<PAGE>
<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K
CURRENT REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported): September 1, 1996 (Amended)
---------------------------
Commission file number 2-76555
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COMMERCE SECURITY BANCORP, INC.
-------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 33-0720548
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(State or other jurisdiction of (I.R.S. Employer or
incorporation or organization) Identification No.)
7777 CENTER AVENUE, HUNTINGTON BEACH, CALIFORNIA 92647-3067
- ------------------------------------------------ ----------
(Address of principal executive offices) (Zip Code)
(714) 895-2929
--------------
(Registrant's telephone number, including area code)
Successor by Merger to
SDN BANCORP, INC.
135 Saxony Road, Encinitas, California 92024-0905
--------------------------------------------------
(Former Name or Former Address, if Changed Since Last Report)
<PAGE>
ITEM 2. ACQUISITION OR DISPOSITION OF ASSETS.
As of September 1, 1996, the registrant completed its merger (the "Merger")
of Commerce Security Bank ("Commerce") and SDN Bancorp, Inc. ("SDN") as
contemplated by the Agreement and Plan of Reorganization dated April 23, 1996
(the "Agreement") to form a new holding company ("Holdco") which would become
the sole shareholder of both companies.
As of August 28, 1996, Dartmouth Capital Group, L.P. (the "Partnership")
invested approximately $14.5 million in the registrant to fund the Commerce
Acquisition. In exchange for that investment, the registrant issued a total of
3,664,776 additional shares of Common Stock at a price per share of $3.95. At
the Partnership's direction the registrant issued 1,080,000 of those shares of
Common Stock, in the aggregate, to certain limited partners of the Partnership
(the "Direct Holders") and the remaining 2,584,776 shares of Common Stock
directly to the Partnership. Giving effect to the issuance of those shares to
fund the Commerce Acquisition, the Partnership owns 48.0% of the Common Stock
and the Direct Holders own, in the aggregate 34.19% of the Common Stock.
Holders of SDN Common Stock were issued one share of Holdco Common Stock
for each share held in SDN. A total of 4,327,606 shares of SDN Common Stock
were outstanding at the time of the Merger. Holders of Commerce Common Stock
were issued 1,527,540 shares of Holdco Common Stock and received cash of
approximately $14.1 million. An additional 58,212 shares of Holdco Common
Stock and cash of approximately $346,000 are held in escrow pending resolution
of the SAIF recapitalization. A total of 99,164 shares were issued to other
direct investors and investment bankers involved in the Merger. There were
9,759,098 total shares outstanding after the Merger.
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS
The following financial statements and pro forma financial information are
being filed within 60 days from which this report was originally filed,
September 15, 1996, for the reported event of September 1, 1996.
Description Page
----------- ----
(a) Financial statements of business acquired 4
(b) Pro forma financial information 19
(c) Exhibits NA
2
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
COMMERCE SECURITY BANCORP, INC.
November 14, 1996 By: /s/ Curt A. Christianssen
-----------------------------------
Curt A. Christianssen
Senior Vice President
Chief Financial Officer
3
<PAGE>
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders
Commerce Security Bank
Sacramento, California
We have audited the accompanying consolidated statements of financial
condition of Commerce Security Bank and subsidiary (the "Bank"), as of
December 31, 1995 and 1994, and the related consolidated statements of
operations, shareholders' equity, and cash flows for each of the three years
in the period ended December 31, 1995. 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 audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of the Bank
at December 31, 1995 and 1994, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1995 in
conformity with generally accepted accounting principles.
As discussed in Note 1 to the financial statements, the Bank adopted
Statement of Financial Accounting Standards (SFAS) No. 122, ACCOUNTING FOR
MORTGAGE SERVICING RIGHTS, as of January 1, 1995.
DELOITTE & TOUCHE LLP
Sacramento, California
February 27, 1996, except for Note 15,
as to which the date is March 27, 1996
4
<PAGE>
COMMERCE SECURITY BANK AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1995 AND 1994
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ASSETS 1995 1994
<S> <C> <C>
Cash and cash equivalents:
Cash and due from banks $ 9,438,041 $ 7,466,795
Federal funds sold 21,000,000 8,200,000
Reverse repurchase agreements 7,000,000 --
Interest bearing deposits in other banks 42,652 2,871,697
------------ ------------
Total cash and cash equivalents 37,480,693 18,538,492
Investment securities:
Available for sale at fair value 7,032,087 --
Held to maturity 10,995,607 21,863,977
------------ ------------
Total investment securities 18,027,694 21,863,977
Mortgage loans held for sale, at the lower of cost or
market 38,336,858 45,340,152
Loans and leases, net of allowance for loan and lease
losses of $2,395,775 and $1,471,443 94,435,087 66,081,297
Accrued interest receivable 1,099,365 839,297
Loan and servicing sales receivable 4,611,625 7,185,048
Mortgage servicing rights 6,327,677 1,101,200
Other real estate owned 1,239,707 4,185,200
Investment in real estate joint ventures held for sale 3,744,409 1,705,465
Premises and equipment, net 2,430,559 3,143,250
FHLB stock 1,171,852 1,118,300
Other assets and prepaid expenses 4,441,721 1,618,418
------------ ------------
TOTAL ASSETS $213,347,250 $172,720,096
------------ ------------
------------ ------------
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Deposits:
Noninterest bearing $ 69,325,380 $ 45,987,058
Interest bearing 122,329,251 105,083,025
Repurchase agreements -- 1,638,000
Accrued expenses and other liabilities 4,939,162 4,007,473
------------ ------------
Total liabilities 196,593,792 156,715,556
------------ ------------
SHAREHOLDERS' EQUITY:
Common stock, $4 par value, 10,000,000 shares
authorized; 861,460 and 860,379 shares
outstanding in 1995 and 1994 3,445,840 3,441,516
Additional paid-in capital 1,035,560 1,031,752
Retained earnings 12,245,490 11,531,272
Net unrealized gain on available-for-sale securities 26,567 --
------------ ------------
Total shareholders' equity 16,753,457 16,004,540
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $213,347,250 $172,720,096
------------ ------------
------------ ------------
</TABLE>
See notes to consolidated financial statements.
5
<PAGE>
COMMERCE SECURITY BANK AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1995 1994 1993
<S> <C> <C> <C>
INTEREST INCOME:
Loans $ 8,826,237 $ 8,795,171 $ 10,350,318
Investment securities 1,936,100 1,623,426 665,266
Lease financing 3,378,072 1,646,898 1,040,867
----------- ----------- ------------
Total interest income 14,140,409 12,065,495 12,056,451
----------- ----------- ------------
INTEREST EXPENSE:
Deposits 6,502,164 4,422,689 4,712,736
Short-term borrowings 233,701 131,594 103,311
----------- ----------- ------------
Total interest expense 6,735,865 4,554,283 4,816,047
----------- ----------- ------------
NET INTEREST INCOME 7,404,544 7,511,212 7,240,404
PROVISION FOR LOAN AND LEASE LOSSES 1,196,090 1,172,000 910,000
----------- ----------- ------------
NET INTEREST INCOME AFTER PROVISION FOR
LOAN AND LEASE LOSSES 6,208,454 6,339,212 6,330,404
----------- ----------- ------------
NONINTEREST INCOME:
Gain on sale of loans, leases, and loan servicing 14,341,386 12,147,570 10,929,213
Servicing and fee income 2,440,478 4,252,005 2,624,146
Other income 19,751 200,375 168,879
----------- ----------- ------------
Total noninterest income 16,801,615 16,599,950 13,722,238
----------- ----------- ------------
NONINTEREST EXPENSE:
Salaries and employee benefits 9,850,516 11,059,656 7,443,276
Occupancy and equipment 3,121,520 2,849,963 2,071,678
Printing and communication 1,456,890 1,414,486 1,146,859
Legal and professional 1,544,548 1,091,939 826,234
Office supplies 446,333 526,296 585,874
Real estate activities 1,224,747 769,439 628,257
Insurance 556,170 612,984 479,627
Other outside service fees 616,889 450,310 357,486
Branch closure costs 603,881 -- --
Other expense 2,357,165 2,264,776 2,170,131
----------- ----------- ------------
Total noninterest expense 21,778,659 21,039,849 15,709,422
----------- ----------- ------------
INCOME BEFORE PROVISION FOR INCOME TAXES 1,231,410 1,899,313 4,343,220
PROVISION FOR INCOME TAXES 517,192 797,700 1,841,125
----------- ----------- ------------
NET INCOME $ 714,218 $ 1,101,613 $ 2,502,095
----------- ----------- ------------
----------- ----------- ------------
EARNINGS PER COMMON AND COMMON EQUIVALENT SHARE $0.83 $1.28 $2.97
------ ----- -----
------ ----- -----
SHARES USED IN COMPUTATION 860,982 863,175 842,583
------- ------- -------
------- ------- -------
</TABLE>
See notes to consolidated financial statements.
