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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997 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.)
24012 Calle de la Plata, Suite 150, Laguna Hills, CA 92653
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: (714) 699-4344
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-K 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-K or any amendment to this Form 10-K. [X]
There were 18,347,397 shares of Common Stock outstanding at March 14, 1998.
The aggregate market value of Common Stock held by non-affiliates at March
14, 1997 was approximately $4,224,000 based upon the last known trade of
$6.00 per share on October 23, 1997.
Documents incorporated by reference: None
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TABLE OF CONTENTS
Page
Part I
Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . 3
Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . 36
Item 3. Legal Proceedings. . . . . . . . . . . . . . . . . . . 38
Item 4. Submission of Matters to a Vote of Security Holders. . 38
Part II
Item 5. Market for the Issuer's Common Stock and Related
Stockholder Matters. . . . . . . . . . . . . . . . . . 39
Item 6. Selected Financial Data. . . . . . . . . . . . . . . . 42
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations. . . . . . . . . . 44
Item 8. Financial Statements . . . . . . . . . . . . . . . . . 53
Item 9. Disagreements on Accounting and Financial Disclosure . 54
Part III
Item 10. Directors and Executive Officers of Issue. . . . . . . 55
Item 11. Executive Compensation. . . . . . . . . . . . . . . . 60
Item 12. Security Ownership of Certain Beneficial Owners
and Management . . . . . . . . . . . . . . . . . . . . 69
Item 13. Certain Relationships and Related Transactions . . . . 75
Part IV
Item 14. Exhibits and Reports on Form 8-K. . . . . . . . . . . 77
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Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . 80
2
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PREAMBLE
THIS ANNUAL REPORT CONTAINS OR INCORPORATES BY REFERENCE CERTAIN
FORWARD-LOOKING STATEMENTS BY THE COMPANY (AS DEFINED HEREIN) REGARDING ITS
FUTURE PLANS, OPERATIONS AND PROSPECTS, WHICH INVOLVE RISKS AND
UNCERTAINTIES. THOSE FORWARD-LOOKING STATEMENTS ARE INHERENTLY UNCERTAIN,
AND ACTUAL RESULTS MAY DIFFER FROM THE COMPANY'S EXPECTATIONS. RISK FACTORS
THAT COULD AFFECT CURRENT AND FUTURE PERFORMANCE INCLUDE BUT ARE NOT LIMITED
TO THE FOLLOWING: (i) ADVERSE CHANGES IN ASSET QUALITY AND THE RESULTING
CREDIT RISK-RELATED LOSSES AND EXPENSE; (ii) ADVERSE CHANGES IN THE ECONOMY
OF CALIFORNIA, THE COMPANY'S PRIMARY MARKET, WHICH COULD FURTHER ACCENTUATE
CREDIT-RELATED LOSSES AND EXPENSES; (iii) ADVERSE CHANGES IN THE LOCAL REAL
ESTATE MARKET THAT CAN ALSO NEGATIVELY AFFECT CREDIT RISK, AS MOST OF THE
COMPANY'S LOANS ARE CONCENTRATED IN CALIFORNIA AND A SUBSTANTIAL PORTION OF
THOSE LOANS HAVE REAL ESTATE AS PRIMARY AND SECONDARY COLLATERAL; (iv) THE
CONSEQUENCES OF CONTINUED BANK ACQUISITIONS AND MERGERS IN THE COMPANY'S
MARKET, RESULTING IN FEWER BUT MUCH LARGER AND FINANCIALLY STRONGER
COMPETITORS WHICH COULD INCREASE TO THE COMPANY'S DETRIMENT, COMPETITION FOR
FINANCIAL SERVICES; (v) FLUCTUATIONS IN MARKET RATES AND PRICES, WHICH CAN
NEGATIVELY AFFECT THE COMPANY'S NET INTEREST MARGIN, ASSET VALUATIONS AND
EXPENSE EXPECTATIONS; AND (vi) CHANGES IN REGULATORY REQUIREMENTS OF FEDERAL
AND STATE AGENCIES APPLICABLE TO BANK HOLDING COMPANIES AND BANKS, WHICH
CHANGES COULD HAVE A MATERIAL ADVERSE EFFECT ON THE COMPANY'S FUTURE
OPERATING RESULTS.
