fees
net of all clearing and brokerage charges set forth in "10c" below and
any direct cost mutually agreed upon by the Bank and RHI.
b.) Employees of the Bank will receive discounts on all personal
securities trades in their accounts.
c.) The following schedule sets for the total commission and brokerage
charges for securities transactions executed through RHI. This
schedule is subject to change upon written notice by RHI to the Bank
or pursuant mutual agreement by the parties hereto.
<TABLE>
<CAPTION>
Order Variable Charges
----- ----------------
<S> <C> <C>
Listed: $25.00 + $0.20/share (Market orders 1-4, 999 shares)
Stocks + $0.30/share (Limit orders 1-4, 999 shares) or
+ $0.25/share (Market or Limit 5,000 shares and over)
Bonds $50.00
OTC Principal:
Stocks $35.00 + $0.25/share (Market or Limit orders on shares under $5,000)
+ $0.150/share (5,000 and over)
GNMA $50.00
Muni $50.00
Corporate $50.00
Treasury $50.00
Syndicate $50.00
Mutual Funds:
Load $50.00
No-Load $50.00
Exchange Fee $50.00
</TABLE>
11. TERM, TERMINATION, EVENT OF DEFAULT - This Agreement shall continue for an
initial term of two (2) years form the date first executed and may be
canceled by either party upon ninety (90) days written notice of
termination to the other party. Notwithstanding the foregoing, the Bank
may terminate this Agreement effective immediately, if the Bank's decision
is a result of an order by a court or regulator, or is made as a result of
litigation, challenging the offering of this service in which the Bank is a
party defendant.
During the term of this Agreement, the Bank will not offer or promote the
services contemplated by
<PAGE>
the Agreement through or by any broker or similar provider other than RHI.
In the event of termination of this Agreement, RHI agrees to release to the
Bank, at the Bank's request, all information the Bank may reasonably
require to continue servicing such Customers. RHI may notify and service
the Bank's Customers, if the Bank terminates the service contemplated by
this Agreement, and the Bank does not, within ninety (90) days thereafter,
provide or arrange for similar services to be provided to its Customers.
Customers may terminate their accounts at any time.
In the event of a challenge by a regulatory body, individual, or other
entity relating to the legality of the performance, by either party, of its
obligations under the provisions of the Agreement, which challenge may
impact the ability to make payments to the Bank hereunder, then the
amounts which would have been paid to the Bank hereunder shall be held in
escrow by RHI, pending resolution of such challenge. If the making of such
challenge is terminated by a settlement agreement, which does not preclude
or limit the making of such payments, such escrow funds will be paid over
to the Bank, with interest; the escrow funds are to be invested in an
account at any federally insured national bank. If the making of such
payment is ultimately determined to be impermissible, or is precluded or
limited pursuant to a settlement agreement relating to such challenge, such
amounts shall be retained by RHI; and the parties hereto shall discuss the
disposition of such amounts, consistent with the original intent of this
Agreement, and the determination of impermissibility of settlement.
12. MISCELLANEOUS - Neither the Bank nor RHI shall hold itself out as an agent
of the other, or any of the subsidiaries, or the companies controlled
directly or indirectly by, or affiliated with, the other.
Neither the Bank nor RHI shall, without having obtained prior approval of
the other, (which approval shall not be unreasonably withheld), distribute
solicitation material, place or agree to place any advertisement in any
manner that makes reference to the other and/or any of the services
embodied in this Agreement.
This Agreement shall inure to the benefit of, and be binding upon, the
successors and assignees of the parties hereto. This Agreement may not be
assigned by any party without the prior written consent of the other
parties. Neither this Agreement, nor activity hereunder, is intended to be
and shall not be treated as, a general or limited partnership, association
or joint venture.
Neither party hereto shall use any service mark, trade name, or trademark
of the other party without the prior written consent of the other, which
consent shall not be unreasonably withheld.
Each party shall have the exclusive right to any such name or mark
developed by it in connection with services performed by it under this
Agreement.
For the purposes of any and all notices, consents, directions, approvals,
requests or other communications required or permitted to be delivered
hereunder:
If to RHI, as follows: R H Investment Corporation, Inc.
Attn: A. L. "Bud" Byrnes, III
15760 Ventura Blvd., Suite 2040
Encino, CA 91436
If to Bank, as follows: Mercantile National Bank
1840 Century Park East
Los Angeles, CA 90067
This Agreement shall be construed in accordance with the laws of the State of
California.
<PAGE>
Any disputes under this Agreement, including interpretation of its terms and
conditions, and any rights and obligations of the parties hereunder shall be
arbitrated in accordance with the Rules of the N.A.S.D. with such arbitration to
occur in Los Angeles, California.