6
<PAGE>
COMMERCE SECURITY BANK AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
- --------------------------------------------------------------------------
<TABLE>
<CAPTION>
NET
UNREALIZED
GAIN ON
AVAILABLE-
FOR-SALE
NUMBER OF ADDITIONAL SECURITIES TOTAL
SHARES COMMON PAID-IN RETAINED (NET OF SHAREHOLDERS'
OUTSTANDING STOCK CAPITAL EARNINGS TAX) EQUITY
------- ---------- ---------- ----------- ------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance at
January 1, 1993 800,000 $3,200,000 $ 800,000 $ 7,927,564 $11,927,564
Net income 2,502,095 2,502,095
Options exercised 59,880 239,520 215,040 454,560
------- ---------- ---------- ----------- ------- -----------
Balance at
December 31, 1993 859,880 3,439,520 1,015,040 10,429,659 14,884,219
Net income 1,101,613 1,101,613
Options exercised 499 1,996 79 2,075
Tax benefit of
options exercised 16,633 16,633
------- ---------- ---------- ----------- ------- -----------
Balance at
December 31, 1994 860,379 3,441,516 1,031,752 11,531,272 16,004,540
Net income 714,218 714,218
Options exercised 1,081 4,324 3,808 8,132
Net unrealized gain
on available-for
sale securities (net
of taxes of $19,240 $26,567 26,567
------- ---------- ---------- ----------- ------- -----------
Balance at
December 31, 1995 861,460 $3,445,840 $1,035,560 $12,245,490 $26,567 $16,753,457
------- ---------- ---------- ----------- ------- -----------
------- ---------- ---------- ----------- ------- -----------
</TABLE>
See notes to consolidated financial statements.
7
<PAGE>
COMMERCE SECURITY BANK AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
- --------------------------------------------------------------------------
<TABLE>
<CAPTION>
1995 1994 1993
------------- --------------- ---------------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income $ 714,218 $ 1,101,613 $ 2,502,095
Adjustments to reconcile net income
to net cash (used in) provided by
operating activities:
Provision for loan and lease losses 1,196,090 1,172,000 910,000
Provision for loss on other
real estate owned 189,840 260,000 317,600
Provision for loss on real estate
joint venture 915,000 -- --
Depreciation and amortization 1,588,750 746,965 631,650
Accretion of premium on investments (169,645) 45,052 68,673
(Gain) loss on sale of premises and
equipment 17,453 273 (12,469)
(Gain) loss on sale of real estate owned (108,468) 112,857 50,438
Mortgage loans originated for sale (946,580,833) (1,142,044,286) (2,208,378,000)
Mortgage servicing rights purchased
and originated (7,680,727) (843,374) (76,150)
Distribution of income from real estate
joint venture -- -- 16,007
Equity in (income) loss of real estate
joint venture (153,012) 78,276 337,348
Proceeds from sales of loans
and servicing 969,623,956 1,192,389,213 2,190,439,573
(Gain) loss on sale of loans and servicing (14,341,386) (12,147,570) (10,929,213)
Net effect of changes in:
Deferred loan origination fees (77,937) (69,881) (47,487)
Accrued interest receivable (260,068) (80,114) (68,149)
Loan and servicing sales receivable 2,573,423 (2,407,202) 1,875,126
FHLB stock (53,555) (390,600) 403,900
Other assets and prepaid expenses (2,823,305) (312,643) 618,971
Accrued expenses and other liabilities 931,688 (1,397,267) 2,260,155
------------- --------------- ---------------
Net cash (used in) provided by
operating activities 5,501,482 36,213,312 (19,079,932)
INVESTING ACTIVITIES:
Proceeds from sale of real estate owned 4,483,829 3,315,956 2,621,115
Additions to other real estate owned -- (21,048) (15,794)
Capital contributions to real estate
joint ventures (2,800,932) -- --
Loans originated for portfolio net
of principal repayments (31,091,651) (11,517,337) (1,522,141)
Purchases of held-to-maturity
investment securities (13,494,011) (14,329,722) --
Maturities of held-to-maturity
investment securities 17,526,506 4,251,006 --
Decrease (increase) in investment
securities -- -- (11,146,340)
Purchases of premises and equipment (312,608) (1,796,124) (777,006)
Proceeds from sale of premises and
equipment 174,906 5,045 192,012
------------- --------------- ---------------
Net cash used in investing activities (25,513,961) (20,092,224) (10,648,154)
FINANCING ACTIVITIES:
Net effect of changes in:
Noninterest bearing deposits 23,338,322 (20,086,272) 61,515,864
Interest bearing deposits 17,246,226 (4,793,668) (12,468,840)
Other borrowings (1,638,000) 1,638,000 --
Proceeds from exercise of stock options 8,132 18,708 322,302
------------- --------------- ---------------
Net cash provided (used) by
financing activities 38,954,680 (23,223,232) 49,369,326
------------- --------------- ---------------
INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS 18,942,201 (7,102,144) 19,641,240
CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR 18,538,492 25,640,636 5,999,396
------------- --------------- ---------------
CASH AND CASH EQUIVALENTS,
END OF YEAR $ 37,480,693 $ 18,538,492 $ 25,640,636
------------- --------------- ---------------
------------- --------------- ---------------
SUPPLEMENTAL DISCLOSURES OF
CASH FLOW INFORMATION:
Cash paid during the year for:
Interest 6,725,010 $ 4,451,248 $ 4,714,593
Income taxes 341,874 700,000 1,305,595
SUPPLEMENTAL DISCLOSURES OF NONCASH
INVESTING AND FINANCING ACTIVITIES:
Real estate acquired through foreclosure 2,273,311 5,166,638 $ 3,601,949
Other real estate owned transferred
to loans 653,603 -- --
Transfer of securities from held to
maturity to available for sale 6,986,280 -- --
Loans made to finance sale of other
real estate owned -- 1,309,454 2,495,475
Tax benefit on exercise of stock options -- 16,633 132,258
</TABLE>
See notes to consolidated financial statements.
8
<PAGE>
COMMERCE SECURITY BANK AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
1. SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
Commerce Security Bank and subsidiary (the "Bank"), is a state chartered
commercial bank. The accounting and reporting policies of the Bank conform to
generally accepted accounting principles and to general practices within the
banking industry. Such principles require management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
the disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates. A
summary of significant accounting policies is as follows:
BASIS OF PRESENTATION -- The consolidated financial statements include the
accounts of Commerce Security Bank and its wholly-owned subsidiary, CSB
Ventures, which invests in real estate joint ventures. All significant
intercompany balances and transactions have been eliminated in consolidation.
NATURE OF OPERATIONS -- The Bank's primary sources of revenue are from the
origination and sale of residential mortgage loans and equipment leases, and
interest income on loans and leases. The Bank's administrative offices and
branch are located in Sacramento, California. It also operates three loan
production offices (LPOs) in California, and one each in Nevada, Arizona,
Colorado, and Oregon for the purpose of originating residential mortgage
loans. In addition, the Bank has three leasing offices, two in California and
one in Washington for the purpose of originating and acquiring equipment
leases.
CASH AND CASH EQUIVALENTS -- Cash and cash equivalents include cash and due
from banks, interest-bearing deposits in financial institutions, federal
funds sold and reverse repurchase agreements. Generally, federal funds are
sold for one-day periods. Reverse repurchase agreements are generally for one
to three day periods.
INVESTMENT IN FEDERAL HOME LOAN BANK STOCK -- As a member of the Federal Home
Loan Bank (FHLB) of San Francisco, the Bank is required to invest in stock of
the FHLB in the amount of 1% of its outstanding home loans, 5% of its
outstanding FHLB advances, or 0.3% of total assets, whichever is highest. At
December 31, 1995 and 1994, the Bank owned 11,570 and 11,008 shares of the
FHLB $100 par value capital stock, respectively, which is stated at cost,
plus accrued dividends.
