<PAGE>
PROSPECTUS
UP TO 3,177,296 SHARES
[LOGO]
MONARCH BANCORP
COMMON STOCK
Monarch Bancorp (the "Company") is offering (the "Offering") up to 3,177,296
shares of its common stock, no par value (the "Common Stock"), in a Rights
Offering and a Public Offering. Holders of record as of the close of business on
March 30, 1995 (the "Record Date") have a nontransferable right (the "Right") to
subscribe for and purchase up to 3,177,296 shares of Common Stock for a cash
price of $1.35 per share (the "Subscription Price"). Holders of Rights ("Rights
Holders") will be able to exercise their rights until 5:00 p.m., California
time, on August 18, 1995, unless extended by the Company (the "Rights Offering
Expiration Date"). The Public Offering in its entirety will expire at 5:00 p.m.
California time on September 2, 1995, unless extended by the Company ("Public
Offering Expiration Date"). The rights offering may be extended until September
2, 1995, and the public offering may be extended until October 2, 1995.
(cover page continued on next page)
-------------------
THE PURCHASE OF COMMON STOCK IN THE OFFERING INVOLVES A HIGH DEGREE OF RISK.
POTENTIAL PURCHASERS SHOULD CAREFULLY CONSIDER THE MATTERS SET FORTH UNDER THE
HEADING "RISK FACTORS COMMENCING ON PAGE 10 OF THIS PROSPECTUS."
THE SECURITIES OFFERED HEREBY ARE NOT SAVINGS OR DEPOSIT ACCOUNTS AND ARE
NOT INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION OR ANY OTHER
GOVERNMENTAL AGENCY.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION
TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<S> <C> <C> <C>
- --------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------
UNDERWRITING
AND OTHER FEES
SUBSCRIPTION AND PROCEEDS TO THE
PRICE EXPENSES (1) COMPANY (2)
- --------------------------------------------------------------------------------------------
Per Share................................ $1.35 $0.094(3) $1.26
Total Maximum(2)......................... $4,289,350 $300,000 $3,989,360
- --------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------
<FN>
- ------------------------
(1) The per share amount constitutes the amount payable to the Financial
Advisors in their capacity as such, which equals 5% of the gross proceeds
received from the Offering. The total amounts include amounts payable to
the Financial Advisors in such capacity. The Company has agreed to
indemnify the Financial Advisors against certain liabilities under the
Securities Act of 1933. See "The Offering."
(2) Includes expenses of the Offering payable by the Company estimated to be
$85,000, including registration fees, legal and accounting fees, printing
and other miscellaneous fees.
(3) Estimated based upon the maximum offering assuming all shares are sold, but
before deducting expenses of the Offering payable by the Company.
</TABLE>
-------------------
THE DATE OF THIS PROSPECTUS IS JULY 14, 1995
<PAGE>
The Company has granted to each shareholder the Right to subscribe for and
purchase, at the Subscription Price, up to four (4) shares of Common Stock for
each share of Common Stock held of record as of the Record Date. The Rights are
not transferable. Once a Rights Holder has exercised the subscription rights,
such exercise may not be revoked. The Rights are not evidenced by certificates.
Following conclusion of the Rights Offering portion of the Offering, all of the
Company's shareholders, including shareholders that have subscribed in the
Private Placement Offering completed March 31, 1995, and the general public,
will be permitted to subscribe for any remaining unsubscribed shares of Common
Stock in the Public Offering portion of the Offering, subject to the right of
the Company, in its sole discretion, to accept or reject any subscription for
Shares in the Public Offering, either in whole or in part. In addition, for
shares sold in the Public Offering in the State of California, a nonshareholder
investor must meet certain minimum suitability standards. (See "The Offering.")
The Company presently intends, but shall not be required to, accept
subscriptions (in addition to Rights subscriptions) from shareholders as of the
Record Date up to amounts that would maintain the ownership percentage of such
shareholders at the Record Date. The Rights Offering and the Public Offering are
being offered on a best efforts basis, and no assurance can be given as to the
number of shares that may be sold.
On March 31, 1995, the Company completed a Private Placement Offering of
4,547,111 shares of its Common Stock, no par value, at a price of $1.35 per
share to several accredited investors as defined in SEC Regulation D, and the
Company raised approximately $5,669,000 in net proceeds in the private placement
(the "Private Placement Offering"). Such accredited investors are not included
as Record Date Holders for the Rights Offering. The Private Placement Offering
was undertaken in order to raise capital (i) in accordance with a Section 8(b)
Order (the "8(b) Order") issued by the FDIC, and entered into between Monarch
Bank, the wholly-owned subsidiary of the Company, and the FDIC, and a Section
1913 Order (the "1913 Order") issued by the California Superintendent of Banks
and agreed to by the Bank (collectively referred to herein as the "Orders"), and
(ii) to provide additional capital for prudent expansion of the Bank and Company
through continued growth of its present facility and possible future facilities.
As of December 31, 1994, the Bank's leverage capital ratio of approximately
2.09% was approximately $2,960,000 below the 7% level which is required under
the terms of the Orders. With the completion of the initial phase of the Private
Placement Offering on March 31, 1995 and the increase in capital of the Bank by
approximately $3,550,000 to approximately $4,846,000, the Bank now exceeds the
minimum capital requirements established by the Orders, as the Bank's leverage
capital ratio as of March 31, 1995 was 7.85%. The Company retained $53,500 from
the net proceeds of the Private Placement Offering for the retirement of debt
and $2,065,000 for general corporate purposes. The Company anticipates retaining
the net proceeds received from the completion of this Offering.
This Offering is being undertaken in order to raise additional capital (i)
for general corporate purposes and to provide for prudent expansion of the
Company through continued growth of its present facility and possible future
facilities, and (ii) to allow shareholders to participate in the
recapitalization of the Company and the Bank at the same price per share as the
investors. Although the Company has had preliminary discussions regarding
possible acquisitions with a number of financial institutions, no agreements or
understandings have been reached at this time.
2
<PAGE>
AVAILABLE INFORMATION
The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
therewith files reports, proxy statements and other information with the
Securities and Exchange Commission (the "Commission"). Such reports, proxy
statements and other information can be inspected and copied at the public
reference facilities maintained by the Commission at Room 1024, Judiciary Plaza,
450 Fifth Street, N.W., Washington, D.C. 20549; and at the Commission's Regional
Offices located on the 15th Floor, 7 World Trade Center, New York, New York
10048 and Suite 1400, 500 West Madison Street, Chicago, Illinois 60661. Copies
of such material may also be obtained at prescribed rates from the Public
Reference Section of the Commission at Judiciary Plaza, 450 Fifth Street, N.W.,
Washington, D.C. 20549.
The Company has filed with the Commission a Registration Statement on Form
SB-2 (the "Registration Statement") pursuant to the Securities Act of 1933, as
amended (the "Securities Act"), with respect to the securities offered hereby.
This Prospectus does not contain all of the information set forth in the
Registration Statement and the exhibits and schedules relating thereto as
permitted by the rules and regulations of the Commission. For further
information pertaining to the Company and the securities offered hereby,
reference is made to the Registration Statement and the exhibits thereto. Items
of information omitted from this Prospectus, but contained in the Registration
Statement, may be obtained at prescribed rates or inspected without charge at
the Commission, Washington, D.C. Any statements contained herein concerning the
provisions of any document are not necessarily complete, and, in each instance,
reference is made to the copy of such document filed as an exhibit to the
Registration Statement or otherwise filed with the Commission. Each such
statement is qualified in its entirety by such reference.
The Company will provide stockholders with annual reports of the Company
containing audited financial statements.
3
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING INFORMATION IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO, AND
SHOULD BE READ IN CONJUNCTION WITH, THE DETAILED INFORMATION AND CONSOLIDATED
FINANCIAL STATEMENTS AND NOTES THERETO SET FORTH ELSEWHERE IN THIS PROSPECTUS OR
INCORPORATED BY REFERENCE HEREIN.
THE COMPANY AND THE BANK
Monarch Bancorp (the "Company") is a Laguna Niguel, California based bank
holding company organized in 1984 and conducting operations through its sole
subsidiary, Monarch Bank (the "Bank"), a California state-chartered bank. The
Company has operated as a one-bank holding company, registered under the Bank
Holding Company Act of 1956 since 1984. The Bank commenced operations in 1980
and currently operates through its head office in Laguna Niguel, California. The
only material activity of the Company is the operation of the Bank. As of March
31, 1995, the Company had consolidated total assets, total deposits and
shareholders' equity of approximately $63 million, $56 million and $6.8 million,
respectively. The Bank is insured under the Federal Deposit Insurance Act, but
it is not a member of the Federal Reserve System.
BUSINESS. The Bank's primary market area is South Orange County,
California. The principal business of the Bank is to accept time and demand
deposits, and to make commercial loans, consumer loans, real estate loans and
other investments. The Bank's loans are primarily short-term and/or adjustable
rate. (See "Business.") The Bank's Strategic Plan since 1987 has emphasized
serving the banking needs of individuals, professionals, and small to
medium-sized businesses in Laguna Niguel, California and the surrounding
communities. The Bank has carved a local niche by being active in civic and
community activities and providing a high degree of individualized personal
service. The Bank was the first in the local area to be open for Saturday
business and maintains operating hours from 7:00 a.m. to 7:00 p.m. in an effort
to serve its largely "commuter" customer base as well as its small business
customers. In addition, it has a chartered courier branch which operates
throughout mid- and southern-Orange County, serving professionals and small
businesses, which has greatly expanded its service area without the need for
additional physical facilities. Since 1987, the Bank's major lending emphasis
has been directed at short term owner-occupied luxury home construction
projects, commercial lending to professionals and individuals, with the
objective of building a balanced community loan and investment portfolio mix.
The Bank relies on a foundation of locally generated deposits and has a low cost
of funds due to a high percentage of low cost and noninterest bearing deposits.
The Bank also originates SBA loans, has a mortgage referral program and its own
credit card program. Due to consolidations, mergers, and the small number of
independent banks headquartered in South Orange County, the Bank believes that,
given appropriate capital resources (a portion of which are intended to be
raised in this Offering), it may be well positioned to prudently expand and
build a larger, regional independent financial institution in the affluent South
Orange County market. (See "Business.")
FINANCIAL CONDITION AND OPERATIONS. Although the Company experienced growth
in both assets and net earnings from 1988 to 1992, weaknesses in the Southern
California economy, particularly with regard to price and demand for real
estate, led to substantial losses in 1993 and 1994, as well as increases in
nonperforming assets. These losses temporarily decreased the capital resources
of the Bank well below regulatory requirements, although the Bank met all
regulatory capital requirements at March 31, 1995. See "RISK FACTORS --
Financial Condition and Operations; Loss in 1993 and 1994" and the financial
information included herein.
ADMINISTRATIVE ACTIONS
As a result of the losses incurred in 1993 and 1994, as well as certain of
the factors that contributed thereto, both the FDIC and the California
Superintendent of Banks issued orders to the Bank requiring it to take
corrective actions and increase its capital ratios. See "RISK FACTORS --
Existing and Potential Enforcement Actions."
PRIVATE PLACEMENT OFFERING AND CORRECTIVE ACTIONS
On March 31, 1995, the Company completed a Private Placement Offering of
4,547,111 shares of its Common Stock, no par value, at a price of $1.35 per
share to several accredited investors pursuant to SEC Regulation D. As a result
of the completion of the Private Placement Offering, the Company raised
4
<PAGE>
approximately $5,669,000 in net proceeds and contributed approximately $3.55
million to the Bank, increasing the Bank's leverage capital ratio to 7.85% as of
March 31, 1995, which was approximately $539,000 above the level required by the
Section 8(b) Order. The Company repaid debt in the amount of $53,500 and
retained approximately $2,065,000 for general corporate purposes. All investors
in the Private Placement Offering completed their purchases prior to the filing
of the Company's Registration Statement on Form SB-2.
A total of 24 accredited investors purchased shares in the Private Placement
Offering. The following table lists investors and any known shareholders with a
beneficial ownership of five percent of the Company Stock as of June 15, 1995.
All shareholders listed in the following table purchased in the Private
Placement Offering. All shares are Common Stock, the only class of security
outstanding.
<TABLE>
<CAPTION>
AMOUNT AND NATURE OF
NAME AND ADDRESS OF BENEFICIAL OWNER BENEFICIAL OWNERSHIP PERCENT OF CLASS
- ---------------------------------------------------------------- -------------------- -----------------
<S> <C> <C>
Peter Huizenga Testamentary Trust............................... 530,000 9.85%
Huizenga Capital Management
Oak Brook, IL 60521
Robert A. Schoellhorn........................................... 530,000 9.85%
c/o Bryan & Gross
Northbrook, IL 60062
Mutual Discovery Fund........................................... 530,000 9.85%
(Mutual Series Fund, Inc.)
Short Hills, NJ 07078
Basswood Partners............................................... 530,000 9.85%
Paramus, NJ 07652
Kenneth Gaspar.................................................. 370,370 6.88%
Lisle, IL
Jerome White.................................................... 333,333 6.19%
Chicago, IL 60606
</TABLE>
The Bank has taken several actions to comply with the Orders, including the
Private Placement Offering and this Offering, and management believes (but
cannot assure that the respective regulator would agree) that the Bank is in
substantial compliance with provisions of the Orders. If the FDIC and the
Superintendent on their next examinations find that the Company has complied
with all the terms of the Orders, the Orders may be lifted in the discretion of
the FDIC and the Superintendent. The Bank's regulatory agencies are required to
examine the Bank within certain statutory time frames, and management of the
Company believes the Bank will be examined before the end of the second quarter
of 1995. See "Business" and "Management's Discussion and Analysis of Financial
Condition and Results of Operation."
USE OF PROCEEDS
The net proceeds of the Offering are estimated to be $3,989,350 if the
maximum 3,177,296 shares of Common Stock are purchased. It is anticipated that
net proceeds from the sale of the shares of Common Stock offered hereby will be
used for general corporate purposes and to allow for the prudent expansion of
the organization through continued growth in its present facility, and
particularly to expand into other communities in Southern California by the
acquisition of other financial institutions or acquisition or establishment of
branches of such institutions subject to regulatory approvals and satisfaction
of the terms of the Orders. Although the Company has had preliminary discussions
with a number of financial institutions regarding possible acquisitions, and the
Company is having ongoing discussions with Rancho Santa Fe National Bank, Rancho
Santa Fe, California, no agreements or understandings have been reached at this
time. See "Use of Proceeds" and "Business."
RISK FACTORS
A PURCHASE OF THE COMPANY'S SECURITIES INVOLVES CERTAIN RISKS. POTENTIAL
PURCHASERS OF RIGHTS OR COMMON STOCK SHOULD CAREFULLY CONSIDER THE INFORMATION
SET FORTH UNDER THE HEADING "RISK FACTORS" WHICH FOLLOWS THIS SUMMARY.
5
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Securities Offered................ The Company offers hereby a maximum aggregate of
3,177,296 shares of Common Stock. With the completion of
the Private Placement Offering, an additional 4,547,111
shares of Common Stock were issued on March 31, 1995,
increasing the outstanding shares of Common Stock of the
Company at that time to 5,341,434 shares, and no shares
of Preferred Stock are outstanding. Upon completion of
this Offering, it is anticipated that up to an
additional 3,177,296 shares of Common Stock will be
issued and that up to 8,518,730 shares of the Company's
Common Stock will be issued and outstanding.
The Offerings..................... The Company is offering the shares of Common Stock in a
Rights and Public Offering (the "Offerings").
The Rights Offering............... Each record holder of Common Stock at the close of
business on the Record Date ("Record Date Holder") has
been granted one nontransferable subscription right
("Right") to subscribe to purchase four (4) shares of
Common Stock for each share of Common Stock held of
record on the Record Date. Payments received for the
shares which are not available for purchase will be
returned without interest. The Rights are not
transferable.
Subscription Price................ $1.35 per share, payable in cash.
Record Date....................... March 30, 1995.
Rights Offering Expiration Date... 5:00 p.m., California Time, August 18, 1995, which may
be extended to September 2, 1995.
Public Offering Expiration Date... 5:00 p.m., California Time, September 2, 1995 which may
be extended for two (2) 15 day periods, and will not be
extended beyond October 2, 1995. In addition, for shares
sold in the State of California, a nonshareholder
investor must meet certain minimum suitability
standards. See "The Offering."
Procedure for Exercising Rights... The Rights may be exercised by properly completing the
subscription order form and forwarding it, with payment
of the Subscription Price for each underlying share
subscribed for pursuant thereto, to Monarch Bank, the
wholly-owned subsidiary of the Company, as escrow agent,
which must receive such subscription order form and
payment at or prior to the Rights Offering Expiration
Date. If subscription order forms and payments are sent
by mail, Rights Holders are urged to use registered
mail, properly insured, with return receipt requested.
See "The Rights Offering -- Exercise of Rights."
ONCE AN INVESTOR HAS SUBSCRIBED, SUCH SUBSCRIPTION MAY
NOT BE REVOKED.
Issuance of Common Stock.......... Certificates representing shares of Common Stock
purchased will be delivered as soon as practical after
the subscriptions have been accepted by the Company.
Public Offering................... The Company anticipates that upon completion of the
Rights Offering, any remaining unsubscribed shares will
be offered to the general public in a Public Offering.
The Company presently intends, but shall not be required
to, accept subscriptions (in addition to Rights
subscriptions) from shareholders as of the Record Date
up to amounts that would maintain the ownership
percentage of such shareholders at the Record Date to
the extent feasible. See "The Offering."
</TABLE>
6
<PAGE>
<TABLE>
<S> <C>
Dilution.......................... Issuance of Common Stock in the Offering could result in
a reduction in the proportionate ownership interest in
the Company. Issuance of Common Stock at the
Subscription Price, net of anticipated expenses, is
expected to result in an immediate dilution in book
value per share to investors in this Offering of
approximately $0.09 as of March 31, 1995. See
"Dilution."
Financial Advisors................ The Company engaged Belle Plaine Partners, Inc. and
McAllen Capital Partners (the "Financial Advisors") to
provide financial advice on and assistance in
structuring the financial aspects of the Private
Placement Offering and this Offering, identifying
potential investors in the Private Placement Offering
and assisting such investors in complying with
regulatory requirements. See "The Offering."
Determination of Offering Price... The price at which the shares of Common Stock are
offered and sold in this Offering was established by the
Board of Directors, who received assistance in setting
such price from the Financial Advisors. The Board of
Directors took into consideration several factors,
including the book value of the Company's Common Stock,
the Company's and the Bank's results of operations,
analysis of the historical growth and growth potential
of the Company and the Company's market area, and
assessment of the Company's and the Bank's management
and financial condition. See "Determination of Offering
Price."
Market for Common Stock........... The Company's Common Stock is currently thinly traded on
the over-the-counter market. The Company desires in the
future to apply to list its Common Stock on the NASDAQ.
However, the Company does not believe that it qualifies
for such listing at this time, and the Company has not
made a decision on whether to apply for listing on the
NASDAQ NMS or NASDAQ Small Cap market. At the present
time, the Company has not met certain criteria for
NASDAQ NMS alternative 1 (net income, pretax income, and
a minimum bid price); alternative 2 (market value of
public float and a minimum bid price); or the NASDAQ
Small Cap Market (minimum bid price) (See "MARKET FOR
COMMON STOCK"). Although the Company hopes to meet the
NASDAQ Small Cap criteria in the near future, no
assurance can be given that the Company will qualify for
listing on NASDAQ. Since January 1, 1995, there were
three transactions totaling 26,691 shares of Common
Stock at prices of $1.50 to $.80 per share between third
parties and not involving the Company, and excluding
shares issued by the Company in the Private Placement
Offering. Shares of Common Stock issued in the Private
Placement Offering are subject to the transferability
restrictions contained in Regulation D, and such shares
may not be sold, hypothecated, pledged or otherwise
transferred except pursuant to an effective registration
statement or an exemption from registration. The Company
has agreed to register such shares by March 31, 1996.
See "Market for Common Stock."
No Board or Financial Advisor
Recommendation.................... An investment in shares of Common Stock must be made
pursuant to each investor's evaluation of its, his or
her best interests. Neither the Company's Board of
Directors nor the Financial Advisors make any
recommendation to prospective investors regarding
whether they should exercise Rights or purchase shares.
See "The Offering."
</TABLE>
7
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
AS OF OR FOR THE
QUARTER ENDED MARCH
31,
--------------------
1995 1994
--------- ---------
(DOLLARS IN
THOUSANDS, EXCEPT
PER SHARE DATA)
<S> <C> <C> <C>
INCOME STATEMENT DATA:
Net interest income................................................................ $ 712 $ 659
Provision for loan losses.......................................................... -- --
Other income....................................................................... 356 167
Other operating expense............................................................ 893 782
Earnings (loss) before income taxes................................................ 175 44
Net earnings (loss)................................................................ 182 44
PER SHARE DATA (4)
Net earnings (loss)................................................................ 0.03 0.06
Book value......................................................................... 1.26 3.60
BALANCE SHEET DATA:
Loans (5).......................................................................... 30,413 34,498
Assets............................................................................. 63,531 67,777
Deposits........................................................................... 55,978 64,919
Allowance for Loan Losses.......................................................... 980 471
Shareholders' equity............................................................... 6,768 2,858
ASSET QUALITY:
Nonperforming loans (6)............................................................ 941 1,749
Other real estate owned ("OREO") (7)............................................... 617 810
Total nonperforming loans and OREO................................................. 1,558 2,559
Loans with modified terms.......................................................... -- --
ASSET QUALITY RATIOS:
Net charge-offs to average loans................................................... 0.51% 1.73%
Nonperforming loans and OREO to total period-end loans and OREO.................... 5.02% 7.25%
Allowance for loan losses to period-end loans...................................... 3.22% 1.37%
Allowance for loan losses to period-end nonperforming loans and OREO............... 62.90% 18.41%
SELECTED PERFORMANCE RATIOS:
Return on average assets........................................................... 0.32% 0.07%
Return on average shareholders' equity............................................. 15.65% 1.39%
Average shareholders' equity to average assets..................................... 2.04% 4.80%
CAPITAL RATIOS:
Tier 1 risk-based.................................................................. 22.28% 8.49%
Total risk-based................................................................... 23.53% 9.38%
Leverage........................................................................... 10.90% 4.65%
<FN>
- ------------------------
(4) All per share numbers are based on the number of shares outstanding at
period end, and have been retroactively adjusted for the one-for-five
reverse stock split effective December 14, 1993. Calculations are based on
number of common and common equivalent shares outstanding of 794,324 in
1994 and 5,341,434 in 1995. Results for the first quarter of 1994 were not
representative of results for the full year, and results for the first
quarter of 1995 may not be representative of the results that will be
achieved for the full year.
(5) Excludes deferred loan fees, unearned interest income on lease financing,
and allowances for loan losses.
(6) Includes nonaccrual loans and loans past due 90 days or more but still
accruing interest.
(7) Includes other real estate acquired by the Company through legal
foreclosure or deed-in-lieu of foreclosure.
</TABLE>
8
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
AS OF OR FOR THE YEAR
ENDED DECEMBER 31,
--------------------------
1994 1993
------------ ------------
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE DATA)
<S> <C> <C>
INCOME STATEMENT DATA:
Net interest income.............................................................. $ 2,835 $ 3,103
Provision for loan losses........................................................ 995 1,280
Other income..................................................................... 649 960
Other operating expense.......................................................... 4,338 4,123
Earnings (loss) before income taxes.............................................. (1,848) (1,340)
Net earnings (loss).............................................................. (1,850) (1,341)
PER SHARE DATA (8)
Net earnings (loss).............................................................. (2.33) (1.71)
Book value....................................................................... 0.88 3.68
BALANCE SHEET DATA:
Loans (9)........................................................................ 31,040 35,369
Assets........................................................................... 59,974 67,119
Deposits......................................................................... 58,643 63,715
Allowance for Loan Losses........................................................ 1,137 1,055
Shareholders' equity............................................................. 702 2,923
ASSET QUALITY:
Nonperforming loans (10)......................................................... 793 2,925
Other real estate owned ("OREO") (11)............................................ 617 1,293
Total nonperforming loans and OREO............................................... 1,410 4,218
Loans with modified terms........................................................ -- --
ASSET QUALITY RATIOS:
Net charge-offs to average loans................................................. 2.82 % 1.96 %
Nonperforming loans and OREO to total period-end loans and OREO.................. 4.45 % 11.89 %
Allowance for loan losses to period-end loans.................................... 3.66 % 3.09 %
Allowance for loan losses to period-end nonperforming loans and OREO............. 80.64 % 25.01 %
SELECTED PERFORMANCE RATIOS:
Return on average assets......................................................... (2.92)% (1.96)%
Return on average shareholders' equity........................................... (74.51)% (33.20)%
Average shareholders' equity to average assets................................... 3.92 % 5.90 %
CAPITAL RATIOS:
Tier 1 risk-based................................................................ 3.58 % 7.55 %
Total risk-based................................................................. 3.79 % 8.81 %
Leverage......................................................................... 1.75 % 4.36 %
<FN>
- ------------------------
(8) All per share numbers are based on the number of shares outstanding at
period end, and have been retroactively adjusted for the one-for-five
reverse stock split effective December 14, 1993. Calculations are based on
Weighted Average number of common and common equivalent shares outstanding
of 794,324 in 1994 and 785,986 in 1993.
(9) Excludes deferred loan fees, unearned interest income on lease financing,
and allowance for loan losses.
(10) Includes nonaccrual loans and loans past due 90 days or more but still
accruing interest.
(11) Includes other real estate acquired by the Company through legal
foreclosure or deed-in-lieu of foreclosure.
</TABLE>
9
<PAGE>
RISK FACTORS
In determining whether or not to purchase the shares of Common Stock,
offered hereby, prospective investors should carefully consider the following
factors in addition to the other information set forth herein.
FINANCIAL CONDITION AND OPERATIONS; LOSS IN 1993 AND 1994
The Company experienced significant economic, financial and operational
related difficulties in recent years. As a result of the local area recession
and the down turn in the Southern California real estate market, the Company
reported a net loss of approximately $1,341,000 for the year ended December 31,
1993 and approximately $1,850,000 for the year ended December 31, 1994, although
the Company reported net earnings of $182,000 during the three months ended
March 31, 1995.
Weaknesses in the Southern California economy, including a deterioration in
the real estate market, led to rising levels of nonperforming assets (defined as
loans on nonaccrual and loans past due 90 days or more still accruing interest)
in 1993. Nonperforming assets grew from approximately $869,000, or 1.27% of
total assets, at December 31, 1992, to approximately $2.9 million, or 4.36% of
total assets, at December 31, 1993, before declining to approximately $793,000,
or 1.32% of total assets at December 31, 1994. Nonperforming assets increased
slightly to $941,000 or 1.49% of total assets as of March 31, 1995. The impact
of the recession on the collectibility of loans, and the value of underlying (or
foreclosed) collateral resulted in high provisions for loan losses and
contributed to the reduction in earnings in 1992, approximately $1,341,000 in
net losses in 1993, and approximately $1,850,000 in net losses in 1994. The net
losses in 1993 and 1994 included approximately $1,280,000 in 1993, and
approximately $995,000 in 1994, provided for loan loss reserves. Included within
such net losses is a charged-off loan in the amount of $375,000, with respect to
which the Company filed a claim under its Bankers Blanket Bond in 1994, settling
with the bond carrier in the amount of $191,000 less expenses of $19,100 in the
first quarter of 1995.
The Company's net loss for 1993 and 1994 also reflected a reduction in net
interest income that was largely attributable to a decline in interest earning
assets and the yields thereon, as well as the loss of income on non-accrual
loans and other non-performing assets.
The ability of the Company to reverse the trend of its net losses is largely
dependent on the quality and level of its earnings and nonperforming assets, the
interest rate environment and the adequacy of its allowance for loan losses.
While the Company has taken significant measures to protect and enhance its
future assets, the real estate market in Southern California and the overall
economy in the area is likely to continue to have a significant effect on the
quality and level of the Company's assets. See "Risk Factors -- on Real Estate
Loans" and "Risk Factors -- Asset Quality; Impact of Recessionary Environment in
the Company's Market Area."
At December 31, 1994, the Company's allowance for loan losses was
approximately $1,137,000, which represented approximately 3.70% of net loans and
approximately 80.6% of nonperforming loans and OREO. At March 31, 1995, the
Company's allowance for loan losses was approximately $980,000, which
represented approximately 3.8% of net loans and 62.9% of nonperforming loans and
OREO. Although management utilizes its best judgment in providing for possible
loan losses and establishing the allowance for loan losses, the allowance is an
estimate which is inherently uncertain, whose predictive value depends on the
outcome of future events. Although certain data indicates that the Company's
asset quality problems may have lessened, including a recent independent loan
audit by the Company's outside loan auditor, there can be no assurance that
these trends will continue or that further deterioration will not occur.
Management of both the Company and the Bank remains committed to devoting
substantial time and resources to the identification, collection and workout of
nonperforming assets. The real estate markets and the overall economy in the
Company's primary market area, however, will be significant determinants of the
quality of the Company's assets in future periods and, thus its financial
condition and operations. No assurance can be given that substantial additional
provisions to the allowance for loan losses or reductions in the carrying value
of OREO will not be required in the future as a result of the possible further
deterioration of the real estate market and the economic conditions in the
Company's primary market area. The impact thereof, and possible future increases
in nonperforming assets could adversely affect the Company's results of
operations and, if sufficiently adverse, lead to further regulatory enforcement
actions. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Business."
10
<PAGE>
EXISTING AND POTENTIAL ENFORCEMENT ACTIONS
The Bank's performance and credit problems from 1992 through 1994 raised
concerns for the FDIC and the Superintendent.
MEMORANDUM OF UNDERSTANDING. As a result of the deficiencies noted above,
on September 22, 1993, the Bank entered into a Memorandum of Understanding (the
"MOU") with both the FDIC and the Superintendent. The MOU required the Bank to
take certain corrective actions, including reductions of problem assets,
correction of deficiencies in credit administration and the calculation of loan
loss reserves, and increases in capital to at least 7% by March 22, 1994.
SECTION 8(B) ORDER. Following the conclusion of examinations in 1994 by the
FDIC and the Superintendent, the Bank stipulated to the issuance of an Order
(the "8(b) Order") by the FDIC and an order (the "1913 Order") by the
Superintendent, without admitting or denying the related charges. The Orders
require the Bank to perform several actions within fixed time limits. The Orders
include requirements with respect to management, Board of Director
participation, the elimination of assets classified loss and the reduction of
substandard assets, restrictions on extensions of credit to classified
borrowers, maintenance of an adequate allowance for loan loss, revised policies
and procedures, a written plan and comprehensive budget, correction of certain
violations of law, and file accurate reports of condition, refraining from cash
dividends without the prior consent of the regulatory agencies, and the filing
of written progress reports. The Orders also required the Bank to have Tier 1
capital in an amount as to equal or exceed 7% of the Bank's total assets by
April 30, 1995, and maintain such ratio thereafter. (See "Risk Factors.")
SECTION 38 NOTICE. As a result of its 1994 examination, the FDIC notified
the Bank that it fell within the undercapitalized capital category under Section
38 of the FDI Act. As a result of such notification, the Bank filed a capital
plan with the FDIC, and the Company executed a guarantee of the capital plan.
However, by March 31, 1995, the Bank achieved compliance with Section 38 as the
Bank's leverage capital ratio exceeded 4% (it was approximately 7.85% at March
31, 1995, following completion of the Private Placement Offering).
The Bank has taken several actions to comply with the Orders, including the
Private Placement Offering and this Offering, and management believes (but
cannot assure that the respective regulator would agree) that the Bank is in
substantial compliance with provisions of the Orders. However, if the FDIC or
the Superintendent determines that the Bank is not in substantial compliance
with the Orders, or that its condition has significantly deteriorated, the Bank
could be subject to additional enforcement actions that would impair the value
of an investment in the Company. Enforcement actions may include the imposition
of civil money penalties, limitations on business activities that can be
conducted and, under extreme circumstances, the imposition of a conservator or
receiver, the termination of insurance of deposits. In addition, the
Superintendent, may under certain circumstances such as insolvency of the
institution or its failure or refusal to comply with the provisions of any
agreement lawfully made by the Superintendent, take control of the Bank and
cause its liquidation or merger or a transfer of its assets and liabilities to
another institution. (See "BUSINESS -- Administrative Actions").
CONCERNS RELATING TO REAL ESTATE LOANS
At December 31, 1994 and March 31, 1995, approximately 83% and 82%,
respectively, of the Company's loans were secured by real estate, either as a
principal source of repayment, or as an additional source of repayment on loans
for non-real estate related purposes. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations." The value of the Company's
real estate collateral has been, and could in the future continue to be,
adversely affected by the economic recession and possible further deterioration
of the real estate market in Southern California.
The Company's primary lending focus has historically been real estate
mortgage lending, construction lending and commercial lending. At December 31,
1994 and March 31, 1995, real estate mortgage, construction and commercial loans
comprised approximately 39%, 13%, and 39%; and 37%, 16% and 28%, respectively,
of total loans in the Company's portfolio. In light of the ongoing economic
recession in
11
<PAGE>
Southern California and the impact it has had and may have on possible further
deterioration of the Southern California real estate market, this real estate
dependence increases the risk of loss in both the Company's loan portfolio and
its holdings of OREO.
ASSET QUALITY; IMPACT OF RECESSIONARY ENVIRONMENT IN THE COMPANY'S MARKET AREA
The Company concentrates on marketing to, and servicing the needs of, small
and medium sized businesses and high net worth individuals in South Orange
County, California. The economy in general and the real estate market in
particular in this market area have suffered from the effects of the current
recession that has negatively impacted the ability of certain borrowers of the
Company to perform under the original terms of their obligations to the Company
and eroded the value of the Company's real estate collateral. In addition, the
bankruptcy of the County of Orange, where the Company, the Bank and most its
customers are located, in late 1994, may also adversely impact the Company
through indirect impact on the level of economic activity, or local taxation
levels. To date, the Company has not experienced any material adverse impact
that it can relate to such bankruptcy.
As of December 31, 1994 and March 31, 1995, the Company had nonperforming
assets and OREO of approximately $1,410,000 and $1,588,000, respectively.
Nonperforming assets were comprised of approximately $431,000 and $454,000 in
nonaccrual loans, approximately $362,000 and $487,000 in loans past due for 90
days or more but still accruing interest and approximately $617,000 and
$617,000, respectively, in OREO at such dates, respectively. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations." The
Bank also has off-balance sheet risk in the normal course of business to meet
the financing needs of its customers. These financial instruments include
commitments to fund commercial and construction loan agreements and standby
letters of credit. See Note 11 to Consolidated Financial Statements of December
31, 1994.
A continuation or worsening of current economic conditions is likely to have
an adverse effect on the Company's business, including the level of
nonperforming assets, the cash flow of borrowers and their ability to repay
outstanding loans, the value of the Company's real estate collateral and OREO
and the demand for new loan originations. Although the Company has taken actions
to reduce its dependence on real estate, a further decline of economic
conditions that would have an adverse impact on the Company remains possible,
while the Company still faces substantial competition in its market area.