PART I
ITEM 1. BUSINESS
BUSINESS OF THE COMPANY
GENERAL
Commerce Security Bancorp, Inc. ("CSBI" or the "Company") is a Delaware
corporation and registered bank holding company under the Bank Holding
Company Act of 1956, as amended (the "BHC Act"). Through its bank
subsidiary, Eldorado Bank, the Company offers a broad range of commercial
banking products and services to small and medium-sized businesses and retail
customers from 17 full service branches offices located primarily in the
Orange County, San Diego County and Sacramento areas of California. The
Bank also operates eight loan production offices, five of which are located
in Northern California with one each in Reno, Nevada; Phoenix, Arizona and
Portland, Oregon. The Company's products include commercial, consumer and
real estate loans, a full range of deposit products and other non-deposit
banking services, as well as small equipment leases and single-family
residential mortgages. The Company's only significant asset is the stock of
Eldorado.
Prior to September 1995, the predecessor to the Company, SDN Bancorp, Inc.
("SDN"), owned a single bank with approximately $56 million in assets which was
categorized as "critically
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undercapitalized" by federal regulators. In September 1995, the Company was
recapitalized by Dartmouth Capital Group, L.P., a Delaware limited
partnership ("DCG"), which assumed control of the Company, installed new
management, and began implementing policies to improve asset quality and
operating performance.
A key element of the Company's strategic plan includes building
profitability through acquisitions of community banks principally, but not
exclusively, in and around its Southern California base, including banks
which are or recently were in troubled condition, and seeking to increase the
earnings of the banks it has acquired through a combination of expense
reduction programs, merger synergies, improvements in asset quality and
strengthening of capital position. Since September 1995, the Company has
completed three acquisitions, increasing the Company's assets by over $840
million, including the acquisition, completed on June 6, 1997, of Eldorado
Bancorp ("Eldorado") and its bank subsidiary, Eldorado Bank, a community bank
based in Tustin, California with approximately $400 million in total assets
(collectively with the financing related thereto, the "Eldorado
Acquisition"). Effective June 30, 1997, the Company consolidated via mergers
(collectively, the "Bank Mergers") into Eldorado Bank the respective
operations of its other subsidiaries -- Liberty National Bank in Huntington
Beach, California ("Liberty"), San Dieguito National Bank in Encinitas,
California ("San Dieguito"), and Commerce Security Bank in Sacramento,
California ("CSB" and as so consolidated with Eldorado Bank, Liberty and San
Dieguito, the "Bank").
The Bank is incorporated under the laws of the State of California and
is licensed by the California State Department of Financial Institutions
("DFI"). The Bank's accounts are insured by the Federal Deposit Insurance
Corporation ("FDIC"), and it is a member of the Federal Reserve System.
The Bank currently operates a total of sixteen full-service banking
offices in Southern California, one full-service banking office in Northern
California and seven loan production offices, four of which are located in
Northern California with one each in Reno, Nevada; Phoenix, Arizona and
Portland, Oregon. The respective product offerings and market areas of the
Bank are summarized below, categorized by the entities that were, until the
Bank Mergers, the Company's separate subsidiary banks. Notwithstanding this
presentation, effective as of June 30, 1997, all of the operations described
below were combined in the Company's sole operating subsidiary, the Bank.
SOUTHERN CALIFORNIA OPERATIONS
GENERAL. Through the Bank, the Company offers a broad range of
commercial banking services in Southern California, catering especially to
small- and medium-sized businesses located in the areas of Orange, Los
Angeles, San Diego, San Bernardino and Riverside counties of California. The
Bank's administrative headquarters is located in Laguna Hills, a residential
community in southern Orange County approximately 50 miles south of Los
Angeles, and full-service banking offices in San Bernardino and Riverside
Counties are located approximately 60 miles and 115 miles east of Los
Angeles, respectively.
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The Bank's commercial banking services including the acceptance of
checking and savings deposits, the making of commercial loans, various types
of real estate loans and consumer loans, Small Business
Administration-guaranteed loans, corporate cash management services,
international banking services and provision of safe deposit, collection,
travelers' checks, notary public and other customary non-deposit banking
services. The Bank also provides small equipment lease financing and
residential mortgage loans. The Bank is a card issuing bank for MasterCard
and Visa and merchant depository for MasterCard and Visa drafts, enabling
merchants to deposit both types of drafts with the Bank. Although the Bank's
marketing emphasizes commercial and professional clients, it 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. In particular, the Bank offers special services to senior citizens,
who constitute an important segment of the population in the Bank's service
area.