INVESTMENT SECURITIES -- At January 1, 1994, the Bank adopted Statement of
Financial Accounting Standards ("SFAS") No. 115, ACCOUNTING FOR CERTAIN
INVESTMENTS IN DEBT AND EQUITY SECURITIES. The effect of the adoption on the
Bank's financial position and results of operations was not material. The
Bank has classified its investment securities as held to maturity or
available for sale. Securities held to maturity are carried at cost adjusted
by the accretion of discounts and amortization of premiums. The Bank has the
ability and positive intent to hold these investment securities to maturity.
Securities available for sale may be sold to implement the Bank's
asset/liability management strategies and in response to changes in
interest rates, prepayment rates and similar factors. These securities are
recorded at their fair value. Unrealized gains or losses are included in
shareholders' equity, net of tax. Gain or loss on the sale of
available-for-sale securities is based on the specific identification method.
9
<PAGE>
LOANS AND LEASES -- Loans are stated at the principal amount outstanding, net
of unearned income, including deferred loan fees and costs. The net deferred
fees and costs are generally amortized into interest income over the loan
term using a method which approximates the interest method. Other
credit-related fees, such as standby letter of credit fees, loan placement
fees and annual credit card fees are recognized as noninterest income over
the commitment period or over the period the related service is performed.
Direct financing leases, which include estimated residual values of leased
equipment, are carried net of unearned income. Income from these leases is
recognized on a basis which produces a level yield on the outstanding net
investment in the lease.
Effective January 1, 1995, the Bank adopted Statements of SFAS No. 114,
ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN, and SFAS No. 118,
ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN -- INCOME RECOGNITION AND
DISCLOSURE. SFAS No. 114 requires that impaired loans be measured based on
the present value of expected future cash flows discounted at the loan's
effective interest rate or as a practical expedient at the loan's observable
market rate or the fair value of the collateral if the loan is collateral
dependent. SFAS No. 118 amends SFAS No. 114 to allow a creditor to use
existing methods for recognizing interest income on impaired loans and
requires certain information to be disclosed. The effect of adopting these
standards was immaterial.
ALLOWANCE FOR LOAN AND LEASE LOSSES -- The allowance for loan and lease
losses is established through a provision charged to expense. Loans and
leases are charged-off against the allowance for loan and lease losses when
management believes that the collectibility of the principal is unlikely. The
allowance is an amount that management believes will be adequate to absorb
losses inherent in existing loans and leases based on evaluations of
collectibility and prior loss experience. The evaluations take into
consideration such factors as changes in the nature and volume of the
portfolio, overall portfolio quality, loan and lease concentrations, specific
problem loans and leases, commitments, and current and anticipated economic
conditions that may affect the borrowers' ability to pay. While management
uses the best information available to evaluate the adequacy of its
allowance, future adjustments to the allowance may be necessary if actual
experience differs from the assumptions used in making the evaluations.
The Bank's policy is to place substantially all loans and leases that are
delinquent 90 days or more as to principal or interest on a nonaccrual of
interest basis (unless the loan is adequately secured and in the process of
collection). Cash payments subsequently received on nonaccrual loans are
recognized as income only where the future collection as to both principal
and interest is considered by management to be probable.
MORTGAGE BANKING ACTIVITIES -- The Bank originates and sells residential
mortgage loans to a variety of secondary market investors, including the
Federal Home Loan Mortgage Corporation (FHLMC), the Federal National Mortgage
Association (FNMA) and others. The bank has an arrangement with the
Government National Mortgage Association (GNMA) whereby loans originated
by the Bank are securitized by GNMA and sold to others. Gains or losses on
the sale of mortgage loans are recognized upon delivery based on the
difference between the selling price and the carrying value of the related
mortgage loans sold. Deferred origination fees and expenses are recognized at
the time of sale in the determination of the gain or loss. The Bank may also
sell the servicing for such loans to either the purchaser of the loans or to
a third party. The Bank recognizes the gain or loss on servicing sold when
all risks and rewards of ownership have transferred.
Mortgage loans held for sale are stated at lower of cost or market value as
determined by outstanding commitments from investors or current investor
yield requirements calculated on an aggregate loan basis. Valuation
adjustments are charged against noninterest income.
10
<PAGE>
Forward commitments to sell, and put options on, mortgage-backed securities
are used to reduce interest rate risk on a portion of loans held for sale and
anticipated loan fundings. The resulting gains or losses on forward
commitments are deferred and included in the carrying values of loans held
for sale. Premiums on put options are capitalized and amortized over the
option period. Gains or losses on forward commitments and put options deferred
against loans held for sale approximately offset equivalent amounts of
unrecognized gains or losses on the related loans. Forward commitments to
sell and put options on mortgage-backed securities that hedge anticipated
loan fundings are not reflected in the statement of financial condition.
Gains or losses on these instruments are not recognized until the actual sale
of loans held for sale. Loans generally fund in 10 to 30 days.
Effective January 1, 1995, the Bank adopted SFAS No. 122, ACCOUNTING FOR
MORTGAGE SERVICING RIGHTS. The statement is required to be adopted for fiscal
years beginning after December 15, 1995. As a result of the early adoption,
originated mortgage servicing rights of $5,815,000, were capitalized during
1995, which increased income before income taxes by a similar amount.
The Bank capitalizes the cost of acquiring mortgage servicing rights through
either the purchase or origination of mortgage loans if it sells or
securitizes those loans, and retains the servicing. The Bank allocates the
cost of the mortgage loans to the mortgage servicing rights and the loans
(without the servicing rights) based on their relative fair values. The fair
value of the mortgage servicing rights is estimated based on observable
market prices. Capitalized mortgage servicing rights are amortized in
proportion to, and over the period of, estimated net servicing income. The
Bank evaluates and measures impairment of capitalized servicing rights at
least quarterly. In performing its impairment analysis, the Bank stratifies
the servicing portfolio based on the relevant risk characteristics of the
underlying loans; including loan type (e.g., conventional/government), loan
term, and interest rate structure (fixed/adjustable). Valuation allowances,
if any, are established for each risk stratum to carry the servicing rights
at the lower of cost or market.
Loan servicing income represents fees earned for servicing real estate and
construction loan participations owned by investors, net of amortization
expense. The fees are generally calculated on the outstanding principal
balances of the loans serviced and are recorded as income when collected.
PREMISES AND EQUIPMENT -- Premises and equipment are carried at cost less
accumulated depreciation and amortization. Depreciation expense is computed
principally on the straight-line method over the estimated useful lives of
the assets. Leasehold improvements are amortized on a straight-line basis
over the period of the lease or the estimated useful life, whichever is
shorter.
OTHER REAL ESTATE OWNED -- Property acquired by the Bank through foreclosure
is initially recorded in the consolidated statements of financial condition
at the lower of estimated fair value less selling costs ("fair value") or
cost. Immediately upon foreclosure, if the fair value is less than the loan
amounts outstanding, any difference is charged against the allowance for
possible loan losses. After acquisition, valuations are periodically
performed and, if the carrying value of the property exceeds the fair value,
a valuation allowance is established by a charge to operations. Subsequent
increases in the fair value may reduce or eliminate the allowance. Required
developmental costs associated with foreclosed property under construction are
capitalized and considered in determining the fair value of the property.
Operating expenses of such properties, net of related income, and gains and
losses on their disposition, are included in noninterest expenses.
11
<PAGE>
INVESTMENT IN REAL ESTATE JOINT VENTURES HELD FOR SALE -- The Bank's
investments in real estate joint ventures is comprised of the Bank's
investment in CSB Ventures, a wholly-owned subsidiary which is consolidated
for financial statement presentation. CSB Ventures has invested in certain
real estate joint ventures (Ventures) which it accounts for using the equity
method. The Ventures each carry real estate investments at the lower of cost
or estimated fair value. Direct writedowns are recorded if total actual or
expected costs are in excess of estimated fair value.
INCOME TAXES -- Deferred tax assets and liabilities are reflected at
currently enacted income tax rates applicable to the period in which the
deferred tax assets or liabilities are expected to be realized or settled. As
changes in tax laws or rates are enacted, deferred tax assets and liabilities
are adjusted through the provision for income taxes.
EARNINGS PER COMMON AND COMMON EQUIVALENT SHARE -- The calculation of primary
earnings per common and common equivalent share is based on the weighted
average number of common and common equivalent shares including the dilutive
effects of stock options computed under the treasury stock method. The Bank's
stock is not traded on any exchange and there is not an active market in the
Bank's stock. Accordingly, the dilutive effect of outstanding stock options is
computed using the greater of the estimated closing price or the estimated
average price of the common stock for the period. Fully diluted earnings per
common and common equivalent share did not differ significantly from primary
earnings per common and common equivalent share. The estimated price of the
Bank's common stock was calculated based on management's estimates.