INTEREST RATE RISK
The Company's net interest income, which is the difference between interest
income received on its interest-earning assets, including loans and investment
securities, and the interest expense incurred in connection with its
interest-bearing liabilities, including deposits, can be significantly affected
by changes in market interest rates. The timing within which the Company's
assets and liabilities reprice is not perfectly matched. Accordingly, the yield
on interest earning assets may at times decline faster than, or not increase as
quickly as, the cost of the Company's funds. A rising interest rate environment
may result in decreased origination of some types of loans (particularly fixed
rate loans), while declining rate environments may lead to increases in demand
for adjustable rate loans, as well as increased principal repayments and
refinancing of higher yielding loans in the Company's portfolio.
RISK OF FAILURE TO MEET CAPITAL REQUIREMENTS
The Company and the Bank are required to maintain certain minimum capital
requirements that are applicable to all bank holding companies and banks. See
"Business." The Bank is also subject to Orders that required the Bank to
increase its Tier 1 capital to 7% of its total assets by April 30, 1995 and to
thereafter maintain such ratio during the life of the Orders. As a result of the
completion of the first phase of the Private Placement Offering, based on
preliminary unaudited figures as of March 31, 1995, the Bank's leverage capital
ratio increased to approximately 7.85%, which was approximately $539,000 above
the 7% level required under the Orders, and the Bank believes it is in
compliance with capital requirements under the Orders. See "Capitalization."
However, no assurance can be given that future results after the Closing Date
will not cause the Bank to once again fall below the capital requirements
established by the Orders or other regulatory requirements. Thus, the Company
may be required to raise additional capital in the future through the sale of
additional securities. Any such sale of additional securities could involve
dilution of the
12
<PAGE>
equity ownership of the shareholders of the Company, including purchasers of
Common Stock in conjunction with this Offering. Furthermore, in the event that
the Company or the Bank fail to satisfy any of the terms of the Orders, they
could be subject to enforcement actions by the Federal Reserve Bank, the FDIC
and/or the Superintendent, including various mandatory and discretionary
sanctions and restrictions provided for in the prompt corrective action
provision of the FDIC Improvement Act. See "Risk Factors -- Existing and
Potential Enforcement Action."
RESTRICTIONS ON PAYMENT OR RECEIPT OF DIVIDENDS
The Company has never paid a cash dividend on the Common Stock. Management
currently intends to retain all future earnings, if any, to increase the capital
of the Company in order to effect planned expansion and increases in the assets
of the Bank. There are various restrictions on the Company's ability to pay a
cash dividend, including a resolution of the Bank's Board of Directors that
prohibits the Company from paying any cash dividend without prior notification
to the Federal Reserve Bank. Furthermore, the ability of the Company to pay a
cash dividend depends largely on the Bank's ability to pay a cash dividend to
the Company. Pursuant to the Orders, the Bank is prohibited from paying any cash
dividend without the prior approval of the FDIC. There are also statutory and
other regulatory restrictions on the Bank's ability to pay cash dividends to the
Company. See "Dividends."
FEDERAL INCOME TAX CONSEQUENCES TO THE COMPANY
Acquisitions of Common Stock by persons who are not currently holders of the
Common Stock, or by current holders whose acquisition would increase or maintain
their equity ownership in the Company above 5%, could result in a current or
future "ownership change" within the meaning of Section 382 of the Code, thereby
imposing an annual limitation significantly reducing the Company's ability to
utilize certain potential tax benefits to reduce taxable income. Due to the
"ownership change" in connection with the completion of the Private Placement
Offering, the Company will lose its right to utilize all or a significant
portion of certain potential tax benefits, including net operating loss
carryforwards of approximately $2.7 million, investment tax carryforwards of
approximately $330,000, and certain unrealized built-in losses as defined in
Section 382(h)(3) of the Code (tax losses inherent in the Company's tax assets
on the date of the ownership change). (See "THE OFFERING -- TAX LIMITATION").
TRADING MARKET FOR THE COMPANY'S COMMON STOCK
Prior to this Offering, the Company's Common Stock has traded only over the
counter through two brokers in San Diego and Orange County on a sporadic basis.
The Company desires in the future to apply to list its Common Stock on NASDAQ.
However, the Company does not believe that it qualifies for such listing at this
time, and the Company has not made a decision on whether to apply for listing on
the NASDAQ NMS or NASDAQ Small Cap markets. At the present time, the Company has
not met certain criteria for NASDAQ NMS alternative 1 (net income, pretax
income, and a minimum bid price); alternative 2 (market value of public float
and a minimum bid price); or the NASDAQ Small Cap Market (minimum bid price)
(See "MARKET FOR COMMON STOCK"). Although the Company hopes to meet the NASDAQ
Small Cap criteria in the near future, no assurance can be given that the
Company will be able to qualify for such listing. There is no assurance that an
active trading market for the Company's Common Stock will develop or be
sustained after this Offering or that the Company's Common Stock will be traded
on a recognized exchange or in any other organized market. See "Market for
Common Stock" and "Determination of Offering Price."
DILUTION
Record Date Holders who do not exercise their Rights in full may suffer a
dilution in their voting rights and their proportional interest in any future
net earnings of the Company. Purchasers in this Offering will suffer an
immediate dilution in book value per share of approximately $0.09 following
completion of this Offering, assuming sale of all shares offered hereby. See
"Dilution" and "Capitalization."
REGULATORY CHANGE
The financial institutions industry is subject to significant regulation,
which has materially affected the business of the Company and other financial
institutions in the past and is likely to do so in the future.
13
<PAGE>
Regulations now affecting the Company may be changed at any time, and the
interpretation of these regulations by examining authorities of the Company is
also subject to change. For a description of certain of the significant changes
which have been enacted, and proposals which have been made recently, see
"Business." There can be no assurance that these or any future changes in the
laws or regulations or in their interpretation will not adversely affect the
business of the Company.
COMPETITION
The Company faces substantial competition for deposits and loans throughout
its market area. Competition for deposits comes primarily from other commercial
banks, savings institutions, credit unions, thrift and loans, money market and
mutual funds and other investment alternatives. Competition for loans comes from
other commercial banks, saving institutions, mortgage banking firms, credit
unions, thrift and loans and other financial intermediaries. The Company faces
competition for deposits and loans throughout its market area not only from
local institutions but also from out-of-state financial intermediaries which
have opened loan production offices or which solicit deposits in its market
area. Many of the financial intermediaries operating in the Company's market
areas offer certain services, such as trust, investment and international
banking services, which the Company does not offer directly. Additionally, banks
with larger capitalization and financial intermediaries not subject to bank
regulatory restrictions have larger lending limits and are thereby able to serve
the credit needs of larger customers.
BEST EFFORTS OFFERING
Because the shares are being offered on a best-efforts basis, and there is
no minimum in the Offering, there is no assurance that all of the shares offered
hereby will be sold. If all or substantially all shares are not sold in the
Offering, the Company may not realize all of its plans for future growth and the
Company may have difficulty or be delayed in listing its shares with NASDAQ. The
offering price of the shares was independently established by the Company's
Board of Directors with assistance from the Financial Advisors. Since this
Offering is not underwritten or being sold through NASD member broker-dealers,
there has not been an independent review of matters covered by this Prospectus
as might be conducted by such members had they been affiliated with this
Offering. (See "THE OFFERING," "USE OF PROCEEDS" and "MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" herein.)
THE OFFERING
GENERAL
The Company hereby offers, both to shareholders of the Company and to the
public, up to a maximum of 3,177,296 shares of Common Stock, no par value per
share, with no minimum.
RIGHTS OFFERING
RIGHTS. Shareholders and non shareholders alike may subscribe for any
number of shares of Common Stock being offered hereby. However, until August 18,
1995, shareholders of record ("Record Date Holders") of Common Stock of the
Company as of the close of business on March 30, 1995 (the "Record Date") will
have a right to subscribe for all or any portion of four (4) shares for each
share of Common Stock held. Shareholders that invested in the Private Placement
Offering on March 31, 1995 are not Record Date Holders. The Company presently
intends, but shall not be required to, accept subscriptions (in addition to
Rights subscriptions) from shareholders as of the Record Date up to amounts that
would maintain the ownership percentage of such shareholders at the Record Date,
to the extent feasible.
The Company has issued Rights to each shareholder on the Record Date at no
charge to the shareholder. The Company is not legally obligated to provide its
shareholders with preemptive rights of any sort. The Company is issuing the
Rights in order to enable its shareholders to participate in the Offering if
they wish.
If the Company determines, following the Rights Offering Expiration Date,
that the issuance of underlying shares (other than pursuant to the exercise of
Rights) will have an adverse effect upon the Company's ability to utilize
certain tax benefits, then the Company will have the right, but not the
obligation, to reduce the number of underlying shares so issuable.
14
<PAGE>
PUBLIC OFFERING. Common Stock not subscribed for in the Rights Offering
will be offered to shareholders who subscribed in the Private Placement Offering
and the general public in the Public Offering. See "The Offering -- Public
Offering." The Rights Offering and the Public Offering are sometimes
collectively referred to herein as the "Offerings."
SUBSCRIPTION PRICE. The Subscription Price is $1.35 per share subscribed
for pursuant to the exercise of Rights or in the Public Offering, payable in
cash.
EXPIRATION DATES. The Rights Offering is expected to expire at 5:00 p.m.,
local time on August 18, 1995 (the "Rights Offering Expiration Date"), and the
Public Offering is expected to expire in its entirety at 5:00 p.m., local time,
on September 2, 1995 (the "Public Offering Expiration Date"). The Public
Offering is subject to extension for up to two 15-day periods or earlier
termination by the Company. The Rights Offering may be extended to September 2,
1995, and the Public Offering will not be extended beyond October 2, 1995.
In compliance with the federal securities laws, any material change to the
terms of the Offering would require an affirmative resolicitation of offerees
hereunder before subscriptions are accepted. The Company will make reasonable
efforts to comply with the securities laws of all states in the United States in
which shareholders entitled to subscribe for the Common Stock pursuant to the
Rights Offering reside. However, no shareholder will receive any subscription
rights if he resides in a foreign country or he resides in a state of the United
States with respect to which any or all of the following apply: (i) a small
number of shareholders reside in such state; (ii) the granting of subscription
rights or the offer or sale of shares of Common Stock to such shareholders would
require the Company or its employees to register, under the securities laws of
such state, as a broker, dealer, salesman or agent or to register or otherwise
qualify its securities for sale in such state; and (iii) such registration or
qualification would be impracticable for reasons of costs or otherwise. To the
extent shares are not sold under such circumstances, such shares will become
available for offer and sale in the Public Offering. No payments will be made in
lieu of the granting of subscription rights to any such person.
In the event Subscriptions for the Rights Offering (i) are not received by
the Rights Offering Expiration Date, (ii) are defectively filled out or
executed, or (iii) are not accompanied by the full payment required for the
shares subscribed for, the subscription rights for the shareholders for whom
such rights have been granted will lapse as though such persons failed to return
the completed Subscription forms within the time period specified.
THE BOARD OF DIRECTORS, MANAGEMENT OF THE COMPANY AND THE FINANCIAL ADVISORS
MAKE NO RECOMMENDATION TO SHAREHOLDERS REGARDING WHETHER THEY SHOULD EXERCISE
THEIR SUBSCRIPTION RIGHTS.
CERTAIN FEDERAL INCOME TAX CONSEQUENCES
CONSEQUENCES TO STOCKHOLDERS -- The following is a summary of certain
federal income tax consequences applicable to stockholders upon the issuance of
the Rights and to Right holders upon the exercise or lapse of such Rights and
purchase and disposition of the Common Stock. This summary is qualified in its
entirety by reference to, and is based upon, laws, regulations, rulings and
decisions in effect on the date of this Prospectus and as those laws,
regulations, rulings and decisions were interpreted on such date. This summary
does not discuss all aspects of federal income taxation that may be relevant to
a particular investor or to certain types of investors subject to special
treatment under the federal income tax laws (for example banks, dealers in
securities, life insurance companies, tax exempt organizations, and foreign
taxpayers), or any aspect of state, local or foreign tax laws. Shareholders
receiving Rights should consult their own tax advisors to determine the proper
tax treatment of their interests in the Rights and the underlying shares of
Common Stock.
ISSUANCE OF RIGHTS
Section 305(a) of the Internal Revenue Code of 1986, (the "Code"), generally
provides that gross income does not include the amount of any distribution by a
corporation to its shareholders of stock or rights to acquire stock of that
corporation. Although there are exceptions to the general rule of Section
305(a), it is the opinion of Dayton & Associates, the Company's certified public
accountants, that the general rule of
15
<PAGE>
Section 305(a) applies to the distribution of Rights to the shareholders of the
Company. Under Section 307 of the Code, the tax basis of the Rights in the hands
of a shareholder of the Company to whom the Rights were issued will be
determined by allocating the tax basis of the Common Stock with respect to which
the distribution was made between the existing shares of Common Stock the
shareholder holds (the "Old Stock") and the Rights in proportion to their
relative fair market values on the date of distribution. If the fair market
value of the Rights on the date of distribution is less than 15% of the fair
market value of the Old Stock, the tax basis of the Rights will be zero and the
tax basis of the Old Stock will be unchanged unless a shareholder makes an
irrevocable election to compute the basis of all Rights received in the manner
described in the preceding sentence. This election is made by attaching a
statement to such shareholder's federal income tax return filed for the taxable
year in which the Rights are received by a shareholder. The Company has not
obtained an independent appraisal of the valuation of the Old Stock or the
Rights. In either case, the holding period of such Rights will include the
period during which the shareholder has held the Old Stock.
EXERCISE OF RIGHTS
No gain or loss will be recognized by shareholders upon exercise of Rights
pursuant to the Offering. The holding period of the Common Stock acquired by a
shareholder upon exercise of the Rights will commence upon the exercise of the
Rights by the holder thereof. The tax basis of such shares will be equal to the
sum of the basis of the Rights exercised, if any, and the exercise price paid
for such shares. Persons who acquire Common Stock in the Public Offering will
take a basis for the shares equal to the Subscription Price and will have a
holding period that commences with the purchase.
EXPIRATION OF RIGHTS
Record Date Holders who allow the Rights received by them on the date of
distribution to expire unexercised will not recognize any gain or loss, and no
adjustment will be made to the basis of their common stock.
SALE OF COMMON STOCK
A shareholder selling Common Stock will recognize gain or loss equal to the
difference between the proceeds of sale and the basis of the Common Stock. Such
gain or loss will be capital gain or loss if the Common Stock is a capital asset
in the hands of the shareholder, and will be long term or short term depending
upon whether the shareholder's holding period is more than one year.
BECAUSE OF THE INDIVIDUAL NATURE OF TAX CONSEQUENCES, RECORD DATE HOLDERS
ARE ADVISED TO CONSULT THEIR TAX ADVISOR WITH RESPECT TO THESE AND OTHER
FEDERAL, STATE AND LOCAL TAX CONSEQUENCES OF THE DISTRIBUTION AND EXERCISE OF
RIGHTS.
CONSEQUENCES TO THE COMPANY -- In general, pursuant to Section 1032(a) of
the Code, no gain or loss will be recognized to the Company on the distribution
to its Record Date Holders of the Rights and any payments subsequently received
pursuant to such Rights. The Company also recognizes no gain or loss on the
forfeiture of such Rights. However, under Section 382 of the Code, as a result
of the completion of the Private Placement Offering, and/or this Offering, and a
change of ownership of more than 50% in value of the Common Stock of the
Company, then the Company will lose its rights to utilize all or a significant
portion of certain tax benefits, including net operating loss carryforwards,
investment tax carryforwards, and certain unrealized built-in losses. (See "THE
OFFERING -- TAX LIMITATION").
Furthermore, if the IRS were to argue that the Rights have a fair market
value of more than zero, the Company could suffer adverse tax consequences. To
the extent that the Rights were viewed as a distribution of earnings, and to the
extent that the amount distributed to Record Date Holders. The foregoing summary
of certain federal income tax consequences constitutes the opinion of the
Company's accountants, Dayton & Associates, and the Company's counsel, Knecht &
Hansen. The opinions of Knecht & Hansen and Dayton & Associates are identical
regarding the material tax consequences, and that the opinions covered the
material federal income tax consequences of the transactions. Such opinions are
limited to the federal income tax consequences applicable to stockholders and to
the Company upon the issuance of the Rights to Rights Holders upon the exercise
or lapse of such Rights.
16
<PAGE>
TAX LIMITATION
As of December 31, 1994, the Company had net operating loss carryforwards of
approximately $2.7 million, investment tax carryforwards of approximately
$330,000, and certain unrealized built-in losses as defined in Section 382
(h)(3) of the Code. The completion of the Private Placement Offering resulted in
an "ownership change" within the meaning of Section 382 of the Code that will
restrict the ability of the Company to deduct previously incurred net operating
loss carryovers or utilize investment tax carryovers. In addition, if this
Offering were to cause an additional ownership change, or if future trading in
the Company's shares were to cause such an ownership change, the Company's
ability to use its net operating loss carryforwards in the future could be
further adversely affected (the "Section 382 Limitation"). The magnitude of the
Section 382 Limitation is dependent upon the value of the Company as defined by
the Code. A central point in this issue is whether any of the subsequent capital
infusion can be included in the valuation. If the additional capital infusion is
not considered, the annual use of the net operating loss carryforward will be
reduced to approximately $60,000 per year. If the additional capital infusion is
considered, the annual use of the net operating loss carryforward will be
approximately $240,000 per year. The Company is considering the advisability of
obtaining a private letter ruling from the Internal Revenue Service. The Company
has reserved the right in its sole judgment and discretion to limit the number
of shares issued as a result of exercises of Rights or in the Public Offering to
reduce the risk that additional Section 382 Limitations will apply. The Company
will determine whether to exercise this discretion by comparing the benefits of
a successful offering with any tax detriments associated with an ownership
change.
An "ownership change" will occur if the aggregate percentage point ownership
increase for all 5% shareholders for a "testing period" exceeds 50 percentage
points. For this purpose, a "5% shareholder" is any direct or indirect holder,
taking certain attribution rules into account, of 5% or more of a corporation's
stock. For this purpose, all holders of less than 5% are collectively treated as
a single 5% shareholder. In general, the "testing period" is the three-year
period ending on the date an ownership change has occurred. Such period may be
less than three years and will begin the first day of the most recent taxable
year from which a net operating loss or excess credit is carried forward. Once
an "ownership change" has occurred, as of that date, only subsequent ownership
changes are tested. In determining the amount by which 5% shareholders have
increased their percentage, the percentage interest of each 5% shareholder on
the testing date is compared to the lowest percentage interest of such
shareholder at any time during the testing period. For example, a shareholder
whose percentage ownership increased from 6% to 20% during the testing period
will be considered to have had an increase of 14 percentage points. If the
aggregate change of all 5% shareholders exceed 50 percentage points as of the
end of the "testing period," then an "ownership change" will have occurred.
The Company retains the discretion to reduce the number of shares of Common
Stock to be received by a Rights Holder or investor in the Public Offering. It
will exercise this discretion by comparing the benefits of a successful offering
with any tax detriments associated with an ownership change.
The foregoing summary of certain tax limitations constitutes the opinion of
the Company's accountants, Dayton & Associates.
REGULATORY LIMITATION
The Company will not be required to issue shares of Common Stock in the
Offering to anyone who in the Company's sole judgment and discretion, is
required to obtain prior clearance, approval or nondisapproval from any state or
federal bank regulatory authority to own or control such shares unless, prior to
the Public Offering Expiration Date, satisfactory evidence of such clearance,
approval or nondisapproval has been provided to the Company.
The Federal Change in Bank Control Act of 1978 prohibits a person, or group
of persons "acting in concert," from acquiring "control" of a bank holding
company unless the Federal Reserve Board has been given 60 days' prior written
notice of such proposed acquisition and within that time period the Federal
Reserve Board has not issued a notice disapproving the proposed acquisition or
extending for up to another 30 days the period during which such a disapproval
may be issued. An acquisition may be made prior to the expiration of the
disapproval period if the Federal Reserve Board issues written notice of its
intent not to disapprove the action. Under a rebuttable presumption established
by the Federal Reserve Board, the
17
<PAGE>
acquisition of more than 10% of a class of voting stock of a bank holding
company with a class of securities registered under Section 12 of the Exchange
Act (such as the Common Stock) would, under the circumstances set forth in the
presumption, constitute the acquisition of control.
In addition, any "company" would be required to obtain the approval of the
Federal Reserve Board under the Bank Holding Company Act of 1956, as amended
("BHC Act") before acquiring 25% (5% in the case of an acquiror that is, or is
deemed to be, a bank holding company) or more of the outstanding Common Stock
of, or such lesser number of shares as constitute control over, the Company.
PUBLIC OFFERING
Shares not subscribed for in the Rights Offering may be purchased by
shareholders that purchased in the Private Placement Offering and by the public.
For shares of Common Stock sold in the Public Offering in the State of
California, nonshareholders must meet or exceed certain investor suitability
standards that have been established by the Company. In order to subscribe for
shares of Common Stock in the public portion of the Offering in the State of
California, a nonshareholder must represent on the Public Offering Subscription
form either (i) that he or she has a net worth (exclusive of home, furnishings
and automobile) of at least $50,000 in 1994 and expects to have income of at
least $50,000 in 1995, or (ii) that he or she has a net worth (exclusive of
home, furnishings and automobile) of at least $150,000.
PLAN OF DISTRIBUTION
The Offering is not underwritten. The Company is offering the shares through
its directors and executive officers on a "best efforts" basis. The directors
and executive officers will not be compensated in connection with selling the
shares, but they will be reimbursed for reasonable out-of-pocket expenses, if
any, incurred in connection with the Offering. It is not expected, however, that
any such expenses will be significant. The Company does not intend to engage or
compensate nor seek the assistance of any broker, underwriter or securities
dealer in connection with the Offering; however, the Company may elect to use
sales resources independent of the Company, and consequently, the Company may in
its sole discretion pay such fees, costs, commissions and expenses of brokers,
underwriters, dealers and other sales personnel as necessary.
The Company engaged the Belle Plaine Partners, Inc. and McAllen Capital
Partners ("the Financial Advisors") to render such services as the Company
requests including (i) reviewing the financial condition and prospects of the
Company and advising the Board of Directors regarding the Private Placement
Offering and the Rights Offering; (ii) assisting the Company in structuring of
the financial aspects of the Private Placement Offering and the Rights Offering;
(iii) assisting the Company in the preparation of the Private Placement
memorandum describing the Company; (iv) identifying potential investors; and (v)
assisting the investors to evaluate the need for, and to make any necessary
applications or notices to regulatory agencies. The Financial Advisors shall not
effect the sale of securities to any investors, and any offers or sales to
investors shall be made by the Company or a properly licensed broker-dealer.
The principals of the Financial Advisors (Mr. John Eggemeyer of Belle Plaine
Partners and Mr. John Rose of McAllen Capital Partners) have extensive
experience in the banking industry and in providing consulting services to
financial institutions. Mr. Eggemeyer is currently Chairman of the Board of
Rancho Santa Fe National Bank since January of 1995, and since 1990 has been
President and principal owner of Belle Plaine Partners. Mr. Eggemeyer was also a
managing director of Mabon Securities Corp., a senior executive officer of TCF
Bank Illinois FSB, President of First Trust Company, President of Intra West
Financial Corporation, and a senior executive officer of Chemical Bank, Norwest
Bancorporation, and First National Bank of Chicago. Mr. Eggemeyer is currently
Chairman of the Board of TCF Bank Illinois FSB and a director of TCF Financial
Corp. Mr. Eggemeyer has over 27 years of banking experience. Since January of
1994, Mr. Rose has been the President and owner of McAllen Capital Partners and
has also assisted several financial institutions in providing consulting and
recapitalization services. Mr. Rose has also been Senior Vice President of River
Valley Savings Bank, President of Livingston Financial Group, a venture capital
firm,
18
<PAGE>
and Senior Vice President of ABN La Salle, North America, all located in
Chicago, Illinois. Mr. Rose is currently an executive officer of FNB
Corporation, Pennsylvania. Mr. Rose has over 20 years of banking experience.
The Financial Advisors will receive a fee equal to five percent (5%) of the
gross proceeds of the Offering and a payment of their expenses. The Company is
also responsible for all NASD and Blue Sky legal expenses and filing fees. The
Company shall also provide to the Financial Advisors a warrant which will
entitle the Financial Advisors to purchase shares equal to 5% of the number of
shares issued and outstanding following completion of this Offering at a price
of 120% of the offering price. The warrant will expire five years after issuance
and will be exercisable after the first year. The Company will attempt to
convert the warrant to an option under the Company's 1993 Stock Option Plan
under the same terms and conditions, except that the term would be extended to
ten (10) years. If this Offering is completely sold, the warrant to the
Financial Advisors will contain 425,937 shares. Pursuant to the agreement
between the Company and the Financial Advisors, the Company has agreed to hold
the Financial Advisors harmless against all losses, claims, damages, liabilities
and expenses which may be asserted against the Financial Advisors, including
liabilities under the Securities Act of 1933, in connection with the offer and
sale of the shares of Common Stock.
On May 17, 1995, the Company and Belle Plaine Partners ("Belle Plaine")
agreed that Belle Plaine would act as the exclusive financial advisor to the
Company in connection with the Company's efforts to (a) acquire other financial
institutions or (b) effect a sale of the Company or a material amount of its
assets or liabilities (collectively, the "Transaction"). Belle Plaine will
provide certain services including (i) assisting the Company in the structuring
of financial aspects of the Transaction, (ii) identifying potential parties, and
(iii) negotiating terms of such transactions. The Company has agreed to pay
Belle Plaine $9,000 upon execution, $9,000 per quarter, certain fees ranging
from 1% to 3% per Transaction, and certain costs and expenses. Pursuant to the
agreement between the Company and Belle Plaine, the Company has agreed to hold
Belle Plaine harmless against all losses, claims, damages, and liabilities under
this agreement.
Other than Mr. Rose agreeing to stand for election to the Board of Directors
of the Company at the Company's 1995 Annual Meeting of Shareholders scheduled
for July 17, 1995, and Mr. Rose agreeing to serve as the Company's Chairman of
the Board, there is no agreement, written or otherwise, between the Company and
Mr. Rose with regard to his position and any future position on the Company's
Board of Directors.
The price of the shares of Common Stock offered in the Private Placement
Offering and in this Offering was independently established by the Board of
Directors, with assistance from the Financial Advisors. The Board of Directors
took into consideration several factors, including the book value of the
Company's Common Stock, the Company's and the Bank's results of operations, and
other factors. (See "DETERMINATION OF OFFERING PRICE.")
The Company understands that its directors and officers, upon and after the
effective date of the Offering, may contact a potential investor, indicating
that the Company's Registration Statement and Offering have been declared
effective, and that the Prospectus and any supplemental materials approved for
use by the Commission would be sent to the potential investor. Such directors or
officers shall inform the potential investor that the Offering has nothing to do
with the potential investor's business activities with the Bank. Such director
and/or officer may follow up such initial contact by telephone or in person once
the potential investor has received the offering materials.
Except for some directors, management does not expect that all directors and
officers will participate in this Offering, and management expects that upon
conclusion of this Offering that the ownership of current directors will be
diluted.
The Company has no devices in place to prevent a change of control, except
requirements of the Change of Bank Control Act. See "The Offering -- Regulatory
Limitation."
ESCROW ACCOUNT
Monarch Bank ("Escrow Agent"), the wholly-owned subsidiary of the Company,
will act as the escrow agent to accept stock orders in the Rights Offering and
the Public Offering. All funds will be held by the
19
<PAGE>
Escrow Agent until such funds are distributed to the Company at the Closing or
refunded to subscribers. Once all conditions precedent to the consummation of
one or more of the Closings have been satisfied or duly waived, the Escrow Agent
will release the funds held in the escrow to the Company. All communications to
the Escrow Agent should be addressed as follows:
Monarch Bank
30000 Town Center Drive
Laguna Niguel, California 92677
Attn: William C. Demmin
Senior Vice President
METHOD OF SUBSCRIBING FOR SHARES
Shares may be ordered in the Offerings by properly completing, signing and
delivering the appropriate Subscription Form accompanying this Prospectus (I.E.,
a Subscription Form for the Rights Offering or the Public Offering). Payment may
be made by personal check, cashier's check or certified check or money order.
Checks should be made payable to the order of "Monarch Bank -- Escrow Agent."
Completed Subscription Forms and full payments for shares subscribed for in the
Rights Offering must be received before 5:00 p.m., local time, on the Rights
Offering Expiration Date and in the Public Offering on or before 5:00 p.m.,
local time, on the Public Offering Expiration Date at the Escrow Agent, unless
extended. ALL SUBSCRIPTIONS ARE IRREVOCABLE.
The method of delivery of a Subscription Form to the Escrow Agent is at the
risk of the person submitting the order. The Company suggests that an overnight
carrier be used to ensure timely delivery. If delivery is made by regular mail
service, the use of registered or certified mail, return receipt requested,
properly insured, is recommended. COMPLETED SUBSCRIPTION FORMS AND PAYMENTS
SHOULD BE MAILED OR DELIVERED TO MONARCH BANK.
THE CLOSINGS
The Company intends to conduct one or more closings in connection with the
Offering. On the Rights Offering Expiration Date, the Company will conduct an
initial closing upon which shares of Common Stock will be issued to subscribers
whose subscriptions have been accepted, the Bank as escrow agent will release
the funds representing the orders of such subscribers, and the Company will
continue the Offering until completion or termination.
DELIVERY OF STOCK CERTIFICATES; REFUNDS
Certificates representing shares of Common Stock subscribed for and issued,
together with any refund, with interest, of the Offering Price for shares of
Common Stock subscribed in the Offering and not issued, will be mailed as soon
as practicable upon the completion or termination of both the Rights Offering
and Offering. Certificates for shares of Common Stock issued pursuant to the
exercise of Rights will be registered in the name of the shareholder exercising
such rights.
AMENDMENT AND WAIVER; TERMINATION
The Company reserves the right to extend the Offering Expiration Date for up
to two periods of an additional 15 days each and to amend the terms and
conditions of the Offering. The amended terms and conditions, if any, may be
more or less favorable to the shareholders of record as of the Record Date. The
Company will not, however, amend the terms of the Offerings to change the
Offering Price, and any material change to the terms of the Offerings would
require an affirmative solicitation by the Company. All questions as to the
validity, form, eligibility (including time of receipt and record ownership) and
acceptance of any stock orders shall be determined by the Board of Directors of
the Company, in its sole discretion, and its determination shall be final and
binding. The Company reserves the right to reject any stock order if such order
is not in accordance with the terms of the Offering or not in proper form or if
the acceptance thereof or the issuance of Units pursuant thereto could be deemed
unlawful. The Company also reserves the right to waive any deficiency or
irregularity with respect to the Subscription Form.
20
<PAGE>
The Company reserves the right, in its sole discretion, at any time prior to
delivery of the shares of Common Stock offered hereby, to terminate the Rights
Offering and the Offering by making a public announcement thereof. In such
event, all funds would be promptly refunded without interest.
ADDITIONAL INFORMATION
Any questions or requests for assistance concerning the method of
subscribing for shares of Common Stock in the Rights Offering or Public Offering
or for additional copies of the Prospectus or Subscription Order Forms should be
directed to E. Lynn Caswell, President and Chief Executive Officer, William C.
Demmin, Senior Vice President, or Carole Z. Bowman, Senior Vice President,
telephone (714) 495-3300.
USE OF PROCEEDS
The net proceeds of the Offering will be used for general corporate banking
purposes and to allow for the prudent expansion of the organization through
continued growth in its present facility, and to expand into other communities
in Southern California, possibly through the acquisition of other financial
institutions or acquisition or establishment of branches of such institutions,
subject to regulatory approvals and satisfaction of the terms of the Orders.
Upon completion of the Private Placement Offering to accredited investors
pursuant to SEC Regulation D on March 31, 1995, the Company issued an additional
4,547,111 new shares of Common Stock, $3,550,000 was contributed to the Bank to
increase the Company's investment in the Bank, $53,500 was used to retire
Company debt, and approximately $2,065,000 was retained by the Company. The
Company believes that it has complied with the capital requirements of the
Orders. In addition, the Company may raise up to an additional $3,989,350
pursuant to this Offering. It is anticipated that the Company will retain the
funds raised upon the completion of this Offering for general corporate
purposes, future investment or acquisition, or to enhance the Bank's capital in
the future. Although the Company has had preliminary discussions regarding
possible acquisitions with a number of financial institutions, and the Company
is having ongoing discussions with Rancho Santa Fe National Bank, Rancho Santa
Fe, California, no agreements or understandings have been reached at this time.
Although the Bank currently exceeds all capital requirements applicable to
its business, no assurance can be given that the results of operations in the
future will not make the capital raised hereby insufficient to maintain the 7%
minimum required by the Orders.
The net proceeds of the Offering initially will be invested in deposits,
debt securities, equity of the Bank, or other liquid investments pending their
allocation to longer term assets.
PRO FORMA CAPITAL AMOUNTS AND CAPITAL RATIOS
The following tables illustrate the capitalization amounts and ratios of the
Company and the Bank as of March 31, 1995 and the pro forma effect of the
Offering on such ratios, assuming all shares of Common Stock offered hereby are
sold, and estimated costs of $300,000 are incurred. The net proceeds from the
Private Placement Offering completed on March 31, 1995 are also included in the
following tables. No minimum number of shares are required to be sold in this
Offering, and actual results of the Offering may be much less than the amounts
and ratios reflected in the following tables.
21
<PAGE>
RISK BASED CAPITAL RATIOS
<TABLE>
<CAPTION>
AT MARCH 31, 1995
----------------------------
THE COMPANY THE BANK
------------- -------------
AMOUNT RATIO AMOUNT RATIO
------ ----- ------ -----
<S> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Tier 1 Capital.............................................. $6,768 21.91% $4,996 16.09%
Tier 1 Capital -- Minimum Required.......................... 1,236 4.00% 1,242 4.00%
Excess.................................................... 5,532 3,754
Tier 1 Capital -- Pro Forma (12)............................ 10,757 30.84% 4,996 16.09%
Excess.................................................... 9,522 3,754
Total Capital............................................... 7,156 23.17% 5,384 17.34%
Total Capital -- Minimum Required........................... 2,471 8.00% 2,484 8.00%
Excess.................................................... 4,685 2,900
Total Capital -- Pro Forma.................................. 11,145 31.95% 5,384 17.34%
Excess.................................................... 8,674 2,900
Risk Weighted Assets (Actual)............................... 30,889 31,052
Risk Weighted Assets (Pro Forma)............................ 34,878 31,052
<FN>
- ------------------------
(12) Net proceeds of approximately $3.99 million would be realized by the
Company after deduction of estimated costs of issuance of approximately
$300,000, and the Company would retain all net proceeds.