Set forth below is a brief description of the evolution of the
respective franchises of Eldorado Bank, Liberty and San Dieguito, whose
operations now comprise the Southern California operations of the Bank.
ELDORADO. Eldorado Bank commenced operations as a California
state-chartered bank in 1972. Until the Bank Mergers, Eldorado Bank
operated a total of 12 banking offices, all in Southern California. Its
original banking and headquarters office was located in Tustin,
California, approximately 35 miles south of Los Angeles. Between 1980
and 1991, Eldorado Bank expanded, through a series of acquisitions, into
the communities of San Bernardino, Indio, Irvine, Palm Desert, Orange,
Huntington Beach and San Clemente. In October 1995, Eldorado acquired
Mariners Bank, with offices in San Clemente, San Juan Capistrano and
Monarch Beach. In September 1996, Eldorado Bank expanded into Los
Angeles County with the opening of a de novo branch banking office in
the Long Beach Community Hospital in the City of Long Beach,
approximately 30 miles south of Los Angeles.
LIBERTY. Liberty commenced operations as a national banking
association in 1982. Prior to the Bank Mergers, its main banking office
was located in Huntington Beach, California, 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 in
Dana Point, California, and in June 1996, Liberty opened a third
full-service branch office in Huntington Beach at the corner of Beach
and Warner. The primary service area of the Huntington Beach branches
includes the cities of Huntington Beach, Westminster, Fountain Valley,
Midway City, South West Santa Ana, Costa Mesa, Newport Beach, West
Irvine, East Seal Beach and Garden Grove, California, from which Liberty
attracted approximately 40% of its business. Prior to the Bank Mergers,
the primary service area of the Dana Point branch includes the cities of
Dana Point, Capistrano Beach, San Juan Capistrano and San Clemente.
Liberty also operated one loan production office, related to its SBA
loan production, in Orinda, California which is located in Northern
California.
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SAN DIEGUITO. San Dieguito commenced operations as a national
banking association in 1980. Until the Bank Mergers, its main banking
office and administrative offices were located in Encinitas, California,
which is approximately 25 miles north of San Diego. In December 1990,
San Dieguito opened its full-service office in Carlsbad, California,
approximately 10 miles north of Encinitas. Together, the Encinitas and
Carlsbad branches provide commercial and consumer banking services
primarily to the north coastal section of San Diego County.
SBA LENDING CONCENTRATION. As discussed in greater detail elsewhere in
this Annual Report, 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. Since 1995, Liberty has qualified as
a "Preferred Lender" under the SBA's programs, allowing it to originate SBA
loans based on its own underwriting decisions and without prior approval of
the SBA. Eldorado Bank qualified as a Preferred Lender in June 1994, and the
Bank maintains its status as a Preferred Lender after the Bank Mergers. 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 capitalized and recognized as income over the estimated life of
the loan. The total SBA loan portfolio serviced by the Company at December
31, 1997 was approximately $302.6 million. Included in this amount is
approximately $105.7 million, that represents the unguaranteed portion of the
SBA loans retained by the Company and SBA loans where the Company
retains 100% interest in the loan.
In recent years, Congress has considered proposals to substantially
reduce the scope of various SBA programs, the level of funding for the SBA
and the attractiveness of the programs that the SBA may offer. Statutory or
regulatory changes in these loan programs that reduce the availability of
such loans, make them less attractive to borrowers, or make them less
profitable for lenders could have a material adverse effect on the Company's
volume of originations and servicing of such loans, and its revenue derived
from such sources. (See "BUSINESS -- Effect of Governmental Policies and
Legislation.")
NORTHERN CALIFORNIA OPERATIONS
GENERAL. Until the Bank Mergers, the Company's Northern California
operations were conducted by CSB through three principal business units: a
Commercial Banking Division, a Mortgage Division and a Leasing Division.
Following the Bank Mergers, all three business units operate as part of the
Bank, although the Commercial Banking Division operates under the name
"Commerce Security Bank."
The Commercial Banking Division focuses on generating loans and raising
deposits primarily in the greater Sacramento area. The Mortgage Division
generates residential mortgage loans (primarily through brokers,
correspondents and direct originations) and sells them in the secondary
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market. The Leasing Division generates equipment leases primarily through
wholesale sources, services those leases and sells blocks of leases to other
institutions. Approximately one-third of the Northern California deposits
consist of title deposits and out-of-market CDs, both of which tend to be
volatile. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
The principal sources of revenue for the Northern California operations
during recent periods have been (i) interest and fees on loans, (ii) gain on
sales of loans and leases, (iii) interest on investments and (iv) service
charges on deposit accounts and other charges and fees. The Mortgage
Division has historically provided a substantial amount of CSB's earnings,
although the Mortgage Division generated losses during each month of 1996 and
during nine out of twelve months of 1997. In part due to the volatility of
the Mortgage Division's operating results, CSB has increased its emphasis on
its Commercial Banking and Leasing Divisions within the past several years in
order to diversify its revenue sources.
