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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE YEAR ENDED DECEMBER 31, 1999 COMMISSION FILE NUMBER 0-15982
NATIONAL MERCANTILE BANCORP
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA
(State or other jurisdiction of
incorporation or organization)
1840 CENTURY PARK EAST
LOS ANGELES, CALIFORNIA
(Address to principal executive offices)
95-3819685
(I.R.S. Employer
Identification No.)
90067
(Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (310) 277-2265
NO SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, NO PAR VALUE
SERIES A NONCUMULATIVE CONVERTIBLE PERPETUAL PREFERRED STOCK
(TITLE OF CLASS)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. /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-KSB. /_/
The aggregate market value of the voting common equity held by
non-affiliates of the registrant, based upon the closing sale price of its
Common Stock as reported by the National Association of Securities Dealers
Automated Quotation System on March 8, 2000, was approximately $6.0 million.
The number of shares of Common Stock, no par value, of the registrant
outstanding as of March 8, 2000 was 890,945.
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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 2000 Annual Meeting of Shareholders are
incorporated by reference in Part III, Items 10-13 of this Annual Report on Form
10-KSB.
THIS REPORT INCLUDES A TOTAL OF 66 PAGES
INDEX TO EXHIBITS ON PAGE 65
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NATIONAL MERCANTILE BANCORP
TABLE OF CONTENTS
FORM 10-KSB
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
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PAGE(S) IN
FORM
10-KSB
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PART I
Item 1. Business.................................................................................... 4
Item 2. Properties.................................................................................. 9
Item 3. Legal Proceedings........................................................................... 10
Item 4. Submission Of Matters To A Vote Of Security Holders......................................... 10
PART II
Item 5. Market For Registrant's Common Equity And Related Shareholder Matters...................... 10
Item 6. Management's Discussion And Analysis Of Financial Condition And Results Of Operations....... 12
Item 7. Financial Statements And Supplementary Data................................................. 40
Item 8. Changes In And Disagreements With Accountants On Accounting And Financial Disclosure........ 40
PART III
Item 9. Directors And Executive Officers Of The Registrant.......................................... 40
Item 10. Executive Compensation...................................................................... 40
Item 11. Security Ownership Of Certain Beneficial Owners And Management.............................. 40
Item 12. Certain Relationships And Related Transactions.............................................. 40
PART IV
Item 13. Exhibits, Financial Statement Schedules, And Reports On Form 8-K............................ 41
Signatures ............................................................................................ 42
Financial Statements..................................................................................... 46
Exhibit Index............................................................................................ 68
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Certain matters discussed in this Form 10-KSB may constitute
forward-looking statements within the meaning of the Securities Exchange Act of
1934 (the "Exchange 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-- Factors Which May Affect Future Operating Results".
PART I
ITEM 1. BUSINESS
National Mercantile Bancorp (the "Company") is a corporation which was
organized under the laws of the State of California in 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"), its wholly owned subsidiary. 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, unless the content requires otherwise references in
this Form 10-KSB to the "Company" reflect the consolidated activities of the
Company and Bank. The Company has been authorized by the Federal Reserve Bank
of San Francisco (the "Reserve Bank") to engage in lending activities
separate from the Bank but to date has not done so.
The Bank was organized in 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") in 1982. The Bank's
primary business activities are to generate loans and deposits.
The Company's present business strategy is attract individual and small
to mid-sized business borrowers in specific market niches located in its
primary service area by offering a variety of loan products and a full range
of banking services coupled with highly personalized service. The Company
lending products include revolving lines of credit, term loans and consumer
and home equity loans, which often contain terms and conditions tailored to
meet the specific demands of the market niche in which the borrower operates,
including the ability to evaluate the revenue streams supporting the loan.
Additionally, the Company provides a wide array of deposit and investment
products that are also designed to meet specific customer needs. In order to
provide the personalized service required by these customers, the Company
uses a team approach to customer service combining an experienced
relationship management officer with operations support personnel.
During the past several years the market niches targeted by the Company
have included the entertainment industry and professional services providers.
Entertainment industry customers include television, music and film
production companies, talent agencies, individual performers, entertainers,
directors and producers (whom the Company attracts by establishing
relationships with business management firms) and others affiliated with the
entertainment industry. Professional service customers include legal,
accounting, insurance, advertising firms and their individual directors,
officers, partners and shareholders.
In beginning of 2000 the Company expanded its targeted market niches to
include healthcare organizations and community-based non-profit
organizations. Healthcare organizations will include primarily outpatient
healthcare providers such as physician medical groups, independent practice
associations and surgery centers. Community-based non-profit organization
will include all such organizations that are based in the Company's primary
service area.
In order to grow and expand its array of products and services, the
Company may from time to time acquire other financial service-related
companies including "in-market' acquisitions with banks of similar size and
market presence. The Company has no current arrangements, understandings or
agreements regarding any such acquisition. No assurance can be made that the
Company will identify an acquisition which can be completed on terms and
conditions acceptable to the Company or that the Company could obtain the
necessary regulatory approvals for an acquisition.
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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 erode. In addition, many of the major
commercial banks operating in the Bank's primary service area offer services,
such as trust services, which are not offered directly by the Bank and, by
virtue of their greater total capitalization, such banks have substantially
higher lending limits than the Bank.
To compete with other financial institutions in its primary service area,
the Bank relies principally upon personal contact by its officers, directors and
employees and providing, through third parties, specialized services such as
messenger services and escrow accounting services. For clients whose loan
demands exceed the Bank's legal lending limit, the Bank will arrange 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 net income of the Bank is 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 United States government securities, varying the discount rate on
member bank borrowings and setting reserve requirements against deposits.
Federal Reserve Board 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, new legislation and other regulatory changes affecting bank
holding companies, banks 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 and other information with the Federal Reserve Board. The Federal
Reserve Board may conduct examinations of the Company and the Bank.
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, (iii) merge
or consolidate with another bank holding company, (iv) with certain exceptions,
from acquiring more than 5% of the voting shares of any company
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that is not a bank and (v) 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, (2) furnishing
services to, or performing services for, its subsidiaries, or (3) conducting
a safe deposit business. 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.
Under the BHC Act and regulations adopted by the Federal Reserve Board, a
bank holding company and its subsidiaries are prohibited from engaging in
certain tie-in arrangements in connection with any extension of credit, lease or
sale of property or financing of services.
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
OCC. As a national bank, the Bank 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.
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,
1999 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 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.
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The OCC regulations incorporate 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
compensation, fees and benefits, and prohibit 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 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.
FDIC. The Bank is subject to examination and regulation by the Federal
Deposit Insurance Corporation (the "FDIC") under the Federal Deposit Insurance
Act ("FDIA") because its deposit accounts are insured by the FDIC under the Bank
Insurance Fund ("BIF").
Under FDIC regulations, insured depository institution's are assigned to
one of three capital groups for insurance premium purposes -- "well
capitalized," "adequately capitalized" and "undercapitalized" -- which are
defined in the same manner as the regulations establishing the prompt corrective
action system under Section 38 of the FDIA, as discussed under "Capital Adequacy
Requirements" below. These three groups are then divided into subgroups which
are based on supervisory evaluations by the institution's primary federal
regulator, resulting in nine assessment classifications. Assessment rates for
BIF-insured banks range from 0% of insured deposits for well-capitalized banks
with minor supervisory concerns to 0.027% of insured deposits for
undercapitalized banks with substantial supervisory concerns.
The FDIC may terminate the deposit insurance of any insured depository
institution if the FDIC determines, after a hearing, that the institution has
engaged or is engaging in unsafe or unsound practices which, as with the OCC's
enforcement authority, are not limited to cases of capital inadequacy, is in an
unsafe or unsound condition to continue operations or has violated any
applicable law, regulation or order or any condition imposed in writing by the
FDIC. In addition, FDIC regulations provide that any insured institution that
falls below a 2% minimum leverage ratio (see below) will be subject to FDIC
deposit insurance termination proceedings unless it has submitted, and is in
compliance with, a capital plan with its primary federal regulator and the FDIC.
The FDIC may also suspend deposit insurance temporarily during the hearing
process if the institution has no tangible capital. The FDIC is additionally
authorized by statute to appoint itself as conservator or receiver of an insured
depository institution (in addition to the powers of the institution's primary
federal regulatory authority) in cases, among others and upon compliance with
certain procedures, of unsafe or unsound conditions or practices or willful
violations of cease and desist orders.
CRA. 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.
In the most recently completed CRA compliance examination, conducted in
March 1998 the OCC assigned the Bank a rating of "satisfactory," the second
highest of four possible ratings. The CRA regulations governing the
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Company and the Bank emphasize 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 regulations also require certain levels of collection and reporting of data
regarding certain kinds of loans.
RECENT LEGISLATION
In November 1999, the Gramm-Leach-Bliley Act (the "GLB Act") became law.
The GLB Act creates a new type of bank holding company known as a "financial
holding company" which may engage in a range of activities that are financial
in nature, including insurance and securities underwriting, insurance sales,
merchant banking, providing financial, investment, or economic advisory
services, any activity that a bank holding company may engage in outside of
the United States, and additional activities that the Federal Reserve Board,
in consultation with the Secretary of the Treasury, determines to be
financial in nature, incidental to a financial activity, or complementary to
a financial activity. The GLB Act establishes the Federal Reserve Board as
the primary regulator of financial holding companies.
In order for a bank holding company to be treated as a financial holding
company, all of the depository institution subsidiaries of the bank holding
company must be well capitalized and well managed, and must have achieved a
rating of satisfactory or better at the most recent Community Reinvestment
Act examination of each such institution. In addition, a bank holding company
must file with the Federal Reserve Board a declaration that the bank holding
company elects to be a financial holding company to engage in activities or
acquire and retain shares of a company that were not permissible for a bank
holding company to engage in or acquire before the enactment of the GLB Act,
and a certification that all of the depository institution subsidiaries of
the bank holding company are well capitalized and well managed. The Federal
Reserve Board recently proposed but has not yet adopted regulations that
establish requirements for the submission of the declaration and the
certification.
The Company has yet to decide whether it will elect to be treated as a
financial holding company.
The GLB Act also repealed the Glass-Steagall Act of 1933, which
separated commercial and investment banking. As a result, the GLB Act permits
the affiliation of commercial banks, securities firms and insurance
companies. This change may increase the ability of insurance companies and
securities firms to acquire, or otherwise affiliate with, commercial banks
and may increase the number of competitors in the banking industry and the
level of competition for banking products.
The GLB Act also establishes new privacy requirements applicable to all
financial institutions. Financial institutions are required to establish a
privacy policy and to disclose the policy at the start of a customer
relationship and once a year thereafter. Additionally, financial institutions
must give a customer the opportunity to block the sharing of the customer's
nonpublic personal information with unaffiliated third parties, except in
certain limited circumstances. Further, financial institutions are barred
from sharing account numbers, credit card numbers or access numbers of
customers with third-party marketers.
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 from 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.
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, 1999, the Company had a Tier 1 leverage ratio
of 8.98% and the Bank's Tier 1 leverage ratio was 8.32%.
The OCC has adopted regulations 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 as of December 31, 1999 the minimum
total risk-based capital, Tier 1 risk-based capital and Tier 1 leverage ratios,
all of which must be satisfied for a bank to be classified as well capitalized,
adequately capitalized or undercapitalized, respectively, together with the
Company's and Bank's ratios which in all cases exceed the well capitalized
minimums:
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TOTAL TIER 1 TIER 1
RISK-BASED RISK-BASED LEVERAGE
CAPITAL RATIO CAPITAL RATIO RATIO
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Actual:
National Mercantile Bancorp.............................. 17.47% 16.21% 8.98%
Mercantile National Bank................................. 16.29% 15.03% 8.32%
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%
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(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.
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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.
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. 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 28, 2000, the Company had six officers but no employees and
the Bank had 48 full-time equivalent employees (including three of whom were
also officers of the Company). 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.
ITEM 2. PROPERTIES
The Bank leases approximately 24,000 square feet in an office building at
1840 Century Park East, Century City, California. The effective rent under this
lease is $2.33 per square feet 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.
In connection with the lease, the Company issued the landlord a warrant
to purchase up to 9.9% of the outstanding shares of capital stock of the
Company at December 31, 1997. The exercise price of the warrant is currently
$5.00 per share of Common Stock and $10.00 per share of Series A
Noncumulative Convertible Perpetual Preferred Stock. The warrant expires on
December 31, 2002. The Company also granted the landlord registration rights
with respect to capital stock purchased by the landlord (or its assignee)
pursuant to the warrant.
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The Company does not directly own or lease any property. Its administrative
offices are located at the Bank's headquarters.
ITEM 3. LEGAL PROCEEDINGS
The Company is from time to time a party to lawsuits in the ordinary course
of business. The Company does not believe that any lawsuits pending at December
31, 1999 will have a material adverse effect on the financial condition of 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
quarter ended December 31, 1999.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Common Stock and Series A Noncumulative Convertible Perpetual
Preferred Stock (the "Series A Preferred") of the Company are traded on the
Nasdaq SmallCap Market, under the symbols MBLA and MBLAP, respectively. The
following table shows the high and low trade prices of the Common Stock and
Series A Preferred for each quarter of 1998 and 1999 as reported by the
Nasdaq. Additionally, there may have been transactions at prices other than
those shown during that time.
<TABLE>
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SERIES A
COMMON STOCK PREFERRED
------------ --------------
QUARTER ENDED: HIGH LOW HIGH LOW
- ------------- ---- ---- ----- -----
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March 31, 1998.............................. 7.50 6.00 14.50 13.50
June 30, 1998............................... 7.63 6.50 15.00 14.00
September 30, 1998.......................... 6.88 5.75 13.75 12.00
December 31, 1998........................... 6.00 4.00 11.75 8.50
March 31, 1999.............................. 5.25 4.00 10.63 8.75
June 30, 1999............................... 5.25 3.75 10.25 7.38
September 30, 1999.......................... 5.25 4.50 10.00 9.00
December 31, 1999........................... 5.00 3.75 9.88 8.00
</TABLE>
The prices of the Common Stock stated above have been restated to
reflect the 100% common stock dividend paid in February 1998.
At March 8, 2000, the Company had 217 shareholders of record for its Common
Stock and 27 shareholders of record for its Series A Preferred. The number of
beneficial owners for the Common Stock and Series A Preferred is higher as many
people hold their shares in "street" name. At March 8, 2000, approximately 81%
and 19% of the Common Stock and Series A Preferred, respectively, were held in
street name.
The Company has not paid a cash dividend on the Common Stock since July
1990, and has never paid a cash dividend on the Series A Preferred. The Series A
Preferred is entitled to a noncumulative cash dividend at a rate of 6.5% of its
liquidation preference quarterly on the first day of January, April, July, and
October of each year, commencing October 1, 1999, before any dividend may be
declared upon or paid upon the Common Stock. As a California corporation, under
the California General Corporation Law, generally the Company may not pay
dividends in cash or property except (ii) out of positive retained earnings or
(ii) if, after giving effect to the distribution, the Company's assets would be
at least 1.25 times its liabilities and its current assets would exceed its
current liabilities (determined on a consolidated basis under generally accepted
accounting principles). At December
Page 10
<PAGE>
31, 1999, the Company had an accumulated deficit of $17.9 million. Further, it
is unlikely the Company's assets will ever be at least 1.25 times its
liabilities. Accordingly, the Company must generate net income of in excess of
$17.9 million before it can pay a dividend in cash or property.
