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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
ANNUAL REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1996 Commission File Number 2-76555
COMMERCE SECURITY BANCORP, INC.
(Exact name of small business issuer in its charter)
Delaware 33-0720548
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization Identification No.)
7777 Center Avenue, Huntington Beach, CA 92647
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: (714) 895-2929
Securities registered pursuant to Section 12 (b) of the Exchange Act:
None
Securities registered pursuant to Section 12 (g) of the Exchange Act:
None
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the issuer was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes [ X] No
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of issuer's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB. [ ]
There were 9,697,430 shares of Common Stock outstanding at March 14, 1997. The
aggregate market value of Common Stock held by non-affiliates at March 14, 1997
was approximately $1,291,000 based upon the last known trade of $3.50 per share
on February 28, 1997.
Documents incorporated by reference: None
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TABLE OF CONTENTS
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Page
Part I
Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . .42
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . .45
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . .46
Part II
Item 5. Market for the Issuer's Common Stock and Related Stockholder
Matters . . . . . . . . . . . . . . . . . . . . . . . . . . .47
Item 6. Management's Discussion and Analysis of Financial Condition
and Results of Operations . . . . . . . . . . . . . . . . . .51
Item 7. Financial Statements. . . . . . . . . . . . . . . . . . . . . . .63
Item 8. Disagreements on Accounting and Financial Disclosure. . . . . . .64
Part III
Item 9. Directors and Executive Officers of Issue. . . . . . . . . . . . .65
Item 10. Executive Compensation. . . . . . . . . . . . . . . . . . . . . .68
Item 11. Security Ownership of Certain Beneficial Owners
and Management . . . . . . . . . . . . . . . . . . . . . . .74
Item 12. Certain Relationships and Related Transactions. . . . . . . . . .77
Part IV
Item 13. Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . . . .78
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .82
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PART I
ITEM 1. BUSINESS
BUSINESS OF THE COMPANY
GENERAL
Commerce Security Bancorp, Inc. (the "Company") was incorporated under the
laws of the State of Delaware in May 1996. The Company became a bank holding
company, registered under the BHC Act, on August 31, 1996 when it became the
parent company of SDN Bancorp, Inc. ("SDN"), and indirectly of Liberty National
Bank ("Liberty") and San Dieguito National Bank ("San Dieguito"), in
anticipation of the CSB Acquisition. On September 1, 1996, the Company
completed the CSB Acquisition, whereupon it also became the direct parent
company of Commerce Security Bank ("CSB"). The Company's only significant
assets are the stock of SDN and CSB, and its primary function is to coordinate
the general policies and activities of its direct and indirect operating
subsidiaries, CSB, Liberty and San Dieguito (the "Banks"), and to pursue the
strategic plan summarized below.
SDN Bancorp was incorporated under the laws of the State of California on
October 19, 1981. SDN Bancorp became a bank holding company on March 22, 1983,
when it acquired 100% of the outstanding shares of San Dieguito National Bank
("San Dieguito"), a national banking association headquartered in Encinitas,
California. Bancorp acquired the Bank's stock pursuant to a reorganization
whereby each outstanding share of the Bank's common stock was converted into one
share of Bancorp's common stock, and all of the outstanding shares of the Bank's
common stock were transferred to Bancorp.
As of September 30, 1995, SDN Bancorp, a California corporation
("Bancorp-CA") completed the recapitalization (the "Recapitalization")
contemplated by the July 21, 1995 Stock Purchase Agreement (the "Stock Purchase
Agreement") whereby Bancorp-CA reincorporated under Delaware law through its
merger (the "Merger") with and into SDN Bancorp, Inc., a newly formed
corporation under Delaware law ("SDN"), with SDN constituting the surviving
corporation, and thereafter issued an aggregate of 841,739 shares of Company
Common Stock to Dartmouth Capital Group, L.P., a Delaware limited partnership
(the "Partnership") together with certain of its partners ("Direct Holders").
The Partnership is controlled by its sole general partner, Dartmouth Capital
Group, Inc., ("DCG, Inc.") a Delaware corporation.
ACQUISITIONS
GENERAL. The Partnership and DCG, Inc. were organized in May 1995 to
evaluate and, if and when appropriate, acquire controlling or substantial equity
positions in, or certain assets and liabilities of, one or more banks or thrifts
or similar financial institutions located principally in California. The
Partnership and DCG, Inc. are registered bank holding companies under the
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Bank Holding Company Act of 1956, as amended. The Partnership and DCG, Inc. are
sometimes collectively referred to in this Annual Report as "Dartmouth Capital
Group." As of the date of this Annual Report, the Partnership's principal asset
is its controlling equity investment in the Company.
LIBERTY. As of March 31, 1996, the registrant completed its Acquisition
(the "Acquisition") of Liberty National Bank ("Liberty") for approximately $15.1
million in cash as contemplated by the October 26, 1995 Agreement and Plan of
Merger by and among the registrant, Liberty, and Dartmouth Capital Group, L.P.,
a Delaware limited partnership ("the Partnership") and the registrant's
controlling shareholder.
As of March 27, 1996, the Partnership invested approximately $13.4 million
in the registrant to fund the Liberty Acquisition. In exchange for that
investment, the registrant issued a total of 3,392,405 additional shares of
Common Stock at a price per share of $3.95, the registrant's book value per
share as of December 31, 1995. At the Partnership's direction the registrant
issued 1,764,000 of those shares of Common Stock, in the aggregate, to certain
limited partners of the Partnership (the "Direct Holders") and the remaining
1,628,405 shares of Common Stock directly to the Partnership. A total of 38,300
shares were issued to investment bankers involved in the Acquisition and an
additional 1,400 shares were issued to the directors of Liberty.
CSB. As of September 1, 1996, the registrant completed its merger (the
"Merger") of Commerce Security Bank ("CSB") 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 (the "Company") 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 CSB
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 CSB Acquisition, the Partnership owns 48.0% of the Common Stock and the
Direct Holders own, in the aggregate 34.2% 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 the Company's
common stock and cash of approximately $346,000 were placed into escrow pending
resolution of the SAIF recapitalization. As a result
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of legislation that recapitalized the SAIF, passed on September 30, 1996, the
stock and cash escrows were distributed, with approximately $96,000 disbursed in
cash and 16,151 common shares distributed. A total of 161,357 shares were issued
to other direct investors who invested in conjunction with the Merger and
investment bankers involved in the Merger.
PENDING ACQUISITIONS. On December 24, 1996, the Company entered into a
definitive Agreement and Plan of Merger (the "Acquisition Agreement") with
Eldorado Bancorp ("Eldorado") of Tustin California, the holding company of
Eldorado Bank. Pursuant to the Acquisition Agreement, CSBI will acquire 100% of
the outstanding stock of Eldorado for cash consideration of $23.00 per share.
Prior to the acquisition, all Eldorado stock options that have not previously
been exercised (the "Existing Options"), including those Existing Options that
have not yet vested, will be canceled in return for the payment by Eldorado of
the difference between the $23.00 price per share and the applicable Existing
Option's exercise price. As of the date of the Acquisition Agreement, Eldorado
had outstanding Existing Options entitling the holders to purchase 314,233
shares of Eldorado common stock, with an average exercise price of $10.27. The
aggregate consideration payable to holders of Eldorado common stock and Existing
Options (net of the tax benefit arising out of the Existing Options) will be
approximately $89.6 million.
ACQUISITION FINANCING. CSBI estimates that approximately $93.5 million of
cash will be necessary to fund the payment of the cash consideration to the
Eldorado shareholders and Option holders and of Acquisition-related expenses
incurred by the Company. The Company will obtain such funding primarily from
existing investors and certain institutional investors. The securities issued
to fund the acquisition will include trust originated preferred stock and
non-cumulative preferred stock, Class A common stock ("Senior Common"), Class B
common stock and warrants to purchase approximately 4.5 million shares of Class
B common stock.
The Company has entered into a definitive agreement to sell the preferred
stock and the Senior Common, the material terms of those securities are
substantially as described below. If the Company is unable to make the
quarterly cash dividend payments due on the preferred stock, it would be
obligated to distribute to the holders of the preferred stock additional shares
of Class B Common/a "PIK Distribution", resulting in a higher effective dividend
rate.
Existing shares of the Company's common stock will be reclassified as
Class B common stock in connection with the transaction. The Senior Common will
be entitled to a liquidation preference over the Class B Common if there is a
liquidation or a change in control of the Company. The preference afforded
Senior Common will have the effect of granting to the holders of those shares a
right to a return of an amount per share equal to the original purchase price
per share (less previous returns of capital and subject to increase as provided
below).
ACQUISITION DEPOSIT. As a condition to entering into the Acquisition
Agreement before the Company's finalization of the terms of the preferred stock
and the Senior Common, the
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Company, in December 1996, placed $4.5 million in an escrow account which would
be forfeited in the event that Company fails to finance the acquisition.
Dartmouth Capital Group, L. P., the Company's controlling shareholder, and one
of the Company's directors provided the funds for the escrow deposit. Those
funds are initially in the form of a loan to the Company which (including
interest thereon) would be converted to shares of Class B common stock upon the
consummation of the Acquisition.
TERMINATION FEE AND STOCK OPTION AGREEMENT. The Acquisition Agreement
contains customary termination and expense allocation provisions, including
provisions requiring Eldorado to pay the Company a termination fee of $3.5
million (the "Termination Fee") in the event that the Acquisition Agreement is
terminated under certain circumstances relating to Eldorado's receipt from a
third party of a competing proposal for the acquisition of Eldorado or its
assets, or for a business combination of Eldorado with a third party.
As a condition to entering into the Acquisition Agreement, the Company and
Eldorado entered into a Stock Option Agreement granting the Company an option
(the "Option") to acquire 468,200 shares of Eldorado common stock (constituting
11.0% of the Eldorado's Common Stock outstanding on a pro forma basis giving
effect to the exercise of the Option) at a price of $22.00 per share. The
Option will become exercisable only in the event that the Acquisition Agreement
is terminated under circumstances that require Eldorado to pay the Termination
Fee. In the event the Option becomes exercisable, the Company (or any
transferee of the Company) may "put" the Option or the shares acquired
thereunder to Eldorado, subject to regulatory approval, during a specified
period in return for payment of an amount determined under a formula contained
in the Option (which amount cannot exceed $1.0 million). The Option will expire
and cease to be exercisable if the Acquisition Agreement is terminated under
circumstances that do not require Eldorado to pay the Termination Fee or if the
Option is not exercised within one year of the date on which it first becomes
exercisable.
STRATEGIC PLAN
Since the 1995 Recapitalization, Company has pursued a strategic plan that
has focused on active and substantial efforts to acquire or enter into business
combinations with other financial institutions. The acquisition of Eldorado,
that is expected to close in the second quarter of 1997, will be the third such
acquisition since the beginning of this year. The Company anticipates that it
will continue this strategic plan after the closing of the Eldorado transaction.
There can be no assurance, however, that the Company will in fact acquire or
enter into any business combination with any other institution.
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The Company's goal is to develop a "super-community bank" with the
following characteristics:
A STRONG COMMUNITY AND RELATIONSHIP ORIENTATION. The Company will
retain local flexibility in those areas that increase market responsiveness,
encourage community involvement, maximize the value of its local identity
and promote local flexibility and responsiveness.
HIGH QUALITY, RESPONSIVE SERVICE, FLEXIBLE POLICIES AND PRICES WITH A
BROAD PRODUCT LINE. The Company will strive to deliver superior customer
service and to develop broad and enduring relationships, while avoiding
excessive concentrations of business risk.
COST EFFICIENCY AND APPROPRIATE TECHNOLOGY. The Company will
centralize those responsibilities and decisions that do not have a direct
impact on customer relationship management and will standardize those
functions, tasks and responsibilities that provide significant operating
efficiencies, add value to customer relationships or control risk.
Specifically, standardization will be pursued in the following areas:
product line and product features, operating policies and procedures, data
processing, management information and financial systems, risk management
and financial control systems, credit policies and processes, marketing
systems and human resources policies and procedures.
SOUTHERN CALIFORNIA SUBSIDIARIES
GENERAL. Currently, through Liberty and San Dieguito, the Company offers a
broad range of commercial banking services in Southern California, catering
especially to small businesses. Liberty and San Dieguito's products include
various types of commercial, consumer and real estate loans, a full range of
deposit products and other non-deposit banking services. In its marketing, the
Company emphasizes commercial and professional clients, but balances its loan
portfolio and deposit mix by offering a full range of consumer financial
services to retail clients within its trade area and to its business client
base.
LIBERTY. Liberty commenced operations as a national banking association in
1982. Its main banking office and administrative offices are located at One
Pacific Plaza, 7777 Center Avenue, Huntington Beach, California, which is near
the intersection of the I-405 (San Diego) Freeway and Beach Boulevard. In June
1992, Liberty opened its full-service South Orange County branch office at 34206
Doheny Park Road, Dana Point, California, and in June 1996, Liberty opened a
third full-service branch office at 17011 Beach Boulevard, Huntington Beach
California, which is close to the Pacific Coast Highway. The primary service
area of the Huntington Beach branches includes the cities of Huntington Beach,
Westminster, Fountain Valley, Mid Way City, South West Santa Ana, Costa Mesa,
Newport Beach, West Irvine, East Seal Beach and Garden Grove, California, from
which Liberty attracts approximately 40% of its business.
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As the result of Liberty's active direct mail marketing, the Huntington
Beach locations also attract customers from a secondary service area consisting
primarily of Anaheim, Santa Ana and Irvine, California. The primary service
area of the Dana Point branch includes the cities of Dana Point, Capistrano
Beach, San Juan Capistrano and San Clemente. The Dana Point branch also
attracts, through its direct mail advertising, customers from a secondary
service area consisting primarily of the cities of Monarch Beach, Mission Viejo
and Laguna Niguel.
In February 1985, Liberty also opened a limited service loan production
office in San Francisco at 44 Montgomery Street, Suite 500, San Francisco,
California, primarily to produce and process loans guaranteed by the U.S. Small
Business Administration ("SBA loans"); that office was relocated to its present
address at 12 Orinda Way, Orinda, California in June 1995.
SAN DIEGUITO. San Dieguito commenced operations as a national banking
association in 1980. Its main banking office and administrative offices are
located at 135 Saxony Road in Encinitas, California, which is approximately 25
miles north of San Diego. In December 1990, San Dieguito opened its
full-service office at 675 Carlsbad Village Drive, Carlsbad, California, in the
downtown area of Carlsbad, approximately 10 miles north of Encinitas. Together,
the main office and the Carlsbad branch provide service primarily to the north
coastal section of San Diego County.
SBA LENDING CONCENTRATION. A substantial portion of the Company's business
consists of originating and servicing SBA loans, and a substantial portion of
its net income is generated from that business. Both San Dieguito and Liberty
are qualified as "Preferred Lenders" under the SBA's programs, allowing them to
originate SBA loans based on their own underwriting decisions and without prior
approval of the SBA. The Company sells the government guaranteed portion of the
SBA loans at a premium, a portion of which is immediately recognized as income.
The remaining portion of the premium, representing the estimated normal
servicing fees or a yield adjustment on the portion of the SBA loan retained by
the Company, is deferred and recognized as income over the estimated life of the
loan. Deferred SBA servicing fees were approximately $1.7 million at December
31, 1996. The total SBA loan portfolio serviced by the Company at December 31,
1996 was approximately $158.1 million; included in this amount is approximately
$46.6 million that represents the portion of the SBA loans retained by the
Company. There have from time to time been proposals in the U.S. Congress to
curtail or otherwise modify the SBA loan guarantee programs. A significant
reduction in the Company's ability to originate new SBA loans as a result of
such legislative changes would have a material and adverse impact on the
Company's asset generation and earnings (See "BUSINESS -- Effect of Governmental
Policies and Legislation.")
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NORTHERN CALIFORNIA SUBSIDIARY
GENERAL. CSB's current principal business units are a Commercial Banking
Division, a Mortgage Division and a Leasing Division. The Commercial Banking
Division focuses on generating loans and raising deposits primarily in the
greater Sacramento area. The Mortgage Division generates residential mortgage
loans, (directly and through brokers and correspondents), and sells them in the
secondary market. The Leasing Division generates equipment leases through
wholesale sources, services those leases and (beginning recently) sells blocks
of leases to other institutions.
Approximately half of CSB's deposits consist of title deposits and
out-of-market CD's, both of which tend to be volatile. Title deposits are
non-interest-bearing deposits, and, while they do not earn interest, CSB
provides these depositors with certain specialized customer services, such as
data processing, accounting, and courier services. CSB controls its customer
service expenses by continuously monitoring the earnings performance of its
account relationships and, on that basis, limiting the amount of servicing
expense. Title deposits are volatile because they are sensitive to prevailing
interest rates and other general economic factors that affect the demand for
real estate. Administrative CDS are out-of-area deposits that are obtained by
placing CSB's rates on various rate bulletin boards available at CD investment
services. Out-of-market CDS are volatile because of the inherent interest rate
sensitivity. CSB deals directly with the depositor and does not pay a fee or
commission for those deposits.
CSB's primary service areas consist of the greater Sacramento area for
commercial loans and deposits and the western United States for residential
mortgage loans and the mid-western and western states for equipment leasing
transactions. In order to compete effectively with the other financial
institutions in its primary service areas, CSB relies primarily upon local
promotional activities, personal contacts by its officers, directors, employees
and shareholders, automated 24-hour banking and the individualized service which
it can provide through its flexible policies. In competing for loans, CSB has
arranged for loans on a participation basis with correspondent banks for
customers whose loan demand exceeds CSB's lending limit, and CSB intends to
continue to do so in the future.
CSB COMMERCIAL BANKING DIVISION. CSB's Commercial Banking Division
operates a commercial banking business in the Greater Sacramento area.
Commercial and real estate lending and deposit gathering from business customers
of CSB are the primary focus of the Division, although the Division also engages
in substantially all of the other business operations customarily conducted by
independent commercial banks in California, including the acceptance of
checking, savings and time deposits, the provision of cash management services,
and the making of commercial, real estate, personal, home improvement and other
installment loans and term extensions of credit.
The largest segment of the Commercial Banking Division's lending consists
of commercial real estate loans and real estate construction loans, which
together aggregated $32.0
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million, or 26.8% of CSB's gross loans and leases and at December 31, 1996.
Loans of all types held by the Commercial Banking Division totaled $59.6 million
at December 31, 1996, or approximately 50.0% of CSB's gross loans and leases.
CSB MORTGAGE DIVISION. CSB entered the mortgage banking business in 1988.
The Mortgage Division (sometimes referred to as the Residential Division)
originates (directly and through brokers), acquires and sells first lien
mortgage loans secured by single family residences. As a matter of normal
practice, the Mortgage Division sells all of the loans it originates. Loans
have historically been sold in the secondary mortgage market on both a servicing
retained basis, in which CSB would continue to service the loan after sale, and
a servicing released basis, in which CSB would transfer the servicing of the
loan to the loan buyer. The Mortgage Division has historically from time to
time also purchased servicing rights on loans it did not originate.
The primary sources of revenue from the Mortgage Division have historically
been bulk sales of servicing rights, loan origination fees, net interest income
earned during the period that the loans are held for sale, gains from the sale
of loans, loan servicing fee income and brokerage fees. Prior to the completion
of the CSB Acquisition, CSB sold the majority of its servicing rights. The
balance of CSB's servicing rights were sold in December 1996. Since May 1996,
however, CSB has undertaken to sell all loans generated by the Mortgage Division
either on a servicing released basis or, if the loans are sold on a servicing
retained basis, to sell the servicing rights to third parties. This change is
motivated in part by changes in the required accounting for retained loan
servicing rights. Those accounting changes have the potential of causing
volatile fluctuations in a mortgage lender's shareholders' equity.
The Mortgage Division originates loans through two primary sources: (a)
the retail market, which represents loans generated by a network of branch
offices staffed with commission based loan officers who solicit loans directly
from real estate brokers, home builders, and personal referral; and (b) the
wholesale market, which represents loans generated through a network of approved
mortgage brokers. All loans originated from these two sources are underwritten
and closed by CSB. These sources are located throughout the Pacific Coast and
Rocky Mountain regions of the United States.
The Division sells the majority of conventional loans originated under
programs offered by the Federal Home Loan Mortgage Corporation (FHLMC or
"Freddie Mac") or the Federal National Mortgage Association (FNMA or "Fannie
Mae"). The Division also originates loans insured by the Federal Housing
Administration (FHA) or guaranteed by the Veterans Administration (VA). Those
loans are sold either under a private sale agreement or pooled to form
Government National Mortgage Association (GNMA) securities. These securities
are then sold to investment banking firms. In addition, CSB originates loans
that are eligible for sale to private investors. Those loans are underwritten
to conform to the individual guidelines of these private investors.
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CSB LEASING DIVISION. CSB entered the leasing market in 1990. The
Leasing Division remained small from 1990 until 1993, when the slowdown in
residential mortgage originations that prevailed throughout the industry
enabled CSB to place more emphasis on the Leasing Division. The Division's
equipment lease portfolio has grown substantially since 1993, increasing from
$9 million at December 31, 1993 to $28.1 million at December 31, 1995, and to
$42.9 million at December 31, 1996.
The production of new leases now comes exclusively from the wholesale
sector through a network of brokers. CSB believes that the use of its
wholesale distribution network provides both risk diversification and costs
efficiencies. As of January 1, 1995, CSB ceased to accept lease applications
directly from customers; in 1994, leases made directly to customers made up
8% of production. The wholesale sources of leases on which CSB now relies are
primarily located throughout the mid-western and western United States. CSB
makes no consumer leases and no automobile leases, either to consumers or
businesses. The average size of CSB's leases originated during 1996 was
approximately $25,000.
CSB REAL ESTATE VENTURES. CSB also invested in several real estate
joint ventures through a subsidiary, CSB Ventures, Inc. ("CSB Ventures"),
prior to the adoption of the Federal Deposit Insurance Corporation
Improvement Act of 1991, which substantially limited banks' authority to make
such investments. CSB Ventures currently retains one of such investments,
having an aggregate net value as of December 31, 1996 of $764,000, which it
is actively marketing for sale. There can be no assurance that the Company
will be able to realize all or substantially all of the current carrying
value of this real estate investment.
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HISTORICAL DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY
The following schedule sets forth (for the Company on a consolidated basis)
the annual average amount outstanding for each major category in the statements
of condition for the periods stated and the percent of total assets. the
Company did not engage in foreign activities in either period.
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995
---- ----
AVERAGE PERCENT AVERAGE PERCENT
BALANCE OF TOTAL BALANCE OF TOTAL
------- -------- ------- --------
ASSETS
Cash and due from banks $ 14,611 6.04% $ 3,757 6.59%
Federal funds sold 17,837 7.37 2,128 3.73
Time deposits with other banks 1,254 .52 868 1.52
Securities 32,886 13.60 5,061 8.88
Loans and leases, net 146,743 60.67 42,272 74.17
Other assets 28,535 11.80 2,909 5.11
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Total Assets $241,866 100.00% $56,995 100.00%
-------- ------ ------- ------
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LIABILITIES:
Deposits
Demand, non-interest-bearing $ 52,273 21.61% $11,197 19.65%
Demand, interest-bearing 24,464 10.11 10,492 18.41
Money market 18,135 7.50 9,176 16.10
Savings 28,917 11.96 5,235 9.18
Time certificates 91,987 38.03 18,394 32.27
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Total Deposits 215,776 89.21 54,494 95.61
Federal funds purchased 16 .01 - -
Other borrowing 402 .17 - -
Long-term debt 537 .22 1,776 3.12
Other liabilities 4,437 1.83 806 1.41
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Total Liabilities 221,168 91.44 57,076 100.14
SHAREHOLDERS' EQUITY
Common Stock 53 .02 2,203 3.87
Surplus 24,709 10.22 2,510 4.40
Undivided Profits (4,064) (1.68) (4,794) (8.41)
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Total Shareholders' Equity 20,698 8.56 (81) (.14)
-------- ------ ------- ------
Total Liabilities and Equity $241,866 100.00% $56,995 100.00%
-------- ------ ------- ------
-------- ------ ------- ------
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PRODUCT FOCUS
The Company intends to coordinate its activities within defined lines of
business. Those lines of business will include:
COMMERCIAL BANKING, including cash management, small business banking,
commercial leasing and commercial real estate, and
RETAIL BANKING, including residential mortgage loans and consumer and
automobile lending.
As a consequence of the 1995 Recapitalization (which fundamentally
changed the Company's capital structure and capital levels, and brought new
management) and the Liberty and CSB Acquisitions (each of which substantially
increased the Company's assets), the historical information and data provided
in this report with respect to the business of CSB, Liberty and San Dieguito
may not be indicative of the Company's current or future operations or
results.
DEPOSITS AND SERVICES
Through its subsidiary Banks, the Company offers a full range of deposit
products, including business and personal checking, savings, time deposits
and money market accounts. It also offers a range of business-oriented
financial services, including international (through correspondent banks) and
domestic letters of credit and night deposit facilities, as well as other
services used by business and consumer customers including safe deposit
services, postage paid bank-by-mail, and transfer services such as wire
transfers, travelers' checks, cashier's checks and money orders. It operates
24-hour automated teller machines ("ATM") at its banking offices, and has
drive-through banking at San Dieguito's main office.
In addition, the Company offers specialized services including cash
management services (i.e. payroll, remittance banking and consolidated
accounts) and courier service to qualifying clients, and appoints personal
account officers to key relationship clients in order to better support their
specific banking requirements. It also offers 24-hour banking by telephone
and banking through the use of personal computers. Its consumer services
complement its business emphasis by offering a range of personal and private
banking financial services such as interest-bearing checking, fee-based
checking, savings, money market accounts, tailored time certificates of
deposit, and personal investment referral.
The Company does not operate a trust department or provide international
banking services directly; however, it can arrange with correspondent
institutions to offer trust and international services to its customers from
time to time upon request. Liberty and San Dieguito do not issue VISA or
MasterCard credit cards, but are a merchant depository for cardholder drafts
under both types of credit cards. CSB does issue VISA credit cards but only
on a limited basis to qualifying business customers.
12
<PAGE>
The following table shows the average amount and average rate paid on
the categories of deposits for each of the past two calendar years:
YEAR ENDING DECEMBER 31,
------------------------
1996 1995
---- ----
(DOLLARS IN THOUSANDS)
AMOUNT RATE AMOUNT RATE
Non-interest-bearing demand $ 52,273 0.00% $11,197 0.00%
Interest-bearing demand 24,464 2.80% 10,492 1.42%
Money Market 18,135 2.72% 9,176 2.52%
Savings 28,917 3.98% 5,235 2.20%
Time 91,987 5.70% 18,394 5.84%
-------- -------
Total $215,776 3.51% $54,494 2.88%
-------- -------
-------- -------
Additionally, the following table shows the maturities of time
certificates of deposits of $100,000, or more at December 31, 1996:
AT DECEMBER 31, 1996
----------------------
(DOLLARS IN THOUSANDS)
Due in three months or less $16,387
Due in over three months through six months 2,754
Due in over six months through twelve months 6,460
Due in over twelve months 302
-------
Total $25,903
-------
-------
BORROWINGS
While the Company has not had need in recent periods for short-term
borrowings to provide liquidity, if necessary the Company is eligible,
through its subsidiary Banks, Liberty and San Dieguito, to borrow at the
Federal Reserve discount window. As of December 31, 1996, San Dieguito had
pledged an aggregate of approximately $1.0 million in commercial mortgage
loans to the Federal Reserve Bank of San Francisco as collateral for such
borrowings, enabling it to borrow up to approximately $550,000.
Additionally, through its subsidiary Bank CSB, the Company is able to borrow
through programs offered at the Federal Home Loan Bank of San Francisco. As
of December 31, 1996, CSB did not have any securities pledged to the Federal
Home Loan Bank of San Francisco as collateral for such borrowings, however,
upon delivery of sufficient securities CSB has the ability to borrow up to
approximately $17.0 million.
Overnight borrowings may also be effected through purchases of Federal
funds from correspondent banks. The Company has had little need of such
borrowings during recent periods. During 1996, an average of $16,000 was
borrowed at a weighted average interest rate of 6.25%. In 1995, an average
of $6,300 was borrowed at a weighted average interest rate of 5.98%.
13
<PAGE>
LENDING BUSINESS
Through its subsidiary Banks, the Company offers a full range of
commercial loans specifically designed to support the banking needs of small
businesses in their market areas. Its products include accounts receivable
financing, term loans, commercial notes, short term commercial real estate
financing and construction financing, including both term and revolving
loans, which generally are secured by business assets of various types. As
noted above, the Company also offers SBA loans. Finally, the Company offers
some types of consumer loans such as automobile loans, overdraft lines of
credit and home equity loans to retail clients within its trade area and to
its business client base.
At December 31, 1996, real estate loans were approximately 55% of the
loan portfolio. Such loans (other than SBA loans) are generally secured by a
first trust deed and are for a period of five years or less with a floating
interest rate. Approximately 57% of the real estate loans were secured by
commercial properties, most of which are owner-occupied, and generally with a
maximum loan-to-value (appraised) ratio of 75%. Construction loans represent
approximately 8% of total real estate loans and are generally made for owner
occupied buildings rather than for speculative purposes. An additional 35%
of the real estate loans are secured by improved single family residential
properties, included in which are approximately $10.8 million of loans that
are held for sale.
The Company's subsidiary Banks, like other lenders, also make a number
of unsecured loans, based upon the cash flow, income, character and/or net
worth of the borrower. Collectibility of those loans is solely dependent
upon the borrower's financial capability at maturity. Unsecured loans, in
many cases, are more risky than secured loans. At December 31, 1996, the
portfolio included $47.8 million in commercial loans and $22.5 million in
installment loans which were considered to be unsecured, for a total of $70.3
million , or 25.6% of the loan portfolio. However, a majority of those loans
are collateralized by junior liens on real estate, by personal property or by
governmental agency guarantees.
Through the Company's subsidiary CSB, the Company originates small
equipment leases to businesses on a wholesale basis. These leases are small
in dollar with the average lease being approximately $25,000 and are
underwritten solely based upon information confirmed on an application
prepared by the lessee. At December 31, 1996, the Company had $46.5 million
of such leases that represented approximately 17% of the Company's total loan
and lease portfolio.
14
<PAGE>
The following table sets forth the amount of domestic loans outstanding
for the Company at the end of each of the past two calendar years, according
to type of loan, inclusive of mortgage loans held for sale. The Company has
no foreign loans or energy-related loans.
DECEMBER 31,
----------------------------------------
1996 1995
--------------- ---------------
% OF % OF
TOTAL TOTAL
AMOUNT LOANS AMOUNT LOANS
------ ----- ------ -----
(DOLLARS IN THOUSANDS)
Commercial $ 47,772 17.41% $ - - %
Real estate-commercial 86,397 31.48 16,188 41.48
Real estate-construction 18,812 6.85 599 1.54
Real estate-other 52,487 19.12 15,710 40.26
Installment loans to individuals 22,512 8.20 6.525 16.72
Lease financing 46,498 16.94 - -
-------- ------ -------- ------
Total 274,478 100.00% 39,022 100.00%
------ ------
------ ------
Less: allowance for loan losses (5,156) (639)
Deferred loan fees (2,444) (45)
-------- --------
Net Loans $266,878 $ 38,338
-------- --------
-------- --------
The following table shows the amounts of certain categories of loans
outstanding as of December 31, 1996, which, based on remaining scheduled
repayments of principal, were due in one year or less, more than one year
through five years, and more than five years. The amounts due after one year
are classified according to the sensitivity to changes in interest rates.
Demand or other loans having no stated maturity and no stated schedule of
repayments are reported as due in one year or less.
DECEMBER 31, 1996
-----------------------------
COMMERCIAL REAL ESTATE
---------- -----------
(DOLLARS IN THOUSANDS)
Aggregate maturities of loans which are due:
In one year of less $39,351 $ 46,134
After one year through five years:
Interest rates are floating or adjustable 8,421 19,034
Interest rates are fixed or predetermined - 12,807
After 5 years:
Interest rates are floating or adjustable - 51,848
Interest rates are fixed or predetermined - 27,873
------- --------
Total $47,772 $157,696
------- --------
------- --------
15
<PAGE>
NONACCRUAL ASSETS
The Company's current policy is to stop accruing interest on loans which
are past due as to principal or interest 90 days or more, except in
circumstances where the loan is well-secured and in the process of
collection. When a loan is placed on nonaccrual, previously accrued and
unpaid interest is generally reversed out of income unless adequate
collateral appears to be available from which to collect the amounts due.
The following table shows the total aggregate principal amount of nonaccrual
and other non-performing loans (accruing loans on which interest or principal
is past due 90 days or more) as of the end of each of the past two years.
For the twelve months ended December 31, 1996, additional gross interest
income of $474,000 would have been recorded on nonaccrual loans, and for
calendar year 1995 additional gross interest income of $192,000 would have
been recorded on nonaccrual loans, in each case had the loans been current.
No accrued but unpaid interest income on such loans was in fact included in
the Company's net income.
AT DECEMBER 31,
--------------
1996 1995
---- -----
(DOLLARS IN THOUSANDS)
Loans on a nonaccrual basis, not restructured $5,483 $1,492
Accruing loans past due 90 days or more 1,314 46
Restructured loans 2,200 82
------ ------
Total $8,997 $1,620
------ ------
------ ------
As a percent of outstanding loans 3.3% 4.2%
Loans aggregating $7.7 million at December 31, 1996 have been designated
as impaired in accordance with SFAS 114 as amended by SFAS 118. The
Company's method used to measure the amount of impairment on these loans is
to compare the loan amount to the fair value of collateral. The total
allowance for loan losses related to these loans was $695,000 at December 31,
1996.
As of the end of the most recent period, management was not aware of any
loans that had not been placed on nonaccrual status as to which there were
serious doubts as to the ability of the respective borrowers to comply with
present loan repayment terms.
As of December 31, 1996, in management's judgment, a concentration of
loans existed in the commercial loan area and real estate loans. At that
date, approximately 49% of the Company's loans were commercial loans, many of
which are secured by real estate collateral. At that date, approximately 26%
of the Company's loans were real estate and construction loans, many of which
are secured by residential mortgages. While management believes such
concentrations to have no more than the normal risk of collectibility, a
substantial decline in real estate values could have an adverse impact on
collectibility, increase the level of real estate-related non-performing
loans, or have other adverse impact. While San Dieguito, Liberty and CSB
remain separate banks and therefore cannot freely
16
<PAGE>
transfer funds between one another, the acquisition of Liberty and CSB
reduces the Company's previous reliance on the narrower San Diego County
market. Nonetheless, economic difficulties that prevail throughout the
broader Southern California market would be likely still to have an adverse
effect on the Company's loan portfolio.
At December 31, 1996, the Company had OREO properties with an aggregate
carrying value of $3.6 million. During 1996, properties with a total
carrying value of $5.5 million were added to OREO, of which $1.6 million were
acquired in both the Liberty and CSB acquisitions and an additional $2.3
million as a result of foreclosure. Properties with a total carrying value
of $4.1 million were sold and properties were written down by approximately
$72,000. During calendar year 1995, properties with a total carrying value
of $1.1 million were added to OREO, properties with a total carrying value of
$476,000 were sold and properties were written down by $383,000. All of the
OREO properties are recorded by the Company at amounts which are equal to or
less than the market value based on current independent appraisals reduced by
estimated selling costs.
ALLOWANCE FOR LOAN LOSSES
The Company maintains an allowance for loan and lease losses, intended to
absorb losses that may occur in its loan portfolio. The Company's aggregate
allowance for loan losses at December 31, 1996 was approximately $5.2
million, or approximately 2.0% of gross loans. (See "MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Allowance
and Provision for Loan Losses" herein.)
In determining the adequacy of the allowance for loan losses, management
considers such factors as historical loan loss experience, known problem
loans, evaluations made by regulatory agencies and the Company's outside loan
reviewer, assessment of economic conditions, and other appropriate data to
identify the risks in the portfolio. In determining the amount of the
allowance, a specific allowance amount is assigned to those loans with
identified special risks, and the remaining loan portfolio is reviewed by
category and assigned a specific allowance percentage for inherent losses.
The allocation process does not necessarily measure anticipated future credit
losses; rather, it reflects management's assessment at a certain date of
perceived credit risk exposure and the impact of current and anticipated
economic conditions, which may or may not result in future credit losses.
In December 1993, the federal banking agencies issued an interagency
policy statement on the allowance for loan and lease losses which, among
other things, establishes certain benchmark ratios of loan loss reserves to
classified assets. The benchmark set forth by such policy statement is the
sum of (i) assets classified loss; (ii) 50% of assets classified doubtful;
(iii) 15% of assets classified substandard; and (iv) estimated credit losses
on other assets over the upcoming 12 months. At December 31, 1996, the
Company's allowance constituted 180% of the benchmark amount suggested by the
federal banking agencies' policy statement.
17
<PAGE>
The table below summarizes average loans outstanding for each of the last
two calendar years, and changes in the allowance for possible loan losses
arising from loan losses and additions to the allowance from provisions
charged to operating expense:
DECEMBER 31,
-----------
1996 1995
---- ----
(DOLLARS IN THOUSANDS)
Average loans outstanding $146,743 $42,272
-------- -------
-------- -------
Allowance for loan losses
Balance at beginning of period $ 639 $ 821
-------- -------
Balance acquired 4,382
Loans charged off during period
Commercial, financial and
agricultural 430 258
Real estate--mortgage 144 115
Installment 76 329
-------- -------
Total 650 702
Recoveries during period
Commercial, financial and
agricultural 103 121
Real estate--mortgage 61 2
Installment 106 102
-------- -------
Total 270 225
-------- -------
Net loans charged off during period 380 477
Additions charged to operations 515 295
-------- -------
Balance at end of period $ 5,156 $ 639
-------- -------
-------- -------
Loan loss and quality ratios:
Net charge-offs to average loans(1) 0.26% 1.13%
Provision for loan losses to
average loans(1) 0.35% 0.70%
Allowance at end of period to
gross loans outstanding at end of period 1.88% 1.64%
Allowance as % of non-performing loans 57.31% 39.44%
___________________________
(1) Charge-offs and provision for loan losses annualized for interim period
computations.