</TABLE>
LEVERAGE CAPITAL RATIOS
<TABLE>
<CAPTION>
AT MARCH 31, 1995
-----------------------------------
THE COMPANY THE BANK
---------------- ----------------
AMOUNT RATIO AMOUNT RATIO
------ -------- ------ --------
<S> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Tier 1 Capital to total Average (Assets).................... $6,768 10.66% $4,996 7.85%
Tier 1 Capital to total Average Assets -- Minimum Required.. 3,175 5.00%(2) 4,457 7.00%(3)
Excess (Deficiency)....................................... 3,593 539
Tier 1 Capital to total Average Assets Pro Forma (1)........ 10,757 15.94%
Excess.................................................... 7,582
Average Assets for the Period (Actual)...................... 63,508 63,671
Pro Forma Assets............................................ 67,497
<FN>
- ------------------------
(2) Under the Federal Reserve Board's leverage capital adequacy guidelines, all
bank holding companies must maintain a leverage capital ratio of at least
3%. However, institutions which are not among the most highly rated by the
federal regulators must maintain a ratio 100-to-200 basis points above the
3% minimum. The federal Reserve Board has not informed the Company of the
amount by which its leverage capital ratio must exceed the 3% minimum, but
the Company is currently in excess of the 5% ratio.
(3) Provides for minimum Tier 1 risk-based capital ratio and minimum total
risk-based capital ratio for bank holding companies and banks established
by Federal Reserve Board regulation, except that the 7% leverage ratio is
the minimum requirement contained in the Orders. See "Management's Discus-
sion and Analysis of Financial condition and Results of Operations" and
"Business."
(4) Net Book value represents the Company's total assets less total
liabilities.
</TABLE>
DILUTION
At March 31, 1995, the book value of the Company's Common Stock(4) was
$6,768,000 or $1.26 per share. Without taking into account any changes in book
value after March 31, 1995, other than to give effect to the completion of this
Offering of 3,177,296 shares of Common Stock, the pro forma book value of the
Company would be $10,757,350 or $1.26 per share of Common Stock. This would
represent a DE MINIMUS decrease in pro forma book value of $0.004 to existing
shareholders, and an immediate decrease in book value of $0.09 to investors in
the shares of Common Stock.
22
<PAGE>
The following table illustrates the pro forma in net book value to
purchasers of shares as of March 31, 1995 assuming the sale of the maximum level
of 3,177,296 shares of Common Stock of the Company and completion of the Private
Placement Offering.
<TABLE>
<S> <C>
Net book value per share before the Offering.................................... $ 1.267
Decrease attributable to subscriptions by Purchasers............................ $ 0.004
Pro forma net book value per share after Offering............................... $ 1.263
Decrease per share to Purchasers................................................ $ 0.09
</TABLE>
DETERMINATION OF OFFERING PRICE
Prior to this Offering, there has been only a limited trading market in the
Company's Common Stock. See "Market for Common Stock." No assurance can be given
that a more active market for the Company's Common Stock will exist as a result
of the Offering. The price at which the shares of Common Stock are offered and
sold in this Offering was independently established by the Board of Directors,
who received assistance in setting such price from the Financial Advisors. The
Board of Directors also took into consideration several factors, including the
book value of the Company's Common Stock, the Company's and the Bank's results
of operations, analysis of the historical growth and growth potential of the
Company and the Company's market area, and assessment of the Company's and the
Bank's management and financial condition. Neither the Company's Board of
Directors or its Financial Advisors make any recommendation to prospective
investors regarding whether they should exercise Rights or purchase shares. (See
"Offering.")
MARKET FOR COMMON STOCK
The Company is aware of two securities dealers who have handled transactions
in its Common Stock: Spelman & Company, San Diego, California, and Crowell,
Weedon & Company, Laguna Hills, California (the "Securities Dealers"). The
Company effected a One-For-Five Reverse Stock Split on December 14, 1993, and
the prices per share listed below have been retroactively adjusted for the
Reverse Stock Split. The Company effected the Reverse Stock Split for several
reasons, including the resulting increase in book value per share to qualify for
listing on NASDAQ.
The Company's Common Stock currently is traded over-the-counter, is not
listed on any exchange, and is not quoted by NASDAQ. Although the Company
desires to be listed on NASDAQ, the Company does not believe it qualifies for
such listing at this time, and the Company has not made a decision on whether to
apply for listing on the NASDAQ National Market System or the Small Cap market.
At the present time, the Company has not met certain criteria for NASDAQ NMS
alternative 1 (Net income of $400,000 in latest fiscal year or 2 of last 3
fiscal years, pretax income of $750,000 in the latest fiscal year or 2 of the
last 3 fiscal years, and a minimum bid price of $5.00 per share); Alternative 2
(market value of public float of $15 million and a minimum bid price of $3.00
per share); or the NASDAQ Small Cap Market ($3.00 minimum bid price). The
Company has had a net loss the last two years, and the bid price of the
Company's stock is $1.30 as of July 11, 1995. No assurance can be given that the
Company will qualify for such listing on NASDAQ, nor that an active public
trading market for the Common Stock will develop subsequent to the Offering. The
number of record holders of the Company's Common Stock as of March 31, 1995 was
approximately 724.
23
<PAGE>
The following table summarizes those trades of Company Common Stock of which
management is aware, setting forth the high and low sales prices for each
quarterly period since December 31, 1992, retroactively adjusted for the
One-For-Five Reverse Stock Split that was effected on December 14, 1993. The
table does not represent all trades that have occurred, of which the Company is
not aware.
<TABLE>
<CAPTION>
APPROXIMATE
SALES PRICES
QUARTER ENDED ---------------
(LAST TRADING DAY) HIGH(1) LOW(1)
- ------------------------------------------------------------ ------- ------
<S> <C> <C>
December 31, 1992........................................... 5.00 3.25
March 31, 1993.............................................. 5.00 4.50
June 30, 1993............................................... 4.75 4.25
September 30, 1993.......................................... 4.25 3.75
December 31, 1993........................................... 4.25 3.75
March 31, 1994.............................................. 3.75 2.50
June 30, 1994............................................... None None
September 30, 1994.......................................... 2.44 1.90
December 31, 1995........................................... 0.80 0.80
March 31, 1995.............................................. 1.50 0.80
<FN>
- ------------------------
(1) High and low prices have been retroactively adjusted to account for the
One-For-Five Reverse Stock Split effective December 14, 1993.
</TABLE>
The information in the above table may not be indicative of the current
value of Common Stock of the Company, and the table is not a representation as
to the future value of the Common Stock of the Company. Since March 31, 1995,
there have not been any significant trades of the Company's Common Stock. Trades
totaling 26,691 shares of the Company's Common Stock occurred during the first
quarter at $1.50 to $.80 per share.
DIVIDENDS
The Company has never paid a cash dividend on the Common Stock. Management
currently intends to retain all earnings, if any, to increase the capital of the
Company to effect planned expansion activities and to pay dividends only when it
is prudent to do so and the Company's performance justifies such action. There
are various limitations on the Company's ability to pay a cash dividend. As part
of Board of Director resolutions, the Company may not pay a cash dividend
without providing prior notice to the Federal Reserve Bank. See "Business."
Furthermore, the ability of the Company to pay a dividend depends largely upon
the Bank's ability to pay a cash dividend to the Company. Pursuant to its Orders
with the FDIC and the Superintendent, the Bank is prohibited from paying any
cash dividends without the prior consent of the FDIC, although the Board of
Directors believes this limitation would be eliminated when and if the Orders
are satisfied and removed by the FDIC and the Superintendent. No assurance can
be given that any dividends will be declared by the Company or the Bank in the
foreseeable future.
Holders of Company Common Stock are entitled to receive dividends declared
by the Company's Board of Directors out of funds legally available therefor
under the laws of the State of California. Under California law, the Company
would be prohibited from paying dividends unless: (1) its retained earnings
immediately prior to the dividend payment equals or exceeds the amount of the
dividend; or (2) immediately after giving effect to the dividend (i) the sum of
the Company's assets would be at least equal to 125% of its liabilities and (ii)
the current assets of the Company would be at least equal to its current
liabilities, or, if the average of its earnings before taxes on income and
before interest expense for the two preceding fiscal years was less than the
average of its interest expense for the two preceding fiscal years, at least
125% of its current liabilities.
The Bank may declare cash dividends to its parent out of funds legally
available therefor. Under California law, funds available for cash dividend
payments by a bank are restricted to the lesser of: (1) retained earnings
(undivided profits), or (ii) the Bank's net income for its last three fiscal
years (less any distributions to shareholders made during such period). Cash
dividends may also be paid out of net income for a bank's past preceding fiscal
year upon the prior approval of the Superintendent, without regard to retained
earnings or net income for its past three fiscal years. If the Superintendent
finds that the stockholders' equity of a bank is not adequate or that the
payment of a dividend would be unsafe or unsound for a bank, the Superintendent
may order a bank not to pay any dividend to a bank's shareholders.
24
<PAGE>
CAPITALIZATION
The following table sets forth the consolidated capitalization of the
Company as of March 31, 1995, adjusted to give pro forma effect to completion of
the Offering as of March 31, 1995, and assumes that (i) 3,177,296 shares are
sold in this Offering, and (ii) the Company will have net proceeds of
approximately $3.99 million, after deducting estimated expenses of $300,000. The
financial information included in this section and throughout this Prospectus
should be read in conjunction with the Consolidated Financial Statements and
accompanying Notes appearing elsewhere herein. The table is provided for the
purpose of illustration only and does not limit the right of the Company to sell
any number of shares of Common Stock in the Offering up to the maximum number of
shares of Common Stock offered. See "Use of Proceeds" for Pro Forma Capital
Ratios.
There is no minimum number of shares to be purchased in this best-efforts
offering, and the actual results of the Offering may be in a range between the
amounts shown in the two columns in the following table. The table also reflects
shares that have already been issued in the Private Placement Offering.
<TABLE>
<CAPTION>
ASSUMING SALE OF
3,177,296 SHARES OF
COMMON STOCK TO
OUTSTANDING COMPLETE THIS
(ACTUAL) OFFERING(6)
------------- -----------------------
<S> <C> <C>
Shareholders' Equity
Preferred Stock, no par value, 5,000,000 shares
authorized, no shares outstanding.................. N/A N/A
Common Stock, no par value, 25,000,000 shares
authorized, 5,341,435 shares outstanding before
completion of this Offering.......................... $ 13,036,000 $ 17,025,350
Accumulated Deficit................................... (5,955,000) (5,955,000)
Unrealized appreciation on certain investment
securities........................................... (150,000) (150,000)
Deferred charge related to SOP........................ (163,000) (163,000)
TOTAL SHAREHOLDERS' EQUITY............................ $ 6,768,000 $ 10,757,350
<FN>
- ------------------------
(6) Does not reflect shares that may be issued pursuant to the granting and
exercise of employee stock options or the exercise of options anticipated
to be issued to the Financial Advisors.
</TABLE>
25
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
STATISTICAL DISCLOSURE
Average balances are based on the annual averages for 1994 and 1993 and are
representative of operations.
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY
The following table sets forth the Company's condensed consolidated average
balances (monthly averages) of each principal category of assets, liabilities
and shareholders' equity for each of the past two years. All amounts are in
thousands as of December 31.
<TABLE>
<CAPTION>
1994 1993
--------- ---------
<S> <C> <C>
ASSETS:
Cash and due from banks............................................................ 3,993 4,502
Due from banks -- time............................................................. 2,712 2,488
Investment securities -- held to maturity.......................................... 5,508 10,148
Investment securities -- available for sale........................................ 11,537 0
Federal funds sold................................................................. 3,817 8,167
Loans (net)........................................................................ 32,397 40,774
Premises and equipment (net)....................................................... 730 568
Other real estate owned............................................................ 1,313 1,037
Other assets....................................................................... 1,302 787
--------- ---------
Total Assets..................................................................... 63,309 68,471
--------- ---------
--------- ---------
LIABILITIES AND SHAREHOLDERS' EQUITY
Demand Deposits.................................................................... 46,148 47,329
Savings Deposits................................................................... 7,369 8,308
Time Deposits...................................................................... 6,872 8,178
Other Debt......................................................................... 54 310
Other Liabilities.................................................................. 383 306
--------- ---------
Total Liabilities................................................................ 60,826 64,431
Common Stock....................................................................... 7,367 7,326
Retained Earnings (Deficit)........................................................ (4,884) (3,286)
--------- ---------
Total Equity..................................................................... 2,483 4,040
--------- ---------
Total Liabilities and Equity................................................... 63,309 68,471
--------- ---------
--------- ---------
</TABLE>
INTEREST RATES AND DIFFERENTIALS
The Company's consolidated earnings depend primarily upon the difference
between the income the Bank receives from its loan portfolio and investment
securities, and its cost of funds -- principally, interest paid on savings and
time deposits. Interest rates charged on the Bank's loans are influenced
principally by the demand for such loans, the supply of money for lending
purposes, and competitive factors. These factors are, in turn, affected by
general economic conditions and other factors beyond the Bank's control, such as
federal economic and tax policies, the general supply of money in the economy,
governmental budgetary actions, and the actions of the Federal Reserve Board.
26
<PAGE>
Information concerning average interest-earning assets and interest-bearing
liabilities, along with the average interest rates earned and paid thereon, is
set forth in the following table. Loan income includes loan fees as accounted
for on a yield basis under SFAS No. 91.
<TABLE>
<CAPTION>
INTEREST RATES AND DIFFERENTIALS
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
YEAR ENDED 12/31/94 YEAR ENDED 12/31/93
----------------------------------- -----------------------------------
<CAPTION>
AVERAGE INCOME/ AVERAGE AVERAGE INCOME/ AVERAGE
BALANCE EXPENSE RATE % BALANCE EXPENSE RATE %
--------- ----------- ----------- --------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS:
Interest-bearing deposits placed with banks.......... 2,712 111 4.09% 2,488 93 3.74%
Investment Securities (HTM).......................... 5,508 258 4.68% 10,148 505 4.98%
Investment Securities (AFS).......................... 11,537 535 4.64% 0 0 0.00%
Federal Funds Sold................................... 3,817 155 4.06% 8,167 210 2.57%
Loans and Leases (net) (1)........................... 32,397 2,879 8.88% 40,774 3,539 8.68%
--------- ----- ----------- --------- ----- -----------
Interest-earning Assets:........................... 55,971 3,938 7.04% 61,577 4,347 7.06%
NON INTEREST-EARNING ASSETS:
Cash and Due from Banks.............................. 3,993 4,502
Premises and equipment (net)......................... 730 568
Other Real Estate owned.............................. 1,313 1,037
Other Assets......................................... 1,302 787
--------- ---------
Total............................................ 63,309 68,471
--------- ---------
--------- ---------
INTEREST-BEARING LIABILITIES:
Interest-bearing Demand Deposits..................... 32,590 723 2.22% 34,906 755 2.16%
Savings Deposits..................................... 7,369 153 2.08% 8,308 212 2.55%
Other Time Deposits.................................. 6,872 224 3.26% 8,178 272 3.33%
Long Term Debt....................................... 54 2 3.70% 78 6 7.69%
--------- ----- ----------- --------- ----- -----------
Total Interest-bearing Liabilities:.............. 46,885 1,102 2.35% 51,470 1,245 2.42%
----- -----
Non-Interest bearing Demand.......................... 13,558 12,423
Non-Interest bearing Liabilities..................... 383 538
Shareholders' equity............................. 2,483 4,040
--------- ---------
63,309 68,471
--------- ---------
--------- ---------
Net Interest Income.................................... 2,836 3,102
----- -----
----- -----
Net Yield on Interest-bearing Assets................... 5.07% 5.04%
----------- -----------
----------- -----------
<FN>
- ------------------------
(1) Non-performing loans are included in average loans, and interest income for
loans includes loan fees. The Bank has no tax-exempt investments.
</TABLE>
27
<PAGE>
The following table sets forth changes in interest income and interest
expense, and the amount of change attributable to variances in volume and
variances in interest rates. The change in interest due to both volume and rate
has been allocated to volume and rate changes in proportion to the relationship
of the absolute dollar amounts of the change in each. Non-performing and
non-accrual loans are included in volume rate loan calculations and loan fees
based on a level yield basis. The Bank has no tax-exempt assets.
<TABLE>
<CAPTION>
INTEREST RATES AND DIFFERENTIALS
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31,
1994 OVER 1993 1993 OVER 1992
--------------------------------------- --------------------------
<CAPTION>
CHANGE DUE
TOTAL CHANGE DUE TO TOTAL TO
INCREASE ------------------------ INCREASE -----------
(DECREASE) VOLUME RATE (DECREASE) VOLUME
------------- ----------- ----------- ------------- -----------
<S> <C> <C> <C> <C> <C>
INTEREST INCOME
Interest and fees on loans......................... (660) (741) 81 (801) (339)
Interest bearing deposits with banks............... 18 8 10 53 65
Interest on investment securities HTM.............. (247) (219) (28) 68 235
Interest on investment securities AFS.............. 535 535 0 0 0
Interest on federal funds sold..................... (55) (143) 88 0 46
--- --- --- --- ---
Total Interest Income................................ (409) (560) 151 (680) 7
--- --- --- --- ---
INTEREST EXPENSE
Interest bearing demand deposits................... (32) (51) 19 140 239
Interest on savings deposits....................... (59) (22) (37) (31) 38
Interest on other time deposits.................... (48) (43) (5) (564) (256)
Long Term Debt..................................... (4) (2) (2) (2) 0
--- --- --- --- ---
Total interest expense............................... (143) (118) (25) (457) 21
--- --- --- --- ---
Net interest income.................................. (266) (443) 176 (223) (14)
--- --- --- --- ---
--- --- --- --- ---
<CAPTION>
<S> <C>
RATE
---------
<S> <C>
INTEREST INCOME
Interest and fees on loans......................... (462)
Interest bearing deposits with banks............... (12)
Interest on investment securities HTM.............. (167)
Interest on investment securities AFS.............. 0
Interest on federal funds sold..................... (46)
---
Total Interest Income................................ (687)
---
INTEREST EXPENSE
Interest bearing demand deposits................... (99)
Interest on savings deposits....................... (69)
Interest on other time deposits.................... (308)
Long Term Debt..................................... (2)
---
Total interest expense............................... (478)
---
Net interest income.................................. (209)
---
---
</TABLE>
INVESTMENT SECURITIES
Investment securities as presented are held by the Bank and are stated at
cost, adjusted for amortization of premiums and accretion of discounts. In
December 1993, the Bank implemented FASB 115, mark-to-market for its investment
securities. As of December 31, 1994 and 1993, respectively, the portfolio was
segregated as follows ($'000)
<TABLE>
<CAPTION>
1994 1993
--------- ---------
<S> <C> <C>
Securities Available for Sale (AFS -- FMV)................................. 11,780 14,914
Securities Held to Maturity (HTM -- cost).................................. 4,358 3,285
--------- ---------
16,138 18,199
--------- ---------
--------- ---------
</TABLE>
In making its determination for classifying each security as available for
sale or held to maturity, the Bank considers several factors including: (i)
short-and mid-term liquidity needs; (ii) the need to have securities available
for pledging purposes for public deposits; (iii) the average life and interest
rate characteristics of the securities (fixed or adjustable rate); and (iv) the
probability of future market interest rate changes. Securities Held to Maturity,
as a rule, are fixed rate investments with short-term maturities in 1995 and
into 1996; securities Available for Sale have either very short maturities or
are tied to floating rates that reprice annually or more frequently.
28
<PAGE>
The following table summarizes the "book" value of investment securities
(cost basis for securities Held to Maturity and current market value for
Available for Sale investments). All dollar amounts are in thousands:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1994 1993
--------- ---------
<S> <C> <C>
U.S. Gov.'s and Agencies................................................... 10,844 15,047
Investment Funds (U.S. Government Securities).............................. 5,191 3,002
--------- ---------
Other Securities........................................................... 103 150
--------- ---------
16,138 18,199
--------- ---------
--------- ---------
</TABLE>
The following tables show the maturities, based on repricing dates and
contract dates, of investment securities at December 31, 1994, and the estimated
weighted average yields of such securities. All dollar amounts are in thousands:
Maturities based on earliest repricing date
<TABLE>
<CAPTION>
AS OF
DECEMBER 31, 1994
--------------------
AMOUNT YIELD
--------- ---------
<S> <C> <C>
Maturing within one year................................................... 14,281 5.68%
Maturing after one year but within five years.............................. 1,857 5.88%
--------- ---------
16,138 5.70%
--------- ---------
--------- ---------
</TABLE>
Maturities based on stated maturities only
<TABLE>
<CAPTION>
AS OF
DECEMBER 31, 1994
--------------------
AMOUNT YIELD
--------- ---------
<S> <C> <C>
Maturing within one year................................................... 5,191 5.62%
Maturing after one year but within five years.............................. 3,743 5.89%
Maturing after five years but within ten years............................. 104 4.28%
Maturing after ten years................................................... 7,100 5.75%
--------- ---------
16,138 5.70%
--------- ---------
--------- ---------
</TABLE>
The Bank does not have a securities Trading Account and does not intend to
trade securities.
Additional discussions concerning investments, including information
relating to derivatives and structured notes, are included in the MD&A section
for INVESTMENT ACTIVITIES and in the audited financial statements that are
included as a part of the December 31, 1994 Form 10-KSB.
29
<PAGE>
LOAN PORTFOLIO
The following table sets forth the amount of loan financing outstanding at
the end of the following periods, according to type of loan. All dollar amounts
are in thousands:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1994 1993
--------- ---------
<S> <C> <C>
Real estate construction................................................... 4,032 5,061
Real estate mortgage....................................................... 12,226 12,138
Commercial................................................................. 12,089 14,037
Installment................................................................ 2,693 4,134
--------- ---------
31,040 35,370
Less: Deferred loan fees................................................. (52) (119)
Allowance for possible loan losses................................... (1,137) (1,056)
--------- ---------
Total loans and leases..................................................... 29,851 34,195
--------- ---------
--------- ---------
</TABLE>
With certain exceptions, the Bank is permitted under California law to make
loans to a single borrower in aggregate amounts up to 15% of the sum of the
Bank's shareholders' equity, allowance for loan losses, capital reserves, if
any, and debentures, if any, for unsecured loans (as defined for regulatory
purposes), and up to 25% of such sum for the aggregate of secured and unsecured
loans (as defined). As of December 31, 1994 these lending limits for the Bank
were approximately $307,000 for unsecured loans, and approximately $511,000 for
secured loans. The Bank sells participations in loans where necessary to stay
within lending limits or to otherwise limit the Bank's exposure in particular
credits. Where deemed appropriate to better utilize available funds, the Bank
may purchase participations in loans.
MATURITIES AND SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES
The following table sets forth the maturity distribution and/or interest
rate sensitivity of the Bank's loan portfolio (excluding residential mortgages
of 1-4 family residences and installment loans) as of December 31, 1994. All
dollar amounts are in thousands:
<TABLE>
<CAPTION>
ONE YEAR
ONE YEAR THROUGH OVER
OR LESS 5 YEARS 5 YEARS TOTAL
----------- ----------- ----------- ---------
<S> <C> <C> <C> <C>
Real estate construction............................. 3,652 380 0 4,032
Commercial and Financial............................. 4,807 6,703 579 12,089
----- ----- --- ---------
8,459 7,083 579 16,121
----- ----- --- ---------
----- ----- --- ---------
Loans maturing after one year with:
Fixed interest rates............................... 4,076 74
Variable interest rates............................ 3,007 505
----- ---
7,083 579
----- ---
----- ---
</TABLE>
NONACCRUAL, PAST DUE AND RESTRUCTURED LOANS
The following table shows Bank nonaccrual, past due and restructured loans.
All dollar amounts are in thousands:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1994 1993
----- ---------
<S> <C> <C>
Non-accrual loans.............................................................. 431 2,420
Loans past due 90 days or more and still accruing interest..................... 362 505
Restructured loans............................................................. 0 0
Interest income that would have been recorded under original terms............. 26 98
Income recorded during period.................................................. 42 0
</TABLE>
30
<PAGE>
There were no commitments to lend additional funds to borrowers listed
non-accrual or past due 90 days or more.
The Bank's policy concerning non-performing loans is to cease accruing
interest, and to charge off all accrued and unpaid interest on loans which are
past due as to principal and/or interest for at least 90 days, or at such
earlier time as Management determines timely collection of the interest to be in
doubt; except that in certain circumstances accrued interest is not charged off
on adequately secured loans which are deemed by Management to be fully
collectible. Additionally, loans which are 90 days or more past due may continue
accruing interest if they are both well secured and in the process of being
collected.
POTENTIAL PROBLEM LOANS
Except as noted above, as of March 31, 1995, Management is not aware of any
borrowers who are experiencing severe financial difficulties, or in the normal
course of business, represent any identified loss potential. The Bank monitors
all loans and completes a monthly internal watch list, which is inclusive of
both loans past due and/or borrowers that have been identified as having special
difficulties. The watch list is reviewed by external credit examiners at least
quarterly and the results submitted to the Board.
LOAN CONCENTRATIONS
The Bank's loan portfolio is diverse, and as of March 31, 1995 there are no
specific concentrations to any one borrower or group of borrowers that are
engaged in similar activities which would cause them to be similarly impacted by
economic or other considerations.
SUMMARY OF LOAN LOSS EXPERIENCE AND RESERVE FOR LOAN LOSSES
The following table summarizes loan balances, loans charged off, the
provision for credit losses charged to expenses, the Reserve, and loan
recoveries. All dollar amounts are in thousands:
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
--------------
1994 1993
------ ------
<S> <C> <C>
RESERVE FOR POSSIBLE CREDIT LOSSES:
Balance -- beginning of period............................ 1,056 575
Loans charged-off:
Real estate........................................... 796 60
Construction.......................................... 0 75
Commercial............................................ 167 599
Installment........................................... 29 81
------ ------
Total............................................... 992 815
RECOVERIES ON LOAN CHARGE-OFFS:
Real estate........................................... 40 8
Construction.......................................... 0 0
Commercial............................................ 33 5
Installment........................................... 5 3
------ ------
Total............................................... 78 16
------ ------
Net loans and leases charged-off............................ 914 799
Provision charged to operating expenses..................... 995 1,280
------ ------
Balance -- end of period.................................. 1,137 1,056
------ ------
------ ------
LOANS:
Average loans outstanding during period................... 32,397 40,774
Total loans at end of period.............................. 29,851 34,195
RATIOS:
Net loans charged-off to average loans.................... 2.82% 1.96%
Reserve as a percent of end of period loans............... 3.81% 3.09%
</TABLE>
31
<PAGE>
The Bank entered 1994 having made a large increase in the Reserve in
December 1993 based on borrowers' information currently available and based on
preliminary economic information that suggested that the recession was showing
signs of improvement. The economy was in fact improving in many areas of the
county -- but not in the local area. The Bank's local market was hit very
severely by the tail end of the recession and, in several instances, in 1994
commercial borrowers who had never reported financial difficulties or were past
due simply declared bankruptcy. In several other cases, individuals who lost
their long-term jobs stopped making payments. In 1994 the Bank charged $542,000
to loan losses concurrent with the acquisition of two properties as OREO. These
losses were both related to a severe drop in the actual and appraised value of
real estate. The two properties that were acquired as OREO were properties that
were originally valued on a cost basis at $2.3 million and $1.3 million,
respectively -- this is the property level that was most severely hit by the
recession. Properties at this value represent an exception for the Bank's loan
portfolio, and Management does not feel there are other large loans with similar
problems in the current portfolio that have not been adequately considered in
the analysis of the Reserve.
While comparative data is not available for December 31, 1994, an Orange
County peer group summary done by Grant Thornton LLP using September 30, 1994
Call Report data shows the following comparisons:
<TABLE>
<CAPTION>
TOTAL ASSETS OF
GREATER THAN $50MM AND
MONARCH LESS THAN OR EQUAL TO $125MM
------- ----------------------------
<S> <C> <C>
Loan Loss Reserve/Gross Total Loans......................... 3.66% 2.81%
Loan/Deposit Ratio.......................................... 50.90% 70.40%
Loan Loss Reserve/Non-Performing Loans...................... 143.38% 140.19%
Non-accrual Loans/Gross Loans............................... 1.39% 3.23%
</TABLE>
The same ratios for banks with total assets of less than $50 million and
those with more than $126 million show similar patterns for problem loans and
generally high reserves. Based on preliminary reports for other banks for
December 1994, other banks are also seeing a decrease in the volume of problem
loans and a settling of the Reserve levels from recent very high levels.
The Bank has not been active in areas that involve hazardous waste, and
based on portfolio reviews by the Bank and during credit review processes
including regulatory examinations, NO loans have been identified that would
appear to be of concern because of hazardous material.
The Bank makes a variety of loans available to its customers. It also
attempts to control or reduce the risks associated with different forms of
lending by (i) employment of experienced loan officers; (ii) loan committee
review and approval of all loans of $250,000 or more to any one borrower; (iii)
loan committee review and approval of any loan which represents an exception to
loan policy and/or of any new or renewed loan to a borrower who has a loan
internally or externally classified as special mention or worse; and (iv) by
limiting loan activity to loan types that are within the experience level of
loan officers and the loan committee. As an additional control for construction
lending, the Bank also uses a professional outside source for all fund control
disbursements.
32
<PAGE>
The Bank's Adequacy Analysis of the Reserve for Loan Losses was prepared
using November 30, 1994 data, with specific changes as part of the 1994 audit to
reflect known changes in the portfolio, shows (dollars in thousands or %):
<TABLE>
<CAPTION>
UNCLASSIFIED RESERVE % RESERVE $
------------ --------- ---------
<S> <C> <C> <C>
Commercial Loans............................................ 6,563 1.00% 66
Construction Loans.......................................... 4,222 1.00% 42
Land Loans.................................................. 1,623 1.00% 16
SBA Loans................................................... 441 1.00% 4
Cash Secured Loans.......................................... 387 0.00% 0
Real Estate Loans........................................... 11,715 1.00% 111
Installment Loans........................................... 2,328 1.00% 23
Home Equity Lines........................................... 809 2.00% 14
Redi-Credit................................................. 234 2.00% 5
Overdrafts.................................................. 13 1.00% 0
MB Credit Cards............................................. 109 1.00% 1
------ --------- ---
28,444 1.00% 282
CLASSIFIED LOANS:
Substandard............................................... 2,764 10.60% 265
Doubtful.................................................. 479 50.00% 240
Loss...................................................... 8 100.00% 8
------ --------- ---
3,251 16.00% 513
------ --------- ---
Total Loans................................................. 31,695 2.50% 795
</TABLE>
The Adequacy Analysis also allows for economic uncertainties and other
possible unknown factors which are included in the $342,000 difference between
the $785,000 calculated reserve and the actual reserve of $1,137,000 in December
1994. Reserves for unclassified loans are calculated based on historic reviews
of charge off activity for similar loan types and other factors including an
assessment of actual collateral and payment history for these loans. Reserves
for classified loans are based on a loan by loan review and estimate of possible
loss should the borrower be unable to fully repay the loan. During December
1994, the one small loan identified as a loss was charged off. The Reserve
analysis was reviewed and confirmed by a firm the Bank uses to perform a
detailed review of loans and of the Reserve, and by the full Board. It was also
carefully reviewed as part of the due diligence done as part of their work in
conjunction with structuring and completing the private placement for the
Company's common stock.
DEPOSITS AND LIABILITY MANAGEMENT
The Bank provides a range of deposit types to meet the needs of the local
community. Time deposits, which are normally sensitive to competitive rate
changes, are generally used to expand or contract the overall liability position
needed to meet the various management ratios established for liquidity, capital,
loans to deposits, and other funding measurements. As a policy, the Bank does
not accept or solicit brokered deposits.
33
<PAGE>
The following tables show the average amount of interest bearing and
non-interest bearing deposits and rates as of December 31, 1994 and 1993,
respectively. All dollar amounts are in thousands:
<TABLE>
<CAPTION>
1994 AVERAGE 1993 AVERAGE
-------------- --------------
BALANCE RATE BALANCE RATE
------- ---- ------- ----
<S> <C> <C> <C> <C>
Non-interest bearing deposits............................... 13,558 0.00% 12,423 0.00%
Interest bearing demand deposits............................ 32,590 2.22% 34,906 2.16%
Savings deposits............................................ 7,369 2.08% 8,308 2.55%
Time deposits............................................... 6,872 3.26% 8,178 3.33%
------- ---- ------- ----
Total (1)................................................... 60,389 1.82% 63,815 1.94%
------- ---- ------- ----
<FN>
- ------------------------
(1) Includes non-interest bearing deposits for both amount and rates. Rates
represent weighted averages.
</TABLE>
The average rates are somewhat deceptive in showing a lowering of cost of
funds, as rates showed a measurable increase in the last few months of 1994. The
cost of funds is also impacted by increases in non-interest bearing deposits
which was part of the Bank's 1994 and 1995 business plan as one way to control
cost of funds.
The following table shows the maturity schedule of time certificates of
deposit of $100,000 or more as of December 31, 1994. All dollar amounts are in
thousands:
<TABLE>
<S> <C>
3 months or less............................................ 1,659
Over 3 months through 6 months.............................. 601
Over 6 months through 12 months............................. 0
Over 1 year................................................. 0
-----
Total................................................... 2,260
-----
-----
</TABLE>
RETURN ON EQUITY AND ASSETS
The following table presents the key ratios for the Company based on average
assets, average equity, and net income for the years 1994 and 1993
<TABLE>
<CAPTION>
1994 1993
------- -------
<S> <C> <C>
Return on assets............................................ (2.9%) (2.0%)
Return on equity............................................ (74.5%) (33.2%)
Equity to assets............................................ 3.9% 5.9%
</TABLE>
34
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
The $1,850,000 loss as of December 31, 1994 embodied three significant
issues: (i) a decrease of approximately $5.1 million in average assets and more
specifically a shift in earning assets from generally higher yielding loans to
generally lower yielding investments; (ii) a continuation of the recession
related credit problems as troubled borrowers from 1993 could no longer meet
their loan commitments in 1994 as measured in a $995,000 provision for loan loss
expense; and (iii) a $360,000 write-off of expenses for a 1994 unsuccessful
public offering.
REDUCTIONS IN ASSETS
The Bank's average assets decreased in 1994 by approximately $5.1 million,
and average earning assets decreased by approximately $5.6 million for five
reasons: (1) the recession; (2) low loan demand; (3) Management's willingness to
allow a reduction in total deposits which could not be profitably used in the
normal lending program or short-term investments; (4) Management's
acknowledgment of the need to manage regulatory capital ratios during a period
of reduced shareholders' equity; and (5) an increase in the average level for
OREO.
Economic conditions in 1994 continued to show the effects of a prolonged
recession in the local market; however, most current information during the
first quarter of 1995 suggests that the local economy is finally starting to
recover. This recovery includes improvements in employment data and an apparent
bottoming of the declines in real estate values. The bankruptcy of Orange County
will impact certain areas of the local economy, but the full extent of the
impact has not as yet been determined.