STOCK OPTIONS -- In October 1995, the Financial Accounting Standards Board
issued SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION. The new
standard defines a fair value method of accounting for stock options and
other equity instruments, such as stock purchase plans. Under this method,
compensation cost is measured based on the fair value of the stock award when
granted and is recognized as an expense over the service period, which is
usually the vesting period.
The new standard permits companies to continue to account for equity
transactions with employees under existing accounting rules, but requires
disclosure in a note to the financial statements of the pro forma net income
and earnings per share as if the company had applied the new method of
accounting. The Bank's stock option plan expired during 1995. As the Bank
has no plans to develop another stock option plan this standard will have no
effect on the Bank.
RECLASSIFICATIONS -- Certain prior year amounts have been reclassified to
conform with the 1995 presentation.
2. CASH AND DUE FROM BANKS
The Bank is required to maintain average reserve balances with the Federal
Reserve Bank. Cash and due from banks in the consolidated statement of
financial condition included amounts so restricted of $1,439,000 and $863,000
at December 31, 1995 and 1994.
12
<PAGE>
3. INVESTMENT SECURITIES
Investment securities have been classified in the statement of financial
position in accordance with management's intent. At December 31, 1994, all
investment securities were classified as held to maturity. At December 31,
the amortized cost of securities and their approximate fair value were as
follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
<S> <C> <C> <C> <C>
AVAILABLE FOR SALE:
DECEMBER 31, 1995:
Mortgage-backed securities $ 6,986,280 $45,807 $ -- $ 7,032,087
----------- ------- -------- -----------
----------- ------- -------- -----------
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSS VALUE
<S> <C> <C> <C> <C>
HELD TO MATURITY:
DECEMBER 31, 1995:
U.S. Treasury securities $ 3,000,000 $ 720 $ 2,999,280
U.S. Agency securities 7,995,607 $ 5,408 8,001,015
----------- ------- -------- -----------
Total $10,995,607 $ 5,408 $ 720 $11,000,295
----------- ------- -------- -----------
----------- ------- -------- -----------
DECEMBER 31, 1994:
U.S. Treasury securities $ 7,821,909 $ -- $ 15,355 $ 7,806,554
U.S. Agency securities 5,494,657 -- 104,524 5,390,133
Mortgage-backed securities 8,547,411 -- 247,719 8,299,692
----------- ------- -------- -----------
Total $21,863,977 $ -- $367,598 $21,496,379
----------- ------- -------- -----------
----------- ------- -------- -----------
</TABLE>
In November 1995, the FASB issued additional implementation guidance
regarding the previously issued SFAS No. 115. In accordance with this
guidance and prior to December 31, 1995, companies were allowed a one-time
reassessment of their classification of securities and were required to
account for any resulting transfers at fair value. Transfers from the
held-to-maturity category that resulted from this one-time reassessment did
not call into question the intent to hold other securities to maturity in the
future. Accordingly, the Bank transferred approximately $6,986,280 of
securities from held to maturity to available for sale to allow the Bank
greater flexibility in managing its interest rate risk and liquidity. The
transferred securities were adjusted to fair value and stockholders' equity
was increased by $26,567, net of income taxes of $19,240.
13
<PAGE>
The amortized cost and estimated fair value of debt securities available for
sale and held to maturity at December 31, 1995, by contractual maturity, are
shown below. Actual maturities may differ from contractual maturities
because borrower's may have the right to call or prepay obligations with or
without call or prepayment penalties.
AVAILABLE FOR SALE
-------------------------------
AMORTIZED
COST FAIR VALUE
After 1 year but within 5 years $ 917,559 $ 915,735
After 10 years 6,068,721 6,116,352
---------- ----------
$6,986,280 $7,032,087
---------- ----------
---------- ----------
HELD TO MATURITY
-------------------------------
AMORTIZED
COST FAIR VALUE
Within 1 year $ 3,000,000 $ 2,999,280
After 1 year but within 5 years 7,995,607 8,001,015
After 5 years but within 10 years -- --
After 10 years -- --
----------- -----------
$10,995,607 $11,000,295
----------- -----------
----------- -----------
No sales of debt securities occurred during each of the three years ended
December 31, 1995.
At December 31, 1995 and 1994, investment securities with amortized costs of
$1,329,565 and $3,502,151, respectively, and estimated market values of
$1,301,746 and $3,446,770, respectively, were pledged as collateral for
borrowings and other purposes required or permitted by law.
4. LOANS AND LEASES
The loan and lease portfolio consists of various types of loans and leases
made principally to borrowers located in Northern California. These loans and
leases are classified by major type as follows:
DECEMBER 31,
-----------------------------
1995 1994
Land $ 2,746,933 $ 2,718,897
Residential real estate 11,660,466 9,797,920
Commercial real estate 18,916,916 19,777,594
Real estate construction 15,896,907 8,241,476
Commercial 17,315,268 8,783,720
Consumer 2,320,702 2,324,551
Direct financing leases 28,102,065 16,114,914
----------- -----------
96,959,257 67,759,072
Less:
Allowance for loan and lease losses (2,395,775) (1,471,443)
Deferred loan fees and costs (128,395) (206,332)
----------- -----------
Loans and leases, net $94,435,087 $66,081,297
----------- -----------
----------- -----------
14
<PAGE>
At December 31, 1995 and 1994, approximately $57,400,000 or 75%, and
$38,850,000 or 57%, respectively, of outstanding loans and leases were
secured by real estate in Northern California. These loans and leases are
expected to be repaid from cash flows of the borrower's employment or from
the sale or operation of the collateral. The repayment of the loans may be
affected by the condition of the local real estate market. The Bank normally
lends funds up to a certain percentage of the collateral's value as stated
in the Bank's underwriting policies based on the type of real estate. The
types of real estate collateral securing the Bank's loan portfolio are single
family residences, apartment complexes, undeveloped land and other real
estate. The Bank's exposure to credit loss, if any, is the difference between
the fair value of the collateral and the outstanding loan balance.
At December 31, 1995, the Bank's recorded investment in loans and leases for
which an impairment has been recognized in accordance with SFAS No. 114 was
approximately $8,352,699. The related valuation allowance was $1,137,597. For
the year ended December 31, 1995, the average recorded investment in loans
and leases for which impairment has been recognized was approximately
$6,411,159. The Bank uses the cash basis method of income recognition for
impaired loans and leases. For the year ended December 31, 1995, the Bank
recognized $320,273 of income on such loans.
As of December 31, 1995 and 1994, there were $4,384,970 and $958,481,
respectively, of loans classified as nonaccrual. Interest income that would
have been recognized on nonaccrual loans if they had performed in accordance
with the terms of the loans was $173,885, $142,905, and $152,791 for the
years ended December 31, 1995, 1994 and 1993, respectively. During 1995, the
Bank received $124,458 in payments on nonaccrual loans all of which was used
to reduce principal. During 1995 and 1994, there were no leases classified as
nonaccrual.
At December 31, 1995, there were no loans or leases past due 90 days or more
and still accruing interest. At December 31, 1994, the Bank had $207,977 in
loans past due 90 days or more in interest or principal and still accruing
interest. These loans were collateralized and in process of collection.
As of December 31, 1995 and 1994, there were no loans or leases outstanding
to directors, officers and their affiliates. During the year ended December
31, 1994, $44,000 in loans to such parties were paid off in full. In the
opinion of management, all transactions entered into between the Bank and
such related parties have been and are, in the ordinary course of business
and made on the same terms and conditions as similar transactions with
unaffiliated persons.
5. ALLOWANCE FOR LOAN AND LEASE LOSSES
A summary of the activity in the allowance for loan and lease losses is as
follows:
YEAR ENDED DECEMBER 31,
------------------------------------------
1995 1994 1993
Balance, beginning of year $1,471,443 $2,202,576 $2,280,347
Provision for loan and lease
losses 1,196,090 1,172,000 910,000
Loans and leases charged off (298,806) (1,925,108) (1,026,224)
Recoveries 27,048 21,975 38,453
---------- ---------- ----------
Balance, end of year $2,395,775 $1,471,443 $2,202,576
---------- ---------- ----------
---------- ---------- ----------
15
<PAGE>
6. MORTGAGE BANKING ACTIVITIES
As part of its mortgage banking activities, the Bank sells a portion of its
mortgage loans to investors subject to certain recourse provisions. The Bank
had recorded a reserve of $186,837 and $146,000 in connection with such sales
at December 31, 1995 and 1994.