Page 11
<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The operating results for 1999 reflected a continuation of the trends
since 1997 of growth in total assets and reduction of nonperforming and
classified assets. The 1999 results reflected management's continued plan to
restructure the balance sheet in order to increase operating revenues while
containing operating expenses. The Company recorded net income of $1.0
million or $0.41 diluted earnings per share for 1999, compared with net
income of $645,000 or $0.25 diluted per share for 1998. The improvement in
earnings during 1999 compared to 1998 was the result principally of an
increase in the net interest income of $391,000 brought about by the growth
in securities and loan portfolios.
The Company's total assets of $156.2 million at December 31, 1999
represented an increase of $14.5 million or 10.3% from total assets of $141.6
million at December 31, 1998. This increase was funded primarily by an
increase of $10.0 million in deposits and an increase of $5.9 million in
other borrowed funds. Substantially all asset growth was in the loan
portfolio. Loans receivable increased to $73.8 million at December 31, 1999
from $57.0 million at December 31, 1998. This $16.9 million increase included
$17.9 million growth in commercial loans, of which $8.4 million were loans to
entertainment industry related borrowers. Securities available-for-sale
decreased 1.4% to $69.5 million at December 31, 1999 compared to $70.5
million at December 31, 1998.
The allowance for credit losses was $1.9 million or 2.6% of loans
receivable at December 31, 1999 compared to $2.1 million or 3.8% of loans
receivable at December 31, 1998. This decrease was primarily the result of net
loan charge-offs of $248,000 during 1999, combined with the increase in the
overall loan portfolio. Nonaccrual loans decreased to $932,000 at December 31,
1999 or 1.3% of loans receivable compared to $1.5 million or 2.6% of loans
receivable at December 31, 1998. Other real estate owned totaled $382,000 at
year-end 1999, a decrease of 35.6 % from $593,000 a year earlier.
<TABLE>
<CAPTION>
INCREASE
(DECREASE)
-------------
1999 AMOUNT % 1998
-------- ------- ----- --------
<S> <C> <C> <C> <C>
Interest income................................... $ 10,545 $ 464 4.6% $ 10,081
Interest expense.................................. 3,558 73 2.1% 3,485
-------- ------- ----- --------
Net interest income............................... 6,987 391 5.9% 6,596
Provision for credit losses....................... - - -
Other operating income............................ 698 (157) (18.4%) 855
Other operating expense........................... 6,624 (174) (2.6%) 6.798
-------- ----- ----- --------
Income before income taxes........................ 1,061 408 62.5% 653
Income taxes...................................... 47 39 0.0% 8
-------- ----- ----- --------
Net income...................................... $ 1,014 $ 369 57.2% $ 645
======== ===== ===== ========
</TABLE>
Page 12
<PAGE>
OPERATIONS SUMMARY ANALYSIS
NET INTEREST INCOME
The Company's earnings depend largely upon the difference between the
income earned on its loans and other investments and the interest paid on its
deposits and borrowed funds. This difference is net interest income. The
Company's ability to generate 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 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.
1999 COMPARED TO 1998
Net interest income increased $391,000 to $7.0 million during 1999. The
components of net interest income continued to change during 1999, reflecting an
increase in interest income from investment securities, compared to 1998.
Average earning assets increased during 1999 to $139.5 million compared to
$127.2 million during 1998. This increase was primarily the result of a $19.3
million increase in average investment securities complemented by the increase
in average deposits of $3.0 million combined with a $8.8 million increase in
average other borrowed funds.
The weighted average yield on interest-earning assets was 7.56% during
1999, a decrease from the weighted average yield of 7.93% during 1998, primarily
as a result of increased volume of investment securities which represented a
higher proportion of average interest earning assets during 1999 compared to
1998, and typically yield less than loans. During 1999, the rates paid on
interest-bearing liabilities decreased compared with 1998 averaging 4.08% in
1999 and 4.37% in 1998 primarily resulting from a downward shift in the average
balance of higher cost non relationship "money desk" deposits during 1999. As a
result, the net yield on interest-earning assets decreased to 5.01% during 1999,
from 5.19% during 1998.
Average loans receivable increased 3.6% to $61.8 million in 1999 from $59.7
million in 1998. This increase was reflected by the growth of the commercial
loan portfolio due to the Company's emphasis in this area.
Average total investment securities increased 32.7% to $70.1 million during
1999 from $52.8 million during 1998. Although year-end balances of investment
securities remained virtually unchanged at December 31, 1999 compared to
December 31, 1998, the growth in average investment securities during 1999
compared to 1998 was reflective of the significant growth of investment
securities during 1998 combined with the fact that the year-end balances at
December 31, 1998 were maintained throughout 1999. The average yield on
investment securities decreased to 6.25% during 1999 compared to 6.34% during
1998.
Average non-interest bearing deposits increased 10.7% to $45.5 million
during 1999 compared to $41.1 million during 1998. Conversely, average
interest-bearing deposits decreased $1.4 million or 2.1% to $66.9 million during
1999 compared to $68.3 million during 1998. Overall average deposit increases
were the result of increased marketing efforts particularly in the business
banking and entertainment divisions. Offsetting these increases was a planned
decrease in higher rate nonrelationship "money desk" deposits to lower cost
relationship related deposits.
Average other borrowed funds, represented collectively by federal funds
purchased, securities sold under agreements to repurchase and other
borrowings, increased 75.8% to $20.3 million during 1999 compared to $11.6
million during 1998. The Company utilized these other borrowings to finance
its growth rather than higher cost "money desk" deposits which would be
inconsistent with the Company's strategy to increase core deposits as a
percentage of its total deposits.
Page 13
<PAGE>
TABLE 2
RATIOS TO AVERAGE ASSETS
<TABLE>
<CAPTION>
1999 1998
------- ------
<S> <C> <C>
Net interest income ...................... 4.78% 4.89%
Other operating income ................... 0.48% 0.63%
Provision for credit losses .............. 0.00% 0.00%
Other operating expense .................. (4.53%) (5.04%)
---- ----
Income before income taxes ............... 0.73% 0.48%
---- ----
Net income ............................ 0.69% 0.48%
==== ====
</TABLE>
INTEREST RATE SPREAD AND NET INTEREST MARGIN
The Company analyzes its earnings performance using, among other
measures, the interest rate spread and net interest margin. The interest rate
spread represents the difference between the weighted average yield received
on interest-earning assets and the weighted average rate paid on
interest-bearing liabilities. Net interest margin is net interest income
expressed as a percentage of average total interest-earning assets (net yield
on interest-earning assets). The Company's net interest margin 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 Company's control, such as federal economic policies, the general supply
of money in the economy, legislative tax policies, governmental budgetary
matters, and actions 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 weighted average yield on each category of interest-earning assets, the
weighted average rate paid on each category of interest-bearing liabilities,
and the resulting interest rate spread and net yield on interest-earning
assets for 1999 and 1998. 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 the Company does not realize such tax benefit due
to the utilization of net operating loss carryforwards.
The Company's net interest margin 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 $45.5 million, representing 40.5%
of average deposits, during 1999, compared to $41.1 million, representing
37.6% of average deposits, during 1998. Of these noninterest-bearing demand
deposits during 1999, $14.7 million or 32.2% of average noninterest-bearing
deposits were represented by real estate title and escrow company deposits,
compared to $15.5 million or 37.8% of average noninterest-bearing deposits
during 1998. While these deposits are noninterest-bearing, they are not
cost-free funds. Customer service expenses, primarily costs related to
external accounting and data processing services provided to title and escrow
company depositors are incurred by the Company to the extent that such
depositors maintain certain average noninterest-bearing deposits. Customer
service expense is classified as other operating expense. If customer service
expenses related to escrow customers had been classified as interest expense,
the Company's reported net interest income for 1999 and 1998, would have been
reduced by $435,000 and $556,000, respectively. Similarly, this would create
identical reductions in other operating expense. The net yield on
interest-earning assets for 1999 and 1998, would have decreased 31 basis
points and 44 basis points, respectively.
Page 14
<PAGE>
TABLE 3
INCREASE (DECREASE) IN INTEREST INCOME/EXPENSE DUE TO CHANGE IN
AVERAGE VOLUME AND AVERAGE RATE (1)
<TABLE>
<CAPTION>
1999 VS 1998
------------------------------------------
INCREASE (INCREASED) DUE TO: NET
--------------------------- INCREASE
VOLUME RATE (DECREASE)
---------- ---------- -------------
(Dollars in thousands)
<S> <C> <C> <C>
Interest Income:
Federal funds sold and securities purchased under agreement to resell.... $ (371) $ (26) $ (397)
Interest-bearing deposits with other financial institutions.............. (13) - (13)
Securities held-to-maturity.............................................. (134) - (134)
Securities available-for-sale............................................ 1,220 (56) 1,164
Loans receivable(2)...................................................... 213 (369) (156)
---------- ---------- -------------
Total interest-earning assets......................................... 915 (451) 464
---------- ---------- -------------
Interest Expense:
Interest-bearing deposits:
Demand................................................................ $ (7) $ 3 $ (4)
Money market... ...................................................... 121 (85) 36
Savings............................................................... (45) (1) (46)
Time certificates of deposit:
$100,000 or more................................................... 322 (114) 208
Under $100,000..................................................... (478) (46) (524)
---------- ---------- -------------
Total time certificates of deposit.................................... (156) (160) (316)
---------- ---------- -------------
Total interest-bearing deposits....................................... (87) (243) (330)
Other borrowings......................................................... (64) (21) (85)
Federal funds purchased and securities sold under agreements to
repurchase.............................................................. 549 (61) 488
---------- ---------- -------------
Total interest-bearing liabilities................................. 398 (325) 73
---------- ---------- -------------
Net interest income................................................... $ 517 $ (126) $ 391
========== ========== =============
</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 15
<PAGE>
TABLE 4
AVERAGE BALANCE SHEET AND
ANALYSIS OF NET INTEREST INCOME
<TABLE>
<CAPTION>
1999 1998
---------------------------------- ----------------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
AMOUNT EXPENSE RATE AMOUNT EXPENSE RATE
------------ --------- -------- ------------ --------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Assets:
Federal funds sold and securities purchased under
agreements to resell................................... $ 7,623 $ 385 5.05% $ 14,493 $ 782 5.40%
Interest-bearing deposits with other financial
institutions .......................................... - - - 214 13 6.07%
Securities held-to-maturity ............................ - - - 2,019 134 6.64%
Securities available-for-sale........................... 70,068 4,379 6.25% 50,788 3,215 6.33%
Loans receivable(1)(2).................................. 61,799 5,781 9.35% 59,663 5,937 9.95%
------------ --------- ------------ ---------
Total interest earning assets....................... 139,490 10,545 7.56% 127,177 10,081 7.93%
--------- ---------
Noninterest earning assets:
Cash and due from banks - demand...................... 7,103 6,403
Other assets.......................................... 2,811 3,225
Allowance for credit losses and net unrealized (loss)
gain on sale of securities available-for-sale........ (3,080) (1,843)
------------ ------------
Total assets........................................ $146,324 $134,962
============ ============
Liabilities and shareholders' equity:
Interest-bearing deposits:
Demand................................................ $ 6,918 $ 91 1.32% $ 7,467 $ 95 $ 1.27%
Money market.......................................... 27,999 805 2.88% 24,179 769 3.18%
Savings .............................................. 1,526 31 2.08% 3,697 77 2.08%
Time certificates of deposit:
$100,000 or more.................................... 19,664 996 5.07% 13,955 788 5.65%
Under $100,000...................................... 10,769 580 5.39% 18,985 1,104 5.82%
------------ --------- ------------ ---------
Total time certificates of deposit.................. 30,433 1,576 5.18% 32,940 1,892 5.74%
------------ --------- ------------ ---------
Total interest-bearing deposits..................... 66,876 2,503 3.74% 68,283 2,833 4.15%
Other borrowings........................................ 19,121 1,005 5.26% 9,276 517 5.57%
Federal funds purchased and securities sold under
agreements to repurchase............................... 1,194 50 4.19% 2,279 135 5.92%
------------ --------- ------------ ---------
Total interest-bearing liabilities.................. 87,191 3,558 4.08% 79,838 3,485 4.37%
--------- ---------
Noninterest-bearing liabilities:
Noninterest bearing demand deposits................... 45,495 41,110
Other liabilities..................................... 1,094 1,001
Shareholders'equity..................................... 12,544 13,013
--------- ---------
Total liabilities and shareholders' equity.............. $146,324 $134,962
========= =========
Net interest income (spread)............................ $ 6,987 3.48% $ 6,596 3.56%
========= =========
Net interest margin(2)..................... 5.01% 5.19%
</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
$145,000 and $200,000 for the years ended December 31, 1999 and 1998,
respectively.
Page 16
<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 are determined
through periodic analysis of the loan portfolio. This analysis includes a
detailed review of the classification and categorization of 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). Management, in
combination with an outside firm, performs a periodic risk and credit analysis
the results of which are reported to the Board of Directors.
For 1999 and 1998, the Company did not record a provision for credit
losses. In 1999 net loan charge-offs were $248,000 compared to net loan
recoveries of $121,000 in 1998.
The Company did not record a provision for credit losses for the past
two years due to a combination of the leveling-off of net charge offs
including net recoveries during 1998; the continued reduction in problem
loans; and the improvement of the Southern California economy. Based on
continued loan growth, the level of non-performing loans, anticipated
recoveries in the first half of 2000 of loans previously charged-off and a
relatively constant level of charge-offs, it is anticipated that the level of
the allowance will remain adequate through the first half of 2000 without a
provision for credit losses. However, credit quality will be influenced by
underlying trends in the economic cycle, particularly Southern California,
and other factors which are beyond management's control. Accordingly no
assurance can be given that the Company will not sustain loan losses that in any
particular period 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 changes
to the provision for credit losses.
OTHER OPERATING INCOME
Other operating income was $698,000 and $855,000 in 1999 and 1998,
respectively. A breakdown of other operating income by category is reflected
below:
TABLE 5
OTHER OPERATING INCOME
<TABLE>
<CAPTION>
1999 1998
------------ -----------
<S> <C> <C>
OTHER OPERATING (LOSSES) INCOME:
SECURITIES TRANSACTIONS:
Net (loss) gain on sale of securities available-for-sale........... $ (1) $ 39
FEE INCOME:
International services............................................. 87 84
Investment services............... ................................ 60 43
Deposit and other customer services................................ 552 540
OTHER:
Reconveyance fees.................................................. - 81
Gain on other real estate owned and fixed assets................... - 68
------------ -----------
Total other operating income...................................... $ 698 $ 855
============ ===========
</TABLE>
Page 17
<PAGE>
SECURITIES TRANSACTIONS
During 1999 the Company recorded a net loss on the sale of $2.1 million
of securities available-for-sale of $1,000. During 1998, the Company sold
$6.1 million of investment securities available-for-sale, realizing a net
gain of $26,000. In addition, as a result of the overall downward trend in
market interest rates during 1998, issuers of securities with an optional
principal redemption feature elected to exercise such "call options".
Consequently, during 1998 $26.7 million of these callable securities were
called prior to final maturity realizing a net gain of $13,000.
FEE INCOME
Fee income related to international, investment and deposit and other
customer services increased by $32,000 or 4.8% to $699,000 during 1999,
compared to equivalent fee income of $667,000 in 1998. This increase is
primarily due to deposit growth of "transaction" type accounts during 1999.
OTHER INCOME
Other income for 1998 included $81,000 representing the reconveyance fee
associated with the full collection of one large nonperforming loan, while
the gain on the sale of other real estate owned and fixed assets amounted to
$68,000 during 1998. No such income was realized during 1999.