Average net loans decreased by approximately $8.4 million in 1994 during a
period when interest rates for both loans and deposits were increasing. The
Bank's primary focus in 1994 was working with existing borrowers who were
attempting to survive the recession while screening all new credit requests
under the highest underwriting standards. Excess funds not used for lending were
moved to other investments, with the Bank electing to maintain a very high level
of cash liquidity rather than reach for higher yielding, longer-term investment
alternatives. The decrease in total interest income of approximately $409,000 is
primarily attributed to the decrease in loan volume since loan rates increased
for most of the year. Interest rates on all earning assets progressively
increased in 1994 as the Federal Reserve systematically increased interest
rates; however, the most measurable increases were during the latter part of the
year. While interest rates were increasing on earning assets and on deposits,
the increase for deposits was much less as the Bank consistently priced its
deposit products nearer the lower end of the deposit rate ranges for other local
financial institutions.
INVESTMENT ACTIVITY
The Bank had a full year's experience with FASB 115 which requires the
investment portfolio to be segmented into three possible categories: available
for sale (AFS), held to maturity (HTM), and trading. The Bank does not have a
trading portfolio and had no sales of securities from either its AFS or HTM
portfolios in 1994, and the Bank does not, as a rule, expect to sell securities
from the AFS portfolio except under unforeseen circumstances to meet specific
funding or liquidity needs. Decisions on the portfolio allocation between AFS
and HTM are made based on the expectation that variable rate securities (AFS
portfolio) would allow for some automatic adjustment to market values over a
reasonably short period (one to two years in most rate change cycles) while the
shorter-term, fixed-rate investments (HTM's) would not be required to book
accounting cost adjustments during swings in investment prices.
While FASB 115 requires the AFS portfolio to be adjusted to market value
directly through the equity account, banking regulators, as a group, have
excluded this equity accounting adjustment from capital ratio calculations
because of the short-term volatility of the adjustments that may or may not
represent a real change in equity capital.
35
<PAGE>
The Bank's investment portfolio, including information through the end of
March, 1995, displays the following volatility in considering the Bank's
investment portfolio:
<TABLE>
<CAPTION>
MARCH 1995 DECEMBER 1994 DECEMBER 1993
----------- --------------- ---------------
<S> <C> <C> <C>
HTM
Cost basis.................................... 4,590 4,405 3,285
Market value.................................. 4,465 4,170 3,274
----------- ------ ------
Appreciation/(depreciation)................. (125) (235) (11)
AFS
Cost basis.................................... 11,910 12,137 14,861
Market value.................................. 11,760 11,780 14,914
----------- ------ ------
Appreciation/(depreciation)................. (150) (357) 53
</TABLE>
While the Bank has divided its portfolio into HTM and AFS components, each
security was purchased with the full intent of holding to maturity based on an
overall yield and position in the Bank's laddered cash flow from investments.
Changes in prices for the bond market are not expected to impact the AFS
portfolio except for FASB 115 accounting adjustments to equity, and Banking
regulators do not include such adjustments, either positive or negative, in
their capital ratio calculations. To reinforce or support its intent to hold all
securities to maturity, the Bank has been very aware of its current and
projected cash liquidity versus funding needs and/or possible large decreases in
deposits. Anticipated loan growth in 1995 is expected to be funded from very
short-term investments and some increases in deposits which will be stressed as
part of relationship banking. The Bank has been able to maintain a strong core
deposit base during 1994 and the start of 1995 during a period of generally
negative press on community banks as a group, and during a period when the Bank
was placed under regulatory orders and saw its capital levels slip below
acceptable levels. The increase in capital in March 1995 should allow the Bank
to continue to maintain its core deposits and attract new deposits at market
rates for growth.
The Bank, as part of its investment portfolio, holds derivative securities.
These securities include three Collateralized Mortgage Obligations (CMOs) which
total approximately $2,487,055 at current market value with a weighted average
rate of 6.82% and a weighted average life of 3.44 years. All three CMO's are
periodically tested using the FFIEC High Risk Security Test, and each of the
securities has passed the tests that are used by bank regulators to assess
relative CMO investment risks. The Bank also holds a $2.5 million SLMA Multi
Step-up security that will reprice to increasingly higher levels each March
unless called during the next four years. The SLMA security paid interest at
5.3% until March 30, 1995 when the rate increased to 5.6%, until March 30, 1996
when the rate increases to 6.25%, until March 30, 1997 when the rate increases
to 7.25%, until March 30, 1998 when the rate increase to 8.25%. The security
matures on March 30, 1999 but is subject to call in whole or in part each
semi-annual interest payment date. This security is carried as held to maturity.
The Bank in establishing its held to maturity portfolio has considered its
intent and ability to hold this investment to maturity versus possible liquidity
needs, and the Bank does not expect to realize any loss or gain on this
security. The book value of this security as of March 31, 1995 was $2.5 million
while the market value was $2.45 million. The Bank's Investment Committee makes
every effort to keep informed about both the perceived and real risks of
derivative securities, and has set general limits on the types of derivatives
the Bank can purchase at the most basic levels which include step-up notes and
CMO's.
As of March 31, 1995, the three CMO's have the following characteristics
including a projected gain or loss given a change in interest rates of plus or
minus 100 basis points:
<TABLE>
<CAPTION>
GAIN/ BOOK MODIFIED GAIN/LOSS GAIN/LOSS
CLASS. RATE COST ($) MARKET ($) LOSS ($) YIELD DURATION +100 BP -100 BP
- -------------------------- --------- ---------- ----------- --------- --------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
AFS....................... ARM 1,004,330 998,090 (6,240) 7.2% 4.51 (7,188) (2,127)
HTM....................... FX 1,008,380 971,835 (36,545) 6.9% 2.46 (46,525) (19,528)
HTM....................... FX 498,905 488,939 (9,966) 4.2% 0.97 (21,891) 13,370
</TABLE>
The Bank has not been involved in any off balance sheet hedging type
activities.
36
<PAGE>
CREDIT RISK AND LOAN ISSUES
NET CHARGE OFFS: The following table illustrates the net results of loan
charge offs and recoveries in 1994, 1993 and 1992 (dollars in thousands):
<TABLE>
<CAPTION>
1994 1993 1992
----- ----- -----
<S> <C> <C> <C>
Real estate.............................................................. 756 52 90
Construction............................................................. 0 75 70
Commercial............................................................... 134 594 32
Installment.............................................................. 24 78 15
--- --- ---
912 799 207
</TABLE>
The trend for net charge offs in 1994, 1993 and 1992 is a direct reflection
of the impact of the recession. Net charge offs on a historic basis on a larger
loan portfolio base in 1991 and 1990 were $27,000 and $31,000, respectively.
Of the $992,000 in total loan losses in 1994, three borrowers accounted for
$717,000 or 72% of the total. Two large real estate loans were acquired through
foreclosure in 1994 and because of the distressed market for million dollar
homes, these loans were written down through the Reserve at the time of
foreclosure by $542,000. One of the properties subsequently sold at the booked
price, and the other is still owned by the Bank at a book value of approximately
$617,000. The Bank is actively attempting to sell this property, and the current
appraised value -- less estimated selling costs -- continues to support this
value; however, there are a limited number of buyers for properties in this
area, and the sales market is slow. Both of these real estate loans were
defaulted upon because of marital problems even though the borrowers appeared to
have adequate cash flows to meet their payments. The third large borrower was a
$175,000 loan that was charged off when the borrower was forced to close one of
his two business locations. There were also 14 additional charge offs with a
mean average of $20,000 and a high of $77,000 and a low of $640.
A review of past due and nonaccrual loans as of December 31, 1994 and 1993
shows:
<TABLE>
<CAPTION>
1994 1993
------------ --------------------
# #
-- $'000 -- $'000
----- ---------
<S> <C> <C> <C> <C>
Past due 60 - 89 days.............................................. 2 3 4 106
Past due 90 + and accruing......................................... 3 362 3 505
Non-accruing....................................................... 6 431 4 2,420
-- --
--- ---------
11 796 11 3,031
</TABLE>
As of April, 1994, the three loans Past due 90 + and still accruing included
(i) two loans that are secured by real estate (supported by current appraisals
or market reviews), and (ii) one loan that has paid off. The nonaccrual loans
include (i) two loans that are secured by real estate with reasonable equity
based on current appraisals; (ii) one loan that was restored to an accrual
status in February 1995 because of improved financial performance and 11
consecutive months of current monthly payments; and (iii) a final loan that is
secured by real estate that is currently being refinanced by another financial
institution.
There are no loans, classified for regulatory purposes as loss, doubtful,
substandard, or special mention that have not been disclosed which represent or
result from trends or uncertainties which management reasonably expects will
materially impact future operating results, liquidity, or capital resources, nor
are there material credits about which management is currently aware of any
information which causes management to have serious doubts as to the ability of
such borrowers to comply with the loan repayment terms.
The Bank holds one OREO property which was written down by $300,000 when it
was acquired in 1994, and by an additional $200,000 as of December 31, 1994. The
property's book value of $617,000 is supported by a current appraisal, and the
property is being actively marketed. This property is located in an area of the
state where real estate sales are still very slow. The original cost of this
home was approximately $2.3 million. The Bank completed the sale of other OREO
properties in 1994 with little or no net gain or loss. The Bank estimates the
monthly carrying cost of the remaining OREO at approximately $5,000 per month.
37
<PAGE>
PUBLIC OFFERING EXPENSES
On May 13, 1994, pursuant to an order from the Securities and Exchange
Commission, Monarch Bancorp commenced an offering of a minimum of 833,333 shares
and a maximum of 2,333,333 shares of Common Stock at a price of $3.00 per share.
The offering was undertaken in order to raise additional capital (i) in
accordance with the Memorandum of Understanding (the "MOU"), an agreement
entered into between Monarch Bank (the wholly-owned subsidiary of the Company),
the Federal Deposit Insurance Corporation, and the California Superintendent of
Banks ("Superintendent"), and (ii) to provide additional capital for prudent
expansion of the Bank through continued growth of its present facility and
possible future facilities. The MOU required the Bank to have a leverage capital
ratio of 7%, and as of December 31, 1993, the Bank had a leverage capital ratio
of 4.63%. The offering was underwritten by Spectrum Securities, Inc. At the
conclusion of the offering on October 15, 1994, Monarch Bancorp failed to raise
the minimum of $2.5 million and the funds held in the impound account at First
Interstate Bank of California were returned with interest to investors
subscribing in the offering. Direct and indirect offering expenses of
approximately $360,000 were written off in the 4th quarter of 1994. As a result
of the failure to receive the minimum amount in the offering, the Bank was not
in compliance with the 7% Tier 1 requirement contained in the MOU.
LIQUIDITY AND INTEREST RATE RISK
During 1994, the Bank consistently maintained very high cash liquidity
(Cash, Investments (both HTM and AFS at cost), and Federal Funds Sold divided by
Total Deposits) of approximately 40% or greater. Conversely, the Bank's
loan-to-deposit ratio for most of 1994 was in the range of 55% to 60%. The high
liquidity was a product of low demand for loans and very high underwriting
standards during the latter part of a major recession.
The following table breaks down rate sensitivity for earning assets (RSA)
and rate sensitive liabilities (RSL) based on the earliest possible repricing
dates for variable rate instruments, or for fixed rate assets and liabilities,
on scheduled maturities. The table includes experience-based prepayment
assumptions for mortgage loans. Mortgage loan repayments are based on a six
moving average for repayments or approximately 3% per month and uses PSA speeds
for projecting repayments on mortgage-backed investment securities. No attempt
has been made to spread interest-bearing transactional based demand accounts
over future periods since the Bank does not have sufficient information to
predict the relative interest rate changes for rate sensitive assets versus rate
sensitive transactional accounts. Preliminary studies of Bank information
suggest both a repricing delay in the relative changes in rates on earning
assets versus interest-bearing demand accounts. The Bank is implementing new
reporting systems for interest rate risk (IRR) using proposed guidelines
detailed in FDICIA 305. This pending regulation establishes new tests for IRR.
Banks who exceed the target levels of IRR will be required to do expanded,
detailed IRR reporting as part of their quarterly Call Reports and may be
subject to requirements to increase their capital to compensate for higher than
targeted IRR. The Bank as of the first quarter of 1995 passes the proposed
regulatory tests and would not be subject to either the additional reporting
requirements or additional capital requirements. The final guidelines for FDICIA
305 are expected to be implemented sometime in 1995, and the Bank, as approved
by
38
<PAGE>
the Board of Directors in its Asset Liability Management Policy, plans to
consistently limit IRR to a level that would preclude any additional capital
requirements. The table uses data from FDIC Call Reports and is similar to the
reporting assumptions required during bank examinations. (Dollars in thousands):
<TABLE>
<CAPTION>
91-365
1 DAY 2-90 DAYS 1-5 YEARS 5+ YEARS TOTAL
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
CD's at other banks.................................... 0 0 788 601 0 1,389
Investments
Fixed rate........................................... 0 0 0 1,753 0 1,753
Floating............................................. 5,191 4,492 2,087 2,664 0 14,434
Loans
Fixed................................................ 0 432 1,993 6,650 671 9,746
Floating............................................. 13,016 704 6,339 805 0 20,864
Nonaccrual........................................... 0 0 431 0 0 431
Federal Funds Sold..................................... 5,891 0 0 0 0 5,891
--------- --------- --------- --------- --------- ---------
Total RSA............................................ 24,098 5,628 11,638 12,473 671 54,508
Savings................................................ 0 3,742 2,494 0 0 6,236
MMDA................................................... 11,436 0 0 0 0 11,436
Now Accounts........................................... 13,351 0 0 0 0 13,351
CD's over $100,000..................................... 0 1,650 601 0 0 2,251
Other CD's............................................. 0 2,755 1,607 230 0 4,592
--------- --------- --------- --------- --------- ---------
Total RSL............................................ 24,787 8,147 4,702 230 0 37,866
--------- --------- --------- --------- --------- ---------
Net RSA-RSL........................................ (689) (2,519) 6,936 12,243 671 16,642
Cumulative RSA-RSL..................................... (3,208) 3,728 15,971 16,642
Cumulative GAP as %.................................... 97% 90% 110% 142% 143%
As % of Total Assets................................... 1% 5% 6% 26% 27%
</TABLE>
As a rule, the Bank works to keep the cumulative difference between RSA and
RSL as balanced as possible over a one year cycle. In 1994 and 1993 deposit
interest rates were low and many deposits shifted balances into shorter term
instruments and out of certificates of deposits (CD). This tended to reduce
total CD deposits as a normal balancing factor for deposit maturities and to
increase the shortest end of rate sensitive liabilities. The Bank, and most
banks as a group, are currently faced with a need to progressively increase
deposit rates which were held low in 1994 because of the lack of competition for
deposits at a time when banks were still operating with low or lower than normal
loan demand. This need and pricing pattern appears to be changing, and the Bank
and the banking industry expect to see cost of funds increase at a much faster
pace in 1995 than in 1994. Bank regulators are reviewing proposed standards for
measuring interest rate risk, and new standards and reporting requirements are
expected to be introduced in 1995.
CASH FLOW -- PARENT COMPANY ONLY
The Company as of December 31, 1994 had $53,500 in notes that mature in
August 1995. These notes were repaid on March 31, 1995 from part of the funds
received from the private placement. During 1994, all corporate expenses were
held to minimum levels, and cash balances currently available are adequate to
meet cash flow needs for the coming year. Following the completion of the
private placement, the Company as of March 31, 1995, has over $2 million in
available cash to support current operations, as additional capital to support
the Bank, or for other possible investments.
As a result of the capital increase for the Bank, the Bank's Tier 1 capital
ratio, as of March 31, 1995 was 7.85%. The increase in the Bank's capital meets
or exceeds the Bank's regulatory commitments to the FDIC and Superintendent to
increase the Bank's ratio for Tier 1 capital to total assets to equal or exceed
7.0% by April 30, 1995.
39
<PAGE>
RECESSION / INFLATION
Based on local newspaper reports, the recent recession was the most severe
experienced in Orange County as measured by decreases in employment and a
significant decline in real estate values. Nearly every area of the local
economy had declines, and virtually all community banks experienced significant
loan losses and declines in the relative size of their loan portfolios as a
direct result of the recession.
The recovery appears to have started in California, but Orange County
continues to lag behind the rest of the country. More recently, this has been
compounded by the bankruptcy filing by Orange County. Through March 1995, the
market for home sales was down for the first three months of 1995 both because
of higher interest rates and concerns about the County, and local businesses
pondering the uncertainty caused by higher interest rates and lack of a
published workout plan by the County. One local economic research organization
has published data that suggests that on a technical basis the local economic
recovery began sooner than previously suggested and is currently stronger than
expected. Several economists feel that the bankruptcy will cause short-term
uncertainty but that the local economy is moving faster into the recovery than
expected, and this will be more evident once the County's workout plan is
completed. One key feature of the plan is a proposed tax increase of one-half
percent that is expected to be presented for vote in June or July. However, no
assurances can be given regarding the possible recovery in the local economy.
OPERATIONS RESULTS
INTEREST INCOME decreased by approximately $409,000 or 9% for the year 1994
versus 1993. The decrease was caused by a decline in loan totals as lending
activity continued to decrease in 1994 under recessionary pressure. The decrease
would have been even greater given the drop in loan volume had interest rates
for earning assets not been increasing.
The average yield on earning assets of 7.04% and 7.06% were consistent for
the year 1994 and 1993, respectively. This static yield during a period when
interest rates were being increased by the Federal Reserve is tied to the
progressive decrease in loan volumes. Loan interest and fee income decreased by
approximately $660,000 in 1994; however, approximately $741,000 of the decrease
was attributed to a decrease in volume while rate increases accounted for an
increase of approximately $81,000 for loans. In part this decreased income was
offset by an increase in both volume and yield on investments, Federal Funds
Sold, and Certificates of Deposit purchased from other financial institutions
which on a combined basis increased by approximately $251,000. This combined
investment income improved by approximately $181,000 from volume increases and
approximately $70,000 from rate increases.
INTEREST EXPENSE declined by approximately $143,000 or 11% in 1994 versus
the prior year as overall interest rates on deposits marginally decreased for
the year while total deposits were dropping.
Based on a review of changes in volumes and rate, the Bank's cost of funds
in 1994 decreased by approximately $118,000 due to a volume drop in average
interesting-bearing deposits of approximately $4.6 million. Changes in rates
accounted for approximately $25,000 in the decrease in cost of funds. During
1994, the Bank and the banking industry were much slower in adjusting deposit
rates in an increasing rate market than they were in increasing rates on the
asset side of the balance sheet. Low deposit rates also compelled many
depositors in 1993 and the start of 1994 to move away from certificates of
deposit into interest bearing transactional accounts or even simple non-interest
bearing demand deposits. This trend started to reverse itself later in 1994 and
continues in the first months of 1995 as the cost of funds was progressively
increasing at the end of the year.
For the years and quarters ended December 31, 1993, March 31, 1994, December
31, 1994, and March 31, 1995, respectively, the Bank's cost of funds for
interest bearing deposits was 2.4%, 2.1%, 2.4%, and 2.8%.
NON-INTEREST INCOME decreased for the comparative years by approximately
$264,000 or 28%. The primary reason for this decrease was the termination of the
sale leaseback on assets which had provided approximately $13,000 per month in
income as the gain on sale was amortized to income. This lease
40
<PAGE>
terminated in September 1993 and represents approximately $111,000 of the
decrease. Rental income decreased by approximately $48,000 or 40% with the
renegotiation at a reduced rate on a subleased facility. The Bank also recorded
a gain on sale of securities in 1993 but wrote down one security in 1994 by
$47,000.
The Bank acquired a mandatory convertible debenture in another financial
institution in 1989 when it sold its residual value in a matured lease. The
debenture was converted to common stock in 1993 at approximately par. The market
for this institution stock, like most financial institutions, was negatively
impacted by the recession and a generally poor perception by investors in the
past year for California community bank stocks. This institution has a very
lightly traded stock that is not listed on an exchange; however, this
institution has been consistently profitable in the past few years. While its
book value supports the original $150,000 cost value, the lack of a current
market and limit recent trades suggest a current "fair market" value of
$103,000. This financial institution paid a dividend in 1995 based on 1994
financial results and appears to be well structured for very positive growth and
stock appreciation in 1995.
The Bank generates a significant amount of income, $230,000 and $278,000 for
the years 1994 and 1993, respectively, from Overdraft Charges for service
charges ($15 per check) relating to checks drawn against insufficient funds
(NSF). This charge is generally made whether the check is paid or not paid. The
Bank very carefully controls and monitors overdraft or potential overdraft
activity, and actual daily overdrafts average less than $25,000. The Bank has
very little charge off activity from overdrafts --the average is less than $500
per year for each of the past five years. The Bank is one of the few financial
institutions that continues to make daily telephone calls to depositors on the
"pending" overdraft report and checks are only paid for established, well-known
depositors or for depositors who make a confirmed deposit the same day to cover
their NSF checks. Based on discussions with other local community banks, this
level of NSF income is consistent with our market place. The Bank's knowledge of
its customers and tight controls over the review and approval process for
overdraft or NSF activity reduce any potential credit exposure.
OPERATING EXPENSES increased by approximately $215,000 or 5.2% for the year
1994 versus 1993. This increase includes specific nonrecurring items for 1994
including: (i) approximately $366,000 in expenses that were written off
following the termination of the public stock offering in 1994 when the Company
failed to raise the minimum of $2.5 million required in the offering; and (ii) a
$200,000 direct write down on December 31, 1994 on the book value of the Bank's
remaining OREO. The OREO adjustment was made to reflect the current estimated
market value of the property in a slow real estate market.
Without these two large expenses, Operating Expenses decreased by $351,000
which reflects numerous areas where expense controls were effective in reducing
costs. Specific material reductions include salary and benefits which decreased
by $51,000, and Office and Occupancy expenses which decreased by $496,000 or 28%
inclusive of the relative expense reductions following the end of the sale
leaseback of Bank assets in September 1993 and other strict expense controls in
all areas of the Bank.
INTERNAL CONTROLS
In addition to the annual audit done by the Company's independent auditors
and periodic examinations by bank regulators, the Audit Committee of the Bank
maintains an engagement with R. Maslac & Associates for periodic loan,
administrative, operational, and data processing audits of internal controls.
These internal control audits are performed on a periodic basis during the year.
Expenses for outside credit and internal control reviews were approximately
$26,000 in 1994, $25,000 in 1993. The Board's committees, and when needed the
full Board, review all reports from these outside reviews.
CAPITAL AND REGULATORY MATTERS
The March 31, 1995 first closing of the private placement allowed the
Company to increase the Bank's capital by $3.6 million and meet the Bank's April
30, 1995 commitments under the Bank's regulatory orders to increase capital. The
private placement process also included a detailed due diligence review of the
Bank's loan portfolio, accounting, and operations. The due diligence process and
the 1994 annual audit were used by the Company to carefully examine the Bank's
assets and operations, and included recommendations for some write offs to
reflect actual or probable losses to Bank assets from the economic problems that
have beset the area -- including the recession and more recently from the
bankruptcy of Orange County. While
41
<PAGE>
the Bank and Company have no assurance that there are no additional surprise
losses, it appears that the Bank is now positioned to operate with sustainable
profitability for the foreseeable future. The current largest challenges for the
Bank are to rebuild loan activity with good credit quality and to progressively
increase the level of total assets and total deposits.
For the past two years, the Bank and company have not generated sufficient
core earnings to cover operating expenses after excluding nonrecurring items
such as offering expenses, OREO expenses, higher than normal legal expenses
because of regulatory issues relating to capital and the regulatory orders, and
a high level of expenses to fund the Allowance for Loan Losses during a period
of high loan losses. As of the end of the first quarter of 1995, the Company did
have core earnings sufficient to just meet its base operating expenses (adjusted
for the nonrecurring $171,000 settlement from a claim against the Bank's blanket
bond); however, the Bank did not make a first quarter contribution to its
Allowance for Loan Losses after having made a very large increase in the last
quarter of 1994, and the Bank continued to have a general decrease in total
assets prior to the March 31, 1995 recapitalization.
Several factors are expected to assist the Company and Bank in returning to
a consistent level of profitability including: (1) the Company and Bank were
recapitalized on March 31, 1995 and both now exceed the regulatory commitments
and meet the "well capitalized" definition that provides a public relations and
general psychological plus in working with new customers for both loan and
deposit business; (2) the Company has maintained over $2 million in cash as an
earning asset, and based on a projected investment yield of 6.0% will earn over
$120,000 per year which is well in excess of its anticipated expenses; (3) on a
net/net basis, the Bank's capital was also increased on March 31, 1995 and this
$3.6 million cash increase has been invested in short and mid-term securities at
an average yield of 7.0% providing the Bank with a new earning asset of
approximately $250,000 per year; (4) the historic loan losses from the past two
years are not expected to continue in 1995, and the Reserve for Loan Losses has
been increased to adequately cover all known or expected loan losses; (5) the
Bank has included in its budget approximately a $10,000 per month Provision for
Loan Loss expense starting in the second quarter of 1995 in anticipation of new
loan growth and to insure to the best of management's ability to keep an
adequately funded Reserve for both known and unknown but possible events; (6) as
of the end of the first quarter of 1995 and the start of the second quarter, the
Bank's loan to deposit ratio averaged 50%, but it is projected to increase to
approximately 65% later in the year with a corresponding increase in relative
loan interest and fees versus investments yields; (7) loan quality is, and
remains a top priority of management, and the Bank has completed virtually a
100% change in its loan staff to increase the level of technical skills and
overall credit administration detail; and (8) the Bank is so structured that it
can increase business volumes without increases in staffing or other overhead
expenses so most, if not all, new business should provide a measurable increase
directly to the bottom line. (See "RISK FACTORS -- Financial Condition and
Operations; Loss in 1993 and 1994, Existing and Potential Enforcement Factors
Concerns Relating to Real Estate Loans, Asset Quality, Interest Rate Risks and
Risk of Failure to Meet Capital Requirements").
While the Bank and Company appear to have reasonable prospects to generate
increasingly improved earnings, management is aware that this will be a
progressive building project and that there are no quick fixes in rebuilding a
good quality loan portfolio. In the short term, income from the new equity that
was booked on March 31, 1995 provides a solid base earning asset.
The Company retained just over $2 million in cash from the private
placement.
The private placement has increased the number of shareholders by
approximately 26 with the largest single shareholder projected to hold under
approximately 10% of the stock.
The stated goal of the Company is to continue to operate the Bank as a
community bank with a local Board of Directors. The Company also has adequate
cash to assist the Bank to expand or to expand the Company's activities into
areas that are approved for bank holding companies to operate. The Company is
investigating opportunities to expand. (See "USE OF PROCEEDS.")
The Bank has developed and the Board of Directors has approved separate
management action plans to address each of the issues detailed in the regulatory
Orders it signed with the FDIC and Superintendent. The
42
<PAGE>
plans are divided into three major sections -- capital, credit administration,
and other items. With the March 31, 1995 completion of the first closing for the
private placement, the Bank has achieved and exceeded the capital ratios
required by April 30, 1995, and the Bank expects to continue to operate with a
leverage ratio of not less than 7.0% during the life of the Orders. Once the
Orders have been removed, the Bank expects to operate at or above the "well
capitalized" level (as periodically defined by bank regulations). As of March
31, 1995, the Bank meets and exceeds the numerical regulatory definitions for a
"well capitalized" bank. The Bank's capital restoration plan and budget were
submitted to the FDIC and Superintendent and were approved in January, 1995.
On March 31, 1995, the Company completed a Private Placement Offering of
4,547,111 shares of its Common Stock, no par value, at a price of $1.35 per
share to several accredited investors as defined in SEC Regulation D. The
Company raised approximately $5,669,000 in net proceeds in the Private Placement
Offering.
The following table lists investors and any known shareholders with a
beneficial ownership of five percent of the Company Stock as of June 15, 1995.
All shareholders listed in the following table purchased in the Private
Placement Offering. All shares are Common Stock, the only class of security
outstanding.
<TABLE>
<CAPTION>
AMOUNT AND NATURE OF
NAME AND ADDRESS OF BENEFICIAL OWNER BENEFICIAL OWNERSHIP PERCENT OF CLASS
- ------------------------------------------------------------ -------------------- ----------------
<S> <C> <C>
Peter Huizenga Testamentary Trust........................... 530,000 9.85%
Huizenga Capital Management
Oak Brook, IL 60521
Robert A. Schoellhorn....................................... 530,000 9.85%
c/o Bryan & Gross
Northbrook, IL 60062
Mutual Discovery Fund....................................... 530,000 9.85%
(Mutual Series Fund, Inc.)
Short Hills, NJ 07078
Basswood Partners........................................... 530,000 9.85%
Paramus, NJ 07652
Kenneth Gaspar.............................................. 370,370 6.88%
Lisle, IL
Jerome White................................................ 333,333 6.19%
Chicago, IL 60606
</TABLE>
As of March 31, 1995, to the best of management's knowledge, the Bank has
met each of the action date requirements defined in the Orders relating to
credit administration including reduction of classified assets to defined
levels. Actions relating to credit administration include revisions to the Loan
Policy; maintenance of an adequate loan loss reserve; and other actions to
strengthen credit administration have also been taken.
Action has also been taken for each of the other items in the Orders, and
the Bank feels that it is in compliance with all of the required actions that
were to be completed by March 31, 1995. It has also instituted action to comply
with the few remaining actions that are tied to dates later in 1995.
The Company and Bank are not aware of any other current regulatory
recommendations or specific pending changes in banking regulations which, if
they were implemented, would have a material effect on the Company or the Bank's
liquidity, capital resources or results of operations.
As of March 31, 1995, the Bank settled a claim filed in 1994 under its
Bankers Blanket Bond for approximately $171,000 net of expenses.
43
<PAGE>
INTERIM MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS
TRENDS, EVENTS, OR UNCERTAINTIES LIKELY TO HAVE A MATERIAL IMPACT ON LIQUIDITY
The capital provided from the private placement on March 31, 1995, which
allowed the Bank to meet and exceed its regulatory commitments to reach a 7.0%
leverage capital ratio and which provided the Company with approximately $2
million in cash reserves for operating capital and possible future growth, had
both direct and indirect impacts on Bank and Company liquidity. While operating
under both regulatory orders and being classified as "undercapitalized" by
regulatory standards, the Bank was limited in its ability to grow under the
provisions of FDIC Section 38 which sets limits on bank asset growth and other
areas of operation when a bank's capital is below 4.0%. By recapitalizing, the
Bank is no longer subject to the limitations of Section 38 and can disclose to
existing and potential depositors that it meets all of the regulatory capital
requirements.
INTERNAL AND EXTERNAL SOURCES OF LIQUIDITY
During 1994 and the in the first quarter of 1995, the Bank was able to
maintain high levels of cash liquidity including cash , Federal Funds Sold, and
short term investment securities. After March 31, 1995, the Bank has both strong
cash liquidity and more options for growth. Prior to March 31, 1995, the Company
had limited liquidity that was not adequate to meet the payments on $53,500 in
notes that matured in August 1995. These notes were fully repaid on March
31,1995 leaving the Company with no outstanding debt and over $2 million in
operating cash which is more than adequate to provide income in excess of any
anticipated expenses.
CAPITAL COMMITMENTS
The Board and Management of the Company have agreed to proceed with a
shareholders rights offering as soon as possible after March 31, 1995 to allow
interested shareholders to participate in purchasing stock on similar terms and
the same price as used in the March 1995 private placement. The expected rights
offering will also be so structured to allow public purchase of unexercised
rights. Funds from the proposed rights and public offering will further increase
the capital levels of the Company and provide additional direct support for the
Bank for possible future expansion. Neither the Company nor the Bank have any
immediate or specific capital expenditures that will draw on current cash
reserves.
TRENDS, EVENTS, OR UNCERTAINTIES LIKELY TO HAVE A MATERIAL IMPACT ON REVENUES OR
INCOME
The Bank and Company have carefully followed the bankruptcy proceedings for
Orange County in an attempt to understand what impact, if any, it will have on
the overall local economy and more specifically on the short-term business
activity as the individuals and business are attempting to recover from the
longest and most severe local recession in recent memory. News reports and
reports by local economic groups suggest that the impact will not be material
overall; however, some reports suggest that real estate values have seen some
additional decline because of uncertainties. Based on available information,
Management feels that there will be some repercussions from the bankruptcy for
firms and individuals who had direct dealings with the County and whose payments
have been frozen and/or cut. As of June, the Bank has only had one borrower
whose loan payments are past due because of the bankruptcy and a workout plan
has been implemented for this borrower for full repayment of principal and
interest. The decline in real estate values attributed to the bankruptcy is
still being mooted but does not appear to have sufficient impact to jeopardize
any of the Bank's collateral value. First quarter surveys of business suggest
that employment will be up in 1995, that profits and overall business will
continue to improve, and that a trend of businesses who were looking to relocate
outside of Orange County has significantly decreased. While local economic
conditions appear to be improving, a national economic slowdown or "bumpy
landing" could be exacerbated by the failure of the County to promptly and
clearly resolve its bankruptcy status. A slow or weak local economy will impede
the Bank's ability to develop the volume of loans under prudent underwriting
standards that are required to make a significant increase in net interest
income.
44
<PAGE>
CAUSES FOR MATERIAL CHANGE FROM PERIOD TO PERIOD IN MARCH 31, 1995 FINANCIAL
STATEMENTS
The first quarter $182,000 profit had three components (1) a $171,000
recovery (net of expenses) for a fidelity bond claim from a prior period loss;
(ii) a recapture of a prior year tax payment for $7,000; and (iii) a small
operating profit for the quarter. The Bank also accrued $30,000 in expenses in
March for a negotiated legal settlement; this settlement was paid in April.
The $3.6 million in new capital and cash received on March 31, 1995 provides
a material base for income in future quarters had no real financial impact for
the quarter except in increasing total deposits (the Company has maintained its
deposit accounts with the Bank including $2 million for the private placement)
and total assets as of the last day of the quarter.
Increasing interest rates allowed the Bank to increase the comparative
quarterly Net Interest Income by $73,000. Using quarter end data, which is
generally consistent with quarterly averages, the major components of earning
assets show (dollars in thousands):
<TABLE>
<CAPTION>
MARCH 1995 MARCH 1994
---------- ----------
<S> <C> <C>
Federal Funds Sold...................... 10,250 4,030
Net Loans............................... 29,383 33,914
Investments............................. 17,733 22,256
---------- ----------
Earning Assets...................... 57,366 60,200
</TABLE>
In mid-March 1994, the average prime rate was 6.0%, the Fed Funds rate was
3.25%, the yield on the investment portfolio was 4.87%. Since March 1994
interest rates were progressively increased by the Federal Reserve, and in March
1995 the average for prime rate was 9.0%, the Federal Fund rate was near 6.0%,
and the Bank's investment portfolio was yielding just over 6.0%
EXPENSE
Expenses for deposits have also been impacted by the overall increase in
interest rates for the first quarter of 1995 when compared to the same period in
1994 but at a much slower rate. Since 1993 the Bank has very carefully
maintained interest rates on deposits to retain core banking relationships
rather than to attract new depositors during a period when the Bank needed to
control its capital ratios and during a period of very slow loan demand. As the
Bank resumes its growth following the March 31, 1995 recapitalization, it
expects to see its cost of funds increase as it raises rates to attract new
deposits at a time when most banks and financial institutions are becoming far
more rate competitive for insured deposits. Banks are also competing for an
increasingly small share of the deposit pool as many investors have moved funds
to non-insured deposit products. As of June 1995, it appears that deposit
interest rate increases have stalled and the markets are now speculating when
the Federal Reserve will next lower rates.