As part of its mortgage banking activities, the Bank may sell the servicing
rights to loans it originates and sells to third party investors. To increase
the fees received from such sales, the Bank may sell the servicing rights
subject to recourse provisions. At December 31, 1995, the Bank had sold loan
servicing rights with recourse on loans with an unpaid principal balance of
approximately $668,000,000, subject to specific limitations on its liability.
The Bank has recorded a reserve of $190,014 relating to these recourse
provisions as of December 31, 1995. At December 31, 1994, the Bank had no
sales of loan servicing rights subject to recourse.
At December 31, 1995 and 1994, the Bank serviced loans and participations for
others as follows:
DECEMBER 31,
-------------------------------
1995 1994
Mortgage loan portfolio serviced for:
FHLMC $350,553,500 $ 405,835,200
FNMA 278,975,200 276,548,300
GNMA 176,869,000 364,428,600
Other 128,395,800 104,790,500
------------- --------------
934,793,500 1,151,602,600
Less:
Loans subserviced for others pending
transfer of servicing rights 397,541,300 489,981,300
------------- --------------
Total $537,252,200 $ 661,621,300
------------- --------------
------------- --------------
The Bank services mortgage loans and participating interests in mortgage
loans owned by investors. Escrow funds held in trust for loans serviced and
included in noninterest bearing deposits were $7,915,816 and $6,424,012 at
December 31, 1995 and 1994, respectively.
The following table provides a summary of the Bank's mortgage servicing
rights portfolio:
DECEMBER 31,
-------------------------------
1995 1994
Balance at beginning of year $1,101,200 $ 289,522
Purchases 1,865,719 843,374
Originations 5,815,008 --
Sales (1,698,440) --
Amortization (755,810) (31,696)
---------- ----------
Balance at end of year $6,327,677 $1,101,200
---------- ----------
---------- ----------
16
<PAGE>
7. LEASES RECEIVABLE
The components of the Bank's leases receivable are summarized below:
DECEMBER 31,
-------------------------------
1995 1994
Future minimum lease payments $32,464,310 $18,355,178
Residuals 786,284 867,063
Initial direct costs 917,632 481,266
Unearned income (6,066,161) (3,588,593)
----------- -----------
$28,102,065 $16,114,914
----------- -----------
----------- -----------
Future minimum lease payments receivable are as follows:
1996 $12,655,574
1997 9,860,449
1998 6,063,785
1999 3,034,705
2000 849,797
-----------
Total $32,464,310
-----------
-----------
There are no contingent rental payments included in income for each of the
three years in the period ended December 31, 1995.
8. OTHER REAL ESTATE OWNED
The balance of other real estate owned (OREO) was $1,239,707 and $4,185,200
net of valuation allowances of $34,640 and $136,500 at December 31, 1995 and
1994, respectively. Included in this balance are in-substance foreclosures of
$653,603 at December 31, 1994, which were transferred to loans effective
January 1, 1995.
An analysis of activity in the valuation allowance for other real estate
owned is as follows:
YEAR ENDED DECEMBER 31,
--------------------------------------------
1995 1994 1993
Balance at beginning of year $ 136,500 $ 275,272 $ 697,380
Provision charged to operations 189,840 260,000 317,600
Balances related to OREO sold (291,700) (398,772) (739,708)
--------- --------- --------
Balance at end of year $ 34,640 $ 136,500 $ 275,272
--------- --------- --------
--------- --------- --------
17
<PAGE>
9. INVESTMENTS IN REAL ESTATE JOINT VENTURES HELD FOR SALE
The Bank's investment in real estate is comprised of the Bank's investment
in CSB Ventures, a wholly-owned subsidiary, which is consolidated for
financial statement presentation. Subject to certain conditions under FDIC
regulations, complete divestiture of real estate investments is required by
December 19, 1996. The Bank has listed all real estate investments for sale.
The Bank is in process of filing a request to extend the mandatory time
period in which it must divest of its real estate investments.
An analysis of activity in real estate joint ventures is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------
1995 1994 1993
<S> <C> <C> <C>
Balance at beginning of year $1,705,465 $1,783,741 $2,137,096
Contributions 2,800,932
Distributions (16,007)
Equity in earnings/losses and writedowns (761,988) (78,276) (337,348)
---------- ---------- ----------
Balance at end of year $3,744,409 $1,705,465 $1,783,741
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
In December 1995, CSB Ventures recorded a provision of $915,000 to reflect
estimated excess costs of land and commercial real estate over the expected
future sales prices.
Contributions to real estate joint ventures included advances of $2,786,997
made by the Bank to reduce CBS Ventures debt to a third party.
10. PREMISES AND EQUIPMENT
Premises and equipment are summarized below:
DECEMBER 31,
ESTIMATED -------------------------
LIVES 1995 1994
Furniture, fixtures and equipment 3-15 years $ 5,025,883 $ 5,249,875
Leasehold improvements 5-10 years 510,191 481,616
Work-in-progress 37,088 44,065
----------- -----------
5,573,162 5,775,556
Less accumulated depreciation
and amortization (3,142,603) (2,632,306)
----------- -----------
Total $ 2,430,559 $ 3,143,250
----------- -----------
----------- -----------
18
<PAGE>
11. DEPOSITS
A summary of deposits is as follows:
DECEMBER 31,
-----------------------------
1995 1994
Noninterest bearing:
Checking $ 18,831,834 $ 8,169,907
Bank controlled 2,612,085 2,136,687
Title and escrow 39,698,314 27,559,672
Custodial 8,183,147 8,120,792
------------ ------------
$ 69,325,380 $ 45,987,058
------------ ------------
------------ ------------
Interest bearing:
Passbook $ 9,305,475 $ 10,289,479
NOW and Super NOW accounts 2,148,866 1,541,088
Money market accounts 13,483,236 11,273,115
Certificates $100,000 or greater 22,812,398 18,805,955
Other certificates 74,579,276 63,173,388
------------ ------------
$122,329,251 $105,083,025
------------ ------------
------------ ------------
A summary of certificate account maturities is as follows:
YEAR ENDED DECEMBER 31,
---------------------------
1995 1994
Three months or less $42,203,889 $32,223,209
Four through twelve months 46,882,296 49,621,128
Thereafter 8,305,489 135,006
----------- -----------
$97,391,674 $81,979,343
----------- -----------
----------- -----------
The Bank has no brokered deposits as of December 31, 1995 and 1994.
12. OTHER BORROWINGS
The Bank has pledged real estate loans with a book value of $33,315,321 and
$2,174,168 at December 31, 1995 and 1994, respectively, as collateral for
advances from the FHLB of San Francisco. The amount of advances available to
the Bank at December 31, 1995 was approximately $16,070,031.
Securities sold under repurchase agreements at December 31, 1994 have
maturities ranging from one to seven days and are secured by U.S. government
and mortgage-backed securities.
19
<PAGE>
The following table represents the maximum month-end outstandings, average
daily outstanding and average rates paid during the year for the two
categories of short-term borrowings.
YEAR ENDED DECEMBER 31,
---------------------------
1995 1994
Securities sold under repurchase agreements:
Daily average balance $ 1,642,164 $ 167,405
Daily average rate 5.56% 5.56%
Maximum month-end balance $15,014,000 $4,500,000
Year-end balance $ 0 $1,638,000
Advances from other banks:
Daily average balance $ 715,890 $ 38,052
Daily average rate 6.58% 4.13%
Maximum month-end balance $ 5,000,000 $1,600,000
Year-end balance $ 0 -
13. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
In the ordinary course of business, the Bank enters into various types of
transactions which involve financial instruments with off-sheet risk. These
financial instruments include commitments to extend credit and sell loans,
standby letters of credit, forward commitments to sell mortgage-backed
securities and put options to sell mortgage-backed securities and are not
reflected in the accompanying statements of financial condition. These
instruments involve, to varying degrees, elements of credit and interest
rate risk in excess of the amount recognized in the consolidated statements
of financial condition. The contract or notional amounts of those
instruments reflect the extent of the Bank's involvement in particular
classes of financial instrument.
The following is a summary of the notional amounts of various off-balance
sheet financial instruments entered into by the Bank as of December 31,
1995:
NOTIONAL AMOUNT
Commitments to extend credit $24,089,023
Standby letters of credit 770,925
Commitments to sell loans 21,281,444
Forward commitments to sell mortgage-backed securities 28,733,500
Put options to sell mortgage-backed securities 14,000,000
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other terminal clauses
and may require payment of a fee. The Bank experiences interest rate risk on
commitments to extend credit which are at fixed rates. Such commitments
total $14,527,024 at December 31, 1995. The Bank uses the same credit
policies in making commitments to extend credit as it does for originating
loans. Since some of the commitments are expected to expire without being
drawn upon, the total commitment amounts do not necessarily represent future
cash requirements.