All obligations of the parties herein with respect to matters through the date
of termination of this Agreement shall survive the termination of this
Agreement.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly
executed as delivered as of the day and year first above written.
R H INVESTMENT CORPORATION, INC. MERCANTILE NATIONAL BANK
By /s/ A.L. "BUD" BYRNES, III By /s/ JOSEPH W. KILEY III
-------------------------------- ------------------------------------
A.L. "Bud" Byrnes, III Joseph W. Kiley III
Chief Executive Officer Executive Vice President & CFO
<PAGE>
WINDSOR FINANCIAL GROUP, INC.
INVESTMENT MANAGEMENT AGREEMENT
This Agreement made this first day of December, 1997 by and between
Mercantile National Bank, ("CLIENT") and Windsor Financial Group, Inc.,
("WFG").
WHEREAS, CLIENT wishes to retain WFG as its investment adviser to invest
and reinvest certain assets upon the terms and conditions set forth below; and
WHEREAS, WFG is willing to provide such investment advisory services to
CLIENT pursuant to these terms and conditions.
NOW, THEREFORE, the parties agree as follows:
1. INVESTMENT MANAGEMENT SERVICES. WFG will provide CLIENT with the
investment management services outlined in Schedule A attached hereto. As
CLIENT's investment advisor, WFG will keep CLIENT's investment portfolio
under continuous supervision. WFG will have no discretionary authority
with respect to specific investment decisions; rather, WFG will make
investment recommendations to an officer(s) designated by CLIENT for
approval prior to execution.
2. SAFEKEEPING OF ASSETS. All assets for which WFG acts as investment adviser
shall at all times be held by a custodian bank or broker/dealer in a
segregated safekeeping account. CLIENT shall furnish WFG with a copy of
all custody agreements between CLIENT and any designated custodian. WFG
will not be responsible for the safekeeping of CLIENT's securities held by
a custodian.
3. EXECUTION OF INVESTMENT DECISIONS. In order to execute CLIENT's investment
decisions, WFG will:
a. purchase, sell, invest and reinvest the assets of the portfolio
according to CLIENT's instructions; and
b. develop and maintain with CLIENT such procedures as are needed to
effect proper delivery of securities purchased and sold; to facilitate
payments, collections and the transmittal of funds; and to ensure the
prompt investment of any available cash, including income, the
proceeds of sales or redemptions, and such additional capital as may
be allocated from time to time to CLIENT's account.
4. COMPENSATION FOR SERVICES. The investment management fee for services
provided by WFG is set forth in Schedule B attached hereto. All fee
statements will be sent out at the beginning of each calendar quarter and
are due upon receipt.
5. REPORTS/MEETINGS. WFG will submit a quarterly status report to CLIENT
listing the assets of the portfolio and the portfolio's value as of the end
of the quarter. WFG will meet the CLIENT at least once per year, and more
frequently at CLIENT's request, to discuss the performance of CLIENT's
investment portfolio and any other matters relating to this Agreement.
6. SELECTION OF BROKERS. The board of directors will have sole discretion to
select brokers from a list provided by WFG to perform brokerage services in
connection with the purchase and sale of assets in the portfolio.
7. PAYMENT OF EXPENSES. WFG shall be responsible for the payment of all costs
and expenses related to the management of CLIENT's account, except for the
following expenses which shall be CLIENT's obligation:
<PAGE>
a. Fees paid for account or legal services rendered to the portfolio at
CLIENT's request;
a. Brokerage commissions and charges, including transfer taxes and
similar taxes incurred in the purchase and sale of securities for
CLIENT's account; and
c. Interest and taxes imposed upon CLIENT's portfolio with respect to its
income or ownership of securities.
8. SERVICES TO THIRD PARTIES. WFT is free to render services to third parties
similar to those rendered to CLIENT under this Agreement, except that no
services rendered to third parties may inhibit or interfere with WFG's
performance of services hereunder.
9. EFFECTIVE DATE/TERMINATION. The effective date of this Agreement shall be
January 1, 1998 and it shall continue into effect until December 31, 1998,
whereupon it may be terminated by either party with 30 days of prior
written notice. Client will be entitled to a refund of any unearned
advisory fees as of the date of termination.
10. NOTICES. Any written notice required under this Agreement shall be
personally delivered or forwarded by first class mail, postage prepaid,
addressed to WFG as follows:
Windsor Financial Group, Inc.
222 South Ninth Street, Suite 2790
Minneapolis, MN 55402
Attention: James A. Powell, Managing Director
and addressed to CLIENT as follows:
Mr. Joseph W. Kiley III
Executive Vice President & CFO
Mercantile National Bank
1840 Century Park East
Los Angeles, CA 90067
or at such other address or place as shall be directed in writing by the
parties.