The primary service areas for the Company's Northern California
operations consist of the greater Sacramento area for commercial loans and
deposits, the western United States for residential mortgage loans and
primarily the mid-western and western states for equipment leasing
transactions.
COMMERCIAL BANKING DIVISION. CSB's Commercial Banking Division has
traditionally focused on commercial and real estate lending and deposit
gathering from business customers, 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 $31.6 million or 5.1% of the Company's gross loans and
leases and 3.9% of the Company's total earning assets, at December 31, 1997.
Loans of all types held by the Commercial Banking Division totaled $59.2
million at December 31, 1997, or approximately 7.3% of the total earning
assets for the Company as a whole.
MORTGAGE DIVISION. CSB entered the mortgage banking business in 1988.
The Mortgage 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 historically were sold in the secondary mortgage market
both on 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 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, brokerage fees and
accretion of capitalized loan servicing rights. In 1996 and the first half
of 1997, CSB sold
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substantially all of its servicing rights, and since September 1996, CSB has
undertaken to sell all loans generated by the Mortgage Division on a
servicing released basis. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
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 on personal referral;
and (b) the wholesale market, which represents loans generated through a
network of approved mortgage brokers. All loans originated from those two
sources are underwritten and closed by the Mortgage Division. Those sources
are located in California and certain contiguous states. In California, the
Mortgage Division operates residential mortgage lending offices in
Sacramento, Stockton, Fairfield and Walnut. Mortgage Division also has loan
production offices located in Portland, Oregon; Reno, Nevada and Phoenix,
Arizona. During the year ended December 31, 1997, wholesale loans accounted
for approximately 80% of the Mortgage Division's total origination volume.
The Division sells the majority of conventional loans originated under
programs offered by the Federal Home Loan Mortgage Corporation ("Freddie
Mac") or the Federal National Mortgage Association ("Fannie Mae"). The
Division also originates loans insured by the Federal Housing Administration
or guaranteed by the Veterans Administration. Those loans typically are sold
under a private sale agreement. Those securities are then sold to investment
banking firms. In addition, the Mortgage Division originates loans that are
eligible for sale to private investors. Those loans are underwritten to
conform to the individual guidelines of these private investors.
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 Leasing
Division's equipment lease portfolio has grown substantially since 1994,
increasing to $38.3 million at December 31, 1997. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
The production of new leases now comes primarily from the wholesale
sector through a network of brokers. The Company believes that the use of
its wholesale distribution network provides both risk diversification and
costs efficiencies. The wholesale sources of leases on which the Bank now
relies are located throughout the United States.
The Leasing Division of the Bank makes no consumer leases and no
automobile leases, either to consumers or businesses. The average size of
the Leasing Division's leases originated during 1997 was approximately
$30,000.
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COMPETITION
There is intense competition in California and elsewhere in the United
States in attracting and retaining deposit accounts, and in making loans to
small businesses and other borrowers. The primary factors in competing for
deposits are interest rates, personalized services, the quality and range of
financial services, convenience of office locations and office hours.
Competition for deposits comes primarily from other commercial banks, savings
institutions, credit unions, money market funds and other investment
alternatives. The primary factors in competing for loans are interest rates,
loan origination fees, the quality and range of lending services and
personalized services. Competition for loans comes primarily from other
commercial banks, savings institutions, mortgage banking firms, credit unions
and other financial intermediaries. The Company faces competition for
deposits and loans throughout its market areas not only from local
institutions but also from out-of-state financial intermediaries which have
opened loan production offices or which solicit deposits in its market areas.
Many of the financial intermediaries operating in the Company's market areas
offer certain services, such as trust and investment services, which the
Company does not offer directly. Additionally, many of the Company's
competitors have greater financial and marketing resources and name
recognition than the Company, and operate on a statewide or nationwide basis
that may give them opportunities to realize greater efficiencies and
economies of scale than the Company.