20
<PAGE>
Standby letters of credit are written conditional commitments issued by the
Bank to guarantee the performance of a customer to a third-party. The credit
risk involved in issuing letters of credit is essentially the same as that
involved in extending loan facilities to customers. The Bank uses the same
underwriting policies as if a loan were made.
Commitments to sell loans are agreements to sell loans originated by the
Bank to investors. These commitments may be optional or mandatory. Under an
optional commitment, a commitment fee is paid and the Bank carries no risk
in excess of the loss of such fee in the event that the Bank is unable to
deliver mortgage loans into the commitment. Mandatory commitments may entail
possible financial risk to the Bank if it is unable to deliver mortgage
loans in sufficient quantity or at sufficient rates to meet the terms of the
commitments. The Bank may also experience interest rate risk for commitments
which are at a fixed rate. Such commitments total $24,733,500 at
December 31, 1995.
The Bank's policy is to hedge a portion of loans held for sale and its
commitments to originate mortgage loans against interest rate risk with
forward commitments to sell, or put options on, mortgage-backed securities.
Forward commitments are contracts for delayed delivery of securities in
which the Bank agrees to make delivery at a specified future date of a
specified security, at a specified price or yield. Put options convey to the
Bank the right, but not the obligation, to sell the securities at a
contractual specified price. Risks arise from the possible inability of
counterparties to meet the terms of their contracts and from movements in
securities values and interest rates. The Bank tries to minimize these risks
by dealing with only primary brokers and maintaining correlation with the
asset or commitment being hedged. The Bank monitors its exposure through the
use of valuation models provided by a financial advisory service. The
unrealized losses on open forward commitments to sell mortgage-backed
securities were $154,676 and $64,793 as of December 31, 1995 and 1994,
respectively. There were no unrealized losses on open put options to sell
mortgage-backed securities as of December 31, 1995 and 1994, respectively.
14. INCOME TAXES
The components of the provision for income taxes for the years ended
December 31 are as follows:
1995 1994 1993
Currently payable (benefit):
Federal $(1,461,231) $ 810,574 $ 775,110
State (170,576) 342,126 323,616
----------- ---------- ----------
Total (1,631,807) 1,152,700 1,098,726
----------- ---------- ----------
Deferred debit (credit):
Federal 1,761,056 (235,000) 622,773
State 387,943 (120,000) 119,626
----------- ---------- ----------
Total 2,148,999 (355,000) 742,399
----------- ---------- ----------
Total $ 517,192 $ 797,700 $1,841,125
----------- ---------- ----------
----------- ---------- ----------
21
<PAGE>
The amount of deferred tax assets (liabilities) resulting from each type of
temporary difference were as follows:
1995 1994 1993
Provision for loan losses $ 776,191 $ 258,487 $ 725,952
FHLB stock dividends (136,800) (108,075) (81,641)
Gain on excess servicing rights - 159,839 81,578
Deferred loan fees - - (996,484)
Deferred loan costs (708,413)
Real estate activities (184,532) (185,225) (216,840)
Gain on sale of loans (2,427,298) - -
California franchise tax 111,739 94,753 159,609
Hedging losses (15,855) (17,018) (42,852)
Accrued expenses 32,506 73,434 22,554
Other reserves 170,714 89,121 238,030
REO loss reserve 430,187 62,067 124,167
Depreciation (250,474) (177,161) (125,678)
California NOL carryforward 153,076 - -
Advance payments on leases 139,677
Unrealized gain on securities available
for sale (19,300)
Other 8,602 (1,903) 49,994
----------- --------- ----------
$(1,919,980) $ 248,319 $ (61,611)
----------- --------- ----------
----------- --------- ----------
1995 1994 1993
Statutory federal expected tax rate 35.0% 35.0% 35.0%
Increase in income taxes resulting from:
State franchise tax (net of federal tax benefit) 7.5 7.5 6.7
Other (0.5) (0.5) 0.7
---- ---- ----
ADJUSTED TAX RATE 42.0% 42.0% 42.4%
---- ---- ----
---- ---- ----
At December 31, 1995 the Bank had Federal net operating losses of
approximately $3,398,000 which will be carried back against prior year's
taxable income. California net operating loss carryforwards of approximately
$1,155,000 will expire in 2000.
State tax laws impose substantial restrictions on the use of NOLs under many
circumstances including Internal Revenue Code (IRC) Section 382, which
restricts the use of NOLs in the event of significant changes in ownership
interests of individual shareholders and defined shareholder groups. As a
result if such changes in the Bank's ownership interests take place as
discussed in Note 19, the Bank is limited in the use of its NOLs to reduce
future taxable income. The annual limitation may be increased to the extent
of any applicable "built-in gains" as defined by IRC Section 382. Subsequent
ownership changes could further restrict NOLs.
15. REGULATORY MATTERS
Although the Bank converted its charter to that of a commercial bank and is
insured by the FDIC, it continues to be subject to the Financial
Institutions Reform, Recovery and Enforcement Act of 1989 (Act).
22
<PAGE>
Subject to certain conditions under FDIC regulations, the Bank must divest
its investment in real estate joint ventures which are held for sale at
December 31, 1995 by December 19, 1996. The Bank is in the process of filing
a request to extend the mandatory time period in which it must divest of its
real estate investments.
Effective February 1994, the Bank entered into a memorandum of understanding
(Memorandum) with the FDIC and the State Banking Department. The Memorandum
included provisions requiring the Bank to reduce classified assets to
specified amounts by specified dates, establish a policy for determining the
adequacy of the reserve for loan losses, implement a liquidity policy, and
maintain the greater of a leverage ratio of 6.5% or total Tier 1 capital of
$12,500,000. Additionally, the Bank was restricted from paying cash
dividends. The Bank was also required to submit a strategic business plan,
and furnish quarterly progress reports to the FDIC and State Banking
Department.
The Memorandum was removed contingent upon the Board of Directors adopting
a resolution proposed by the FDIC and the State Banking Department. The
Board adopted the State Banking Department resolution in January 1996 and
the FDIC resolution March 27, 1996. The resolution requires the Bank to
reduce classified assets to specified amounts by specified dates,
establish and implement a loan review policy, maintain an adequate reserve
for loan losses, and maintain a leverage ratio of at least 6.5%. The Bank
is also required to submit a strategic business plan, and furnish quarterly
progress reports to the FDIC and State Banking Department.
The Bank is subject to various regulatory capital requirements administered
by federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandates and possible additional discretionary actions
by regulators that, if undertaken, could have a material direct effect on
the Bank's financial statements. Capital adequacy guidelines and the
regulatory framework for prompt corrective action require that the Bank meet
specific capital adequacy guidelines that involve quantitative measures of
the Bank's assets, liabilities and certain off-balance sheet items as
calculated under regulatory accounting practices. The Bank's capital amounts
and classification are also subject to qualitative judgments by the
regulators about components, risk weighting and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the
table below) of total and Tier 1 capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier 1 capital to average assets
(as defined). Management believes, as of December 31, 1995, the Bank meets
all capital adequacy requirements which it is subject to.
As of December 31, 1995, the most recent notification from the FDIC
categorized the Bank as well-capitalized under the regulatory framework
for prompt corrective action. To be categorized as well-capitalized, the
Bank must maintain minimum total and Tier 1 risk-based and Tier 1 leverage
ratios as set forth in the table. There are no conditions or events since
the notification that management believes have changed the institution's
category.
23
<PAGE>
The Bank's actual capital amounts and ratios are also presented in the table:
<TABLE>
<CAPTION>
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
-------------------------- ---------------------------- ---------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
<S> <C> <C> <C> <C> <C> <C>
AS OF DECEMBER 31, 1995:
Total capital (to risk
weighted assets) $18,508,551 13.18% $11,232,600 8% $14,040,750 10%
Tier I capital (to risk
weighted assets) 16,753,457 11.93% 5,616,300 4% 8,424,450 6%
Tier I capital (to
average assets) -
leverage ratio 16,753,457 7.62% 7,792,306 4% 9,740,382 5%
AS OF DECEMBER 31, 1994:
Total capital (to risk
weighted assets) 17,363,414 15.97% 8,698,016 8% 10,872,520 10%
Tier I capital (to risk
weighted assets) 16,004,540 14.72% 4,349,060 4% 6,523,590 6%
Tier I capital (to
average assets) -
leverage ratio 16,004,540 8.89% 7,201,143 4% 9,001,429 5%
</TABLE>
16. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each material class of financial instruments at December 31, 1995.