OTHER OPERATING EXPENSES
Other operating expenses totaled $6.6 million in 1999 compared to $6.8
million in 1998. A breakdown of other operating expense by category is reflected
below:
TABLE 6
OTHER OPERATING EXPENSES
<TABLE>
<CAPTION>
1999 1998
------------ -----------
<S> <C> <C>
OTHER OPERATING EXPENSES:
Salaries and related benefits...................................... $ 3,229 $ 3,168
Net occupancy...................................................... 1,002 903
Furniture and equipment............................................ 217 287
Printing and communications........................................ 265 231
Insurance and regulatory assessments............................... 297 304
Customer services.................................................. 673 797
Computer data processing........................................... 311 264
Legal services..................................................... 70 146
Other professional services........................................ 301 300
Other real estate owned expenses................................... 45 141
Promotion and other expenses....................................... 214 257
------------ -----------
Total other operating expenses.............................. $ 6,624 $ 6,798
============ ===========
</TABLE>
The 2.6% decrease in other operating expense was primarily attributable to
increased deferred loan origination costs caused by increased loan volume and an
increase in the costs allowed under Statement of Financial
Page 18
<PAGE>
Accounting Standard No. 91 "Accounting for Deferred Loan Origination Fees and
Costs". This $230,000 increase in deferred cost offset the increase of $226,000
in salary expense, excluding payroll taxes and related benefits.
The 11.0% increase in net occupancy expense, which totaled $1.0 million
during 1999 compared to $903,000 during 1998, was caused by increased escalation
and operating costs associated with the Company's corporate and retail premises
lease. Furniture and equipment expenses decreased 24.4% during 1999 to $217,000,
compared to 287,000 during 1998 as a result of reduced depreciation costs caused
by the deletion of certain computer equipment during 1998. This caused an
acceleration of depreciation expense during 1998 associated with the computer
equipment that was replaced. Customer service expenses decreased 15.6% during
1999 to $673,000 from $797,000 during 1998 caused primarily by decreased cost
associated with the 5.8% decrease in average real estate title and escrow
deposits which averaged $14.7 million during 1999 compared to $15.5 million
during 1998. OREO expenses decreased $96,000 to $45,000 during 1999 compared to
$141,000 during 1998 primarily as a result of a valuation adjustment totaling
$100,000 recorded during 1998. Legal expenses decreased 52.1% to $70,000 during
1999 from $146,000 during 1998 primarily due to recoveries of previously
expensed legal costs associated with the collection efforts of various loans
during 1999.
INCOME TAXES
Deferred tax assets and liabilities are recognized for the expected future
tax consequences of existing differences between financial reporting and tax
reporting basis of assets and liabilities, as well as for operating losses and
tax credit carryforwards, using enacted tax laws and rates. Deferred tax assets
will be reduced through a valuation allowance whenever it becomes more likely
than not that all or some portion will not be realized. Deferred income taxes
(benefit) 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 (benefit) for
the year. At December 31, 1999, the Company's net deferred tax asset totaled
$8.3 million, which was fully reserved.
The Company's deferred tax asset consists primarily of federal and state
NOL's that total $20.3 and $4.7 million, respectively. The federal NOL's
expire beginning in 2007 through 2012 and the California carryforwards expire
beginning in 2000 through 2002.
No income tax provision was recorded during 1999 and 1998 other than
alternative minimum tax of $47,000 and $8,000, respectively, due to the
utilization of previously unrecognized tax benefits to offset current period tax
liability.
Additionally, federal and state income tax laws provide that following an
ownership change of a corporation with a NOL, 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, built-in losses or tax credit
carryovers 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 future taxable income by the NOL's could be
severely limited.
ACCUMULATED OTHER COMPREHENSIVE INCOME
Changes in the unrealized gain (loss) on available-for-sale securities is
the only component of other comprehensive income for the Company. At December
31, 1999 the unrealized loss on available-for-sale securities was $2.5 million
compared to an unrealized gain of $211,000 at December 31, 1998.
Page 19
<PAGE>
During 1999 the U.S. economy experienced an overall increase in general
market interest rates. For instance, during 1999 the interest rate on a
30-year U.S. Treasury Note increased to 6.48% at December 31, 1999 from 5.09%
at December 31, 1998. This increase, which on a total return basis was one of
the most significant in history, adversely affected the estimated fair value
of the Company's portfolio of primarily fixed-rate available-for-sale
securities, causing the unrealized loss at December 31, 1999.
FINANCIAL CONDITION
REGULATORY CAPITAL
At December 31, 1999, the Company's and Bank's Tier 1 capital, which is
comprised of shareholders' equity as modified by certain regulatory adjustments,
amounted to $14.1 million and $12.9 million, respectively. At December 31, 1998,
the Company's and the Bank's Tier 1 capital amounted to $13.0 million and $9.7
million, respectively. On July 31, 1999 the Company contributed $2.4 million of
capital to the Bank which enabled it to increase its legal lending limit and
provide capital for continued growth. 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, 1999 and 1998.
TABLE 7
REGULATORY CAPITAL INFORMATION
OF THE COMPANY AND BANK
<TABLE>
<CAPTION>
DECEMBER 31,
WELL CAPITALIZED ------------------------
STANDARDS 1999 1998
------------------ ---------- ----------
<S> <C> <C> <C>
COMPANY:
Tier 1 leverage ........................ 5.00% 8.98% 8.78%
Tier 1 risk-based capital .............. 6.00% 16.21% 17.38%
Total risk-based capital ............... 10.00% 17.47% 18.65%
BANK:
Tier 1 leverage ........................ 5.00% 8.32% 6.69%
Tier 1 risk-based capital .............. 6.00% 15.03% 13.48%
Total risk-based capital ............... 10.00% 16.29% 14.75%
</TABLE>
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. The
Company's liquidity position is enhanced by its ability to raise additional
funds as needed through available borrowing or accessing the wholesale
deposit market.
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 85.4% and 90.7% of funding for average total
assets in 1999 and 1998, respectively. This reduction of 5.3% was directly
attributable to the increased volume of LIBOR interest rate index based
borrowings, the proceeds of which were used to purchase LIBOR based investment
securities.
A significant portion of remaining funding of average total assets is
provided by other borrowings, specifically FHLB advances, which averaged $19.1
million during 1999 compared to $9.3 million during 1998.
Page 20
<PAGE>
Liquidity is also provided by assets such as federal funds sold and
securities purchased under resale agreements which may be immediately
converted to cash at minimal cost. The aggregate of these assets averaged
$7.6 million during 1999, as compared to $14.5 million during 1998. This
decrease resulted primarily from the growth in the Company's average
investment securities portfolio during 1999.
Liquidity is also provided by the portfolio of available-for-sale
securities, which averaged $70.1 million during 1999. In addition, the unpledged
portion of investment securities at December 31, 1999 totaled $40.2 million and
would be available as collateral for borrowings. Maturing loans also provide
liquidity, of which $22.9 million of the Bank's loans are scheduled to mature in
2000.
ASSET LIABILITY MANAGEMENT
The principal objective of the Company's asset/liability management is
to maximize the net yield on interest-earning assets subject to margin
volatility and liquidity constraints. Margin volatility results when the rate
reset (or repricing) characteristics of the Company's interest-earning assets
are materially different from those of its interest-bearing liabilities.
Liquidity risk results from the mismatching of asset and liability cash
flows. Management chooses asset/liability strategies that are intended to
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, is
used to estimate the theoretical price sensitivity of shareholders' equity to
changes in interest rates.
Generally, an asset sensitive gap indicates that net interest income
will improve during a period of rising interest rates while a liability
sensitive gap indicates that net interest income will improve during a period
of declining interest rates. Conversely, an asset sensitive gap indicates
that net interest income will drop during a period declining interest rates,
while a liability sensitive gap indicates that net interest income will drop
during a period of rising interest rates. The gap report is based on the
contractual cash flows of the Company's assets and liabilities. The
contractual life of these assets and liabilities may differ substantially
from their expected lives however. For example, checking accounts are subject
to immediate withdrawal. Experience suggests that these accounts will have an
average life of several years. Also, certain loans are subject to prepayment.
The cash flows shown in the gap report are adjusted to reflect these
behaviors.
Table 8 compares the Company's interest rate gap position as of December
31, 1999 and 1998. The gap report shows the Company's cumulative one year
interest rate asset sensitivity gap of $12.7 million at December 31, 1999, a
change from as asset sensitivity gap of $11.9 million at December 31, 1998. The
Company has increased its loan receivable portfolio that reprice within one year
to $48.8 million at December 31, 1999 compared to $40.0 million at December 31,
1998. This change was offset by an increase in borrowings, which reprice within
one year to $23.7 million at December 31, 1999 compared to $20.3 million at
December 31, 1998 along with increases in time certificates of deposits which
reprice within one year to $24.7 million at year end 1999 from $20.8 million at
year end 1998.
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 changing interest rates. This process allows the Company to
fully explore the complex relationships within the gap over time and various
interest rate scenarios.
Page 21
<PAGE>
At December 31, 1999 and 1998, the Company's distribution of
rate-sensitive assets and liabilities was as follows:
TABLE 8
RATE-SENSITIVE ASSETS AND LIABILITIES
<TABLE>
<CAPTION>
DECEMBER 31, 1999
-----------------------------------------------------------
MATURING OR REPRICING IN
-----------------------------------------------------------
LESS AFTER THREE AFTER ONE
THAN MONTHS YEAR
THREE BUT WITHIN BUT WITHIN AFTER
MONTHS ONE YEAR 5 YEARS 5 YEARS TOTAL
-------- ------------ ---------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Rate-Sensitive Assets:
Federal funds sold and securities
purchased under agreements to resell............. $ 4,450 $ -- $ -- $ -- $ 4,450
Securities available-for-sale, at amortized cost.. 15,991 5,214 30,283 20,476 71,964
FRB and other stock, at cost...................... -- -- -- 1,746 1,746
Loans receivable.................................. 40,617 8,197 13,018 12,011 73,843
------- ------- -------- ------- --------
Total rate-sensitive assets................... 61,058 13,411 43,300 34,233 152,003
Rate-Sensitive Liabilities:
Interest bearing deposits:
Demand, money market and savings................ 4,111 9,250 13,406 10,357 37,124
Time certificates of deposit.................... 11,299 13,425 1,309 -- 26,033
Other borrowings.................................. 23,700 -- 2,500 -- 26,200
------- ------- -------- ------- --------
Total rate-sensitive liabilities................ 39,110 22,675 17,215 10,357 89,357
Interest rate-sensitivity gap..................... 21,948 (9,264) 26,085 23,876 62,646
======= ======= ======= ======= ========
Cumulative interest rate-sensitivity gap.......... $21,948 $12,684 $38,770 $62,646
======= ======= ======= =======
Cumulative ratio of rate sensitive assets to
rate-sensitive liabilities....................... 156% 121% 149% 170%
======= ======= ======= =======
</TABLE>
Page 22
<PAGE>
TABLE 8 (CONTINUED)
RATE-SENSITIVE ASSETS AND LIABILITIES
<TABLE>
<CAPTION>
DECEMBER 31, 1999
-----------------------------------------------------------
MATURING OR REPRICING IN
-----------------------------------------------------------
LESS AFTER THREE AFTER ONE
THAN MONTHS YEAR
THREE BUT WITHIN BUT WITHIN AFTER
MONTHS ONE YEAR 5 YEARS 5 YEARS TOTAL
-------- ------------ ---------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Rate-Sensitive Assets:
Federal funds sold and securities
purchased under agreements to resell.............. $ 6,800 $ -- $ -- $ -- $ 6,800
Securities available-for-sale, at amortized cost... 15,871 1,409 2,182 50,785 70,247
FRB and other stock, at cost....................... -- -- -- 1,391 1,391
Loans receivable................................... 23,562 16,391 11,738 5,281 56,972
------- ------- -------- ------- --------
Total rate-sensitive assets...................... 46,233 17,800 13,920 57,457 135,410
Rate-Sensitive Liabilities:
Interest bearing deposits:
Demand, money market and savings................. 3,361 7,637 10,998 8,554 30,550
Time certificates of deposit..................... 9,743 11,089 7,668 547 29,047
Federal funds purchased and securities
sold under agreements to repurchase............... 1,000 -- -- -- 1,000
Other borrowings................................... 15,800 3,500 -- -- 19,300
------- ------- -------- ------- --------
Total rate-sensitive liabilities................. 29,904 22,226 18,666 9,101 79,897
Interest rate-sensitivity gap...................... 16,329 (4,426) (4,746) 48,356 55,513
======= ======= ======== ======= ========
Cumulative interest rate-sensitivity gap........... $16,329 $11,903 $ 7,157 $55,513
======= ======= ======== =======
Cumulative ratio of rate sensitive assets to
rate-sensitive liabilities........................ 155% 123% 110% 169%
======= ======= ======== =======
</TABLE>
Page 23
<PAGE>
INVESTMENT SECURITIES
The Company invests in investment securities consisting primarily of
mortgage-related securities to: (i) generate interest income pending the
ability to deploy those funds in loans meeting the Company's lending
strategies; (ii) increase net interest income where the rates earned on such
investments exceed the related cost of funds, consistent with the management
of interest rate risk; and (iii) provide sufficient liquidity in order to
maintain cash flow adequate to fund the Company's operations and meet
obligations and other commitments on a timely and cost efficient basis.
The Company generally classifies its investment securities as
available-for-sale except for investment securities which the Company has the
ability and the positive intent to hold to maturity which are classified as
held-to-maturity securities. There were no held-to-maturity securities at
December 31, 1999 and 1998.
Table 9 provides certain information regarding the Company's investment
securities at December 31, 1999 and 1998.
TABLE 9
ESTIMATED FAIR VALUES OF AND UNREALIZED
GAINS AND LOSSES ON INVESTMENT SECURITIES
<TABLE>
<CAPTION>
DECEMBER 31, 1999 DECEMBER 31, 1998
============================================= ==============================================
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) (DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury securities............. $ 2,015 $ - $ 13 $ 2,002 $ 1,001 $ 7 $ - $ 1,008
GNMA-issued/guaranteed mortgage
pass through certificates........... 7,646 15 126 7,535 - - - -
Other U.S. government and federal
agency securities................... 1,937
3 - 1,940 - - - -
FHLMC/FNMA-issued mortgage
pass through certificates........... 15,185 - 448 14,737 16,933 100 3 17,030
CMO's and REMIC's issued by U.S.
government-sponsored agencies....... 40,174 - 1,827 38,347 48,278 146 41 48,383
Privately issued corporate bonds,
CMO's and REMIC's securities........ 5,007 - 79 4,928 4,035 2 - 4,037
FRB and other equity stocks.......... 1,746 - -
1,746 1,391 - - 1,391
----------- ---------- ---------- ---------- ---------- ---------- ---------- --------
$73,710 $18 $2,493 $71,235 $71,638 $225 44 $71,849
=========== ========== ========== ========== ========== ========== ========== ========
</TABLE>
As of December 31, 1999 the Company held $2.0 million, representing
aggregate amortized cost and estimated fair values of an investment security
issued by Structured Asset Mortgage Investments, Inc. This represented the only
security from any issuer other than by the U.S. government and U.S. government
agencies and corporations, in which the aggregate book value exceeded 10% of the
Company's shareholders' equity.
Page 24
<PAGE>
The Company's present strategy is to stagger the maturities of its
investment securities to meet overall liquidity requirements of the Company.
The average duration of total securities at December 31, 1999 was 2.57 years
compared with 2.65 years at December 31, 1998. Table 10 sets forth
information concerning the maturity of and weighted average yield of the
Company's investment securities at December 31, 1999.