NON-INTEREST INCOME
The net settlement for the bond claim is included in Other Income, and this
$171,000 accounts for a majority of the $189,000 increase in Non-interest
Income. During the past year, the Bank has consistently worked to increase its
normal service charge income by reducing the level of waived charges. Specific
income generated in the first quarter of 1995 from NSF checking activities
showed a marginal increase over the same period in 1994. NSF activity has been
consistent for several years with no measurable losses from this deposit
activity. The Bank continues to call each NSF customer and to work with each
customer to insure their checks are covered; in some instances the Bank will
allow a short term overdraft for customers who have other compensating balances
or who have known financial strengths.
OPERATING EXPENSES
SALARY AND BENEFITS increased for the comparative periods by $26,000;
however, this includes unequal adjustments for the cash surrender value of Bank
owned insurance policies on senior officers. Actual salary expenses were
approximately $14,000 higher in the first quarter of 1995 than the same period
in 1994 because of the addition of a new, experienced VP level loan officer at
the start of 1995 before other staffing changes were completed later in the
quarter. The increased salary expense is directly related to staffing changes
being made to improve credit administration. The Bank instituted a full salary
freeze in mid-1993
45
<PAGE>
and this freeze has been continued through the first quarter of 1995. A $55,000
comparative increase in OFFICE OPERATIONS for the first quarter of 1995 is
reflective of a $50,000 extra ordinary recovery in 1994. On a direct comparison
basis, operations expenses have been relatively flat for the two comparative
quarters. DEPRECIATION EXPENSE has declined by $9,000 for the comparative
quarters as older but functional equipment becomes fully depreciated.
PROFESSIONAL SERVICES expenses increased for the comparative quarters because of
increased costs relating to regulatory issues. OTHER expenses includes the
$30,000 accrued expense for a legal settlement that was negotiated in February
and March and paid in April 1995.
ALLOWANCE FOR LOAN LOSSES
The Bank made a major increase in its Allowance for Loan Losses in December
1994 based on a careful analysis of the existing portfolio, on a contingent
factor for the possibility of new problem assets as a result of the carryover
from the recession, and on a careful review of the Bank as part of the due
diligence process in structuring the private placement.
The Bank has taken, and is taking, specific steps to improve credit
administration and its focus on credit quality including but not limited to:
specific staffing changes to improve technical lending skills; increased
emphasis in anticipatory analysis of the adequacy of the Allowance for Loan
Losses for unknown credit problems that could arise at the end of a recession
and slow start of a recovery cycle; and investing time and expense in revising
and updating written policies and procedures.
While progress is being made in credit administration, nonperforming loans
are still higher than desired.
SUMMARY OF LOAN LOSS EXPERIENCE
Charge offs, recoveries, problem loans, and loan related data is detailed in
the following table:
<TABLE>
<CAPTION>
MARCH '95
----------
<S> <C>
Allowance for loan losses December 31, 1994................. 1,137,000
Charge offs -- commercial loans............................. 163,000
Recoveries -- real estate................................... 6,000
----------
Net charge offs............................................. 157,000
----------
OREO........................................................ 617,000
Nonaccrual Loans............................................ 454,000
Accruing loans past due 90+................................. 487,000
Allowance for Loan Losses................................... 980,000
Period-end Gross Loans...................................... 30,413,000
Average Gross Loans......................................... 30,723,000
Net charge-offs to average loans............................ .005%
</TABLE>
No provision expenses were made during the first quarter of 1995 to increase
the Allowance for Loan Losses because of (i) the large increase that was made as
of December 1994 was made in anticipation of probable losses for the first
quarter of 1995 at a time when; (ii) the Bank had a very low volume of lending
in the first quarter of 1995 and actually reduced total loan outstandings. In
the first quarter of 1995, much of Management's attention was focused on
compliance with regulatory orders which were signed in December 1994 and on
completion of the private placement.
The Bank's one OREO property has been written down to 90% of the lower of
the appraised value or expected market value. The property is located in an
exclusive residential area that was especially hard hit by the large drop in
million dollar residences in California over the past few years. The Bank has
had several offers on this property and, as of June 15 1995, was in process of
opening an escrow to a qualified buyer. The Bank does not anticipate any loss on
the sale of this property other than writedowns that were made in 1994.
Nonaccrual loans and loans past due 90 + days are generally collateralized
and/or in the process of collection. As of May 1995, the Bank expects possible
charge offs from known problem loans of approximately $350,000 if it is not
successful in structuring workout plans with certain borrowers by the end of the
second quarter. Charge off and recovery activity for the balance of the year are
expected to be immaterial for
46
<PAGE>
the balance of the year unless new, unknown problems are discovered. In
reviewing the current portfolio, Management has considered (i) the level of
historic losses; (ii) the substantial shrinkage of the loan portfolio and the
lack of significant new loan activity in the past two years; (iii) the value of
collateral supporting the loans; (iv) known or suspected problems with
borrowers; and (v) the impact that changes in staff and credit administration is
having on both the management of the current portfolio and new loans. Should the
Bank charge off all of the possible $350,000 the Allowance for Loan Losses would
total approximately $640,000 or 2.3% of projected total loans as of the end of
the quarter.
BUSINESS
GENERAL
The Company was organized and incorporated under the laws of the State of
California on May 20, 1983 at the direction of the Board of Directors of Monarch
Bank (the "Bank") and for the purpose of becoming a bank holding company by
acquiring all of the outstanding capital stock of the Bank. The reorganization
of the Bank and the Company was effected on June 18, 1984. The Company's
principal business is to serve as a holding company for its banking subsidiary
and other possible banking or banking-related subsidiaries which the Company or
the Bank may form or acquire. Since inception, the Company has not been active
except through its subsidiaries. The Company has no salaried employees, and
shares both executive management and its Board of Directors with its banking
subsidiary, the Bank.
MONARCH BANK
The Bank was incorporated under the laws of the State of California on
October 3, 1979 and was licensed by the California Superintendent of Banks (the
"Superintendent") and commenced operations as a California state-chartered bank
on April 21, 1980. The Bank is an insured bank under the Federal Deposit
Insurance Act up to the applicable limits thereof, but like many state-chartered
banks of its size in California, it is not a member of the Federal Reserve
System. The Bank is subject to regulation, supervision, and regular examination
by the Superintendent and the FDIC, and is subject to applicable provisions of
the Federal Reserve Act and regulations issued pursuant thereto. The regulations
of these various agencies govern most aspects of the Bank's business, including
required reserves on deposits, investments, loans, certain of their check
clearing activities, issuance of securities, payment of dividends, opening of
branches, and numerous other areas. As a consequence of the extensive regulation
of commercial banking activities in the United States, the Bank's business is
particularly susceptible to changes in California and the Federal legislation
and regulations which may have the effect of increasing the cost of doing
business, limiting permissible activities, or increasing competition.
The Bank conducts a general banking business including the acceptance of
checking and savings deposits and the making of commercial, real estate,
installment and other term loans. The Bank is located at 30000 Town Center
Drive, Laguna Niguel, California. The Bank issues Master Card credit cards
through a correspondent bank. The Bank is a merchant depository for cardholder
drafts under Visa and Master Card credit cards and, similar to other
state-chartered banks of its size, can provide investment and international
banking services through its major correspondent banks. The Bank is not a member
of the Federal Reserve System.
The Bank's primary market area is South Orange County, California. The
principal business of the Bank is to accept time and demand deposits, and to
make commercial loans, consumer loans, real estate loans, and other investments.
The Bank offers a broad range of banking products and services, including many
types of business and personal savings and checking accounts and other consumer
banking services. The Bank originates several types of loans, including secured
and unsecured commercial and consumer loans, commercial and residential real
estate mortgage loans, and commercial and residential construction loans. The
Bank's loans are primarily short-term and/or adjustable rate. Special services
or requests beyond the limits of the Bank are arranged through correspondent
banks. The Bank currently offers access to ATM networks, and investment or
international services through other major banks.
Since 1987, the Bank's Strategic Plan has emphasized serving the banking
needs of individuals, professionals, and small to medium-sized businesses in
Laguna Niguel, California and the contiguous communities
47
<PAGE>
which adjoin it. The Bank has carved a local niche by being active in civic and
community activities and providing a high degree of individualized personal
service. The Bank was the first in the local area to be open for Saturday
business and maintains operating hours from 7:00 a.m. to 7:00 p.m. in an effort
to serve its largely commuter customer base as well as its mall business
customers. In addition, it has a chartered courier branch which operates
throughout mid- and southern-Orange County, serving professionals and small
businesses, which has greatly expanded its service area without the need for
additional physical facilities. Under present management since 1987, the Bank's
major lending emphasis has been directed at short term owner-occupied luxury
home construction projects, commercial lending to professionals and individuals,
with the objective of building a balanced community loan and investment
portfolio mix (although real estate loans, and other loans secured by real
estate, have dominated the portfolio in the past). The Bank relies on a
foundation of locally generated deposits and Management believes it has a
relatively low cost of funds due to a high percentage of low cost and
noninterest bearing deposits. The Bank also originates SBA loans, has a mortgage
referral program and operates its own credit card program on a small scale. Due
to consolidations, mergers, and a reduced number of independent banks
headquartered in South Orange County, the Bank believes that, when it has
sufficient capital resources, it will be well positioned to prudently expand and
seek to build a larger, regional independent financial institution in the
affluent South Orange County market.
Since its inception, it has been the Bank's policy to develop specialized
markets which Management believes have the potential for generating high return
on assets. In selecting divisions to penetrate these markets, the Bank has given
preference to those markets which it believed to be able to obtain independent
sources of funding, such as the packaging and selling of loans or the sale of
loan participations.
In January 1990, the Bank received a license from the State of California to
sell disability and life insurance. Recent changes in federal legislation limit
state chartered bank activities in selling insurance without a special waiver
from the FDIC. The Bank has no plans to request such a waiver or to engage in
direct sales of insurance that would be otherwise authorized under the state
license. The Bank received approval in 1991 from the State Banking Department to
engage in certain equity ownership in real estate projects. The FDIC on December
9, 1992 approved rules that restrict this kind of real estate investment by
state banks. The Bank has not made, and under the new rules, does not currently
anticipate making any direct equity investments in real estate projects.
In 1992 the Bank entered into the SBA lending market on a limited basis.
Outside sources are used to assist in the documentation, and loans are generally
expected to be held in the Bank's portfolio rather than sold. SBA loans will
help meet the business loan needs of the community as well as offer an
additional source of diversification for the loan portfolio.
The Bank provides item processing services to another local bank under a
three-year contract that was signed in 1992; however, this contract matured in
March 1995 and has not been renewed. Planned staff reductions and other direct
reductions in expenses are expected to approximately offset this loss in
revenue. A "new" service was introduced in 1993 to allow the Bank to process
electronic fund transfers for certain of its customers. This represents a new
technical service for many of the Bank's customers and a new source of fee
income for the Bank. The Bank has limited this service to existing customers as
an additional component of relationship banking.
As part of its package of products, the Bank introduced its own Monarch Bank
Credit Card (Visa) in 1993. The Bank's intent was to use this card to complement
its relationship banking concept; the Bank does not intend to mass market the
card and has established high credit qualifications for the card. As of December
31, 1994, the Bank had approximately $100,000 in outstanding balances from
credit card activity.
As part of its efforts to achieve long term stable profitability and respond
to a changing economic environment in Southern California and South Orange
County, the Company and the Bank have augmented its traditional focus by
broadening the credit and customer services provided to individuals,
professionals and small and medium size businesses. The Company and the Bank
believe that additional capital will permit an acceleration of this effort,
leading to greater diversification of both the Bank's loan portfolio and deposit
base and new sources of fee income. Areas of current and intended future
diversification include expanded
48
<PAGE>
days and hours of operation, mortgage, brokerage, annuity and mutual funds
products, as well as the acquisition of other financial institutions or branches
of other financial institutions, in cities and areas adjoining its Laguna Niguel
headquarters.
The Company believes (but cannot assure) that the franchise value of the
Bank, in part due to the shrinking number of independent banks in South Orange
County, can be greatly enhanced by expansion into the affluent markets of Laguna
Beach, Laguna Hills, Leisure World (the largest retirement community in the
United States), Lake Forest, Mission Viejo, Dana Point, San Juan Capistrano and
San Clemente. These communities are among communities with the highest per
capita incomes in California, most of which do not presently have a locally
headquartered independent community bank. Very few bank charters are presently
being granted, and the capitalization requirements for such charters are
substantially higher than in the past; therefore, it is Management's belief that
a well run community bank which concentrates its expansion in such an affluent
coastal area of Southern California can, over a five to ten year period,
substantially improve its franchise value, as well as its assets size and income
levels. See "Risk Factors" and "Use of Proceeds." However, no assurances can be
given that the Company will experience an improvement in its franchise value or
achieve any of the goals referred to herein.
It is the Company's belief that substantial opportunity exists within the
Bank's South Orange County market area to prudently expand the operations of the
Bank into the remainder of that metropolitan area. Banks in San Clemente, Laguna
Beach and Lake Forest have been acquired by other larger financial institutions,
leaving a void, the Company believes, in contiguous communities with populations
of 25,000 to 75,000, which have no locally headquartered community bank. In
addition, the severe problems associated with the savings and loan industry and
the problems being experienced by other independent banks within Orange County,
with operations in South Orange County, have resulted in a number of branch
facilities being made available for sale. The Company also believes that one or
more small institutions may be available at attractive prices and that branches
of other financial institutions may be available at substantially below their
investment cost. Although the Company has had preliminary discussions with a
number of financial institutions regarding possible acquisitions, and the
Company is having ongoing discussions with Rancho Santa Fe National Bank, no
agreements or understandings have been reached at this time. The Company has
been contacted by other financial institutions with regard to their interest in
selling various branches of their companies. Except as otherwise stated, no
negotiations are ongoing with respect to such transactions, and the Company
cannot predict whether assets or banks can definitely be acquired on terms
acceptable to the Company. Acquisitions of this nature can take from 60 to 90
days or longer for the approval and purchase of assets and branches, and 6 to 12
months or longer for the negotiation, approval and purchase of an entire
financial institution. While the Bank is under no restrictions relative to
acquisitions with regard to the Orders, regulatory approval can be expected to
be difficult to obtain during the life of the Orders. No assurance can be given
that the Company can successfully negotiate the acquisition of other
institutions or branches at prices that would be acceptable to it, or that any
such acquisition would receive the requisite regulatory and shareholder (if
applicable) approvals.
MONARCH BANCORP
Upon the reorganization of the Bank as a wholly-owned subsidiary, the
Company became a bank holding company within the meaning of the Bank Holding
Company Act of 1956, as amended (the "Act"), and is subject to the supervision
and regulation of the Board of Governors of the Federal Reserve System (the
"Board"). The Company functions primarily as the sole stockholder of the Bank
and its nonbank subsidiary, and the Company establishes general policies and
activities of the operating subsidiaries.
The capital stock of the Company is subject to the registration requirements
of the Securities Act of 1933. The common stock of the Bank is exempt from such
requirements. The Company is also subject to the periodic reporting requirements
of the Securities Exchange Act of 1934, which include, but are not limited to,
the filing of annual, quarterly and other reports with the Securities and
Exchange Commission.
The Company, as a bank holding company, is subject to regulation under the
Bank Holding Company Act of 1956, as amended, and is registered with and subject
to the supervision of the Federal Reserve Board. The Company is required to
obtain the prior approval of the Federal Reserve Board before it may acquire all
49
<PAGE>
or substantially all of the assets of any bank, or ownership or control of
voting shares of any bank if, after giving effect to such acquisition, the
Company would own or control, directly or indirectly more than 5% of such bank.
The Bank Holding Company Act prohibits the Company from acquiring any voting
shares of, interest in, or all or substantially all of the assets of a bank
located outside the State of California unless the laws of such state
specifically authorize such acquisition.
Under the Bank Holding Company Act, the Company may not engage in any
business other than managing or controlling banks or furnishing services to its
subsidiaries, except that it may engage controlling banks as to be a proper
incident thereto. The Company is also prohibited, with certain exceptions, from
acquiring direct or indirect ownership or control of more than 5% of the voting
shares of any company unless the company is engaged in such activities. The
Federal Reserve Board's approval must be obtained before the shares of any such
company can be acquired and, in certain cases, before any approved company can
open new offices. In making such determinations the Federal Reserve Board
considers whether the performance of such activities by a bank holding company
would offer advantages to the public, such as greater convenience, increased
competition, or gains in efficiency, which outweigh possible adverse effects,
such as undue concentration of resources, decreased or unfair competition,
conflicts of interest, or unsound banking practices. Further, the Federal
Reserve Board is empowered to differentiate between activities commenced de novo
and activities commenced by acquisition, in whole or in part, of a going
concern.
Although the fullest scope of permitted activities is uncertain and cannot
be predicted, the major non-banking activities that have been permitted to bank
holding companies with certain limitations are: making, acquiring or servicing
loans that would be made by a mortgage, finance, credit card or factoring
company; operating an industrial loan company; leasing real and personal
property; acting as an insurance agent, broker, or principal with respect to
insurance that is directly related to the extension of credit by the bank
holding company or any of its subsidiaries and limited to repayment of the
credit in the event of death, disability or involuntary unemployment; issuing
and selling money orders, savings bonds and travelers checks; performing certain
trust company services; performing appraisals of real estate and personal
property; providing investment and financial advice; providing data processing
services; providing courier services; providing management consulting advice to
nonaffiliated depository institutions; arranging commercial real estate equity
financing; providing certain securities brokerage services; underwriting and
dealing in government obligations and money market instruments; providing
foreign exchange advisory and transactional services; acting as a futures
commission merchant; providing investment advice on financial futures and
options on futures; providing consumer financial counseling; providing tax
planning and preparation services; providing check guaranty services; engaging
in collection agency activities; and operating a credit bureau.
The Company's primary sources of income are the receipt of dividends and
management fees from its subsidiaries, and interest income on its investments.
The Bank's ability to make such payments to the Company is subject to certain
statutory and regulatory restrictions.
The Company and its subsidiaries are prohibited from engaging in certain
tie-in arrangements in connection with any extension of credit, sale or lease of
property or furnishing of services. For example, with certain exceptions the
Bank may not condition an extension of credit on a customer's obtaining other
services provided by it, the Company or any other subsidiary or on a promise by
the customer not to obtain other services from a competitor.
As a bank holding company, the Company is required to file reports with the
Federal Reserve Board and to provide such additional information as the Federal
Reserve Board may require. The Federal Reserve Board also has the authority to
examine the Company and each of its subsidiaries with the cost thereof to be
borne by the Company.
In addition, banking subsidiaries of bank holding companies are subject to
certain restrictions imposed by federal law in dealings with their holding
companies and other affiliates. Subject to certain exceptions set forth in the
Federal Reserve Act, a bank can loan or extend credit to an affiliate, purchase
or invest in the securities of an affiliate, purchase assets from an affiliate,
accept securities of an affiliate as collateral security for a loan or extension
of credit to any person or company or issue a guarantee, acceptance or letter of
credit
50
<PAGE>
on behalf of an affiliate only if the aggregate amount of the above transactions
of the Bank and its subsidiaries does not exceed 10% of the Bank's capital stock
and surplus on a per affiliate basis or 20% of the Bank's capital stock and
surplus on an aggregate affiliate basis. Such transaction must be on terms and
conditions that are consistent with safe and sound banking practices. A bank and
its subsidiaries generally may not purchase a low-quality asset, as that term is
defined in the Federal Reserve Act, from an affiliate. Such restrictions also
prevent a holding company and its other affiliates from borrowing from a banking
subsidiary of the holding company unless the loans are secured by collateral.
The BHC Act also prohibits a bank holding company or any of its subsidiaries
from acquiring voting shares or substantially all the assets of any bank located
in a state other than the state in which the operations of the bank holding
company's banking subsidiaries are principally conducted unless such acquisition
is expressly authorized by statutes of the state in which the bank to be
acquired is located. Legislation recently adopted in California permits
out-of-state bank holding companies to acquire California banks on a regional
basis as of July 1, 1987, and on a nationwide reciprocal basis as of January 1,
1991. See "Effect of Governmental Policies and Recent Legislation" later in this
section regarding the Interstate Banking Act signed into law on September 29,
1994.
The BHC Act and regulations of the Federal Reserve Board also impose certain
constraints on the redemption or purchase by a bank holding company of its own
shares of stock.
The Federal Reserve Board has cease and desist powers to cover parent bank
holding companies and nonbanking subsidiaries where action of a parent bank
holding company or its non-financial institutions represents an unsafe or
unsound practice or violation of law. The Federal Reserve Board has the
authority to regulate debt obligations (other than commercial paper) issued by
bank holding companies by imposing interest ceilings and reserve requirements on
such debt obligations.
EFFECT OF GOVERNMENTAL POLICIES AND RECENT LEGISLATION
Banking is a business that depends on rate differentials. In general, the
difference between the interest rate paid by the Bank on its deposits and its
other borrowings and the interest rate received by the Bank on loans extended to
its customers and securities held in the Bank's portfolio comprise the major
portion of the Bank's earnings. These rates are highly sensitive to many factors
that are beyond the control of the Bank. Accordingly the earnings and growth of
the Bank are subject to the influence of local, domestic and foreign economic
conditions, including recession, unemployment and inflation.
The commercial banking business is not only affected by general economic
conditions but is also influenced by the monetary and fiscal policies of the
federal government and the policies of regulatory agencies, particularly the
Federal Reserve Board. The Federal Reserve Board implements national monetary
policies (with objectives such as curbing inflation and combating recession) by
its open-market operations in United States Government securities, by adjusting
the required level of reserves for financial intermediaries subject to its
reserve requirements and by varying the discount rates applicable to borrowings
by depository institutions. The actions of the Federal Reserve Board in these
areas influence the growth of bank loans, investments and deposits and also
affect interest rates charged on loans and paid on deposits. The nature and
impact of any future changes in monetary policies cannot be predicted.
From time to time, legislation is enacted which has the effect of increasing
the cost of doing business, limiting or expanding permissible activities or
affecting the competitive balance between banks and other financial
intermediaries. Proposals to change the laws and regulations governing the
operations and taxation of banks, bank holding companies and other financial
intermediaries are frequently made in Congress, in the California legislature
and before various bank regulatory and other professional agencies. The
likelihood of any major changes and the impact such changes might have on the
Bank are impossible to predict. Certain of the potentially significant changes
which have been enacted and proposals which have been made recently are
discussed below.
51
<PAGE>
FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991
On December 19, 1991, the FDIC Improvement Act was enacted into law. Set
forth below is a brief discussion of certain portions of this law and
implementing regulations that have been adopted or proposed by the Federal
Reserve Board, the Comptroller of the Currency ("Comptroller"), the Office of
Thrift Supervision ("OTS") and the FDIC (collectively, the "federal banking
agencies").
STANDARDS FOR SAFETY AND SOUNDNESS. The FDIC Improvement Act requires the
federal banking agencies to prescribe, by regulation, standards for all insured
depository institutions and depository institution holding companies relating to
internal controls, loan documentation, credit underwriting, interest rate
exposure and asset growth. Standards must also be prescribed for classified
loans, earnings and the ratio of market value to book value for publicly traded
shares. The FDIC Improvement Act also requires the federal banking agencies to
issue uniform regulations prescribing standards for real estate lending that are
to consider such factors as the risk to the deposit insurance fund, the need for
safe and sound operation of insured depository institutions and the availability
of credit. Further, the FDIC Improvement Act requires the federal banking
agencies to establish standards prohibiting compensation, fees and benefit
arrangements that are excessive or could lead to financial loss.
In July 1992, the federal banking agencies issued a joint advance notice of
proposed rule making requesting public comment on the safety and soundness
standards required to be prescribed by the FDIC Improvement Act. The purpose of
the notice is to assist the federal banking agencies in the development of
proposed regulations. In accordance with the FDIC Improvement Act, final
regulations must become effective no later than December 1, 1993.
In December 1992, the federal banking agencies issued final regulations
prescribing uniform guidelines for real estate lending. The regulations, which
are effective March 19, 1993, require insured depository institutions to adopt
written policies establishing standards, consistent with such guidelines, for
extensions of credit secured by real estate. The policies must address loan
portfolio management, underwriting standards and loan-to-value limits that do
not exceed the supervisory limits prescribed by the regulations.
PROMPT CORRECTIVE REGULATORY ACTION. The FDIC Improvement Act requires each
federal banking agency to take prompt corrective action to resolve the problems
of insured depository institutions that fall below one or more prescribed
minimum capital ratios. The purpose of this law is to resolve the problems of
insured depository institutions at the least possible long-term cost to the
appropriate deposit insurance fund.
The law required each federal banking agency to promulgate regulations
defining the following five categories in which an insured depository
institution will be placed, based on the level of its capital ratios: well
capitalized (significantly exceeding the required minimum capital requirements),
adequately capitalized (meeting the required capital requirements),
undercapitalized (failing to meet any one of the capital requirements),
significantly undercapitalized (significantly below any one capital requirement)
and critically undercapitalized (failing to meet all capital requirements).
In September 1992, the federal banking agencies issued uniform final
regulations implementing the prompt corrective action provisions of the FDIC
Improvement Act. Under the regulations, an insured depository institution will
be deemed to be:
- "well capitalized" if it (i) has total risk-based capital of
10% or greater, Tier 1 risk-based capital of 6% or greater and
a leverage capital ratio of 5% or greater and (ii) is not
subject to an order, written agreement, capital directive or
prompt corrective action directive to meet and maintain a
specific capital level for any capital measure;
- "adequately capitalized" if it has total risk-based capital of
8% or greater, Tier 1 risk-based capital of 4% or greater and a
leverage capital ratio of 4% or greater (or a leverage capital
ratio of 3% or greater if the institution is rated composite 1
under the applicable regulatory rating system in its most
recent report of examination);
52
<PAGE>
- "undercapitalized" if it has total risk-based capital that is
less than 8%, Tier 1 risk-based capital that is less than 4% or
a leverage capital ratio that is less than 4% (or a leverage
capital ratio that is less than 3% if the institution is rated
composite 1 under the applicable regulatory rating system in
its most recent report of examination);
- "significantly undercapitalized" if it has total risk-based
capital that is less than 6%, Tier 1 risk-based capital that is
less than 3% or a leverage capital ratio that is less than 3%;
and
- "critically undercapitalized" if it has a ratio of tangible
equity to total assets that is equal to or less than 2%.
An institution that, based upon its capital levels, is classified as well
capitalized, adequately capitalized or undercapitalized may be reclassified to
the next lower capital category if the appropriate federal banking agency, after
notice and opportunity for hearing, (i) determines that the institution is in an
unsafe or unsound condition or (ii) deems the institution to be engaging in an
unsafe or unsound practice and not to have corrected the deficiency. At each
successive lower capital category, an insured depository institution is subject
to more restrictions and federal banking agencies are given less flexibility in
deciding how to deal with it.
As of March 31, 1995, the Bank had a total risk-based capital ratio of
17.34%, a Tier 1 risk-based capital ratio of 16.09% and a leverage capital ratio
of 7.85% and is considered to be adequately capitalized. Based solely upon these
ratios and the existence of the Section 8(b) Order, the Bank is considered to be
adequately capitalized as of March 31, 1995 under the prompt corrective action
provisions of the FDIC Improvement Act. A subsequent reduction in the Bank's
capital could cause it to fall within a lower capital category and subject it to
the mandatory and discretionary sanctions applicable to that category. Further,
as noted above, an institution that, based upon its capital levels, is
adequately capitalized or undercapitalized can, under certain circumstances, be
reclassified to the next lower capital category.
OTHER ITEMS. The FDIC Improvement Act also, among other things, (i) limits
the interest paid on deposits deemed to be brokered, and limits the unrestricted
use of such deposits to only those institutions that are well capitalized; (ii)
requires the FDIC to charge insurance premiums based on the risk profile of each
institution; (iii) eliminates "pass through" deposit insurance for certain
employee benefit accounts unless the depository institution is well capitalized
or, under certain circumstances, adequately capitalized; (iv) prohibits insured
state chartered banks from engaging as principal in any type of activity that is
not permissible for a national bank unless the FDIC permits such activity and
the bank meets all of its regulatory capital requirements; (v) directs the
appropriate federal banking agency to determine the amount of readily marketable
purchased mortgage servicing rights that may be included in calculating such
institution's tangible, core and risk-based capital; and (vi) provides that,
subject to certain limitations, any federal savings association may acquire or
be acquired by any insured depository institution.
The FDIC has regulations implementing the risk-based premium system mandated
by the FDIC Improvement Act. Under the regulations insured depository
institutions are now required to pay insurance premiums within a range of 23
cents per $100 of deposits to 31 cents per $100 of deposits depending on their
risk classification. To determine the risk-based assessment for each
institution, the FDIC will categorize an institution as well capitalized,
adequately capitalized or undercapitalized based on its capital ratios. A well
capitalized institution is one that has at least a 10% total risk-based capital
ratio, a 6% Tier 1 risk-based capital ratio and a 5% Tier 1 leverage capital
ratio. An adequately capitalized institution will have at least an 8% total
risk-based capital ratio, a 4% Tier 1 risk-based capital ratio and a 4% Tier 1
leverage capital ratio. An undercapitalized institution will be one that does
not meet either of the above definitions. The FDIC will also assign each
institution to one of the three subgroups based upon reviews by the
institution's primary
53
<PAGE>
federal or state regulatory, statistical analyses of financial statements and
other information relevant to evaluating the risk posed by the institution. As a
result, the assessment rates within each of three capital categories will be as
follows (expressed as cents per $100 of deposits):
<TABLE>
<CAPTION>
SUPERVISORY
SUBGROUP
----------
A B C
-- -- --
<S> <C>
Well capitalized........................ 23 26 29
Adequately capitalized.................. 26 29 30
Undercapitalized........................ 29 30 31
</TABLE>
The FDIC has recently announced a proposal to lower banks' deposit insurance
premiums. The plan would reduce assessments from their current rates of 23 to 31
cents, or basis points, per every hundred dollars in insured deposits, to a rate
of 4 to 31 basis points, depending upon the condition of the bank. The FDIC
estimates that up to 90% of all banks will have substantial reductions in their
premiums, bringing the average Bank Insurance Fund premium to 4.5 cents, a
reduction from the current 23 cents. The new rates will not go into effect until
the FDIC can verify that the Bank Insurance Fund has reached the 1.25%
recapitalization level. Under the proposal, banks that are not well capitalized
and considered to be in sound condition may face a greater competitive
disadvantage than in the past due to larger differences in deposit insurance
assessments.
In addition, the FDIC has issued final and proposed regulations implementing
provisions of the FDIC Improvement Act relating to powers of insured state
banks. Final regulations issued in October 1992 prohibit insured state banks
from making equity investments of a type, or in an amount, that are not
permissible for national banks. In general, equity investments include equity
securities, partnership interests and equity interests in real estate. Under the
final regulations, non-permissible investments must be divested by no later than
December 19, 1996. The Bank has no such non-permissible investments.
Regulations issued in December 1993 prohibit insured state banks from
engaging as principal in any activity not permissible for a national bank,
without FDIC approval. The proposal also provides that subsidiaries of insured
state banks may not engage as principal in any activity that is not permissible
for a subsidiary of a national bank, without FDIC approval.
The impact of the FDIC Improvement Act on the Bank is uncertain, especially
since many of the regulations promulgated thereunder have only been recently
adopted and certain of the law's provisions still need to be defined through
future regulatory action. Certain provisions, such as the recently adopted real
estate lending standards and the limitations on investments and powers of state
banks and the rules to be adopted governing compensation, fees and other
operating policies, may affect the way in which the Bank conducts its business,
and other provisions, such as those relating to the establishment of the
risk-based premium system, may adversely affect the Bank's results of
operations. Furthermore, the actual and potential restrictions and sanctions
that apply to or may be imposed on undercapitalized institutions under the
prompt corrective action and other provisions of the FDIC Improvement Act may
significantly adversely affect the operations and liquidity of the Bank, the
value of its Common Stock and its ability to raise funds in the financial
markets.
CAPITAL ADEQUACY GUIDELINES
The Federal Reserve Board and the FDIC have issued guidelines to implement
the risk-based capital requirements. The guidelines are intended to establish a
systematic analytical framework that makes regulatory capital requirements more
sensitive to differences in risk profiles among banking organizations, takes
off-balance sheet items into account in assessing capital adequacy and minimizes
disincentives to holding liquid, low-risk assets. Under these guidelines, assets
and credit equivalent amounts of off-balance sheet items, such as letters of
credit and outstanding loan commitments, are assigned to one of several risk
categories, which range from 0% for risk-free assets, such as cash and certain
U.S. Government securities, to 100% for relatively high-risk assets, such as
loans and investments in fixed assets, premises and other real
54
<PAGE>
estate owned. The aggregated dollar amount of each category is then multiplied
by the risk-weight associated with that category. The resulting weighted values
from each of the risk categories are then added together to determine the total
risk-weighted assets.
A banking organization's qualifying total capital consists of two
components: Tier 1 capital (core capital) and Tier 2 capital (supplementary
capital). Tier 1 capital consists primarily of common stock, related surplus and
retained earnings, qualifying noncumulative perpetual preferred stock and
minority interests in the equity accounts of consolidated subsidiaries.
Intangibles, such as goodwill, are generally deducted from Tier 1 capital;
however, purchased mortgage servicing rights and purchase credit card
relationships may be included, subject to certain limitations. At least 50% of
the banking organization's total regulatory capital must consist of Tier 1
capital.
Tier 2 capital may consist of (i) the allowance for possible loan and lease
losses in an amount up to 1.25% of risk-weighted assets; (ii) cumulative
perpetual preferred stock and long-term preferred stock and related surplus;
(iii) hybrid capital instruments (instruments with characteristics of both debt
and equity), perpetual debt and mandatory convertible debt securities; and (iv)
eligible term subordinated debt and intermediate-term preferred stock with an
original maturity of five years or more, including related surplus, in an amount
up to 50% of Tier 1 capital. The inclusion of the foregoing elements of Tier 2
capital are subject to certain requirements and limitations of the federal
banking agencies.
The Federal Reserve Board and the FDIC have also adopted a minimum leverage
capital ratio of Tier 1 capital to average total assets of 3% for the highest
rated banks. This leverage capital ratio is only a minimum. Institutions
experiencing or anticipating significant growth or those with other than minimum
risk profiles are expected to maintain capital well above the minimum level.