18
<PAGE>
Based upon the average aggregate loan losses in each of the preceding two
years for all California banks, the following table indicates management's
allocation of the allowance for each of the past two calendar years:
YEAR ENDED DECEMBER 31,
------------------------------------------------
(DOLLARS IN THOUSANDS)
1996 1995
---- ----
PERCENTAGE PERCENTAGE
AMOUNT OF OF TOTAL AMOUNT OF OF TOTAL
ALLOWANCE ALLOWANCE ALLOWANCE ALLOWANCE
--------- ---------- --------- ----------
Commercial, financial
and agricultural $ 63 1.2% $ 32 5.0%
Real estate & constructio 1,182 22.9 242 37.9
Consumer 666 12.9 51 8.0
Unallocated 3,245 63.0 314 49.1
-------- ----- ----- -----
Total $ 5,156 100.0% $ 639 100.0%
-------- ----- ----- -----
-------- ----- ----- -----
The calculation of the adequacy of the allowance for loans losses
requires the use of management estimates. These estimates are inherently
uncertain and depend on the outcome of future events. Management's estimates
are based upon previous loan loss experience and current economic conditions
as well as the volume, growth and composition of the loan portfolio, the
estimated value of collateral and other relevant factors. The Company's
lending is concentrated in Southern California, which has experienced adverse
economic conditions, including declining real estate values. These factors
have adversely affected borrowers' ability to repay loans. Although
management believes the level of the allowance is adequate to absorb losses
inherent in the loan portfolio, an additional decline in the local economy
may result in increasing losses that cannot reasonably be predicted at this
date. Given the current economic conditions in the Company's market area the
importance of real estate values to the Company's loan portfolio, it is
possible the level of non-performing loans may increase until the local
economy improves significantly. The possibility of increased costs of
collection, nonaccrual of interest on those which are or may be placed on
nonaccrual, and further charge-offs could have an adverse impact on the
Company's financial condition in the future.
Although no assurance can be given that actual losses will not exceed the
amount provided for in the allowance, management believes that the allowance
for loan losses is adequate in light of all known relevant factors. Even if
it is adequate, however, increased costs of collection on some of these
loans, nonaccrual of interest on those which are or may be placed on
nonaccrual, and the possibility of further charge-offs could have an adverse
impact on the Company's profitability in the near future. (See "MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS --
Allowance and Provision for Loan Losses" herein for additional information.)
19
<PAGE>
INVESTMENT SECURITIES
The Company maintains a portion of its assets in investment securities to
balance risk and to ensure adequate liquidity. (See "MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Liquidity"
herein.) At December 31, 1996, approximately $20.0 million, or 57% of the
Company's investment securities were classified as held-to-maturity and the
remaining $15.2 million, or 43% were classified as available-for-sale. The
amortized cost and estimated market value of the Company's investments at
December 31, 1996 were as follows:
AT DECEMBER 31, 1996
--------------------
(DOLLARS IN THOUSANDS)
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAIN LOSS VALUE
Available for Sale:
U.S. Treasury $14,394 $ 25 $(9) $14,410
State and municipal securities 761 4 - 765
------- ---- --- -------
Total $15,155 $ 29 $(9) $15,175
------- ---- --- -------
------- ---- --- -------
AT DECEMBER 31, 1996
--------------------
(DOLLARS IN THOUSANDS)
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAIN LOSS VALUE
Held to Maturity:
U.S. Treasury $ 499 $ 3 $ - $ 502
U.S. Government Agencies 19,226 30 (150) 19,106
State and municipal securities 300 3 (1) 302
------- ---- ----- -------
Total $20,025 $ 36 $(151) $19,910
------- ---- ----- -------
------- ---- ----- -------
20
<PAGE>
The following tables show the maturities of investment securities
December 31, 1996 and 1995, and the weighted average yields of such
securities:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------
1996 1995
---- ----
WEIGHTED WEIGHTED
BOOK MARKET AVERAGE BOOK MARKET AVERAGE
VALUE VALUE YIELD VALUE VALUE YIELD
------- ------- -------- ------ ------ --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
U.S. Government agencies and Municipal Bonds
Within one year........................................... $ 9,212 $ 9,219 5.73% $3,980 $4,013 6.15%
After one year but within five years.................... 24,267 24,271 6.46 2,949 2,954 5.85
After five years ....................................... 1,701 1,595 6.50 80 90 9.44
------- ------- ------ ------
Total................................................... $35,180 $35,085 6.26% $7,009 $7,057 6.06%
Federal Reserve Bank Stock:
No stated maturity...................................... $ 491 491 6.00% $ 113 $ 113 6.00%
------- ------- ------ ------
Total Federal Reserve Bank stock...................... $ 491 $ 491 6.00% $ 113 $ 113 6.00%
------- ------- ------ ------
Total investment portfolio................................ $35,671 $35,576 6.26% $7,122 $7,170 6.06%
------- ------- ------ ------
------- ------- ------ ------
</TABLE>
COMPETITION
The banking and financial services business in California generally, and
in the Company's market area specifically, is highly competitive. The
increasingly competitive environment is a result primarily of changes in
regulation, changes in technology and product delivery systems, and the
accelerating pace of consolidation among financial services providers. The
market is dominated by a relatively small number of major banks which have
many offices operating over wide geographic areas. The Company competes for
loans, deposits and customers for financial services with other commercial
banks, savings and loan associations, securities and brokerage companies,
mortgage companies, insurance companies, finance companies, money market
funds, credit unions, and other nonbank financial service providers. Many of
these competitors are much larger in total assets and capitalization, have
greater access to capital markets and offer a broader array of financial
services than the Company. In order to compete with the other financial
services providers, the Company principally relies upon local promotional
activities, personal relationships established by officers, directors and
employees with their respective customers, and specialized services tailored
to meet their customers' needs.
The Company has developed its business through the services it offers and
through an aggressive program of referrals, advertising and officer
solicitation. In the early years, both San Dieguito and Liberty experienced
their initial growth through director-referred business and direct officer
calls on prospective business clients. As the banks matured, their marketing
emphasis switched to newspaper advertising, direct mail promotion and
aggressive officer sales calling programs. More recently, Liberty's
marketing mix has also included telemarketing and cable television
advertising. As previously noted, the Company's key clients are assigned
personal account officers who are primarily responsible for their various
client relationships.
21
<PAGE>
SUPERVISION AND REGULATION
The Company and its subsidiary banks are subject to extensive regulation
and supervision under various federal and state laws. The Company is a bank
holding company subject to regulation and supervision by the FRB pursuant to
the BHC Act. Bank holding companies must file with the FRB an annual report
and such additional reports as the FRB may require and are subject to
periodic examinations by the FRB.
Liberty and San Dieguito are national banks, having been chartered by the
Office of the Comptroller of the Currency (the "OCC") under the National Bank
Act, and therefore are subject to regulation, supervision and periodic
examination by the OCC. CSB is a California-chartered commercial bank that is
not a member of the Federal Reserve System, is subject to regulation,
supervision and periodic examination by the California State Banking
Department (the "Banking Department") and the FDIC.
Each Operating Bank's deposits are insured by the FDIC to the maximum
extent permitted by law, which is currently $100,000 per depositor in most
cases. The deposits of San Dieguito and Liberty are insured under the FDIC's
Bank Insurance Fund ("BIF"), while the deposits of CSB are insured under the
FDIC's Savings Association Insurance Fund ("SAIF").
The regulations of the FRB, the OCC, the FDIC and the Banking Department
will govern most aspects of the Operating Banks' business and operations,
including, but not limited to, the scope of their respective businesses,
investments, reserves against deposits, the nature and amount of any
collateral for loans, the timing of availability of deposited funds, the
issuance of securities, the payment of dividends, bank expansion and bank
activities, including real estate development and insurance activities. The
Operating Banks are also subject to requirements and restrictions of various
consumer laws and regulations.
The federal and state banking agencies have broad enforcement powers over
depository institutions, including the power to impose substantial fines and
other civil and criminal penalties, to terminate deposit insurance, and to
appoint a conservator or receiver under a variety of circumstances. The FRB
also has broad enforcement powers over bank holding companies, including the
power to impose substantial fines and other civil and criminal penalties.
At the direction of the FDIC and the Banking Department, CSB's Board of
Directors adopted a resolution in March 1996 requiring CSB to, among other
things, (i) maintain a leverage capital ratio of at least 6.5%; (ii) reduce
classified assets to prescribed amounts by specified dates; (iii) establish
policies for identifying problem assets; (iv) increase CSB's allowance for
loan losses and thereafter maintain its allowance at such levels determined
to be adequate by its Board of Directors; and (v) periodically report on
certain matters to the FDIC and the Banking Department until further notice
from those regulators. (For discussions of capital ratios and other bases
upon which banks are evaluated by banking regulators, see "BUSINESS --
Capital Adequacy Requirements" and "-- Safety and Soundness Standards"
herein.) Prior to the adoption of those resolutions, CSB had operated under
a Memorandum of Understanding
22
<PAGE>
entered into with the FDIC and the Banking Department in 1994 that contained
substantially similar requirements. The FDIC and the Banking Department have
terminated their interests in the Memorandum of Understanding, conditioned on
CSB's Board's adoption of the resolutions described above.
The following sections of this report are a description of statutory and
regulatory provisions and proposals, which is not intended to be a complete
description of those provisions or their effects on the Company or the Banks,
and is qualified in its entirety by reference to the particular statutory or
regulatory provisions or proposals.
LIMITATIONS ON BANK HOLDING COMPANY ACTIVITIES
With certain limited exceptions, the BHCA requires every bank holding
company to obtain the prior approval of the FRB before undertaking any of the
following activities: (i) acquiring direct or indirect ownership or control
of any voting shares of another bank or bank holding company if, after such
acquisition, it would own or control more than 5% of any class of voting
shares (unless it already owns or controls the majority of such shares); (ii)
acquiring all or substantially all of the assets of another bank or bank
holding company; or (iii) merging or consolidating with another bank holding
company. The FRB will not approve any acquisition, merger or consolidation
that would have a substantially anti-competitive result, unless the
anti-competitive effects of the proposed transaction are clearly outweighed
by a greater public interest in meeting the convenience and needs of the
community to be served. The FRB also considers capital adequacy and other
financial and managerial factors, as well as compliance with the Community
Reinvestment Act of 1977 (the "CRA"), in reviewing proposed acquisitions or
mergers. (See "BUSINESS -- Consumer Protection Laws and Regulations -- The
Community Reinvestment Act" herein.)
With certain exceptions, the BHCA also prohibits a bank holding company
from acquiring or retaining direct or indirect ownership or control of more
than 5% of the voting shares of any company which is not a bank or bank
holding company, or from engaging directly or indirectly in activities other
than those of banking, managing or controlling banks, or providing services
for its subsidiaries. The principal exceptions to those prohibitions involve
certain non-bank activities which, by statute or by FRB regulation or order,
have been identified as activities closely related to the business of banking
or of managing or controlling banks. In making that determination, the FRB
considers whether the performance of such activities by a bank holding
company can be expected to produce benefits to the public such as greater
convenience, increased competition or gains in efficiency, which can be
expected to outweigh the risks of possible adverse effects such as undue
concentration of resources, decreased or unfair competition, conflicts of
interest or unsound banking practices.
Furthermore, under the BHCA and certain regulations of the FRB, a bank
holding company and its subsidiaries are prohibited from engaging in certain
tie-in arrangements in connection with any extension of credit, lease or sale
of property or furnishing of services. For example, in general, none of the
Operating Banks may condition the extension of credit to a customer upon the
customer obtaining other services from Holdco or any of its other
subsidiaries, or upon the customer promising not to obtain
23
<PAGE>
services from a competitor.
REGULATORY RESTRICTIONS ON DISTRIBUTIONS TO SHAREHOLDERS
STOCK REDEMPTIONS. Bank holding companies are required to give the FRB
notice of any purchase or redemption of their outstanding equity securities
if the gross consideration for the purchase or redemption, when combined with
the net consideration paid for all such purchases or redemptions during the
preceding 12 months, is equal to 10% or more of the bank holding company's
consolidated net worth. The FRB may disapprove such a purchase or redemption
if it determines that the proposal would violate any law, regulation, FRB
order, directive, or any condition imposed by, or written agreement with, the
FRB. Bank holding companies whose capital ratios exceed the thresholds for
"well capitalized" banks on a consolidated basis are exempt from the
foregoing requirement if they were composite CAMEL-rated 1 or 2 in their most
recent inspection and are not the subject of any unresolved supervisory
issues.
DIVIDENDS. FRB policies declare that a bank holding company should not
pay cash dividends on its common stock unless its net income is sufficient to
fund fully each dividend, and its prospective rate of earnings retention
after the payment of such dividend appears consistent with its capital needs,
asset quality and overall financial condition. Other policies forbid the
payment by bank subsidiaries to their parent companies of management fees
which are unreasonable in amount or exceed the fair market value of the
services rendered.
One of the principal sources of revenue for The Company will be the
dividends received from the subsidiary banks and other subsidiaries, if any,
and interest earned on short-term investments and advances to subsidiaries.
Federal law restricts the amount of dividends that national banks such as
Liberty and San Dieguito may lawfully pay. In general, a national bank may
not pay a dividend that would impair its capital. In addition, a dividend
may not be paid if the total of all dividends declared by a national bank in
any calendar year is in excess of the current year's net profits combined
with the retained net profits of the two preceding years (less any required
transfers to surplus), unless the bank obtains the prior approval of the OCC.
A dividend also may not be paid in excess of a bank's undivided profits then
on hand, after deducting bad debts in excess of the reserve for loan losses.
Under the more restrictive of those limitations, as of December 31, 1996, San
Dieguito could not have declared a dividend.
Under California law, CSB may only declare a cash dividend out of CSB's
net profits up to the lesser of CSB's retained earnings or net income for the
last three fiscal years (less any distributions to shareholders made during
such period). In the event that CSB has no retained earnings or net income
for the prior three fiscal years, cash dividends may be paid in an amount not
exceeding the greatest of (i) net income for CSB's previous fiscal year, (ii)
net income for CSB's current fiscal year or (iii) retained earnings of CSB,
upon obtaining the prior approval of the Superintendent. Limitations on each
Bank's ability to pay dividends to its corporate parent may impact the
Company's ability to meet obligations incurred.
24
<PAGE>
The payment of dividends on capital stock by The Company and the
Operating Banks may also be limited by other factors, including applicable
regulatory capital requirements and broad enforcement powers of the federal
regulatory agencies. Both the federal banking agencies and, in the case of a
state-chartered bank, the Banking Department, have broad authority to
prohibit a bank (or, where applicable, a bank holding company) from engaging
in banking practices which the banking agency considers to be unsafe or
unsound. It is possible, depending upon the financial condition of the bank
or holding company in question and other factors, that the applicable
regulator may assert that the payment of dividends or other payments by the
bank or holding company is considered an unsafe or unsound banking practice
and, therefore, implement corrective action to address such a practice.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") generally prohibits a depository institution from making any
capital distribution (including payment of a dividend) or paying any
management fee to its holding company if the depository institution would
thereafter be "undercapitalized" for regulatory purposes.
Those regulations and restrictions may limit The Company's ability to
obtain funds from the Operating Banks for its cash needs, including funds for
payment of interest and operating expenses and dividends, if any.
TRANSACTIONS WITH AFFILIATES
The Banks are subject to restrictions under federal law which limit
certain transactions by each of them with The Company and its non-banking
subsidiaries, including extensions of credit, investments or asset purchases.
Extensions of credit by any subsidiary bank with any one affiliate are
limited in amount to 15% of such subsidiary bank's unimpaired capital and
surplus or 25% of unimpaired capital and surplus if the extensions of credit
are fully secured in accordance with applicable regulations. Federal law
also provides that extensions of credit to affiliates must be made on
substantially the same terms as, and following credit underwriting procedures
that are no less stringent than, those prevailing at the time for comparable
transactions involving other non-affiliated, or, in the absence of comparable
transactions, on terms and under circumstances, including credit standards,
that in good faith would be offered to, or would apply to, affiliates. The
purchase of low quality assets from affiliates is generally prohibited.
RESTRICTIONS ON CHANGES OF CONTROL
Subject to certain limited exceptions, no company (as defined in the
BHCA) or individual can acquire control of a bank holding company, such as
The Company, without the prior approval or non-disapproval, as the case may
be, of the FRB. Prior approval of the FRB would be required for an
acquisition of control of the Company by a "company" as defined in the BHCA.
In general, FRB regulations provide that "control" means the power to vote
25% or more of any class of voting stock, the power to control in any manner
the election of a majority of the board of directors, or the power to
exercise, directly or indirectly, a controlling influence over management or
policies as determined by the FRB. As part of such acquisition, the company
would be required to register as a bank holding company (if not already so
registered) and have its business activities limited to those activities
which the FRB
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determines to be so closely related to banking as to be a proper incident
thereof. (See "BUSINESS -- Limitations on Bank Holding Company Activities"
herein.) FRB regulations also provide that there is a presumption that any
company which owns less than 5% of any class of voting securities of a bank
holding company does not have control over that company.
Any individual (or group of individuals acting in concert) who intends to
acquire control of a bank holding company, such as the Company, generally
must give 60 days prior notice to the FRB under regulations promulgated
pursuant to the Change in Bank Control Act of 1978. Control for the purpose
of those regulations is presumed to exist if, among other things, an
individual owns, controls or has the power to vote 25% or more of a class of
voting stock of the bank or bank holding company, or an individual owns,
controls or has the power to vote 10% or more of a class of voting stock of
the bank or bank company and (i) the company's shares are registered pursuant
to Section 12 of the Exchange Act, or (ii) such person would be the largest
shareholder of the institution. The statute and underlying regulations
authorize the FRB to disapprove the proposed transaction based on the
evaluation of certain specified factors, including, without limitation,
competition, management and financial condition.
CROSS-GUARANTEE AND HOLDING COMPANY LIABILITY
Any FDIC-insured depository institution may be liable for any loss
incurred by the FDIC, or any loss which the FDIC reasonably anticipates
incurring, in connection with the default of any commonly controlled
FDIC-insured depository institution or any assistance provided by the FDIC to
any such institution in danger of default. Any obligation or liability owed
by a subsidiary depository institution to its parent company is subordinate
to the subsidiary institution's cross-guarantee liability. If any of the
Company's direct or indirect subsidiary banks were placed into
conservatorship or receivership, because of the cross-guarantee provisions,
The Company would likely lose its investment in all of its subsidiary banks.
The FDIC may provide federal assistance to a "troubled institution"
without placing the institution into conservatorship or receivership. In
such case, pre-existing debt holders and shareholders may be required to make
substantial concessions and the FDIC may succeed to some or all of their
interests.
FRB policy requires bank holding companies to serve as a source of
financial strength to their subsidiary banks by standing ready to use
available resources to provide adequate capital funds to subsidiary banks
during periods of financial stress or adversity.
In the event of a bank holding company's bankruptcy under Chapter 11 of
the U.S. Bankruptcy Code, the trustee will be deemed to have assumed and is
required to cure immediately any deficit under any commitment by the debtor
to any of the federal banking agencies to maintain the capital of an insured
depository institution, and any claim for a subsequent breach of such
obligation will generally have priority over most other unsecured claims.
(See "BUSINESS -- Prompt Corrective Action Provisions" herein.)
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CAPITAL ADEQUACY REQUIREMENTS
The Company and SDN are subject to regulations of the FRB governing
capital adequacy. The Operating Banks are subject to similar regulations of
the OCC (in the case of San Dieguito and Liberty) and the FDIC (in the case
of CSB). In each case, those regulations incorporate both risk-based and
leverage capital requirements. As noted below, the federal banking agencies
have proposed regulations which would impose additional capital requirements
on banks and bank holding companies based on the market risk in foreign
exchange and commodity activities and in the trading of debt and equity
investments.
Each of the federal regulators has established risk-based and leverage
capital guidelines for the banks or bank holding companies it regulates,
which set total capital requirements and define capital in terms of "core
capital elements," or Tier 1 capital and "supplemental capital elements," or
Tier 2 capital. Tier 1 capital is generally defined as the sum of the core
capital elements less goodwill and certain intangibles. The following items
are defined as core capital elements: (i) common shareholders' equity; (ii)
qualifying noncumulative perpetual preferred stock and related surplus; and
(iii) minority interests in the equity accounts of consolidated subsidiaries.
Supplementary capital elements include: (i) allowance for loan and lease
losses (but not more than 1.25% of an institution's risk weighted assets);
(ii) perpetual preferred stock and related surplus not qualifying as core
capital; (iii) hybrid capital instruments, perpetual debt and mandatory
convertible debt instruments; and (iv) term subordinated debt and
intermediate-term preferred stock and related surplus. The maximum amount of
supplemental capital elements which qualifies as Tier 2 capital is limited to
100% of Tier 1 capital, net of goodwill.
Each of the Operating Banks is required to maintain a minimum ratio of
qualifying total capital to total risk-weighted assets of 8.0%, at least
one-half of which must be in the form of Tier 1 capital. Risk-based capital
ratios are calculated to provide a measure of capital that reflects the
degree of risk associated with a banking organization's operations for both
transactions reported on the balance sheet as assets, and transactions, such
as letters of credit and recourse arrangements, which are recorded as
off-balance sheet items. Under the risk-based capital guidelines, the
nominal dollar amounts of assets and credit-equivalent amounts of off-balance
sheet items are multiplied by one of several risk adjustment percentages,
which range from 0% for assets with low credit risk, such as certain U.S.
Treasury securities, to 100% for assets with relatively high credit risk,
such as business loans.
Banks that have received the highest composite regulatory CAMEL rating
and are not anticipating or experiencing any significant growth must maintain
a ratio of Tier 1 capital to adjusted total assets ("Leverage Capital Ratio")
of at least 3.0%. All other institutions are required to maintain a leverage
ratio of at least 100 to 200 basis points above the 3.0% minimum, for a
minimum of 4.0% to 5.0%.
Recently adopted regulations by the federal banking agencies have revised
the risk-based capital standards to take adequate account of concentrations
of credit and the risks of non-traditional activities. Concentrations of
credit refers to situations where a lender has a relatively large proportion
of loans involving one borrower, industry, location, collateral or loan type.
Non-traditional activities are
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considered those that have not customarily been part of the banking business
but that start to be conducted as a result of developments in, for example,
technology or financial markets. The regulations require institutions with
high or inordinate levels of risk to operate with higher minimum capital
standards. The federal banking agencies also are authorized to review an
institution's management of concentrations of credit risk for adequacy and
consistency with safety and soundness standards regarding internal controls,
credit underwriting or other operational and managerial areas.
Further, the banking agencies recently have adopted modifications to the
risk-based capital regulations to include standards for interest rate risk
exposures. Interest rate risk is the exposure of a bank's current and future
earnings and equity capital arising from adverse movements in interest rates.
While interest risk is inherent in a bank's role as financial intermediary,
it introduces volatility to bank earnings and to the economic value of the
bank. The banking agencies have addressed this problem by implementing
changes to the capital standards to include a bank's exposure to declines in
the economic value of its capital due to changes in interest rates as a
factor that the banking agencies will consider in evaluating an institution's
capital adequacy. Bank examiners will consider a bank's historical financial
performance and its earnings exposure to interest rate movements as well as
qualitative factors such as the adequacy of a bank's internal interest rate
risk management. The federal banking agencies recently considered adopting a
uniform supervisory framework for all institutions to measure and assess each
bank's exposure to interest rate risk and establish an explicit capital
charge based on the assessed risk, but ultimately elected not to adopt such a
uniform framework. Even without such a uniform framework, however, each
Operating Bank's interest rate risk exposure is assessed by its primary
federal regulator on an individualized basis, and it may be required by the
regulator to hold additional capital for interest rate risk if it has a
significant exposure to interest rate risk or a weak interest rate risk
management process.
In certain circumstances, a federal banking agency may determine that the
capital ratios for a regulated bank must be maintained at levels which are
higher than the minimum levels required by the guidelines or the regulations.
A bank which does not achieve and maintain the required capital levels may
be issued a capital directive by the agency to ensure the maintenance of
required capital levels. In addition, each of the Operating Banks is
required to meet guidelines of the FDIC concerning maintenance of an adequate
allowance for loan and lease losses.
PROMPT CORRECTIVE ACTION PROVISIONS
FDICIA amended the Federal Deposit Insurance Act ("FDIA") to establish a
format for closer monitoring of insured depository institutions and to enable
prompt corrective action by regulators when an institution begins to
experience difficulty. The general thrust of those provisions is to impose
greater scrutiny and more restrictions on institutions as they have
decreasing levels of capitalization. FDICIA establishes five capital
categories: "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized," and "critically
undercapitalized." Under the regulations, a "well capitalized" institution
has a ratio of total capital to total risk-weighted assets ("Total Risk-Based
Capital Ratio") of at least 10.0%, a ratio of Tier 1 capital to total
risk-weighted assets ("Tier 1 Risk-Based Capital Ratio") of at least 6.0%, a
Leverage Capital Ratio of at least 5.0% and is not subject to any
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written order, agreement, or directive; an "adequately capitalized"
institution has a Total Risk-Based Capital Ratio of at least 8.0%, a Tier 1
Risk-Based Capital Ratio of at least 4.0% and a Leverage Capital Ratio of at
least 4.0% (3.0% or more if given the highest regulatory rating and not
experiencing significant growth), but does not otherwise qualify as "well
capitalized." An "undercapitalized" institution fails to meet one of the
three minimum capital requirements for "adequately capitalized" banks. A
"significantly undercapitalized" institution has a Total Risk-Based Capital
Ratio of less than 6.0%, a Tier 1 Risk-Based Capital Ratio of less than 3.0%
and/or a Leverage Capital Ratio of less than 3.0%. A "critically
undercapitalized" institution has a ratio of tangible equity to assets of
2.0% or less. Under certain circumstances, a "well capitalized," "adequately
capitalized" or "undercapitalized" institution may be required to comply with
supervisory actions as if the institution was in the next lowest capital
category.
Undercapitalized depository institutions are subject to restrictions on
borrowing from the FRB. In addition, undercapitalized depository
institutions are subject to growth and activity limitations and are required
to submit "acceptable" capital restoration plans. Such a plan will not be
accepted unless, among other things, the depository institution's holding
company, if any, guarantees the capital plan, up to an amount equal to the
lesser of 5.0% of the depository institution's assets at the time it becomes
undercapitalized or the amount of the capital deficiency when the institution
fails to comply with the plan. The federal banking agencies may not accept a
capital plan without determining, among other things, that the plan is based
on realistic assumptions and is likely to succeed in restoring the depository
institution's capital. If a depository institution fails to submit an
acceptable plan, it is treated as if it is significantly undercapitalized and
ultimately may be placed into conservatorship or receivership.
Significantly undercapitalized depository institutions may be subject to
a number of requirements and restrictions, including orders to sell
sufficient voting stock to become adequately capitalized; more stringent
requirements to reduce total assets; cessation of receipt of deposits from
correspondent banks; further activity restrictions; prohibitions on dividends
to the holding company; and requirements that the holding company divest its
bank subsidiary, in certain instances. Subject to certain exceptions,
critically undercapitalized depository institutions must have a conservator
or receiver appointed for them within a certain period after becoming
critically undercapitalized.
RISK MANAGEMENT
Beginning in 1996, FRB examiners are instructed to assign a formal
supervisory rating to the adequacy of an institution's risk management
processes, including its internal controls. The five ratings are strong,
satisfactory, fair, marginal and unsatisfactory. The specific rating of risk
management and internal controls will be given significant weight when
evaluating management under the bank (CAMEL) and bank holding company (BOPEC)
rating systems.
SAFETY AND SOUNDNESS STANDARDS
In February 1995, the federal banking agencies adopted final safety and
soundness standards for all insured depository institutions. The standards,
which were issued in the form of guidelines rather
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than regulations, relate to internal controls, information systems, internal
audit systems, loan underwriting and documentation, compensation and interest
rate exposure. In general, the standards are designed to assist the federal
banking agencies in identifying and addressing problems at insured depository
institutions before capital becomes impaired. If an institution fails to
meet these standards, the appropriate federal banking agency may require the
institution to submit a compliance plan. Failure to submit an acceptable
compliance plan may result in enforcement proceedings. In addition, the
agencies have reissued asset quality and earnings standards for public
comment, as the Riegle Community Development and Regulatory Improvement Act
of 1994 gave the agencies flexibility to issue broader standards and the
agencies determined that the ratios previously proposed were too restrictive.
(See "BUSINESS -- Recent and Proposed Legislation -- Riegle Community
Development and Regulatory Improvement Act of 1994" herein.)
LIMITATIONS ON DEPOSIT TAKING
FDICIA provides that a bank may not accept, renew or roll over brokered
deposits unless (i) it is "well capitalized," or (ii) it is adequately
capitalized and receives a waiver from the FDIC permitting it to accept
brokered deposits paying an interest rate not in excess of 75 basis points
over certain prevailing market rates. FDIC regulations define brokered
deposits to include any deposit obtained, directly or indirectly, from any
person engaged in the business of placing deposits with, or selling interests
in deposits of, an insured depository institution, as well as any deposit
obtained by a depository institution that is not "well capitalized" for
regulatory purposes by offering rates significantly higher (generally more
than 75 basis points) than the prevailing interest rates offered by
depository institutions in such institution's normal market area. In
addition, FDICIA provides that institutions which are ineligible to accept
brokered deposits are ineligible for pass-through deposit insurance or
employee benefit plan deposits.
PREMIUMS FOR DEPOSIT INSURANCE
The FDIC has adopted final regulations implementing a risk-based premium
system, as required by federal law. Under the regulations, insured
depository institutions are required to pay insurance premiums depending on
their risk classification. Under the FDIC's risk-based insurance system,
institutions insured by BIF, such as San Dieguito and Liberty, currently
subject to premiums of between 0 to 27 cents per $100 of deposits.
Institutions insured by SAIF, such as CSB, pay premiums on a risk-related
basis of 23 cents per $100 to 31 cents per $100.
To arrive at a risk-based assessment for each depository institution, the
FDIC places it in one of nine risk categories using a two-step process based
first on capital ratios and then on relevant supervisory information. Each
institution is assigned to one of three capital categories: "well
capitalized," "adequately capitalized," or "undercapitalized." A well
capitalized institution is one that has a Total Risk-Based Capital Ratio of
at least 10.0%, a Tier 1 Risk-Based Capital Ratio of at least 6.0% and a
Leverage Capital Ratio of at least 5.0%. An adequately capitalized
institution has at least an Total Risk-Based Capital Ratio of at least 8.0%,
a Tier 1 Risk-Based Capital Ratio of at least 4.0% and a Leverage Capital
Ratio of at least 4.0%. An undercapitalized institution is one that does not
meet either
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of the above definitions. The FDIC also assigns each institution to one of
three supervisory subgroups based on an evaluation of the risk posed by the
institution (group "A" institutions being perceived to present the least risk
and group "C" institutions being perceived to present the greatest risk).
The FDIC makes this evaluation based on reviews by the institution's primary
federal or state regulator, statistical analyses of financial statements, and
other information relevant to gauging the risk posed by the institution.
Those supervisory evaluations modify premium rates within each of the three
capital groups, resulting in a matrix of nine separate assessment categories.
As a result of the passage of the Deposit Insurance Funds Act of 1996
(see "BUSINESS -- Recent Legislation -- Deposit Insurance Funds Act of
1996"), effective January 1, 1997, the deposit assessment matrix for both
SAIF-assessable and BIF-assessable depository institutions, is as follows (in
cents per $100 of deposits):
SUPERVISORY SUBGROUP
------------------------
A B C
--- --- ---
MEETS NUMERICAL STANDARDS FOR:
Well capitalized 0(2) 3 17
Adequately capitalized 3 10 24
Undercapitalized 10 24 27
For purposes of the assessments of FDIC insurance premiums that will be
paid during the first half of 1997, which will be based on capital levels as
of December 31, 1996, San Dieguito was "well capitalized" and Liberty and CSB
were "adequately capitalized". FDIC regulations prohibit disclosure of the
"supervisory subgroup" to which an insured institution is assigned. The
insurance assessments paid during the twelve, nine and four months ended
December 31, 1996 (which were based on capital levels as of December 31, 1995
and June 30, 1996) were $101,000, $34,000 and $53,000, respectively, for San
Dieguito, Liberty and CSB. Additionally, CSB paid $943,000 to the FDIC for
the SAIF special assessment assessed in November 1996 (see "BUSINESS -- Recent
Legislation -- Deposit Insurance Funds Act of 1996").
CONSUMER PROTECTION LAWS AND REGULATIONS
The bank regulatory agencies are focusing greater attention on compliance
with consumer protection laws and their implementing regulations.
Examination and enforcement have become more intense in nature, and insured
institutions have been advised to monitor carefully compliance with various
consumer protection laws and their implementing regulations. Each of the
Operating Banks is subject to many federal consumer protection statutes and
regulations including, but not limited to, the Community Reinvestment Act
(the "CRA"), the Truth in Lending Act (the "TILA"), the Fair Housing Act (the
"FH Act"), the Equal Credit Opportunity Act (the "ECOA"), the Real Estate
Settlement
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(2)Subject to a statutory minimum annual assessment of $2,000.
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Procedures Act ("RESPA"), and the Home Mortgage Disclosure Act (the "HMDA").
Due to heightened regulatory concern related to compliance with the CRA,
TILA, FH Act, ECOA and HMDA generally, the Operating Banks may incur
additional compliance costs or be required to expend additional funds for
investments in its local community.
THE COMMUNITY REINVESTMENT ACT. The CRA, enacted into law in 1977, is
intended to encourage insured depository institutions, while operating safely
and soundly, to help meet the credit needs of their communities. The CRA
specifically directs the federal regulatory agencies, in examining insured
depository institutions, to assess their record of helping to meet the credit
needs of their entire community, including low- and moderate-income
neighborhoods, consistent with safe and sound banking practices. The CRA
further requires the agencies to take a financial institution's record of
meeting its community credit needs into account when evaluating applications
for, among other things, domestic branches, consummating mergers or
acquisitions, or holding company formations.
In April 1995, the agencies adopted new, interagency regulations
implementing CRA. The 1995 final rule changed the objective criteria for
evaluation. The final rule seeks to take into account the unique
characteristics and needs of each institution's community, as well as the
capacity and relevant constraints upon institutions for meeting the credit
needs of the assessment area. The evaluations can be completed under a small
institution performance standard for those institutions whose total assets
are $250 million or under. Large institution performance criteria covers all
institutions with assets of $250 million or more and for multiple-bank
holding companies with total bank and thrift assets in excess of $1 billion.
There are also performance criteria for wholesale, limited purpose
institutions.
The agencies use the CRA assessment factors in order to provide a rating
to the financial institution. The ratings range from a high of "outstanding"
to a low of "substantial noncompliance". Each Operating Bank was last
examined for CRA compliance by its primary regulator within the past 12
months and received a "satisfactory" CRA Assessment Rating.
THE EQUAL CREDIT OPPORTUNITY ACT. The ECOA, enacted into law in 1974,
prohibits discrimination in any credit transaction, whether for consumer or
business purposes, on the basis of race, color, religion, national origin,
sex, marital status, age (except in limited circumstances), receipt of income
from public assistance programs, or good faith exercise of any rights under
the Consumer Credit Protection Act. In addition to prohibiting outright
discrimination on any of the impermissible bases listed above, an effects
test has been applied to determine whether a violation of the ECOA has
occurred. This means that if a creditor's actions have had the effect of
discriminating, the creditor may be held liable -- even when there is no
intent to discriminate. In addition to actual damages, the ECOA provides for
punitive damages of up to $10,000 in individual lawsuits and up to the lesser
of $500,000 or 1.0% of the creditor's net worth in class action suits.
Successful complainants may also be entitled to an award of court costs and
attorneys' fees.
THE FAIR HOUSING ACT. The FH Act, enacted into law in 1968, regulates
many practices, including making it unlawful for any lender to discriminate
in its housing-related lending activities against any person because of race,
color, religion, national origin, sex, handicap, or familial status. The FH
Act is
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broadly written and has been broadly interpreted by the courts. A number of
lending practices have been found to be, or may be considered, illegal under
the FH Act, including some that are not specifically mentioned in the FH Act
itself. Among those practices that have been found to be, or may be
considered, illegal under the FH Act are: declining a loan for the purposes
of racial discrimination; making excessively low appraisals of property based
on racial considerations; pressuring, discouraging, or denying applications
for credit on a prohibited basis; using excessively burdensome qualifications
standards for the purpose or with the effect of denying housing to minority
applicants; imposing on minority loan applicants more onerous interest rates
or other terms, conditions, or requirements; and racial steering, or
deliberately guiding potential purchasers to or away from certain areas
because of race.
The FH Act provides that aggrieved persons may sue anyone who they
believe has discriminated against them. The FH Act provides that the
Attorney General of the United States may sue for an injunction against any
pattern or practice that denies civil rights granted by the FH Act. The FH
Act allows a person to file a discrimination complaint with the Department of
Housing and Urban Development ("HUD"). Penalties for violation of the FH Act
include actual damages suffered by the aggrieved person and injunctive or
other equitable relief. The courts also may assess civil penalties.
THE TRUTH IN LENDING ACT. The TILA, enacted into law in 1968, is
designed to ensure that credit terms are disclosed in a meaningful way so
that consumers may compare credit terms more readily and knowledgeably. As a
result of the TILA, all creditors must use the same credit terminology and
expressions of rates, the annual percentage rate, the finance charge, the
amount financed, the total of payments and the payment schedule.
Under certain circumstances involving extensions of credit secured by the
borrower's principal dwelling, the TILA and FRB Regulation Z provide a right
of rescission. The consumer cannot be required to pay any amount in the form
of money or property either to the creditor or to a third party as a part of
the transaction in which a consumer exercises the right of rescission. Any
amount of this nature already paid by the consumer must be refunded. Such
amounts include finance charges already accrued and paid, as well as other
charges such as application and commitment fees or fees for a title search or
appraisal.
The TILA requirements are complex, however, and even inadvertent
non-compliance could result in civil liability or the extension of the
rescission period for a mortgage loan for up to three years from the date the
loan was made. Recently, a significant number of individual claims and
purported consumer class action claims have been commenced against a number
of financial institutions, their subsidiaries, and other mortgage lending
companies, seeking civil statutory and actual damages and rescission under
the TILA, as well as remedies for alleged violations of various state unfair
trade practices acts and restitution or unjust enrichment with respect to
mortgage loan transactions.