TABLE 10
MATURITIES OF AND WEIGHTED AVERAGE YIELDS ON
INVESTMENT SECURITIES
<TABLE>
<CAPTION>
AFTER ONE BUT AFTER FIVE BUT
WITHIN ONE YEAR WITHIN FIVE YEARS WITHIN TEN YEARS
---------------------- --------------------- ----------------------
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
=========== =========== =========== ========== =========== ==========
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Securities available-for-sale:
U.S Treasury........................ $ - - $ 2,002 5.84% $ - -
GNMA-issued/guaranteed mortgage
pass-through certificates.......... - - - -- - -
Other U.S. government and federal
agencies........................... - - 1,940 7.14% - -
FHLMC/FNMA-issued mortgage
pass-through certificates.......... - - 1,684 6.49% - -
CMO's and REMIC's issued by
U.S. government-sponsored
agencies............................ - - - - - -
Privately issued corporate bonds,
CMO's and REMIC's securities........ 993 5.42% - - -
FRB and other equity stocks.......... - - - - - -
----------- ----------- -----------
$ 993 5.42% $ 5,626 6.48% $ - -
=========== =========== ===========
AMORTIZED COST $ 1,005 $ 5,653 $ $ -
=========== =========== ===========
</TABLE>
<TABLE>
<CAPTION>
AFTER TEN YEARS
-------------------
AMOUNT YIELD TOTAL YIELD
========== ========= ========== =========
<S> <C> <C> <C> <C>
Securities available-for-sale:
U.S Treasury........................ $ - - $ 2,002 5.84%
GNMA-issued/guaranteed mortgage
pass-through certificates.......... 7,535 7.44% 7,535 7.44%
Other U.S. government and federal
agencies........................... - - 1,940 7.14%
FHLMC/FNMA-issued mortgage
pass-through certificates.......... 13,053 6.31% 14,737 6.33%
CMO's and REMIC's issued by
U.S. government-sponsored
agencies........................... 38,347 6.62% 38,347 6.62%
Privately issued corporate bonds,
CMO's and REMIC's securities....... 3,935 6.36% 4,928 6.17%
FRB and other equity stocks......... 1,746 5.05% 1,746 5.05%
----------- ----------
$ 64,616 6.59% $ 71,235 6.57%
=========== ===========
AMORTIZED COST $ 67,052 $ 73,710
=========== ===========
</TABLE>
Actual maturities may differ from contractual maturities to the extent that
borrowers have the right to call or prepay obligations with or without call or
repayment penalties.
LENDING ACTIVITIES
The Company's present lending strategy is attract individual and small to
mid-sized business borrowers in specific market niches located in its primary
service area by offering a variety of loan products and a full range of
banking services coupled with highly personalized service. Loan products
include revolving lines of credit, term loans and consumer and home equity
loans, and often contain terms and conditions tailored to meet the specific
demands of market niche in which the borrower operates, including the ability
to evaluate the revenue streams supporting the loan. In order to provide the
personalized service required by these customers, the Company uses a team
approach to customer service combining an experienced relationship management
officer with operations support personnel.
During the past several years the market niches targeted by the Company
have included the entertainment industry and professional services providers.
Entertainment industry customers include television, music and film
production companies, talent agencies, individual performers, entertainers,
directors and producers (whom the Company attracts by establishing
relationships with business management firms), and others affiliated with the
entertainment industry. Professional service customers include legal,
accounting, insurance, advertising firms and their individual directors,
officers, partners and shareholders.
In beginning of 2000 the Company expanded its targeted market niches to
include healthcare organizations and community-based non-profit
organizations. Healthcare organizations will include primarily outpatient
healthcare providers such as physician medical groups, independent practice
associations and surgery centers. Community-based non-profit organization
will include all such organizations that are based in the Company's primary
service area.
Page 25
<PAGE>
LOAN PORTFOLIO
The following table sets forth the composition of the Company's loan
portfolio at the dates indicated:
TABLE 11
LOAN PORTFOLIO COMPOSITION
<TABLE>
<CAPTION>
DECEMBER 31,
================================================================
1999 1998
================================ ==============================
AMOUNT PERCENT AMOUNT PERCENT
============== ============== =============== =============
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Commercial loans:
Secured by one to four family
residential properties............................ $ 4,405 6% $ 5,005 9%
Secured by multifamily
residential properties............................ 5,355 7 3,111 5
Secured by commercial real
properties........................................ 28,233 38 20,839 36
Other - secured and
unsecured......................................... 33,221 45 24,337 43
Real estate construction and land
development............................................ 6 - - -
Home equity lines of credit................................. 367 1 271 -
Consumer installment and
unsecured loans to individuals......................... 2,496 3 3,707 7
------------ ----------- ------------ -----------
Total loans outstanding........................... 74,083 100% 57,270 100%
=========== ===========
Deferred net loan origination
fees and purchased loan discount....................... (240) (298)
------------ ------------
Loans receivable, net....................................... $ 73,843 $ 56,972
============ ============
</TABLE>
Most of the Company's commercial loans are generally within $100,000 to
$2.1 million and its consumer and home equity loans generally are less than
$100,000. The Company may not make any loan in excess of its loan to one
borrower limit under applicable regulations ($2.4 million at December 31, 1999).
If a borrower requests a loan in excess of that amount the Company may originate
the loan with the participation of one or more other lenders.
COMMERCIAL LOANS. The Company offers adjustable and fixed rate secured and
unsecured commercial loans for working capital, the purchase of assets and other
business purposes. The Company underwrites these loans primarily on the basis
that borrower's cash flow and the ability to service the debt without reliance
on the liquidation of the underlying collateral where applicable.
Collateral for commercial loans may include commercial or residential real
property, accounts receivable, inventory, equipment, marketable securities or
other assets. Real estate secured loans generally have terms ranging from five
to ten years and payments based on a 15 to 25 year amortization schedule. Real
estate secured loans
Page 26
<PAGE>
frequently have a maturity date shorter than the amortization period.
The original principal amount of a real estate secured loan generally does
not exceed 65% to 75% of the appraised value of the property (or the lesser
of the appraised value or the purchase price for the property if the loan is
made to finance the purchase of the property).
Unsecured commercial loans include short-term term loans and lines of
credit. The Company's underwriting guidelines for these loans generally
require that the borrower have low levels of existing debt, working capital
sufficient to cover the loan and a history of earnings and cash flow.
Typically, unsecured lines of credit must be unused for a continuous 30-day
period within each year to demonstrate the borrower's ability to have
sufficient funds to operate without the credit line.
REAL ESTATE CONSTRUCTION AND LAND DEVELOPMENT LOANS. Real estate
construction and land development loans are short-term secured loans made to
finance the construction of commercial and single-family residential
properties or for improvements to raw land. Over the past several years, the
Company has de-emphasized its focus on this type of lending to emphasize
relationship-oriented commercial loans.
CONSUMER LOANS AND HOME EQUITY LINES OF CREDIT. The Company offers consumer
loans and home equity lines of credit principally as accommodation to
individuals associated with the Company's business borrowers. Home equity lines
of credit provide the borrower with a line of credit in an amount which
generally does not exceed 80% of the appraised value of the borrower's residence
net of senior mortgages. Consumer loans are primarily adjustable rate open-ended
unsecured loans (such as credit card loans) but also include fixed rate term
loans (generally under five years) to purchase personal property which are
secured by that personal property. These loans (other than purchase money loans)
generally provide for monthly payments of interest and a portion of the
outstanding principal balance.
Page 27
<PAGE>
LOAN CONCENTRATIONS
The Company provides banking services to the entertainment industry in
Southern California. Table 12 below presents information about the Company's
loans outstanding to entertainment-related customers at December 31, 1999 and
1998.
TABLE 12
INDUSTRY CONCENTRATIONS OF LOANS
<TABLE>
<CAPTION> DECEMBER 31,
----------------------------
1999 1998
------------ ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Entertainment industry-related loans (1):
Loans for single productions of motion picture and television
feature films ........................................................ $ 2,001 $ 1,418
Other loans to entertainment-related enterprises, such as television,
music, film and talent agencies ...................................... 13,632 7,269
Loans to individuals involved primarily in the entertainment industry ..... 4,623 3,368
Loans to business management, legal and accounting firms,
including their principals and employees, serving primarily the
entertainmemt industry ................................................. 262 64
------------ ------------
Total entertainment industry-related loans ................................ $ 20,518 $ 12,119
============ ============
Percent of total loans outstanding ........................................ 27.7% 21.2%
</TABLE>
(1) Included are loans secured by liens on residential and commercial
real property amounting to $2.9 million at December 31, 1999
and $1.4 million at December 31, 1998
The concentration of loans to the entertainment-related industry at
December 31, 1999, increased to $20.5 million or 27.7% of the total
portfolio, as compared to $12.1 million, or 21.2% at December 31, 1998. The
increase during 1999 was the direct result of management plans to expand the
entertainment division following the growth of production staff in this area,
in response to the prominence of entertainment-related companies in the
Company's primary service area.
The Company believes that the varying nature of customers represented
within this group, as set forth in Table 12, indicates reasonable
diversification, although significant increases occurred during 1999 with
respect to loans to entertainment-related enterprises, such as television,
music, film and talent agencies. Single customer concentration risk is
evident by the existence of ten borrowers with individual loan balances
greater than $1.0 million, aggregating $11.1 million or 54.0% of
entertainment industry loans at December 31, 1999. Management believes its
underwriting standards, collateral and guarantees supporting such borrowings
are sufficient to mitigate the risk of credit concentration. In addition,
loans for the production of independently produced motion picture and
television feature films presented in Table 12, are generally 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.
Page 28
<PAGE>
LOAN RATE COMPOSITION AND MATURITIES
Of the Company's total loans outstanding, 56.8% and 62.6% had adjustable
rates at December 31, 1999 and 1998, respectively. Adjustable rate loans have
interest rates tied to the prime rate and generally adjust with changes in
the rate on a monthly or quarterly basis.
Of the Company's total loans outstanding at December 31, 1999, 30.9%
were due in one year or less, 37.0% were due in 1--5 years and 32.1% were due
after 5 years. The loan maturities shown in Table 13 below are based on
contractual maturities. As is customary in the banking industry, loans 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.
TABLE 13
LOAN MATURITIES
<TABLE>
<CAPTION>
DECEMBER 31, 1999
--------------------------------------------
INTEREST RATES INTEREST RATES
ARE FLOATING ARE FIXED OR
OR ADJUSTABLE PREDETERMINED TOTAL
--------------- -------------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Aggregate maturities of total loans outstanding:
Commercial secured by real estate
In one year or less ......................... $ 2,353 $ 691 $ 3,044
After one year but within five years ........ 3,301 8,733 12,034
After five years ............................ 8,865 14,188 23,053
Commercial other secured and unsecured
In one year or less ......................... 11,850 5,985 17,835
After one year but within five years ........ 13,465 1,699 15,164
After five years ............................ 525 -- 525
Other ............................................ --
In one year or less ......................... 1,360 660 2,020
After one year but within five years ........ 148 66 214
After five years ............................ 194 -- 194
------------ ------------ ------------
Total loans outstanding ............................... $ 42,061 $ 32,022 $ 74,083
============ ============ ============
</TABLE>
CREDIT RISK MANAGEMENT
The Company assesses and manages credit risk on an ongoing basis through
diversification guidelines, lending limits, credit review and approval
policies and internal monitoring. As part of the control process, an
independent credit review firm regularly examines the Company's loan
portfolio and other credit processes, the Company's loan portfolio and other
related products, including unused commitments and letters of credit. In
addition to this credit review process, the Company's loan portfolio is
subject to examination by external regulators in the normal course of
business. Underlying trends in the economic and business cycle will influence
credit quality. The Company seeks to manage and control its risk through
diversification of the portfolio by type of loan, industry concentration and
type of borrower.
NONPERFORMING ASSETS
Nonperforming assets consist of nonperforming loans and other real estate
owned. Nonperforming loans are (i) loans which have been placed on nonaccrual
status, (ii) troubled debt restructurings ("TDR's"), or (iii) loans which
Page 29
<PAGE>
are contractually past due ninety days or more with respect to principal or
interest, and have not been restructured or placed on nonaccrual status and
are accruing interest, as described below. Other real estate owned consists of
real properties securing loans of which the Company has taken title in
partial or complete satisfaction of the loan. Information about nonperforming
assets is presented in Table 14.
TABLE 14
NONPERFORMING ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1999 1998
------------ ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Nonaccrual loans .......................................................... $ 932 $ 1,505
Troubled debt restructurings .............................................. -- --
Loans contractually past due ninety or more days with respect
to either principal or interest and still accruing interest .......... -- --
------------ ------------
Nonperforming loans ....................................................... 932 1,505
Other real estate owned ................................................... 382 593
Other assets-SBA guaranteed loan .......................................... 150 --
------------ ------------
Total nonperforming assets ................................................ $ 1,464 $ 2,098
============ ============
Allowance for credit losses as a percent of nonaccrual loans .............. 203.4% 142.5%
Allowance for credit losses as a percent of nonperforming loans ........... 203.4% 142.5%
Total nonperforming assets as a percent of loans receivable ............... 2.0% 3.7%
Total nonperforming assets as a percent of total
shareholders' equity ................................................. 12.6% 15.8%
</TABLE>
NONACCRUAL LOANS. Nonaccrual loans are those loans 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
Company'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, 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, 1999, decreased to $932,000 from $1.5
million at December 31, 1998. Nonaccrual loans at December 31, 1999 were
comprised primarily of Small Business Administration ("SBA") loans, including
$779,000 which is guaranteed by the SBA. The additional interest income that
would have been recorded from nonaccrual loans, if the loans had not been on
nonaccrual status, was $131,000 and $162,000 for 1999 and 1998, 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
9 and 13 basis points for 1999 and 1998, respectively.
Page 30
<PAGE>
TROUBLED DEBT RESTRUCTURINGS. A TDR is 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, 1999 and 1998, the Company had no TDR's.
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 a loan is considered well secured if the collateral
has a realizable value in excess of the amount of principal and accrued
interest outstanding and/or is guaranteed by a financially capable party.
A Loan is 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.
There were no loans contractually past due 90 or more days and still
accruing interest at December 31, 1999 and 1998.
OTHER REAL ESTATE OWNED. The Company carries OREO at the lesser of the
Bank's recorded investment or the fair value less selling costs. The Company
periodically revalues OREO properties and charges other expenses for any
further write-downs. OREO at December 31, 1999 consisted of two properties
including three undeveloped commercially zoned parcels and one undeveloped
multi-family zoned parcel. During February 2000, the Company sold the three
undeveloped commercially zoned parcels for a net gain of $10,000. While the
Company is currently marketing the remaining property for sale, no assurances
can be given that it will be sold at the carrying value.
OTHER ASSETS- SBA GUARANTEED LOAN. Other assets - SBA guaranteed loan
consists of one developed commercial retail property. The value of this
developed commercial retail property is supported by a guarantee from the
SBA. During February 2000, the Company was paid an amount approximately the
carrying value by the SBA as full settlement.
IMPAIRED LOANS
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. At
December 31, 1999, the Bank had classified $932,000 of its loans as impaired
for which no related specific reserves was provided. The average recorded
investment in, and the amount of interest income recognized on impaired loans
during the year ended December 31, 1999, were $1.3 million and $81,000,
respectively.
Foregone interest income attributable to nonperforming loans amounted to
$131,000 for the year ended December 31, 1999 and $162,000 for the same
period in 1998. This resulted in a reduction in yield on average loans
receivable of 22 basis points and 27 basis points for the years ended
December 31, 1999 and 1998, respectively.