Furthermore, higher leverage capital ratios are required to be considered well
capitalized or adequately capitalized under the prompt corrective action
provisions of the FDIC Improvement Act.
As of March 31, 1995, the Company and the Bank had total risk-based capital
ratios of 23.12% and 17.34%, Tier 1 risk-based capital ratios of 21.87% and
16.09% and leverage ratios of 10.67% and 7.85%, respectively.
CHANGES IN ACCOUNTING PRINCIPLES
In February 1992, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 109 "Accounting for Income Taxes," which supersedes SFAS No. 96 of the
same title. SFAS No. 109 is effective for fiscal years beginning after December
31, 1992, or earlier at the Bank's option. SFAS No. 109 employs an asset and
liability approach in accounting for income taxes payable or refundable at the
date of the financial statements as a result of all events that have been
recognized in the financial statements and as measured by the provisions of
enacted tax laws. Adoption by the Bank of SFAS No. 109 is not expected to have a
material impact on the Bank's financial statements.
In addition, in December 1991, the FASB issued SFAS No. 107, "Disclosures
about Fair Value of Financial Instruments," which is effective for fiscal years
ending after December 15, 1992 (December 15, 1995 in the case of entities with
less than $150 million in total assets). SFAS No. 107 requires financial
intermediaries to disclose, either in the body of their financial statements or
in the accompanying notes, the "fair value" of financial instruments for which
it is "practicable to estimate that value." SFAS No. 107 defines "fair value" as
the amount at which a financial instrument could be exchanged in a current
transaction between willing parties, other than in a forced or liquidation sale.
Quoted market prices, if available, are deemed the best evidence of the fair
value of such instruments. Most deposit and loan instruments issued by financial
intermediaries are subject to SFAS No. 107 and its effect will be to require
financial statement disclosure of the fair value of most of the assets and
liabilities of financial intermediaries such as the Bank. Management is unable
to predict what effect, if any, such disclosure requirements could have on the
market price of the common stock of the Bank or its ability to raise funds in
the financial markets.
In May 1993, the FASB issued Statement of Financial Standards No. 114,
"Accounting by Creditors for Impairment of a Loan" ("SFAS No. 114"), as amended
by SFAS 118. Under the provisions of SFAS No. 114, a loan is considered impaired
when, based on current information and events, it is probable that a creditor
55
<PAGE>
will be unable to collect all amounts due according to the contractual terms of
the loan agreement. SFAS No. 114 requires creditors to measure impairment of a
loan based on the present value of expected future cash flows discounted at the
loan's effective interest rate. If the measure of the impaired loan is less than
the recorded investment in the loan, a creditor shall recognize an impairment by
creating a valuation allowance with a corresponding charge to bad debt expense.
This statement also applies to restructured loans and changes the definition of
in-substance foreclosures to apply only to loans where the creditor has taken
physical possession of the borrower's assets. SFAS No. 114 applies to financial
statements for fiscal years beginning after December 15, 1994. Earlier
implementation is permitted. The Company is currently evaluating the impact of
the statement on its results of operations and financial position but does not
expect the statement will have a material impact on operation or the Company's
financial position.
In June, 1993, the FASB issued a new Financial Accounting Series Statement
addressing the accounting and reporting for investments in equity securities
that have readily determinable fair values and for all investments in debt
securities. Those investments would be classified in three categories and
accounted for as follows: (i) debt securities that the entity has the positive
intent and ability to hold to maturity would be classified as "held to maturity"
and reported at amortized cost; (ii) debt and equity securities that are held
for current resale would be classified as trading securities and reported at
fair value, with unrealized gains and losses included in earnings; and (iii)
debt and equity securities not classified as either securities held to maturity
or trading securities would be classified as securities available for sale, and
reported at fair value, with unrealized gains and losses excluded from earnings
and reported as a separate component of shareholders' equity. The rule is
effective for financial statements for calendar year 1994, but may be applied to
an earlier fiscal year for which annual financial statements have not been
issued.
The Bank has both investment securities classified as "held to maturity" and
investment securities classified as "available for sale." Securities classified
as available for sale are reported at their fair value at the end of each fiscal
quarter. Accordingly, the value of such securities fluctuates based on changes
in interest rates. Generally, an increase in interest rates will result in a
decline in the value of investment securities available for sale, while a
decline in interest rates will result in an increase in the value of such
securities. Therefore, the value of investment securities available for sale and
the Bank's shareholders' equity is subject to fluctuation based on changes in
interest rates. As a consequence, the Bank's capital levels for regulatory
purposes could change based solely on fluctuations in interest rates and
fluctuations in the value of investment securities held for sale.
INTERSTATE BANKING ACT
On September 29, 1994, the President signed the Riegle-Neal Interstate
Banking and Branching Efficiency Act of 1994 (the "Interstate Banking Act"). The
Interstate Banking Act establishes full, nationwide interstate banking and
branching. Among other things, the Interstate Banking Act permits eligible bank
holding companies to acquire banks located in any state, beginning September 29,
1995; allows a bank to merge with a bank in another state, beginning June 1,
1997, provided neither state takes legislative action before May 31, 1997 to
"opt-out" (i.e., prohibit interstate mergers); prohibits an interstate merger,
other than one involving affiliated banks or initial entry into a state, if the
resulting holding company or bank would control more than 10 percent of the
deposits held by insured depository institutions nationwide or 30 percent of the
deposits held by depository institutions in any state affected by the merger;
permits states to prohibit interstate acquisitions of banks under five years of
age; permits a bank to establish de novo branches in any state in which the bank
does not maintain a branch only if the state adopts a law that expressly permits
all out-of-state banks to establish de novo branches in such state (the state
"opt-in" election); subjects national bank branches to certain state laws
regarding community reinvestment, consumer protection, fair lending and the
establishment of intrastate branches; allows foreign banks to establish
branches, either de novo or by acquisition and merger, in any state outside the
state in which the bank has its U.S. headquarters to the same extent that a
domestic bank may establish such branches; permits the Comptroller of the
Currency to continue to preempt the application of state laws to national bank
branches, but creates a new "notice and opportunity to comment" procedure when
the OCC is considering certain preemptions of state
56
<PAGE>
law; and neither grants nor limits the authority of states to tax interstate
operations as permitted under the U.S. Constitution or other federal law. The
Company cannot predict the impact the Interstate Banking Act will have on the
banking industry or the business and value of the Company.
HAZARDOUS WASTE CLEAN-UP COSTS
Management is aware of recent legislation and court actions concerning
lender liability relating to hazardous waste clean-up costs and continued
liability. Based on a general survey of the Bank's loan portfolio, conversations
with local authorities and appraisers, and the type of lending currently and
historically done by the Bank (the Bank as a rule has not made the types of
loans generally associated with hazardous waste contamination problems)
management is not aware of any potential liability for hazardous waste
contamination.
OTHER REGULATIONS AND POLICIES
The federal regulatory agencies have adopted regulations that implement
Section 304 of FDICIA which requires federal banking agencies to adopt uniform
regulations prescribing standards for real estate lending. Each insured
depository institution must adopt and maintain a comprehensive written real
estate lending policy, developed in conformance with prescribed guidelines, and
each agency has specified loan-to-value limits in guidelines concerning various
categories of real estate loans.
Various requirements and restrictions under the laws of the United States
and the State of California affect the operations of the Bank. Federal
regulations include requirements to maintain non-interest bearing reserves
against deposits, limitations on the nature and amount of loans which may be
made, and restrictions on payment of dividends. The California Superintendent of
Banks regulates the number and locations of the branch offices of bank.
California law exempts banks from the usury laws.
Under the Financial Institutions Supervisory Act, the Federal Reserve Board
also has authority to prohibit a bank from engaging in business practices which
it considers to be unsafe or unsound. It is possible, depending upon the
financial condition of the bank in question and other factors, that the Federal
Reserve Board could assert that the payment of dividends or other payments might
under some circumstances be such an unsafe or unsound practice.
Future cash dividends by the Bank to the Company will generally depend upon
the assessment of their respective Boards of Directors of the future capital
requirements of such institutions and other factors.
MONETARY POLICY
The earnings and growth of the Bank will be affected not only by general
economic conditions, both domestic and international, but also by the monetary
and fiscal policies of the United States and its agencies, particularly the
Federal Reserve Board. The Federal Reserve Board can and does implement national
monetary policy, such as seeking to curb inflation and combat recession, by its
open market operations in U.S. Government securities, limitations upon savings
and time deposit interest rates, and adjustments to the discount rates
applicable to borrowings by banks which are members of the Federal Reserve
System. The actions of the Federal Reserve Board influence the growth of bank
loans, investments and deposits and also affect interest rates charged on loans
and paid on deposits. The nature and impact that future changes in fiscal or
monetary policies or economic controls may have on the Bank's business and
earnings cannot be predicted.
Other legislation has been proposed or is pending before the United States
Congress which could affect the financial institution industry. Such legislation
includes proposals to further alter the structure, regulation, and competitive
relationships of the nation's financial institutions, to reorganize the federal
regulatory structure of the financial institution industry, and to change the
range of financial services which banks and bank holding companies can provide.
It cannot be predicted whether the pending or proposed legislation will be
adopted or what effect such legislation will have on commercial banking in
general or the business of the Bank in particular.
57
<PAGE>
It is impossible to predict with any degree of accuracy the competitive
impact these laws will have on commercial banking in general and the business of
the Bank in particular. However, there appears to be a lessening of the
historical distinction between the services offered by financial institutions
and other businesses offering financial services. It is anticipated that banks
will experience increased competition for deposits and loans and increases in
their cost of funds.
ADMINISTRATIVE ACTIONS
MEMORANDUM OF UNDERSTANDING. As a result of the deficiencies noted above,
on September 22, 1993, the Bank entered into the MOU with both the FDIC and the
Superintendent. Among other items the MOU set forth specific requirements
designed to address the Bank's problem loans and nonperforming assets, as well
as the correction of deficiencies in credit administration and calculation of
the loan loss reserve. Many of the corrective actions required by the MOU were
undertaken by the Bank prior to the effective date of the MOU, and all of the
above described activities have assisted the Bank in complying with the terms of
the MOU.
The MOU also required, among other things, that the Bank must have a Tier 1
capital ratio of at least 7% by March 22, 1994. In an attempt to comply with the
capital requirements under the MOU, the Company entered into a best-efforts
Underwriting Agreement with Spectrum Securities, we prepared a Registration
Statement on Form SB-2 and commenced a Rights and Public Offering on May 13,
1994. At the conclusion of the Offering on October 15, 1994, Monarch Bancorp
failed to raise the minimum of $2.5 million and the funds held in the Impound
Account at First Interstate Bank of California were returned with interest to
investors subscribing to the Offering. As a result of the failure to receive the
minimum amount in the Offering, the Bank was not in compliance with the 7% Tier
1 requirement contained in the MOU. The Orders described below superseded the
MOU.
SECTION 8(B) ORDER
Following the conclusion of the 1994 FDIC examination of the Bank, for the
purpose of cooperating with the FDIC and without admitting or denying any
allegations, Monarch Bank, the wholly-owned subsidiary of the Company,
stipulated to the issuance of a Section 8(b) Order (the "8(b) Order"). The 8(b)
Order became effective on December 23, 1994, and the 8(b) Order requires the
Bank to perform several actions within certain time frames. The 8(b) Order
includes the following requirements: (i) management shall have qualifications
and experience commensurate with each member's duties and responsibilities of
the Bank, and the qualifications of management shall be assessed on its ability
to comply with the requirements of the 8(b) Order, operate the Bank in a safe
and sound manner, comply with applicable laws and regulations, and restore all
aspects of the Bank to a safe and sound condition; (ii) the Board of Directors
shall increase its participation in the affairs of the Bank, including the
review and approval of several reports, operating policies and committee
actions; (iii) by no later than April 30, 1995, the Bank shall have Tier 1
capital in an amount as to equal or exceed 7% of the Bank's total assets, and
thereafter, during the life of the 8(b) Order, the Bank shall maintain Tier 1
capital in such an amount as to equal or exceed 7% of the Bank's total assets,
and the Bank shall adopt a capital plan to meet the minimum risk-based capital
requirements as described in the FDIC rules and regulations; (iv) the Bank shall
eliminate from its books all assets classified loss on the recent examination,
and to reduce assets classified substandard according to the schedule contained
in the 8(b) Order, and the Bank shall eventually reduce the total of all
adversely classified assets; (v) prohibitions and restrictions concerning
further extensions of credit to borrowers whose assets have been adversely
classified; (vi) revise and implement an amended loan policy to improve credit
administration and underwriting procedures; (vii) reduce loan concentrations;
(viii) establish and maintain an adequate reserve for loan losses, implement the
policy for determining the adequacy of the loan loss reserve, and the Board of
Directors shall review the reserve at least once each calendar quarter; (ix)
prepare and implement a written plan and comprehensive budget for all categories
of income and expense to be submitted to the FDIC and the Superintendent for
review and comment and an evaluation by the Board of Directors of the actual
performance of the plan and budget on a quarterly basis; (x) a correction, to
the extent possible, of certain violations of law contained in the examination
report; (xi) adopt and implement a policy to provide for adequate internal
routine and control policies consistent with safe and sound banking practices,
develop and
58
<PAGE>
implement an internal audit program that establishes procedures to protect the
integrity of the Bank's operational and accounting systems; (xii) file amended
Consolidated Reports of Condition as of March 31, 1994 and June 30, 1994, and
thereafter file accurate Consolidated Reports of Condition; (xiii) not pay cash
dividends without the prior consent of the FDIC; and (xiv) file written progress
reports with the FDIC.
SECTION 1913 ORDER
As a result of a recent examination by the California State Banking
Department, the Bank agreed to a final order under California Financial Code
Section 1913 (the "1913 Order") with the California State Banking Department
(the "Department") that is effective December 14, 1994. The 1913 Order provides
that the Bank shall take certain actions, including the following: (i) the Bank
shall retain management acceptable to the Department and the FDIC that shall
operate the Bank in a safe and sound manner and implement the provisions of the
Order; (ii) the Bank shall adopt and implement a comprehensive business plan to
provide forward planning and restoring the Bank to a sound condition, and such
plan shall be submitted to the Department and the FDIC for review and comment;
(iii) by April 30, 1995, the Bank shall increase its tangible shareholders'
equity by an amount which equals or exceeds $2 million, and shall have tangible
shareholders' equity which equals or exceeds 7% of total tangible assets, and
thereafter the Bank shall maintain tangible shareholders' equity in such an
amount as to equal or exceed 7% of total tangible assets; (iv) the Bank shall
charge-off all assets that have been classified loss, and the Bank shall reduce
assets classified substandard according to the reduction schedule contained in
the 1913 Order; (v) the Bank shall maintain an adequate allowance for loan loss,
the Board shall review the adequacy of the allowance for loan loss at the end of
each calendar quarter; (vi) the Bank shall adopt and implement a budget for
1995, which shall be acceptable to the Department and the FDIC; (vii) the Bank
shall adopt and implement written policies and procedures to ensure adequate
supervision of lending activities in a form acceptable to the Department and the
FDIC; (viii) the Bank shall not make any distributions to shareholders except
with the prior written approval of the Superintendent; (ix) the Bank shall
correct all violations of law; and (x) the Bank shall furnish a written progress
report to the Department and the FDIC.
SECTION 38 NOTICE. As a result of its 1994 examination, the FDIC notified
the Bank that it fell within the undercapitalized capital category under Section
38 of the FDI Act. As a result of such notification, the Bank filed a capital
plan with the FDIC, and the Company executed a guarantee of the capital plan.
However, by March 31, 1995, the Bank achieved compliance with Section 38 as the
Bank's leverage capital ratio exceeded 4% (it was approximately 7.85% at March
31, 1995, following completion of the Private Placement Offering).
Based on preliminary unaudited figures as of March 31, 1995, as a result of
the completion of the first phase of the Private Placement Offering, the Bank's
leverage capital ratio increased to approximately 7.85%, which was approximately
$538,000 above the 7% level required under the Orders. See "Capitalization."
However, no assurance can be given that the results of subsequent operations and
this Offering will maintain the 7% minimum imposed under the Orders.
The Bank as of March 31, 1995 is in full compliance with the provisions of
the Orders relating to capital and capital ratios. Management of the Bank has
taken specific action to improve the Bank's credit administration including the
adoption of revised policies for lending and loan administration, changes to
staff to improve technical lending skills, and reducing classified loans. The
Board is increasing its participation in the affairs of the Bank and the Bank
has charged-off all assets classified loss on the recent examination and is
currently in compliance with the reduction schedule of classified assets
contained in the 8(b) Order. The Bank has not extended any credit to an
individual whose extension of credit has been charged-off or classified loss,
and the Loan Committee of the Bank will approve any further renewal or extension
of credit to a borrower whose loan was classified substandard. The Bank has also
amended its policies and procedures. The Board of Directors will be reviewing
the reserve for loan losses and that additional provisions were made as of
December 31, 1994 in order to establish an adequate reserve for loan losses. The
Bank has already filed amended Consolidated Reports of Condition and Income.
However, compliance with the terms of the Orders will be determined by the
FDIC and the Superintendent during subsequent examinations of the Company and
the Bank. The FDIC and the Superintendent
59
<PAGE>
have not made a determination of the Bank's compliance with the Orders, and
there can be no assurance given that in its next examination the FDIC and/or the
Superintendent will agree with management's analysis. The Bank's regulatory
agencies are required to examine the Bank within certain statutory time frames,
and management of the Company believes the Bank will be examined before the end
of the second quarter of 1995. In the event the FDIC and/or the Superintendent
determines that the Company or the Bank are not in compliance with the terms of
the Orders, or the FDIC and/or the Superintendent otherwise determine that the
Company or the Bank is engaging in unsafe or unsound practices in conducting its
business or otherwise violating any law, rule or regulation, the FDIC and/or the
Superintendent would have available to it various remedies, including taking one
or more of the enforcement actions discussed below. There can be no assurance
that the steps taken by the Company and the Bank will be sufficient to terminate
the Orders or that enforcement actions will not be commenced in the future.
Although the Board of Directors of the Company believes the Bank is
currently in compliance with the Orders, if the Bank is not in compliance with
the Orders as determined by the FDIC and/or the Superintendent, the Bank could
be subject to further enforcement action. If the FDIC and/or the Superintendent
determines that the Bank is subject to further enforcement action or takes other
material adverse actions against the Bank, the Company will comply with federal
securities laws and any material adverse action against the Company or other
adverse change will require an affirmative resolicitation, notwithstanding that
subscriptions may not be revoked as described in the "OFFERING" herein.
LEGAL PROCEEDINGS
In the ordinary course of business, the Bank is subject to claims, counter
actions, and other litigation. No single action or similar group of claims
exceeds 10 percent of liquid assets (Cash and Federal Funds Sold).
At the present time, the Bank is a defendant in litigation brought by an
account holder related to the Bank's activities as custodian for self-directed
Individual Retirement Accounts administered by First Pension Corporation and its
successor, Summit Trust Services, both of which appear to be insolvent. The
litigation seeks damages of $32,000 against the Bank. Based on facts known to
them at this time, the Board of Directors, management and the Bank's
representatives do not believe to the best of their knowledge that the Bank has
any material liability to any account holder for which the Bank acted as
custodian. However, no assurance can be given that further litigation involving
the Bank will not result or that liability may not be incurred.
EMPLOYEES
At December 31, 1994, the Company and the Bank had 42 full-time equivalent
employees. The Company believes that its employee relations are excellent.
COMPETITION
The banking business in California generally, and in the Bank's primary
service areas specifically, is highly competitive with respect to both loans and
deposits, and is dominated by a relatively small number of major banks with many
offices and operations over a wide geographic area. Among the advantages such
major banks have over the Bank are their ability to finance wide-ranging
advertising campaigns and to allocate their investment assets to regions of
higher yield and demand. Such banks offer certain services such as trust
services and international banking which are not offered directly by the Bank
(but which can be offered indirectly by the Bank through correspondent
institutions). In addition, by virtue of their greater total capitalization,
such banks have substantially higher lending limits than the Bank. (Legal
lending limits to an individual customer are based upon a percentage of a bank's
total capital accounts, and the Bank's legal lending limits will be
substantially increased as a result of this Offering.) Banks also compete with
money market funds and other money market instruments which are not subject to
interest rate ceilings.
In order to compete with other competitors in their primary service areas,
the Bank attempts to use to the fullest extent the flexibility which its
independent status permits. This includes an emphasis on specialized services,
local promotional activity, and personal contacts by their respective officers,
directors and employees. The Bank offers highly personalized banking services.
60
<PAGE>
In addition, as a result of consolidations and mergers, such as the Bank of
America and Security Pacific National Bank merger, and the failure of some
financial institutions in the Bank's market area, the Bank, as the only
locally-owned Bank in Laguna Niguel, has recently experienced an increased
demand for its services in its local market area.
PROPERTIES
The Bank's office is located in a shopping/business center at 30000 Town
Center Drive, Laguna Niguel, California. The leased building is free standing,
and has approximately 8,500 square feet of space. The land and building were
leased on August 1, 1991 for a twenty (20) year term with three 10-year options.
After the first five (5) years of the lease, the lease is subject to annual cost
of living increases; the annual rent, as of December 1994, was approximately
$10,000 per month triple net. The facility is equipped with a vault and
safe-deposit boxes, eight (8) teller stations, two (2) automatic teller
machines, four (4) drive-up teller stations, a night depository, and includes
parking adjacent to the Bank.
An administrative office, located 27751 La Paz Road in Laguna Niguel, is a
free standing building with approximately 7,750 square feet of space. The lease
on this facility was renewed in June 1991 for five years. The monthly rental as
of December 31, 1994 was approximately $4,700.
The Company formerly occupied approximately 5,000 square feet of space at
30100 Town Center Drive, Laguna Niguel. This facility has a 13 year lease which
started in 1983 and ends in June 1996. The facility was subleased in 1987
through September 1993 with an option to extend the sublease until June 1996.
The original sublease was structured as a pass-through for income approximately
equal to expense. In late 1993 the Bank's tenant agreed to exercise its option
but at current market rates for similar property. As a result of this renewal,
which include free rent and a reduced rate, the Bank recorded a projected loss
on this property of $61,000 in December 1993 and $20,000 in 1994. The Bank's
expense and income for this sublease are the same after the accounting
adjustment for the projected difference in income versus expense.
Rental income from subleased properties totaled approximately $69,000 and
$118,000 in 1994 and 1993, respectively.
CHANGE IN ACCOUNTANTS
On October 4, 1994, the Board of Directors of Monarch Bancorp through its
Audit Committee dismissed Deloitte & Touche as its auditors.
Deloitte & Touche's report dated January 28, 1994 (except for Note 16 as to
which the date is April 14, 1994) on the Company's financial statements for the
year-ended December 31, 1993 did not include an adverse opinion or disclaimer
opinion nor was it qualified as to audit scope or accounting principles; the
report did include a statement of uncertainty relating to a Memorandum of
Understanding between the Company's wholly-owned subsidiary, Monarch Bank, and
the Federal Deposit Insurance Corporation and the California State Banking
Department that required the Bank to meet certain prescribed requirements. The
report dated January 29, 1993 for the year-ended December 31, 1992 did not
contain an adverse opinion or a disclaimer of opinion and was not qualified or
modified as to uncertainty, audit scope or accounting principles.
During the Company's fiscal years ended December 31, 1993 and December 31,
1992, and the subsequent interim period, there were no disagreements with
Deloitte & Touche on any matter of accounting principles or practices, financial
statement disclosure or auditing scope or procedure which, if not resolved to
Deloitte & Touche's satisfaction, would have caused it to make reference to the
subject matter of the disagreement in connection with its report.
On October 9, 1994, the Board of Directors Audit Committee of the Company
engaged the firm of Dayton & Associates, Laguna Hills, California as auditors to
examine the books and accounts of the Company for the fiscal year ended December
31, 1994. The Company has not during its fiscal years ended December 31, 1993
and December 31, 1992, and the subsequent interim period, consulted with Dayton
& Associates regarding the application of accounting principles to a specific
transaction or the type of audit opinion that might be rendered on the Company's
financial statements.
61
<PAGE>
MANAGEMENT
DIRECTORS
The following table sets forth, as of March 31, 1995, as to each of the
directors of the Company, such person's age, such person's principal occupation
during the past five years, and the period during which such person has served
as a director of the Company and the Bank.
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION DIRECTOR OF DIRECTOR OF
NAME AND OFFICE HELD AGE FOR PAST FIVE YEARS COMPANY SINCE BANK SINCE
- ---------------------------------------- --- ------------------------------------ ----------------- -------------
<S> <C> <C> <C> <C>
Rice E. Brown, Director 57 President of Rice Brown Financial 1988 1988
Services
E. Lynn Caswell, Chairman of the Board, 50 Commercial Banking and Bank Holding 1987 1987
President and Chief Executive Officer Company Management
Raymond B. Cox, Director 86 President, Cox Marketing Associates 1983 1979
William C. Demmin, Director and 49 Commercial Banking and Bank Holding 1993 1993
Executive Vice President and Chief Company Management
Financial Officer (7)
Alfred H. Jannard, Director (8) 54 Owner -- Niguel Pharmacy 1993 1993
Cheryl Moore, Director (9) 48 Owner and retailer -- Something 1993 1993
Moore
Margaret A. Redmond, Director 54 Vice President & Office Manager of a 1988 1988
Professional Orthodontia Practice
Firm
<FN>
- ------------------------
(7) Mr. Demmin has served as Senior Vice President and Chief Financial Officer
and Corporate Secretary for the Company and Bank since 1987. His
appointment to the Company and Bank Board of Directors is effective as of
May 15, 1993. Mr. Demmin was promoted to Executive Vice President of the
Company and the Bank in April 1995.
(8) Mr. Jannard, a long-time shareholder of the Company and a member of the
Bank's Advisory Board, was appointed to the Company and Bank Board of
Directors effective May 15, 1993. Mr. Jannard has owned and operated Niguel
Pharmacy since 1979 and is a long-time resident of Laguna Niguel.
(9) Ms. Moore, a long-time shareholder of the Company and a member of the
Bank's Advisory Board, was appointed to the Company and Bank Board of
Directors effective May 15, 1993. Ms. Moore is a long-time resident of
Laguna Niguel and has owned and operated two businesses in Laguna Niguel,
most recently, Something Moore, Inc.
</TABLE>
The Company has agreed to appoint Mr. John Rose as a member of the Board of
Directors subject to regulatory approval. Mr. Rose is one of the Financial
Advisors who assisted the Company in structuring and completing the first phase
of the Private Placement Offering. Mr. Rose has an extensive background in
banking and finance. Since January 1994, Mr. Rose has been President and owner
of McAllen Capital Partners, Chicago, Illinois and Mr. Rose is also currently an
executive officer of FNB Corporation, Pennsylvania. From February 1992 to
December 1993, Mr. Rose was Senior Vice President of River Valley Savings Bank,
Chicago, Illinois. From May 1988 to January 1992, Mr. Rose was President of
Livingston Financial Group, Chicago, Illinois, a venture capital firm, and Mr.
Rose has over 20 years of banking experience.
EXECUTIVE OFFICERS
The Company's directors are elected on a one year basis to serve until the
next annual meeting of shareholders and until their successors are elected and
have qualified.
62
<PAGE>
The following table sets forth as to each of the persons who currently
serves as an Executive Officer of the Company and the Bank, such person's age,
such person's principal occupation during the past five years, such person's
current position with the Bank, and the period during which the person has
served in such position.
<TABLE>
<CAPTION>
YEAR OF YEAR OF
POSITION WITH PRINCIPAL OCCUPATION APPOINTMENT TO APPOINTMENT TO
NAME AGE COMPANY AND BANK FOR PAST FIVE YEARS COMPANY BANK
- ------------------------- --- ---------------------- --------------------------- --------------- ---------------
<S> <C> <C> <C> <C> <C>
E. Lynn Caswell (10) 50 Chairman of the Board, Commercial Banking and Bank 1987 1987
President and CEO Holding Company Management
William Demmin (11) 50 Executive Vice Bank and Bank Holding 1987 1987
President and CFO Company Management
Louis Cumming (12) 55 Executive Vice Bank and Bank Holding -- 1995
President and Chief Company Management
Credit Officer
<FN>
- ------------------------
(10) On July 27, 1987, Mr. E. Lynn Caswell was appointed President and Chief
Executive Officer and a member of the Board of Directors of the Company and
the Bank, and on April 20, 1988 was appointed Chairman of the Board of
Directors. Mr. Caswell was formerly the President and Chief Executive
Officer of the Bank of San Diego, and Chief Operating Officer of BSD
Bancorp, its parent Company from 1984 to 1987, and he has over 26 years of
banking experience.
(11) On August 10, 1987, Mr. William C. Demmin was appointed Senior Vice
President and Chief Financial Officer of the Company and the Bank. Mr.
Demmin was promoted to Executive Vice President of the Company and the Bank
in April 1995. From 1986 to 1987, Mr. Demmin served as Cashier of Commer-
cial Center Bank of Santa Ana, California and he had previously served as
Senior Vice President, Chief Financial officer, and Cashier of First
American Bank & Trust in Laguna Beach from 1983 to 1986. Mr. Demmin had
previously served Bank of America for 11 years, and he has over 27 years of
banking experience.
(12) On April 28, 1995, Mr. Louis Cumming was appointed Executive Vice President
and Senior Credit Officer of the Bank. Mr. Cumming was formerly the
Executive Vice President and Senior Credit Officer of Cuyamaca Bank from
1992 to April 1994, Senior Vice President of First National Bank from 1989
to 1992, and he has over 30 years of banking experience.
</TABLE>
COMMITTEES OF THE BOARD OF DIRECTORS
During 1994, the Board of Directors of the Company held seven (7) meetings.
The Bank, during 1994, held fifteen (15) regular meetings, one (1) special
meeting and seven (7) joint Executive Sessions. All Directors attended at least
80% of the Board meetings of the Company and Bank.
The Bank Loan Committee, which is responsible for reviewing and approving
loans, held twenty-one (21) meetings during 1994. Members of the Bank Loan
Committee also function as the Bank's Investment Committee.
The Board of Directors Audit Committee held five (5) meetings in 1994, and
also met to review quarterly financial reports. The members of the Audit
Committee are: Rice E. Brown, Raymond B. Cox, Alfred H. Jannard, Cheryl Moore
and Margaret A. Redmond. The duties of the Committee include meetings and
discussions with the Company's external auditors and meetings with outside
operational auditors who are engaged to perform internal control audits and
review and approve various financial reports.
The Company and Bank do not have Compensation or Nominating committees and
handle matters that might otherwise be delegated to these committees in
executive session; all Board members are included in the executive sessions.
63
<PAGE>
COMMON STOCK OWNERSHIP DIRECTORS, EXECUTIVE OFFICERS, AND CERTAIN PRINCIPAL
SHAREHOLDERS
The following table lists of any known shareholders with a beneficial
ownership of five percent of the Company Stock as of March 31, 1995. All shares
of Common Stock, the only class of security outstanding.
<TABLE>
<CAPTION>
AMOUNT AND NATURE OF PERCENT OF
NAME AND ADDRESS OF BENEFICIAL OWNER BENEFICIAL OWNERSHIP CLASS
- ------------------------------------------------------------- -------------------- ---------------
<S> <C> <C>
Peter Huizenga Testamentary Trust............................ 530,000 9.85%
Huizenga Capital Management
Oak Brook, IL 60521
Robert A. Schoellhorn........................................ 530,000 9.85%
Byan & Gross
Northbrook, IL 60062
Mutual Discovery Fund........................................ 530,000 9.85%
(Mutual Series Fund, Inc.)
Short Hills, NJ 07078
Basswood Partners............................................ 530,000 9.85%
Paramus, NJ 07652
Kenneth Gaspar............................................... 370,370 6.88%
Lisle, IL
Jerome White................................................. 333,333 6.19%
Donaldson, Lufkin & Jenerette
Chicago, IL 60606
</TABLE>
SECURITY OWNERSHIP OF MANAGEMENT
The following table reflects as of March 31, 1995 the beneficial ownership
of management of the Company's Common stock including stock options which have
been vested or stock options that will be vested within 60 days. All of the
individuals, except Mr. Cumming, are directors of the Bank and Company.
Mr. John Rose is expected to become a director of the Company. As of March
31, 1995, Mr. Rose held 185,185 shares of common Stock or 3.47% of the
outstanding shares. Assuming the completion of this Offering, his ownership is
projected to represent approximately 2.98%.
<TABLE>
<CAPTION>
AMOUNT AND NATURE OF
BENEFICIAL
BENEFICIAL OWNER DIRECTOR OWNERSHIP (15) PERCENT OF CLASS
- -------------------------------------------------------------- ----------------------- -----------------
<S> <C> <C>
Rice E. Brown................................................. 12,345 .23%
E. Lynn Caswell (16).......................................... 53,415 .99%
Louis F. Cumming (17)......................................... -- --
Raymond B. Cox................................................ 23,689 .44%
William C. Demmin (8)......................................... 26,882 .50%
Alfred H. Jannard............................................. 11,840 .22%
Cheryl Moore.................................................. 8,108 .15%
Margaret A. Redmond........................................... 26,396 .44%
All seven (7) directors as a group............................ 162,675 3.02%
<FN>
- ------------------------
(15) Beneficial owner of a security includes any person who, directly or
indirectly, through any contract, arrangement, understanding, relationship,
or otherwise has or shares: (a) voting power, which includes the power to
vote, or to direct the voting power, of such security; and/or (b)
investment power, which includes the power to dispose, or to direct the
disposition of, such security. Beneficial owner also includes any person
who has the right to acquire beneficial ownership of such security as
defined above within 60 days of the Record Date. The calculation includes
vested stock options totaling 51,320 option shares.
(16) Mr. Caswell and Mr. Demmin are also executive officers.
</TABLE>
64
<PAGE>
<TABLE>
<S> <C>
(17) Mr. Cumming is an executive officer of the Bank, but he does not hold an
officer position with the Company, nor is he a director of the Company or
the Bank. Mr. Cumming replaces Mr. Richard Cordova as Senior Vice President
and Chief Credit Officer of the Bank, who resigned in April 1995.
</TABLE>
EXECUTIVE COMPENSATION
The Company's executive officers are E. Lynn Caswell, Chairman of the Board,
President and Chief Executive Officer; William C. Demmin, Executive Vice
President and Chief Financial Officer. The Company paid no salaries in 1994.
The following table reflects all compensation paid to Mr. E. Lynn Caswell,
the Company's and Bank's Chief Executive Officer. No other executive officer
received total annual salary and bonus of $100,000 or more.