THE HOME MORTGAGE DISCLOSURE ACT. The HMDA, enacted into law in 1975,
grew out of public concern over credit shortages in certain urban
neighborhoods. One purpose of the HMDA is to provide public information that
will help show whether financial institutions are serving the housing credit
needs
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of the neighborhoods and communities in which they are located. The HMDA
also includes a "fair lending" aspect that requires the collection and
disclosure of data about applicant and borrower characteristics as a way of
identifying possible discriminatory lending patterns and enforcing
anti-discrimination statutes. The HMDA requires institutions to report data
regarding applications for one-to-four family loans, home improvement loans,
and multifamily loans, as well as information concerning originations and
purchases of such types of loans. Federal bank regulators rely, in part, upon
data provided under the HMDA to determine whether depository institutions
engage in discriminatory lending practices.
Compliance with the HMDA and implementing regulations is enforced by the
appropriate federal banking agency, or in some cases, by HUD. Administrative
sanctions, including civil money penalties, may be imposed by supervisory
agencies for violations. The HMDA requires depository institutions to
compile and disclose certain information with respect to mortgage loans,
including the census tract, income level, racial characteristics and gender
of the borrower or potential borrower. In addition, the HMDA data may have a
material effect on the regulators' assessment of an institution, particularly
in connection with an institution's application to enter into a merger or to
acquire one or more branches.
THE REAL ESTATE SETTLEMENT PROCEDURES ACT. RESPA, enacted into law in
1974, requires lenders to provide borrowers with disclosures regarding the
nature and cost of real estate settlements. Also, RESPA prohibits certain
abusive practices, such as kickbacks, and places limitations on the amount of
escrow accounts. Violations of RESPA may result in imposition of the
following penalties: (1) civil liability equal to three times the amount of
any charge paid for the settlement services; (2) the possibility that court
costs and attorneys' fees can be recovered; and (3) a fine of not more than
$10,000 or imprisonment for not more than one year, or both. Recently, a
significant number of individual claims and purported consumer class action
claims have been commenced against a number of financial institutions, their
subsidiaries, and other mortgage lending companies alleging violations of
RESPA's escrow account rules and seeking civil damages, court costs, and
attorneys' fees.
CERTAIN OTHER ASPECTS OF FEDERAL AND STATE LAW
Each Operating Bank is also subject to federal and state statutory and
regulatory provisions covering, among other things, security procedures,
currency and foreign transactions reporting, insider transactions, management
interlocks, loan interest rate limitations, electronic funds transfers, funds
availability, and truth-in-savings disclosures.
FEDERAL SECURITIES LAWS
The Company is obligated to file periodic reports with the Securities and
Exchange Commission pursuant to Section 15(d) of the Securities Exchange Act
of 1934, as amended (the "Exchange Act").
RECENT LEGISLATION
Federal and state laws applicable to financial institutions have
undergone significant changes in
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recent years. The most significant recent federal legislative enactments are
the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 and
the Riegle Community Development and Regulatory Improvement Act of 1994,
which are discussed below. Other legislation which has been or may be
proposed to the Congress or the California Legislature and regulations which
may be proposed by the FRB, the OCC, the FDIC and the Banking Department may
affect the business of the Company and one or more of the Banks. It cannot be
predicted whether any pending or proposed legislation or regulations will be
adopted or the effect such legislation or regulations may have upon the
business of the Company or one or more of the Banks; however, because of the
significance of its impact on CSB and manner in which it is addressed under
the Reorganization Agreement, the proposals to impose a one-time charge on
SAIF-insured institutions are discussed collectively and in general terms
below.
RIEGLE-NEAL INTERSTATE BANKING AND BRANCHING EFFICIENCY ACT OF 1994. On
September 29, 1994, President Clinton signed into law the Riegle-Neal
Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate
Banking Act"). The Interstate Banking Act regulates the interstate activities
of banks and bank holding companies and establishes a framework for
nationwide interstate banking and branching. The most salient features of
the Interstate Banking Act are set forth below.
INTERSTATE BANK MERGERS. Commencing June 1, 1997, a bank in one state
generally will be permitted to merge with a bank located in another state
without the need for explicit state law authorization. However, states can
prohibit interstate mergers involving state banks they have chartered, or
national banks having a main office in such state, if they "opt-out" of this
portion of the federal legislation (i.e., enact state legislation that
prohibits merger transactions involving out-of-state banks) prior to June 1,
1997. Such state legislation must apply equally to all out-of-state banks.
Alternatively, interstate bank mergers can be approved under the Interstate
Banking Act prior to June 1, 1997, if the home state of each bank involved in
the subject transaction has enacted legislation prior to the time of such
approval that expressly permits the interstate merger and such legislation
applies equally to all out-of-state banks.
BANK HOLDING COMPANY ACQUISITIONS. Commencing September 29, 1995, bank
holding companies were permitted to acquire banks located in any state,
provided that the bank holding company is both adequately capitalized and
adequately managed. This new law is subject to two exceptions: first, any
state may still prohibit bank holding companies from acquiring a bank which
is less than five years old; and second, no interstate acquisition can be
consummated by a bank holding company if the acquiror would control more then
10.0% of the deposits held by insured depository institutions nationwide or
30.0% percent or more of the deposits held by insured depository institutions
in any state in which the target bank has branches.
DE NOVO BRANCHING. A bank may establish and operate DE NOVO branches in
any state in which the bank does not maintain a branch if that state has
enacted legislation to expressly permit all out-of-state banks to establish
branches in that state.
OTHER PROVISIONS. Among other things, the Interstate Banking Act amends
the Community Reinvestment Act to require that in the event a bank has
interstate branches, the appropriate federal
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banking regulatory agency must prepare for such institution a written
evaluation of (i) the bank's record of performance; and (ii) the bank's
performance in each applicable state. Commencing June 1, 1997, interstate
branches will be prohibited from being used as deposit production offices;
foreign banks will be permitted to establish branches in any state other than
its home state to the same extent that a bank chartered by the foreign bank's
home state may establish such branches; and certain procedural safeguards
have been imposed upon the OCC prior to preempting state laws regarding
community reinvestment, consumer production, fair lending and establishment
of interstate branches, whether or not related to interstate branching. It
is impossible to ascertain at this time with any degree of certainty what
impact the Interstate Banking Act will have on the banking industry in
general or the Operating Banks in particular.
CALDERA, WEGGELAND, AND KILLEA CALIFORNIA INTERSTATE BANKING AND
BRANCHING ACT OF 1995. On September 28, 1995, California Governor Pete
Wilson signed into law the Caldera, Weggeland, and Killea California
Interstate Banking and Branching Act of 1995 (the "Caldera Weggeland Act").
The Caldera Weggeland Act, which became effective on October 2, 1995, is
designed to implement important provisions of the Interstate Banking Act (see
"BUSINESS -- Recent and Proposed Legislation -- The Riegle Neal Interstate
Banking and Branching Act of 1994" herein) and repeal or modify provisions of
the California Financial Code which are obsolete or impose undue regulatory
burdens. A summary of the most significant provisions of the Caldera
Weggeland Act is set forth below.
REPEAL OF THE CALIFORNIA INTERSTATE BANKING ACT OF 1986. The California
Interstate (National) Banking Act of 1986 (the "1986 Act"), which was adopted
to permit and regulate interstate banking in California, was largely
preempted by the Interstate Banking Act. Consequently, the Caldera Weggeland
Act repealed the 1986 Act in its entirety. Under the 1986 Act, among other
things, an out-of-state bank holding company was not permitted to establish a
DE NOVO California bank except for the purpose of taking over the deposits of
a closed bank. The repeal of the 1986 Act eliminates this restriction.
INTERSTATE BANKING. The Interstate Banking Act provides that bank
holding companies are permitted to acquire banks located in any state so long
as the bank holding company is both adequately capitalized and adequately
managed (subject to certain minimum age requirements of the target bank) and,
provided that, if the acquisition would result in a deposit concentration in
excess of 30.0% in the state in which the target bank has branches, the
responsible federal banking agency may not approve such acquisition unless,
among other alternatives, the acquisition is approved by the state bank
supervisor of that state. The Caldera Weggeland Act authorizes the
California Superintendent of Banks (the "Superintendent") to approve such an
interstate acquisition if the Superintendent finds that the transaction is
consistent with public convenience and advantage in California.
INTERSTATE BRANCHING. Effective June 1, 1997, the Interstate Banking Act
permits a bank, which is located in one state (the "home state") and which
does not already have a branch office in a second state (the "host state"),
to establish a branch office in the host state through acquisition by merging
with a bank located in the host state. The Interstate Banking Act also
permits each state to either "opt-out" from this legislation, i.e., prohibit
all interstate mergers, or "opt-in-early," i.e., enact a law authorizing
interstate branching in advance of the June 1, 1997 effective date of the
Interstate Banking Act.
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Additionally, the Interstate Banking Act permits a host state to authorize
interstate entry by acquisition of a branch office of a host state bank or by
establishment of a DE NOVO branch office in the host state.
By means of the Caldera Weggeland Act, the State of California has
elected to "opt-in-early" to interstate branching by permitting a foreign
(other state) bank to acquire an entire California bank by merger or purchase
and thereby establish one or more California branch offices. The Caldera
Weggeland Act expressly prohibits a foreign (other state) bank which does not
already have a California branch office from (i) purchasing a branch office
of a California bank (as opposed to the entire bank) and thereby establishing
a California branch office or (ii) establishing a California branch office on
a DE NOVO basis.
AGENCY. The Caldera Weggeland Act permits California state banks, with
the approval of the Superintendent, to establish agency relationships with
FDIC-insured banks and savings associations. While the Interstate Banking
Act authorizes agency relationships only between subsidiaries of a bank
holding company, the Caldera Weggeland Act is more expansive in that it
permits California state banks to establish agency relationships with both
affiliated and unaffiliated depository institutions. Additionally, the list
of authorized agency activities was expanded by this California statute to
include, in addition to the activities listed in the Interstate Banking Act,
evaluating loan applications and disbursing loan funds. The general law on
agency applies to these relationships and the Superintendent is authorized to
promulgate regulations for the supervision of such activities.
The changes effected by Interstate Banking Act and Caldera Weggeland Act
may increase the competitive environment in which any of the Operating Banks
operates in the event that out-of-state financial institutions directly or
indirectly enter any of the Operating Banks' market areas. It is expected
that the Interstate Banking Act will accelerate the consolidation of the
banking industry as a number of the largest bank holding companies attempt to
expand into different parts of the country that were previously restricted.
However, at this time, it is not possible to predict what specific impact, if
any, the Interstate Banking Act and the Caldera Weggeland Act will have on
the Company or the Banks, the competitive environment in which each of them
operates, or the impact on any of them of any regulations to be proposed
under the Interstate Banking Act and Caldera Weggeland Act.
RIEGLE COMMUNITY DEVELOPMENT AND REGULATORY IMPROVEMENT ACT OF 1994. On
September 23, 1994, President Clinton signed into law the Riegle Community
Development and Regulatory Improvement Act of 1994 (the "Regulatory
Improvement Act"). The Regulatory Improvement Act provides regulatory relief
for both large and small banks by, among other things, reducing the burden of
regulatory examinations, streamlining bank holding company procedures and
establishing a formal regulatory appeals process. The Regulatory Improvement
Act also addresses a variety of other topics, including, but not limited to,
mortgage loan settlement procedures, call reports, insider lending, money
laundering, currency transaction reports, management interlocks, foreign
accounts, mortgage servicing and credit card receivables. Although the
Regulatory Improvement Act should reduce the regulatory burden currently
imposed on banks, it is not possible to ascertain the precise effect its
various provisions will have on the Company or the Banks.
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DEPOSIT INSURANCE FUND ACT OF 1996. On September 30, 1996, President
Clinton signed into law the Deposit Insurance Fund Act of 1996 ("Funds Act").
Among other things, the Funds Act called for a special assessment for
SAIF-member savings association in order to capitalize the Savings
Association Insurance Fund ("SAIF"). The assessment was determined based
upon the assessable deposits of the member institution as of March 31, 1995
times a multiplier of .657 basis points. As a result of the special
assessment required by the Funds Act, SAIF was capitalized at the target
Designated Reserve Ratio ("DRR") of 1.25 percent of estimated insured
deposits on October 1, 1996.
Section 7 of the Federal Deposit Insurance Act, as amended by the Funds
Act, requires the FDIC to set assessments in order to maintain the target
DRR. The Board has, therefore, lowered the rates on assessments paid to the
SAIF, while simultaneously widening the spread between the lowest and highest
rates to improve the effectiveness of the FDIC's risk-based premium system.
The Board has also established a process, similar to that which has applied
to the Bank Insurance Fund ("BIF"), for adjusting the rate schedules for both
the SAIF and the BIF within a limited range without notice and comment to
maintain each of the fund balances at the target DRR.
The Funds Act also separates, effective January 1, 1997, the Financing
Corporation ("FICO") assessment to service the interest on its bond
obligations from the SAIF assessment. The amount assessed on individual
institutions by the FICO will be in addition to the amount paid for deposit
insurance according to the FDIC's risk-related assessment rate schedules.
However, between October 1, 1996 and January 1, 1997, any amount required by
the FICO will be deducted from the amounts the FDIC is authorized to assess
SAIF-member savings associations, and must not be assessed against Sasser and
BIF-member Oakar institutions. FICO assessment rates for the first
semiannual period of 1997 were set at 1.30 basis points annually for
BIF-assessable deposits and 6.48 basis points annually for SAIF-assessable
deposits. (These rates may be adjusted quarterly to reflect changes in
assessment bases for the BIF and the SAIF. By law, the FICO rate on
BIF-assessable deposits must be one-fifth the rate on SAIF-assessable
deposits until the insurance funds are merged or until January 1, 2000,
whichever occurs first).
The rule establishes a SAIF rate schedule of 0 to 27 basis points
effective for Sasser banks and for BIF-member Oakar institutions on October
1, 1996, and effective for all institutions beginning January 1, 1997. The
rule establishes a special interim rate schedule of 18 to 27 basis points
annually between October 1, 1996 and January 1, 1997, for SAIF-member savings
associations that pay assessments to the FICO.
EFFECT OF GOVERNMENTAL POLICIES AND LEGISLATION
GENERAL. Banking is a business which depends on rate differentials. In
general, the difference between the interest rate paid by the Banks on their
deposits and their other borrowings and the interest rate received by the
Banks on loans extended to their customers and securities held in their
respective portfolios comprise the major portion of the Company's earnings.
These rates are highly sensitive to many factors that are beyond the control
of the Company. Accordingly, the earnings and growth of the Company is
subject to the influence of domestic and foreign economic conditions,
including inflation,
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recession and unemployment.
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
FRB. The FRB can and does implement national monetary policies (with
objectives such as curbing inflation and combating recession) by its
open-market operations in United States Government securities, by its control
of the discount rates applicable to borrowings by depository institutions,
and by adjusting the required level of reserves for financial institutions
subject to its reserve requirements. The actions of the FRB in these areas
influence the growth of bank loans, investments and deposits and also affect
interest rates charged on loans and paid on deposits. As demonstrated over
the past year by the FRB's actions regarding interest rates, its policies
have a significant effect on the operating results of commercial banks, and
are expected to continue to do so in the future. The nature and impact of
any future changes in monetary policies is not predictable.
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 institutions. Proposals to change the laws and regulations
governing the operations and taxation of banks, bank holding companies and
other financial institutions frequently are made in Congress, in the
California legislature and before various bank regulatory and other
professional agencies. For example, legislation was introduced in Congress
which would repeal the current statutory restrictions on affiliations between
commercial banks and securities firms. Under the proposed legislation, bank
holding companies would be allowed to control both a commercial bank and a
securities affiliate, which could engage in the full range of investment
banking activities, including corporate underwriting. The likelihood of any
major legislative changes and the impact such changes might have on the
Company are impossible to predict. (See "BUSINESS -- Supervision and
Regulation" herein.)
RELIANCE ON SBA PROGRAMS. As noted above, with the acquisition of
Liberty in March 1996, a significant portion of the Company's business now
consists of originating and servicing loans under the programs of the U.S.
Small Business Administration. Significant cuts in SBA programs would likely
have a material adverse impact on the Company.
Various items of legislation were introduced in U.S. Congress in 1995
that would have curtailed or otherwise modified the SBA's programs to varying
degrees, many of which were premised on the broad goal of federal government
debt reduction. Ultimately, Congress passed and the President signed the
Small Business Lending Enhancement Act of 1995 (the "Act"). The Act reduced
the amount of the subsidy to borrowers inherent in the SBA's guaranty of
loans under its various programs, thus causing the SBA to increase the fees
it charges for its guarantee. (The actual payments by the SBA on its
guaranties plus the cost of program administration have historically exceeded
the aggregate guarantee fees collected by the SBA.) At the same time,
however, by reducing the per-loan subsidy by an amount greater than the
reduction in the SBA's budget, the Act sought to increase the total number
and dollar amount of loans that the SBA would guarantee. While management
has not discerned a material decrease in the number or quality of borrowers
seeking SBA loans as a result of the increase in the
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guarantee fees charged to borrowers, it is possible that such a decrease will
occur over the long term.
In addition, while Congress' consideration of the SBA's programs and its
passage of the Act in 1995 may suggest that the SBA is not likely to be
discontinued in its entirety in the foreseeable future, to the extent that
Congress and/or present or future Presidential Administrations make deficit
reduction a priority, all federal programs, including the SBA loan programs,
may face funding reductions.
ACCOUNTING CHANGES
In June 1996 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities" ("FAS
125"). This statement provides consistent accounting and reporting standards
for the transfers and servicing of financial assets and the extinguishment of
liabilities. The Company will adopt FAS 125 effective January 1, 1997 and
does not expect the adoption to have a material impact on its financial
statements.
EMPLOYEES
Collectively, the Company and its subsidiary Banks employed 343 full-time
equivalent individuals as of December 31, 1996. The Company and SDN have no
employees of their own except its President, Robert P. Keller, who is also an
employee of each of its subsidiary Banks and its Treasurer and Chief
Financial Officer, Curt A. Christianssen, who is also an employee of each of
the subsidiary Banks. Of the above-mentioned individuals, 43 were a Vice
President (or above) of either San Dieguito, Liberty or CSB. These officers
have been specifically recruited for their banking background and experience
in working with small businesses and professionals. The Company has entered
into separate written employment contract with Robert P. Keller, President
and Chief Executive Officer of the Company and Chairman and Chief Executive
Officer for each of the subsidiary Banks. (See "EXECUTIVE COMPENSATION ---
Keller Employment Agreement" herein.) The only employees of Liberty as to
whom Liberty is subject to written employment contracts are Philip S. Inglee,
President and Chief Operating Officer; Richard I. Ganulin, Executive Vice
President and Credit Administrator; and Catherine C. Clampitt, Senior Vice
President. The only employees of CSB as to whom CSB is subject to written
employment contracts are John Kay, Executive Vice President of the Commercial
Banking Division and Fred Neal, Executive Vice President of the Residential
Mortgage Division. Neither SDN nor San Dieguito is subject to a written
employment contract with any employee. The Company believes its and its
Banks' employee relations are excellent. None of the Company's employees or
its subsidiaries employees are represented by a union or covered under a
collective bargaining agreement.
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SELECTED STATISTICAL AND FINANCIAL INFORMATION
The following table represents selected financial data of Bancorp for
each of the last five years for the period ended, or as of December 31.
AS OF AND FOR THE YEARS ENDED DECEMBER 31,
------------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
1996 1995 1994 1993 1992
<S> <C> <C> <C> <C>
SUMMARY OF OPERATIONS
- ---------------------
Net interest income before
provision for possible loan loss $11,708 $2,817 $ 2,861 $ 2,994 $4,079
Provision for possible loan loss 515 295 583 1,085 350
------- ------ ------- ------- ------
Net interest income after provision
for possible loan loss 11,193 2,522 2,278 1,909 3,729
Net non-interest expense 10,371 3,595 3,267 3,885 3,960
------- ------ ------- ------- ------
Income (loss) before income taxes
and extraordinary item 822 (1,073) (989) (1,976) (231)
Income taxes (benefit) (1,503) (443) - - -
------- ------ ------- ------- ------
Income (loss) before extraordinary item 2,325 (630) (989) (1,976) (231)
Extraordinary item: forgiveness of
indebtedness net of $443,000 income taxes - 625 - - -
------- ------ ------- ------- ------
Net income (loss) $ 2,325 $ (5) $ (989) $(1,976) $ (231)
------- ------ ------- ------- ------
------- ------ ------- ------- ------
Per share data:
Income (loss) before
extraordinary item $.44 $(2.35) $(18.41) $(36.78) $(0.41)
Extraordinary item - 2.33 - - -
Income (loss) per share $.44 $(0.02) $(18.41) $(36.78) $(4.30)
Average shares outstanding 5,300,773 268,198 53,728 53,728 53,728
FINANCIAL POSITION
- ------------------
Assets $437,060 $55,905 $57,686 $61,916 $80,200
Loans, net 266,878 38,338 45,492 48,179 55,789
Deposits 383,031 51,431 55,876 59,651 76,149
Shareholders' equity (deficit) 40,772 3,541 (948) 41 2,017
SELECTED FINANCIAL RATIOS
- -------------------------
Return on average equity (3) 11.23% nm nm (201.43)% (10.32)%
Return on average assets 0.96% (0.01)% (1.61)% (2.97)% (0.28)%
Average equity to average assets 8.56% (0.14)% (0.09)% 1.47% 2.74%
Dividend payout ratio - - - - -
</TABLE>
- ----------------------
(3) Return on average equity is not meaningful as the average equity for 1994
and 1995 was negative.
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ITEM 2. PROPERTIES
As national banks, San Dieguito and Liberty are precluded from engaging
in real estate development activities other than as lenders. Each bank owns
and leases properties for use as bank premises and otherwise owns real estate
taken in foreclosure. The Company maintains its office at the same location
as the main banking office of Liberty. In management's opinion, each bank
has adequate insurance to cover its interest in its premises and other real
estate owned.
SAN DIEGUITO PREMISES. San Dieguito presently operates two full-service
banking offices in San Diego County. Its principal market area is the
northern coastal area of San Diego County. San Dieguito's main banking
office and administration offices are located at 135 Saxony Road in
Encinitas, California. This is a two-story, freestanding building that San
Dieguito occupies pursuant to a 20-year, triple net lease which commenced
March 1982, with an option to extend for an additional 10 years. Increases
in rent will occur in May of 1997 as well as during the option period.
San Dieguito's branch banking office at 675 Carlsbad Village Drive,
Carlsbad, California, opened in December 1990. This office is a one-story,
freestanding building that San Dieguito occupies pursuant to a 15-year lease
with options to extend for two five-year periods. The rent increases 4.0%
per year for each new lease year through December 2000, at which time rent
will be adjusted to fair market rent as of that time, determined in
accordance with procedures provided in the lease. Thereafter, the rent
increases 4.0% per year from that new base through the remaining original
term of the lease.
LIBERTY PREMISES. Liberty's main banking office and administration
offices occupy substantially all of the first floor of the building located
at One Pacific Plaza, 7777 Center Avenue, Huntington Beach, California. The
lease of the first floor of the building, where Liberty's Head Office Branch
and most of its administration offices are located, is for a term of 20 years
commencing on October 1, 1981, with four consecutive renewal options of five
years each. The base rent for the first floor of the building adjusts
periodically to the fair market rental value of such premises commencing on
the tenth anniversary of the lease. In addition, the base rent for the first
floor of this building will be increased every three years during the lease
by an amount equal to the lesser of: (i) 8.5% times the current base rent; or
(ii) and amount equal to 75% of the percentage adjustment in the Consumer
Price Index.
Liberty owns the property at 34206 Doheny Park Road, Dana Point, at
which its South Orange County branch is located. Office space of the
building is 1,488 square feet.
Liberty leases the property located at 17011 Beach Boulevard, Huntington
Beach at which its Beach Boulevard branch is located. The lease is for a
term of 62 months commencing on June 1, 1996 with two consecutive renewal
options of five years each.
Liberty also leases the office housing its Northern California LPO.
That office is located
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at 12 Orinda Way, Orinda, California, which is leased on a month-to-month
basis.
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CSB PREMISES CSB's banking and administrative offices occupy suites
101, 200, 204 and 325 of the building located at 1545 River Park Drive,
Sacramento, California. The lease for these premises has an initial term of
seven years expiring April 30, 2000 with the option to extend for three
consecutive five year periods. The base rent is subject to periodic fixed
increases as prescribed in the lease.
CSB's residential mortgage operations occupy space in the building
located at 1451 River Park Drive, Sacramento, California. The lease for
these premises has an initial term of five years expiring March 31, 1999 with
the option to renew for two consecutive three year periods. The base rent is
subject to periodic fixed increases as prescribed in the lease. The mortgage
division of CSB also lease space for their wholesale and retail loan
origination activity ("LPO"s). The leases for these LPO premises are either
month-to-month or fixed short term leases and are located at and expire as
follows:
1981 North Broadway, Walnut Creek, California October 31, 1997
995 Oliver road, Fairfield, California Month to month
1776 West March Lane, Stockton, California May 31, 2001
11768 Atwood Boulevard, Auburn, California Month to month
2398 East Camelback Road, Phoenix, Arizona October 31, 1999
10300 South West Greenburg Road, Portland, Oregon October 31, 1999
8400 East Prentice Avenue, Englewood, Colorado May 31, 1997
350 South Center Street, Reno, Nevada Month to month
CSB's residential division formerly housed its operations and operated
LPOs in premises it now has under sublease agreements. The leases for these
premises are located at and expire as follows:
2033 Howe Avenue, Sacramento, California December 31, 1999
500 Ygnacio Valley Road, Walnut Creek, California April 30, 1997
3 Hutton Center, Santa Ana, California March 31, 1998
CSB's primary leasing operation occupies suites 130 and 146 in the
building located at 1451 River Park Drive, Sacramento, California. The lease
for these premises has an term of four years with an expiration of September
30, 1998. The base rent is subject to periodic fixed increases as prescribed
in the lease. The leasing division operations also occupy suite 189 in the
building located at 5070 North Sixth Street, Fresno, California and suite 220
in the building located at 515 116th Avenue N.E., Bellevue, Washington. The
lease for the Fresno office has a term of four years and expires March 31,
1997 and the lease for the Bellevue office has a term of one year, renewable
annually.
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ITEM 3. LEGAL PROCEEDINGS
As of December 31, 1996, the Company did not have any asserted lawsuits
against it. The Banks have been subject to various legal actions which are
deemed to be part of its normal course of business. Management, after
consultation with legal counsel, believes that the ultimate liability, if any,
arising from such actions will not have a materially adverse affect on the
financial position or results of operations of the Bank or Bancorp.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted by the Bank or Bancorp to a vote of its security
holders, through the solicitation of proxies or otherwise, during the fourth
quarter of its fiscal year ended on December 31, 1996.
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PART II
ITEM 5. MARKET FOR ISSUER'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS
ISSUER AS SUCCESSOR TO SDN BANCORP, INC.
The Company was organized to effect the September 1, 1996 acquisition of
CSB (the "CSB Acquisition") for a combination of cash and common stock, $.01 par
value per share ("Common Stock"), as described below. As contemplated by the
Agreement and Plan of Reorganization dated April 23, 1996 (the "CSB Agreement")
between SDN Bancorp, Inc. ("SDN") and CSB, SDN formed the Company to become the
sole shareholder of SDN and CSB. In connection with that reorganization (the
"1996 Reorganization"), each shareholder of SDN received one share of Common
Stock for each share of SDN common stock. For purposes of reporting under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), the Company is
the successor registrant to SDN, which, prior to the completion of the CSB
Acquisition, filed reports with pursuant to Section 15(d) of the Exchange Act.
MARKET FOR ISSUER'S COMMON STOCK
Trading in Common Stock and, prior to the CSB Acquisition, SDN common
stock, has been extremely limited. Such trades cannot be characterized as
amounting to an active trading market. The Common Stock is registered with the
National Association of Securities Dealers ("NASD") and is traded only
over-the-counter (NASD/CBNK), but is not listed on any exchange, and is not
quoted on the National Association of Securities Dealers' Automated Quotation
System ("NASDAQ").
No trades in Common Stock have been reported by securities dealers during
the last two years. This does not include shares that may have been traded
directly by shareholders or through other dealers as to which no information is
generally available to the Company.
DIVIDEND POLICY
Holders of Common Stock are entitled to receive dividends as and when
declared by the Board of Directors out of funds legally available therefor under
the laws of the State of Delaware. The Company does not expect to pay Common
Stock dividends for the foreseeable future, and certain terms of the "Senior
Securities" that the Company expects to issue to fund the Eldorado acquisition
(each as defined below under "Unregistered Sales of Securities--Funding for
Eldorado Acquisition") will prohibit the payment of Common Stock dividends
various certain circumstances.
The Company is not permitted to pay any dividends without the consent of
the Federal Reserve Bank of San Francisco. As National Banks, San Dieguito and
Liberty are subject to
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certain restrictions on the payment of dividends and may require approval of
the Office of the Comptroller of the Currency. As a State Bank, CSB is
subject to certain restrictions on the payment of dividends and may require
approval of the State Banking Department and the Federal Deposit Insurance
Corporations. (see "BUSINESS -- Regulatory Restrictions on Distributions to
Shareholders -- Dividends".)
HOLDERS OF COMMON STOCK
As of March 14, 1997, there were approximately 460 holders of record of
Common Stock.
UNREGISTERED SALES OF SECURITIES
Described below are sales and other issuances of equity securities during
the year ended December 31, 1996 by the Company and, prior to the CSB
Acquisition, SDN that were not registered under the Section 5 of the Securities
Act of 1933, as amended (the "Securities Act").
FUNDING FOR LIBERTY ACQUISITION. On March 31, 1996, SDN completed its
acquisition (the "Liberty Acquisition") of Liberty National Bank ("Liberty") for
approximately $15.1 million in cash as contemplated by the October 26, 1995
Agreement and Plan of Merger by and among SDN, Liberty, and Dartmouth Capital
Group, L.P., a Delaware limited partnership (the "Partnership"), the Company's
controlling shareholder. As of March 27, 1996, the Partnership invested
approximately $13.4 million in the Company to fund the Liberty Acquisition. In
exchange for that investment, SDN issued a total of 3,392,405 additional shares
of SDN common stock at a price per share of $3.95, SDN's book value per share as
of December 31, 1995. At the Partnership's direction, SDN issued 1,764,000 of
those shares of Common Stock, in the aggregate, to certain limited partners of
the Partnership who are accredited investors (the "Direct Holders" and, together
with the Partnership, "Dartmouth Capital") and the remaining 1,628,405 shares of
Common Stock directly to the Partnership. SDN's issuance of common stock to
Dartmouth Capital to fund the Liberty Acquisition was exempt from registration
under the Securities Act by virtue of Regulation D promulgated under the
Securities Act ("Regulation D") and/or Section 4(2) of the Securities Act.
FUNDING FOR CSB ACQUISITION. As of August 31, 1996, the Partnership
invested approximately $14.5 million in the SDN to fund the CSB Acquisition.
In exchange for that investment, SDN issued a total of 3,664,776 shares of SDN
at a price per share of $3.95. At the Partnership's direction, SDN issued
1,080,000 of those shares of Common Stock, in the aggregate, to the Direct
Holders and the remaining 2,584,776 shares of Common Stock directly to the
Partnership. SDN's issuance of common stock to Dartmouth Capital to fund the
CSB Acquisition was exempt from registration under the Securities Act by virtue
of Regulation D and/or Section 4(2) thereof.
Contemporaneously with the completion of the 1996 Reorganization, holders
of SDN
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common stock were issued one share of 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 1996 Reorganization. Such issuance was exempt from registration
under the Securities Act because it did not constitute a sale of Common
Stock. In addition, the issuance was exempt from registration pursuant to
Section 3(a)(10) of the Securities Act by virtue of a determination made by
the California Commissioner of Corporations that the terms of 1996
Reorganization, including the terms of the CSB Agreement, were fair to the
holders of SDN common stock, as contemplated by a no-action letter dated July
12, 1996 (the "No-action Letter").
Also as part of the 1996 Reorganization, the Company issued a total of
1,527,540 shares of Common Stock and paid approximately $14.1 million in cash,
in the aggregate, to the holders of CSB common stock as of the closing of the
CSB Acquisition. In addition, pursuant to the terms of the CSB Agreement, the
Company issued an additional 58,212 shares of common stock and delivered
approximately $346,000 of cash to be held in escrow pending resolution of
certain contingencies related to the CSB Acquisition. The Company's issuance of
Common Stock was exempt from registration pursuant to Section 3(a)(10) of the
Securities Act by virtue of a determination made by the California Commissioner
of Corporations that the terms of the 1996 Reorganization, including the CSB
Agreement, were fair to the holders of CSB common stock, as contemplated by the
No-action Letter.
Upon consummation of the CSB Acquisition, the Company issued a total of
27,964 shares of Common Stock to the investment bankers that advised CSB, the
number of such shares being based upon the amount of Common Stock received by
CSB shareholders in the CSB Acquisition. The Company's issuance of those shares
was exempt from registration under the Securities Act by virtue of Regulation D
and/or Section 4(2) thereof.
Contemporaneously with the 1996 Reorganization, the Company sold a total of
81,800 shares to certain directors and officers of the Company's subsidiaries
and other accredited investors at a price of approximately $5.18 per share. The
Company issuance of those shares was exempt from registration under the
Securities Act by virtue of Regulation D and/or Section 4(2) thereof.
KELLER RESTRICTED STOCK. During the year ended December 31, 1996, the
Company and, prior to the CSB Acquisition, SDN issued a total of 49,062 shares
of Common Stock to Robert P. Keller, President and Chief Executive Officer of
the Company, pursuant to the terms of the Mr. Keller's Employment Agreement with
the Company. The Company issuance of those shares was exempt from registration
under the Securities Act by virtue of Regulation D and/or Section 4(2) thereof.
FUNDING FOR ELDORADO ACQUISITION. On December 24, 1996, the Company
entered into a definitive Agreement and Plan of Merger (the "Eldorado
Agreement") with Eldorado Bancorp ("Eldorado") of Tustin California, the holding
company of Eldorado Bank. Pursuant to the Eldorado Agreement, the Company will
acquire 100% of the outstanding stock of
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<PAGE>
Eldorado for cash consideration of $23.00 per share. The aggregate
consideration payable to holders of Eldorado stock and stock options (net of
the tax benefit arising out of the stock options) will be approximately $89.6
million.
The Company estimates that approximately $93.5 million of cash will be
necessary to fund the payment of the cash consideration to the holders of
Eldorado stock and stock options and related acquisition expenses. The Company
intends to obtain such funding primarily from existing investors and certain
institutional investors.
The Company expects that the securities issued to fund the Eldorado
acquisition will consist of trust originated preferred stock and non-cumulative
preferred stock, Class A common stock ("Senior Common" and together with the
preferred stock, the "Senior Securities"), Class B common stock and warrants to
purchase approximately 4.5 million shares of Class B common stock. Existing
shares of Common Stock will be reclassified as Class B common stock in
connection with the Eldorado transaction. The issuance of the Senior
Securities, the Class B common stock and the warrant will be exempt from
registration under the Securities Act by virtue of Regulation D and/or
Section 4(2) thereof.
As a condition to entering into the Eldorado Agreement before the
finalization of the terms of the Senior Securities, the Company placed
$4.5 million in an escrow account which will be forfeited in the event that the
Company fails to finance the Eldorado acquisition. Pursuant to agreements
entered into in December 1996 with the Company, the Partnership and one of the
Company's directors provided the funds for that escrow deposit. Those funds are
initially in the form of a loan to the Company which (including interest
thereon) would be converted to shares of Class B common stock upon the
consummation of the Eldorado acquisition at a price of $4.40 per share. The
Company's issuance of such shares of Class B common stock will be exempt from
registration under the Securities Act by virtue of Regulation D and/or
Section 4(2) thereof.
Also in December 1996, the Company accepted subscriptions agreements from
certain of the Direct Holders and other accredited investors to purchase up to
approximately $15.2 million of Class B Common Stock at a price of $4.81 per
share to fund a portion of the Eldorado acquisition. Those subscribers will
receive a 1% commitment fee based upon the maximum amount of their commitment.
The Company's issuance of such shares of Class B common stock will be exempt
from registration under the Securities Act by virtue of Regulation D and/or
Section 4(2) thereof.
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ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
This information should be read in conjunction with the audited
consolidated financial statements and the notes thereto of Commerce Security
Bancorp, Inc. (the "Company") included in Item 7 of this Annual Report. SDN
Bancorp, Inc. ("SDN") became a wholly-owned subsidiary of the Company effective
August 31, 1996 as part of the 1996 Reorganization described elsewhere in this
report (see "BUSINESS -- Acquisitions"). Management believes the Company should
be regarded as a successor reporting company to SDN.
Except for the historical information contained herein, the following
discussion contains forward looking statements that involve risks and
uncertainties. The Company's actual results could differ materially from those
discussed here. Factors that could cause or contribute to such differences
include, but are not specifically limited to, changes in regulatory climate,
shifts in interest rate environment, change in economic conditions of various
markets the Company serves, as well as the other risks detailed in this section,
and in the sections entitled Results of Operations and Liquidity and Capital
Resources.
As a result of the 1996 Reorganization, described elsewhere in this report,
since September 1, 1996, the registrant has owned 100% of CSB and SDN. SDN
owns 100% of San Dieguito National Bank ("SDNB") and, as of March 31, 1996, SDN
completed the Liberty Acquisition as described in the footnotes to the
accompanying consolidated condensed financial statements (see "BUSINESS --
Acquisitions"). Both the Liberty and CSB acquisitions were accounted for using
the purchase method of accounting for business combinations. Accordingly, the
following discussion relates to the operating results of SDNB for the twelve
months ended December 31, 1996, the operating results of Liberty for the nine
months ended December 31, 1996 and the operating results of CSB for the four
months ended December 31,1996 and the financial condition of SDNB, Liberty and
CSB combined (collectively the "Banks").
FINANCIAL CONDITION
Total assets of The Company at December 31, 1996 were $437.1 million
compared to total assets of $55.9 million at December 31, 1995. The increase
in total assets since December 31, 1995 is attributed primarily to the assets of
Liberty, acquired on March 31, 1996, and CSB acquired on September 1, 1996, that
had total assets of $149.0 million and $232.1 million at December 31, 1996,
respectively. Total earning assets of the Company at December 31, 1996 were
$321.3 million compared to total earning assets of $49.3 million at
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<PAGE>
December 31, 1995. Earning assets increased primarily due to the Liberty
Acquisition and CSB Acquisition. Liberty and CSB had total earning assets
of $133.9 million and $147.4 at December 31, 1996, respectively.