ALLOWANCE FOR CREDIT LOSSES
The Company has a process by which it reviews and manages the credit
quality of the loan portfolio. This process includes a risk rating system,
uniform underwriting criteria, early identification of problem credits,
regular monitoring of any classified assets graded as "criticized" by the
Company's internal grading system, and an
Page 31
<PAGE>
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. The CAC is currently chaired by the Senior Vice President--Special
Assets, with the results of the CAC's meetings reviewed by the Officers and
Directors' Loan Committee quarterly.
The calculation of the adequacy of the allowance for credit losses is
based on a variety of factors, including loan classifications, migration
trends and underlying cash flow and collateral values. On a periodic basis
(two times per year), management engages an outside loan review firm to
review the Company's loan portfolio, risk grade accuracy and the
reasonableness of loan evaluations. Annually, this outside loan review team
analyzes the Company's methodology for calculating the allowance for credit
losses based on the Company's loss histories and policies. The Company uses a
migration analysis as part of its allowance for credit losses 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 Company'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 Company'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, based on information known to management, that the
allowance for credit losses at December 31, 1999 was adequate to absorb
estimated losses in the existing loan portfolio. However, credit quality is
affected by many factors beyond the control of the Company, including local
and national economies, and facts may exist which are not known to the
Company which adversely affect the likelihood of repayment of various loans
in the loan portfolio and realization of collateral upon a default.
Accordingly, no assurance can be given that the Company will not sustain loan
losses materially in excess of the allowance for credit losses. In addition,
the OCC, as an integral part of its examination process, periodically reviews
the allowance for credit losses and could require additional provisions for
credit losses.
Table 15 presents, at December 31, 1999 and 1998, the composition of the
Company's allocation of the allowance for credit losses to specific loan
categories designated by management for this purpose. The Company'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.
Page 32
<PAGE>
TABLE 15
ALLOCATION OF ALLOWANCE FOR CREDIT LOSSES
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------
1999 %(1) 1998 %(1)
-------- -------- -------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Allocation of the Allowance for Credit Losses:
Commercial loans:
Secured by one to four family residential properties ....... $ 102 6% $ 132 9%
Secured by multifamily residential properties .............. 103 7 73 5
Secured by commercial real properties ...................... 659 38 590 36
Other - secured and unsecured .............................. 938 45 1,061 43
Real estate construction and land development ................... -- -- -- --
Home equity lines of credit ..................................... 3 1 4 0
Consumer installment and unsecured loans to individuals (1) ..... 91 3 284 7
-------- -------- -------- --------
Allowance allocable to loans receivable .................... $ 1,896 100% $ 2,144 100%
======== ======== ======== ========
</TABLE>
- -----------------
(1) Percentage of loans in each category to total loans
Page 33
<PAGE>
Table 16 presents an analysis of changes in the allowance for credit
losses during the period indicated:
TABLE 16
ANALYSIS OF CHANGES IN ALLOWANCE FOR CREDIT LOSSES
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1999 1998
--------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Balance, beginning of period ......................................... $ 2,144 $ 2,023
Loan charge-offs:
Real estate construction and land development ................... -- --
Commercial loans:
Secured by one to four family residential properties ....... -- 4
Secured by multifamily residential properties .............. -- --
Secured by commercial real properties ...................... 128 31
Other - secured and unsecured .............................. 344 176
Home equity lines of credit ..................................... -- --
Consumer installment and unsecured loans to individuals.......... 105 196
--------- ---------
Total loan charge-offs .......................................... 577 407
Recoveries of loans previously charged off:
Real estate construction and land development ................... -- --
Commercial loans:
Secured by one to four family residential properties ....... 30 1
Secured by multifamily residential properties .............. -- 10
Secured by commercial real properties ...................... 144 --
Other - secured and unsecured .............................. 100 216
Home equity lines of credit ..................................... -- --
Consumer installment and unsecured loans to individuals.......... 55 301
--------- ---------
Total recoveries of loans previously charged off ................ 329 528
--------- ---------
Net charge-offs (recoveries) .................................... 248 (121)
Provision for credit losses ..................................... -- --
--------- ---------
Balance, end of period .......................................... $ 1,896 $ 2,144
========= =========
Net loan charge-offs (recoveries) as a percentage of
allowance for credit losses ................................ 13.08% -5.66%
Net loan charge-offs (recoveries) as a percentage of
average gross loans outstanding during the period .......... 0.40% -0.20%
Recoveries of loans previously charged off as a percentage
of loans charged off in the previous year .................. 80.86% 40.16%
</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 customers. In addition to undisbursed commitments to extend credit under
loan facilities, these instruments include conditional obligations under
standby and commercial letters of credit. The Company's exposure to credit
loss in the event of nonperformance by customers is represented by the
contractual amount of the instruments.
Standby letters of credit are conditional commitments issued by the
Company to secure the financial performance of a customer to a third party
and are primarily issued to support private borrowing arrangements. The
credit risk involved in issuing a letter of credit for a customer is
essentially the same as that involved in extending a loan to that customer.
The Company uses the same credit underwriting policies in accepting such
contingent obligations as it does for loans. When deemed necessary, the
Company holds appropriate
Page 34
<PAGE>
collateral supporting those commitments. The nature of collateral obtained
varies and may include deposits held in financial institutions and real
properties.
At December 31, 1999 and 1998, standby letters of credit amounted to
$422,000 and $652,000, respectively, and there were no commercial letters of
credit outstanding.
Undisbursed commitments under revocable and irrevocable loan facilities
amounted to $14.7 million and $11.6 million at December 31, 1999 and 1998,
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.
DEPOSITS
As indicated in Table 17, the Bank experienced a 2.7% increase in
average total deposits during 1999 compared to 1998. This increase in
deposits occurred primarily as a result of growth in non-interest bearing and
money market deposits of $5.3 million and growth in money market deposits of
$3.8 million, offset by a planned decline in higher cost money desk deposits
of $7.6 million.
TABLE 17
DEPOSIT COMPOSITION
(BALANCES ARE AVERAGES)
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------------
1999 1998
----------------------- -------------------------
AMOUNT PERCENT AMOUNT PERCENT
---------- -------- ---------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Noninterest-bearing demand
deposits:
Real estate title and escrow
company customers ................. $ 14,652 13% $ 15,546 14%
Other noninterest-bearing
demand ............................ 30,843 27 25,564 24
Interest-bearing demand ..................... 6,918 6 7,467 7
Money market ................................ 27,999 25 24,179 22
Savings ..................................... 1,526 1 3,697 3
Time certificates of deposit:
Money desk ............................. 072 11 19,718 18
Other:
$100,000 or more .................. 23 13 7,809 7
Under $100,000 .................... 4,238 4 5,413 5
---------- -------- ---------- ----------
Total time certificates of deposit .......... 30,433 28 32,940 30
---------- -------- ---------- ----------
Total Deposits ......................... $ 112,371 100% $ 109,393 100%
========== ======== ========== ==========
</TABLE>
Page 35
<PAGE>
TABLE 18
MATURITIES OF TIME CERTIFICATES OF DEPOSIT
$100,000 OR MORE
<TABLE>
<CAPTION>
DECEMBER 31, 1999
------------------------------------------
MONEY ALL
DESK OTHER TOTAL
------------ ------------ ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Aggregate maturities of time certificates of deposit:
In three months or less ....................................... $ -- $ 8,373 $ 8,373
After three months but within six months ...................... 2,574 2,992 5,566
After six months but within twelve months ..................... 2,674 2,875 5,549
After twelve months ........................................... -- -- --
------------ ------------ ------------
Total time certificates of deposit $100,000 or more ...... $ 5,248 $ 14,240 $ 19,488
============ ============ ============
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1998
------------------------------------------
MONEY ALL
DESK OTHER TOTAL
------------ ------------ ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Aggregate maturities of time certificates of deposit:
In three months or less ....................................... $ -- $ 6,025 $ 6,025
After three months but within six months....................... -- 2,355 2,355
After six months but within twelve months ..................... 501 837 1,338
After twelve months ........................................... 5,148 100 5,248
------------ ------------ ------------
Total time certificates of deposit $100,000 or more ...... $ 5,649 $ 9,317 $ 14,966
============ ============ ============
</TABLE>
BORROWINGS
Borrowings and related weighted average rates are summarized below in Table
19.
TABLE 19
BORROWINGS
<TABLE>
<CAPTION>
1999 1998
------------------------------------------ ----------------------------------------
YEAR-END AVERAGE YEAR-END AVERAGE
-------------------- ------------------- -------------------- ------------------
BALANCE RATE BALANCE RATE BALANCE RATE BALANCE RATE
--------- ------ --------- ------- --------- ------- --------- ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Federal funds purchased and securities
sold under repurchase agreements .... -- -- $ 1,194 4.19% $ 1,000 5.54% $ 2,279 5.92%
Other borrowings ......................... 26,200 5.79% 19,121 5.26% 19,300 5.38% 9,276 5.57%
</TABLE>
The maximum amount of securities sold with agreements to repurchase at
any month end was $2.0 million, and $4.0 million during 1999 and 1998,
respectively.
The maximum amount of other borrowings at any month end was $26.2
million during 1999 and $19.3 million during 1998.
Page 36
<PAGE>
At December 31, 1999, $15.7 million of borrowed funds were scheduled to
mature during 2000, and $10.5 million were scheduled to mature during 2001.
SELECTED FINANCIAL RATIOS
The following table 20 sets forth selected financial ratios:
TABLE 20
SELECTED PERFORMANCE RATIOS:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
----------------------
1999 1998
------- --------
<S> <C> <C>
Return on average assets .............................. 0.69% 0.48%
Return on average shareholders' equity ................ 8.08% 4.96%
Average shareholders' equity to average assets ........ 8.57% 9.64%
</TABLE>
RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board ("FASB") issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," as amended by
SFAS No. 137 "Accounting for Derivative Instruments and Hedging Activities
- -Deferral of the Effective Date of FASB Statement No. 133." The Company is
required to and will implement the provision of this new standard on January
1, 2001. SFAS No. 133 establishes accounting and reporting standards
requiring that every derivative instrument be recorded in the Statement of
Financial Condition as either an asset or as a liability measured at its fair
value and that changes in the fair value be recognized currently in the
Statement of Operations. The Company has not yet quantified the impact of
adopting SFAS No. 133 on its financial statements but does not believe it
will have a material effect of the Company's financial position or results of
operations.
Page 37
<PAGE>
YEAR 2000 MATTERS
THE FOLLOWING CONSTITUTES A "YEAR 2000 READINESS" DISCLOSURE UNDER THE YEAR 2000
INFORMATION AND READINESS DISCLOSURE ACT.
As the Year 2000 approached, a critical issue emerged regarding how
existing application software programs and operating systems can accommodate
this date value. In brief, many existing application software products 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.
Addressing the risks posed by the Year 2000 problem was among the
Company's highest priorities. The Company established a comprehensive program
comprised of numerous individual projects which address the following broad
areas: data processing systems, telecommunications and data networks,
physical facilities and security systems, vendor risk, customer risk,
liquidity risk, contingency planning, testing and communications. The goal of
the Company's Year 2000 program was to assure that the Company was able to
conduct normal business before, during and after the century date change.
The Company has not experienced any business interruption with respect to
its operations, vendors or customers as a result of the Year 2000 date change.
FACTORS WHICH MAY AFFECT FUTURE OPERATING RESULTS
The Company's results of operations and financial condition are affected
by many factors, including the following.
CHANGING ECONOMIC CONDITIONS
The Company's results of operation and financial condition are strongly
influenced by economic conditions in its market area (principally the Los
Angeles metropolitan area) as well as regional and national economic
conditions and in its niche markets, including the entertainment industry in
Southern California. During the past several years economic conditions in
these areas have been favorable. A deterioration in these economic conditions
could affect the financial condition and cash flows of its borrowers, which
could lead to higher levels of loan defaults, a decline in the value of
collateral for the loans. In addition, an unfavorable economy could reduce
the demand for the Company's loans and other products and services.
INTEREST RATE RISK
The Company's operating results depend to a large extent on its net
interest income. Changes in market interest rates can affect the Company's
net interest income by affecting the spread between its interest-earning
assets and interest-bearing liabilities. This may be due to the different
maturities of its interest-earning assets and interest-bearing liabilities,
as well as an increase in the general level of interest rates. Changes in
market interest rates also affect, among other things:
-- The Company's ability to originate loans;
-- The ability of borrowers to make payments on loans;
-- The value of its interest-earning assets and its ability to realize
gains from the sale of these assets;
-- The average life of its interest-earning assets; and
-- The Company's ability to obtain deposits instead of other available
investment alternatives.
Page 38
<PAGE>
Interest rates are highly sensitive to many factors, including
governmental monetary policies, domestic and international economic and
political conditions and other factors beyond its control.
RISK OF DECLINES IN ASSET QUALITY
The Company's results of operations depend significantly on the quality
of its assets. While the Company has developed and implemented underwriting
policies and procedures in connection with the making of loans, compliance
with these policies and procedures in making loans does not guarantee
repayment of the loans. High levels of non-performing assets will adversely
affect the Company's results of operations and financial condition. A
borrower's ability to pay its loan in accordance with its terms can be
adversely affected by a number of factors, such as a decrease in the
borrower's revenues and cash flows due to adverse changes in economic
conditions or a decline in the demand for the borrower's products and/or
services. The Company has devoted and continues to devote substantial time
and resources to the identification, collection and workout of non-performing
assets, which has resulted in a significant decrease in its nonperforming
assets from $12.0 million, or 5.2%, of total assets at December 31, 1994 to
$1.5 million, or 0.9%, of total assets at December 31, 1999. However, no
assurance can be given that the Company will not have material additional
non-performing assets in the future.
ADEQUACY OF ALLOWANCES FOR LOSSES
The Company establishes allowances for credit losses against each
segment of its loan portfolio. At December 31, 1999, its allowance for credit
losses equaled 2.6% of loans receivable and 203.4% of nonperforming loans.
Although the Company believes that it had established adequate allowances for
credit losses as of December 31, 1999, credit quality is affected by many
factors beyond the control of the Company, including local and national
economies, and facts may exist which are not known to the Company which
adversely affect the likelihood of repayment of various loans in the loan
portfolio and realization of the collateral upon a default. Accordingly, no
assurance can be given that the Company will not sustain loan losses
materially in excess of the allowance for credit losses. In addition, the
OCC, as an integral part of its examination process, periodically reviews its
allowance for credit losses and could require additional provisions for
credit losses. Material future additions to the allowance for loan losses may
also be necessary due to increases in the size of the loan portfolio.
Increases in the provisions for credit losses would adversely affect its
results of operations.
COMPETITION
The banking business is highly competitive. The Company's primary
service area is dominated by a relatively small number of major banks which
have many offices over a wide geographic area and much greater name
recognition. Increasing competition in the markets for the Company's products
and services can reduce the demand for the Company's products and services
and require the Company to originate those products and services on less
favorable terms.
REGULATION
Both the Company, as a bank holding company, and the Bank, as a national
bank, are subject to significant governmental supervision and regulation,
which is intended primarily for the protection of depositors. Statutes and
regulations affecting it may be changed at any time, and the interpretation
of these statutes and regulations by examining authorities also may change.
The Company cannot assure you that future changes in applicable statutes and
regulations or in its interpretation will not adversely affect its business.
Page 39
<PAGE>
ITEM 7. 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.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item will appear under the "Election of
Directors," "Directors and Executive Officers," and "Section 16(a) Beneficial
Ownership Reporting Compliance" in the Company's proxy statement for the 2000
Annual Meeting of Shareholders (the "2000 Proxy Statement"), and such
information either shall be (i) deemed to be incorporated herein by reference
to that portion of the 1999 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-KSB.