The Company competes principally on the basis of personalized
attention and special services which it provides its customers, principally
individuals and small to medium sized businesses and by promotional
activities of the Company's officers, directors and employees. Most of the
Bank's offices offer extended weekday banking hours and some branches offer
Saturday banking hours. The Bank also operates drive-up banking facilities at
seven of its branches and provides a variety of personalized services. In
addition, the Bank operates 24-hour automatic teller machines (ATM) at nine
of its locations and is a member of Instant Teller network and Plus System
network, which link bank ATMs nationwide.
For customers whose loan demands exceeds the Company's lending
limits, the Company has attempted in the past, and intends to continue in the
future, to arrange for such loans on a participation basis with correspondent
banks. The Company also assists customers requiring other services, such as
trust services not offered by the Company, by obtaining such services from
trust companies and correspondent banks.
HISTORICAL DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY
The table on the following page presents, for the periods indicated, the
distribution of average assets, liabilities and shareholders' equity, as well
as the total dollar amounts of interest income from average interest-bearing
assets and the resultant yields, and the dollar amounts of interest expense
and resultant cost expressed in both dollars and rates. Non-accrual loans
are included in the calculation of the average loans while non-accrued
interest thereon is excluded from the computation of rates earned.
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<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996 December 31, 1995
------------------------------ ------------------------------ -------------------------------
Interest Average Interest Average Interest Average
Average Income or Yield or Average Income or Yield or Average Income or Yield or
Balance Expense Cost Balance Expense Cost Balance Expense Cost
-------- --------- --------- -------- --------- --------- ------- -------- ---------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets:
Loans(1) $464,788 $47,230 10.16% $146,743 $16,383 11.16% $42,272 $4,086 9.67%
Investment Securities(2) 82,450 4,979 6.04 32,886 1,968 5.98 5,061 311 6.15
Federal funds sold 23,853 1,286 5.39 17,837 934 5.24 2,128 117 5.50
Other earning assets - - - 1,254 67 5.34 868 54 6.22
-------- ------- -------- ------- ------ ------
Total interest-earning
assets: 571,091 53,495 9.37 198,720 19,352 9.74 50,329 4,568 9.08
Non-earning assets:
Cash and demand
deposits with banks 64,934 14,611 3,757
Other assets 70,302 28,535 2,909
-------- --------- --------
Total assets $706,327 $241,866 $56,995
-------- --------- --------
-------- --------- --------
LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing
liabilities:
Deposits
Interest-bearing
demand 68,824 1,325 1.93 24,464 686 2.80 10,492 149 1.42
Money market 68,943 2,336 3.39 18,135 493 2.72 9,176 231 2.52
Savings 106,956 5,117 4.78 28,917 1,150 3.98 5,235 115 2.20
Time 170,809 9,365 5.48 91,987 5,241 5.70 18,394 1,075 5.84
-------- ------- -------- ------- ------ ------
Total interest-bearing
deposits 415,532 18,143 4.37 163,503 7,570 4.63 43,297 1,570 3.63
Short-term borrowing 12,478 563 4.51 418 13 3.11 - - -
Long-term debt 15,982 1,908 11.94 537 61 11.36 1,776 181 10.19
-------- ------- -------- ------- ------ ------
Total interest-bearing
liabilities 443,992 20,614 4.64 164,458 7,644 4.65 45,073 1,751 3.88
Non-interest bearing
liabilities:
Demand deposits 181,481 52,273 11,197
Other liabilities 8,735 4,437 806
-------- -------- -------
Total liabilities 634,208 221,168 57,076
Shareholders' equity 72,119 20,698 (81)
-------- -------- -------
Total liabilities and
shareholders' equity $706,327 $241,866 $56,995
-------- -------- -------
-------- -------- -------
-------- -------- ------
Net interest income: $32,881 $11,708 $2,817
-------- -------- ------
-------- -------- ------
Net yield on
interest-earning assets 5.76% 5.89% 5.60%
-------- -------- ------
-------- -------- ------
</TABLE>
- ---------------
(1) Includes the deduction of the average balance in the allowance for
loan losses of $7.6 million, $5.1 million and $639,000 in 1997,
1996 and 1995, respectively. Loan fees of $2.9 million, $1.2
million and $104,000 are included in the computations for 1997,
1996 and 1995, respectively.
(2) Yields are calculated on historical cost and exclude the impact of
the unrealized gain (loss) on available for sale securities.