Total loans and leases of the Company at December 31, 1996 were $272.0
million, including $10.8 million of mortgage loans held for sale, compared to
$39.0 million at December 31, 1995. Loans and leases acquired in the Liberty
Acquisition and CSB Acquisition account for the increase in total loans. Loans
and leases at Liberty and CSB at December 31, 1996 were $103.3 million and
$129.8 million, respectively. Additionally, The Company had $54.1 million in
mortgage loan and servicing sale receivables at December 31, 1996.
The Banks hold loans and leases in their portfolio that at December 31,
1996 represented 83.1% and 16.9% of total loans and leases, respectively. The
four largest lending categories are: (i) commercial real estate loans; (ii)
construction and other loans secured by real estate; (iii) commercial loans and
(iv) loans to individuals. At December 31, 1996, these categories accounted for
approximately 37.8%, 31.3%, 21.0% and 9.9% of total loans, respectively. Leases
are made to finance small equipment for businesses.
Included among the Banks' portfolio of loans are approximately $42.4
million of SBA loans made by the Banks guaranteed by the United States
Government to the extent of 75% to 90% of the principal and interest due on such
loans. Liberty and SDNB are active in originating this type of loan. Liberty
generally sells the government guaranteed portion of these loans to participants
in the secondary market and retains servicing responsibilities and the
unguaranteed portion of the loans while SDNB generally retains the entire loan
for its own portfolio.
The government guaranteed portion of the SBA loans are sold at a premium, a
portion of which is immediately recognized as income. The remaining premium,
representing estimated normal servicing fees or a yield adjustment on the
portion of the SBA loan retained by the Banks, is deferred and recognized as
income over the estimated life of the loan. Deferred SBA servicing fees for
Liberty were approximately $1.4 million at December 31, 1996. The total SBA loan
portfolio serviced by Liberty at December 31, 1996 was approximately $153.5
million and included in this amount was approximately $42.4 million
representing the portion of the SBA loans retained by Liberty. The total SBA
loan portfolio serviced by SDNB at December 31, 1996 was approximately $5.0
million and included in this amount was approximately $4.5 million representing
the portion of the SBA loans retained by SDNB.
Total investments of the Company at December 31, 1996 were $49.2 million
compared to $10.3 million at December 31, 1995. Investment securities increased
largely due to the Liberty Acquisition and CSB Acquisition. Investments at
Liberty and CSB at December 31, 1996 were $30.6 million and $17.5 million,
respectively. The investment portfolio primarily
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consists of U.S. government and municipal securities, Federal funds sold,
reverse repurchase agreements and certificates of deposits held at other
depository institutions. U.S. government and municipal securities were $35.2
million, or 71.5% of the total portfolio, of which $20.0 million are
categorized as held to maturity and $15.2 million are categorized as
available for sale. Federal funds sold and certificates of deposit were
$13.7 million and $338,000, respectively, or 27.8% and .7% of the total
portfolio, respectively.
Total deposits were $383.0 million at December 31, 1996 compared to
$51.4 million at December 31, 1995. The increase in total deposits since
December 31, 1995 is attributed to the addition of Liberty's and CSB's
deposits that at December 31, 1996 were $133.9 million and $198.5 million,
respectively. Non-interest bearing demand accounts were $126.9 million, or
33.1% of total deposits, at December 31, 1996. Interest bearing deposits
are comprised of interest bearing demand accounts, regular savings accounts,
money market accounts, time deposits of under $100,000 and time deposits of
$100,000 or more which were $38.6 million, $42.2 million, $25.6 million,
$123.8 million and $25.9 million, respectively, or 10.1%, 11.0%, 6.7%, 32.3%
and 6.8% of total deposits, respectively.
RESULTS OF OPERATIONS
NET INCOME.
The Company had net income of $2.3 million for the year ended December 31,
1996 compared to a net loss of $5,000 for the year ended December 31, 1995.
Included in the $5,000 1995 net loss is a $625,000 extraordinary gain from
extinguishment of debt, net of tax benefit of $443,000, in connection with the
Recapitalization. The Company's loss before extraordinary item for the year
ended December 31, 1995 was $630,000. The increase in net income before
extraordinary items is due to an increase in net interest income, non-interest
income and tax benefit of $8.9 million, $4.2 million and $1.1 million,
respectively, partially offset by increased provision for loan and lease losses,
non-interest expense and income taxes of $237,000, $11.2 million and $856,000,
respectively. Net income per share in 1996 was $.44 per share compared to a net
loss per share of $.02 (after adjustment for extraordinary item) in 1995.
In 1995, the Company had a consolidated net loss of $5,000 for the year
ended December 31, 1995, compared to a consolidated net loss of $989,000 for
the same period in 1994. Included in the $5,000 net loss is an extraordinary
gain from extinguishment of debt of $625,000, net of tax benefit of $443,000,
in connection with the Recapitalization. The Company's loss before
extraordinary item for the year ended December 31, 1995 was $630,000 versus
a net loss of $989,000 for the same period in 1994. The decrease in the loss
before extraordinary item in 1995 is due to a $288,000 decrease in the
provision for loan losses and a $30,000 increase in non-interest income
partially offset by a $358,000 increase in non-interest expense, and a
$44,000 decrease in net interest income. Net loss per share (after
adjustment for extraordinary item) was $.02 in 1995, compared to a net loss
per share of $18.41 in 1994.
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<PAGE>
NET INTEREST INCOME AND NET INTEREST MARGIN.
The Company's net interest income increased $8.9 million in 1996 due to an
increase of $14.8 million in interest income partially offset by increased
interest expense of $5.9 million. Interest income and interest expense
increased primarily due to an increase in interest earning assets and
liabilities acquired in the Liberty and CSB acquisitions. Increased yields on
earning assets and increased cost of interest bearing liabilities also
contributed to the increases in interest income and interest expense. The yield
on interest-earning assets rose to 9.74% from 9.08% in 1995 and the cost of
interest-bearing liabilities rose to 4.65% from 3.88% in 1995. As a result of
these factors the net yield on earning assets rose to 5.89% in 1996 from 5.60%
in 1995.
In 1995, The Company's net interest income decreased $44,000 due to an
increase of $222,000 in interest expense, partially offset by an increase of
$178,000 in interest income. Interest expense increased primarily due to an
increase in the average rate paid on interest-bearing liabilities that rose to
3.88% in 1995 from 3.10% in 1994, partially offset by a decrease in total
interest-bearing liabilities. Interest income increased primarily due to an
increase in the average yield earned on interest-earning assets, that rose to
9.08% in 1995 from 8.15% in 1994, partially offset by a decrease in total
interest-earning assets. As a result of these factors, the net yield earned on
interest earning assets increased to 5.60% in 1995 from 5.31% in 1994.
Loan fee income increased $1.1 million to $1.2 million in 1996 from
$104,000 in 1995. Much of this increase is attributable to the fees earned at
Liberty on the sale of SBA loans into the secondary market. Loan fee income
decreased $26,000 to $104,000 in 1995 from $130,000 in 1994 which reflects the
decline in local real estate and construction lending.
The tables on the following pages set forth the average amount outstanding
for each major category in the statements of condition for each of the past two
years. They also indicate the total amount of interest earned, or paid, for the
periods covered and the average rates earned or paid during those periods for
each such category. The Company has not engaged in foreign activities in any of
the periods represented. Nonaccrual loans are included in total loans
outstanding while non-accrued interest thereon is excluded from the computation
of rates earned.
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<TABLE>
<CAPTION>
DECEMBER 31, 1996 DECEMBER 31, 1995
---------------------------- ---------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME OR YIELD AVERAGE INCOME OR YIELD
BALANCE EXPENSE OR COST BALANCE EXPENSE OR COST
------- -------- ------ ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
ASSETS
Interest-earning assets:
Loans(2)...................... $146,743 $16,383 11.16% $ 42,272 $ 4,086 9.67%
Investment securities......... 32,886 1,968 5.98 5,061 311 6.15
Federal funds sold............ 17,837 934 5.24 2,128 117 5.50
Interest-bearing deposits
with financial institutions. 1,254 67 5.34 868 54 6.22
------ ----- ------ ----
Total interest-earning assets... 198,720 19,352 9.74 50,329 4,568 9.08
Other assets:
Cash and demand
deposits with banks........... 14,611 3,757
Other assets.................. 28,535 2,909
------- ------
Total Assets.............. $241,866 $ 56,995
-------- --------
-------- --------
LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
Deposits
Interest-bearing demand..... $ 24,464 686 2.80% 10,492 149 1.42%
Money market................ 18,135 493 2.72 9,176 231 2.52
Savings..................... 28,917 1,150 3.98 5,235 115 2.20
Time........................ 91,987 5,241 5.70 18,394 1,075 5.84
-------- ------ ------ -----
Total interest-bearing
deposits................ 163,503 7,570 4.63 43,297 1,570 3.63
Fed Funds Purchased............. 16 1 6.25 -0- -0- -0-
Other borrowing................. 402 12 2.99 -0- -0- -0-
Long-term debt................. 537 61 11.36 1,776 181 10.19
---- --- ----- ---
Total interest-bearing
liabilities............. 164,458 7,644 4.65 45,073 1,751 3.88
Other liabilities:
Non interest-bearing
demand deposits............. 52,273 11,197
Other liabilities............. 4,437 806
------ ------
Total liabilities............. 221,168 57,076
Shareholders' equity............ 20,698 (81)
------- ------
------- ------
Total liabilities and
Shareholders' equity.... $241,866 $ 56,995
------- ------
------- ------
Net interest income:............ $11,708 $ 2,817
------- -------
------- -------
Net yield on interest-earning
assets...................... 5.89% 5.60%
----- -----
----- -----
</TABLE>
- --------------------------------
(2)Includes the deduction of the average balance in the allowance for loan
losses of $639,000 in 1995 and $821,000 in 1994. Loan fees of $104,000 in 1995
and $130,000 in 1994 are included in the computations.
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<PAGE>
The following table sets forth changes in interest income and interest
expense on the basis of allocation to changes in rates and changes in volume of
the various components. Nonaccrual loans are included in total loans
outstanding while non-accrued interest thereon is excluded from the computation
of rates earned.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED FOR THE YEAR ENDED
DECEMBER 31, 1996 DECEMBER 31, 1995
COMPARED TO COMPARED TO
DECEMBER 31, 1995 DECEMBER 31, 1994
INCREASE (DECREASE) INCREASE (DECREASE)
DUE TO CHANGE IN: DUE TO CHANGE IN:
--------------------------- --------------------------
(DOLLARS IN THOUSANDS)
NET NET
CHANGE RATE VOLUME MIX CHANGE RATE VOLUME MIX
------ ---- ------ --- ------ ---- ------ ---
<S> <C> <C> <C> <C> <C> <C> <C> <C>
INTEREST EARNING
ASSETS
Loans $12,297 $633 $10,099 $1,565 $42 $498 $(405) $(51)
Investment Securities 1,657 (8) 1,710 (45) 64 34 26 4
Federal Funds Sold 817 (6) 864 (41) 61 18 33 10
Interest-bearing deposits
with financial institutions 13 (8) 24 (3) 11 18 (5) (2)
----- ----- ----- ----- ----- ----- ----- -----
Total interest-earning
assets 14,784 611 12,697 1,476 178 568 (351) (39)
INTEREST BEARING
LIABILITIES
Deposits
Interest-bearing demand 537 145 199 193 (18) (6) (12) 0
Money Market 262 18 226 18 (85) (7) (79) 1
Savings 1,035 93 520 422 (20) (2) (18) 0
Time 4,166 (27) 4,301 (108) 348 309 27 12
----- ----- ----- ----- ----- ----- ----- -----
Total interest-bearing
deposits 6,000 229 5,246 525 225 294 (82) 13
Fed funds purchased and
securities sold under
agreements to repurchase 1 0 0 1 0 0 0 0
Other borrowing 12 0 0 12 0 0 0 0
Long-term debt (120) 21 (127) (14) (3) 9 (12) 0
----- ----- ----- ----- ----- ----- ----- -----
Total interest-bearing
liabilities 5,893 250 5,119 524 222 303 (94) 13
----- ----- ----- ----- ----- ----- ----- -----
Net Interest income $8,891 $361 $7,578 $952 $(44) $265 $(257) $(52)
----- ----- ----- ----- ----- ----- ----- -----
----- ----- ----- ----- ----- ----- ----- -----
</TABLE>
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ALLOWANCE AND PROVISION FOR LOAN LOSSES
The provision for loan losses is an expense charged against operating
income and added to the allowance for loan losses. The allowance for loan
losses represents the amounts which have been set aside for the specific
purpose of absorbing losses which may occur in the Banks' loan portfolios.
Management of the Banks continue to carefully monitor the allowance for loan
losses in relation to the size of the Banks' loan portfolio and known risks or
problem loans.
The calculation of the adequacy of the allowance for loans losses requires
the use of management estimates. These estimates are inherently uncertain and
depend on the outcome of future events. Management's estimates are based upon
previous loan loss experience, current economic conditions as well as the
volume, growth and composition of the loan portfolio, the estimated value of
collateral and other relevant factors. The Bank's lending is concentrated in
Southern California, which has experienced adverse economic conditions,
including declining real estate values. These factors have adversely affected
borrowers' ability to repay loans. Although management believes the level of
the allowance as of December 31, 1996 is adequate to absorb losses inherent in
the loan portfolio, additional decline in the local economy may result in
increasing losses that cannot reasonably be predicted at this date. The
possibility of increased costs of collection, non-accrual of interest on those
which are or may be placed on non-accrual, and further charge-offs could have
an adverse impact on the Bank's and Bancorp's financial condition in the
future.
The allowance for loan losses was $5.2 million or 1.9% of gross loans, at
December 31, 1996, compared to $639,000, or 1.6%, of gross loans at December
31, 1995 and $821,000, or 1.8%, of gross loans for the same period in 1994. The
provision for loan losses for the year ended December 31, 1996 was $532,000
compared to $295,000, for the same period in 1995, and $583,000 for the same
period in 1994.
NON-INTEREST INCOME.
Non-interest income increased by $4.2 million to $4.9 million in 1996
from $696,000 in 1995. The increase was primarily due to the high level of
non-interest income earned at Liberty and CSB. The sources of this fee
income is primarily derived from the servicing and sale of loans including
SBA, residential mortgages and small equipment leases.
Non-interest income increased by $30,000 in 1995 compared to 1994. This
was primarily due to $60,000 of legal costs reimbursed from a loan recovery.
Non-interest income increased $11,000, or 1.7%, from $655,000 in 1993 to
$666,000 in 1994, due to an increase in gain on sale of OREO, partially offset
by a decrease in deposit service charges.
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NON-INTEREST EXPENSE
Non-interest expense increased $11.2 million to $15.3 million in 1996 from
$4.1 million in 1995. The increase in expense is largely attributable to the
expenses of Liberty and CSB. Expenses increased in the areas of salaries and
employee benefits by $5.0 million, occupancy and equipment by $2.4 million and
$3.8 million in other non-interest expenses.
Non-interest expense increased $358,000 in 1995 compared to 1994. This
increase is largely comprised of a $309,000 increase in losses and carrying
costs of OREO, $86,000 of other expense recorded in June 1995 as a result of
the May 1995 OCC examination, and $50,000 of accrued operational expenses
relating to changes contemplated as a part of the Recapitalization. These
increases in non-interest expense were offset by a $94,000 decrease in salaries
and employee benefits and a $16,000 decrease in occupancy and equipment
expenses.
The Bank took a number of actions during 1996 to reduce non-interest
expenses and increase non-interest income. The Company continues to evaluate
ways to realize even greater efficiencies and ways to reduce overhead costs.
Much of the improvements to be derived in the future will be borne out through
the consolidation of administrative functions and concentrating on synergies of
revenue production across the Banks.
PROVISION FOR INCOME TAXES.
The Company recorded a net benefit for taxes on continuing operations
totaling $1.5 million in 1996 compared to a net benefit of $443,000 in 1995.
The benefit in 1996 results from the release of the valuation allowance which
had previously been provided against the federal and state deferred tax assets
of the Company. That valuation allowance had ben provided against the net
operating loss carry forwards and other tax attributes of the Company. However,
the Company's operating results adequately support the realizability of the
deferred tax assets at December 31, 1996 and therefore the valuation allowance
is no longer required. Of the $2.0 million total allowance which was released
in 1996, approximately $413,000 was utilized to offset tax expense related to
1996 operating income, with the additional $1.5 million representing the
aforementioned net benefit. The benefit in 1995 was recognized as an offset to
the tax expense of $443,000 relating to the extraordinary gain from the
extinguishment of debt in 1995; on a net basis the Company recorded no tax
expense or benefit in 1995.
CAPITAL RESOURCES
As of March 27, 1996, Dartmouth Capital Group, L.P. (the "Partnership")
invested approximately $13.4 million in the registrant to fund the Liberty
Acquisition. In exchange for that investment, the registrant issued a total of
3,392,405 additional shares of Common Stock at a price per share of $3.95, the
registrant's book value per share as of December 31, 1995. At the Partnership's
direction the registrant issued 1,764,000 of those shares of Common Stock, in
the aggregate, to certain limited partners of the Partnership (the "Direct
Holders") and the remaining
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<PAGE>
1,628,405 shares of Common Stock directly to the Partnership. A total of
38,300 shares were issued to investment bankers involved in the Acquisition
and an additional 1,400 shares were issued sold to the directors of Liberty.
As of August 28, 1996, the Partnership invested approximately $14.5 million
in the registrant to fund the CSB 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 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 CSB
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 the Company's
common stock and cash of approximately $346,000 were placed into escrow pending
resolution of the SAIF recapitalization. As a result of legislation that
recapitalized the SAIF, passed on September 30, 1996, the stock and cash escrows
were distributed, with approximately $96,000 disbursed in cash and 16,151 common
shares distributed. A total of 161,356 shares were issued to other direct
investors who invested in conjunction with the Merger and investment bankers
involved in the Merger.
Current risk-based regulatory capital standards generally require banks and
holding companies to maintain a ratio of "core" or "Tier 1" capital (consisting
principally of common equity) to risk-weighted assets of at least 4%, a ratio of
Tier 1 capital to adjusted total assets (leverage ratio) of at least 3% and a
ratio of total capital (which includes Tier 1 capital plus certain forms of
subordinated debt, a portion of the allowance for loan losses and preferred
stock) to risk-weighted assets of at least 8%. Risk-weighted assets are
calculated by multiplying the balance in each category of assets according to a
risk factor which ranges from zero for cash assets and certain government
obligations to 100% for some types of loans, and adding the products together.
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<PAGE>
The Company and San Dieguito were well capitalized and Liberty and CSB were
adequately capitalized as of December 31, 1996 for federal regulatory purposes.
As of December 31, 1996, the Company had a combined leverage ratio was 6.98%,
Tier 1 risk-weighted capital ratio was 9.22% and a total risk-weighted capital
ratio was 10.64%. CSB's, Liberty's and San Dieguito's leverage ratio, Tier 1
risk-weighted capital ratio, and total risk-weighted capital ratios are set
forth in the following table:
San
Liberty CSB Dieguito
------- ----- --------
Leverage ratio 6.19% 4.99% 11.05%
Tier 1 risk-weighted capital ratio 8.68% 6.90% 14.52%
Total risk-weighted capital ratio 9.97% 8.15% 15.78%
LIQUIDITY
The Banks rely on deposits as their principal source of funds and,
therefore, must be in a position to service depositors' needs as they arise.
Management of the Banks attempt to maintain a loan-to-deposit ratio of not
greater than 80% and a liquidity ratio (liquid assets, including cash and due
from banks, Federal funds sold and investment securities to deposits) of
approximately 20%. The average loan-to-deposit ratio was 68% in 1996, 78% in
1995, and 79% in 1994. The average liquidity ratio was 30% in 1996, 22% in 1995
and 20% in 1994. At December 31, 1996, the Company's loan-to-deposit ratio was
71% and the liquidity ratio was 22%. While fluctuations in the balances of a
few large depositors cause temporary increases and decreases in liquidity from
time to time, the Company and its subsidiary Banks have not experienced
difficulty in dealing with such fluctuations from existing liquidity sources.
Should the level of liquid assets (primary liquidity) not meet the
liquidity needs of the Bank, other available sources of liquid assets
(secondary liquidity), including the purchase of Federal Funds, sale of
repurchase agreements, sale of loans, and the discount window borrowing from
the Federal Reserve Bank, could be employed. The Company and its subsidiary
Banks have rarely used these sources in the past since its liquidity levels have
been maintained primarily through funds provided by deposits.
INTEREST RATE SENSITIVITY
The table on the following page analyzes the assets and liabilities of the
Company at December 31, 1996, by interest rate sensitivity, showing the amount
of each category which is subject to repricing over specified time horizons.
By definition, rate-sensitive assets less rate-sensitive liabilities equals the
gap for that time horizon. The gap is negative if liabilities exceed the assets
that are subject to repricing in a given time horizon. The Company's policy is
to control the rate sensitivities in order that the one year cumulative gap does
not exceed a positive or negative 10% of total assets.
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<PAGE>
<TABLE>
<CAPTION>
OVER 3
MONTHS OVER 1
3 MONTHS TO 12 YEAR TO OVER ZERO
OR LESS MONTHS 5 YEARS 5 YEARS RATE(5) TOTAL
------- ------ ------- ------- ---- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Cash and due from banks $ - $ - $ - $ - $ 32,522 $ 32,522
Interest-bearing deposits
w/financial institutions 338 - - - - 338
Investment securities 3,666 9,197 22,305 32 - 35,200
Federal funds sold 13,700 - - - - 13,700
Loans and leases 145,835 43,916 59,568 25,224 - 274,655
Loan and servicing sale receivable 54,080 - - - - 54,080
Premises and equip, net - - - - 3,911 3,911
Other assets(6) - - - - 22,654 22,654
-------- -------- -------- -------- -------- --------
Total assets $217,619 $53,113 $81,873 $25,368 $59,087 $437,060
LIABILITIES AND
SHAREHOLDERS EQUITY
Non-interest bearing
demand deposits $ - $ - $ - $ - $126,885 $126,885
Interest-bearing demand 38,602 - - - - 38,602
Money market and savings 25,662 - - - - 25,662
Time under $100,000 40,076 72,007 11,706 - - 123,789
Time of $100,000 or more 16,387 9,214 302 - - 25,903
Notes payable - 4,500 - - - 4,500
Mandatory convertible debentures - - 537 - - 537
Other liabilities - - - - 8,220 8,220
Shareholders' equity - - - - 40,772 40,772
-------- -------- -------- -------- -------- --------
Total liabilities &
shareholders' equity $162,917 $ 85,721 $12,545 $ - $ 175,877 $437,060
-------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- --------
Gap (assets-liabilities and
shareholders' equity) $54,702 $(32,608) $69,328 $25,368 $(116,790)
Cumulative Gap $54,702 $ 22,094 $91,422 $116,790
Cumulative gap as a % of total assets 12.52% 5.06% 20.92% 26.72%
</TABLE>
ECONOMIC CONSIDERATIONS
Approximately half of the Bank's loan portfolio at December 31, 1996
consisted of short-term loans tied to a floating interest rate which are
either floating rate loans or change at least quarterly with 68% of the
portfolio that either matures or has its interest rate subject to change
within a one year horizon. This loan portfolio mix enables the Banks to
adjust yields quickly in a changing interest rate environment. The Banks'
assets that are interest sensitive are more sensitive to interest rate
changes than its interest sensitive liabilities. This is partly because
- ----------------
(5) Assets or liabilities which are not interest rate-sensitive.
(6) Allowance for possible loan losses of $5.2 million as of December 31, 1996
is included in other assets.
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<PAGE>
it has more short term or immediately repriceable interest sensitive assets
and longer term fixed rate interest bearing liabilities. Given these
circumstances and absent other factors, declining market rates of interest
will generally have a negative impact on the Bank's net interest income,
while rising interest rates will have a positive effect.
The commercial banking activity of the Banks concentrate on serving the
needs of small and medium-size businesses, professionals and individuals located
primarily in the counties of Orange, San Diego and Sacramento. The general
economy in these market areas, and particularly the real estate market, is
slowly recovering from the results of a prolonged recession that has adversely
affected the ability of certain borrowers of the Bank to perform their
obligations to the Bank. The residential mortgage origination activity is
centered in the five western states of the country which have been experience
strong population growth and stable economic growth. Originations of small
equipment leases are done throughout the country with a concentration in
Northern California, which provides geographic diversity.
The assessment of recent economic reports and the current economic
environment in the Company's market areas are encouraging. Local economists
have stated they believe the Southern California economy has stopped its
decline and feel we have experienced a modest recovery during 1996 with the
outlook for the first part of 1997 being positive.
The financial condition of the Banks has been, and is expected to continue
to be, affected by overall general economic conditions and the real estate
market in California. The future success of the Banks is dependent, in large
part, upon the quality of its assets. Although management of the Bank has
devoted substantial time and resources to the identification, collection and
workout of non-performing assets, the real estate markets and the overall
economy in California are likely to have a significant effect on the Bank's
assets in future periods and, accordingly, the Company's financial condition and
results of operations.
INFLATION
The majority of the Company's assets and liabilities are monetary items
held by the Banks, the dollar value of which is not affected by inflation. Only
a small portion of total assets is in premises and equipment. The lower
inflation rate of recent years did not have the positive impact on the Banks
that was felt in many other industries. The small fixed asset investment of
the Company minimizes any material misstatement of asset values and
depreciation expenses which may result from fluctuating market values due to
inflation. A higher inflation rate, however, may increase operating expenses
or have other adverse effects on borrowers of the Banks, making collection more
difficult for the Banks. Rates of interest paid or charged generally rise if
the marketplace believes inflation rates will increase.
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<PAGE>
ITEM 7. FINANCIAL STATEMENTS
Financial Statements Page No.
-------------------- --------
Report of Independent Accountants F1
Consolidated Statements of Condition December 31, 1996 and 1995 F2
Consolidated Statements of Operations - Years ended
December 31, 1996, 1995 and 1994 F4
Consolidated Statements of Shareholders' Equity - Years ended
December 31, 1996, 1995 and 1994 F5
Consolidated Statements of Cash Flows - Years ended
December 31, 1996, 1995 and 1994 F6
Notes to Consolidated Financial Statements -
December 31, 1996, 1995 and 1994 F8
63
<PAGE>
ITEM 8. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
64
<PAGE>
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF ISSUER
The following table provides certain information with respect to the directors
and executive officers of the Company as of March 31, 1997.
Name Age Position
- ---- --- --------
Edward A. Fox 60 Director
Charles E. Hugel 68 Director
Robert P. Keller 58 Director, President and
Chief Executive Officer
K. Thomas Kemp 55 Director
Jefferson W. Kirby 34 Director
Peter H. Paulsen 62 Director
Curt A. Christianssen 36 Senior Vice President,
Treasurer and Chief Financial
Officer
EDWARD A. FOX served as Dean of the Amos Tuck School of Business at
Dartmouth College in Hanover, New Hampshire from 1990 until his retirement in
September 1994. Prior to 1990, Mr. Fox was founding President and Chief
Executive Officer of the Student Loan Marketing Association (Sallie Mae) in
Washington, D.C. Mr. Fox currently serves as a director of College Construction
Loan Insurance Corp. (Connie Lee), Delphi Financial Corp., Greenwich Capital
Management Corp., New England Mutual Life Insurance Company and Choate Rosemary
Hall. Mr. Fox has agreed to serve as the non-executive Chairman of the Company
following the Closing, if so elected by the Company's Board of Directors.
CHARLES E. HUGEL served as Chairman and Chief Executive Officer of
Combustion Engineering, Inc. in Stamford, Connecticut from 1982 to 1990.
Prior to joining Combustion Engineering, Inc., he spent 30 years with AT&T,
most recently as an Executive Vice President. Mr. Hugel also served as a
director of Nabisco, Inc. and its corporate successor, RJR/Nabisco, Inc.,
from 1978 to 1986. Mr. Hugel presently serves on the boards of directors of
Eaton Corp. and Pitney-Bowes, Inc.
ROBERT P. KELLER is the President and Chief Executive Officer of the
Company and of the General Partner of the Dartmouth Partnership. From 1994 to
1995, Mr. Keller was President and Chief Executive Officer of Independent
Bancorp of Arizona, Inc., a Nasdaq-listed bank holding company with assets of
$1.8 billion, which was acquired by Norwest Corporation in February 1995. From
October 1991 to June 1994, Mr. Keller served as President and Chief Executive
Officer of New Dartmouth Bank, a privately owned financial institution with
assets of $1.7
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<PAGE>
billion, located in Manchester, New Hampshire, which was acquired by Shawmut
National Corporation in 1994. From 1989 to 1991, he served as Chief
Operating Officer of Dartmouth Bancorp, Inc., also located in Manchester, New
Hampshire. During 1988 and 1989, Mr. Keller served as Executive Vice
President and Chief Operating Officer of American Federal Bank in Dallas,
Texas, which was created through the merger of 12 independent thrifts under
the Southwest Plan. Prior to 1988, he served for 13 years as an officer of
Indian Head Banks Inc. of New Hampshire (acquired by the Fleet/Norstar Group
Inc. in 1988), most recently as Executive Vice President and Chief
Financial/Administrative Officer. Mr. Keller also serves on the boards of
directors of Centricut, LLC, Pennichuck Corporation, Source One Mortgage
Services Corporation and White Mountain Holdings, Inc.
K. THOMAS KEMP currently serves as Executive Vice President of Fund
American Enterprises Holdings, Inc. (formerly Fireman's Fund Corporation) and
President and Chief Executive Officer of White Mountain Holdings, Inc. Mr. Kemp
serves on the boards of directors of Fund American, White Mountain, Valley
Insurance Co., Financial Security Assurance, LTD., Main Street America Holdings
and Centricut, LLC.
JEFFERSON W. KIRBY has been employed since 1992 by Alleghany Corporation
and was appointed Vice President in 1994. From 1987 to 1990, he was an
employee of Bankers Trust Corporation, and from 1990 to 1992, he was an
employee of BT Securities Corp., both affiliates of Bankers Trust New York
Corporation. Mr. Kirby is also a director of Connecticut Surety Corporation,
The Covenant Group, Inc. and F.M. Kirby Foundation, Inc., a charitable
organization.
PETER H. PAULSEN was the founder and majority shareholder of CSB and
served as its Chairman of the Board since its inception in 1984 until the CSB
Acquisition. Mr. Paulsen has been active in real estate development, first
as a construction foreman and mason contractor, then as a builder of homes
and apartment buildings. Mr. Paulsen was also a founding director of
California Business Bank in San Jose, California.
CURT A. CHRISTIANSSEN currently is the Senior Vice President, Treasurer and
Chief Financial Officer of the Company and each of its operating banks, and
Chief Financial Officer of the General Partner of the Dartmouth Partnership.
Prior to the Liberty Acquisition in March 1996, Mr. Christianssen served as
Chief Financial Officer of Liberty from October 1993. From October 1991 to
April 1993, Mr. Christianssen served as an Executive Vice President and Chief
Financial/Administrative Officer of Olympic National Bank. Previously Mr.
Christianssen was employed by the Resolution Trust Company as a Vice President
responsible for general accounting and data processing for Gibraltar Savings and
Loan Association, a $15 billion institution, and as the Chief Financial Officer
for the receiver for Unity Savings and Loan Association.
Each of the current directors of the Company, other than Mr. Paulsen, also
serves as a director of the General Partner of the Dartmouth Partnership. There
are no family relationships
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<PAGE>
between any of the Company's directors or executive officers.
AUDIT COMMITTEE. The current members of the Company's Audit Committee are
Jefferson W. Kirby (Chairman), Edward A. Fox and K. Thomas Kemp. The Audit
Committee functions include reviewing the financial statements of the Company
and its subsidiaries and the scope of the annual audit by the Company's
independent certified public accountants, and appointing the independent
certified public accountant on an annual basis. The Committee also monitors the
Company's internal financial and accounting controls.
COMPENSATION COMMITTEE. The current members of the Company's Compensation
Committee are K. Thomas Kemp (Chairman), Edward A. Fox and Charles E. Hugel.
The Compensation Committee reviews and makes recommendations to the Board of
Directors on matters concerning the salaries and other employee benefits for the
Company's officers.
DIRECTOR COMPENSATION
Since the 1995 Recapitalization, the directors of the Company (and SDN
prior to the CSB Acquisition) have not received any compensation for serving on
the Board of Directors or any committee or attending meetings thereof. The
Board of Directors may choose to institute director compensation after the
Eldorado acquisition. All directors receive reimbursement of reasonable
expenses incurred in attending Board and committee meetings and otherwise
carrying out their duties.
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<PAGE>
ITEM 10. EXECUTIVE COMPENSATION
EXECUTIVE COMPENSATION SUMMARY
Mr. Keller is the only current executive officer of the Company who
received compensation in excess of $100,000 from the Company during the fiscal
year ended December 31, 1996. Mr. Keller commenced his employment as SDN's
Chief Executive Officer on October 1, 1995. The table set forth below contains
a summary of the annual and other compensation paid to Mr. Keller during 1996
and the quarter ended December 31, 1995. As of the date of this report, Mr.
Keller's annual base salary is $250,000.
<TABLE>
<CAPTION>
ANNUAL LONG TERM COMPENSATION
COMPENSATION AWARDS
--------------------------------------- -----------------------
RESTRICTED SECURITIES
NAME AND BASE OTHER ANNUAL STOCK UNDERLYING ALL OTHER
PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION AWARDS OPTIONS COMPENSATION
- ------------------ ---- ------ ----- ------------ -------- ---------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Robert P. Keller 1996 $185,240 -- -- 51,592 (1) $1,316
President and Chief 1995 $ 37,500(2) -- -- -- -- $3,918(3)
Executive Officer
</TABLE>
- ---------------
(1) Mr. Keller's employment agreement entitles him to receive an award of stock
options equal to 50% of the shares reserved under the stock option pool.
See "-- Keller Employment Agreement -- Stock Option Awards" below. Giving
effect to the completion of the Eldorado acquisition referenced elsewhere
in this report (see "ITEM 5. MARKET FOR ISSUER'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS"), Mr. Keller would be entitled to receive an option
covering approximately 746,000 shares of Common Stock.
(2) Period from October 1, 1995 to December 31, 1995.
(3) Includes reimbursement for moving expenses.
KELLER EMPLOYMENT AGREEMENT
CAPACITY AND TERM. In July 1996, the Company entered into an employment
agreement with Mr. Keller that was effective retroactive as of October 1, 1995.
The Company has agreed to employ Mr. Keller as the Company's senior most
executive officer, to nominate Mr. Keller to serve as a director of the Company,
and to cause Mr. Keller to be elected as a director of each of the Company's
subsidiaries that is a depository institution or otherwise a "significant
subsidiary," as defined under SEC regulations. Mr. Keller's employment
agreement has a three-year term, ending on September 30, 1998, and will be
renewed automatically for successive one-year periods unless either the Company
or Mr. Keller gives the other notice at least one year prior to the end of the
term or any extension thereof. Upon consummation of the Company Merger, Holdco
will assume the Company's obligations under Mr. Keller's employment agreement.
BASE SALARY. Mr. Keller's base salary under the employment agreement will
depend upon the
68
<PAGE>
Company's consolidated assets. Mr. Keller's base salary currently is
$250,000. If the Company's consolidated assets increase to more than $800
million (but not greater than $1.2 billion), Mr. Keller's base salary will
be $300,000. If the Company's consolidated assets exceed $1.2 billion, Mr.
Keller's base salary will be $350,000.
For purposes of Mr. Keller's employment agreement, the Company's
consolidated assets are calculated as of the end of each of the Company's
fiscal quarters and are equal to the Company's average consolidated assets
for the 6-month period then ended calculated on a daily basis in accordance
with generally accepted accounting principles ("Average Consolidated
Assets"), except that if the Company's consolidated assets as of the end of
a fiscal quarter vary by more than 20 percent from the Average Consolidated
Assets for the two consecutive quarters ended as of that date, the Company's
consolidated assets as of that date are used for purposes of determining any
adjustment to Mr. Keller's salary. If, subsequent to an increase in Mr.
Keller's base salary, the Company's Average Consolidated Assets as of the end
of any fiscal quarter are less than the most recently applied asset threshold
for determining Mr. Keller's salary, Mr. Keller's base salary will be
decreased, effective as of the beginning of the quarter next following the
measurement date, in accordance with the salary schedule described above. If
the Company's Average Consolidated Assets exceed $1.8 billion, Mr. Keller may
request that the Compensation Committee of the Company's Board of Directors
(the "Committee") consider and make a recommendation to the Company's Board
of Directors whether it is appropriate to increase his annual salary. Mr.
Keller's base salary, as so determined, is hereinafter referred to as his
"Base Salary."
RESTRICTED STOCK AWARDS. Mr. Keller's employment agreement generally
obligates the Company to issue shares of restricted Common Stock (the
"Restricted Stock") to Mr. Keller whenever, during the term of the agreement,
the Company issues Common Stock or a Common Stock Equivalent (as defined in the
employment agreement), including shares of Common Stock issued in the CSB
Acquisition. Mr. Keller will not be entitled to receive any Restricted Stock as
a consequence of the sale of Common Stock or a Common Stock Equivalent to the
Dartmouth Partnership or director qualifying shares to any director of a
subsidiary of the Company or the award of employee stock options or the issuance
of Common Stock upon the exercise thereof.
The number of shares of Restricted Stock that will be issued to Mr. Keller
will be equal to 3.0 percent of the sum of (x) the number of shares of Common
Stock then issued by the Company or, in the case of the issuance of a Common
Stock Equivalent, the number of shares of Common Stock which such Common Stock
Equivalent may be converted into or exchanged for, and (y) the number of shares
of Restricted Stock to be issued to Mr. Keller at that time. Subject only to
restrictions on transferability and forfeiture conditions described below,
Mr. Keller will have all the rights of a shareholder with respect to the
Restricted Stock, including, without limitation, the right to vote the
Restricted Stock and to receive any dividend or other distribution with respect
thereto. Prior to the end of Restricted Period (as defined in Mr. Keller's
employment agreement), Mr. Keller may not sell, assign, transfer, pledge,
hypothecate or otherwise encumber or transfer the Restricted Stock, except as
permitted by the Committee. If Mr. Keller's employment under the employment
agreement is terminated for cause (as defined in the employment agreement) prior
to the end of the Restricted
69
<PAGE>
Period, or if Mr. Keller resigns from the Company during the Restricted
Period without the consent of the Board of Directors of the Company, any
Restricted Stock then outstanding will be forfeited to the Company without
any payment to Mr. Keller.