ITEM 10. 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," and "Directors and Executive Officers--Compensation
Committee Interlocks and Insider Participation" in the 1999 Proxy Statement,
and such information either shall be (i) deemed to be incorporated herein by
reference to those portions of the 1999 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-KSB.
ITEM 11. 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 1999 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-KSB.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item will appear under the caption
"Certain Relationships and Related Transactions" in the 1999 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-KSB.
Page 40
<PAGE>
PART IV
ITEM 13. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents have been filed as part of this report:
1. FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Public Accountants ......................................................... 45
Consolidated Balance Sheet at December 31, 1999 .................................................. 46
Consolidated Statements of Operations for the years ended December 31, 1999 and 1998 ............. 47
Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31,
1999 and 1998 ................................................................................... 48
Consolidated Statements of Cash Flows for the years ended December 31, 1999 and 1998 ............. 49
Notes to Consolidated Financial Statements for the two years ended December 31, 1999 ............. 50
</TABLE>
2. FINANCIAL STATEMENT SCHEDULES
None.
(b) Reports on Form 8-K
None.
(c) Exhibits
See Index to Exhibits on page E-1 of this Report on Form 10-KSB
(d) See Item 14(a) above.
Page 41
<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 24, 2000
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 24, 2000
/s/ ROBERT E. THOMSON
- ----------------------------------------------------------
Robert E. Thomson Vice Chair March 24, 2000
/s/ DONALD E. BENSON
- ----------------------------------------------------------
Donald E. Benson Director March 24, 2000
/s/ JOSEPH N. COHEN
- ----------------------------------------------------------
Joseph N. Cohen Director March 24, 2000
/s/ ALAN GRAHM
- ----------------------------------------------------------
Alan Grahm Director March 24, 2000
/s/ ANTOINETTE HUBENETTE, M.D.
- ----------------------------------------------------------
Antoinette Hubenette, M.D. Director March 24, 2000
/s/ JOSEPH W. KILEY III
- ----------------------------------------------------------
Joseph W. Kiley III Director and Chief March 24, 2000
Financial Officer
</TABLE>
Page 42
<PAGE>
<TABLE>
<S> <C> <C>
/s/ SCOTT A. MONTGOMERY
- ----------------------------------------------------------
Scott A. Montgomery Director and Chief March 24, 2000
Executive Officer
/s/ DION G. MORROW
- ----------------------------------------------------------
Dion G. Morrow Director March 24, 2000
/s/ CARL R. TERZIAN
- ----------------------------------------------------------
Carl R. Terzian Director March 24, 2000
</TABLE>
Page 43
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and the Board of Directors
of National Mercantile Bancorp and Subsidiary:
We have audited the accompanying consolidated balance sheet of National
Mercantile Bancorp (a California corporation) and subsidiary (the "Company")
as of December 31, 1999, and the related consolidated statements of
operations, changes in shareholders' equity and cash flows for each of the
two years in the period ended December 31, 1999. 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 audit.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. 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, the financial statements referred to above present fairly, in
all material respects, the financial position of National Mercantile Bancorp
and subsidiary as of December 31, 1999, and the results of their operations
and their cash flows for each of the two years in the period ended December
31, 1999 in conformity with accounting principles generally accepted in the
United States.
Arthur Andersen LLP
Los Angeles, California
January 14, 2000
Page 44
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
Page 45
<PAGE>
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
1999
------------
(DOLLARS IN THOUSANDS)
<S> <C>
ASSETS
Cash and due from banks-demand ............................................... $ 5,789
Federal funds sold and securities purchased
under agreements to resell .............................................. 4,450
------------
Cash and cash equivalents .......................................... 10,239
Securities available-for-sale, at fair value;
aggregate amortized cost of $71,964 ..................................... 69,489
FRB and other stock, at cost ................................................. 1,746
Loans receivable ............................................................. 73,843
Allowance for credit losses ............................................. (1,896)
------------
Net loans receivable ............................................... 71,947
Premises and equipment, net .................................................. 626
Other real estate owned, net ................................................. 382
Accrued interest receivable and other assets ................................. 1,724
------------
Total assets ...................................................... $156,153
============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing demand .............................................. $ 53,827
Interest-bearing demand ................................................. 8,669
Money market ............................................................ 25,376
Savings ................................................................. 3,079
Time certificates of deposit:
$100,000 or more ................................................... 19,488
Under $100,000 ..................................................... 6,545
------------
Total deposits ................................................ 116,984
Federal funds purchased and securities sold
under agreements to repurchase .......................................... --
Other borrowings ............................................................. 26,200
Accrued interest payable and other liabilities ............................... 1,382
------------
Total liabilities .................................................. 144,566
Shareholders' equity:
Preferred stock: (10,000 shares undesignated)
Series A non-cumulative convertible perpetual preferred stock;
authorized 990,000 shares; issued and outstanding 900,000
shares ............................................................. 7,350
Common stock, no par value; authorized 10,000,000
shares; issued and outstanding 677,195 shares ...................... 24,614
Accumulated deficit ..................................................... (17,902)
Accumulated other comprehensive income .................................. (2,475)
------------
Total shareholders' equity ......................................... 11,587
------------
Total liabilities and shareholders' equity ......................... $156,153
============
</TABLE>
See accompanying notes to consolidated financial statements.
Page 46
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
------------------------------
1999 1998
----------- ------------
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE DATA)
<S> <C> <C>
Interest income:
Loans, including fees .......................................................... $ 5,781 $ 5,937
Securities held-to-maturity .................................................... -- 134
Securities available-for-sale .................................................. 4,379 3,215
Federal funds sold and securities purchased under agreements to resell ......... 385 782
Interest-bearing deposits with other financial institutions .................... -- 13
----------- ------------
Total interest income ................................................ 10,545 10,081
Interest expense:
Interest-bearing demand ........................................................ 91 95
Money market and savings ....................................................... 836 846
Time certificates of deposit:
$100,000 or more .......................................................... 996 788
Under $100,000 ............................................................ 580 1,104
----------- ------------
Total interest expense on deposits ................................... 2,503 2,833
Federal funds purchased and securities sold under agreements to repurchase ..... 50 135
Other borrowings ............................................................... 1,005 517
----------- ------------
Total interest expense ............................................... 3,558 3,485
----------- ------------
Net interest income before provision for credit losses ............... 6,987 6,596
Provision for credit losses ......................................................... -- --
----------- ------------
Net interest income after provision for credit losses .......................... 6,987 6,596
Other operating income:
Net (loss) gain on sale of securities available-for-sale ....................... (1) 39
International services ......................................................... 87 84
Investment division ............................................................ 60 43
Deposit-related and other customer services .................................... 552 621
Gain on sale of other real estate owned and fixed assets ....................... -- 68
----------- ------------
Total other operating income ......................................... 698 855
Other operating expenses:
Salaries and related benefits .................................................. 3,229 3,168
Net occupancy .................................................................. 1,002 903
Furniture and equipment ........................................................ 217 287
Printing and communications .................................................... 265 231
Insurance and regulatory assessments ........................................... 297 304
Customer services .............................................................. 673 797
Computer data processing ....................................................... 311 264
Legal services ................................................................. 70 146
Other professional services .................................................... 301 300
Other real estate owned expenses ............................................... 45 141
Promotion and other expenses ................................................... 214 257
----------- ------------
Total other operating expenses ....................................... 6,624 6,798
----------- ------------
Net income before income tax provision ......................................... 1,061 653
Income tax provision ................................................................ 47 8
----------- ------------
Net income ..................................................................... $ 1,014 $ 645
=========== ============
Earnings per share:
Basic ..................................................................... $ 1.50 $ 0.95
=========== ============
Diluted ................................................................... $ 0.41 $ 0.25
=========== ============
</TABLE>
See accompanying notes to consolidated financial statements.
Page 47
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK
-------------------- -------------------
SHARES AMOUNT SHARES AMOUNT
--------- ------- -------- --------
(DOLLARS IN THOUSANDS EXCEPT SHARE DATA)
<S> <C> <C> <C> <C>
Balance at January 1, 1998 ...................................... 900,000 $7,350 677,144 $24,613
Return of fractional common
shares due to reverse stock split ..................... (96) --
Comprehensive income:
Other comprehensive income:
Unrealized holding gain during the period .............
Less: Reclassification adjustment
for gain included in
net income ...................................
Net income .................................................
Comprehensive income .............................
--------- ------- -------- --------
Balance at December 31, 1998 .................................... 900,000 7,350 677,048 24,613
Stock options exercised .................................... 147 1
Comprehensive income:
Other comprehensive income:
Unrealized holding loss during
the period .......................................
Add: Reclassification adjustment
for losses included in
net income ...................................
Net income .................................................
Comprehensive income .............................
--------- ------- -------- --------
Balance at December 31, 1999 .................................... 900,000 $7,350 677,195 $24,614
========= ======= ======== =========
</TABLE>
<TABLE>
<CAPTION>
ACCUMULATED
OTHER
ACCUMULATED COMPREHENSIVE
DEFICIT INCOME TOTAL
------------ -------------- ----------
<S> <C> <C> <C>
Balance at January 1, 1998 ...................................... $(19,561) $ 38 $12,440
Return of fractional common
shares due to reverse stock split ..................... --
Comprehensive income:
Other comprehensive income:
Unrealized holding gain during the period ............. 212 212
Less: Reclassification adjustment
for gain included in
net income ................................... (39) (39)
Net income ................................................. 645 645
Comprehensive income ............................. 818
------------ -------------- ----------
Balance at December 31, 1998 .................................... (18,916) 211 13,258
Stock options exercised .................................... 1
Comprehensive income:
Other comprehensive income:
Unrealized holding loss during
the period ....................................... (2,687) (2,687)
Add: Reclassification adjustment
for losses included in
net income ................................... 1 1
Net income ................................................. 1,014 1,014
----------
Comprehensive income ............................. (1,672)
------------ -------------- ----------
Balance at December 31, 1999 .................................... $(17,902) $(2,475) $11,587
============ ============== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
Page 48
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------
1999 1998
------------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Net cash flow from operating activities:
Net income ..................................................................... $ 1,014 $ 645
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization .................................................. 191 248
Gain on sale of premises and equipment ......................................... -- (9)
Gain on sale of other real estate owned ........................................ -- (59)
Provision for other real estate owned .......................................... 35 100
Net loss (gain) on sale of securities available-for-sale ....................... 1 (39)
Net amortization of premiums on securities ..................................... 61 94
Net accretion of discounts on loans purchased .................................. (34) (32)
(Increase) decrease in accrued interest receivable and other assets ............ (126) 377
Increase in accrued interest payable and other liabilities ..................... 289 66
------------- -------------
Net cash provided by operating activities ............................ 1,431 1,391
Cash flows from investing activities:
Net decrease in interest-bearing deposits with other financial
institutions .............................................................. -- 250
Purchase of securities available-for-sale ...................................... (15,967) (71,359)
Proceeds from sales of securities available-for-sale ........................... 1,016 6,102
Proceeds from repayments and maturities of securities available-for-sale........ 12,817 20,004
Proceeds from repayments and maturities of securities-held-to-maturity ......... -- 14,000
Loan originations and principal collections, net................................ (17,085) 4,257
Proceeds from sale of other real estate owned .................................. -- 319
Net purchases of premises and equipment ........................................ (91) (179)
------------- -------------
Net cash used in investing activities ................................ (19,310) (26,606)
Cash flows from financing activities:
Net increase in demand deposits, money market and savings accounts ............. 13,026 11,925
Net decrease in time certificates of deposit ................................... (3,014) (2,341)
Net decrease in securities sold under agreements to repurchase
and federal funds purchased ............................................... (1,000) (4,050)
Net increase in other borrowings ............................................... 6,900 15,800
Net proceeds from exercise of stock options .................................... 1 --
------------- -------------
Net cash provided by financing activities ............................ 15,913 21,334
------------- -------------
Net decrease in cash and cash equivalents ........................................... (1,966) (3,881)
Cash and cash equivalents, January 1 ................................................ 12,205 16,086
------------- -------------
Cash and cash equivalents, December 31 .............................................. $ 10,239 $ 12,205
============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
Page 49
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of National Mercantile Bancorp (the
"Company") and of its wholly owned subsidiary Mercantile National Bank (the
"Bank") conform to generally accepted accounting principles and to prevailing
practices within the banking industry. The preparation of these consolidated
financial statements requires management to make estimates and assumptions that
affect the reported amount of assets and liabilities, and disclosure of
contingent assets and liabilities at the date of consolidated financial
statements and the reported amounts of revenues and expenses during reported
periods. Actual results could differ from those estimates.
The Company, through the Bank, engages in commercial banking in the Los
Angeles area serving niche markets represented by professional, business and
entertainment borrowers, and associated individuals with commercial banking and
personal banking needs.
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company
and the Bank. All intercompany transactions and balances have been eliminated.
The Bank is the Company's only subsidiary.
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.
SECURITIES
Securities held-to-maturity are carried at cost adjusted for
amortization of premium and accretion of discounts, as the Company has the
ability and management has the positive intent to hold such securities until
maturity. Securities available-for-sale are carried at estimated fair value.
Unrealized gains or losses on available-for-sale securities are excluded from
earnings and reported as accumulated other comprehensive income in a separate
component of shareholders' equity until realized. Because the Company has net
operating loss carryforwards, no tax expense (benefit) has been recorded from
unrealized gains (losses). Premiums or discounts on held-to maturity and
available-for-sale securities are amortized or accreted into income using the
effective interest method. Realized gains or losses on sales of
held-to-maturity or available-for-sale securities are recorded 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 loan origination costs.
Interest income is accrued as earned. Net deferred fees are accreted into
interest income using the effective interest method. Loans are placed on
nonaccrual status when a loan becomes 90 days past due as to interest or
principal unless the loan is both well secured and in process of collection.
Loans are also placed on nonaccrual status when the full collection of interest
or principal becomes uncertain. When a loan is placed on nonaccrual status, the
accrued and unpaid interest receivable is reversed and the accretion of deferred
loan fees is ceased. Thereafter, interest collected on the loan is accounted for
on the cash collection or cost recovery method until qualifying for return to
accrual status. Generally, a loan may be returned to accrual status when all
delinquent principal and interest are brought current in accordance with the
terms of the loan agreement and certain performance criteria have been met.
Page 50
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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.
ALLOWANCE FOR CREDIT LOSSES
The provisions for credit losses charged to operations reflects
management's judgment of the adequacy of the allowance for credit losses and
are determined through periodic analysis of the loan portfolio, problem loans
and consideration of such other factors as the Bank's loan loss experience,
trends in problem loans, concentrations of credit risk, and economic
conditions (particularly Southern California), as well as the results of the
Company's ongoing examination process and its regulatory examinations.
The calculation of the adequacy of the allowance for credit losses is based
on a variety of factors, including loan classifications, migration trends 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 allowance for credit losses based on the Bank's loss histories
and policies. The Bank uses a migration analysis as part of its allowance for
credit losses 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.
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 (3
years to 5 years) of each type of asset. Leasehold improvements are amortized
using the straight-line method over the term of the related leases or the
service lives (10 years to 20 years) of the improvements, whichever is shorter.
Gains and losses on dispositions are reflected in current operations.
Maintenance and repairs are charged to other operating expenses as incurred.