CASH AND FEDERAL FUNDS SOLD--The carrying amount of cash and due from banks
and federal funds sold approximates the fair value.
INVESTMENT SECURITIES--The fair value of securities held as investments is
based on quoted market prices or dealer quotes.
LOANS AND LEASES--The fair value of loans and leases is based upon the
aggregate estimated fair values of homogeneous loan groups, giving effect
to time and maturity. The fair value of fixed rate loans is estimated by
discounting estimated future cash flows, using a discount rate adjusted by
estimated credit risk for each loan group. The fair value of variable rate
loans is estimated to approximate carrying value. Where credit deterioration
has occurred, management has reduced estimated cash flows to give effect to
estimated future losses.
LOANS HELD FOR SALE--The fair value of loans held for sale is estimated
using current rates on outstanding commitments from investors or current
investor yield requirements.
MORTGAGE SERVICING RIGHTS--The fair value of mortgage servicing rights is
estimated using quoted market prices for similar servicing products.
24
<PAGE>
DEPOSITS--The carrying amount of demand and savings deposits is the amount
payable on demand which approximates fair value. The carrying amount for
variable rate, fixed term time deposit accounts approximates fair value. The
fair value of fixed rate time deposits is estimated using a discounted cash
flow calculation. The discount rate on such deposits is based upon rates
currently offered for deposits of similar remaining maturities.
COMMITMENTS TO EXTEND CREDIT AND STANDBY LETTERS OF CREDIT--The fair value of
commitments is estimated using the fees currently charged to enter into
similar agreements, taking into account the remaining terms of the agreements
and the present creditworthiness of the counterparties. The fair value of
letters of credit is based on fees currently charged for similar agreements
or on the estimated cost to terminate them or otherwise settle the
obligations with the counterparties at the reporting date. The fair value of
commitments to extend credit and standby letters of credit is not material.
COMMITMENTS TO SELL LOANS AND FORWARD COMMITMENTS TO SELL MORTGAGE-BACKED
SECURITIES--The fair value estimated is based on quoted prices for financial
instruments with identical or similar terms.
PUT OPTIONS TO SELL MORTGAGE-BACKED SECURITIES--The estimated fair value is
derived from active exchange quotations. The fair value of options is not
material.
The estimated fair values of the Company's financial instruments at December
31, 1995 are as follows (in thousands):
CARRYING FAIR
VALUE VALUE
Financial assets:
Cash and federal funds sold $ 37,480,693 $ 37,480,693
Investments securities 18,027,694 18,032,382
Loans and leases receivable 94,435,087 94,468,502
Loans held for sale 38,336,858 38,475,974
Mortgage servicing rights 6,327,677 6,729,910
------------ ------------
$194,608,009 $195,187,461
------------ ------------
------------ ------------
Financial liabilities:
Deposits $191,654,631 $192,203,407
------------ ------------
------------ ------------
Off balance sheet assets (liabilities):
Commitments to sell loans $(21,438,293)
Forward commitments to sell mortgage-backed
securities (154,676)
17. EMPLOYEE BENEFIT
On June 7, 1985, the Bank adopted an incentive stock option plan (the Plan).
The Plan authorized the issuance of up to 110,000 shares of the Bank's
authorized, but unissued common stock. Qualified options were granted only to
full-time employees of the Bank. The exercise price of options granted under
the Plan were set to be not less than the fair market value of the Bank's
common stock on the granting date as determined by the Board of Directors. The
Plan expired June 7, 1995. All outstanding options expired at that date.
25
<PAGE>
Changes in options are as follows:
WEIGHTED
AVERAGE
COMMON EXERCISE PRICE OPTION
STOCK PER SHARE PRICE
Outstanding, January 1, 1993 68,160 $5.00-$11.11 $5.86
Options exercised (59,880) $5.00-$11.11 $5.38
Expired or canceled (1,520) $6.00-$11.11 $7.49
-------
Outstanding, December 31, 1993 6,760 $6.00-$11.11 $9.71
Options exercised (940) $6.00-$11.11 $9.95
Expired or canceled (635) $8.00-$11.11 $10.97
-------
Outstanding, December 31, 1994 5,185 $6.00-$11.11 $9.56
-------
Options exercised (1,081) $6.00-$11.11 $7.52
Expired or canceled (4,104) $6.00-$11.11 $10.52
-------
Outstanding, December 31, 1995 0
-------
The Bank has also established the Commerce Security Bank 401(k) Savings Plan
which qualifies under the Internal Revenue Code Section 401(k). Employee
contributions to the Plan may be matched by the Bank at the discretion of the
Board of Directors. Employee contributions to the Plan are immediately vested
while any matching contributions made by the Bank vest at different
percentages based on years of service. For the years ended December 31, 1995,
and 1994, the Bank contributed approximately $264,000 and $271,000,
respectively, to the Plan. The Bank did not make a contribution for the year
ended December 31, 1993.
18. COMMITMENTS AND CONTINGENCIES
LITIGATION--The Bank is also involved in certain legal proceedings arising in
the normal course of its business. Bank management, after reviewing these
matters with outside counsel, considers that the aggregate liabilities, if
any, will not be material to the financial statements.
LEASES--A summary of noncancellable future operating lease commitments at
December 31, 1995 follows:
1996 $1,415,056
1997 1,286,082
1998 1,130,184
1999 703,443
Thereafter 158,289
----------
$4,693,054
----------
----------
It is expected that in the normal course of business, expiring leases will be
renewed or replaced.
Rent expense under all noncancellable operating lease obligations aggregated
$1,500,446, $1,325,245 and $937,868 for the years ended December 31, 1995,
1994 and 1993, respectively.
26
<PAGE>
19. SUBSEQUENT EVENT
On January 24, 1996, the Bank signed a letter of intent with agreement to be
acquired by SDN Bancorp, Inc. to form a business combination and created a
Bank Holding Company subject to shareholder and regulatory approval.
27
<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
The following Unaudited Pro Forma Condensed Combined Statement of Condition
as of December 31, 1995, and the Unaudited Pro Forma Condensed Combined
Statement of Operations for the year ended December 31, 1995, give effect to
the Liberty Acquisition and the Commerce Acquisition, which will be accounted
for by the purchase method of accounting, as if such transaction had occurred
on January 1, 1995.
The pro forma information is based on the historical consolidated financial
statements of SDN, Liberty and Commerce under the assumptions and adjustments
set forth in the accompanying Notes to the Unaudited Pro Forma Condensed
Combined Financial Statements. The Pro Forma Condensed Combined Financial
Statements do not reflect any cost savings in connection with the Liberty
Acquisition or the Commerce Acquisition.
The information shown below should be read in conjunction with the
consolidated historical financial statements of SDN, Liberty and Commerce,
including the respective notes thereto, which are included elsewhere in this
Report or other filings. The pro forma data is presented for comparative
purposes only and is not necessarily indicative of the combined financial
position or results of operations in the future or of the combined financial
position or results of operations which would have been realized had the
acquisition been consummated during the period or as of the date for which the
pro forma data is presented.
Pro forma per share amounts for the combined Liberty and SDN entity are
based upon issuance of 3,430,380 shares of SDN common stock which were
subsequently exchanged share for share in Holdco. The issuance price of the SDN
common stock used to determine the number of shares issued is approximately
$3.95 per common share. Pro forma per share amounts for the combined pro forma
SDN and Commerce entity are based upon issuance of 5,431,492 shares of Holdco
common stock. The issuance price of the Holdco common stock used to determine
the number of shares issued is approximately $3.95 per common share.