In general, the "Restricted Period" will expire upon the earliest to
occur of the following events: (a) a Change in Control (as defined in Mr.
Keller's employment agreement) of the Company; (b) Mr. Keller's retirement
from the Company after attaining age 62; (c) the effective date of Mr.
Keller's resignation from the Company with the consent of the Board of
Directors; (d) the effective date of the expiration of Mr. Keller's
employment agreement pursuant to notice of non-renewal given by the Company;
(e) the effective date of Mr. Keller's termination of his employment
agreement for cause (as defined in the agreement); (f) the effective date of
the termination of Mr. Keller's employment by the Company due to a
"disability" (as defined in the employment agreement); or (g) Mr. Keller's
death. In the case of Restricted Stock that is issued to Mr. Keller as a
consequence of the Company's issuance of a Common Stock Equivalent, the
Restricted Period will terminate on the later of (x) the date on which such
Common Stock Equivalent first becomes convertible into or exchangeable for
shares of Common Stock and (y) the earliest to occur of the events specified
in the immediately preceding sentence. If any Common Stock Equivalent is
redeemed in whole or in part by the Company prior to the date such Common
Stock Equivalent is convertible into or exchangeable for shares of Common
Stock, upon such redemption there shall be forfeited to the Company, without
any payment to Mr. Keller, a pro rata portion of the shares of Restricted
Stock issued as a consequence of the Company's sale of such Common Stock
Equivalent.
STOCK OPTION AWARDS. Mr. Keller's employment agreement obligates the
Company's Board of Directors to adopt a stock option plan (the "Option Plan")
pursuant to which the Board of Directors or the Committee may grant stock
options to Mr. Keller and other officers of the Company or any of its
subsidiaries. Mr. Keller's employment agreement specifies that the number of
shares of Common Stock reserved for issuance under the Option Plan (the "Option
Pool") will not be less than 6.0% of the sum of (x) the number of shares of
Common Stock that the Board of Directors estimates in good faith will be
outstanding on December 31, 1996, taking into account any proposed issuance of
securities then pending, and (y) the shares reserved for issuance under the
Option Plan.
Mr. Keller's employment agreement provides that promptly following the
adoption of the Option Plan, the Company will grant to Mr. Keller an option
exercisable for a number of shares of Common Stock equal to 50.0% of the shares
in the Option Pool, and that if the Company thereafter increases the number of
shares in the Option Pool, the Company will promptly grant to Mr. Keller an
option exercisable for a number of shares of Common Stock equal to 50.0% of the
amount by which the Company increases the Option Pool. Mr. Keller's employment
agreement also specifies that the exercise price, vesting schedule and other
terms of any stock option granted to him under the Option Plan will be
substantially similar to the terms of any other contemporaneously granted stock
option under the Option Plan, except that any stock option granted to Mr. Keller
will (a) not have an exercise price less than the fair market value of the
Common Stock at the time of grant; (b) to the extent the stock option has an
escalating exercise price or a fixed exercise price with a premium over
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<PAGE>
the then fair market value of the Common Stock, reflect an annual percentage
increase of not greater than the then current yield to maturity of the most
recently auctioned 5-year U.S. Treasury Notes; (c) vest over a period of not
more than four years from the date of grant; (d) provide that if Mr. Keller's
employment is terminated by the Company other than for cause (as defined Mr.
Keller's employment agreement), the stock option will continue to be
exercisable until such date as it would have expired if Mr. Keller had
continued to be employed by the Company; and (e) provide that upon a Change
in Control of the Company (as defined in Mr. Keller's employment agreement),
any stock option then outstanding will become fully exercisable.
SUPPLEMENTAL RETIREMENT PROGRAM. Mr. Keller's employment agreement
obligates the Company to provide supplemental retirement benefits through a
non-qualified, unfunded arrangement equal up to 35% of Mr. Keller's Average
Base Salary after seven years of service. The supplemental retirement
benefit accrues and vests annual at the rate of 5% per year. The
supplemental retirement benefit will be paid monthly for ten years commencing
upon (a) the later of Mr. Keller's retirement date or age 65 or (b) Mr.
Keller's death. Any retirement benefits remaining unpaid at Mr. Keller's
death will be paid to his designated beneficiary.
BENEFITS UPON TERMINATION. Mr. Keller's employment agreement provides
that if his employment is terminated by the Company without cause or by him
due to a material change in the nature or scope of his responsibilities or
duties, or a material breach by the Company of the employment agreement, the
Company generally will be obligated to pay Mr. Keller his Base Salary for the
remainder of the term of his employment agreement or 18 months, whichever is
greater. During such period, the Company also would be obligated to continue
certain employee benefits, such as life, health, accident and disability
insurance coverage, which Mr. Keller was receiving immediately preceding his
termination. In addition, upon the events described above, Mr. Keller's
supplemental retirement benefits would become fully vested, and upon his
attainment of age 65, the Company would be obligated to pay him an amount
sufficient to assure that he receives the amount to which he would have been
entitled under the Supplemental Retirement Program had he been employed by
the Company for three years, and all options granted to Mr. Keller to
purchase Common Stock will become fully vested and exercisable.
If Mr. Keller's employment is terminated by the Company because Mr.
Keller becomes disabled (as defined in the employment agreement), Mr. Keller
will be entitled to receive not less than 50.0% of his then Base Salary until
age 65. In addition, all of his options to purchase the Company Common Stock
will immediately become fully vested and exercisable.
If Mr. Keller's employment agreement expires following a notice of
non-renewal given by the Company, Mr. Keller would be entitled to the
continuance for a period of six months of his Base Salary and the employee
benefits which Mr. Keller was receiving immediately prior to such
termination.
Payments to which Mr. Keller would be entitled upon termination will be
reduced by amounts earned by Mr. Keller for services provided to another
party after such termination.
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<PAGE>
Mr. Keller would have no duty, however, to mitigate such payments by seeking
to provide services to another party. Mr. Keller's employment agreement also
provides that under certain circumstances involving a Change in Control, the
amount of benefits provided under his employment agreement would be reduced
if, after applying the excise tax provisions to the payments under the
Internal Revenue Code of 1986, as amended, the net economic benefit to Mr.
Keller would be increased by effecting such a reduction.
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<PAGE>
STOCK OPTION PLAN
Mr. Keller's employment agreement obligates the Company to adopt by the
Option Plan by October 1, 1996 pursuant to which the Company Board of
Directors or the Committee may grant stock options to Mr. Keller and other
officers of the Company or any of its subsidiaries. Mr. Keller's employment
agreement specifies that the number of shares of Common Stock available in
the Option Pool will not be less than 6.0% of the sum of (x) the number of
shares of Common Stock that the Board of Directors estimates in good faith
will be outstanding on December 31, 1996, taking into account any proposed
issuance of securities then pending, and (y) the shares reserved for issuance
under the Option Plan. Mr. Keller's employment agreement also provides that
promptly following the adoption of the Option Plan, the Company will grant to
Mr. Keller an option exercisable for a number of shares of Common Stock equal
to 50.0% of the shares in the Option Pool, and that if the Company thereafter
increases the number of shares in the Option Pool, the Company will promptly
grant to Mr. Keller an option exercisable for a number of shares of Common
Stock equal to 50.0 % of the amount by which the Company increases the Option
Pool. As of the date of this report, the exercise price, vesting schedule
and other terms of stock options to be granted under the Option Plan have not
been finally determined. Giving effect to the completion of the Eldorado
acquisition referenced elsewhere in this report (see "ITEM 5. MARKET FOR
ISSUER'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS"), Mr. Keller would be
entitled to receive an option covering approximately 746,000 shares of Common
Stock. See "-- Keller Employment Agreement -- Stock Option Awards" above.
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<PAGE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
GENERAL. The following table sets forth, in accordance with the Securities
and Exchange Commission's beneficial ownership rules, certain information about
the only persons known by SDN to be the beneficial owners of more than 5% of the
outstanding shares of SDN Common Stock as of December 31, 1996. This
information has been furnished by the persons listed in the table. Unless
otherwise indicated, each of the beneficial owners has sole voting and
investment power with respect to its or his shares.
Name and Address Number of Shares Percent
of Beneficial Owners Beneficially Owned of Class
-------------------- ------------------ --------
Dartmouth Capital Group, L.P. 4,642,920 47.9%
Dartmouth Capital Group, Inc.(1)
7777 Center Avenue
Huntington Beach, CA 92647
Peter H. Paulsen 1,377,101 14.2%
2746 E. Smith Road
Bellingham, WA 98226
Ernest J. Boch(2) 1,159,000 12.0%
Subaru of New England, Inc.
95 Morse Street
Norwood, MA 02062
Shareholders of General Partner 3,307,592 34.1%
as a Group(3)(4)
(11 shareholders)
- ---------------
(1) As the sole general partner of the Dartmouth Partnership, the Dartmouth
General Partner exercises sole control over the voting and disposition of the
shares of Common Stock held of record by the Dartmouth Partnership.
(2) Excludes shares beneficially owned by the Dartmouth General Partner.
Each of Messrs. Boch, Fox and Kirby is a principal shareholder and director
of the Dartmouth General Partner and, pursuant to the terms of a shareholder
agreement among such shareholders (the "DCG Shareholder Agreement") each has
a right to designate a director of the Dartmouth General Partner. Messrs.
Boch, Fox and Kirby disclaim beneficial ownership of shares of Common Stock
beneficially owned by the Dartmouth General Partner.
(3) Includes, in one case, shares held by an affiliate of the shareholder.
(4) In the case of Robert P. Keller, a shareholder of the Dartmouth General
Partner, includes 51,592 shares of Restricted Stock issued to Mr. Keller
pursuant to the terms of his employment agreement, but excludes shares that
will be subject to an option that the Company has agreed to grant to Mr.
Keller promptly following the adoption of the Option Plan. (See "EXECUTIVE
COMPENSATION -- Keller Employment Agreement -- Restricted Stock Awards" and
"--Stock Option Plan" herein.)
74
<PAGE>
DARTMOUTH CAPITAL GROUP. Dartmouth Capital Group and the Dartmouth General
Partner were organized in May 1995 to identify, evaluate and, if and when
appropriate, acquire controlling or substantial equity positions in, or certain
assets and liabilities of, one or more financial institutions located
principally in California. Both are registered bank holding companies under the
BHCA. As of the date of this report Dartmouth Capital Group's sole investment
and principal asset is a controlling equity investment in the Company which it
acquired in the 1995 Recapitalization. In connection with SDN's March, 1996
acquisition of Liberty, Dartmouth Capital Group invested an additional $13.4
million in SDN Common Stock and in connection with the CSB Acquisition and 1996
Reorganization invested an additional $15.1 million in common stock of the
company. (See "BUSINESS -- Acquisitions" herein.) The Dartmouth Partnership
has loaned $4.3 million to fund a substantial portion of the deposit that the
Company was required to make prior to entering into the Eldorado Agreement. The
terms of such arrangement. The principal and interest due on such loans will be
converted to shares of Class B common stock upon the consummation of the
Eldorado acquisition at a price of $4.40 per share. The Dartmouth Partnership
also has agreed to purchase up to $6.8 million of Senior Securities (as defined
elsewhere in this report). See "ITEM 5. MARKET FOR ISSUER'S COMMON STOCK AND
RELATED STOCKHOLDER MATTERS."
The Dartmouth General Partner has complete control of the management and
conduct of the Dartmouth Capital Group, including all actions pertaining to its
investment in the Company. Ultimate control over Dartmouth Capital Group rests
with the shareholders of the Dartmouth General Partner. The DCG Shareholder
Agreement provides that each shareholder (or, in the case of two affiliated
shareholders, the affiliates as a group) has a right to designate a director of
the Dartmouth General Partner. Rights to designate directors may from time to
time also be granted to third parties, including limited partners of Dartmouth
Capital Group who are not shareholders of the Dartmouth General Partner. As of
the date of this Annual Report, there are 11 shareholders of the Dartmouth
General Partner, each of whom is a limited partner (or an affiliate of a limited
partner) of Dartmouth Capital Group. As of the date of this report, the
Dartmouth General Partner has eight directors.
76
<PAGE>
SECURITY OWNERSHIP OF MANAGEMENT
The following table sets forth certain information as of December 31, 1996,
with respect to each executive officer and director of the Company, and all
officers and directors as a group. This information has been furnished by the
persons listed in the table
Name and Title Number of Shares Percent
of Beneficial Owners Beneficially Owned of Class
-------------------- ------------------ --------
Robert P. Keller (1) (2) 74,592 *%
Director, President and
Chief Executive Officer
Peter H. Paulsen 1,377,101 14.2%
Director
Edward A. Fox (1) 387,000 4.0%
Director
Jefferson W. Kirby (1) 386,000 4.0%
Director
Charles E. Hugel (1) 301,000 3.1%
Director
K. Thomas Kemp (1) 29,000 *%
Director
Curt A. Christianssen 1,000 *%
Senior Vice President and
Chief Financial Officer
All Directors and Officers 2,555,693 26.4%
as a Group (1) (2) (3)
- ----------------
* Less than 1%.
(1) Excludes shares beneficially owned by the Dartmouth General Partner. Each
of Messrs. Keller, Fox, Hugel, Kemp and Kirby is a principal shareholder and
director of the Dartmouth General Partner and, pursuant to the terms of the DCG
Shareholder Agreement each has a right to designate a director of the Dartmouth
General Partner. Messrs. Keller, Fox, Hugel, Kemp and Kirby disclaim beneficial
ownership of shares of Common Stock beneficially owned by the Dartmouth General
Partner.
(2) Includes 51,592 shares of Restricted Stock issued to Mr. Keller pursuant to
the terms of his employment agreement. (See "EXECUTIVE COMPENSATION -- Keller
Employment Agreement -- Restricted Stock Awards" herein.)
(3) Excludes shares of Common Stock that will be reserved for issuance to the
Company's executive officers in connection with the Option Plan. (See
"EXECUTIVE COMPENSATION -- Stock Option Plan" herein.)
77
<PAGE>
ITEM 12. CERTAIN TRANSACTIONS AND RELATED TRANSACTIONS
CERTAIN TRANSACTIONS
Except as described in this Section, there are no existing or proposed
material transactions between the Company or the Banks and any of the Company's
executive officers, directors, or beneficial owners of 5% or more of the common
stock, or the immediate family or associates of any of the foregoing persons.
In December 1996, the Dartmouth Partnership and Peter H. Paulsen, a
director of the Company, loaned $4.3 million and $200,000, respectively, to fund
the deposit that the Company was required to make prior to entering into the
Eldorado Agreement. The principal and interest due on such loans will be
converted to shares of Class B common stock upon the consummation of the
Eldorado acquisition at a price of $4.40 per share.
Also in December 1996, certain directors of the Company and other Direct
Holders agreed to purchase up to approximately $15.2 million of Class B common
Stock at a price of $4.81 per share to fund a portion of the Eldorado
acquisition.
The Dartmouth Partnership also has agreed to purchase up to $6.8 million of
Senior Securities (as defined elsewhere in this report) under certain
circumstances. See "ITEM 5. MARKET FOR ISSUER'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS."
Some of the directors and executive officers of the Company's bank
subsidiaries (collectively, the "Banks") and their immediate families, as well
as the companies with which such directors and executive officers are
associated, are customers of, and have had banking transactions with the Banks
in the ordinary course of the Banks' business and the Banks expect to have such
ordinary banking transactions with such persons in the future. In the opinion
of management of the Company and the Banks, 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. Although the Banks do not have any
limits on the aggregate amount it would be willing to lend to directors and
officers as a group, loans to individual directors and officers must comply with
the Banks' lending policies and statutory lending limits. Total loans to
executive officers and directors at December 31, 1996 were $2.0 million.
78
<PAGE>
ITEM 13. EXHIBITS AND REPORTS ON 8-K
(a) Exhibit Index
2.1 Agreement and Plan of Merger dated December 24, 1996 between
Commerce Security Bancorp, Inc. (the "Company") and Eldorado
Bancorp ("Eldorado") (filed as Exhibit 2.1 to the Company's
Current Report on Form 8-K dated December 24, 1996 and
incorporated by reference herein)
2.2 Stock Option Agreement dated December 24, 1996 between the
Company and Eldorado (filed as Exhibit 2.2 to the Company's
Current Report on Form 8-K dated December 24, 1996 and
incorporated by reference herein)
3.1 Certificate of Incorporation of (filed as Exhibit 10.3 to the
Company's Quarterly Report on Form 10-QSB for the quarter
ended September 30, 1996 and incorporated by reference
herein)
3.2 Bylaws of the Company, (filed as Exhibit 10.2 to the
Company's Quarterly Report on Form 10-QSB for the quarter
ended September 30, 1996 and incorporated by reference
herein)
4.1 Indenture with respect to Mandatory Convertible Debentures of
SDN Bancorp, Inc. ("SDN") due 1998 (filed as Exhibit 4 to
SDN's Registration Statement on Form S-1, File No. 33-4045
filed March 17, 1986 and incorporated by reference herein)
10.1 Form of Loan/Subscription Agreement dated December 1996
between the Company and Dartmouth Capital Group, L.P. (the
"Dartmouth Partnership") and Peter H. Paulsen
10.2 Form of Common Stock Subscription Agreement dated December
21, 1996 ("1996 Subscription Agreement") between the Company
and the various subscribers thereto, including certain
directors of the Company
10.3 Form of Amendment to 1996 Subscription Agreement
10.4 Form of Commitment Letter dated March 21, 1997 between the
Dartmouth Partnership and the Company
10.5 Lease for 135 Saxony Road, Encinitas, California (filed as
Exhibit 10.4 to SDN's Registration Statement on Form S-14,
File No. 2-76555 filed March 18, 1982 and incorporated by
reference herein)
79
<PAGE>
10.6 Lease for 6354 Corte del Abeto, Carlsbad, California (filed
as Exhibit 10.6 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1984 and incorporated by
reference herein).
10.7 Lease Agreement between Sheryl L. Bullock as Trustee, as
Landlord, and San Dieguito National Bank, as tenant, dated
July 27, 1990 (filed as Exhibit 10.1 to SDN's Form 10-Q for
the quarter ended June 30, 1990 and incorporated by reference
herein)
10.8 Lease Agreement for 7777 Center Avenue, Huntington Beach,
California between Alvamij Huntington Beach, Inc. as
Landlord, and Liberty National Bank, as Tenant, dated August
20, 1981 and amended February 14, 1986 (filed as Exhibit 10.3
to SDN's report on Form 10-Q for the quarter ended March 31,
1996)
10.9 Lease Agreement for 17011 Beach Boulevard, Huntington Beach,
California between Liu Corp., as Landlord, and Liberty
National Bank, as Tenant, dated December 15, 1995 (filed as
Exhibit 10.4 to SDN's report on Form 10-Q for the quarter
ended March 31, 1996)
10.10 Employment Agreement between Liberty National Bank and Philip
S. Inglee dated July 20, 1995 (filed as Exhibit 10.5 to
SDN's report on Form 10-Q for the quarter ended March 31,
1996)
10.11 Employment Agreement between Liberty National Bank and
Catherine C. Clampitt dated April 1, 1995 (filed as Exhibit
10.8 to SDN's report on Form 10-Q for the quarter ended March
31, 1996)
10.12 Employment Agreement dated October 1, 1995 between Robert P.
Keller and the Company* (filed as Exhibit 10.1 to the
Company's Form 10-Q for the quarter ended September 30, 1996
and incorporated by reference herein)
20. Terms of Primary Stock Right dated September 28, 1995 (filed
as Exhibit 20.1 to SDN's Annual Report on Form 10-KSB for the
year ended December 31, 1995 and incorporated by reference
herein)
21. Subsidiaries of the Registrant (filed as Exhibit 22 to SDN's
Registration Statement on Form S-1, File No. 33-4045 filed
March 17, 1986 and incorporated by reference herein)
- --------------
* Denotes Executive Compensation Plan or Arrangement
(b) Reports on Form 8-K.
80
<PAGE>
1) Definitive Agreement signed to acquire Eldorado Bancorp, dated
December 24, 1996
81
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the issuer has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
COMMERCE SECURITY BANCORP, INC.
By Robert P. Keller /s/
- ----------------------------------------
Robert P. Keller
President, Chief Executive Officer
Date: April 14, 1997
By Curt A. Christianssen /s/
- ---------------------------------------
Curt A. Christianssen
Senior Vice President
Chief Financial Officer
Date: April 14, 1997
82
<PAGE>
SIGNATURES (Continued)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the issuer
and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
Robert P. Keller /s/ Director, President April 14, 1997
- ------------------------- and Chief Executive
Robert P. Keller Officer
K. Thomas Kemp /s/ Director April 14, 1997
- -------------------------
K. Thomas Kemp
Edward A. Fox /s/ Director April 14, 1997
- -------------------------
Edward A. Fox
Charles E. Hugel /s/ Director April 14, 1997
- -------------------------
Charles E. Hugel
Jefferson W. Kirby /s/ Director April 14, 1997
- -------------------------
Jefferson W. Kirby
Supplemental Information to be Furnished with Reports Filed Pursuant to Section
15(d) of the Act by Issuers Which Have Not Registered Securities Pursuant to
Section 12 of the Act.
None
83
<PAGE>
EXHIBIT INDEX
Number Description Page
------ ----------- ----
10.1 Form of Loan/Subscription Agreement dated December 1996
between the Company and Dartmouth Capital Group, L.P. (the
"Dartmouth Partnership") and Peter H. Paulsen
10.2 Form of Common Stock Subscription Agreement dated December
21, 1996 ("1996 Subscription Agreement") between the Company
and the various subscribers thereto, including certain
directors of the Company
10.3 Form of Amendment to 1996 Subscription Agreement
10.4 Form of Commitment Letter dated March 21, 1997 between the
Dartmouth Partnership and the Company
84
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
---------------------------------
February 12, 1997
To the Board of Directors and Shareholders of
Commerce Security Bancorp, Inc.
In our opinion, the accompanying consolidated statement of condition and the
related consolidated statements of operations, of shareholders' equity and of
cash flows present fairly, in all material respects, the financial position of
Commerce Security Bancorp, Inc. and its subsidiaries at December 31, 1996 and
1995, and the results of their operations and their cash flows for the years
then ended in conformity with generally accepted accounting principles. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for the
opinion expressed above.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CONDITION
DECEMBER 31, 1996 AND 1995
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
December 31,
------------------
1996 1995
---- ----
<S> <C> <C>
Assets
- ------
Cash and due from banks $32,522,000 $ 3,640,000
Federal funds sold 13,700,000 2,300,000
Interest bearing deposits in other financial institutions 338,000 989,000
Held-to-maturity investment securities at amortized
cost, approximate fair value of $19,910,000 and
$7,057,000 at December 31, 1996 and 1995, respectively 20,025,000 7,009,000
Available-for-sale investment securities 15,175,000 -
Mortgage loans held for sale 10,837,000 -
Loans and leases, net 256,041,000 38,338,000
Loan and servicing sale receivable 54,080,000 -
Premises and equipment, net 3,911,000 597,000
Real estate acquired through foreclosure, net 3,635,000 1,411,000
Intangibles arising from acquisitions, net 10,736,000 -
Accrued interest receivable and other assets 16,060,000 1,621,000
------------ ----------
Total assets $437,060,000 $ 55,905,000
------------ ----------
------------ ----------
</TABLE>
See notes to consolidated financial statements.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CONDITION (Continued)
DECEMBER 31, 1996 AND 1995
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
December 31,
1996 1995
---- ----
<S> <C> <C>
Liabilities and Shareholders' Equity
- ------------------------------------
Deposits:
Demand:
Non-interest bearing $126,885,000 $ 13,445,000
Interest bearing 38,602,000 10,582,000
Savings:
Regular 42,190,000 4,714,000
Money market 25,662,000 8,558,000
Time:
Under $100,000 123,789,000 11,580,000
$100,000 or more 25,903,000 2,552,000
------------ ------------
Total deposits 383,031,000 51,431,000
Due to related parties 4,500,000 -
Accrued expenses and other liabilities 8,220,000 396,000
Mandatory convertible debentures 537,000 537,000
------------ ------------
Total liabilities 396,288,000 52,364,000
Commitments and contingencies (Note 16)
Shareholders' equity:
Preferred stock, $.01 par value, 1,000,000 shares
authorized; no shares issued and outstanding at
December 31, 1996 and 1995
Common stock, $.01 par value, 12,000,000
shares authorized; 9,697,430 issued and
outstanding at December 31, 1996 97,000 -
Common stock, $.01 par value, 5,000,000
shares authorized; 895,467 issued and
outstanding at December 31, 1995 - 9,000
Additional paid-in capital 42,394,000 7,593,000
Accumulated deficit (1,736,000) (4,061,000)
Unrealized gain on securities available-for-sale 17,000 -
------------ ------------
Total shareholders' equity 40,772,000 3,541,000
------------ ------------
Total liabilities and shareholders' equity $437,060,000 $55,905,000
----------- ------------
----------- ------------
</TABLE>
See notes to consolidated financial statements.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS FOR THE
YEARS ENDED DECEMBER 31, 1996, 1995, 1994
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For the Years Ended December 31,
----------------------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Interest and Fee Income:
Interest and fees on loans $ 14,782,000 $ 4,086,000 $ 4,044,000
Lease financing 1,601,000 - -
Interest on investment securities 1,968,000 311,000 247,000
Interest on Federal funds sold 934,000 117,000 56,000
Interest on deposits with financial institutions 67,000 54,000 43,000
----------- ---------- ---------
Total interest income 19,352,000 4,568,000 4,390,000
Interest Expenses:
Demand deposits 1,473,000 149,000 167,000
Savings deposits 856,000 346,000 451,000
Time deposits 5,241,000 1,075,000 727,000
Debentures and other borrowed funds 74,000 181,000 184,000
----------- ---------- ---------
Total interest expense 7,644,000 1,751,000 1,529,000
----------- ---------- ---------
Net interest income 11,708,000 2,817,000 2,861,000
Provision for loan and lease losses 515,000 295,000 583,000
----------- ---------- ---------
Net interest income after provision for loan and lease losses
11,193,000 2,522,000 2,278,000
Non-interest income:
Service charges 2,911,000 464,000 464,000
Other income 1,988,000 232,000 202,000
----------- ---------- ---------
Total non-interest income 4,899,000 696,000 666,000
Non-interest expense:
Salaries and employee benefits 6,816,000 1,811,000 1,905,000
Occupancy and equipment 2,726,000 346,000 335,000
Professional, regulatory and other services 733,000 861,000 877,000
Legal 453,000 113,000 124,000
Insurance 262,000 114,000 117,000
Losses and carrying cost of real estate acquired
through foreclosure 288,000 531,000 222,000
Other 3,992,000 515,000 353,000
----------- ---------- ---------
Total non-interest expense 15,270,000 4,291,000 3,933,000
----------- ---------- ---------
Income (loss) before taxes and extraordinary item 822,000 (1,073,000) (989,000)
Income tax benefit 1,503,000 443,000 -
----------- ---------- ---------
Income (loss) before extraordinary item 2,325,000 (630,000) (989,000)
Extraordinary item:
Gain on forgiveness of debt, net of income taxes of $443,000 - 625,000 -
----------- ---------- ---------
Net income (loss) $2,325,000 $ (5,000) $ (989,000)
----------- ---------- ---------
----------- ---------- ---------
Net income (loss) per common share:
Income (loss) before extraordinary item $ 0.44 $(2.35) $(18.41)
Extraordinary item - gain on forgiveness of debt, net of income taxes - 2.33 -
Net income (loss) $0.44 $(0.02) $(18.41)
</TABLE>
See notes to consolidated financial statements.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OF SHAREHOLDERS' EQUITY
DECEMBER 31, 1996 AND 1995
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Unrealized
Gain on
Additional Securities
Number of Common Paid-in Accumulated Available
Shares Stock Capital Deficit for Sale Total
------ ----- ------ ------- -------- -----
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1993 564,145 $2,951,000 $ - $(2,910,000) - $41,000
Net loss - - - (989,000) - (989,000)
---------- ----------- ---------- ----------- ---------- ----------
Balance at December 31, 1994 564,145 2,951,000 - (3,899,000) - (948,000)
Merger and reverse stock split
(1 for 21) (537,281) (2,951,000) 2,951,000 - - -
Stock dividend 26,864 1,000 156,000 (157,000) - -
Issuance of common stock 841,739 8,000 4,486,000 - - 4,494,000
Net loss - - - (5,000) - (5,000)
---------- ----------- ---------- ----------- ---------- ----------
Balance at December 31, 1995 895,467 9,000 7,593,000 (4,061,000) - 3,541,000
Fractional share adjustment 34
Issuance of common stock - Liberty 3,432,105 34,000 13,373,000 - - 13,407,000
Issuance of common stock - Commerce 5,369,824 54,000 21,428,000 - - 21,482,000
Unrealized gain on securities available for sale - - - - 17,000 17,000
Net income - - - 2,325,000 - 2,325,000
---------- ----------- ---------- ----------- ---------- ----------
Balance at December 31, 1996 9,697,430 $97,000 $42,394,000 $(1,736,000) $17,000 $40,772,000
---------- ----------- ---------- ----------- ---------- ----------
---------- ----------- ---------- ----------- ---------- ----------
</TABLE>
See notes to consolidated financial statements.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
Consolidated Statement of Cash Flows
For the Years Ended December 31, 1996, 1995 and 1994
- -----------------------------------------------------------------------------
<TABLE>
<CAPTION>
For the Years Ended December 31,
-----------------------------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Operating Activities:
Net income (loss) $ 2,325,000 $ (5,000) $ (989,000)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Provision for loan and lease losses and real estate
acquired through foreclosure 587,000 678,000 715,000
Gain on sale of real estate acquired through foreclosure (135,000) - -
Loss on sale of premises and equipment 85,000 - -
Depreciation and amortization 820,000 201,000 204,000
Accretion/amortization related to securities, net (252,000) - -
Mortgage loans originated for sale (242,339,000) - -
Proceeds from sales of loans and servicing 258,373,000 - -
Mortgage servicing rights purchased and originated (275,000) - -
Equity in loss of real estate joint venture 56,000 - -
Loss on sale of loans and servicing 2,119,000 - -
Increase in loan and servicing sale receivable (47,769,000) - -
Extraordinary item-gain on forgiveness of debt - (1,068,000) -
Other, net (8,312,000) 20,000 326,000
------------- ----------- ----------
Net cash (used in) provided by operating activities (34,717,000) (174,000) 256,000
Investing Activities:
Decrease in interest bearing deposits with other
financial institutions 1,241,000 89,000 191,000
Purchases of investment securities (32,445,000) (5,890,000) (3,110,000)
Proceeds from sales and maturities of investment securities 56,627,000 3,416,000 2,945,000
Net decrease (increase) in loans (29,022,000) 5,807,000 923,000
Purchases of premises and equipment (860,000) (19,000) (62,000)
Proceeds from sale of premises and equipment 56,000 - -
Proceeds from sale of real estate acquired through foreclosure 4,188,000 476,000 1,277,000
Capital expenditures for other real estate owned (2,256,000) - -
Purchase of Liberty National Bank, net of cash received 7,283,000 - -
Purchase of Commerce Security Bank, net of cash received 53,175,000 - -
----------- ----------- ----------
Net cash provided by investing activities 57,987,000 3,879,000 2,164,000
</TABLE>
See notes to consolidated financial statements.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
Consolidated Statement of Cash Flows
For the Years Ended December 31, 1996, 1995 and 1994
- -----------------------------------------------------------------------------
<TABLE>
<CAPTION>
For the Years Ended December 31,
------------------------------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Financing Activities:
Net decrease in deposits (22,377,000) (4,445,000) (3,775,000)
Repayment of notes payable to shareholder - (656,000) -
Proceeds from issuance of notes payable to related parties 4,500,000 - 14,000
Issuance of common stock 34,889,000 4,494,000 -
------------ ------------- -----------
Net cash provided by (used in) financing activities 17,012,000 (607,000) (3,761,000)
------------ ------------- -----------
Net increase (decrease) in cash and cash equivalents 40,282,000 3,098,000 (1,341,000)
Cash and cash equivalents at beginning of period 5,940,000 2,842,000 4,183,000
------------ ------------ -----------
Cash and cash equivalents at end of period $ 46,222,000 $ 5,940,000 $ 2,842,000
------------ ------------ -----------
------------ ------------ -----------
Supplemental disclosures:
Cash paid for interest on deposits 7,670,000 1,673,000 1,384,000
Loans transferred to foreclosed real estate 2,256,000 982,000 1,251,000
Loans originated to finance the sale of real estate - 371,000 377,000
Cash paid for income taxes - 2,000 2,000
</TABLE>
See notes to consolidated financial statements.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996 and 1995 Page 1
- -----------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
BASIS OF PRESENTATION
Commerce Security Bancorp, Inc. (CSB, Inc.) a Delaware corporation and bank
holding company, and its wholly-owned subsidiaries Commerce Security Bank
(CSB), SDN Bancorp (SDN), San Dieguito National Bank (SDNB) and Liberty
National Bank (LNB) are included in the accompanying consolidated financial
statements and are collectively referred to as the "Company" or the "Bank".
Significant intercompany transactions and accounts have been eliminated.
Certain prior year amounts have been reclassified to conform with the 1996
presentation.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets, liabilities and disclosures in the
financial statements. Actual results could differ from those estimates.
RISKS AND UNCERTAINTIES
In the normal course of its business, the Company encounters two significant
types of risk: economic and regulatory. Economic risk is comprised of three
components - interest rate risk, credit risk and market risk. The Company is
subject to interest rate risk to the degree that its interest-earning
liabilities mature and reprice at different speeds, or on a different basis,
than its interest-bearing assets. Credit risk is the risk of default on the
Company's loan portfolio that results from the borrower's inability or
unwillingness to make contractually required payments. Market risk results
from changes in the value of assets and liabilities which may impact, favorably
or unfavorably, the realizability of those assets and liabilities.
The Company is subject to the regulations of various governmental agencies.
These regulations can and do change significantly from period to period. The
Company is also subject to periodic examinations by the regulatory agencies,
which may subject it to changes in asset valuations, in amounts of required
loss allowances and in operating restrictions resulting from the regulators'
judgments based on information available to them at the time of their
examination.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1996 the Financial Accountings Standards Board issued Statement of
Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities" (FAS 125). This
statement provides consistent accounting and reporting standards for the
transfers and servicing of financial assets and the extinguistment of
liabilities. The Company will adopt FAS 125 effective January 1, 1997 and does
not expect the adoption to have a material impact on its financial statements.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996 and 1995 Page 2
- -----------------------------------------------------------------------------
NOTE 1: (Continued)
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash and due from banks and federal funds
sold. Generally, federal funds sold are sold for one-day periods.
INVESTMENT SECURITIES
The Company has classified its investment securities as held-to-maturity and
available-for-sale. No trading portfolio is maintained. Investment
securities classified as held-to-maturity are carried at cost, adjusted for the
amortization of premiums and the accretion of discounts. Premiums and
discounts are amortized and accreted to operations using the straight line
method, which management believes approximates the interest method. Management
has the intent and ability to hold these assets as long-term investments until
their expected maturities. Under certain circumstances, including the
significant deterioration of the issuer's credit worthiness or a significant
change in tax-exempt status or statutory or regulatory requirements, securities
classified as held-to-maturity may be sold or transferred to another
classification.
Investment securities classified as available-for-sale may be held for
indefinite periods of time and may be sold to implement the Bank's
asset/liability management strategies and in response to changes in interest
rates and/or prepayment risk and similar factors. These securities are
recorded at estimated fair value. Unrealized gains and losses are reported as
a separate component of shareholders' equity, net of income taxes.
Gains and losses on investment securities are generally determined on the
specific identification method and are included in other income.
LOANS AND LEASES
Loans are stated at principal amounts outstanding, net of unearned income,
including discounts and fees. Net deferred fees and costs are generally
amortized into interest income over the life of the related loans using a
method that approximates the level yield method.
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.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996 and 1995 Page 3
- -----------------------------------------------------------------------------
NOTE 1: (Continued)
ALLOWANCE FOR ESTIMATED LOAN AND LEASE LOSSES
A provision for estimated loan and lease losses is charged to expense when, in
the opinion of management, such losses are expected to be incurred or are
inherent in the portfolio. 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. Management's estimates are used
to determine the allowance that is considered adequate to absorb losses
inherent in the existing loan and lease portfolio. These estimates are
inherently uncertain and their accuracy depends on the outcome of future
events. Management's estimates are based on previous loan loss experience,
specific problem loans and leases, current economic conditions that may impact
the borrower's ability to pay, volume, growth and composition of the loan
portfolio, value of the collateral and other relevant factors.
NONPERFORMING AND PAST DUE LOANS
Included in the nonperforming loan category are loans which have been
categorized by management as nonaccrual because collection of interest is
doubtful, and loans which have been restructured to provide a reduction in the
interest rate or a deferral of interest or principal payments.
When payment of principal or interest on a loan is delinquent for 90 days, or
earlier in some cases, the loan is placed on nonaccrual status, unless the loan
is in the process of collection and the underlying collateral fully supports
the carrying value of the loan. When a loan is placed on nonaccrual status,
interest accrued during the period prior to the judgment of uncollectibility is
charged to operations. Generally, any payments received on nonaccrual loans
are applied first to outstanding loan amounts and next to the recovery of
charged-off loan amounts. Any excess is treated as recovery of lost interest.
Restructured loans are those loans on which concessions in terms have been
granted because of a borrower's financial difficulty. Interest is generally
accrued on such loans in accordance with the new terms.
MORTGAGE BANKING ACTIVITIES
The Company 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 Company has an arrangement with the Government National Mortgage
Association (GNMA) whereby loans originated by the Company are securitized by
GNMA and sold to others. Gains and losses on the sale of mortgage loans are
recognized upon delivery based on the difference between the selling price and
the carrying value of
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996 and 1995 Page 4
- -----------------------------------------------------------------------------
NOTE 1: (Continued)
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
Company sells the servicing for such loans to either the purchaser of the loans
or to a third party. The Company 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 the lower of cost or market as
determined by the outstanding commitments from investors or current investor
yield requirements calculated on an aggregate loan basis. Valuation
adjustments are charged against noninterest income.