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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. Non-accrual 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 DECEMBER 31,
-------------------------------------------------------------------------------------------
1997 COMPARED TO 1996 1996 COMPARED TO 1995
------------------------------------------- -------------------------------------------
NET NET
CHANGE RATE VOLUME MIX CHANGE RATE VOLUME MIX
------- ------ ------- ------- ------- ---- ------ ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
INTEREST INCOME
Loans $30,847 $(1,472) $35,507 $(3,188) $12,297 $633 $10,099 $1,565
Investment Securities 3,011 18 2,966 27 1,657 (8) 1,710 (45)
Federal Funds Sold 352 28 315 9 817 (6) 864 (41)
Other earning asses (67) - (67) - 13 (8) 24 (3)
------- ------- ------- ------- ------- ---- ------- ------
Total interest income 34,143 (1,426) 38,721 (3,152) 14,784 611 12,697 1,476
INTEREST EXPENSE
Interest-bearing demand 639 (215) 1,244 (390) 537 145 199 193
Money Market 1,843 121 1,381 341 262 18 226 18
Savings 3,967 233 3,104 630 1,035 93 520 422
Time 4,124 (198) 4,491 (169) 4,166 (27) 4,031 (108)
Short-term borrowing 550 (12) 703 (141) 13 0 0 13
Long-term debt 1,847 3 1,754 90 (120) 21 (127) (14)
------- ------- ------- ------- ------- ---- ------- ------
Total interest expense 12,970 (68) 12,677 361 8,891 361 7,578 952
------- ------- ------- ------- ------- ---- ------- ------
Net interest income $21,173 $(1,425) $26,044 $(3,446) $ 5,893 $250 $ 5,119 $ 524
------- ------- ------- ------- ------- ---- ------- ------
------- ------- ------- ------- ------- ---- ------- ------
</TABLE>
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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, 1997 all of the Company's investment securities
were classified as available-for-sale. The amortized cost and estimated
market value of the Company's investments at December 31, 1997 were as
follows:
<TABLE>
<CAPTION>
At December 31, 1997
--------------------
(Dollars in thousands)
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gain Loss Value
--------- ---------- ---------- ---------
Available for Sale:
<S> <C> <C> <C> <C>
U.S. Treasury $21,415 $ 51 $ - $21,466
U.S. Government Agencies 13,460 - - 13,460
State and municipal securities 615 - - 615
Mortgage-backed securities 30,725 - (9) 30,716
Corporate bonds and equities 1,038 - - 1,038
------ ---- ------- -------
Total $67,253 $ 51 ($ 9) $67,295
------ ---- ------- -------
------ ---- ------- -------
</TABLE>
The following tables show the maturities of investment securities at
December 31, 1997, and the weighted average yields of such securities:
<TABLE>
<CAPTION>
After One Year but After Five Years but
Within One Year Within Five Years Within Ten Years After Ten Years
Amount Yield Amount Yield Amount Yield Amount Yield
------ ----- ------ ----- ------ ----- ------ -----
(Dollars in Thousands)
Securities available-for-sale:
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasuries $21,466 6.03% $ - -.- % $ - -.-% $ - -.- %
U.S. Government agencies 1,500 5.52 8,458 6.13 3,503 7.30 - -.-
State and municipal bonds - -.- - -.- 615 7.80 - -.-
Mortgage backed securities 371 7.33 24 8.74 21,743 6.81 8,577 7.44
Corporate debt and other 538 9.88 500 8.14 - -.- - -.-
------- ---- ------ ---- ------- ---- ------- -----
Total investment portfolio $23,875 6.10% $8,982 6.25% $25,861 6.90% $ 8,577 7.44%
</TABLE>
Additional information concerning investment securities is provided in
the notes to the accompanying financial statements.
12
<PAGE>
LOANS AND LEASES
The following table sets forth the amount of loans and leases outstanding
for the Company at the end of each of the years indicated, according to type
of loan, inclusive of mortgage loans held for sale. The Company has no
foreign loans or energy-related loans.