<TABLE>
<CAPTION>
SECURITIES
PROFIT OTHER ANNUAL UNDERLYING
NAME AND POSITION YEAR SALARY SHARING COMPENSATION OPTIONS
- ----------------------------------- --------- ---------- --------- ------------- -----------
<S> <C> <C> <C> <C> <C>
E. Lynn Caswell.................... 1994 $ 128,182 $ -- $ -- --
1993 128,182 -- 21,324 55,620
1992 124,730 31,553 8,700 --
</TABLE>
Mr. E. Lynn Caswell executed an Employment Agreement dated July 23, 1987,
and amended effective July 23, 1989, and July 23, 1991 with the Company and the
Bank. The Agreement is now effective for a three (3) year period with automatic,
subsequent three (3) year renewals, unless notice is given thirty (30) days
prior to the end of any given period. The Agreement provides for a base salary
with annual cost of living adjustments to a maximum of 8%. Mr. Caswell's current
base annual salary as of February 28, 1994 is $128,182. In addition, Mr. Caswell
receives an automobile allowance, reimbursement for various business expenses,
use of the Bank's club memberships, four weeks annual vacation, insurance,
including disability and life insurance equal to four (4) times annual salary,
and other health and Company benefits. Mr. Caswell is entitled to receive
director's fees. A profit sharing agreement equal to 10% of the pre-tax profit
of the Bancorp, as calculated in accordance with generally accepted accounting
principles, is payable to Mr. Caswell within three (3) months after the end of
the fiscal year. The Agreement may be terminated without cause by majority vote,
or as the result of a merger or corporate dissolution. Should the Agreement be
terminated, Mr. Caswell would receive no less than six (6) months base salary,
auto allowance, and insurance benefits. The profit sharing arrangement of 10% of
the pre-tax profit would be calculated and payable as of the date of the
termination of the Agreement.
STOCK OPTIONS
The Monarch Bancorp 1983 Stock Option Plan (the "1983 Plan") was adopted on
May 24, 1983 and amended, by the Board of Directors in May 1988 and March 1989,
and by Shareholders at the July 12, 1988 Annual Meeting of Shareholders, to
increase the number of authorized shares of the Company and to reflect changes
affecting stock options as contained in the Tax Reform Act of 1986. The
California Department of Corporations issued a permit for the amended 1983 Plan
in March 1989. The 1983 Plan has been qualified as an incentive stock option
under Section 422A of the Internal Revenue Code of 1954, as amended by the
Economic Recovery Act of 1981 and the Tax Reform Act of 1986. The 1983 Plan
expired in March 1993.
The Monarch Bancorp 1993 Stock Option Plan (the "1993 Plan") was adopted on
March 16, 1993 by the Board of Directors, and approved by Shareholders of the
Company at the June 7, 1993 Annual Meeting of Shareholders. The California
Department of Corporations issued a permit for the 1993 Plan, and the Company
intends to register with the Securities and Exchange Commission the shares
reserved for issuance under the 1993 Plan. The 1993 Plan allows for the issuance
of nonqualified and incentive stock options as defined under the Internal
Revenue Code.
The 1983 and the 1993 Plans provided for an aggregate total of 204,030
shares or 25.7% of the issued and outstanding shares of the Company as of March
30, 1995, or 3.82% of the issued and outstanding shares of the Company as of the
Record Date. The Board of Directors on May 16, 1995 approved a proposed
amendment to the 1993 Plan, subject to the approval of the California
Commissioner of Corporations and
65
<PAGE>
the holders of a majority of the issued and outstanding shares of the Company,
that would increase the number of shares that are subject to the 1993 Plan to
approximately 10% of the issued and outstanding shares of the Company following
completion of this Offering.
On March 31, 1995, the Company completed a Private Placement Offering of
4,547,111 shares of its Common Stock at a price of $1.35 per share to several
accredited investors as defined in SEC Regulation D. If the Company successfully
completes this Offering and sells an additional 3,177,296 shares of Common
Stock, the Company will have 8,518,730 shares of the Company's Common Stock
issued and outstanding, and the Company would then increase the number of shares
in the 1993 Plan to 851,873 shares.
The 1993 Plan is similar to the 1983 Plan in several respects, except that
options may be granted to consultants and business associates of the Company and
the Bank, the 1993 Plan allows that an optionee has a right to exercise vested
options in the event of termination for cause for a period of at least 30 days
following such termination, and the 1993 Plan does not allow for acceleration of
unvested options for any reason.
The Company has agreed to grant to the Financial Advisors, in addition to
the cash compensation payable under the engagement letter, warrants that will
entitle the Financial Advisors to purchase shares equal to 5% of the number of
shares issued and outstanding following this Offering, at a price of 120% of the
offering price. The warrants will be for a term of five years and will be
exercisable after the first year. The options will be non-transferrable. The
Company has agreed to convert the warrants to stock options under the same terms
and conditions as the warrants except that the term will be extended to ten (10)
years. The Board of Directors intends to cancel existing stock options and
substitute new stock options on prices, and for terms, financially comparable to
terms of the options described above for the Financial Advisors.
OPTIONS/SAR GRANTS IN LAST FISCAL YEAR
INDIVIDUAL GRANTS
<TABLE>
<CAPTION>
PERCENT OF TOTAL
OPTIONS/SARS GRANTED TO EXERCISE OR
OPTIONS/SARS EMPLOYEES IN FISCAL BASE EXPIRATION
NAME GRANTED (#) YEAR PRICE ($/SH) DATE
- ------------------------ ------------- ----------------------- --------------- -------------
<S> <C> <C> <C> <C>
NONE
</TABLE>
Mr. Caswell received options to purchase 2,000 shares of the Company's
Common Stock in September 1993 at fair market value as defined in the Company's
1993 Stock Option Plan. Mr. Caswell was one of nine individuals who received
options in 1993.
At the request of the Board of Directors, Mr. Caswell also voluntarily
canceled 53,620 options that had been granted in 1988. These options under the
terms of the 1983 Stock Option Plan had been fully vested over a five year
period, and were exercisable at an average price of $4.28 per share. The Company
reissued 53,620 options under the 1993 Stock Option Plan at $4.25 per share. The
replacement options will be vested as to 1/5 per year over five years and expire
in September 2003.
AGGREGATED OPTIONS EXERCISED IN LAST FISCAL YEAR AND
FY-END OPTION/SAR VALUES
<TABLE>
<CAPTION>
VALUE OF
NUMBER OF UNEXERCISED
UNEXERCISED IN-THE-MONEY
SHARES OPTIONS/SARS OPTIONS/SARS
ACQUIRED AT FY-END (#) AT FY-END (#)
ON EXERCISE VALUE REALIZED EXERCISABLE/ EXERCISABLE/
NAME (#) ($) UNEXERCISABLE UNEXERCISABLE
- -------------------------- -------------- ---------------- --------------- -------------
<S> <C> <C> <C> <C>
E. Lynn Caswell........... -- -- 10,000/55,620 *
</TABLE>
KSOP
On January 1, 1993 the Company and Bank completed the formation of the
Monarch Bank Employee Stock Ownership and Salary Deferral Plan ("KSOP") with the
first deduction from employee salaries on
66
<PAGE>
January 15, 1993. In 1992, the KSOP obtained a $250,000 loan from another
financial institution, which is guaranteed by the Company, and acquired 53,360
shares of previously issued Company stock at a price of $1.00 per share. In
March 1993, the KSOP acquired an additional 198,255 shares at $1.00 per share in
a private placement offering. Repayments on the loan are made by employee salary
deductions and from possible matching contributions by the Bank. Under the terms
of the KSOP, shares will be distributed to participants at the end of each year,
actual release of shares to the participants is contingent upon the repayment
progress of the loan. The amount of matching contributions made by the Company
was $19,920 in 1993 and $46,108 in 1994.
DESCRIPTION OF PLAN AND TRUST
On May 16, 1995, the Board of Directors of the Company approved the 1995
Directors Deferred Compensation Plan (hereinafter "the Plan"). The Plan is
effective for fees earned on and after July 1, 1995, subject to shareholder
approval. Full power to construe, interpret and administer the Plan is vested
with the Administrative Committee (hereinafter "the Committee"), which consists
of all non-director executive officers of the Company. The Board of Directors
also approved a trust agreement for deferred amounts, the Directors Deferred
Compensation Trust Agreement.
Approval of the Plan and Trust is subject to shareholder approval in order
to assure that the Plan qualifies for exemption from short-swing profit
liability pursuant to Rule 16b-3 of the SEC. If stockholders do not approve the
Plan, the Board will consider whether to implement the Plan or may seek a ruling
that the Rule 16b-3 exemption is not required.
The Plan allows amendments to be made by the Board from time to time,
provided that no such amendment may (without a director's consent) alter rights
to payments of amounts already credited to accounts or delay the time at which
deferred amounts were scheduled to be paid under the Plan. The Company intends
to maintain the Plan and Trust in a manner that will allow ongoing availability
of the exemption under SEC Rule 16b-3 (unless a ruling is received indicating
that such exemption is not necessary and therefore currently intends to submit
to stockholders for approval any amendments which would materially increase the
benefits available under the Plan or the number of shares of common stock of the
Company ("Company Stock") which may be issued under the Plan, or materially
modify the requirements for participation in the Plan.
The Plan allows all directors of the Company and Monarch Bank, including
employee directors, (currently a total of 7 persons), to elect by written notice
to defer payment of all or a portion of their director's fees for the next
succeeding calendar year, and of all or any portion of any grant of Company
Stock to the director made on or after the election. Participation in the Plan
is voluntary and directors may change their elections annually. The Plan allows
optional deferral of existing fees and awards of Company Stock, with investment
of such deferrals in Company Stock. Elections with respect to deferred amounts
are to be made in writing by the director prior to the latest to occur of the
following: (i) the beginning of the calendar year for which the fees are to be
earned; (ii) the director's first day of board service in the year; or (iii) the
first day of the calendar month next following the date the director first
becomes eligible to participate in the Plan; provided that directors who file
Form 4 reports with the SEC cannot make elections later than six months prior to
the date on which any fees deferred by the director are invested in the Company
Stock.
The Company will establish on its books a separate account for each of its
directors who participates in the Plan. All deferred amounts are invested in
Company Stock and the value of a director's account is measured by the value of
and income from the Company common stock. At the time a director makes his or
her first election, the director may also choose to have deferred amounts
contributed to a trust commonly known as a "rabbi" trust, established to aid in
the accumulation of assets for payment of deferred amounts. Separate accounts
are to be set up for each director who elects to make deferrals, and the Company
may, in its discretion, contribute to the trust an amount equal to the deferred
amount, if it is done within five business days after the deferred amount would
otherwise be paid to the director.
67
<PAGE>
The Company will pay all administrative expenses of the Plan for its
participating directors as well as the applicable portion of trustee's fees and
expenses, currently estimated at $1,000 per year. (If the Company does not pay,
the trust is liable for the expenses.) All income received by the trust, net of
expenses and taxes (if any) will be reinvested in Company Stock.
Not later than the next regularly scheduled meeting of the Committee
following a director's termination of service, the Committee must direct the
trustee to commence distribution of the amounts credited to such director's
account and direct the trustee as to the form of payment (whether in cash or in
Company Stock). Amounts held in the account are paid in a lump sum or in annual
installments, consistent with the method of payment selected by the director at
the time the deferral election was initially made. In the event of an
"unforeseen emergency", such as a severe financial hardship to the director
resulting from a sudden and unexpected illness or accident of the director,
beneficiary or dependent, (as defined by Section 152(a) of the Internal Revenue
Code), the Committee may determine the amount to be paid from the deferred
amount.
In the event of death, a director's payment shall be made to the persons
named in the last written instrument signed by the director and received by the
Committee prior to the director's death, and in the event the director fails to
name any person, the amounts shall be paid to the director's estate or the
appropriate distributee thereof.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Some of the directors and executive officers of the Company and its
subsidiaries and the companies with which they are associated are customers of,
and have had banking transactions with, Monarch Bank in the ordinary course of
the Bank's business, and the Bank expects to have banking transactions with such
person in the future. In Management's opinion, all loans and commitments to lend
included in such transactions were made in compliance with applicable laws on
substantially the same terms including interest rates and collateral, as those
prevailing for comparable transactions with other persons of similar
creditworthiness and did not involve more than a normal risk of collectibility
or present other unfavorable features. The amount of all such loans and credit
extensions, to all executive officers, directors, and principal shareholders of
the Company, together with their associates, was $141,191 on December 31, 1994
constituting approximately 16% of the Bank's equity capital accounts on that
date.
The Bank's health and life insurance programs have been contracted, based on
a competitive bid, through Rice Brown Financial, which is owned by Rice Brown,
an insurance broker and a director of the Company and the Bank.
In 1989, the Bank sold its residual value in a matured lease to former
director Parker in exchange for a convertible debenture in another bank. The
debenture was converted into shares of common stock in July 1992; and the Bank
continues to hold this investment at a carrying value of $103,000. The book
value of the shares of such stock owned by the Bank is approximately $165,942.
The market price for the stock is not meaningful since it is very thinly traded.
Pursuant to Federal and state statutes and regulations, the Board of
Directors of the Company is required to insure that all ongoing and future
transactions with related parties are on terms no less favorable than could be
obtained from independent third parties, and that any such transactions will be
approved by a majority of disinterested directors of the Company.
DESCRIPTION OF CAPITAL STOCK
GENERAL
The Company's Articles of Incorporation, as amended, authorize the issuance
of 25,000,000 shares of no par value Common Stock and 5,000,000 shares of
Preferred Stock. As of the date of this Prospectus, there are 5,341,434 shares
of the Common Stock and no shares of the Preferred Stock issued and outstanding.
COMMON STOCK
The holders of the Common Stock are entitled to one vote per share on all
matters requiring stockholder action, except that in connection with the
election of directors, the shares may be voted cumulatively
68
<PAGE>
if a candidate's or candidates' name(s) have been properly placed in nomination
prior to the voting and a shareholder present at the meeting has given notice of
his or her intention to vote his or her shares cumulatively. If a shareholder
has given such notice, then all shareholders entitled to vote for the election
of directors may cumulate their votes. Cumulative voting entitles a shareholder
to give one or more nominees as many votes as is equal to the number of
directors to be elected multiplied by the number of shares owned by such
shareholder, or to distribute his or her votes on the same principle between two
or more nominees as he or she sees fit.
The holders of Common Stock have no preemptive or other Rights and there are
no redemption, sinking fund or conversion privileges applicable thereto. The
holders of Common Stock are entitled to receive dividends as and when declared
by the Board of Directors out of funds legally available therefor, subject to
the restrictions by its regulators. See "Business." Upon liquidation,
dissolution or winding up of the Company, holders of Common Stock are entitled
to share ratably in all assets remaining after payment of liabilities. All
outstanding shares of Common Stock are fully paid and nonassessable and the
shares of Common Stock to be issued in the Offering will, upon delivery and
payment therefor in accordance with the terms of the Offering, be fully paid and
nonassessable.
The registrar and transfer agent for the Company's Common Stock is U.S.
Stock Transfer Company.
PREFERRED STOCK
The Preferred Stock may be issued from time to time in one or more series.
The Board of Directors is authorized to fix the number of shares of any series
of Preferred Stock and to determine the designation of any such shares. The
Board of Directors is also authorized to determine or alter the rights,
preferences, privileges and restrictions granted to or imposed upon any wholly
unissued series of Preferred Stock and, within the limits and restrictions
stated in any resolution or resolutions of the Board of Directors originally
fixing the number of shares constituting any series, to increase or decrease
(but not the number of shares of such series then outstanding) the number of
shares of any series subsequent to the issues of shares of that series. The
Board of Directors does not presently intend to issue any Preferred Stock.
Although it is not possible to state the actual effects of any issuance of
Preferred Stock upon the rights of holders of other securities of the Company,
such effects might include (i) restrictions on Common Stock dividends if
Preferred Stock dividends have not been paid; (ii) dilution of the voting power
and equity interest of warrant holders of Common Stock to the extent that any
Preferred Stock series has voting rights, or that any Preferred Stock shares are
convertible into Common Stock, or (iii) inability of current holders of Common
Stock to share in the Company's assets upon liquidation until satisfaction of
any liquidation preferences granted to the holders of the Preferred Stock. In
addition, the issuance of Preferred Stock under certain circumstances may have
the effect if discouraging an attempt to change control of the Company by, for
example, creating voting impediments to the approval of mergers or other similar
transactions involving the Company.
Subject to such preferential rights as may be determined by the Board of
Directors of the Company in the future in connection with the issuance, if any,
of shares of Preferred Stock, holders of Common Stock are entitled to cast one
vote for each share held of record and to cumulate votes for the election of
directors, to receive such dividends as may be declared by the Board of
Directors out of legally available funds and to share ratably in any
distribution of the Company's assets after payment of all debts and other
liabilities, upon liquidation, dissolution or winding up of the Company.
Shareholders do not have preemptive rights or other rights to subscribe for
additional shares, and the Common Stock is not subject to conversion or
redemption. The outstanding shares of Common stock are, and the shares of Common
Stock to be issued in the Offering, will be, upon delivery and payment therefor
in accordance with the terms of the Offering, fully paid and nonassessable.
LEGAL MATTERS
The validity of the securities offered hereby will be passed upon for the
Company by Knecht & Hansen, a partnership of professional corporations, Newport
Beach, California. Knecht & Hansen beneficially owns 3,200 shares of Common
Stock of the Company.
69
<PAGE>
EXPERTS
The consolidated balance sheet of the Company as of December 31, 1994 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, 1994 included in this Prospectus have been audited by Dayton & Associates,
independent auditors, as stated in their report appearing herein, and have been
so included in reliance upon the report of such firm given upon their authority
as experts in accounting and auditing.
70
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Independent Auditors' Report............................................................................... F-1
Consolidated Balance Sheets at December 31, 1994........................................................... F-2
Consolidated Statements of Operations for the years ended December 31, 1994 and 1993....................... F-3
Consolidated Statement of Shareholders' Equity for the years ended December 31, 1994
and 1993.................................................................................................. F-4
Consolidated Statements of Cash Flows for the years ended December 31, 1994 and 1993....................... F-5
Notes to Consolidated Financial Statements................................................................. F-6
Unaudited Consolidated Balance Sheet at March 31, 1995..................................................... F-19
Unaudited Consolidated Statements of Income for the three months ended March 31, 1995
and 1994.................................................................................................. F-20
Unaudited Consolidated Statement of Cash Flows for the three months ended March 31, 1995 and 1994.......... F-21
Notes to Unaudited Consolidated Financial Statements....................................................... F-22
</TABLE>
71
<PAGE>
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders
Monarch Bancorp
Laguna Niguel, California
We have audited the accompanying consolidated balance sheet of Monarch
Bancorp and Subsidiaries as of December 31, 1994 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, 1994. These financial
statements are the responsibility of the Bank's management. Our responsibility
is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides 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 Monarch Bancorp and
Subsidiaries as of December 31, 1994, and the results of its operations and its
cash flows for each of the two years in the period ended December 31, 1994, in
conformity with generally accepted accounting principles.
As discussed in Note 17, the 1994 financial statements have been restated.
DAYTON & ASSOCIATES
February 7, 1995, except for Note 16
as to
which the date is March 31, 1995 and
Note 17 as to which the date is
April 25, 1995
Laguna Hills, California
F-1
<PAGE>
MONARCH BANCORP
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
1994
------------
<S> <C>
Cash and due from banks (Note 10)................................................................... $ 4,761,921
Federal funds sold.................................................................................. 5,891,000
------------
Total cash and cash equivalents................................................................. 10,652,921
Interest bearing deposits with other banks.......................................................... 1,382,000
Investment securities -- Held to Maturity, at cost (fair value of $4,123,460) (Note 3).............. 4,357,946
Investment securities -- Available for Sale, at fair value (cost of $12,136,884) (Note 3)........... 11,780,442
Loans (Notes 4, 11, and 14):
Real estate -- mortgage........................................................................... 12,226,201
Real estate -- construction....................................................................... 4,031,698
Commercial........................................................................................ 12,088,885
Installment....................................................................................... 2,693,276
------------
Gross loans..................................................................................... 31,040,060
Less: Deferred loan fees.......................................................................... (52,226)
Allowance for possible loan losses........................................................... (1,136,971)
------------
Net loans....................................................................................... 29,850,863
Premises and equipment, net (Note 5 and 14)......................................................... 650,057
Other real estate owned............................................................................. 617,275
Accrued interest receivable and other assets........................................................ 682,451
------------
TOTAL ASSETS.................................................................................... $ 59,973,955
------------
------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest bearing............................................................................... $ 14,790,641
Interest bearing demand........................................................................... 30,774,961
Savings........................................................................................... 6,235,646
Time certificates of deposit of $100,000 or more.................................................. 2,260,550
Other time deposits............................................................................... 4,581,503
------------
Total deposits.................................................................................. 58,643,301
Notes payable (Note 6).............................................................................. 53,500
Other borrowing (Note 9)............................................................................ 172,856
Accrued interest payable and other liabilities...................................................... 402,776
------------
TOTAL LIABILITIES............................................................................... 59,272,433
Commitments and contingencies (Note 10)
Shareholders' equity (Notes 1, 2, 7, 9, 12, and 15) Preferred stock, no par value, 5,000,000
shares authorized, none issued at December 31, 1994 or 1993, respectively
Common stock, no par value, 25,000,000 shares authorized, 794,324 shares outstanding at December
31, 1994 and 1993, respectively.................................................................. 7,367,601
Accumulated deficit............................................................................... (6,136,790)
Unrealized appreciation (depreciation) on investment securities available for sale (Note 3)....... (356,433)
Deferred charge related to KSOP................................................................... (172,856)
------------
Net Shareholders' equity........................................................................ 701,522
------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY...................................................... $ 59,973,955
------------
------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-2
<PAGE>
MONARCH BANCORP
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------
1994 1993
------------- -------------
<S> <C> <C>
Interest Income
Interest and fees on loans....................................................... $ 2,877,686 $ 3,539,083
Interest on interest bearing deposits in other banks............................. 111,440 93,304
Interest on investment securities................................................ 793,562 504,704
Interest on federal funds sold................................................... 154,919 210,462
------------- -------------
Total interest income.......................................................... 3,937,607 4,347,553
Interest Expense:
Interest expense on deposits..................................................... 1,100,405 1,238,711
Interest expense on notes payable and other borrowings........................... 1,796 5,845
------------- -------------
Total interest expense......................................................... 1,102,201 1,244,556
Net Interest Income................................................................ 2,835,406 3,102,997
Provision for Possible Loan Losses (Note 4)........................................ 995,001 1,280,000
------------- -------------
Net Interest Income After Provisions for Possible Loan Losses...................... 1,840,405 1,822,997
Other Income:
Overdraft service charges........................................................ 230,186 277,915
Deposit service charges.......................................................... 170,846 164,450
Rental income.................................................................... 70,502 118,380
Data processing income........................................................... 122,487 116,978
Late charges on loans............................................................ 20,177 42,767
Service charges, commissions, and other fees..................................... 81,988 88,466
Gain (loss) on investments....................................................... (47,000) 39,974
Gain on sale of assets (Note 14)................................................. 0 111,482
------------- -------------
Total other income............................................................. 649,186 960,412
Other Operating Expenses:
Salaries and employee benefits................................................... 1,788,271 1,839,277
Office operations................................................................ 676,431 799,028
Occupancy expenses (Note 14)..................................................... 614,768 988,324
Professional services............................................................ 276,004 236,301
Public offering expenses (Note 16)............................................... 365,641 0
Other real estate owned.......................................................... 242,589 86,358
Advertising and business promotion............................................... 110,294 124,135
Other............................................................................ 263,910 49,862
------------- -------------
Total other operating expenses................................................. 4,337,908 4,123,285
Loss Before Provision for Income Taxes............................................. (1,848,317) (1,339,876)
Provision for Income Taxes (Note 8)................................................ 1,600 1,600
------------- -------------
Net Loss....................................................................... $ (1,849,917) $ (1,341,476)
------------- -------------
------------- -------------
Weighted average number of common and common equivalent shares outstanding (Note
1)................................................................................ 794,324 785,986
Per share information:
Net loss per share............................................................... $ (2.33) $ (1.71)
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
MONARCH BANCORP
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1994 AND 1993
<TABLE>
<CAPTION>
NET UNREALIZED
APPRECIATION
DEFERRED (DEPRECIATION)
CHARGE ON SECURITIES
ACCUMULATED RELATED AVAILABLE SHAREHOLDERS'
SHARES AMOUNT DEFICIT TO KSOP FOR SALE EQUITY
--------- ------------ ------------- ----------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1993.............. 737,297 $ 7,083,466 $ (2,945,397) $ (250,000) $ 0 $ 3,888,069
Exercise of stock options
(Note 7)............................. 4,000 19,000 0 0 0 19,000
Stock purchases (Note 7).............. 52,783 264,097 0 0 0 264,097
Conversion of debt.................... 244 1,038 0 0 0 1,038
Repayment of KSOP debt
(Note 9)............................. 0 0 0 39,089 0 39,089
Unrealized appreciation on investment
securities Available for Sale (Note
3)................................... 0 0 0 0 53,435 53,435
Net loss.............................. 0 0 (1,341,476) 0 0 (1,341,476)
--------- ------------ ------------- ----------- -------------- -------------
Balance at December 31, 1993............ 794,324 7,367,601 (4,286,873) (210,911) 53,435 2,923,252
Repayment of KSOP debt
(Note 9)............................. 0 0 0 38,055 0 38,055
Net change in unrealized depreciation
on investment securities Available
for Sale (Note 3).................... 0 0 0 0 (409,868) (409,868)
Net loss.............................. 0 0 (1,849,917) 0 0 (1,849,917)
--------- ------------ ------------- ----------- -------------- -------------
Balance at December 31, 1994............ 794,324 $ 7,367,601 $ (6,136,790) $ (172,856) $ (356,433) $ 701,522
--------- ------------ ------------- ----------- -------------- -------------
--------- ------------ ------------- ----------- -------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
MONARCH BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------
1994 1993
------------- -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss............................................................................ $ (1,849,917) $ (1,341,476)
Adjustments to reconcile net loss to net cash used in operating activities
(Loss) gain on investment securities............................................ 47,000 (39,974)
Provision for possible loan losses.............................................. 995,001 1,280,000
Provision for possible losses on real estate owned.............................. 200,000 64,026
Depreciation.................................................................... 186,658 172,971
Amortization of bond discounts.................................................. (44,316) 96,002
Deferred gain on sale leaseback................................................. 0 (110,938)
Deferred loan fees.............................................................. (175,110) (264,027)
(Increase) decrease in accrued interest receivable and other assets............. 42,521 (29,346)
Increase in accrued interest payable and other liabilities...................... 186,362 18,878
------------- -------------
Net cash used in operating activities......................................... (411,801) (153,884)
CASH FLOWS FROM INVESTING ACTIVITIES:
Net decrease (increase) in interest-bearing deposits in other banks............... 2,173,000 (2,470,000)
Securities held to maturity:
Proceeds from maturities........................................................ 4,140,452 2,220,848
Purchases....................................................................... (5,201,119) (16,824,280)
Proceeds from the sale of investment securities................................. 0 3,685,850
Securities available for sale:
Proceeds from maturities........................................................ 3,301,435 0
Purchases....................................................................... (996,562) 0
Net decrease in loans............................................................. 2,338,073 8,958,081
Purchases of premises and equipment............................................... (30,588) (521,345)
Proceeds from sale of real estate owned........................................... 2,066,217 634,955
------------- -------------
Net cash provided (used) in investing activities................................ 7,790,908 (4,315,891)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) noninterest bearing demand................................ 1,791,683 (1,325,515)
Net increase (decrease) in interest-bearing demand, savings deposits, and other
time deposits.................................................................... (6,382,201) 2,387,459
Net decrease in time deposits of $100,000 or more................................. (481,508) (1,310,000)
Payments on maturing debt......................................................... 0 (35,500)
Proceeds from the issuance of common stock........................................ 0 284,135
------------- -------------
Net cash provided (used) by financing activities................................ (5,072,026) 579
------------- -------------
Net increase (decrease) in cash and cash equivalents.............................. 2,307,081 (4,469,196)
Cash and cash equivalents at beginning of year.................................... 8,345,840 12,815,036
------------- -------------
Cash and cash equivalents at end of year........................................ $ 10,652,921 $ 8,345,840
------------- -------------
------------- -------------
NON-CASH ACTIVITIES:
Property acquired through foreclosure............................................. $ 2,180,926 $ 1,357,416
------------- -------------
------------- -------------
Transfer of securities to available for sale...................................... $ 0 $ 14,860,849
------------- -------------
------------- -------------
Adjustments to securities available for sale...................................... $ (409,868) $ 53,435
------------- -------------
------------- -------------
Repayment of KSOP debt............................................................ $ 38,055 $ 39,089
------------- -------------
------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
MONARCH BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include
Monarch Bancorp (the Company) and its wholly owned subsidiaries, Monarch Bank
(Bank) and M. B. Mortgage Co. M. B. Mortgage is currently inactive. All
significant intercompany balances and transactions have been eliminated.
STATEMENTS OF CASH FLOWS: For purposes of reporting cash flows, cash and
cash equivalents include cash and due from banks and federal funds sold.
Interest paid for the years ended December 31, 1994 and 1993 was approximately
$1,082,000 and $1,116,000, respectively. Income taxes paid for the years ended
December 31, 1994, and December 31, 1993 was $1,600, respectively.
INVESTMENT SECURITIES: As of December 31, 1993, the Company adopted
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." This statement addresses the
accounting and reporting for investments in equity securities that have readily
determinable fair values, and all investments in debt securities. Under this
statement, securities are classified into three categories as follows:
HELD-TO-MATURITY SECURITIES (HTM) -- Securities that the Company has the
positive intent and ability to hold to maturity. These securities are to be
reported at amortized cost.
TRADING SECURITIES -- Securities that are bought and held principally
for the purpose of selling them in the near term. These securities are to be
reported at fair value with unrealized gains and losses included in
earnings.
AVAILABLE-FOR-SALE SECURITIES (AFS) -- Securities not classified as
either held-to-maturity or trading securities. Securities classified as
available for sale are those debt securities that the Bank intends to hold
for an indefinite period of time, but not necessarily to maturity. Any
decision to sell a security classified as available for sale would be based
on various factors, including significant movements in interest rates,
changes in the maturity mix of the Bank's assets and liabilities, liquidity
needs, regulatory capital considerations, and other similar factors.
Securities available for sale are carried at fair value. Unrealized gains or
losses are reported as increases or decreases in stockholder's equity, net
of the related deferred tax effect. Realized gains or losses, determined on
the basis of the cost of specific securities sold, are included in earnings.
LOANS: Loans are stated at amounts advanced less payments received.
Interest income on loans is accrued daily as earned using the "simple-interest"
method, except when a loan is 90 days delinquent (unless well secured and in the
process of being collected) or where reasonable doubt exists as to the
collectibility of the interest, in which case the accrual of income is
discontinued and any previously accrued interest is reversed.
The adequacy of the allowance for possible loan losses is determined by
management based on a number of factors, including loan loss experience, review
of problem loans, quality of the portfolio, and current economic conditions.
Loans which are considered to be uncollectible are charged to the allowance for
possible loan losses, and subsequent recoveries are added to the allowance. The
allowance is also increased (decreased) by credits for loan losses charged
against (returned to) income. Management believes the allowance for possible
loan losses reflects all losses inherent in the loan portfolio.
Loan origination fees offset by certain direct loan origination costs are
deferred and amortized over the expected lives of the related loans as an
adjustment of yield.
PREMISES AND EQUIPMENT: Premises and equipment are stated at cost, less
accumulated depreciation and amortization which are charged to expense on a
straight-line basis over the estimated useful lives of the assets which range
from 5-10 years or, in the case of leasehold improvements, over the terms of the
leases, if shorter.
F-6
<PAGE>
MONARCH BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. ACCOUNTING POLICIES (CONTINUED)
OTHER REAL ESTATE OWNED: Other real estate owned (acquired through
foreclosure or deed in lieu) is carried at fair value less estimated selling
costs. Any reduction to fair value at the time of acquisition is recorded as a
charge against the allowance for possible loan losses. Any subsequent reduction
is recorded as expense. Gains or losses upon disposition are reflected in
current operations. Loans that are in foreclosure proceedings or that represent
"insubstance foreclosures" are carried as loans as required by bank regulatory
guidelines.
INCOME TAXES: As of January 1, 1993, the Company adopted SFAS No. 109,
"Accounting for Income Taxes." This statement requires an asset and liability
approach for computing deferred income taxes. A deferred tax asset is recognized
for temporary differences which will result in future deductible amounts and
carryforwards. A deferred tax liability is recognized for temporary differences
which will result in future taxable amounts. In the event the future
consequences of differences between financial reporting bases and the tax bases
of the Company's assets and liabilities result in a deferred tax asset, SFAS 109
requires an evaluation of the probability of being able to realize the future
benefits indicated by such asset. A valuation allowance related to a deferred
tax asset is recorded when it is more likely than not that some portion or all
of the deferred tax asset will not be realized. The impact of adopting this
standard was not significant.
NEW ACCOUNTING STANDARDS: In May 1993, the Financial Accounting Standards
Board ("FASB") issued Statement of Financial Accounting Standards No. 114,
"Accounting by Creditors for Impairment of a Loan," which was amended by SFAS
No. 118 in October 1994. This statement amends FASB statements Nos. 5,
"Accounting for Contingencies," and 15, "Accounting by Debtors and Creditors for
Troubled Debt Restructurings." This statement prescribes that a loan is impaired
when it is probable that a creditor will be unable to collect all amounts due
(principal and interest) according to the contractual terms of the loan
agreement. Measurements of the impairment can be based on the expected future
cash flows of an impaired loan which are to be discounted at the loan's
effective interest rate or impairment can be measured by reference to an
observable market price, if one exists, or the fair value of the collateral for
a collateral-dependent loan. Creditors may select the measurement method on a
loan-by-loan basis except that collateral dependent loans for which foreclosure
is probable must be measured at the fair value of the collateral. Additionally,
the statement prescribes measuring impairment of a restructured loan by
discounting the total expected future cash flows of the loan's effective rate of
interest in the original loan agreement. Finally, the impact of initially
applying the statement is reported as a part of bad-debt expense. The Company
must adopt this standard by 1995. The Company has not yet determined the effects
of adopting this standard.
In December 1991, the FASB issued SFAS No. 107, "Disclosures About Fair
Value of Financial Instruments." Implementation of SFAS No. 107 is required for
fiscal years ending after December 15, 1992 for institutions with assets greater
than $150 million, and for fiscal years ending after December 15, 1995 for all
other institutions, however, earlier adoption is permitted. SFAS No. 107
requires disclosures about fair value for all financial instruments. The Company
will implement the new standard in 1995.
RECLASSIFICATIONS: Certain reclassifications have been made to the 1993
financial statements to conform to the 1994 presentation.
SHARES OF COMMON STOCK: In December 1993, the Company completed a 1-for-5
reverse stock split and reduced the authorized and issued shares of common stock
of the Company.
EARNINGS PER SHARE: Earnings per share information is based on average
shares outstanding during the year plus the effect of dilutive stock options.