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 and 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 and losses on forward commitments and put options deferred
against loans held for sale approximately offset equivalent amounts of
unrecognized gains and 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 and
losses on these instruments are not recognized until the actual sale of the
loans held for sale. Loans generally fund in 10 to 30 days from the date of
commitment.
In 1996, the Company sold its portfolio of loan servicing and no longer
services mortgage loans for others. Previously, the Company capitalized the
cost of acquiring mortgage servicing rights through either purchase or
origination of mortgage loans if it sold or securitized those loans, and
retained the servicing. The Company allocated the cost of the mortgage loans
to the mortgage servicing rights and the loans (without the servicing rights)
based on observable market prices. Capitalized mortgage servicing rights were
amortized in proportion to, and over the period of, estimated net servicing
income. Capitalized servicing rights were evaluated and measured for
impairment on a quarterly basis. In performing its impairment analysis, the
Company stratified the servicing portfolio based on the relevant risk
characteristics of the underlying loans, loan term and interest rate structure
(fixed/adjustable). Valuation allowances, if any, were established for each
risk stratum to carry the servicing rights at the lower of cost or market.
Loan servicing income represented 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.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996 and 1995 Page 5
- -----------------------------------------------------------------------------
NOTE 1: (Continued)
PREMISES AND EQUIPMENT
Premises and equipment are carried at cost less accumulated depreciation and
amortization. Depreciation on furniture, fixtures and equipment is computed
using the straight-line method over the estimated useful lives, which range
from two to fifteen years. Leasehold improvements are amortized using the
straight-line method over the estimated useful lives of the improvements or the
remaining lease term, whichever is shorter. Expenditures for betterments or
major repairs are capitalized and those for ordinary repairs and maintenance
are charged to operations as incurred.
REAL ESTATE ACQUIRED THROUGH FORECLOSURE
The Company records real estate acquired through foreclosure or "deed in lieu
of" as the lesser of the outstanding loan amount or the fair value less
estimated costs to sell, at the time of foreclosure. Any resulting loss on
foreclosure is charged to the valuation allowance for loan losses and a new
basis is established in the property. A valuation allowance is established to
reflect declines in value subsequent to foreclosure, if any, below the new
basis. 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 other non-interest
expenses.
INTANGIBLES ARISING FROM ACQUISITIONS
The Company has paid amounts in excess of fair value for CSB's and LNB's core
deposits and tangible assets. Such amounts are being amortized by systematic
charges to income (primarily for periods from 10 to 25) over a period which is
no greater that the estimated remaining life of the assets acquired or not to
exceed the estimated average remaining life of the existing deposit base
assumed. The Company periodically reviews intangibles to assess recoverability
and impairment is recognized in operations if permanent loss of value occurs.
DEPOSITS
Customer accounts comprise primarily the Bank's savings and checking accounts.
Customer accounts vary as to terms, with the major differences being minimum
balance required, maturity, interest rates and the provisions for payment of
interest. SDNB's and LNB's customer accounts are insured by the FDIC, through
the BIF for up to an aggregate amount of $100,000 per customer. CSB's deposits
are insured through the SAIF.
Interest is accrued and paid either to the customer or added to the customer's
account on a periodic basis. On term accounts, the forfeiture of interest
(because of withdrawal prior to maturity) is offset as of the date of
withdrawal against interest expense.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996 and 1995 Page 6
- -----------------------------------------------------------------------------
NOTE 1: (Continued)
FEDERAL AND STATE TAXES
The Company provides for income taxes under the provisions of Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes" (FAS
109). Under the liability method which is prescribed by FAS 109, a deferred
tax asset and/or liability is computed for both the expected future impact of
differences between the financial statement and tax bases of assets and
liabilities, and for the expected future tax benefit to be derived from tax
loss and tax credit carryforwards. FAS 109 also requires the establishment of
a valuation allowance, if necessary, to reflect the likelihood of realization
of deferred tax assets. The effect of tax rate changes will be reflected in
income in the period such changes are enacted.
Deferred income taxes are provided by applying the statutory tax rates in
effect at the balance sheet date to temporary differences between the book
basis and the tax basis of assets and liabilities. The resulting deferred tax
assets and liabilities are adjusted to reflect changes in tax laws or rates.
EARNINGS PER COMMON SHARE
Earnings per share is computed by dividing net income by the weighted average
number of common shares outstanding during the year and dilutive common stock
equivalents by using the treasury stock method. The weighted average number of
common shares used to compute earnings per share were 5,300,773, 268,198 and
53,728 for the years ended December 31, 1996, 1995 and 1994, respectively.
NOTE 2 - ACQUISITIONS AND 1996 REORGANIZATION:
On March 31, 1996, SDN completed its acquisition of LNB (the "Liberty
Acquisition") for approximately $15.1 million in cash. LNB had total assets of
approximately $149 million as of the acquisition date.
As of March 27, 1996, Dartmouth Capital Group, L.P. ("Partnership"), SDN's
controlling shareholder, invested approximately $13.4 million in SDN to fund
the Liberty Acquisition. In exchange for that investment, SDN issued a total
of 3,392,405 additional shares of SDN common stock at a price per share of
$3.95, SDN's book value per share as of December 31, 1995. At the
Partnership's direction, SDN issued 1,764,000 of those shares of common stock,
in the aggregate, to certain limited partners of the Partnership (the "Direct
Holders") and the remaining 1,628,405 shares of common stock directly to the
Partnership. A total of 38,300 shares were issued to investment bankers
involved in the Acquisition and an additional 1,400 shares were issued to the
directors of Liberty.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995 PAGE 7
- ------------------------------------------------------------------------------
NOTE 2: (Continued)
As of September 1, 1996, the Company completed the plan of reorganization (the
"1996 Reorganization") contemplated by the Agreement and Plan of Reorganization
dated April 23, 1996 (the "Agreement") between SDN and CSB. As part of the
1996 Reorganization, SDN became a subsidiary of the Company, effective August
31, 1996, in a transaction in which SDN shareholders received shares of the
Company's common stock in exchange for all of the outstanding shares of SDN
common stock. As of September 1, 1996, the Company completed the acquisition
of CSB (the "Commerce Acquisition") in which the Company acquired all of the
outstanding shares of CSB. SDN and CSB remain wholly-owned subsidiaries of the
Company. Through SDN, the Company controls LNB and SDNB, SDN's wholly-owned
subsidiaries.
Prior to August 31, 1996, the Partnership invested approximately $14.5 million
in SDN to fund the Commerce Acquisition. In exchange for that investment, SDN
issued a total of 3,664,776 additional shares of SDN common stock at a price
per share of $3.95 pursuant to a subscription agreement entered into in March
1996. At the Partnership's direction, SDN issued 1,080,000 of those shares of
common stock, in the aggregate, to certain limited Direct Holders and the
remaining 2,584,776 shares of common stock directly to the Partnership.
Holders of SDN common stock were issued one share of Company 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 1996 Reorganization. Holders of CSB common
stock were issued 1,527,540 shares of Company common stock and received cash of
approximately $14.1 million. An additional 58,212 shares of the Company's
common stock and cash of approximately $346,000 are held in escrow pending
final resolution of the SAIF recapitalization. As a result of legislation that
recapitalized the SAIF, passed on September 30, 1996, the stock and cash
escrows were distributed, with approximately $96,000 disbursed in cash and
16,151 common shares distributed. A total of 161,356 shares were issued to
other direct investors who invested in conjunction with the 1996 Reorganization
and investment bankers involved in the 1996 Reorganization. There were
9,697,430 total Company shares outstanding after the 1996 Reorganization.
Upon the completion of the 1996 Reorganization, the Partnership owned 48.0%
of the common stock and the Direct Holders owned, in the aggregate, 34.2% of
the Company's common stock. Both the Liberty Acquisition and Commerce
Acquisition were accounted for using the purchase method of accounting in
accordance with Accounting Principles Board Opinion No. 16, "Business
Combinations". Under this method of accounting, the purchase price was
allocated to the assets acquired and deposits and liabilities assumed based
on their fair values as of the acquisition date. The consolidated financial
statements include the operations of LNB and CSB from the date of
acquisition. Intangibles arising from the transactions totaled approximately
$3.8 million in the Liberty Acquisition and $7.2 million in the Commerce
Acquisition.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995 PAGE 8
- ------------------------------------------------------------------------------
NOTE 2: (Continued)
The following table sets forth selected pro forma combined financial
information of SDN, LNB and CSB for the years ended December 31, 1996 and 1995.
The pro forma operating data reflects the effect of the Liberty Acquisition and
the Commerce Acquisition as if each was consummated at the beginning of the
period presented. The pro forma results are not necessarily indicative of the
results that would have occurred had such acquisitions actually occurred as of
such dates, nor are they necessarily indicative of the results of future
operations.
<TABLE>
<CAPTION>
Pro Forma Combined for
Year Ended December 31,
------------------------------
1996 1995
(Unaudited) (Unaudited)
----------- -----------
<S> <C> <C>
Interest Income $32,616,000 $31,338,000
Interest Expense 13,707,000 14,070,000
----------- -----------
Net interest income 18,909,000 17,268,000
Provision for loan losses 1,005,000 1,641,000
----------- -----------
Net interest income after provision
for loan losses 17,904,000 15,627,000
Non-interest income 10,584,000 19,850,000
Non-interest expense 34,882,000 34,825,000
----------- -----------
(Loss) income before taxes (6,394,000) 652,000
Income tax (benefit) provision (4,221,000) 447,000
Extraordinary item-gain on
extinguishment of debt -- 625,000
----------- -----------
Net (loss) income $(2,173,000) $ 830,000
----------- -----------
----------- -----------
</TABLE>
On December 24, 1996, the Company entered into an agreement with Eldorado
Bancorp, the holding company of Eldorado Bank, to acquire 100% of the
outstanding stock of Eldorado Bancorp for cash consideration of $23 per share.
The aggregate consideration payable to holders of Eldorado common stock,
including consideration for outstanding options, will be approximately $89.6
million. In connection with this acquisition, the Company issued two notes in
the amounts of $200,000 and $4,300,000 to a director and the partnership,
respectively. These funds were placed on deposit to be utilized for the
acquisition of Eldorado. At September 30, 1996, Eldorado Bank had assets of
approximately $390 million (unaudited). The acquisition will be accounted for
using the purchase method. Completion of the transaction is contingent upon
the approval of shareholders and state and federal regulators.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995 PAGE 9
- ------------------------------------------------------------------------------
NOTE 3 - CASH AND DUE FROM BANKS:
The Bank is required to maintain average reserve balances with the Federal
Reserve Bank. Included in cash and due from banks in the consolidated
statement of financial condition are restricted amounts aggregating $1,775,000
and $275,000 at December 31, 1996 and 1995, respectively.
NOTE 4 - INVESTMENT SECURITIES:
As of December 31, 1996, all of the Company's investment securities were
classified in accordance with management's intent. At December 31, 1996 and
1995, the Company's investment portfolio was classified as follows:
<TABLE>
<CAPTION>
December 31, 1996
----------------------------------------------
Gross Unrealized Estimated
Amortized ------------------ Market
Cost Gains Losses Value
----------- ------- -------- -----------
<S> <C> <C> <C> <C>
Available for Sale:
U.S. Treasury $14,394,000 $25,000 $ (9,000) $14,410,000
State and municipal securities 761,000 4,000 - 765,000
----------- ------- -------- -----------
Total $15,155,000 $29,000 $ (9,000) $15,175,000
----------- ------- -------- -----------
----------- ------- -------- -----------
</TABLE>
<TABLE>
<CAPTION>
December 31, 1996
----------------------------------------------
Gross Unrealized Estimated
Amortized ------------------ Market
Cost Gains Losses Value
----------- ------- --------- -----------
<S> <C> <C> <C> <C>
Held to Maturity:
U.S. Treasury $ 499,000 $ 3,000 $ - $ 502,000
U.S. Government agencies 19,226,000 30,000 (150,000) 19,106,000
State and municipal securities 300,000 3,000 (1,000) 302,000
----------- ------- --------- -----------
Total $20,025,000 $36,000 $(151,000) $19,910,000
----------- ------- -------- -----------
----------- ------- -------- -----------
</TABLE>
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995 PAGE 10
- ------------------------------------------------------------------------------
NOTE 4: (Continued)
<TABLE>
<CAPTION>
December 31, 1995
----------------------------------------------
Gross Unrealized Estimated
Amortized ------------------ Market
Cost Gains Losses Value
----------- ------- -------- -----------
<S> <C> <C> <C> <C>
Held to Maturity:
U.S. Treasury $ 1,403,000 $16,000 $ - $ 1,419,000
U.S. Government agencies 4,839,000 15,000 (3,000) 4,851,000
State and municipal securities` 687,000 10,000 - 697,000
Mortgage-backed securities 80,000 10,000 - 90,000
----------- ------- -------- -----------
Total $ 7,009,000 $51,000 $ (3,000) $ 7,057,000
----------- ------- -------- -----------
----------- ------- -------- -----------
</TABLE>
Amortized cost and estimated market value of debt securities at December 31,
1996, by contractual maturity, are shown below.
<TABLE>
<CAPTION>
Estimated
Amortized Market
Cost Value
----------- -----------
<S> <C> <C>
Due in one year or less $ 9,212,000 $ 9,219,000
Due after one year through five years 24,267,000 24,271,000
Due after five years through ten years - -
Due after ten years 1,701,000 1,595,000
----------- -----------
Subtotal $35,180,000 $35,085,000
----------- -----------
----------- -----------
</TABLE>
Investment securities with an amortized cost of $8,963,000 and $4,522,000 and
an estimated market value of $8,849,000 and $4,560,000 at December 31, 1996 and
1995, respectively, were pledged to secure public deposits and for other
purposes required or permitted by law.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995 PAGE 11
- ------------------------------------------------------------------------------
NOTE 5 - LOANS AND LEASES:
The loan and lease portfolio consists of the various types of loans and leases
that are classified as held to maturity and available for sale. These loans
and leases are classified by major type as follows:
<TABLE>
<CAPTION>
December 31,
--------------------------
1996 1995
------------ -----------
<S> <C> <C>
Commercial real estate $ 86,397,000 $16,188,000
Residential real estate 52,487,000 15,710,000
Real estate construction 12,352,000 599,000
Consumer 22,512,000 6,525,000
Commercial 47,772,000 -
Land 6,460,000 -
Direct financing leases 46,498,000 -
------------ -----------
274,478,000 39,022,000
Less:
Allowance for loan and lease losses (5,156,000) (639,000)
Deferred loan fees and costs (2,444,000) (45,000)
------------ -----------
Mortgage loans held for sale and
loans and leases, net $266,878,000 $38,338,000
------------ -----------
------------ -----------
</TABLE>
The components of the Bank's leases receivable are summarized below:
<TABLE>
<CAPTION>
December 31, 1996
-----------------
<S> <C>
Future minimum lease payments $53,508,000
Residuals 511,000
Initial direct costs 1,018,000
Unearned income (8,539,000)
-----------
Total $46,498,000
-----------
-----------
</TABLE>
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995 PAGE 12
- ------------------------------------------------------------------------------
NOTE 5: (Continued)
At December 31, 1996, future minimum lease payments receivable are as follows:
<TABLE>
<CAPTION>
<S> <C>
1997 $17,456,000
1998 15,379,000
1999 11,013,000
2000 5,962,000
2001 3,199,000
Thereafter 499,000
-----------
Total $53,508,000
-----------
-----------
</TABLE>
There are no contingent rental payments included in income for the year ended
December 31, 1996.
As of December 31, 1996 and 1995, loans outstanding to directors, officers and
entities with which each of these individuals are associated, which in
aggregate exceed $60,000 per individual, were $2,043,000 and $173,000,
respectively. 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 consistent with
the Bank's general lending policies for similar transactions with unaffiliated
persons.
An analysis of the activity with respect to these related party loans is as
follows:
<TABLE>
<CAPTION>
Year ended December 31,
----------------------
1996 1995
---------- ---------
<S> <C> <C>
Beginning balance $ 173,000 $317,000
Balance acquired 1,935,000 -
New loans 144,000 61,000
Repayments/reductions (193,000) (23,000)
Other - no longer related party (16,000) (182,000)
---------- ---------
Ending balance $2,043,000 $173,000
---------- ---------
---------- ---------
</TABLE>
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995 Page 13
- -------------------------------------------------------------------------------
NOTE 5: (Continued)
The following table represents information relating to nonperforming and past
due loans:
December 31,
-------------------------
1996 1995
---------- ----------
Nonaccrual, not restructured $5,483,000 $1,492,000
90 days or more past due, not on nonaccrual 1,314,000 46,000
Restructured loans 2,200,000 82,000
---------- ----------
Total $8,997,000 $1,620,000
---------- ----------
---------- ----------
At December 31, 1996 and 1995, loans aggregating $7,683,000 and $1,361,000,
respectively, have been designated as impaired. The total allowance for loan
losses related to these loans was $695,000 and $196,500 at December 31, 1996
and 1995, respectively.
The average balance of impaired loans during 1996 and 1995 was $5,193,000 and
$1,985,000, respectively. Interest income on impaired loans of $43,000 and
$10,000 was recognized for cash payments received in 1996 and 1995,
respectively. The Company is not committed to lending additional funds to
debtors whose loans have been modified.
With respect to the above nonperforming loans, the following table presents
interest income actually earned and additional interest income that would have
been earned under the original terms of the loans:
Year Ended December 31,
-------------------------
1996 1995
---------- ----------
Nonaccrual loans:
Income recognized $ 5,000 $ 10,000
Income foregone 474,000 192,000
Restructured loans:
Income recognized 38,000 -
Income foregone 5,000 3,000
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995 Page 14
- -------------------------------------------------------------------------------
NOTE 5: (Continued)
An analysis of the activity in the allowance for loan and lease losses is as
follows:
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------
1996 1995 1994
--------- -------- --------
<S> <C> <C> <C>
Balance at beginning of year $ 639,000 $ 821,000 $ 823,000
Balance acquired 4,382,000 - -
Provision for loan and lease losses 515,000 295,000 583,000
Loans charged off (650,000) (702,000) (671,000)
Loan recoveries 270,000 225,000 86,000
--------- -------- --------
Balance at end of year $5,156,000 $ 639,000 $ 821,000
--------- -------- --------
--------- -------- --------
</TABLE>
NOTE 6 - MORTGAGE BANKING ACTIVITIES:
The Bank originates and sells residential mortgage loans to secondary market
investors subject to certain recourse provisions. The Bank had recorded a
reserve of $436,000 in connection with such sales at December 31, 1996.
As part of its mortgage banking activities, the Bank sells, subject to
recourse, the servicing rights to loans it originates and sells to third
party investors. At December 31, 1996, the Bank had sold loan servicing
rights with recourse on loans with an unpaid principal balance of
approximately $21,342,000. The Bank has recorded reserves of $264,000
relating to these recourse provisions as of December 31, 1996.
NOTE 7 - REAL ESTATE ACQUIRED THROUGH FORECLOSURE:
An analysis of the activity in the allowance for credit losses on real estate
acquired through foreclosure as of December 31, 1996 and 1995 is as follows:
Year Ended December 31,
-------------------------
1996 1995
--------- ----------
Balance at the beginning of year $320,000 $ 3,000
Balance acquired 576,000 -
Provision charged to expense 72,000 383,000
Balances related to properties sold (483,000) -
Charge-offs - (66,000)
--------- ----------
Balance at the end of year $485,000 $320,000
--------- ----------
--------- ----------
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995 Page 15
- -------------------------------------------------------------------------------
NOTE 8 - PREMISES AND EQUIPMENT:
Premises and equipment are summarized as follows:
December 31,
-------------------------
1996 1995
---------- ----------
Furniture, fixtures and equipment $ 9,179,000 $ 1,424,000
Leasehold improvements 2,694,000 1,323,000
11,873,000 2,747,000
Less: Accumulated depreciation and amortization (7,962,000) (2,150,000)
---------- ----------
Premises and equipment, net $ 3,911,000 $ 597,000
---------- ----------
---------- ----------
Depreciation and amortization of premises and equipment included in non-interest
expense amounted to $642,000 and $201,000 in 1996 and 1995, respectively.
NOTE 9 - DEPOSITS:
A summary of deposits is as follows:
December 31,
---------------------------
1996 1995
----------- -----------
Noninterest bearing:
Checking $ 63,373,000 $ 13,445,000
Bank controlled 4,211,000 -
Title and escrow 58,141,000 -
Custodial 1,160,000 -
----------- -----------
126,885,000 13,445,000
Interest bearing:
Passbook $ 42,190,000 4,714,000
NOW and Super NOW 38,602,000 10,582,000
Money market 25,662,000 8,558,000
Certificates of deposit $100,000 or greater 25,903,000 2,552,000
Other certificates 123,789,000 11,580,000
----------- -----------
256,146,000 37,986,000
Total deposits $383,031,000 $ 51,431,000
----------- -----------
----------- -----------
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995 Page 16
- -------------------------------------------------------------------------------
NOTE 9: (Continued)
A summary of certificate of deposit maturities is as follows:
Year Ended December 31,
---------------------------
1996 1995
------------ -----------
One year $138,142,000 $14,000,000
Two years 11,400,000 114,000
Three years 60,000 18,000
Four years 90,000 -
Five years - -
Thereafter - -
------------ -----------
$149,692,000 $14,132,000
------------ -----------
------------ -----------
A summary of certificate of deposit of $100,000 or more maturities is as
follows:
Year Ended December 31,
---------------------------
1996 1995
----------- -----------
Three months or less $16,387,000 $ 1,952,000
Four through six months 2,754,000 300,000
Seven through twelve months 6,460,000 200,000
Thereafter 302,000 100,000
----------- -----------
$25,903,000 $ 2,552,000
----------- -----------
----------- -----------
Interest expense for certificates of deposit in amounts of $100,000 or more was
$677,000 and $218,000 for the years ended December 31, 1996 and 1995,
respectively.
NOTE 10 - MANDATORY CONVERTIBLE DEBENTURES:
The mandatory convertible debentures bear interest at Wall Street Journal prime
plus 3.0%, payable quarterly. The debentures are mandatorily convertible at
May 30, 1998 into SDN common stock, at a rate equal to the lower of: (i) $52.50
per share (subject to certain anti-dilutive adjustments and the power of SDN's
Board of Directors to reduce the conversion price), or (ii) the then current
fair market value per share of SDN common stock. Prior to May 30, 1998, the
debentures are convertible, at the option of the holder, between April 15 and
June 15 of each calendar year, or within 60 days after the date of any Notice
of Redemption by SDN, at a price of $52.50 per share (subject to anti-dilutive
adjustments and the power of the SDN's Board of Directors to reduce the
conversion price).
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995 Page 17
- -------------------------------------------------------------------------------
NOTE 10: (Continued)
The debentures are not subject to any sinking fund requirements and are
subordinated in right of payment to the obligations of SDN under any other
indebtedness. At SDN's option, the debentures are redeemable, subject to
Federal Reserve Bank approval, at 100% of par if the notice is sent. The
indenture does not provide for a right of acceleration of the debentures upon a
default in payment of interest or principal or in the performance of any
covenant in the debentures or the indenture, and no trustee is appointed under
the indenture to enforce the rights of the debenture holders. Prior to
conversion of the debentures, a debenture holder has none of the rights or
privileges of a shareholder of SDN.
NOTE 11 - INCOME TAXES:
The components of the provision for (benefit) from income taxes for the years
ended December 31 are as follows:
Year Ended December 31,
---------------------------
1996 1995
----------- -----------
Current provision (benefit):
Federal $(38,000) $ -
State 5,000 -
Total (33,000) -
----------- -----------
Deferred benefit:
Federal (1,276,000) (322,000)
State (194,000) (121,000)
----------- -----------
Total (1,470,000) (443,000)
----------- -----------
Total income tax benefit $(1,503,000) $ (443,000)
----------- -----------
----------- -----------
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995 Page 18
- -------------------------------------------------------------------------------
NOTE 11: (Continued)
The amount of deferred tax assets (liabilities) resulting from each type of
temporary difference were as follows:
December 31,
---------------------------
1996 1995
----------- -----------
Deferred tax liabilities:
FHLB stock dividends $(174,000) $ -
Deferred loan costs (679,000) -
State taxes (223,000) -
Fixed asset basis difference (172,000) -
----------- -----------
Deferred tax liabilities (1,248,000) -
----------- -----------
Deferred tax assets:
Provision for loan losses $1,202,000 $ 113,000
Deferred rent 66,000 -
Accrued expenses 51,000 -
Other reserves 645,000 -
Real estate acquired through foreclosure 88,000 133,000
NOL carryforward 1,509,000 1,376,000
Advance payments on leases 128,000 -
SAIF accrual 26,000 -
Fixed asset basis difference - 157,000
General business credit 77,000 77,000
AMT credit 104,000 12,000
Other 116,000 86,000
----------- -----------
Deferred tax assets 4,012,000 1,954,000
Less: valuation reserve - (1,954,000)
----------- -----------
Net deferred tax asset 4,012,000 -
Total net deferred tax asset $2,764,000 $ -
----------- -----------
----------- -----------
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995 PAGE 19
- -------------------------------------------------------------------------------
NOTE 11: (Continued)
Year Ended December 31,
-----------------------
1996 1995
----------- ----------
Statutory federal expected tax rate 34.0% 34.0%
Increase in income taxes resulting from:
State franchise tax (net of federal benefit) 7.5 7.5
Goodwill 18.9 -
Other (0.4) (0.3)
----------- ----------
Effective tax rate 60.0 41.2
Release of valuation allowance (242.8) -
----------- ----------
Total effective tax rate (182.8)% 41.2%
----------- ----------
----------- ----------
At December 31, 1995 the individual banks had federal net operating loss
carryforwards of approximately $3,622,000, which expire in 2009 through 2011
and California net operating loss carryforwards of approximately $1,509,000
which will expire in 1999 through 2000.
Use of these NOLs are subject to limitations imposed by the Internal Revenue
Code Section 382, which restrict the use of NOLs in the event of a significant
change in ownership interests of individual shareholders and defined
shareholder groups. These limitations are not expected to impact the Company's
ability to utilize these NOLs.
NOTE 12 - CAPITAL ADEQUACY:
- ---------------------------
The individual banks are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on each Bank's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, each Bank
must meet specific capital guidelines that involve quantitative measures of the
individual Bank's assets, liabilities and certain off-balance sheet items as
calculated under regulatory accounting practices. Management believes, as of
December 31, 1996, that each Bank meets all capital adequacy requirements to
which it is subject. Further, there are no conditions or events since December
31, 1996 that management believes have changed either CSB, Inc.'s or the
individual Bank's capital classifications.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995 PAGE 20
- -------------------------------------------------------------------------------
NOTE 12: (Continued)
- --------
In order to meet minimum regulatory capital requirements, an institution must
maintain a Tier 1 Capital Ratio of four percent and a Total Capital Ratio of
eight percent. The Leverage Ratio guidelines establish a minimum ratio of
Tier one capital to average assets, excluding goodwill and certain other
items, of at least three percent. The following table represents each Bank's
actual capital ratios and amounts and minimum required capital amounts (in
thousands):
December 31, 1996 December 31, 1995
-------------------------- ----------------------------
Amount Amount
for Minimum for Minimum
Actual Capital Actual Capital
-------------- ---------------
Ratio Amount Adequacy Ratio Amount Adequacy
------ ------ -------- ----- ------ --------
Tier 1 Capital:
CSB, Inc. (1) 9.22% $29,867 $12,953 - - -
CSB (1) 6.90 12,069 6,999 - - -
LNB 8.68 9,131 4,208 - - -
SDNB 14.52 6,174 1,700 9.44% $3,833 $1,625
Leverage Capital:
CSB, Inc. (1) 6.98% 29,867 12,845 - - -
CSB (1) 4.99 12,069 7,251 - - -
LNB 6.19 9,131 4,428 - - -
SDNB 11.05 6,174 1,676 6.71% $3,833 $3,249
Total Capital:
CSB, Inc. (1) 10.64% 34,466 25,906 - - -
CSB (1) 8.15 14,263 13,999 - - -
LNB 9.97 10,483 8,416 - - -
SDNB 15.78 6,708 3,401 10.69% $4,342 $1,713
(1) Reflects March 1997 agreements which retroactively release the Bank from
contingent recourse liability with respect to $206,309,000 of previously sold
mortgage servicing rights.
NOTE 13 - INTEREST RATE RISK:
- -----------------------------
The Company is principally engaged in providing commercial loans and leases
with interest rates that fluctuate with various market indices and variable-
rate real estate loans. These loans are primarily funded through short-term
demand deposits and certificates of deposit with fixed rates. At December 31,
1996, the Bank had interest-earning assets of $187,021,000 having a weighted
average effective yield of 10.3% and interest-bearing liabilities of
$153,792,000 with a weighted average rate of 5.0%.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995 PAGE 21
- -------------------------------------------------------------------------------
NOTE 14 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK:
- ------------------------------------------------------------
In the ordinary course of business, the Company enters into various types of
transactions which involve financial instruments with off-balance 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. The contract
or notional amounts of those instruments reflect the extent of the Company'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 Company as of December 31, 1996:
Commitments to extend credit $56,127,000
Standby letters of credit 1,586,000
Commitments to sell loans -
Forward commitments to sell mortgage-backed securities 19,500,000
Put options to sell mortgage-backed securities 9,050,000
Commitments to extend credit are agreements to lend to a customer as long as
there are no violations of any condition established in the contract.
Commitments generally have fixed expiration dates or other terminal clauses and
may require the payment of fees. The Bank experiences interest rate risk on
commitments to extend credit which are at fixed rates. Such commitments
totaled $17,161,000 at December 31, 1996.
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
options 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
the mortgage loans into the commitment. Mandatory commitments may entail
possible financial risk to the Bank if it is unable to deliver the mortgage
loans in sufficient quantity or at sufficient rates for commitments which are
at a fixed rate. There were no such commitments at December 31, 1996.
The Bank's policy is to hedge a portion of its 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
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995 PAGE 22
- -------------------------------------------------------------------------------
NOTE 14: (Continued)
- --------
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
contractually 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 contracts to sell mortgage-backed securities were $4,000
as of December 31, 1996. There were no outstanding forward contracts to sell
mortgage-backed securities at December 31, 1995.
NOTE 15 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS:
- ----------------------------------------------------------------
As of December 31, 1996, a fair value analysis was completed for certain
components of the balance sheet for purposes of complying with FAS 107. The
assumption used in arriving at these fair values are detailed below. The
following values were determined in this analysis:
Current Value Fair Value
Cash, Federal funds sold and
interest bearing deposits $ 46,560,000 $ 46,560,000
Investment securities 35,200,000 35,085,000
Loan and leases receivable 263,641,000 265,235,000
Loan and servicing sale receivable 54,080,000 54,080,000
Loans held for sale 10,837,000 10,945,000
Deposits 383,031,000 379,544,000
Due to related parties 4,500,000 4,500,000
Accrued expenses and other liabilities 8,220,000 8,220,000
Mandatory convertible debentures 537,000 537,000
CASH, FEDERAL FUNDS SOLD AND INTEREST BEARING DEPOSITS
- ------------------------------------------------------
Cash, Federal funds sold and interest bearing deposits are valued at par. Cash
is held on deposit at either the Federal Reserve or at correspondent banks.
Federal funds sold are held in depository institutions that are well
capitalized and have at least A+ ratings. As such, there is very little credit
risk and due to the overnight nature of Federal funds, little interest rate
risk. Interest bearing deposits represent certificates of deposits with
maturities of less than 270 days.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995 PAGE 23
- -------------------------------------------------------------------------------
NOTE 15: (Continued)
INVESTMENT SECURITIES
All investment securities are readily tradable and have an easily determined
market value. These market values at December 31, 1996 are used in determining
the fair value. Current value represents the historical cost basis of all
securities.
LOAN AND LEASE RECEIVABLE
Loans were broken into three components for analysis (1) fixed rate loans, (2)
variable rate loans and (3) nonaccrual loans. The credit risk component of the
fair value analysis is assumed to be approximated by the loan loss reserve.
Separate analysis is conducted on the adequacy for the allowance for loan and
lease losses and should be a reasonable proxy for this credit risk component.
Fixed rate loans and leases - Fixed rate commercial loans are valued using a
discounted cash flow model that assumes a prepayment rate of 10% and future cash
flows are discounted at the current prime rate plus 50 basis points. These
commercial loans were grouped in categories by maturity and the weighted
average maturity and rate were used in computing the future cash flows. Leases
are regularly sold into the secondary market and on average have sold at a
premium of approximately 6 percent. To determine the fair value of leases,
this potential sale premium was discounted to 5 percent to account for
delinquent leases that would not garner the same sale premium. Fixed rate
residential mortgage loans were valued at par realizing that any premiums
attributable to the performing portfolio would be offset by discounts in the
delinquent portion of the portfolio.
Variable rate loans - Variable rate loans were broken down into four
categories, those that (1) reset at least quarterly, (2) reset at least
annually, (3) reset every five years or more frequently and (4) reset less
frequently than five years. Loans that reset at least quarterly were valued at
a premium of 3 percent while loans that reset at least annually are valued at
par and loans that reset more frequently and less frequently are discounted 1
percent and 5 percent, respectively.
Nonaccrual loans - Nonaccrual loans are valued at par. The major valuation of
these loans are related to credit risk which is taken up in the use of the
allowance for the overall credit risk component.
LOANS HELD FOR SALE
Loans held for sale are valued at a premium of 1 percent. These loans consist
of residential mortgage loans and are largely fixed rate product. The premium
used approximates the gain that would be recognized on the sale of these loans,
discounted for hedging and sales costs.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995 PAGE 24
- -------------------------------------------------------------------------------
NOTE 15: (Continued)
DEPOSITS
Deposits consist of both non-interest and interest bearing accounts. Each type
of account has been valued differently as described below.
Non-interest bearing demand - Core non-interest bearing deposits are a premium
account for commercial banks and as such have been valued with a factor of .95.
Non-core type accounts such as title company deposits and custodial accounts
have been valued at par due to their temporary and volatile nature.
Interest bearing demand, savings and money market accounts - These accounts are
all priced competitively in the marketplace and are low cost funds for the
Bank. As such, these deposits have also been ascribed as premium accounts and
valued with a factor of .99.
Certificates of deposit - Certificates of deposit accounts ("CD") were marked
to market utilizing current CD rates compared to rates being paid. CDs were
grouped based upon their remaining maturities and the weighted average maturity
and rates were grouped based upon their remaining maturities and the weighted
average maturity and rates were utilized in the analysis. Current rates for
CDs were determined utilizing the Treasury rates for comparable maturities less
25 basis points. Generally, rates currently being paid are higher than current
market rates which results in these accounts having a lower fair value.
DUE TO RELATED PARTIES AND ACCRUED EXPENSES AND OTHER LIABILITIES
Notes payable to related parties and accrued expenses and other liabilities
have maturities of less than one year and are stated at cost.
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
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 credit worthiness 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.
Forward Commitments to Sell Mortgage-Backed Securities - The fair value
estimated is based on quoted prices for financial instruments with identical or
similar terms. The fair value of forward commitments to sell mortgage-backed
securities is not material.
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.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995 PAGE 25
- -------------------------------------------------------------------------------
NOTE 16 - COMMITMENTS AND CONTINGENCIES:
The Bank is involved in certain legal proceedings arising in the normal course
of its business. Bank management, after reviewing these matters with outside
counsel, believes that the ultimate liability arising from these proceedings,
if any, will not have a material affect on the financial statements.
A summary of noncancellable future operating lease commitments at December 31,
1996 follows:
1997 $1,849,000
1998 1,711,000
1999 1,370,000
2000 980,000
2001 741,000
Thereafter -
----------
$6,651,000
----------
----------
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
$1,101,000, $417,000 and $521,000 for the years ended December 31, 1996, 1995
and 1994, respectively.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995 PAGE 26
- -------------------------------------------------------------------------------
NOTE 17 - PARENT COMPANY INFORMATION:
The following are condensed financial statements of Commerce Security Bancorp,
Inc. (parent company only) as of December 31, 1996 and for the year then ended:
CONDENSED STATEMENT OF CONDITION
December 31,
1996
------------
Assets
Cash and due from banks $ 4,644,000
Investments 408,000
Investment in subsidiary 37,701,000
Receivables and other assets 639,000
------------
Total assets $ 43,392,000
------------
------------
Liabilities and Shareholders' Equity
Due to subsidiary $ 35,000
Notes payable to shareholders 4,500,000
------------
Total liabilities 4,535,000
------------
Shareholders' equity:
Common stock 97,000
Additional paid-in-capital 42,394,000
Accumulated deficit (3,651,000)
Unrealized gain on investments, net of tax 17,000
------------
Total shareholders' equity 38,857,000
------------
Total liabilities and shareholders' equity $ 43,392,000
------------
------------
CONDENSED STATEMENT OF OPERATIONS
Year Ended
December 31,
1996
------------
Interest income $ 8,000
Non-interest income 154,000
Non-interest expense 162,000
------------
Net income $ -
------------
------------
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995 PAGE 27
- -------------------------------------------------------------------------------
NOTE 17: (Continued)
CONDENSED STATEMENT OF CASH FLOWS
Year Ended
December 31,
1996
------------
Operating activities:
Net income $ -
Adjustments to reconcile net income to net
cash used by operating activities:
Accretion/amortization related to securities 1,000
Increase in other assets (639,000)
Increase in other liabilities 35,000
------------
Net cash used by operating activities (603,000)
------------
Investing activities:
Purchase of investment securities (409,000)
Purchase of CSB (20,327,000)
Purchase of SDN Bancorp (21,008,000)
------------
Net cash used by investing activities (41,744,000)
------------
Financing activities:
Net proceeds from issuance of notes payable 4,500,000
Issuance of common stock 42,491,000
------------
Net cash provided by financing activities 46,991,000
------------
Net increase in cash 4,644,000
Cash at beginning of year -
------------
Cash at end of year $4,644,000
------------
------------
<PAGE>
SUBSCRIPTION AGREEMENT
(COMMON STOCK)
THIS SUBSCRIPTION AGREEMENT (the "Agreement") is made and entered into as
of the 20th day of December, 1996, by and between Commerce Security Bancorp,
Inc., a Delaware corporation with its principal place of business located in
Huntington Beach, California (the "Company"), and the investor whose name
appears on the signature page hereto (the "Subscriber").