OTHER REAL ESTATE OWNED
Other Real Estate Owned ("OREO") is comprised of real estate acquired in
satisfaction of loans. Properties acquired by foreclosure or deed in lieu of
foreclosure are transferred to OREO and are initially recorded at the lower
of the loan balance or fair value, at the date of transfer of the property
establishing a new cost basis. Subsequently OREO is carried at the lower of
cost or fair value less costs to sell. The fair value of the OREO property is
based upon a current appraisal. Losses that result from the ongoing periodic
valuation of these properties are charged against
Page 51
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
other operating expenses in the period in which they are identified. Expenses
for holding costs are changed to other operating expenses as incurred.
INCOME TAXES
The Company and the Bank file consolidated federal income tax return and
combined state income tax returns.
Deferred tax assets and liabilities are recognized for the expected future
tax consequences of existing differences between financial reporting and tax
reporting basis of assets and liabilities, as well as for operating losses and
tax credit carryforwards, using enacted tax laws and rates. Deferred tax assets
will be reduced through a valuation allowance whenever it becomes more likely
than not that all, or some portion will not be realized. Deferred income taxes
(benefit) 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 (benefit) for
the year.
COMPREHENSIVE INCOME
Comprehensive income is defined as change in equity during a period from
transactions and other events and circumstances from nonowner sources. The
accumulated balance of other comprehensive income is required to be displayed
separately from retained earnings and additional capital paid in the
consolidated balance sheet.
The components of other comprehensive income together with total
comprehensive income are reported in the consolidated statement of changes in
shareholders' equity. The accumulated balance of other comprehensive income is
not reported as a net amount after taxes due to the size and availability of the
Company's net operating loss carry forwards.
EARNINGS PER SHARE
Page 52
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Basic earnings 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 per share for
the years ended December 31, 1999 and 1998 was 677,137 and 677,061,
respectively. The weighted average number of common shares and common share
equivalents outstanding used in computing diluted earnings per share for the
years ended December 31, 1999 and 1998 was 2,477,614, and 2,537,280,
respectively. All periods presented were restated to reflect the 100% common
stock dividend declared January 8, 1998 and paid February 13, 1998 which 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>
PER SHARE
NET INCOME SHARES AMOUNT
-------------- -------------- --------------
(IN THOUSANDS)
<S> <C> <C> <C>
FOR THE YEAR ENDED 1999:
Basic EPS ................................ $1,014 677,137 $1.50
==============
Effect of dilutive securities:
Options and warrants .................. 477
Convertible preferred stock ........... 1,800,000
-------------- --------------
Diluted EPS .............................. $1,014 2,477,614 $0.41
============== ============== ==============
FOR THE YEAR ENDED 1998:
Basic EPS ................................ $ 645 677,061 $0.95
==============
Effect of dilutive securities:
Options and warrants .................. 60,219
Convertible preferred stock ........... 1,800,000
-------------- --------------
Diluted EPS .............................. $ 645 2,537,280 $0.25
============== ============== ==============
</TABLE>
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.
Page 53
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
STOCK OPTIONS
Compensation expense is recorded on the date of grant only if the
current market price of the underlying stock exceeded the exercise price. Pro
forma net income and pro forma earnings per share disclosures for employee stock
option grants are based on recognition as expense, over the vesting period, the
fair value on the date of grant of all stock-based awards made during 1999
and 1998.
RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board ("FASB") issued Statement of
Financial Accounting Standard ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities," as amended by SFAS No. 137 "Accounting
for Derivative Instruments and Hedging Activities -Deferral of the Effective
Date of FASB Statement No. 133." The Company is required to and will
implement the provision of this new standard on January 1, 2001. SFAS No. 133
establishes accounting and reporting standards requiring that every
derivative instrument be recorded in the Statement of Financial Condition as
either an asset or as a liability measured at its fair value and that changes
in the fair value be recognized currently in the Statement of Operations. The
Company has not yet quantified the impact of adopting SFAS No. 133 on its
financial statements but does not believe it will have a material effect of
the Company's financial position or results of operations.
Page 54
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 2--INVESTMENT SECURITIES
The following is a summary of amortized cost, gross unrealized gains, gross
unrealized losses, and estimated fair values of the Company's investment
securities available-for-sale at December 31, 1999:
<TABLE>
<CAPTION>
DECEMBER 31, 1999
-------------------------------------------------
TOTAL GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSS VALUE
---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
U.S. Treasury securities .................... $ 2,015 $ - $ 13 $ 2,002
GNMA-issued/guaranteed mortgage
pass through certificates ................ 7,646 15 126 7,535
Other U.S. government and federal
agency securities ........................ 1,937 3 - 1,940
FHLMC/FNMA-issued mortgage
pass through certificates ................ 15,185 - 448 14,737
CMO's and REMIC's issued by U.S.
government-sponsored agencies ........... 40,174 - 1,827 38,347
Privately issued corporate bonds,
CMO's and REMIC's securities ............. 5,007 - 79 4,928
FRB and other equity stocks ................. 1,746 - - 1,746
---------- ---------- ----------- ----------
$ 73,710 $ 18 $ 2,493 $ 71,235
========== ========== =========== ==========
</TABLE>
Gross realized losses related to investment securities was $1,000 for
the year ended December 31, 1999 and $39,000 of gross realized gains for the
year ended December 31, 1998.
The estimated fair value and amortized cost of investment securities at
December 31, 1999 by contractual maturity, are shown below:
<TABLE>
<CAPTION>
AFTER ONE BUT AFTER FIVE BUT
WITHIN ONE YEAR WITHIN FIVE YEARS WITHIN TEN YEARS
--------------------------- ------------------------- ------------------------
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
---------- ---------- ---------- ---------- ---------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Securities available-for-sale:
U.S Treasury .................... $ - - $ 2,002 5.84% $ - -
GNMA-issued/guaranteed mortgage
pass-through certificates .... - - - - - -
Other U.S. government and federal
agencies ..................... - - 1,940 7.14% - -
FHLMC/FNMA-issued mortgage
pass-through certificates .... - - 1,684 6.49% - -
CMO's and REMIC's issued by
U.S. government-sponsored
agencies ..................... - - - - - -
Privately issued corporate bonds,
CMO's and REMIC's securities . 993 5.42% - - - -
FRB and other equity stocks ..... - - - - - -
---------- ---------- ---------- ---------- ---------- -----------
$ 993 5.42% $ 5,626 6.48% $ - -
========== ========== ========== ========== ========== ===========
AMORTIZED COST .................. $ 1,005 $ 5,653 $ -
========== ========== ========== ========== ========== ===========
</TABLE>
<TABLE>
<CAPTION>
AFTER TEN YEARS WEIGHTED
--------------------------- AVERAGE
AMOUNT YIELD TOTAL YIELD
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Securities available-for-sale:
U.S Treasury .................... $ - - $ 2,002 5.84%
GNMA-issued/guaranteed mortgage
pass-through certificates .... 7,535 7.44% 7,535 7.44%
Other U.S. government and federal
agencies ..................... - - 1,940 7.14%
FHLMC/FNMA-issued mortgage
pass-through certificates .... 13,053 6.31% 14,737 6.33%
CMO's and REMIC's issued by
U.S. government-sponsored
agencies ..................... 38,347 6.62% 38,347 6.62%
Privately issued Corporate bonds,
CMO's and REMIC's securities . 3,935 6.36% 4,928 6.17%
FRB and other equity stocks ..... 1,746 5.05% 1,746 5.05%
---------- ---------- ---------- ----------
$ 64,616 6.59% $ 71 6.57%
========== ========== ========== ==========
AMORTIZED COST .................. $ 67,052 $ 73,710
========== ========== ========== ==========
</TABLE>
Actual maturities may differ from contractual maturities to the extent that
borrowers have the right to call or prepay obligations with or without call or
repayment penalties.
Page 55
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Investment securities totaling $2.0 million were pledged to secure
government tax deposits, bankruptcy deposits, or for other purposes required or
permitted by law at December 31, 1999.
NOTE 3--LOANS RECEIVABLE AND ALLOWANCE FOR CREDIT LOSSES
The following is a summary of the major categories of loans receivable
outstanding at December 31, 1999:
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS)
<S> <C>
Commercial loans:
Secured by one-to-four family residential properties .... $ 4,405
Secured by multifamily residential properties ........... 5,355
Secured by commercial real properties ................... 28,233
Other, secured and unsecured ............................ 33,221
Real estate construction and land development .............. 6
Home equity lines of credit ................................ 367
Consumer installment and unsecured loans to individuals .... 2,496
--------
74,083
Unearned income ......................................... (240)
--------
$ 73,843
========
Weighted average yield for loans at December 31 ......... 9.27%
</TABLE>
At December 31, 1999, the Company had identified impaired loans with
recorded investments of $932,000. At December 31, 1999 no related specific
allowance for credit losses were necessary for these loans. During 1999 and
1998, the average recorded investment of impaired loans was $1.3 million and
$6.5 million, respectively. During the years ended December 31, 1999 and 1998
interest income recognized on impaired loans was $81,000 and $542,000,
respectively.
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 outstanding principal balance of these loans was $9,000 at
December 31, 1999 and $580,000 at December 31, 1998. During 1999 there were
$15,000 of advances and $586,000 of repayments. Interest income recognized on
these loans amounted to $3,000 during 1999 and 1998. At December 31, 1999,
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.
Page 56
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The following is a summary of activity in the allowance for credit
losses for the years ended December 31, 1999 and 1998:
<TABLE>
<CAPTION>
1999 1998
---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Balance, beginning of year .................. $ 2,144 $ 2,023
Provision for credit losses ................. - -
Loans charged off ........................... (577) (407)
Recoveries of loans previously charged off .. 329 528
---------- ----------
Balance, end of year ........................ $ 1,896 $ 2,144
========== ==========
</TABLE>
The following is a summary of nonperforming loans at December 31, 1999:
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS)
<S> <C>
Nonaccrual loans ..................................................... $ 932
Troubled debt restructurings ......................................... -
Loans contractually past due ninety or more days with respect
to either principal or interest and still accruing interest ....... -
------
$ 932
======
</TABLE>
Interest foregone on nonperforming loans outstanding at December 31,
1999 and 1998 was $131,000 and $162,000, respectively. Foregone interest on
nonperforming loans does not include interest forgone on loans on nonperforming
status that were restored to performing status prior to year end, or subsequent
to either being charged off prior to year end or transferred to OREO prior to
year end.
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, 1999, loans aggregating
$38.4 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, 1999, the Company's loans
to businesses and individuals engaged in entertainment industry-related
activities amounted to $20.5 million, none of which are collateralized by real
property.
Page 57
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 4--PREMISES AND EQUIPMENT AND LEASE COMMITMENTS
The following is a summary of the major components of premises and
equipment at December 31, 1999:
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS)
<S> <C>
Leasehold improvements ............................. $ 1,688
Furniture, fixtures and equipment .................. 3,346
----------
5,034
Less accumulated amortization and depreciation ..... (4,408)
----------
$ 626
==========
</TABLE>
Depreciation and amortization expense was $191,000 in 1999 and $248,000
in 1998. Net rental expense on operating leases included in net occupancy
expense in the Consolidated Statements of Operations was $827,000 in 1999 and
$722,000 in 1998.
The Bank leases approximately 24,000 square feet in an office building
at 1840 Century Park East, Los Angeles, California. The effective rent under
this lease is $2.33 per square feet 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.
In connection with the lease, the Company issued the landlord a
warrant to purchase up to 9.9% of the outstanding shares of capital stock of
the Company at December 31, 1997. The exercise price of the warrant is
currently $5.00 per share of Common Stock and $10.00 per share of Series A
Preferred. The warrant expires on December 31, 2002. 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 future net minimum annual rental commitments at December 31, 1999
are summarized below.
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS)
FOR THE YEAR ENDING DECEMBER 31,
<S> <C>
2000 ................................... $ 744
2001 ................................... 863
2002 ................................... 823
2003 ................................... 823
2004 ................................... 688
-----------
$ 3,941
===========
</TABLE>
Page 58
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 5--INCOME TAXES
A current federal and state income tax provision of $47,000 and $8,000
was recognized during 1999 and 1998, respectively, primarily due to alternative
minimum tax ("AMT") that could not be offset by net operating loss carryforwards
("NOL").
A reconciliation of the amounts computed by applying the federal
statutory rate of 34% for 1999 and 1998 to the income and the effective tax rate
are as follows:
<TABLE>
<CAPTION>
1999 1998
-------------------- --------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Tax provision (benefit) at statuory rate ........................ $ 360 34.0% $ 222 34.0%
Increase (reduction) in taxes resulting from:
Tax-exempt income on state municipal securities and loans .... - -
Valuation allowance on deferred tax asset .................... (327) (30.8) (202) (30.9)
Other, net ................................................... 13 1.2 (12) (1.9)
-------- -------- -------- --------
$ 47 4.4% $ 8 1.2%
======== ======== ======== ========
</TABLE>
The major components of the net deferred tax asset at December 31, 1999
are as follows:
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS)
<S> <C>
Deferred tax assets:
Net operating losses ................................... $ 7,241
OREO reserves .......................................... 458
Accrued expenses ....................................... 323
Alternative minimum tax credits ........................ 254
Nonaccrual interest .................................... 58
State taxes ............................................ 1
Loan Fees .............................................. 65
Other .................................................. 8
----------
Total deferred tax assets .............................. 8,408
----------
Deferred tax liabilities:
Bad debt expense ....................................... 68
Depreciation ........................................... 34
----------
Total deferred tax liabilities ......................... 102
----------
Net deferred tax asset .................................... 8,306
Valuation allowance ....................................... (8,306)
----------
Deferred tax asset, net of valuation allowance ............ $-
==========
</TABLE>
A valuation allowance has been placed against 100% of the net deferred
tax asset due to the uncertainty as to its ultimate realization.
Page 59
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
For tax purposes at December 31, 1999, the Company had (i) federal NOL's
of $20.3 million, which begin to expire in 2007; (ii) California NOL's of $4.7
million, of which $3.2 million will expire in 2000 and $1.2 million will expire
in 2001; and (iii) an AMT credit at December 31, 1999 of $254,000 which may be
carried forward indefinitely.
NOTE 6--BENEFIT PLANS
STOCK INCENTIVE PLANS. At December 31, 1999, the Company had in
effect one stock incentive plan pursuant to which up to a total of 348,510
shares of common stock may be issued. Under this plan, the Company could
grant to directors, officers, employees and consultants stock-based incentive
compensation in a variety of forms, including without limitation
non-qualified options, incentive options, sales and bonuses of common stock
and stock appreciation rights. Generally, awards under these plans may be
granted by the Board of Directors or a committee of the Board of Directors on
such terms and conditions as the Board or committee determines. However, the
exercise price of options granted to non-employee directors may not be less
than the fair market value of the common stock on the date of grant. At
December 31, 1999, the only outstanding awards under this plan were stock
options, and at that date 80,270 shares were available for future awards.
At December 31, 1999, there were also outstanding options and tandem
stock appreciation rights granted under three prior stock incentive plans.
The following summarizes option grants, cancellations and exercises
under the stock incentive plans for the periods indicated.
<TABLE>
<CAPTION>
OPTION PRICE
RANGE PER
SHARE
<S> <C> <C>
Outstanding, January 1, 1998 166,428 $4.83 - $8.52
Granted ............................. 126,970 4.63 - 7.38
Cancelled ........................... (16,250) 6.00 - 7.96
Exercised ........................... - -
-------
Outstanding, December 31, 1998 277,148 4.63 - 8.52
Granted ............................. 91,350 4.44 - 4.88
Cancelled ........................... (19,600) 4.50 - 7.07
Exercised ........................... (147) 6.00 - 6.00
-------
Outstanding, December 31, 1999 348,751 $4.44 - $8.52
-------
</TABLE>
Of the outstanding options at December 31, 1999: (i) options to
purchase 221,873 shares were vested and exercisable; and (ii) the remaining
options become exercisable as follows: 2000 -- 66,538; 2001 -- 50,367; and
2002 -- 9,826.