<TABLE>
<CAPTION>
December 31,
--------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Commercial $115,919 $ 47,772 $16,188 $18,936 $19,883
Real estate-commercial 235,244 86,397 - - -
Real estate-construction 35,617 18,812 599 1,170 2,137
Real estate-mortgage 128,362 106,567 15,710 18,060 18,034
Installment loans to individuals 62,323 22,512 6,525 8,201 9,030
Lease financing 40,819 46,498 - - -
-------- -------- ------- ------- -------
Total 618,284 328,558 39,022 46,367 49,084
Less: allowance for loan
and lease losses (9,395) (5,156) (639) (821) (823)
Deferred loan fees (3,006) (2,444) (45) (54) (82)
-------- -------- ------- ------- -------
Net Loans $605,883 $320,958 $38,338 $45,492 $48,179
-------- -------- ------- ------- -------
-------- -------- ------- ------- -------
</TABLE>
The following table shows the amounts of certain categories of loans
outstanding as of December 31, 1997, 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. Demand or other loans having
no stated maturity and no stated schedule of repayments are reported as due
in one year or less.
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-----------------------
COMMERCIAL REAL ESTATE
---------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Aggregate maturities of loans which are due:
Within one year $ 72,154 $ 64,608
After one year but within five years:
Interest rates are floating or adjustable 23,764 54,406
Interest rates are fixed or predetermined 6,192 28,376
After 5 years:
Interest rates are floating or adjustable 7,969 111,350
Interest rates are fixed or predetermined 5,840 140,483
-------- --------
Total $115,919 $399,223
-------- --------
-------- --------
</TABLE>
As of December 31, 1997, in management's judgment, a concentration of
loans existed in commercial loans and real estate loans. At that date,
approximately 57% of the Company's loans were commercial loans or commercial
real estate loans, representing 19% and 38% of total loans, respectively.
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
13
<PAGE>
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 impacts.
NON-PERFORMING 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 non-accrual, previously accrued and
unpaid interest is generally reversed out of income. The following table
shows the total aggregate principal amount of non-accrual 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. The
Company's impaired loans pursuant to SFAS 118 are loans that are non-accrual
and those that have been restructured. Twelve months ended December 31, 1997
additional gross interest income of $980,000 would have been recorded on
impaired loans, and for calendar year 1996 additional gross interest income
of $474,000 would have been recorded on impaired 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 as of December 31, 1997 and 1996.
The following table summarizes the loans for which the accrual of
interest has been discontinued and loans more than 90 days past due and still
accruing interest, including those loans that have been restructured:
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------------
1997 1996 1995 1994 1993
------- ------ ------ ------ ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Non-accrual Loans, not restructured $10,589 $5,483 $1,492 $616 $637
Accruing loans past due 90 days or more 4,638 1,314 46 826 150
Restructured loans 2,779 2,200 82 1,050 1,605
------- ------ ------ ------ ------
Total $18,006 $8,997 $1,620 $2,492 $2,393
------- ------ ------ ------ ------
------- ------ ------ ------ ------
As a percent of outstanding loans 2.9% 2.7% 4.2% 5.4% 4.8%
</TABLE>
Loans aggregating $13.4 million at December 31, 1997 have been
designated as impaired in accordance with SFAS 114 as amended by SFAS 118.
The Company's impaired loans are all collateral dependent, and as such the
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 $1.6 million at December 31, 1997. At
December 31, 1996, loans aggregating $7.7 million were designated as impaired
and the total allowance for loan losses related to these loans was $695,000.
The average balance of impaired loans during 1997 and 1996 was $13.4 million
and $5.2 million, respectively.
14
<PAGE>
As of the end of the most recent period, management was not aware of any
loans that had not been placed on non-accrual status as to which there were
serious doubts as to the ability of the respective borrowers to comply with
present loan repayment terms.
At December 31, 1997, the Company had OREO properties with an aggregate
carrying value of $2.7 million. During 1997, properties with a total
carrying value of $4.1 million were added to OREO, of which $481,000 were
acquired in the Eldorado Acquisition and an additional $3.6 million as a
result of foreclosures. During 1997, properties with a total carrying value
of $3.9 million were sold and properties were written down by approximately
$1.1 million. 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 $3.2
million were acquired in both the Liberty and CSB acquisitions and an
additional $2.3 million as a result of foreclosures. Properties with a total
carrying value of $4.1 million were sold and properties were written down by
approximately $72,000 during 1996. 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 AND LEASE 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 and lease losses at December 31, 1997 was
approximately $9.4 million, or approximately 1.8% of gross portfolio loans.
(See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS--Allowance and Provision for Loan and Lease Losses" herein.)
In determining the adequacy of the allowance for loan and lease 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 an 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. While management believes the allowance to be adequate, it should be
noted that it is based on estimates and ultimate losses may vary from the
estimates if future conditions differ materially from the assumptions used in
making the evaluation.