WHEREAS, the Company is seeking commitments from several accredited
investors through a private placement (the "Private Placement") of shares of its
common stock, par value $.01 (the "Common Stock"), and certain other securities
in connection with the proposed acquisition (the "Acquisition") by the Company
of the Target Company (as such term is used in the Company's December 18, 1996
Private Placement Memorandum pertaining to the Private Placement (together with
the December 20, 1996 Supplement and any other supplement, amendment or annex
thereof or any document incorporated by reference therein, the "Memorandum"));
WHEREAS, the Subscriber desires to commit irrevocably to purchase, subject
only to those certain limited conditions described hereinafter, specified
amounts of the Company's Common Stock and to subscribe for and purchase such
amounts (the "Subscription"), at a per share price of $4.81 (the "Subscription
Price"), all as is more particularly set forth herein;
WHEREAS, if the Company enters into a definitive acquisition agreement (the
"Acquisition Agreement") with the Target Company, certain events including the
Target Company Redemption as defined in the Memorandum (each a "Reduction
Event") could have the effect of reducing the number of Placement Shares (as
hereinafter defined) to be sold to the Subscriber; and
WHEREAS, in connection with the Private Placement, the Subscriber desires
to obtain and the Company is willing to grant to the Subscriber certain
registration rights with respect to the Placement Shares;
NOW, THEREFORE, in consideration of the foregoing and the respective
representations, warranties, covenants and other agreements set forth herein,
and intending to be legally bound hereby, the parties hereto agree as follows:
1. PURCHASE AND DELIVERY OF PLACEMENT SHARES
(a) Subject to the terms and conditions herein set forth, the Subscriber
hereby irrevocably agrees and commits to purchase from the Company, at the
Subscription Price per share, up to the number of shares of Common Stock as are
specified on the signature page hereof (as the same may be reduced as a
consequence of a Reduction Event, the "Placement Shares").
<PAGE>
(b) The Subscriber acknowledges and agrees that its Subscription is hereby
conditioned upon acceptance by the Company and may be accepted or rejected, in
whole (but not in part), by the Company in its sole discretion (the date on
which the Company accepts this Subscription Agreement being hereinafter called
the "Acceptance Date").
(c) The Subscriber and the Company hereby acknowledge and agree that (x)
the Company has entered into, or contemplates entering into, one or more other
Common Stock Subscription Agreements with certain other parties (collectively,
the "Subscribers") on terms substantially similar to this Agreement (except that
they may provide for the purchase of a different maximum number of Placement
Shares) and (y) the occurrence of one or more Reduction Events could have the
effect of reducing or eliminating the number of Placement Shares available
hereunder. Subject to Section 1(d), the Placement Shares available for issuance
to Subscribers shall be allocated as nearly as possible on a pro rata basis
among all Subscribers based upon the number of Placement Shares subscribed for
by each such Subscriber, after giving effect to the limitation set forth in
Section 4(b).
(d) No reduction in the number of Placement Shares available for issuance
to Subscribers as a consequence of a Reduction Event shall reduce the
Subscriber's Maximum Share Amount (as defined hereinafter) by more than
one-third. No such reduction shall be made to the number of Placement Shares
that Dartmouth Capital Group, L.P. and certain related parties shall be entitled
to purchase in exchange for funding the Deposit (as defined in the Memorandum)
with the Target Company.
(e) Subject to the terms, conditions and limitations herein set forth, the
Company shall pay to the Subscriber at the Funding (as hereinafter defined) a
commitment fee (the "Commitment Fee") equal to one percent (1%) of the product
of the Subscription Price multiplied by the difference between (x) the number of
shares that the Company had agreed to make available to the Subscriber at the
time of the Company's acceptance of the Subscription (the "Maximum Share
Amount") and (y) the number of Placement Shares actually issued to the
Subscriber, provided that the Subscriber has fully complied with all of the
terms of this Agreement.
2. THE FUNDING
As soon as practicable following its final determination of the total
number of Placement Shares available for sale to the Subscribers made in
anticipation of the closing of the transactions contemplated hereby, the Company
shall notify the Subscriber of the number of Placement Shares, to be purchased
by the Subscriber pursuant to Section 1(a) and the amount of the Commitment Fee
to be paid pursuant to Section 1(e). Contemporaneously with the execution and
delivery of this Agreement, the Subscriber has executed and delivered to the
Company the Escrow Agreement in the form attached as Annex A to this Agreement.
The Subscriber agrees to deliver payment for the Placement Shares, net of the
Commitment Fee, to the Company's escrow agent for deposit in
-2-
<PAGE>
an escrow account within three (3) business days following receipt of notice
from the Company that all of the material conditions to the closing of the
Acquisition have been satisfied or, if permitted, duly waived. The name of the
escrow agent and instructions for payment of the aggregate Subscription Price
shall be included in the Company's notice. The delivery of, and the release
from escrow of the payment for, the Placement Shares shall take place at the
executive offices of the Company at One Pacific Plaza, 7777 Center Avenue,
Huntington Beach, California, at 9:00 a.m., California time, prior to, but
substantially simultaneously with, the closing of the Acquisition, such time and
date to be not more than five (5) business days after the foregoing notification
and to be specified therein (such time and date being referred to as the
"Funding Time," the date of the Funding being referred to as the "Funding Date"
and the consummation of the Private Placement being referred to as the
"Funding").
3. DELIVERY OF PLACEMENT SHARES
At the Funding, the Placement Shares to be sold to the Subscriber
hereunder, registered in the name of the Subscriber or its nominee(s), as the
Subscriber may specify in writing at least three (3) days prior to the Funding
Date, shall be delivered by or on behalf of the Company to the Subscriber, for
the Subscriber's account, against delivery by the Subscriber of the aggregate
Subscription Price therefor, net of the Commitment Fee, in immediately available
funds in the form of one or more federal funds checks or a wire transfer to an
account designated by the Company. If the Subscriber shall fail to timely
provide information regarding the registered holder of the Placement Shares,
such shares shall be delivered to the Subscriber in the form of one certificate
registered in the Subscriber's name.
4. AGREEMENTS AND CONSENTS OF THE SUBSCRIBER
The Subscriber hereby agrees with the Company as follows:
(a) Subject only to the immediately following sentence, the
Subscriber agrees that this Agreement is irrevocable and that the rights and
obligations of any party hereto shall not be terminated or affected by operation
of law, whether by death, incompetence, disability or the occurrence of any
other event affecting a Subscriber. If and only if the Company has not accepted
this Subscription Agreement in accordance with Section 1(b) on or before the
twentieth (20th) calendar day following the Subscriber's delivery hereof to the
Company, then at any time after such date but before the acceptance hereof by
the Company, the Subscriber may withdraw its Subscription hereunder by notice to
the Company. In the event that the Company has not entered into the Acquisition
Agreement on or before January 15, 1997, the Company or the Subscriber may upon
five (5) business days' notice to the other party hereto terminate this
Agreement, which termination shall be without liability to either party. In the
event that the Funding Date does not occur on or before August 15, 1997 or the
Acquisition Agreement is terminated, this Agreement shall terminate without
liability to any party hereto.
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(b) Notwithstanding anything to the contrary contained herein, the
Subscriber acknowledges and agrees that the Company may decline to issue any of
the Placement Shares or pay any portion of the Commitment Fee to the Subscriber
hereunder if, in the reasonable opinion of the Company's counsel, the Subscriber
is required to obtain prior clearance or approval of such transaction from any
state or federal bank regulatory authority and if, in the reasonable opinion of
such counsel, the requisite approval or clearance has not been obtained or
satisfactory evidence thereof has not been presented to the Company by the
Funding Date.
(c) The Subscriber hereby acknowledges and understands that although
the Company has retained The Shattan Group LLC ("TSG") to serve as placement
agent in connection with the offering of securities other than Common Stock in
connection with the Private Placement, the Subscriber has not relied upon any
representation made or information provided by TSG in the Subscriber's decision
to enter into a Subscription Agreement or otherwise invest in the Placement
Shares.
5. REPRESENTATIONS AND WARRANTIES OF THE COMPANY
The Company hereby represents and warrants to the Subscriber as
follows:
(a) As of the Acceptance Date, the Company is, and at all times
thereafter through the time of the Funding, the Company will have been, duly
organized and validly existing and in good standing as a corporation organized
under the laws of the State of Delaware, with corporate power and authority to
own, lease and operate its properties and to conduct its business as described
in the Memorandum and to perform its obligations under this Agreement.
(b) Each direct or indirect wholly-owned subsidiary of the Company
(each, a "Subsidiary"), and to the Company's knowledge, each direct or indirect
wholly-owned subsidiary of the Target Company (each, a "Target Subsidiary"), has
been duly incorporated and is validly existing as a corporation in good standing
under the laws of the jurisdiction of its incorporation and is duly qualified as
a foreign corporation to transact business and is in good standing in each
jurisdiction where the failure to so qualify would have a material adverse
effect on the conduct of the business of, the condition (financial or otherwise)
of, or the earnings or business of (collectively, the "Condition") the Company
and its Subsidiaries and the Target Company and the Target Subsidiaries
considered as one enterprise; all of the issued and outstanding capital stock of
each Subsidiary has been duly authorized and validly issued and is fully paid
and (except as provided by law) nonassessable and is owned by the Company,
directly or through Subsidiaries, free and clear of any mortgage, pledge, lien,
encumbrance or claim whatsoever, and to the Company's knowledge, all of the
issued and outstanding capital stock of each Target Subsidiary has been duly
authorized and validly issued and is fully paid and (except as provided by law)
nonassessable and is owned by the Target Company, directly or through Target
Subsidiaries, free and clear of any mortgage, pledge, lien, encumbrance or claim
whatsoever; except for the
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Subsidiaries and other than as reflected in the financial statements or except
as otherwise reflected in the Memorandum, the Company does not and, to the
Company's knowledge, the Target Company does not, directly or indirectly, own
any shares of stock or any securities of any corporation or have any equity
interest in any firm, partnership, association or other entity.
(c) The Company and its Subsidiaries and, to the Company's knowledge,
the Target Company and the Target Subsidiaries possess all material licenses,
permits and other governmental authorizations as are currently required for the
conduct of their respective businesses, and all such licenses, permits and other
governmental authorizations are in full force and effect; the Company and its
Subsidiaries and, to the Company's knowledge, the Target Company and the Target
Subsidiaries are in compliance therewith except to the extent that
non-compliance would not, individually or in the aggregate, have a material
adverse effect on the Condition of the Company and its Subsidiaries and the
Target Company and the Target Subsidiaries considered as one enterprise; and
neither the Company nor any of its Subsidiaries or, to the Company's knowledge,
neither the Target Company nor any of the Target Subsidiaries has received
notice of any proceeding or action relating to the revocation or modification of
any such material license, permit or other governmental authorization.
(d) Neither the Company nor any of the Subsidiaries and, to the
Company's knowledge, neither the Target Company nor any of the Target
Subsidiaries is in violation of its charter or other organizational document or
bylaws or materially in default in the performance or observance of the
obligations, agreements, covenants or conditions contained in any contract,
indenture, mortgage, loan agreement, note, lease or other instrument to which it
is a party or by which it or any of them or any of their properties may be bound
and that is material to the Company and its Subsidiaries and the Target Company
and the Target Subsidiaries considered as one enterprise.
(e) The execution, delivery and performance of this Agreement by the
Company and the consummation by the Company of the transactions contemplated
hereby, including the filing of an amended and restated Certificate of
Incorporation (the "Amended and Restated Charter") which contemplates the terms
of the Placement Shares and the Securities (as defined in the Memorandum)
offered in the Private Placement, have been duly authorized by all necessary
corporate action of the Company, and constitute a valid and legally binding
instrument of the Company enforceable in accordance with its terms, subject to
bankruptcy, insolvency, fraudulent transfer, reorganization, moratorium and
similar laws of general applicability relating to or affecting creditors' rights
and to general equity principles.
(f) The execution and delivery of this Agreement, the consummation by
the Company of the transactions herein contemplated and the compliance by the
Company with the terms hereof will not conflict with, or result in a breach or
violation of any of the terms or provisions of, or constitute a default under,
the Certificate of Incorporation, assuming the filing,
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prior to the Funding, of the Amended and Restated Charter, or Bylaws of the
Company, or any indenture, mortgage, deed of trust, loan agreement or other
agreement or instrument to which the Company is a party or by which any of its
properties or assets are bound, with such exceptions as would not have a
material adverse effect on the Condition of the Company and its Subsidiaries and
the Target Company and the Target Subsidiaries, considered as one enterprise, or
any applicable law, rule, regulation, judgment, order or decree of any
governmental, governmental instrumentality or court having jurisdiction over the
Company or any of its properties or assets; and no consent, approval,
authorization, order, registration or qualification of or with any such
government, governmental instrumentality or court is required for the valid
authorization, execution, delivery and performance by the Company of this
Agreement, the Placement Shares, and the Commitment Fee or the consummation by
the Company of the other transactions contemplated by this Agreement, except
such federal and state regulatory approvals as are described in the Memorandum
and such consents, approvals, authorizations, registrations or qualification as
may be required under state securities or "blue sky" laws.
(g) When issued and delivered by the Company against payment
therefor, the Placement Shares will be duly authorized, validly issued, fully
paid and non-assessable, and the forms of certificates evidencing the Placement
Shares will be in due and proper form.
(h) Relying in part on the representations and warranties of the
Subscribers set forth in Section 6, the offering of the Placement Shares to the
Subscriber is exempt from registration under the Securities Act of 1933, as
amended (the "Securities Act"), pursuant to Section 4(2) thereof.
(i) The Memorandum does not contain an untrue statement of a material
fact or omit to state a material fact required to be stated therein or necessary
to make the statements therein, in light of the circumstances under which they
were made, not misleading with respect to information regarding the Company and
its Subsidiaries, and as of the date of the Memorandum and at all times
thereafter through the Acceptance Date, the Memorandum will not contain an
untrue statement of a material fact or omit to state a material fact necessary
in order to make the statements therein, in light of the circumstances under
which they were made, not misleading with respect to information regarding the
Company and its Subsidiaries.
(j) The Company has no reason to believe that the information
concerning the Target Company that is contained in the Memorandum is not true
and correct in all material respects or that the representations and warranties
of the Target Company as set forth in the Acquisition Agreement (as defined in
the Memorandum) are not true and correct in all material respects.
(k) The accountants who certified the financial statements and
supporting schedules of SDN Bancorp, Inc., Liberty National Bank and Commerce
Security Bank included
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in the 1996 Information Statement (as defined in the Memorandum) are independent
public accountants within the meaning of the Securities Act and the rules and
regulations promulgated thereunder (the "Securities Act Regulations").
(l) The financial statements of the Company as at September 30, 1996
and for the three- and nine-month periods then ended included in the Memorandum
and the historical financial statements of SDN Bancorp, Inc., Liberty National
Bank and Commerce Security Bank included in the 1996 Information Statement (1)
comply in all material respects, except as may be reflected in the notes to the
financial statements, as to form with the accounting requirements of the
Securities Act, the Securities Act Regulations, and the Securities Exchange Act
of 1934, as amended (the "Exchange Act"), (2) present fairly in all material
respects the financial position of the respective entities as at the dates
indicated and the results of their operations for the periods specified, except
as described in the Offering Materials (as defined in the Memorandum) and (3)
have been prepared in conformity with generally accepted accounting principles
applied on a consistent basis, except as stated therein or, in the case of
unaudited statements, as permitted by SEC Form 10-Q or 10-QSB, as applicable.
Except as set forth in the pro forma financial statements of the Company
included in the Memorandum, such pro forma financial statements comply in all
material respects with the requirements of Regulation S-X and reflect all
adjustments necessary to present fairly the pro forma financial position of the
Company at the dates indicated.
(m) From September 30, 1996 through and including the Acceptance
Date, and except as described in the Memorandum, (1) no event or development has
occurred with respect to the Company or any of its Subsidiaries or, to the
Company's knowledge, the Target Company or any of the Target Subsidiaries that,
individually or in the aggregate, has had or could reasonably be expected to
have, a material adverse effect on the Condition of the Company and its
Subsidiaries and the Target Company and its Subsidiaries, considered as one
enterprise, whether or not arising in the ordinary course of business, (2) other
than the Acquisition Agreement and the agreements relating to the Private
Placement and described in the Memorandum, there have been no material
transactions or agreements entered into by the Company or any of its
Subsidiaries or, to the Company's knowledge, the Target Company or any of the
Target Subsidiaries other than those in the ordinary course of business, (3)
except pursuant to agreements relating to the Private Placement and described in
the Memorandum, neither the Company nor any of its Subsidiaries has issued or
purported to issue any securities or, other than in the ordinary course of
business, incurred any material liability or obligation, direct or contingent,
for borrowed money, and (4) neither the Company nor any of its Subsidiaries and,
to the Company's knowledge, neither the Target Company nor any of the Target
Subsidiaries has not entered into or modified any outstanding, material
agreement with, or plan or undertaking submitted to, any regulatory or
supervisory agency or body which would materially modify the ability of the
Company and its Subsidiaries or the Target Company and the Target Subsidiaries
to continue to conduct their respective businesses as now currently conducted.
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<PAGE>
(n) The Company's capitalization as of September 30, 1996 and as
adjusted to give effect to the issuance of the Securities are as set forth in
the Memorandum under the heading "USE OF PROCEEDS AND CAPITALIZATION" and the
Securities conform in all material respects to the respective descriptions
thereof in the Memorandum.
(o) Except as disclosed in the Memorandum, the Company and its
Subsidiaries and, to the Company's knowledge, the Target Company and the Target
Subsidiaries have conducted and are conducting their businesses so as to comply
in all material respects with all applicable statutes and regulations to which a
failure to comply could, individually or in the aggregate, reasonably be
expected to have a material adverse effect on the Condition of the Company and
its Subsidiaries and the Target Company and its Subsidiaries, considered as one
enterprise. Except as disclosed in the Memorandum, neither the Company nor any
of its Subsidiaries and, to the Company's knowledge, neither the Target Company
nor any of the Target Subsidiaries is materially in violation of any written
directive from any regulatory or governmental body to make any material change
in the method of conducting its business; there is no charge, investigation,
action, suit or proceeding before or by any court or governmental agency or body
(domestic or foreign) pending or, to the knowledge of the Company, threatened
against the Company or any of its Subsidiaries or, to the Company's knowledge,
the Target Company or any of the Target Subsidiaries that is material to the
Condition of the Company and its Subsidiaries and the Target Company and the
Target Subsidiaries, considered as one enterprise, except as may be disclosed in
the Memorandum; all pending or threatened legal or governmental proceedings to
which the Company or any of its Subsidiaries or, to the Company's knowledge, the
Target Company or any of the Target Subsidiaries is a party or of which any of
their respective properties or assets is the subject which are not described in
the Memorandum, including ordinary routine litigation incidental to their
business, considered in the aggregate, could not reasonably be expected to have
a material adverse effect upon the Condition of the Company and its Subsidiaries
and the Target Company and the Target Subsidiaries, considered as one
enterprise.
6. REPRESENTATIONS, WARRANTIES AND COVENANTS OF THE SUBSCRIBER
The Subscriber hereby represents, warrants and covenants to the
Company as follows:
(a) If the Subscriber is a corporation, the Subscriber is duly
incorporated, validly existing and in good standing under the laws of its
jurisdiction of organization, with full power and authority (corporate and
other) to perform its obligations under this Agreement.
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<PAGE>
If the Subscriber is a trust, the Trustee has been duly appointed
as Trustee of the Subscriber with full power and authority to act on behalf of
the Subscriber and to perform the obligations of the Subscriber under this
Agreement.
If the Subscriber is a limited partnership, the Subscriber is
duly organized, validly existing and in good standing under the laws of its
jurisdiction of organization, with full power and authority to perform its
obligations under this Agreement.
If the Subscriber is an individual, the Subscriber has the full
power and authority to perform its obligations under this Agreement.
(b) The execution, delivery and performance of this Agreement by the
Subscriber and the consummation by the Subscriber of the transactions
contemplated hereby have been duly authorized by all necessary corporate or
other action of the Subscriber; and this Agreement, when duly executed and
delivered by the Subscriber and accepted by the Company, will constitute a valid
and legally binding instrument, enforceable in accordance with its terms,
subject to bankruptcy, insolvency, fraudulent transfer, reorganization,
moratorium and similar laws of general applicability relating to or affecting
creditors' rights and to general equity principles.
(c) The Subscriber is not insolvent and has sufficient cash funds on
hand to purchase the Placement Shares on the terms and conditions contained in
this Agreement and has no reason to believe that it will not have such funds on
or about the Funding Date. Upon a reasonable request by the Company, the
Subscriber will provide the Company with evidence or substantiation that such
Subscriber has the financial means to satisfy its financial obligations under
this Agreement and the foregoing evidence and substantiation shall be a true and
accurate representation of such means.
(d) Except as may be disclosed on Annex B to this Agreement, no
state, federal or foreign regulatory approvals, permits, licenses or consents or
other contractual or legal obligations are required in order for the Subscriber
to enter into this Agreement or to purchase the Placement Shares. Based upon
the advice of Subscriber's counsel, Subscriber has no reason to believe that the
regulatory approvals listed on Annex B, if any, will not be received within
usual and customary time frames and without the imposition of any terms or
conditions that would have an adverse effect on the Company's operations or
strategic plan.
(e) The execution and delivery of this Agreement, the consummation by
the Subscriber of the transactions herein contemplated and the compliance by the
Subscriber with the terms hereof do not and will not conflict with, or result in
a breach or violation of any of the terms or provisions of, or constitute a
default under, the constituent documents of the Subscriber or any indenture,
mortgage, deed of trust, loan agreement or other agreement or instrument to
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which the Subscriber is a party or by which any of the Subscriber's properties
or assets are bound, or any applicable law, rule, regulation, judgment, order or
decree of any government, governmental instrumentality or court, domestic or
foreign, having jurisdiction over the Subscriber or any of the Subscriber's
properties or assets; and no consent, approval, authorization, order,
registration or qualification of or with any such government, governmental
instrumentality or court, domestic or foreign, is required for the valid
authorization, execution, delivery and performance by the Subscriber of this
Agreement or the consummation by the Subscriber of the transactions contemplated
by this Agreement except as may be disclosed on Annex B.
(f) Except as may be disclosed in the Memorandum, the Subscriber has
not entered into any contracts, arrangements, understandings or relationships
(legal or otherwise) with any other person or persons with respect to the
transactions contemplated by this Agreement or any securities of the Company,
including but not limited to transfer or voting of any of the securities,
finder's fees, joint ventures, loan or option arrangements, puts or calls,
guarantees of profits, division of profits or loss, or the giving or withholding
of proxies; and the Subscriber does not own any securities of the Company which
are pledged or otherwise subject to a contingency the occurrence of which would
give another person voting power or investment power over such securities.
(g) The Subscriber has been advised and understands that the
Placement Shares have not been registered under the Securities Act in reliance
upon the exemption from such registration provided in Section 4(2) thereof and
that the Placement Shares have not been registered under the securities laws of
any state in reliance on exemptions therefrom and, therefore, the Placement
Shares may not be resold unless registered under applicable state securities
laws or an exemption from registration is available. The Company is and will be
under no obligation to register the Placement Shares under the Securities Act
except to the extent provided in the Registration Rights Agreement (as defined
hereinafter), when executed by the Company.
(h) The Subscriber acknowledges receipt of, and has had a reasonable
opportunity to review, the Memorandum and understands that no person has been
authorized to provide any additional information regarding the Company, the
Target Company or the Proposed Acquisition (other than information which
otherwise is publicly available) or make any representations that were not
contained in such Memorandum, and the Subscriber has not relied on any such
other information or representations in making a decision to purchase any of the
Placement Shares. The Subscriber understands that an investment in the
Placement Shares involves a high degree or risk, including the risks set forth
under the heading "RISK FACTORS" in the Memorandum.
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<PAGE>
(i) The Subscriber has such knowledge and experience in financial and
business matters as to be capable of evaluating the merits and risks of an
investment in the Placement Shares, is able to bear the economic risk of an
investment in the Placement Shares, including at the date hereof, the ability to
afford a complete loss of the investment, and is (i) a sophisticated
institutional or corporate investor as well as an "accredited investor" as
defined in Rule 501(a) under the Securities Act; or (ii) a sophisticated
individual investor as well as an "accredited investor" as defined in
Rule 501(a) under the Securities Act. The Subscriber agrees to provide promptly
such additional information as may be reasonably required by the Company for
compliance with the securities laws of the state in which the Subscriber is
located.
(j) The Subscriber intends to purchase the Placement Shares offered
in the Memorandum for the account of the Subscriber and its affiliates and not,
in whole or in part, for the account of any other person. The Subscriber
represents and warrants to, and covenants and agrees with, the Company that the
Placement Shares to be acquired by it hereunder are being acquired for its own
account for investment and with no intention of distributing or reselling such
Placement Shares or any part thereof or interest therein in any transaction
which would be in violation of the securities laws of the United States of
America or any state.
(k) The Subscriber has been advised that, prior to any registration
of the Placement Shares pursuant to the provisions of the Registration Rights
Agreement, any and all certificates representing the Placement Shares and any
and all certificates issued in replacement thereof or in exchange therefor shall
bear the following legend or one substantially similar thereto:
THESE SECURITIES HAVE NOT BEEN REGISTERED UNDER THE
SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"), OR THE
SECURITIES LAWS OF ANY STATE IN RELIANCE ON EXEMPTIONS
THEREFROM AND, THEREFORE, MAY NOT BE RESOLD UNLESS
REGISTERED UNDER THE ACT AND APPLICABLE STATE SECURITIES
LAWS OR AN EXEMPTION FROM REGISTRATION IS AVAILABLE
(INCLUDING, WITHOUT LIMITATION, THE EXEMPTION PROVIDED UNDER
RULE 144A OF THE ACT).
In addition, certificates representing the Placement Shares acquired by
Subscribers located in certain states will bear additional legends as required
by the securities laws of those states.
(l) The Subscriber will not sell or otherwise transfer any of the
Placement Shares, except in compliance with the provisions of the applicable
securities laws and as stated in any legend. The Subscriber has been advised
that (i) there are significant restrictions on the transfer or the Placement
Shares, (ii) there is no active market for the Common Stock, (iii) no
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trading market for the Placement Shares is likely to be available in the
foreseeable future, and (iv) an investment in the Placement Shares may be
extremely illiquid.
7. FUNDING CONDITIONS.
The respective obligations of the Subscriber and the Company to consummate
the purchase and sale of the Placement Shares and, if applicable, the payment of
the Commitment Fee shall be subject, in the discretion of the Company or the
Subscriber, as the case may be, to the following conditions:
(a) All representations and warranties and other statements of the
other party are, at and as of the Funding Time (except as expressly provided
otherwise), true and correct in all material respects (assuming that the other
party shall have performed in all material respects all of its obligations
hereunder theretofore to be performed).
(b) The Company has complied in all material respects with all
agreements and satisfied in all material respects all conditions on its part to
be performed or satisfied hereunder at or prior to the Funding.
(c) No stop order suspending the Private Placement shall have been
issued, and no proceeding for that purpose shall have been instituted or, to the
knowledge of the Company or the Subscriber, threatened by any regulatory or
governmental body.
(d) The Company shall have entered into an Acquisition Agreement that
is substantially similar in all material respects to the Acquisition Agreement
described in the Memorandum, which Acquisition Agreement shall provide for
Merger Consideration (as defined in the Memorandum) of not more than $23.00 per
share of Target Company common stock; all of the material conditions to the
closing of the Acquisition shall have been satisfied or, if permitted, duly
waived, and the Funding of the sale of the Placement Shares shall occur prior
to, but substantially simultaneous with, the closing of the Acquisition pursuant
to the Acquisition Agreement.
(e) Other than as contemplated by the Memorandum, there shall not
have been any change effected without the Subscriber's prior written consent
(which shall not be unreasonable withheld) after the date of this Agreement in
the charter or other organizational document or bylaws of the Company adversely
affecting the rights of the holders of the Placement Shares; PROVIDED, HOWEVER,
that an increase in the Company's authorized capital stock, whether or not
described in the Memorandum, shall not be deemed to adversely affect the rights
of the holders of the Placement Shares.
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<PAGE>
(f) At the Funding, the Subscriber shall have received a
certificate, dated as of the Funding Date, of the Chief Executive Officer and
the Chief Financial Officer of the Company in which such officers state that, to
their knowledge, the closing conditions specified in paragraphs (a) through (e)
of this Section have been satisfied.
(g) At the Funding, the Company shall have executed and delivered to
the Subscriber a registration rights agreement in the form attached hereto as
Annex C (the "Registration Rights Agreement").
(h) At the Funding, the Company and the Subscriber shall have
received the customary form of opinion, dated as of such date, of Nutter,
McClennen & Fish, LLP, outside counsel for the Company, in form and substance
satisfactory to your counsel, and such other customary closing documentation as
the parties may reasonably request.
8. SURVIVAL OF REPRESENTATIONS, WARRANTIES AND AGREEMENTS.
Notwithstanding any investigation made by any party to this Agreement, all
covenants, agreements, representations and warranties made by the Company and
the Subscriber herein shall survive the execution of this Agreement, the
delivery to the Subscriber of certificates representing the Placement Shares
being purchased and the payment therefor.
9. BROKER'S FEE.
The Subscriber represents to the Company that it has taken no action which
would entitle anyone to a broker's or finder's fee or other compensation in
connection with the transactions contemplated hereby.
10. INDEMNITY.
The Subscriber agrees to indemnify and hold harmless the Company and each
employee, officer and director of the Company from and against any loss, damage
or liability caused by or arising out of a breach of any representation,
warranty or agreement of the Subscriber contained in this Agreement or in any
other document provided by the Subscriber to the Company in connection with the
Subscriber's investment in Placement Shares.
11. TERMINATION.
(a) Either of the parties hereto may terminate this Agreement (i) if
the Funding Date does not occur by August 15, 1997 through no fault of the
Subscriber, (ii) any federal or state regulator shall have made a final
determination denying an application of either party to the Acquisition
Agreement, the granting of which is essential to the consummation of the
Proposed
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Acquisition, or (iii) the Target Company terminates the Acquisition Agreement.
In addition, this Agreement shall terminate upon mutual consent of the parties
hereto.
(b) The Company and the Subscriber hereby agree that any termination
of this Agreement pursuant to Section 11(a) (other than termination in the event
of a breach of this Agreement by the Subscriber or misrepresentation of any of
the statements made herein by the Subscriber) shall be without liability of the
Company or the Subscriber.
12. NOTICES.
All communications hereunder shall be in writing and, if to the
Company, will be mailed, delivered or telecopied and confirmed to it at One
Pacific Plaza, 7777 Center Avenue, Huntington Beach, California 92647,
Attention: Robert P. Keller, Facsimile: (714) 891-8884; and if to the
Subscriber, will be mailed, delivered or telecopied and confirmed to it at the
address set forth on the signature page hereto;
13. BINDING EFFECT.
This Agreement shall be binding upon, and shall inure solely to the
benefit of, each of the parties hereto, and each of their respective heirs,
executors, administrators, successors and permitted assigns, and no other person
shall acquire or have any right under or by virtue of this Agreement.
14. GOVERNING LAW.
This Agreement shall be governed by, and construed in accordance with
the laws of the State of Delaware without regard to the conflict of law
provisions thereof.
15. ENTIRE AGREEMENT.
This Agreement represents the entire understanding of the parties with
respect to the matters addressed herein and supersedes all prior written and
oral understandings concerning the subject matter herein.
16. ASSIGNMENT.
This Agreement may not be assigned by the Subscriber without the consent of
the Company.
17. SUCCESSORS.
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<PAGE>
This Agreement shall inure to the benefit of and be binding upon the
Company, the Subscriber and their respective successors and permitted assigns.
Nothing expressed herein is intended or shall be construed to give any person
other than the persons referred to in the preceding sentence any legal or
equitable right, remedy or claim under or in respect of this Agreement.
18. SEVERABILITY OF PROVISIONS.
Any covenant, provision, agreement or term of this Agreement that is
prohibited or is held to be void or unenforceable in any jurisdiction shall as
to such jurisdiction, be ineffective to the extent of such prohibition or
unenforceability without invalidating the remaining provisions thereof.
19. MISCELLANEOUS.
Neither this Agreement nor any term hereof may be changed, waived,
discharged or terminated orally, but only by an instrument in writing signed by
the party against whom enforcement of the change, waiver, discharge or
termination is sought. The headings in this Agreement are for the purposes of
references only and shall not limit or otherwise affect the meaning hereof.
20. EXECUTION IN COUNTERPARTS.
This Agreement may be executed in any number of the counterparts, each
of which counterparts when so executed and delivered shall be deemed to be an
original, but all such respective counterparts shall together constitute but one
and the same instrument.
* * *
-15-
<PAGE>
IN WITNESS WHEREOF, and intending to be legally bound thereby, each of the
Subscriber and Commerce Security Bancorp, Inc. has signed or caused to be signed
its name under seal as of the day and year first above written.
Maximum Number of Shares of INDIVIDUAL INVESTOR:
Common Stock Desired
To Be Purchased
Hereunder: --------------------------------
(Print Name)
- --------------------------- --------------------------------
(Signature)
Mailing
Address:
-----------------------------
-----------------------------
Telephone:
----------------------------
Facsimile:
----------------------------
PARTNERSHIP, CORPORATION, TRUST OR
INSTITUTIONAL INVESTOR:
-----------------------------------
(Print Name of Entity)
By:
-------------------------------
Name:
Title:
Jurisdiction
of Organization:
--------------------------
Mailing
Address:
----------------------------------
----------------------------------
Telephone:
----------------------------------
Facsimile:
----------------------------------
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<PAGE>
ACCEPTANCE OF SUBSCRIPTION
The Company hereby accepts the above subscription for Placement Shares.
COMMERCE SECURITY BANCORP, INC.
By:
----------------------------------
Name: Robert P. Keller
Title: President and Chief Executive Officer
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<PAGE>
ANNEX B
DESCRIPTION OF REQUIRED REGULATORY APPROVALS
TO BE OBTAINED BY THE SUBSCRIBER
-18-
<PAGE>
SUBSCRIPTION AGREEMENT
(COMMON STOCK)
THIS SUBSCRIPTION AGREEMENT (the "Agreement") is made and entered into as
of the ___ day of _____________, 199__, by and between Commerce Security
Bancorp, Inc., a Delaware corporation with its principal place of business
located in Huntington Beach, California (the "Company"), and the investor whose
name appears on the signature page hereto (the "Subscriber").
WHEREAS, the Company is seeking commitments from several accredited
investors through a private placement (the "Private Placement") of shares of its
common stock, par value $.01 (the "Common Stock"), and certain other securities
in connection with the proposed acquisition (the "Acquisition") by the Company
of the Target Company (as such term is used in the Company's December 18, 1996
Private Placement Memorandum pertaining to the Private Placement (together with
the December 20, 1996 Supplement and any other supplement, amendment or annex
thereof or any document incorporated by reference therein, the "Memorandum"));
WHEREAS, the Subscriber desires to commit irrevocably to purchase, subject
only to those certain limited conditions described hereinafter, specified
amounts of the Company's Common Stock and to subscribe for and purchase such
amounts (the "Subscription"), at a per share price of $4.81 (the "Subscription
Price"), all as is more particularly set forth herein;
WHEREAS, if the Company enters into a definitive acquisition agreement (the
"Acquisition Agreement") with the Target Company, certain events including the
Target Company Redemption as defined in the Memorandum (each a "Reduction
Event") could have the effect of reducing the number of Placement Shares (as
hereinafter defined) to be sold to the Subscriber; and
WHEREAS, in connection with the Private Placement, the Subscriber desires
to obtain and the Company is willing to grant to the Subscriber certain
registration rights with respect to the Placement Shares;
NOW, THEREFORE, in consideration of the foregoing and the respective
representations, warranties, covenants and other agreements set forth herein,
and intending to be legally bound hereby, the parties hereto agree as follows:
<PAGE>
1. PURCHASE AND DELIVERY OF PLACEMENT SHARES
(a) Subject to the terms and conditions herein set forth, the Subscriber
hereby irrevocably agrees and commits to purchase from the Company, at the
Subscription Price per share, up to the number of shares of Common Stock as are
specified on the signature page hereof (as the same may be reduced as a
consequence of a Reduction Event, the "Placement Shares").
(b) The Subscriber acknowledges and agrees that its Subscription is hereby
conditioned upon acceptance by the Company and may be accepted or rejected, in
whole (but not in part), by the Company in its sole discretion (the date on
which the Company accepts this Subscription Agreement being hereinafter called
the "Acceptance Date").
(c) The Subscriber and the Company hereby acknowledge and agree that (x)
the Company has entered into, or contemplates entering into, one or more other
Common Stock Subscription Agreements with certain other parties (collectively,
the "Subscribers") on terms substantially similar to this Agreement (except that
they may provide for the purchase of a different maximum number of Placement
Shares) and (y) the occurrence of one or more Reduction Events could have the
effect of reducing or eliminating the number of Placement Shares available
hereunder. Subject to Section 1(d), the Placement Shares available for issuance
to Subscribers shall be allocated as nearly as possible on a pro rata basis
among all Subscribers based upon the number of Placement Shares subscribed for
by each such Subscriber, after giving effect to the limitation set forth in
Section 4(b).
(d) No reduction in the number of Placement Shares available for issuance
to Subscribers as a consequence of a Reduction Event shall reduce the
Subscriber's Maximum Share Amount (as defined hereinafter) by more than
one-third. No such reduction shall be made to the number of Placement Shares
that Dartmouth Capital Group, L.P. and certain related parties shall be entitled
to purchase in exchange for funding the Deposit (as defined in the Memorandum)
with the Target Company.
(e) Subject to the terms, conditions and limitations herein set forth, the
Company shall pay to the Subscriber at the Funding (as hereinafter defined) a
commitment fee (the "Commitment Fee") equal to one percent (1%) of the product
of the Subscription Price multiplied by the difference between (x) the number of
shares that the Company had agreed to make available to the Subscriber at the
time of the Company's acceptance of the Subscription (the "Maximum Share
Amount") and (y) the number of Placement Shares actually issued to the
Subscriber, provided that the Subscriber has fully complied with all of the
terms of this Agreement.