11. GOVERNING LAW. This Agreement shall be construed and enforced in
accordance with the laws of the State of Minnesota.
12. LIABILITY OF WFG. WFG, its officers, employees and agents, shall not be
liable for any losses sutained by CLIENT's investment portfolio as a result
of the decrease in value of any securities in the portfolio or for any
other reason, whether or not such losses are attributable to any opinion,
action or failure to act by WFG, unless WFG fails to act in good faith or
is guilty of gross negligence or willful misconduct. Nothing herein shall
in any way constitute a waiver or limitation of CLIENT's rights under state
and federal securities laws.
13. ASSIGNMENT. This Agreement is not assignable by either party without the
written consent of the other party.
14. INVESTMENT ADVISERS ACT. WFG is, and will continue to be during the term
of this Agreement, registered under and in compliance with the Investment
Advisers Act of 1940.
<PAGE>
IN WITNESS WHEREOF, the parties executed this Agreement as of the day and year
first written above.
WINDSOR FINANCIAL GROUP, INC. CLIENT
By /s/ JAMES A. POWELL By /s/ JOSEPH W. KILEY III
-------------------------------- -------------------------------------
James A. Powell Joseph W. Kiley III
Managing Director Executive Vice President & CFO
Receipt is hereby acknowledged of a copy of Form ADV, Part II, as required by
the Securities Exchange Commission under Rule 204-3, under the Investment
Adviser's Act of 1940.
By /s/ JOSEPH W. KILEY III
--------------------------------
Joseph W. Kiley III
<PAGE>
ATTACHMENT A
BANK INVESTMENT MANAGEMENT
SERVICES PROVIDED
I. Fee based professional portfolio management to assist in the development
of appropriate investment asset strategies by qualified investment
professionals.
II. Enhanced reporting capabilities including quarterly performance evaluation
against an established benchmark.
III. Development of investment portfolio policies and strategies within the
context of bank management goals.
IV. Credit review of asset purchases.
V. Regular contact with professional portfolio manager regarding the
development of specific bank strategies.
VI. Client meetings as appropriate or deemed necessary by management with a
minimum of an annual on site meeting.
VII. Execution on all trades as necessary to implement bank investment
strategies.
VIII. Quantitative analysis of all purchases.
IX. Assistance in the pricing of public and other large deposits.
<PAGE>
SCHEDULE B
INVESTMENT PORTFOLIO MANAGEMENT
WINDSOR FINANCIAL GROUP, INC.
FEE SCHEDULE FOR 1/1/98 THROUGH 12/31/98
Par Value of the Portfolio as of 12/31/97 times .0007 (7 basis points)
To be paid in four installments at the beginning of each calendar quarter.
<PAGE>
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in the 1990 Stock Option Plan
Registration Statement No. 33-23303, the 1994 Stock Option Plan Registration
Statement No. 33-94828 and the 1996 Stock Incentive Plan Registration
Statement No. 333-33139 of our report dated January 23, 1998, appearing in
this Annual Report on Form 10-K of National Mercantile Bancorp for the year
ended December 31, 1997.
Los Angeles, California
March 11, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 4,186
<INT-BEARING-DEPOSITS> 250
<FED-FUNDS-SOLD> 11,900
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 26,478
<INVESTMENTS-CARRYING> 14,000
<INVESTMENTS-MARKET> 14,010
<LOANS> 61,252
<ALLOWANCE> 2,023
<TOTAL-ASSETS> 119,405
<DEPOSITS> 97,388
<SHORT-TERM> 8,550
<LIABILITIES-OTHER> 1,027
<LONG-TERM> 0
0
7,350
<COMMON> 24,613
<OTHER-SE> (19,523)
<TOTAL-LIABILITIES-AND-EQUITY> 119,405
<INTEREST-LOAN> 5,947
<INTEREST-INVEST> 1,940
<INTEREST-OTHER> 713
<INTEREST-TOTAL> 8,600
<INTEREST-DEPOSIT> 2,756
<INTEREST-EXPENSE> 2,856
<INTEREST-INCOME-NET> 5,744
<LOAN-LOSSES> 0
<SECURITIES-GAINS> (37)
<EXPENSE-OTHER> 6,098
<INCOME-PRETAX> 132
<INCOME-PRE-EXTRAORDINARY> 132
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 132
<EPS-PRIMARY> 0.20
<EPS-DILUTED> 0.08
<YIELD-ACTUAL> 5.63
<LOANS-NON> 1,201
<LOANS-PAST> 0
<LOANS-TROUBLED> 5,422
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 2,969
<CHARGE-OFFS> 1,315
<RECOVERIES> 369
<ALLOWANCE-CLOSE> 2,023
<ALLOWANCE-DOMESTIC> 1,424
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 599
</TABLE>