28
<PAGE>
COMMERCE SECURITY BANCORP, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF CONDITION
DECEMBER 31, 1995
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
Pro Forma Pro Forma
-------------------------
SDN CSB Adjustments (1) Combined
--------- --- ----------- --------
<S> <C> <C> <C> <C>
ASSETS
Cash and due from banks $ 12,094 $ 9,481 $ (803) a $ 20,772
Federal funds sold 9,450 21,000 - 30,450
Reverse repurchase agreements - 7,000 - 7,000
Securities 41,763 18,028 - 59,791
Mortgage loans held for sale - 38,337 - 38,337
Loans, net 127,907 96,831 - 224,738
Less: allowance for loan loss (2,325) (2,396) - (4,721)
Premises and equipment, net 1,823 2,431 - 4,254
Goodwill and other intangibles 4,508 6,328 4,794 b 15,630
Other assets 6,843 16,307 337 c 23,487
-------- -------- -------- --------
Total assets $202,063 $213,347 $ 4,328 $419,738
-------- -------- -------- --------
-------- -------- -------- --------
LIABILITIES AND
SHAREHOLDERS' EQUITY
Deposits:
Non-interest bearing $35,864 $ 69,325 - $ 105,189
Interest bearing 146,447 122,329 - 268,776
-------- -------- -------- --------
Total deposits 182,311 191,654 - 373,965
Accrued interest payable
and other liabilities 2,661 4,940 - 7,601
-------- -------- -------- --------
Total liabilities 184,972 196,594 - 381,566
Common stock 43 - 55 d 98
Additional paid-in capital 21,109 4,481 16,545 d 42,135
Retained earnings (deficit) (4,061) 12,272 (12,272) d (4,061)
-------- -------- -------- --------
Total shareholders' equity 17,091 16,753 4,328 38,172
-------- -------- -------- --------
Total liabilities and
shareholders' equity $202,063 $213,347 $ 4,328 $419,738
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
See accompanying notes to the unaudited pro forma condensed combined financial
statements.
29
<PAGE>
COMMERCE SECURITY BANCORP, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1995
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
Pro Forma Pro Forma
-------------------------
SDN CSB Adjustments (1) Combined
---------- --- ----------- --------
<S> <C> <C> <C> <C>
Interest Income
Interest and fees on loans and leases $ 15,027 $ 12,204 $ - $ 27,231
Interest on investment securities 1,653 1,513 3,166
Interest on Federal funds sold 558 423 (40) a 941
--------- --------- ------- ---------
Total interest income 17,238 14,140 (40) 31,338
Interest Expense
Deposits 7,147 6,502 - 13,649
Debentures and other 187 234 - 421
--------- --------- ------- ---------
Total interest expense 7,334 6,736 - 14,070
--------- --------- ------- ---------
Net interest income 9,904 7,404 (40) 17,268
Provision for loan losses 445 1,196 - 1,641
--------- --------- ------- ---------
Net income after provision for loan losses 9,459 6,208 (40) 15,627
Non-interest income 3,048 16,802 - 19,850
Non-interest expense 12,567 21,779 479 b 34,825
--------- --------- ------- ---------
Income(loss) before provision for income
tax and extraordinary item (60) 1,231 (519) 652
Provision(benefit) for income taxes (87) 517 17 447
--------- --------- ------- ---------
Income(loss) before extraordinary item 27 714 (502) 205
Extraordinary item, net of taxes 625 - - 625
--------- --------- ------- ---------
Net income (loss) $ 652 $ 714 $ (502) $ 830
--------- --------- ------- ---------
--------- --------- ------- ---------
Weighted average common
shares outstanding 3,698,578 9,130,070
Income per common share $ 0.18 $0.09
</TABLE>
See accompanying notes to the unaudited pro forma condensed combined financial
statements.
30
<PAGE>
SDN BANCORP, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF CONDITION
DECEMBER 31, 1995
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
Pro Forma
--------------------------
SDN LNB Adjustments (1) Combined
---------- --------- ----------- --------
<S> <C> <C> <C> <C>
ASSETS
Cash and due from banks $ 4,629 $ 7,874 $ (409) a $ 12,094
Federal funds sold 2,300 9,350 (2,200) a 9,450
Securities 7,009 34,754 - 41,763
Loans, net 38,977 88,930 - 127,907
Less: allowance for loan loss (639) (1,686) - (2,325)
Premises and equipment, net 597 1,226 - 1,823
Goodwill and other intangibles - - 4,508 b 4,508
Other assets 3,032 3,652 159 c 6,843
-------- -------- -------- --------
Total assets $ 55,905 $144,100 $ 2,058 $202,063
-------- -------- -------- --------
-------- -------- -------- --------
LIABILITIES AND
SHAREHOLDERS' EQUITY
Deposits:
Non-interest bearing $ 13,445 $ 22,419 - $ 35,864
Interest bearing 37,986 108,461 - 146,447
-------- -------- -------- --------
Total deposits 51,431 130,880 - 182,311
Accrued interest payable
and other liabilities 933 1,728 - 2,661
-------- -------- -------- --------
Total liabilities 52,364 132,608 - 184,972
Common stock 9 3,260 (3,226) d 43
Additional paid-in capital 7,593 4,062 9,454 d 21,109
Retained earnings (deficit) (4,061) 4,170 (4,170) d (4,061)
-------- -------- -------- --------
Total shareholders' equity 3,541 11,492 2,058 17,091
-------- -------- -------- --------
Total liabilities and
shareholders' equity $ 55,905 $144,100 $ 2,058 $202,063
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
See accompanying notes to the unaudited pro forma condensed combined financial
statements.
31
<PAGE>
SDN BANCORP, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1995
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
Pro Forma
-------------------------
SDN LNB Adjustments (1) Combined
---------- --------- ----------- --------
<S> <C> <C> <C> <C>
Interest Income
Interest and fees on loans and leases $ 4,086 $ 10,941 $ - $ 15,027
Interest on investment securities 365 1,288
1,653
Interest on Federal funds sold 117 590 (149) a 558
-------- -------- -------- -------
Total interest income 4,568 12,819 (149) 17,238
Interest Expense
Deposits 1,570 5,577 - 7,147
Debentures and other 181 6 - 187
-------- -------- -------- -------
Total interest expense 1,751 5,583 - 7,334
-------- -------- -------- -------
Net interest income 2,817 7,236 (149) 9,904
Provision for loan losses 295 150 - 445
-------- -------- -------- -------
Net income after provision for loan losses 2,522 7,086 (149) 9,459
Non-interest income 696 2,352 - 3,048
Non-interest expense 4,291 7,825 451 b 12,567
-------- -------- -------- -------
Income(loss) before provision for income
tax and extraordinary item (1,073) 1,613 (600) (60)
Provision(benefit) for income taxes (443) 608 252 (87)
-------- -------- -------- -------
Income(loss) before extraordinary item (630) 1,005 (348) 27
Extraordinary item, net of taxes 625 - - 625
-------- -------- -------- -------
Net income (loss) $ (5) $ 1,005 $ (348) $ 652
-------- -------- -------- -------
-------- -------- -------- -------
Weighted average common
shares outstanding 268,198 3,698,578
Income per common share $(0.02) $0.18
</TABLE>
See accompanying notes to the unaudited pro forma condensed combined financial
statements.
32
<PAGE>
NOTES TO THE
UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
NOTE 1: The Pro Forma Condensed Combined Financial Statements have been prepared
to reflect the acquisition of Liberty for an aggregate price of $15.0 million
and the acquisition of Commerce for an aggregate price of $20.7 million. Pro
forma adjustments have been made to reflect:
a) the transaction costs incurred in conjunction with the Liberty
Acquisition and the Commerce Acquisition, net of additional cash provided by the
Partnership in funding the transaction. Also reflected is the $2.2 million
redemption of Liberty's capital as a funding component of the Liberty
Acquisition. Included in the Pro Forma Condensed Combined Statement of
Operations is an adjustment to interest on Federal funds sold to reflect the
foregone income at the prevailing Federal funds rates for the year.
b) the excess of the cost over the fair value of the net assets acquired in
the acquisitions are as follows:
Liberty Commerce
------- --------
Purchase price $15,027 $20,744
Historical net tangible assets acquired 11,428 16,753
Estimated closing adjustments (973) (803)
Estimated fair value adjustments 64 -
------- --------
Estimated fair value of net assets 10,519 15,950
------- --------
Excess cost over net assets acquired $ 4,508 $ 4,794
------- --------
------- --------
Included in the Pro Forma Condensed Combined Statement of Operation is an
adjustment to non-interest expense that reflects the amortization of the excess
cost over net assets acquired over a useful life of ten years utilizing the
straight line method.
c) the tax benefit related to the expenses incurred in conjunction with the
Acquisition and establishment of a valuation reserve for the state deferred tax
asset.
d) the elimination of the historical shareholders' equity in accordance
with purchase method of accounting, which reflects the issuance of a total of
3,430,380 shares in the Liberty Acquisition and 5,431,492 shares in the Commerce
Acquisition in exchange for cash investment by the Partnership, other direct
investors and services rendered by investment bankers.