-2-
<PAGE>
2. THE FUNDING
As soon as practicable following its final determination of the total
number of Placement Shares available for sale to the Subscribers made in
anticipation of the closing of the transactions contemplated hereby, the Company
shall notify the Subscriber of the number of Placement Shares, to be purchased
by the Subscriber pursuant to Section 1(a) and the amount of the Commitment Fee
to be paid pursuant to Section 1(e). Contemporaneously with the execution and
delivery of this Agreement, the Subscriber has executed and delivered to the
Company the Escrow Agreement in the form attached as Annex A to this Agreement.
The Subscriber agrees to deliver payment for the Placement Shares, net of the
Commitment Fee, to the Company's escrow agent for deposit in an escrow account
within three (3) business days following receipt of notice from the Company that
all of the material conditions to the closing of the Acquisition have been
satisfied or, if permitted, duly waived. The name of the escrow agent and
instructions for payment of the aggregate Subscription Price shall be included
in the Company's notice. The delivery of, and the release from escrow of the
payment for, the Placement Shares shall take place at the executive offices of
the Company at One Pacific Plaza, 7777 Center Avenue, Huntington Beach,
California, at 9:00 a.m., California time, prior to, but substantially
simultaneously with, the closing of the Acquisition, such time and date to be
not more than five (5) business days after the foregoing notification and to be
specified therein (such time and date being referred to as the "Funding Time,"
the date of the Funding being referred to as the "Funding Date" and the
consummation of the Private Placement being referred to as the "Funding").
3. DELIVERY OF PLACEMENT SHARES
At the Funding, the Placement Shares to be sold to the Subscriber
hereunder, registered in the name of the Subscriber or its nominee(s), as the
Subscriber may specify in writing at least three (3) days prior to the Funding
Date, shall be delivered by or on behalf of the Company to the Subscriber, for
the Subscriber's account, against delivery by the Subscriber of the aggregate
Subscription Price therefor, net of the Commitment Fee, in immediately available
funds in the form of one or more federal funds checks or a wire transfer to an
account designated by the Company. If the Subscriber shall fail to timely
provide information regarding the registered holder of the Placement Shares,
such shares shall be delivered to the Subscriber in the form of one certificate
registered in the Subscriber's name.
4. AGREEMENTS AND CONSENTS OF THE SUBSCRIBER
The Subscriber hereby agrees with the Company as follows:
(a) Subject only to the immediately following sentence, the
Subscriber agrees that this Agreement is irrevocable and that the rights and
obligations of any party hereto shall not be terminated or affected by operation
of law, whether by death, incompetence, disability or the
-3-
<PAGE>
occurrence of any other event affecting a Subscriber. If and only if the
Company has not accepted this Subscription Agreement in accordance with Section
1(b) on or before the twentieth (20th) calendar day following the Subscriber's
delivery hereof to the Company, then at any time after such date but before the
acceptance hereof by the Company, the Subscriber may withdraw its Subscription
hereunder by notice to the Company. In the event that the Company has not
entered into the Acquisition Agreement on or before January 15, 1997, the
Company or the Subscriber may upon five (5) business days' notice to the other
party hereto terminate this Agreement, which termination shall be without
liability to either party. In the event that the Funding Date does not occur on
or before August 15, 1997 or the Acquisition Agreement is terminated, this
Agreement shall terminate without liability to any party hereto.
(b) Notwithstanding anything to the contrary contained herein, the
Subscriber acknowledges and agrees that the Company may decline to issue any of
the Placement Shares or pay any portion of the Commitment Fee to the Subscriber
hereunder if, in the reasonable opinion of the Company's counsel, the Subscriber
is required to obtain prior clearance or approval of such transaction from any
state or federal bank regulatory authority and if, in the reasonable opinion of
such counsel, the requisite approval or clearance has not been obtained or
satisfactory evidence thereof has not been presented to the Company by the
Funding Date.
(c) The Subscriber hereby acknowledges and understands that although
the Company has retained The Shattan Group LLC ("TSG") to serve as placement
agent in connection with the offering of securities other than Common Stock in
connection with the Private Placement, the Subscriber has not relied upon any
representation made or information provided by TSG in the Subscriber's decision
to enter into a Subscription Agreement or otherwise invest in the Placement
Shares.
5. REPRESENTATIONS AND WARRANTIES OF THE COMPANY
The Company hereby represents and warrants to the Subscriber as
follows:
(a) As of the Acceptance Date, the Company is, and at all times
thereafter through the time of the Funding, the Company will have been, duly
organized and validly existing and in good standing as a corporation organized
under the laws of the State of Delaware, with corporate power and authority to
own, lease and operate its properties and to conduct its business as described
in the Memorandum and to perform its obligations under this Agreement.
(b) Each direct or indirect wholly-owned subsidiary of the Company
(each, a "Subsidiary"), and to the Company's knowledge, each direct or indirect
wholly-owned subsidiary of the Target Company (each, a "Target Subsidiary"), has
been duly incorporated and is validly existing as a corporation in good standing
under the laws of the jurisdiction of its incorporation and is duly qualified as
a foreign corporation to transact business and is in good standing in each
-4-
<PAGE>
jurisdiction where the failure to so qualify would have a material adverse
effect on the conduct of the business of, the condition (financial or otherwise)
of, or the earnings or business of (collectively, the "Condition") the Company
and its Subsidiaries and the Target Company and the Target Subsidiaries
considered as one enterprise; all of the issued and outstanding capital stock of
each Subsidiary has been duly authorized and validly issued and is fully paid
and (except as provided by law) nonassessable and is owned by the Company,
directly or through Subsidiaries, free and clear of any mortgage, pledge, lien,
encumbrance or claim whatsoever, and to the Company's knowledge, all of the
issued and outstanding capital stock of each Target Subsidiary has been duly
authorized and validly issued and is fully paid and (except as provided by law)
nonassessable and is owned by the Target Company, directly or through Target
Subsidiaries, free and clear of any mortgage, pledge, lien, encumbrance or claim
whatsoever; except for the Subsidiaries and other than as reflected in the
financial statements or except as otherwise reflected in the Memorandum, the
Company does not and, to the Company's knowledge, the Target Company does not,
directly or indirectly, own any shares of stock or any securities of any
corporation or have any equity interest in any firm, partnership, association or
other entity.
(c) The Company and its Subsidiaries and, to the Company's knowledge,
the Target Company and the Target Subsidiaries possess all material licenses,
permits and other governmental authorizations as are currently required for the
conduct of their respective businesses, and all such licenses, permits and other
governmental authorizations are in full force and effect; the Company and its
Subsidiaries and, to the Company's knowledge, the Target Company and the Target
Subsidiaries are in compliance therewith except to the extent that
non-compliance would not, individually or in the aggregate, have a material
adverse effect on the Condition of the Company and its Subsidiaries and the
Target Company and the Target Subsidiaries considered as one enterprise; and
neither the Company nor any of its Subsidiaries or, to the Company's knowledge,
neither the Target Company nor any of the Target Subsidiaries has received
notice of any proceeding or action relating to the revocation or modification of
any such material license, permit or other governmental authorization.
(d) Neither the Company nor any of the Subsidiaries and, to the
Company's knowledge, neither the Target Company nor any of the Target
Subsidiaries is in violation of its charter or other organizational document or
bylaws or materially in default in the performance or observance of the
obligations, agreements, covenants or conditions contained in any contract,
indenture, mortgage, loan agreement, note, lease or other instrument to which it
is a party or by which it or any of them or any of their properties may be bound
and that is material to the Company and its Subsidiaries and the Target Company
and the Target Subsidiaries considered as one enterprise.
(e) The execution, delivery and performance of this Agreement by the
Company and the consummation by the Company of the transactions contemplated
hereby, including the filing of an amended and restated Certificate of
Incorporation (the "Amended and Restated
-5-
<PAGE>
Charter") which contemplates the terms of the Placement Shares and the
Securities (as defined in the Memorandum) offered in the Private Placement, have
been duly authorized by all necessary corporate action of the Company, and
constitute a valid and legally binding instrument of the Company enforceable in
accordance with its terms, subject to bankruptcy, insolvency, fraudulent
transfer, reorganization, moratorium and similar laws of general applicability
relating to or affecting creditors' rights and to general equity principles.
(f) The execution and delivery of this Agreement, the consummation by
the Company of the transactions herein contemplated and the compliance by the
Company with the terms hereof will not conflict with, or result in a breach or
violation of any of the terms or provisions of, or constitute a default under,
the Certificate of Incorporation, assuming the filing, prior to the Funding, of
the Amended and Restated Charter, or Bylaws of the Company, or any indenture,
mortgage, deed of trust, loan agreement or other agreement or instrument to
which the Company is a party or by which any of its properties or assets are
bound, with such exceptions as would not have a material adverse effect on the
Condition of the Company and its Subsidiaries and the Target Company and the
Target Subsidiaries, considered as one enterprise, or any applicable law, rule,
regulation, judgment, order or decree of any governmental, governmental
instrumentality or court having jurisdiction over the Company or any of its
properties or assets; and no consent, approval, authorization, order,
registration or qualification of or with any such government, governmental
instrumentality or court is required for the valid authorization, execution,
delivery and performance by the Company of this Agreement, the Placement Shares,
and the Commitment Fee or the consummation by the Company of the other
transactions contemplated by this Agreement, except such federal and state
regulatory approvals as are described in the Memorandum and such consents,
approvals, authorizations, registrations or qualification as may be required
under state securities or "blue sky" laws.
(g) When issued and delivered by the Company against payment
therefor, the Placement Shares will be duly authorized, validly issued, fully
paid and non-assessable, and the forms of certificates evidencing the Placement
Shares will be in due and proper form.
(h) Relying in part on the representations and warranties of the
Subscribers set forth in Section 6, the offering of the Placement Shares to the
Subscriber is exempt from registration under the Securities Act of 1933, as
amended (the "Securities Act"), pursuant to Section 4(2) thereof.
(i) The Memorandum does not contain an untrue statement of a material
fact or omit to state a material fact required to be stated therein or necessary
to make the statements therein, in light of the circumstances under which they
were made, not misleading with respect to information regarding the Company and
its Subsidiaries, and as of the date of the Memorandum and at all times
thereafter through the Acceptance Date, the Memorandum will not contain an
untrue statement of a material fact or omit to state a material fact necessary
in order to make the
-6-
<PAGE>
statements therein, in light of the circumstances under which they were made,
not misleading with respect to information regarding the Company and its
Subsidiaries.
(j) The Company has no reason to believe that the information
concerning the Target Company that is contained in the Memorandum is not true
and correct in all material respects or that the representations and warranties
of the Target Company as set forth in the Acquisition Agreement (as defined in
the Memorandum) are not true and correct in all material respects.
(k) The accountants who certified the financial statements and
supporting schedules of SDN Bancorp, Inc., Liberty National Bank and Commerce
Security Bank included in the 1996 Information Statement (as defined in the
Memorandum) are independent public accountants within the meaning of the
Securities Act and the rules and regulations promulgated thereunder (the
"Securities Act Regulations").
(l) The financial statements of the Company as at September 30, 1996
and for the three- and nine-month periods then ended included in the Memorandum
and the historical financial statements of SDN Bancorp, Inc., Liberty National
Bank and Commerce Security Bank included in the 1996 Information Statement (1)
comply in all material respects, except as may be reflected in the notes to the
financial statements, as to form with the accounting requirements of the
Securities Act, the Securities Act Regulations, and the Securities Exchange Act
of 1934, as amended (the "Exchange Act"), (2) present fairly in all material
respects the financial position of the respective entities as at the dates
indicated and the results of their operations for the periods specified, except
as described in the Offering Materials (as defined in the Memorandum) and (3)
have been prepared in conformity with generally accepted accounting principles
applied on a consistent basis, except as stated therein or, in the case of
unaudited statements, as permitted by SEC Form 10-Q or 10-QSB, as applicable.
Except as set forth in the pro forma financial statements of the Company
included in the Memorandum, such pro forma financial statements comply in all
material respects with the requirements of Regulation S-X and reflect all
adjustments necessary to present fairly the pro forma financial position of the
Company at the dates indicated.
(m) From September 30, 1996 through and including the Acceptance
Date, and except as described in the Memorandum, (1) no event or development has
occurred with respect to the Company or any of its Subsidiaries or, to the
Company's knowledge, the Target Company or any of the Target Subsidiaries that,
individually or in the aggregate, has had or could reasonably be expected to
have, a material adverse effect on the Condition of the Company and its
Subsidiaries and the Target Company and its Subsidiaries, considered as one
enterprise, whether or not arising in the ordinary course of business, (2) other
than the Acquisition Agreement and the agreements relating to the Private
Placement and described in the Memorandum, there have been no material
transactions or agreements entered into by the Company or any of its
Subsidiaries or, to the Company's knowledge, the Target Company or any
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<PAGE>
of the Target Subsidiaries other than those in the ordinary course of business,
(3) except pursuant to agreements relating to the Private Placement and
described in the Memorandum, neither the Company nor any of its Subsidiaries has
issued or purported to issue any securities or, other than in the ordinary
course of business, incurred any material liability or obligation, direct or
contingent, for borrowed money, and (4) neither the Company nor any of its
Subsidiaries and, to the Company's knowledge, neither the Target Company nor any
of the Target Subsidiaries has not entered into or modified any outstanding,
material agreement with, or plan or undertaking submitted to, any regulatory or
supervisory agency or body which would materially modify the ability of the
Company and its Subsidiaries or the Target Company and the Target Subsidiaries
to continue to conduct their respective businesses as now currently conducted.
(n) The Company's capitalization as of September 30, 1996 and as
adjusted to give effect to the issuance of the Securities are as set forth in
the Memorandum under the heading "USE OF PROCEEDS AND CAPITALIZATION" and the
Securities conform in all material respects to the respective descriptions
thereof in the Memorandum.
(o) Except as disclosed in the Memorandum, the Company and its
Subsidiaries and, to the Company's knowledge, the Target Company and the Target
Subsidiaries have conducted and are conducting their businesses so as to comply
in all material respects with all applicable statutes and regulations to which a
failure to comply could, individually or in the aggregate, reasonably be
expected to have a material adverse effect on the Condition of the Company and
its Subsidiaries and the Target Company and its Subsidiaries, considered as one
enterprise. Except as disclosed in the Memorandum, neither the Company nor any
of its Subsidiaries and, to the Company's knowledge, neither the Target Company
nor any of the Target Subsidiaries is materially in violation of any written
directive from any regulatory or governmental body to make any material change
in the method of conducting its business; there is no charge, investigation,
action, suit or proceeding before or by any court or governmental agency or body
(domestic or foreign) pending or, to the knowledge of the Company, threatened
against the Company or any of its Subsidiaries or, to the Company's knowledge,
the Target Company or any of the Target Subsidiaries that is material to the
Condition of the Company and its Subsidiaries and the Target Company and the
Target Subsidiaries, considered as one enterprise, except as may be disclosed in
the Memorandum; all pending or threatened legal or governmental proceedings to
which the Company or any of its Subsidiaries or, to the Company's knowledge, the
Target Company or any of the Target Subsidiaries is a party or of which any of
their respective properties or assets is the subject which are not described in
the Memorandum, including ordinary routine litigation incidental to their
business, considered in the aggregate, could not reasonably be expected to have
a material adverse effect upon the Condition of the Company and its Subsidiaries
and the Target Company and the Target Subsidiaries, considered as one
enterprise.
-8-
<PAGE>
6. REPRESENTATIONS, WARRANTIES AND COVENANTS OF THE SUBSCRIBER
The Subscriber hereby represents, warrants and covenants to the
Company as follows:
(a) If the Subscriber is a corporation, the Subscriber is duly
incorporated, validly existing and in good standing under the laws of its
jurisdiction of organization, with full power and authority (corporate and
other) to perform its obligations under this Agreement.
If the Subscriber is a trust, the Trustee has been duly appointed
as Trustee of the Subscriber with full power and authority to act on behalf of
the Subscriber and to perform the obligations of the Subscriber under this
Agreement.
If the Subscriber is a limited partnership, the Subscriber is
duly organized, validly existing and in good standing under the laws of its
jurisdiction of organization, with full power and authority to perform its
obligations under this Agreement.
If the Subscriber is an individual, the Subscriber has the full
power and authority to perform its obligations under this Agreement.
(b) The execution, delivery and performance of this Agreement by the
Subscriber and the consummation by the Subscriber of the transactions
contemplated hereby have been duly authorized by all necessary corporate or
other action of the Subscriber; and this Agreement, when duly executed and
delivered by the Subscriber and accepted by the Company, will constitute a valid
and legally binding instrument, enforceable in accordance with its terms,
subject to bankruptcy, insolvency, fraudulent transfer, reorganization,
moratorium and similar laws of general applicability relating to or affecting
creditors' rights and to general equity principles.
(c) The Subscriber is not insolvent and has sufficient cash funds on
hand to purchase the Placement Shares on the terms and conditions contained in
this Agreement and has no reason to believe that it will not have such funds on
or about the Funding Date. Upon a reasonable request by the Company, the
Subscriber will provide the Company with evidence or substantiation that such
Subscriber has the financial means to satisfy its financial obligations under
this Agreement and the foregoing evidence and substantiation shall be a true and
accurate representation of such means.
(d) Except as may be disclosed on Annex B to this Agreement, no
state, federal or foreign regulatory approvals, permits, licenses or consents or
other contractual or legal obligations are required in order for the Subscriber
to enter into this Agreement or to purchase the Placement Shares. Based upon
the advice of Subscriber's counsel, Subscriber has no reason
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<PAGE>
to believe that the regulatory approvals listed on Annex B, if any, will not be
received within usual and customary time frames and without the imposition of
any terms or conditions that would have an adverse effect on the Company's
operations or strategic plan.
(e) The execution and delivery of this Agreement, the consummation by
the Subscriber of the transactions herein contemplated and the compliance by the
Subscriber with the terms hereof do not and will not conflict with, or result in
a breach or violation of any of the terms or provisions of, or constitute a
default under, the constituent documents of the Subscriber or any indenture,
mortgage, deed of trust, loan agreement or other agreement or instrument to
which the Subscriber is a party or by which any of the Subscriber's properties
or assets are bound, or any applicable law, rule, regulation, judgment, order or
decree of any government, governmental instrumentality or court, domestic or
foreign, having jurisdiction over the Subscriber or any of the Subscriber's
properties or assets; and no consent, approval, authorization, order,
registration or qualification of or with any such government, governmental
instrumentality or court, domestic or foreign, is required for the valid
authorization, execution, delivery and performance by the Subscriber of this
Agreement or the consummation by the Subscriber of the transactions contemplated
by this Agreement except as may be disclosed on Annex B.
(f) Except as may be disclosed in the Memorandum, the Subscriber has
not entered into any contracts, arrangements, understandings or relationships
(legal or otherwise) with any other person or persons with respect to the
transactions contemplated by this Agreement or any securities of the Company,
including but not limited to transfer or voting of any of the securities,
finder's fees, joint ventures, loan or option arrangements, puts or calls,
guarantees of profits, division of profits or loss, or the giving or withholding
of proxies; and the Subscriber does not own any securities of the Company which
are pledged or otherwise subject to a contingency the occurrence of which would
give another person voting power or investment power over such securities.
(g) The Subscriber has been advised and understands that the
Placement Shares have not been registered under the Securities Act in reliance
upon the exemption from such registration provided in Section 4(2) thereof and
that the Placement Shares have not been registered under the securities laws of
any state in reliance on exemptions therefrom and, therefore, the Placement
Shares may not be resold unless registered under applicable state securities
laws or an exemption from registration is available. The Company is and will be
under no obligation to register the Placement Shares under the Securities Act
except to the extent provided in the Registration Rights Agreement (as defined
hereinafter), when executed by the Company.
(h) The Subscriber acknowledges receipt of, and has had a reasonable
opportunity to review, the Memorandum and understands that no person has been
authorized to
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<PAGE>
provide any additional information regarding the Company, the Target Company or
the Proposed Acquisition (other than information which otherwise is publicly
available) or make any representations that were not contained in such
Memorandum, and the Subscriber has not relied on any such other information or
representations in making a decision to purchase any of the Placement Shares.
The Subscriber understands that an investment in the Placement Shares involves a
high degree or risk, including the risks set forth under the heading "RISK
FACTORS" in the Memorandum.
(i) The Subscriber has such knowledge and experience in financial and
business matters as to be capable of evaluating the merits and risks of an
investment in the Placement Shares, is able to bear the economic risk of an
investment in the Placement Shares, including at the date hereof, the ability to
afford a complete loss of the investment, and is (i) a sophisticated
institutional or corporate investor as well as an "accredited investor" as
defined in Rule 501(a) under the Securities Act; or (ii) a sophisticated
individual investor as well as an "accredited investor" as defined in
Rule 501(a) under the Securities Act. The Subscriber agrees to provide promptly
such additional information as may be reasonably required by the Company for
compliance with the securities laws of the state in which the Subscriber is
located.
(j) The Subscriber intends to purchase the Placement Shares offered
in the Memorandum for the account of the Subscriber and its affiliates and not,
in whole or in part, for the account of any other person. The Subscriber
represents and warrants to, and covenants and agrees with, the Company that the
Placement Shares to be acquired by it hereunder are being acquired for its own
account for investment and with no intention of distributing or reselling such
Placement Shares or any part thereof or interest therein in any transaction
which would be in violation of the securities laws of the United States of
America or any state.
(k) The Subscriber has been advised that, prior to any registration
of the Placement Shares pursuant to the provisions of the Registration Rights
Agreement, any and all certificates representing the Placement Shares and any
and all certificates issued in replacement thereof or in exchange therefor shall
bear the following legend or one substantially similar thereto:
THESE SECURITIES HAVE NOT BEEN REGISTERED UNDER THE
SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"), OR THE
SECURITIES LAWS OF ANY STATE IN RELIANCE ON EXEMPTIONS
THEREFROM AND, THEREFORE, MAY NOT BE RESOLD UNLESS
REGISTERED UNDER THE ACT AND APPLICABLE STATE SECURITIES
LAWS OR AN EXEMPTION FROM REGISTRATION IS AVAILABLE
(INCLUDING, WITHOUT LIMITATION, THE EXEMPTION PROVIDED UNDER
RULE 144A OF THE ACT).
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<PAGE>
In addition, certificates representing the Placement Shares acquired by
Subscribers located in certain states will bear additional legends as required
by the securities laws of those states.
(l) The Subscriber will not sell or otherwise transfer any of the
Placement Shares, except in compliance with the provisions of the applicable
securities laws and as stated in any legend. The Subscriber has been advised
that (i) there are significant restrictions on the transfer or the Placement
Shares, (ii) there is no active market for the Common Stock, (iii) no trading
market for the Placement Shares is likely to be available in the foreseeable
future, and (iv) an investment in the Placement Shares may be extremely
illiquid.
7. FUNDING CONDITIONS.
The respective obligations of the Subscriber and the Company to consummate
the purchase and sale of the Placement Shares and, if applicable, the payment of
the Commitment Fee shall be subject, in the discretion of the Company or the
Subscriber, as the case may be, to the following conditions:
(a) All representations and warranties and other statements of the
other party are, at and as of the Funding Time (except as expressly provided
otherwise), true and correct in all material respects (assuming that the other
party shall have performed in all material respects all of its obligations
hereunder theretofore to be performed).
(b) The Company has complied in all material respects with all
agreements and satisfied in all material respects all conditions on its part to
be performed or satisfied hereunder at or prior to the Funding.
(c) No stop order suspending the Private Placement shall have been
issued, and no proceeding for that purpose shall have been instituted or, to the
knowledge of the Company or the Subscriber, threatened by any regulatory or
governmental body.
(d) The Company shall have entered into an Acquisition Agreement that
is substantially similar in all material respects to the Acquisition Agreement
described in the Memorandum, which Acquisition Agreement shall provide for
Merger Consideration (as defined in the Memorandum) of not more than $23.00 per
share of Target Company common stock; all of the material conditions to the
closing of the Acquisition shall have been satisfied or, if permitted, duly
waived, and the Funding of the sale of the Placement Shares shall occur prior
to, but substantially simultaneous with, the closing of the Acquisition pursuant
to the Acquisition Agreement.
(e) Other than as contemplated by the Memorandum, there shall not
have been any change effected without the Subscriber's prior written consent
(which shall not be
-12-
<PAGE>
unreasonable withheld) after the date of this Agreement in the charter or other
organizational document or bylaws of the Company adversely affecting the rights
of the holders of the Placement Shares; PROVIDED, HOWEVER, that an increase in
the Company's authorized capital stock, whether or not described in the
Memorandum, shall not be deemed to adversely affect the rights of the holders of
the Placement Shares.
(f) At the Funding, the Subscriber shall have received a
certificate, dated as of the Funding Date, of the Chief Executive Officer and
the Chief Financial Officer of the Company in which such officers state that, to
their knowledge, the closing conditions specified in paragraphs (a) through (e)
of this Section have been satisfied.
(g) At the Funding, the Company shall have executed and delivered to
the Subscriber a registration rights agreement in the form attached hereto as
Annex C (the "Registration Rights Agreement").
(h) At the Funding, the Company and the Subscriber shall have
received the customary form of opinion, dated as of such date, of Nutter,
McClennen & Fish, LLP, outside counsel for the Company, in form and substance
satisfactory to your counsel, and such other customary closing documentation as
the parties may reasonably request.
8. SURVIVAL OF REPRESENTATIONS, WARRANTIES AND AGREEMENTS.
Notwithstanding any investigation made by any party to this Agreement, all
covenants, agreements, representations and warranties made by the Company and
the Subscriber herein shall survive the execution of this Agreement, the
delivery to the Subscriber of certificates representing the Placement Shares
being purchased and the payment therefor.
9. BROKER'S FEE.
The Subscriber represents to the Company that it has taken no action which
would entitle anyone to a broker's or finder's fee or other compensation in
connection with the transactions contemplated hereby.
10. INDEMNITY.
The Subscriber agrees to indemnify and hold harmless the Company and each
employee, officer and director of the Company from and against any loss, damage
or liability caused by or arising out of a breach of any representation,
warranty or agreement of the Subscriber contained in this Agreement or in any
other document provided by the Subscriber to the Company in connection with the
Subscriber's investment in Placement Shares.
-13-
<PAGE>
11. TERMINATION.
(a) Either of the parties hereto may terminate this Agreement (i) if
the Funding Date does not occur by August 15, 1997 through no fault of the
Subscriber, (ii) any federal or state regulator shall have made a final
determination denying an application of either party to the Acquisition
Agreement, the granting of which is essential to the consummation of the
Proposed Acquisition, or (iii) the Target Company terminates the Acquisition
Agreement. In addition, this Agreement shall terminate upon mutual consent of
the parties hereto.
(b) The Company and the Subscriber hereby agree that any termination
of this Agreement pursuant to Section 11(a) (other than termination in the event
of a breach of this Agreement by the Subscriber or misrepresentation of any of
the statements made herein by the Subscriber) shall be without liability of the
Company or the Subscriber.
12. NOTICES.
All communications hereunder shall be in writing and, if to the
Company, will be mailed, delivered or telecopied and confirmed to it at One
Pacific Plaza, 7777 Center Avenue, Huntington Beach, California 92647,
Attention: Robert P. Keller, Facsimile: (714) 891-8884; and if to the
Subscriber, will be mailed, delivered or telecopied and confirmed to it at the
address set forth on the signature page hereto;
13. BINDING EFFECT.
This Agreement shall be binding upon, and shall inure solely to the
benefit of, each of the parties hereto, and each of their respective heirs,
executors, administrators, successors and permitted assigns, and no other person
shall acquire or have any right under or by virtue of this Agreement.
14. GOVERNING LAW.
This Agreement shall be governed by, and construed in accordance with
the laws of the State of Delaware without regard to the conflict of law
provisions thereof.
15. ENTIRE AGREEMENT.
This Agreement represents the entire understanding of the parties with
respect to the matters addressed herein and supersedes all prior written and
oral understandings concerning the subject matter herein.
-14-
<PAGE>
16. ASSIGNMENT.
This Agreement may not be assigned by the Subscriber without the consent of
the Company.
17. SUCCESSORS.
This Agreement shall inure to the benefit of and be binding upon the
Company, the Subscriber and their respective successors and permitted assigns.
Nothing expressed herein is intended or shall be construed to give any person
other than the persons referred to in the preceding sentence any legal or
equitable right, remedy or claim under or in respect of this Agreement.
18. SEVERABILITY OF PROVISIONS.
Any covenant, provision, agreement or term of this Agreement that is
prohibited or is held to be void or unenforceable in any jurisdiction shall as
to such jurisdiction, be ineffective to the extent of such prohibition or
unenforceability without invalidating the remaining provisions thereof.
19. MISCELLANEOUS.
Neither this Agreement nor any term hereof may be changed, waived,
discharged or terminated orally, but only by an instrument in writing signed by
the party against whom enforcement of the change, waiver, discharge or
termination is sought. The headings in this Agreement are for the purposes of
references only and shall not limit or otherwise affect the meaning hereof.
20. EXECUTION IN COUNTERPARTS.
This Agreement may be executed in any number of the counterparts, each
of which counterparts when so executed and delivered shall be deemed to be an
original, but all such respective counterparts shall together constitute but one
and the same instrument.
* * *
-15-
<PAGE>
IN WITNESS WHEREOF, and intending to be legally bound thereby, each of the
Subscriber and Commerce Security Bancorp, Inc. has signed or caused to be signed
its name under seal as of the day and year first above written.
Maximum Number of Shares of INDIVIDUAL INVESTOR:
Common Stock Desired
To Be Purchased
Hereunder: ---------------------------------------
(Print Name)
- ------------------------------ ---------------------------------------
(Signature)
Mailing
Address:
-------------------------------
-------------------------------
Telephone:
---------------------------------
Facsimile:
---------------------------------
PARTNERSHIP, CORPORATION, TRUST OR
INSTITUTIONAL INVESTOR:
------------------------------------
(Print Name of Entity)
By:
---------------------------------
Name:
Title:
Jurisdiction
of Organization:
--------------------
Mailing
Address:
-------------------------------
-------------------------------
Telephone:
---------------------------------
Facsimile:
---------------------------------
-16-
<PAGE>
ACCEPTANCE OF SUBSCRIPTION
The Company hereby accepts the above subscription for Placement Shares.
COMMERCE SECURITY BANCORP, INC.
By:
----------------------------------------
Name: Robert P. Keller
Title: President and Chief Executive Officer
-17-
<PAGE>
FIRST AMENDMENT TO SUBSCRIPTION AGREEMENT
(COMMON STOCK)
THIS FIRST AMENDMENT TO SUBSCRIPTION AGREEMENT (the "First Amendment") is
made and entered into as of the ___ day of April, 1997, by and between Commerce
Security Bancorp, Inc., a Delaware corporation (the "Company"), and the investor
whose name appears on the signature page hereto (the "Subscriber"). All
capitalized terms used and not defined herein shall have the respective meanings
set forth in the Subscription Agreement, dated as of December 21, 1996 (the
"Subscription Agreement"), by and between the Company and the Subscriber.
WHEREAS, the parties desire to amend the Subscription Agreement as set
forth herein;
NOW, THEREFORE, in consideration of the premises contained herein and for
other good and valuable consideration, the receipt and sufficiency of which are
hereby acknowledged, the parties agree as follows:
1. The Subscriber acknowledges that the Subscriber has received and has
had an opportunity to review Supplement No. 1, dated December 20, 1996, and
Supplement No. 3, dated April 4, 1997, to the Company's Private Placement
Memorandum dated December 18, 1996 (collectively, with each Supplement thereto,
the "Memorandum").
2. The term Placement Shares shall mean shares of Class B Common Stock,
$.01 par value per share, the relative rights and preferences of which are
defined in the form of Amended and Restated Certificate of Incorporation
attached as Exhibit C to the Securities Purchase Agreement (as defined in
Supplement No. 3 to the Memorandum).
3. Section 1(d) of the Subscription Agreement is hereby amended by
DELETING the following sentence:
"No reduction in the number of Placement Shares available for issuance
to Subscribers as a consequence of a Reduction Event shall reduce the
Subscriber's Maximum Share Amount (as defined hereinafter) by more
than one-third."
4. Section 1(e) of the Subscription Agreement shall be deleted in its
entirety and the following paragraph shall be substituted in lieu thereof:
"(e) Subject to the terms, conditions and limitations herein set
forth, the Company shall pay to the Subscriber at the Funding (as
hereinafter defined) a commitment fee (the "Commitment Fee") equal to
one percent (1%) of the product of the Subscription Price
<PAGE>
multiplied by the number of shares that the Company had agreed to make
available to the Subscriber at the time of the Company's acceptance of
the Subscription (the "Maximum Share Amount"), provided that the
Subscriber has fully complied with all of the terms of this
Agreement."
5. Except as expressly amended herein, the Subscription Agreement remains
in full force and effect as amended hereby.
IN WITNESS WHEREOF, and intending to be legally bound thereby, each of the
Subscriber and Commerce Security Bancorp, Inc. has signed or caused to be signed
its name under seal as of the day and year first above written.
SUBSCRIBER: INDIVIDUAL INVESTOR:
--------------------------------------
(Print Name)
--------------------------------------
(Signature)
PARTNERSHIP, CORPORATION, TRUST OR
INSTITUTIONAL INVESTOR:
--------------------------------------
(Print Name of Entity)
By:
----------------------------------
Name:
Title:
COMPANY: COMMERCE SECURITY BANCORP, INC.
By:
----------------------------------
Name: Robert P. Keller
Title: President and Chief Executive Officer
-2-
<PAGE>
1STAMEND.
-3-
<PAGE>
DARTMOUTH CAPITAL GROUP, L.P.
CONFIDENTIAL
March 21, 1997
Commerce Security Bancorp, Inc.
7777 Center Avenue
Huntington Beach, CA 92647
Attention: Robert P. Keller
President and Chief Executive Officer
Ladies and Gentlemen:
On December 31, 1996, Dartmouth Capital Group, L.P. ("DCG") and Commerce
Security Bancorp, Inc. (the "Company") entered into a standby commitment letter
(the "Standby Commitment Letter"), whereby DCG committed to provide up to
$7,600,000 of additional funding for the Company's proposed acquisition (the
"Proposed Acquisition") of Eldorado Bancorp ("Eldorado") if the Company does not
obtain regulatory approval for a Target Redemption Amount of at least
$12,000,000. The Standby Commitment Letter was amended and restated effective
January 14, 1997 to clarify certain interpretive issues. DCG and the Company
desire to further amend the Standby Commitment Letter to alter the basis on
which the Company can draw upon the Standby Commitment (as defined herein) and
to alter the types of securities in which the funds drawn under the Standby
Commitment shall be invested.
In furtherance of the foregoing, the Standby Commitment Letter is hereby
further amended and restated to read as follows:
1. SECURITIES PURCHASE AGREEMENT. Reference is made to the Securities
Purchase Agreement dated February 13, 1997 (as amended on March 21, 1997, the
"Securities Purchase Agreement") by and among the Company, Madison Dearborn
Capital Partners II, L.P., Olympus Growth Fund II, L.P., and the other parties
named therein. Capitalized terms used in this Standby Commitment and not
otherwise defined shall have the respective meanings assigned to such terms in
the Securities Purchase Agreement.
<PAGE>
Commerce Security Bancorp, Inc.
March 21, 1997
Page 2
2. STANDBY COMMITMENT. DCG hereby agrees to purchase up to $6,800,000 of
Senior Securities (the "Standby Commitment") on the terms and conditions set
forth in the Securities Purchase Agreement to the extent the Company draws on
the Standby Commitment in accordance with the terms hereof. The Company, in its
sole discretion, may draw upon the Standby Commitment to the extent (on a
dollar-for-dollar basis) that the Company must reduce, in accordance with
Section 1(e) of the Securities Purchase Agreement, the aggregate Subscription
Price payable by MDP and Olympus, and MDP and Olympus shall not have assigned to
a third party the right to purchase Senior Securities.
3. NOTICE OF STANDBY COMMITMENT DRAW. The Company shall notify DCG not
less than twenty (20) business days prior to the Funding Date if the Company
intends to draw on the Standby Commitment.
4. DCG AS PURCHASER UNDER SECURITIES PURCHASE AGREEMENT. DCG agrees that
if the Company draws on the Standby Commitment, DCG shall be bound as a
Purchaser by all of the terms and conditions of the Securities Purchase
Agreement as if it were an original signatory thereto, and DCG shall execute
such instruments as the Company may reasonably request to confirm DCG's
agreement to be bound by the Securities Purchase Agreement.
5. EXPIRATION OF THE STANDBY COMMITMENT. The Standby Commitment will
expire on the earlier of (x) the termination of the Securities Purchase
Agreement and (y) the close of business (Pacific time) on the Funding Date.
6. STANDBY COMMITMENT FEE. In consideration for providing the Standby
Commitment, the Company shall pay to DCG in cash on the Funding Date an amount
equal to the product of (x) $372.61 multiplied by (y) the number of days elapsed
from December 31, 1996 to and including the Funding Date.
7. EXPENSES. The Company shall, promptly upon DCG's request therefor,
reimburse DCG for such reasonable legal, accounting and consulting fees as are
incurred by DCG in connection with the Standby Commitment or the enforcement of
this Standby Commitment Letter.
8. GOVERNING LAW. This Standby Commitment Letter shall be governed by
the internal laws of the State of Delaware.
9. COUNTERPARTS. This Standby Commitment Letter may be executed in
counterparts, each of which shall be deemed to constitute an original but all of
which together shall constitute one and the same instrument.
<PAGE>
Commerce Security Bancorp, Inc.
March 21, 1997
Page 3
If the foregoing terms and conditions are acceptable to you, please so
indicate by signing both of the enclosed copies of this letter where indicated
and returning one to the undersigned, whereupon this Standby Commitment Letter
shall be the binding obligation of the Company and DCG.
Very truly yours,
DARTMOUTH CAPITAL GROUP, L.P.
By: DARTMOUTH CAPITAL GROUP, INC.
By:
--------------------------
Name: Robert P. Keller
Title: President
Agreed To And Accepted As
Of The Date Above Written
COMMERCE SECURITY BANCORP, INC.
By:
-----------------------------
Name: Robert P. Keller
Title: President and
Chief Executive Officer
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<PAGE>
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<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-1-1996
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