Page 60
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The estimated per share weighted average fair value of options
granted was $2.48 and $4.22 during 1999 and 1998. The Company applies
Accounting Principles Board Opinion No. 25 and related Interpretations in
accounting for the Plans. Accordingly, no compensation cost has been
recognized for the 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 options granted been determined based on the
fair value at the grant dates for awards under the Plans consistent with the
method of SFAS No. 123, the Company's net income for 1999 and 1998 would have
been decreased by $105,000 and $91,000, respectively. Basic and diluted
earnings per share would have decreased by $.15 and $.04 for 1999,
respectively, and $.13 and $.04 for 1998, respectively.
The fair values of options granted during 1999 and 1998 were
estimated on the date of grant using the Black-Scholes option-pricing model
with the following weighted-average assumptions used: 1999-no dividend yield,
expected volatility of 74%, risk-free interest rate of 6.44%, and an expected
life of 10 years; 1998 - no dividend yield, expected volatility of 74%,
risk-free interest rate of 4.65%, 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 currently remains in force for
employee contributions only. Should the Company elect to match participant
contributions, such matching becomes vested when the employee reaches three
years of service.
NOTE 7 - BORROWED FUNDS
The following summarizes borrowed funds and weighted average rates.
<TABLE>
<CAPTION>
1999
--------------------------------------------------
YEAR-END AVERAGE
----------------------- -----------------------
BALANCE RATE BALANCE RATE
--------- ----- ---------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Federal funds purchased and securities
sold under repurchase agreements .... $ - - $ 1,194 4.19%
Other borrowings ....................... 26,200 5.79% 19,121 5.26%
</TABLE>
The maximum amount of federal funds purchased and securities sold
with agreements to repurchase at any month end was $2.0 million during 1999.
The average amount of federal funds purchased and securities sold under
agreement to repurchase was $1.2 million during 1999.
Other borrowings are primarily comprised of Federal Home Loan Bank
("FHLB") advances. At December 31, 1999 FHLB advances included; $9.2 million
overnight variable rate borrowings, with a weighted average rate of 4.75%
based on the federal funds rate; variable rate borrowings of $6.5 million
maturing October 2000 and $8.0 million maturing July 2001 with a weighted
average rate of 6.42% based on the London Inter Bank Offering Rate ("LIBOR")
index; and $2.5 million Putable borrowing with a fixed rate of 5.93%, a first
Put date of July 2002 and every three months thereafter, with a final
maturity of July 2004. The maximum amount of other borrowings outstanding at
any month-end was $26.2 million during 1999.
The Bank had $12.3 million of unused borrowing capacity from the FHLB
at December 31, 1999.
Page 61
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 8--AVAILABILITY OF FUNDS FROM BANK; RESTRICTIONS ON CASH BALANCES; CAPITAL
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. 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.
The OCC also has authority 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.
In addition, federal law restricts the Bank's extension of credit to,
the issuance of a guarantee or letter of credit on behalf, investments in or
taking as collateral stock or other securities of the Company. 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).
Federal Reserve Board regulations require the Bank to maintain certain
minimum certain minimum reserve balances. Cash balances maintained to meet
reserve requirements are not available for use by the Bank or the Company.
During 1999 and 1998 the average reserve balances for the Bank were
approximately $1,256,000 and $758,000, respectively. Neither the Company nor the
Bank is required to maintain compensating balances to assure credit availability
under existing borrowing arrangements.
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 the Company's and the Bank's assets, liabilities, and certain
off-balance-sheet items as calculated under regulatory accounting practices. The
Company's and the Bank's 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 (as defined in the
regulations) to risk-weighted assets (as defined). Management believes, as of
December 31, 1999, the Company and Bank meet all capital adequacy requirements
to which it is subject.
Page 62
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
At December 31, 1999 and 1998, the most recent notification from the
OCC categorized the Bank as well capitalized under the regulatory framework
for prompt corrective action. To be categorized as well as capitalized, the
Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1
leverage ratios as set forth in the following table. There are no conditions
or events since the most recent notification which management believes have
changed the Bank's category.
The following table presents, at the dates indicated, certain
information regarding the regulatory capital of the Company and the Bank and
the required amounts of regulatory capital for the Company and the Bank to
meet applicable regulatory capital requirements and, in the case of the Bank,
to be well capitalized under the prompt corrective action rules.
<TABLE>
<CAPTION>
TO BE CATEGORIZED
AS WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION
------------------- ------------------ ------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------- ------ ------- ------ ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1999
Total Capital to Risk Weighted Assets
Company ........................................ $15,156 17.47% $ 6,940 >=8.0% n/a
Bank ........................................... 14,035 16.29% 6,890 >=8.0% $ 8,613 >=10.0%
Tier 1 Capital to Risk Weighted Assets
Company ........................................ 14,062 16.21% 3,470 >=4.0% n/a
Bank ........................................... 12,949 15.03% 3,445 >=4.0% 5,168 >=6.0%
Tier 1 Capital to Average Assets
Company ........................................ 14,062 8.98% 6,264 >=4.0% n/a
Bank ........................................... 12,949 8.32% 6,223 >=4.0% 7,778 >=5.0%
As of December 31, 1998
Total Capital to Risk Weighted Assets
Company ........................................ 14,001 18.65% $ 6,004 >=8.0% n/a
Bank ........................................... 10,646 14.75% 5,775 >=8.0% $ 7,219 >=10.0%
Tier 1 Capital to Risk Weighted Assets
Company ........................................ 13,048 17.38% 3,002 >=4.0% n/a
Bank ........................................... 9,728 13.48% 2,888 >=4.0% 4,331 >=6.0%
Tier 1 Capital to Average Assets
Company ........................................ 13,048 8.78% 5,945 >=4.0% n/a
Bank ........................................... 9,728 6.69% 5,819 >=4.0% 7,274 >=5.0%
</TABLE>
NOTE 9--COMMITMENTS AND CONTINGENCIES
In the normal course of business, the Company is a party to financial
instruments with off-balance-sheet risk. These financial instruments include
commitments to extend credit, letters of credit and financial guarantees. These
instruments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amount reflected in the consolidated statement of
financial condition.
Exposure to credit loss in the event of non-performance by the other
party to the financial instrument for commitments to extend credit, letters of
credit and financial guarantees written, is represented by the contractual
notional amount of those instruments. The Company uses the same credit policies
in making commitments and conditional obligations as is does for on-balance
sheet instruments.
The Company had outstanding loan commitments aggregating $14.7
million at December 31, 1999. In addition, the Company had $422,000
outstanding letters of credit at December 31, 1999. Substantially all of the
Company's loan commitments at December 31, 1999 were for commercial loans
with variable interest rates.
Page 63
.<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Loan commitments are agreements to lend to a customer subject to certain
conditions. Loan commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since a portion of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements.
The Company is from time to time is party to lawsuits, which arise in
the normal course of business. The Company does not believe that any pending
lawsuit at December 31, 1999 will have a material adverse effect on the
financial position or results of operations of the Company.
NOTE 10--SUPPLEMENTAL CASH FLOW INFORMATION
The following information supplements the statements of cash flows
for the years ended December 31, 1999 and 1998:
<TABLE>
<CAPTION>
1999 1998
---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Interest paid ................................................ $ 3,491 $ 3,459
Non-Cash Investing and Financing Transactions:
Unrealized (loss) gain on securities available-for-sale ... (2,686) 173
Transfers to OREO from loans receivable, net ................. - 176
</TABLE>
NOTE 11--DISCLOSURES ABOUT THE FAIR VALUE OF FINANCIAL INSTRUMENTS
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.
SECURITIES: For securities classified as available-for-sale, fair
value equals 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
establishing the credit risk component of the fair value calculations for loans
the Company concluded the allowance for credit losses represented a reasonable
estimate of credit risk component of the fair value at December 31, 1999.
Page 64
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
DEPOSITS: The fair value of demand and interest checking, 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.
BORROWED FUNDS: The carrying value for this relatively short-term debt
is a reasonable approximation of its fair value. Borrowings with maturities
greater than one year bear interest at variable rates.
The estimated fair values of financial instruments are presented below.
<TABLE>
<CAPTION>
DECEMBER 31, 1999
-----------------------
CARRYING FAIR
AMOUNT VALUE
---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Financial Assets:
Cash, cash equivalents and deposit with
other financial institutions ............... $ 10,239 $ 10,239
Securities available-for-sale ................. 71,235 71,235
Loans, net of allowance for credit losses ..... 71,947 72,540
Financial Liabilities:
Demand deposits, money market and savings ..... 90,951 76,250
Time certificates of deposit .................. 26,033 26,112
Federal funds purchased and securities sold
under agreements to repurchase ............. - -
Other borrowings .............................. 26,200 26,093
</TABLE>
Page 65
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 12--PARENT COMPANY INFORMATION
The following financial information presents the statements of
condition of the Company on a parent-only basis as of December 31, 1999, and
the related statements of operations and cash flows for each of the years in
the two-year period ended December 31, 1999.
STATEMENTS OF CONDITION
<TABLE>
<CAPTION>
DECEMBER 31,
1999
------------
(DOLLARS IN
THOUSANDS)
------------
<S> <C>
Cash with Bank ................................. $ 15
Federal Funds .................................. 600
Loan receivable ................................ 496
Investment in the Bank ......................... 10,473
Other assets ................................... 3
--------
Total assets ............................. $ 11,587
========
Liabilities .................................... $ -
Shareholders' equity:
Preferred stock ............................. 7,350
Common stock ................................ 24,614
Accumulated deficit ......................... (17,902)
Accumulated other comprehensive income ...... (2,475)
--------
Total shareholders' equity .................. 11,587
--------
Total liabilities and shareholder's equity $ 11,587
========
</TABLE>
Page 66
<PAGE>
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1999 1998
---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Interest income ...................................................... $ 195 $ 310
Other income ......................................................... - -
---------- ----------
Total operating income ............................................... 195 310
Other operating expense .............................................. 1 3
---------- ----------
Income before equity in undistributed net income of the Bank ...... 194 307
Equity in undistributed net income of the Bank ....................... 820 338
---------- ----------
Net income ........................................................... $ 1,014 $ 645
========== ==========
</TABLE>
STATEMENTS OF CASH FLOW
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1999 1998
---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Cash flows from operating activities:
Net income ........................................................ $ 1,014 $ 645
Adjustment to reconcile net income to net cash
provided by operating activities.:
Equity in undistributed net income of the Bank, net ............ (820) (338)
Other, net ..................................................... 12 32
---------- ----------
Net cash provided by operating activities....................... 206 339
Cash flows from investing activities:
Investment in Bank ................................................ (2,400) (2,000)
Proceeds of matured securities held-to maturity ................... - 2,000
Purchase of loans participated and principal collections, net ..... 2,410 (1,870)
---------- ----------
Net cash provided by (used in) investing activities ............ 10 (1,870)
Cash flows from financing activities:
Proceeds from stock options exercised ............................. 1 -
---------- ----------
Net cash provided by financing activities ...................... 1 -
---------- ----------
Net increase (decrease) in cash and cash equivalents ................. 217 (1,531)
Cash and cash equivalents, beginning of the year ..................... 398 1,929
---------- ----------
Cash and cash equivalents, end of the year ........................... $ 615 $ 398
========== ==========
</TABLE>
Page 67
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NO.
- -------
<S> <C>
3.1 Amended and Restated Articles of Incorporation, dated June 20, 1997 (1)
3.2 Bylaws of the Company, as amended, restated as of December 18, 1992 (2)
10.1 Employment Agreement dated January 1, 1999 between Mercantile National
Bank and Scott A. Montgomery (3)
10.2 Letter Agreement dated July 17, 1996 between Mercantile National Bank
and Joseph W. Kiley III (4)
10.3 Form of Indemnity Agreement between the Company and its directors (5)
10.4 First Floor Lease at 1840 Century Park East, Los Angeles, California,
dated as of December 21, 1982 between Northrop Corporation and
Mercantile National Bank (2)
10.5 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 (2)
10.6 Lease Restructure Agreement dated December 31, 1995 by and between
California State Teachers' Retirement System and Mercantile National
Bank (6)
10.7 Warrant Agreement dated December 31, 1995 by and between the Company and
California State Teachers' Retirement System (6)
10.8 Registration Rights Agreement dated December 31, 1995 by and between the
Company and California State Teachers' Retirement System (6)
10.9 National Mercantile Bancorp amended 1996 Stock Incentive Plan (7)
10.10 Registration Rights Agreement between the Company and Conrad Company (8)
</TABLE>
Page 68
<PAGE>
<TABLE>
<S> <C>
10.11 Registration Rights Agreement between the Company and Wildwood
Enterprises Inc. Profit Sharing Plan and Trust (8)
10.12 Bank Service Agreement dated April 21, 1997 between RH Investment
Corporation and Mercantile National Bank (1)
10.13 Investment Management Agreement dated December 1, 1997 between
Mercantile National Bank and Windsor Financial Group, Inc (1)
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-KSB)
21. Subsidiaries of the Registrant
27. Financial Data Schedule
</TABLE>
- ---------------
(1) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
year ended December 31, 1997.
(2) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
year ended December 31, 1992 and incorporated herein by reference.
(3) Filed as an exhibit to the Company's Report on Form 10-Q for the quarter
ended March 31, 1999 and incorporated herein by reference.
(4) 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.
(5) 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.
(6) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
year ended December 31, 1995 and incorporated herein by reference.
(7) Filed as an exhibit to the Company's Report on Form 10-Q for the quarter
ended March 31, 1998 and incorporated herein by reference.
(8) 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.
Page 69
<PAGE>
Exhibit 21
Subsidiaries of the Registrant
Mercantile National Bank
1840 Century Park East
Los Angeles, California 90067
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM NATIONAL
MERCANTILE BANCORP DECEMBER 31, 1999 CONSOLIDATED FINANCIAL STATEMENTS AND
RELATED SCHEDULES AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 5,789
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 4,450
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 71,235
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 73,843
<ALLOWANCE> 1,896
<TOTAL-ASSETS> 156,153
<DEPOSITS> 116,984
<SHORT-TERM> 15,700
<LIABILITIES-OTHER> 1,382
<LONG-TERM> 10,500
0
7,350
<COMMON> 24,614
<OTHER-SE> (20,377)
<TOTAL-LIABILITIES-AND-EQUITY> 156,153
<INTEREST-LOAN> 5,781
<INTEREST-INVEST> 4,379
<INTEREST-OTHER> 385
<INTEREST-TOTAL> 10,545
<INTEREST-DEPOSIT> 2,503
<INTEREST-EXPENSE> 3,558
<INTEREST-INCOME-NET> 6,987
<LOAN-LOSSES> 0
<SECURITIES-GAINS> (1)
<EXPENSE-OTHER> 6,624
<INCOME-PRETAX> 1,061
<INCOME-PRE-EXTRAORDINARY> 1,014
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,014
<EPS-BASIC> 1.50
<EPS-DILUTED> .41
<YIELD-ACTUAL> 5.01
<LOANS-NON> 932
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 2,144
<CHARGE-OFFS> 577
<RECOVERIES> 329
<ALLOWANCE-CLOSE> 1,896
<ALLOWANCE-DOMESTIC> 1,225
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 671
</TABLE>