F-7
<PAGE>
MONARCH BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. REGULATORY MATTERS
Following the conclusion of a joint, second quarter 1994 FDIC and California
State Banking Department (Superintendent) examination of the Bank, Monarch Bank
stipulated to the issuance of a Section 8(b) Order and a California Financial
Code Section 1913 Order (the "Orders") which became effective on December 23,
1994 and December 14, 1994, respectively. The Orders are similar in content and
require the Bank to perform several actions within certain time frames and
include the following: (i) to have and retain management who are acceptable to
the Superintendent and the FDIC and who are qualified to restore the Bank to a
safe and sound condition; (ii) the Board of Directors to increase its
participation in the affairs of the Bank; (iii) by no later than April 30, 1995,
the Bank shall have Tier 1 capital in an amount as to equal or exceed 7% of the
Bank's total assets and to adopt a capital plan to meet the minimum risk-based
capital requirements as described in FDIC rules and regulations; (iv) to
eliminate from its books all assets classified loss in the 1994 examination and
to reduce assets classified substandard according to defined schedules; (v)
prohibits and restricts further extensions of credit to borrowers whose assets
were adversely classified in the 1994 examination; (vi) requires the Bank to
revise and amend its loan policy and improve credit administration procedures;
(vii) to reduce loan concentrations; (viii) to establish and maintain an
adequate reserve for loan losses and revise the Bank's policy for determining
the adequacy of the loan loss reserve; (ix) to prepare and implement a written
plan and budget for review and comment by the FDIC and for the Board's review
versus actual performance on a quarterly basis; (x) to correct, to the extent
possible, certain violations of law contained in the examination report; (xi) to
adopt and implement a policy to provide for adequate internal controls and an
internal audit program; (xii) to file amended Call Reports where needed; (xiii)
to not pay cash dividends without the prior consent of the FDIC and
Superintendent; and (xiv) to file written progress reports with the FDIC and
Superintendent.
The Bank, as a result of the 1994 examinations, was also notified by the
FDIC that the Bank had fallen within the undercapitalized capital category under
Section 38 of the FDIC Act. The Bank is subject to mandatory restrictions under
Section 38 including the submission of a capital restoration plan and
restrictions on asset growth, acquisitions, new activities, new branches,
payment of dividends, or making other capital distributions or management fees.
The Bank has filed and the FDIC has approved a capital restoration plan, and
Monarch Bancorp has executed a guarantee of the capital plan.
F-8
<PAGE>
MONARCH BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INVESTMENT SECURITIES
Investment securities consist of the following at December 31:
<TABLE>
<CAPTION>
1994
------------------------------------------------------
<S> <C> <C> <C> <C>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
------------- ----------- ----------- -------------
SECURITIES HELD TO MATURITY:
US Government Securities............................... $ 246,379 $ -- $ (2,984) $ 243,395
US Agency Securities................................... 2,500,000 -- (151,250) 2,348,750
Mortgage-backed Securities............................. 1,507,730 -- (80,252) 1,427,478
Other securities....................................... 103,837 -- -- 103,837
------------- ----------- ----------- -------------
$ 4,357,946 $ -- $ (234,486) $ 4,123,460
------------- ----------- ----------- -------------
------------- ----------- ----------- -------------
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
------------- ----------- ----------- -------------
<S> <C> <C> <C> <C>
SECURITIES AVAILABLE FOR SALE:
Mortgage-backed Securities............................. $ 6,946,300 $ -- $ (356,442) $ 6,589,858
US Government fund..................................... 5,190,584 -- -- 5,190,584
------------- ----------- ----------- -------------
$ 12,136,884 $ -- $ (356,442) $ 11,780,442
------------- ----------- ----------- -------------
------------- ----------- ----------- -------------
</TABLE>
Adjustments in book value of ($356,442) and $53,435 were recorded on
December 31, 1994 and 1993, respectively in order to mark the AFS securities to
estimated fair value, and a similar net unrealized gain (loss) was recorded to
shareholders' equity.
The amortized cost and estimated fair value of HTM securities and AFS
securities at December 31, 1994, by contractual maturity, are shown below.
Expected maturities will differ from contractual maturities because of the
payment stream associated with mortgage-backed securities.
<TABLE>
<CAPTION>
AMORTIZED ESTIMATED FAIR AMORTIZED ESTIMATED FAIR
COST (HTM) VALUE (HTM) COST (AFS) VALUE (AFS)
------------ --------------- ------------- --------------
<S> <C> <C> <C> <C>
Due in one year or less........................... $ -- $ -- $ 5,190,584 $ 5,190,584
Due after one year through five years............. 2,746,379 2,592,145 996,570 996,563
Due after five years through ten years............ 103,837 103,837 -- --
Mortgage-backed securities........................ 1,507,730 1,427,478 5,949,729 5,593,295
------------ --------------- ------------- --------------
$ 4,357,946 $ 4,123,460 $ 12,136,883 $ 11,780,442
------------ --------------- ------------- --------------
------------ --------------- ------------- --------------
</TABLE>
There were no sales of securities in 1994, gross realized gains and gross
realized losses on sales of securities were:
<TABLE>
<CAPTION>
1993
---------
<S> <C>
Gross realized gains:
U.S. Government and agency securities............................................ $ 40,487
---------
---------
Gross realized losses:
U.S. Government and agency securities............................................ $ 513
---------
---------
</TABLE>
At December 31, 1994 investment securities with a carrying amount of
approximately $2,271,000 were pledged as collateral to secure public deposits.
F-9
<PAGE>
MONARCH BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. LOANS
Most of the loans made by the Bank are to customers located in the Orange
County, California area. Mortgage and construction loans are collateralized by
real estate trust deeds. The Bank generally requires security in the form of
assets, including real estate, on commercial and installment loans. The ability
of the Bank's customers to honor their loan agreements is dependent upon the
general economy of the Bank's market area.
Following is a summary of transactions affecting the allowance for possible
loan losses:
<TABLE>
<CAPTION>
1994 1993
------------ ------------
<S> <C> <C>
Beginning balance................................................. $ 1,055,347 $ 575,294
Provision for loan losses....................................... 995,001 1,280,000
Amounts charged off............................................. (991,694) (815,233)
Recoveries...................................................... 78,317 15,286
------------ ------------
Ending balance.................................................... $ 1,136,971 $ 1,055,347
------------ ------------
------------ ------------
</TABLE>
Loans aggregating approximately $362,000 and $505,000 were past due 90 days
or more but were accruing interest, and loans aggregating approximately $431,000
and $2,420,000 were on non-accrual as of December 31, 1994 and 1993,
respectively. Interest income that was not recognized because accrual of
interest on the related loan had been discontinued amounted to approximately
$26,000 and $98,000 for the years ended December 31, 1994 and 1993,
respectively.
The Bank's lending is concentrated in Orange County and surrounding areas,
which have experienced adverse economic conditions, including declining real
estate values. Although management believes the level of its allowance for
possible loan losses and the carrying value of its other real estate owned as of
December 31, 1994 is appropriate, additional decline in the local economy may
result in losses that cannot reasonably be predicted at this time.
In the ordinary course of business, the Bank has granted loans to certain
officers and directors and the companies with which they are associated. Changes
in the aggregate of loans outstanding to a total of five (5) such individual
parties are as follows:
<TABLE>
<S> <C>
Balance, January 1, 1993......................................... $ 559,924
Additions...................................................... 22,391
Deletions...................................................... (296,263)
---------
Balance, December 31, 1993....................................... 286,052
Additions...................................................... 73,701
Deletions...................................................... (218,562)
---------
Balance, December 31, 1994....................................... $ 141,191
---------
---------
</TABLE>
Additions represent new loans or advances made in the normal business
process of the Bank. Deletions represent repayments of loans from normal monthly
reduction on installment type loans and final payments on other loans.
In the opinion of management, all extensions of credit to related parties
are on terms similar to transactions with nonaffiliated parties and none of the
loans to insiders were past due as of December 31, 1994.
F-10
<PAGE>
MONARCH BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. PREMISES AND EQUIPMENT
The components of premises and equipment at December 31, are as follows:
<TABLE>
<CAPTION>
1994
------------
<S> <C>
Furniture, fixtures and equipment............................................... $ 989,769
Leasehold improvements.......................................................... 13,774
------------
1,003,543
Less accumulated depreciation and amortization.................................. (353,486)
------------
$ 650,057
------------
------------
</TABLE>
Depreciation expense was $186,658 and $172,971 for the years ended December
31, 1994 and 1993, respectively. During 1988, the Bank sold and leased back
certain of its furniture and equipment (Note 14).
In December 1993, the Bank began to renegotiate the option period on a
sublease at a reduced rate and recorded a $61,000 projected loss; an additional
loss on the differential between projected future income and expense of $19,522
was recorded in 1994 at the completion of the negotiations (Note 10).
6. NOTES PAYABLE
Convertible subordinated debentures totaling $53,500 were outstanding for
years ended December 31, 1994.
The convertible subordinated debentures were issued in 1988 and 1989
pursuant to a private placement offering. These debentures mature in August 1995
and require semiannual interest payments at a floating rate equal to one percent
less than prime rate. One member of the Board of Directors owns $3,500 of the
outstanding debentures.
The debentures outstanding at December 31, 1994 are convertible into shares
of the Company's common stock at a price equal to the Company's market value on
the last day of the month previous to the date of conversion. The debentures are
subordinate to senior indebtedness of the Company (as defined) and may be
redeemed by the Company at any time at face value plus accrued interest.
7. SHAREHOLDERS' EQUITY
During 1993, shareholders' equity was increased from the exercise of stock
options, conversion of debt, and a private placement. During the year ended
December 31, 1993 these changes were as follows:
<TABLE>
<S> <C>
Exercise of stock options......................................... $ 19,000
Option price.................................................... $ 4.75
Number of options exercised (shares issued)..................... 4,000
Conversion of debt................................................ $ 1,038
Conversion price................................................ $ 4.25
Shares issued................................................... 244
Private placement................................................. $ 264,097
Price........................................................... $ 5.00
Shares issued................................................... 52,783
</TABLE>
F-11
<PAGE>
MONARCH BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. INCOME TAXES
The provision for income taxes consists of the following for the years ended
December 31:
<TABLE>
<CAPTION>
1994 1993
--------- ---------
<S> <C> <C>
Current:
Federal.................................................................. $ -- $ --
State.................................................................... 1,600 1,600
--------- ---------
$ 1,600 $ 1,600
--------- ---------
--------- ---------
</TABLE>
The provision for income taxes differs from that which would result from
applying the U. S. statutory rate as follows:
<TABLE>
<CAPTION>
1994 1993
----------- -----------
<S> <C> <C>
Expected (benefit) provision at 34% statutory rate.................. $ (629,972) $ (455,558)
Provision for state income taxes, net of Federal Benefit............ 1,600 1,600
Addition to Valuation Allowance..................................... 629,972 --
Unbenefited net operating loss...................................... -- 455,558
----------- -----------
Provision for income taxes.......................................... $ 1,600 $ 1,600
----------- -----------
----------- -----------
</TABLE>
As of December 31, 1994, the Company had net operating loss carryforwards
for federal income tax purposes of approximately $2,679,000. Expiration dates of
the loss carryforwards are as follows:
<TABLE>
<CAPTION>
EXPIRATION DATE AMOUNT
- -------------------------------------------------------------------------------- ------------
<S> <C>
2000............................................................................ $ 35,000
2001............................................................................ 87,000
2002............................................................................ 255,000
2004............................................................................ 1,000
2005............................................................................ 16,000
2006............................................................................ 11,000
2007............................................................................ 57,000
2008............................................................................ 1,010,000
2009............................................................................ 1,207,000
------------
$ 2,679,000
------------
------------
</TABLE>
The Company has a California net operating loss carryforward of
approximately $1,134,000 at December 31, 1994 which will expire in the year
ending December 31, 1998.
At December 31, 1994, the Company also has investment tax credit carryovers
of approximately $333,000 to offset against future federal tax liabilities.
Carryforward amounts expire at various dates beginning in 2000.
F-12
<PAGE>
MONARCH BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. INCOME TAXES (CONTINUED)
The components of the Company's deferred tax assets and liabilities at
December 31, are:
<TABLE>
<CAPTION>
1994 1993
------------- -------------
<S> <C> <C>
Loan Loss Reserves.............................................. $ 360,000 $ 368,000
Net Operating Loss Carryforward................................. 997,000 542,000
Other Assets/liabilities........................................ 210,000 --
Federal Income Tax Credit Carryforward.......................... 333,000 333,000
------------- -------------
Total Assets.................................................... 1,900,000 1,243,000
Valuation Allowance............................................. (1,900,000) (1,195,000)
------------- -------------
Total Deferred Asset............................................ -- 48,000
Other assets/liabilities........................................ -- (48,000)
------------- -------------
Total Deferred Liability........................................ -- (48,000)
------------- -------------
Net Deferred Taxes.............................................. $ -- $ --
------------- -------------
------------- -------------
</TABLE>
Pursuant to the Tax Reform Act of 1986, use of the Company's net operating
loss carryforwards may be substantially limited if a cumulative change in
ownership of more than 50% occurs within any three year period. As of December
31, 1994, such cumulative change was less than 50%.
9. BENEFIT PLANS
The Company has a stock option plan which provides that options for up to
30% of the outstanding shares of the Company's common stock may be granted to
full-time salaried officers, key employees and directors of the Company. Options
are not to be granted for less than the fair market value of the stock at the
date of grant and are exercisable for five or ten years from the date of grant.
Options outstanding are exercisable at values ranging from $4.25 to $5.00 per
share.
A summary of the changes in outstanding options follows:
<TABLE>
<CAPTION>
1994 1993
--------- ---------
<S> <C> <C>
Balance, at January 1................................................... 113,016 104,016
Options granted....................................................... 0 22,000
Options exercised..................................................... 0 (4,000)
Options canceled........................................................ (4,000) (9,000)
--------- ---------
Balance, at December 31................................................. 109,016 113,016
--------- ---------
--------- ---------
</TABLE>
Options for approximately 50,000 shares were exercisable at December 31,
1994.
During 1992 the Company and Bank adopted the Monarch Bancorp and Monarch
Bank Employee Stock Ownership and Salary Deferral Plan ("KSOP"), which is
available to all employees, with the first deduction from employees' salaries on
January 15, 1993. In 1992 the KSOP obtained a $250,000 loan from another
financial institution, which is guaranteed by the Company, and acquired 10,672
shares of previously issued Company stock at a price of $5.00 per share. In
March 1993, the KSOP acquired an additional 39,651 shares at $5.00 per share in
a private placement offering. Repayments on the loan are made by employee salary
deductions and from possible matching contributions by the Bank. The loan has a
term of five years and an interest rate of 8%. Matching Bank contributions
totaled $46,108 and $19,920 in 1994 and 1993 respectively.
F-13
<PAGE>
MONARCH BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. COMMITMENTS AND CONTINGENCIES
The Company conducts operations from leased facilities under operating
leases which expire on various dates through 2001. The Company has three ten
year options to renew the lease on its branch facility.
The following is a schedule of future minimum rental payments required under
operating leases that have initial or remaining noncancelable lease terms in
excess of one year as of December 31, 1994:
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31 AMOUNT
- -------------------------------------------------------------------------------- ------------
<S> <C>
1995............................................................................ $ 257,489
1996............................................................................ 187,762
1997............................................................................ 123,218
1998............................................................................ 123,218
1999............................................................................ 123,218
Thereafter...................................................................... 195,096
------------
$ 1,010,001
------------
------------
</TABLE>
Minimum rental payments are subject to increase based on changes in the
consumer price index. Annual rental expense from operating leases was
approximately $297,000 and $701,000 in 1994 and 1993, respectively.
Sublease rental income for the years ended December 31, 1994 and 1993
totaled approximately $69,000 and $118,000, respectively. The sub-lease matured
in 1993 and was renegotiated at a lower rate in mid-1994 and extended to June
1996 to coincide with the Bank's lease commitment on the property. A projected
loss of approximately $61,000 on this sublease was recorded in 1993 and an
additional $20,000 in 1994 to recognize the estimated difference (loss) in
rental income to be collected under one sublease agreement versus rent required
to be paid under the Company's master lease.
The Bank is required to maintain reserve balances with the Federal Reserve
Bank. The required balance at December 31, 1994 was approximately $530,000.
The Bank is a defendant in litigation and claims arising in the normal
course of business. Management, after consultation with legal counsel, believes
that the liabilities, if any, arising from such litigation or claims will not be
material to the Company's consolidated financial position and results of
operations.
The Company and Bank executed a three year Employment Agreement effective
July 23, 1991 with an executive officer that provides for a base salary with
annual cost of living adjustments and other defined benefits. Should the
Employment Agreement be terminated without cause, or as a result of merger or
corporate dissolution, the executive would receive not less than six months base
salary and benefits nor more than one year's base salary. This agreement was
extended for an additional year or until July 1995 by the Board of Directors.
11. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Bank is a party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to fund commercial and
construction loan agreements and standby letters of credit.
These instruments involve credit risk in excess of the amounts recognized as
loans in the consolidated balance sheets. As of December 31, 1994 and 1993 the
Bank had outstanding commitments under standby letters of credit of
approximately $10,000 and $252,000, respectively, and commitments to fund
personal
F-14
<PAGE>
MONARCH BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK (CONTINUED)
lines of credit and commercial and construction loans of approximately
$4,055,000 and $5,933,000, respectively, which represents the Bank's maximum
exposure to credit loss in the event of nonperformance by the other party.
Credit policies and collateral requirements for these commitments are similar to
those for loans already outstanding (Note 4).
Commitments generally have fixed expiration dates. The Bank minimizes
interest rate risk associated with these instruments through variable rate
structures.
12. RESTRICTIONS ON PAYMENT OF DIVIDENDS
As of December 31, 1994, the Company was not eligible to pay dividends
because of the accumulated deficit in shareholders' equity.
The Bank is subject to certain restrictions under regulations governing
state banks which limit its ability to transfer funds to the Company through
intercompany loans, advances, or cash dividends. As of December 31, 1994, the
Board under the terms of certain regulatory Orders (Note 2) may not pay
dividends without the prior approval of the FDIC and State Superintendent of
Banks
F-15
<PAGE>
MONARCH BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. CONDENSED (PARENT COMPANY ONLY) FINANCIAL INFORMATION
<TABLE>
<CAPTION>
CONDENSED BALANCE SHEETS
<S> <C>
DECEMBER
31,
1994
-----------
Assets:
Cash.......................................................... $ 21,750
Investment in bank subsidiary................................. 907,473
-----------
$ 929,223
-----------
-----------
Liabilities:
Notes payable................................................. $ 53,500
Other borrowing............................................... 172,856
Other liabilities............................................. 1,345
-----------
227,701
Shareholders' equity............................................ 701,522
-----------
$ 929,223
-----------
-----------
</TABLE>
<TABLE>
<CAPTION>
CONDENSED STATEMENTS OF OPERATIONS
<S> <C> <C>
1994 1993
---------- ----------
Total Interest income.............................. $ 516 $ 1,482
Interest expense................................... 1,796 5,845
Other.............................................. 2,165 732
---------- ----------
Total Expenses............................. 3,961 6,577
---------- ----------
Loss before equity in undistributed earnings of
bank subsidiary................................... (3,445) (5,095)
Equity in undistributed losses of bank
subsidiary........................................ (1,771,470) (1,335,465)
---------- ----------
Net loss................................... $(1,774,915) $(1,340,560)
---------- ----------
---------- ----------
<CAPTION>
CONDENSED STATEMENTS OF CASH FLOWS
1994 1993
---------- ----------
<S> <C> <C>
Net loss........................................... $(1,774,915) $(1,340,560)
Net adjustments to loss............................ 1,771,470 1,335,465
---------- ----------
Cash flows from operating activities............... (3,445) (5,095)
Cash flows from investing activities............... 277 (280,726)
Cash flows from financing activities............... 0 248,636
---------- ----------
Net decrease in cash............................... (3,168) (37,185)
Cash beginning of year............................. 24,918 62,103
Cash end of year................................... $ 21,750 $ 24,918
---------- ----------
---------- ----------
</TABLE>
14. RELATED PARTY TRANSACTIONS
During 1989 and prior years, the Bank executed certain transactions with a
former director and shareholder and a company controlled by that former director
as follows:
In 1988, the Bank sold and leased back substantially all of its
furniture and equipment. This transaction was brokered through a company
controlled by the former director. The excess of sales proceeds over
carrying cost, aggregating $740,061, was deferred and recognized ratably
over the
F-16
<PAGE>
MONARCH BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. RELATED PARTY TRANSACTIONS (CONTINUED)
leaseback term (five years) on a straight-line basis. Amortization of this
excess amounted to approximately $110,000 in 1993. The lease was accounted
for as an operating lease with monthly payments of $39,249 due over a
five-year term. The Bank pledged certain investment securities to secure
payment of rental and other amounts due under the lease agreement (Note 3).
This lease matured in September 1993 and the Bank exercised its option and
repurchased these assets at a cost of approximately $377,000.
In 1989, the Bank sold its residual value in a matured lease to the
former director in exchange for a convertible debenture in another bank. The
debenture was converted into shares of common stock in July 1992; and the
Bank continues to hold this investment at a market value of $103,000.
The Bank's health and life insurance programs have been contracted based on
competitive bids through Rice Brown Financial. Mr. Brown is an insurance broker
and a director of the Company and the Bank.
15. RISK-BASED CAPITAL STANDARDS
The Bank is required to maintain certain regulatory capital ratios. These
ratios at December 31, 1994 were as follows:
<TABLE>
<CAPTION>
MINIMUM MONARCH
RATIO BANK
----------- -----------
<S> <C> <C>
Tier 1 leverage capital ratio........................................... 4.0% 2.1%
Tier 1 risk-based capital ratio......................................... 4.0% 4.1%
Total risk-based capital................................................ 8.0% 4.8%
</TABLE>
During 1994, the Bank was notified by the FDIC that its capital had fallen
within the undercapitalized category under Section 38 of the FDIC Act. Section
38 requires or permits the FDIC to take certain mandatory and discretionary
actions when an institution becomes undercapitalized for prompt corrective
action purposes. At December 31, 1994, the Bank was subject to mandatory
restrictions of Section 38 including submission of a capital restoration plan
and restrictions on asset growth, acquisitions, new activities, new branches,
payment of dividends, or making any other capital distribution or management
fees. As a result of such notification, the Bank filed a capital plan with the
FDIC and Monarch Bancorp executed a guarantee of the capital plan.
At periodic intervals, the FDIC routinely examines the Company's
consolidated financial statements as part of their legally prescribed oversight
of the banking industry. Based on these examinations, the regulators can direct
that the Bank's financial statements be adjusted in accordance with their
findings.
16. SUBSEQUENT EVENTS
As part of Monarch Bank's Capital Restoration Plan that was filed in
December 1994, the Company on December 20, 1994 engaged Belle Plaine Partners,
Inc., and McAllen Capital Partners (the Financial Advisors) as advisors in
connection with the recapitalization of the Company and Bank. The Financial
Advisors assisted the Company in structuring and promoting a Private Placement
Stock Offering (the Offering) for a minimum of 2,592,593 shares up to a maximum
of 5,555,556 shares of its common stock at a price of $1.35 per share. The
Offering was directed to "accredited investors" as defined in Rule 501(a) of
Regulation D of the Securities and Exchange Commission. The Offering terminates
on April 30, 1995.
On March 31, 1995, the Company had a first closing of the Offering for
approximately $6,139,000 and issued 4,547,111 new shares of common stock.
Proceeds from the Offering were used to pay approximately $470,000 in Offering
expenses; $3,550,000 to increase the Company's investment in Monarch Bank;
$53,500 to retire Company debt; and approximately $2,065,000 in cash is being
held by the Company for future operating needs or investments.
F-17
<PAGE>
MONARCH BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
16. SUBSEQUENT EVENTS (CONTINUED)
As a result of the capital increase for the Bank, the Bank's Tier 1 capital
ratio, as of March 31, 1995 was 8.16%. The increase in the Bank's capital meets
or exceeds the Bank's regulatory commitments to the FDIC and Superintendent to
increase the Bank's ratio for Tier 1 capital to total assets to equal or exceed
7.0%.
Two investors have filed with the Federal Reserve and the State
Superintendent of Banks to allow two of the new investors to acquire interests
of between 10% and 15% of the Company. Subject to regulatory approval, the
Company currently expects to complete the Offering with the additional sale of
approximately 878,000 shares of common stock. Completion of an additional
closing would provide approximately $1,185,000 in additional capital. Once the
Offering has closed, the Company expects to conduct a shareholders' rights
offering for shareholders of record prior to the Offering.
As discussed in Note 8, pursuant to the Tax Reform Act of 1986, use of the
Company's net operating loss carryforwards may be substantially limited if a
cumulative change in ownership of more than 50% occurs within any three year
period. The recapitalization of ownership pursuant to the first closing of the
offering on March 31, 1995, will result in an ownership change in excess of 50%,
which will substantially limit the use of the Company's net operating loss and
tax credit carryforwards. The extent of this limitation has not been determined
at this time.
17. RESTATEMENT OF 1994 FINANCIAL STATEMENTS
Subsequent to the original issuance of the 1994 financial statements, the
Bank discovered a significant possible loss in a real estate loan. The economic
events that resulted in this loss were present at December 31, 1994 and,
accordingly, the 1994 financial statements have been restated to include an
additional $200,000 in the provision for possible loan losses.
F-18
<PAGE>
PART 1 ITEM 1
FINANCIAL STATEMENTS
MONARCH BANCORP
CONDENSED, CONSOLIDATED BALANCE SHEET
(UNAUDITED)
(000'S OMITTED)
ASSETS
<TABLE>
<CAPTION>
MARCH 31,
1995
-----------
<S> <C>
Cash and due from banks................................................................................ $ 3,835
Interest bearing deposits and investment securities.................................................... 17,733
Federal funds sold..................................................................................... 10,250
Loans and leases (net)................................................................................. 29,383
Premises and equipment................................................................................. 632
Other real estate owned................................................................................ 617
Other assets........................................................................................... 871
-----------
Total assets......................................................................................... $ 63,321
-----------
-----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits............................................................................................... $ 58,643
Notes payable.......................................................................................... 0
Other borrowings....................................................................................... 163
Deferred gain on sale of assets........................................................................ 0
Accrued interest payable and other liabilities......................................................... 412
-----------
TOTAL LIABILITIES.................................................................................... 56,553
Common stock, no par value, authorized 25,000,000 shares 5,341,435 and 794,324 shares outstanding at
3/31/95 and at 12/31/94, respectively................................................................. 13,036
Accumulated deficit.................................................................................... (5,955)
Unrealized appreciation (depreciation) on investment securities available for sale..................... (150)
Deferred charge related to KSOP........................................................................ (163)
-----------
TOTAL SHAREHOLDERS' EQUITY........................................................................... 6,768
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........................................................... $ 63,321
-----------
-----------
</TABLE>
(see accompanying notes)
F-19
<PAGE>
MONARCH BANCORP
CONDENSED, CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS
PERIOD ENDED
------------------------
MARCH 31, MARCH 31,
1995 1994
----------- -----------
<S> <C> <C>
(000'S OMITTED)
INTEREST AND LOAN FEE INCOME:
Investment securities.................................................................... $ 259 $ 204
Federal funds sold....................................................................... 48 21
Loans and leases......................................................................... 691 700
----------- -----------
TOTAL INTEREST INCOME.................................................................. 998 925
INTEREST EXPENSE:
Deposits................................................................................. 285 265
Notes payable............................................................................ 1 1
----------- -----------
TOTAL INTEREST EXPENSE................................................................. 286 266
----------- -----------
NET INTEREST INCOME........................................................................ 712 659
Less increase in provision for loan losses............................................... 0 0
----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES........................................ 712 659
OTHER OPERATING INCOME:
Service charges on deposit accounts...................................................... 117 101
Other service charge and fee income...................................................... 67 66
Other income............................................................................. 172 0
----------- -----------
TOTAL OTHER INCOME..................................................................... 356 167
OTHER OPERATING EXPENSES:
Salaries and benefits.................................................................... 430 404
Office operations........................................................................ 287 232
Depreciation............................................................................. 40 49
Advertising and marketing................................................................ 31 37
Other real estate owned.................................................................. 12 5
Professional services.................................................................... 63 54
Other.................................................................................... 30 1
----------- -----------
TOTAL OPERATING EXPENSES............................................................... 893 782
Net income before provision for taxes...................................................... 175 44
Provision for taxes...................................................................... (7) 0
----------- -----------
NET INCOME AFTER PROVISION FOR TAXES....................................................... $ 182 $ 44
----------- -----------
----------- -----------
PER SHARE INFORMATION
Number of shares (Weighted average)...................................................... 835,563 794,324
Income per share (dollars)............................................................... $0.22 $0.06
</TABLE>
(see accompanying notes)
F-20
<PAGE>
MONARCH BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THREE MONTH PERIOD
ENDED
------------------------
MARCH 31, MARCH 31,
1995 1994
----------- -----------
<S> <C> <C>
(000'S OMITTED)
Cash flows from operating activities:
Net income............................................................................... $ 182 $ 44
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan loss................................................................ 0 0
Depreciation, amortization............................................................. (40) (49)
Increase (decrease) in accrued interest payable and other liabilities.................. 10 (97)
Increase in accrued interest receivable and other assets............................... (188) (233)
----------- -----------
NET CASH (FROM) USED BY OPERATING ACTIVITIES......................................... (37) (335)
Cash flows from investing activities:
Principal payments received on investment securities..................................... 169 5,575
Purchases of investment securities....................................................... (250) (5,959)
Increase in net loans.................................................................... 623 367
Proceeds from sale of oreo............................................................... 0 1,252
Additions to premises and equipment...................................................... (22) (10)
----------- -----------
NET CASH USED BY INVESTING ACTIVITIES................................................ 520 1,225
Cash flows from financing activities:
Net decrease in demand and savings deposits.............................................. (2,665) (442)
Repayment of debt........................................................................ (54) 0
Proceeds from issuance of common stock................................................... 5,668 284
Proceeds from issuance of debt........................................................... 0 0
----------- -----------
NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES..................................... 2,949 (158)
Net increase (decrease) in cash and cash equivalents....................................... 3,432 732
Cash and cash equivalents at beginning of three month period............................... 10,653 8,346
----------- -----------
CASH AND CASH EQUIVALENTS AT THE END OF THREE MONTH PERIOD................................. $ 14,085 $ 9,078
----------- -----------
----------- -----------
NON-CASH ACTIVITIES:
Property acquired through foreclosure.................................................... $ 0 $ 810
----------- -----------
----------- -----------
Repayment of KSOP debt................................................................... $ 10 $ 9
----------- -----------
----------- -----------
Equity adjustments for FASB 115 changes to AFS securities................................ $ 206 ($ 119)
----------- -----------
----------- -----------
</TABLE>
(see accompanying notes)
F-21
<PAGE>
MONARCH BANCORP
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1995
1. In the opinion of management of Monarch Bancorp (the "Company"), the
following accompanying unaudited consolidated financial statements contain
all adjustments (consisting only of normal, recurring accruals) necessary to
present fairly the consolidated financial position of the Company at March
31, 1995, and the consolidated results of operations for the three months
ended March 31, 1995 and March 31, 1994, and the cash flows for the same
three month periods. These consolidated financial statements do not include
all disclosures associated with the Company's annual financial statements
and, accordingly, should be read in conjunction with such statements.
2. The results of operations for the three month period ended March 31, 1995
are not necessarily indicative of the results to be expected for the full
year.
NEW ACCOUNTING STANDARDS: In May 1993, the Financial Accounting Standards
Board ("FASB") issued Statement of Financial Accounting Standards No. 114,
"Accounting by Creditors for Impairment of a Loan," which was amended by SFAS
No. 118 in October 1994. This statement amends FASB statements Nos. 5,
"Accounting for Contingencies," and 15, "Accounting by Debtors and Creditors for
Troubled Debt Restructuring." This statement prescribes that a loan is impaired
when it is probable that a creditor will be unable to collect all amounts due
(principal and interest) according to the contractual terms of the loan
agreement. Measurements of the impairment can be based on the expected future
cash flows of an impaired loan which are to be discounted at the loan's
effective interest rate or impairment can be measured by reference to an
observable market price, if one exists, or the fair value of the collateral for
a collateral-dependent loan. Creditors may select the measurement method on a
loan-by-loan basis except that collateral dependent loans for which foreclosure
is probable must be measured at the fair value of the collateral. Additionally,
the statement prescribes measuring impairment of a restructured loan by
discounting the total expected future cash flows of the loan's effective rate of
interest in the original loan agreement. Finally, the impact of initially
applying the statement is reported as a part of bad-debt expense. The Company
must adopt this standard by 1995. The Company adopted FASB 114 and 118 as of
January 1, 1995. As of March 31, 1995 the Bank used these Standard as an
integral part of the quarterly assessment of the adequacy of the Allowance for
Loan Losses. In the first quarter of 1995, the Bank had three loans defined as
impaired totaling $454,000 with a related allowance for credit loss of $97,000
as determined in accordance with the Statement, all three loans had a related
allowance for credit losses. Income is reported on a cash-basis, and no income
from impaired loans was recorded in the first quarter of 1995. Based on the
first quarters use of FASB 114 and 118, no material effects are expected from
continued use and application of these Statements.
In December 1991, the FASB issued SFAS No. 107, "Disclosures About Fair
Value of Financial Instruments." Implementation of SFAS No. 107 is required for
fiscal years ending after December 15, 1992 for institutions with assets greater
than $150 million, and for fiscal years ending after December 15, 1995 for all
other institutions, however, earlier adoption is permitted. SFAS No. 107
requires disclosures about fair value for all financial instruments. The Company
will implement the new standard in 1995.
F-22
<PAGE>
- -------------------------------------------
-------------------------------------------
- -------------------------------------------
-------------------------------------------
NO DEALER, SALESMAN, OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS AND,
IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE COMPANY OR THE SELLING AGENT. NEITHER THE DELIVERY
OF THIS PROSPECTUS NOR ANY SALE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE
ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY
SINCE THE DATE HEREOF. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY ANY SECURITIES TO ANY PERSON IN ANY JURISDICTION
IN WHICH SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED, OR IN WHICH THE PERSON
MAKING SUCH OFFER OR SOLICITATION IS NOT QUALIFIED TO DO SO, OR TO ANY PERSON TO
WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION.
-------------------
TABLE OF CONTENTS
-------------------
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Prospectus Summary............................. 4
Summary Consolidated Financial Data............ 8
Risk Factors................................... 10
The Offering................................... 14
Use of Proceeds................................ 21
Dilution....................................... 22
Determination of Offering Price................ 23
Market for Common Stock........................ 23
Dividends...................................... 24
Capitalization................................. 25
Management's Discussion and Analysis
of Financial Condition and Results
of Operations................................. 26
Business....................................... 47
Management..................................... 62
Description of Capital Stock................... 68
Legal Matters.................................. 69
Experts........................................ 70
</TABLE>
-------------------
ALL DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT
PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN
ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
UP TO 3,177,296 SHARES
MONARCH BANCORP
COMMON STOCK
-----------------
PROSPECTUS
-----------------
- -------------------------------------------
-------------------------------------------
- -------------------------------------------
-------------------------------------------