The Federal Reserve and the DFI, as an integral part of their respective
supervisory functions, periodically review the Company's allowance for loan
and lease losses. Such regulatory agencies may require the Company to
increase its provision for loan lease losses or to recognize further loan
charge-offs, based upon judgments different from those of management.
15
<PAGE>
In December 1993, the federal banking agencies issued an inter-agency
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, 1997, the
Company's allowance constituted over 250% of the benchmark amount suggested
by the federal banking agencies' policy statement.
The table below summarizes average loans outstanding, gross portfolio
loans, non-performing loans and changes in the allowance for possible loan
and lease losses arising from loan and lease losses and additions to the
allowance from provisions charged to operating expense:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- ------- ------ ------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Average loans outstanding $464,788 $146,743 $42,272 $46,979 $49,243
Gross portfolio loans $522,054 $263,641 $39,022 $46,367 $49,084
Non-performing loans $ 18,006 $ 8,997 $ 1,620 $ 2,492 $ 2,392
Allowance for loan losses
Balance at beginning of period $ 5,156 $ 639 $ 821 $ 823 $ 771
Balance acquired 4,076 4,382 - - -
Loans charged off during period
Commercial 467 430 258 532 687
Leases 1,092 - - - -
Real estate 610 144 115 25 37
Installment 334 76 329 114 371
------- ------- ------- ------ ------
Total 2,503 650 702 671 687
Recoveries during period
Commercial 397 103 121 33 30
Leases 33 - - - -
Real estate 517 61 2 - 25
Installment 224 106 102 53 7
------- ------- ------- ------ ------
Total 1,171 270 225 86 62
------- ------- ------- ------ ------
Net loans charged off during period 1,331 380 477 585 625
Additions charged to operations 1,495 515 295 583 1,085
------- ------- ------- ------ ------
Balance at end of period $ 9,395 $ 5,156 $ 639 $ 821 $ 823
------- ------- ------- ------ ------
------- ------- ------- ------ ------
Loan loss and quality ratios:
Net charge-offs to average loans .29% 0.26% 1.13% 1.25% 1.27%
Provision for loan losses to average loans .32% 0.35% 0.70% 1.24% 2.20%
Allowance at end of period to gross
portfolio loan outstanding at end of
period 1.80% 1.88% 1.64% 1.77% 1.68%
Allowance as % of non-performing loans 52.18% 57.31% 39.44% 32.95% 34.41%
</TABLE>
16
<PAGE>
DEPOSITS
The following table shows the average amount and average rate paid on
the categories of deposits for each of years indicated:
<TABLE>
<CAPTION>
1997 1996 1995
Amount Rate Amount Rate Amount Rate
------ ---- ------ ---- ------ ----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Non-interest bearing demand $181,481 0.00% $ 52,273 0.00% $11,197 0.00%
Interest-bearing demand 68,824 1.93% 24,464 2.80% 10,492 1.42%
Money Market 68,943 3.39% 18,135 2.72% 9,176 2.52%
Savings 106,956 4.78% 28,917 3.98% 5,235 2.20%
Time 170,809 5.48% 91,987 5.70% 18,394 5.84%
-------- -------- -------
Total $597,013 3.04% $215,776 3.51% $54,494 2.88%
-------- -------- -------
-------- -------- -------
</TABLE>
Additionally, the following table shows the maturities of time
certificates of deposits of $100,000, or more at December 31, 1997:
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997
----------------------
(DOLLARS IN THOUSANDS)
<S> <C>
Due in three months or less $42,195
Due in over three months through six months 28,51
Due in over six months through twelve months 8,033
Due in over twelve months 3,336
-------
Total $82,076
-------
-------
</TABLE>
The Bank had deposits of title and escrow companies at December 31, 1997
of approximately $76.7 million, or approximately 10.0% of total deposits. The
deposits are considered volatile as the amount of these deposits can
fluctuate during each month and are also subject to seasonal fluctuations.
These deposits averaged $43.5 million for the twelve months ended December
31, 1997, or 7.3% of average total deposits. The Bank does not place undue
reliance on these deposits as a source of funding for its operations and has
sufficient liquidity and borrowing capability to absorb these fluctuations.
ACCOUNTING CHANGES
In June 1996 the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities" (SFAS 125). This Statement provides consistent accounting and
reporting standards for the transfers and servicing of financial assets and
the extinguishment of liabilities. The Company adopted SFAS 125 effective
January 1, 1997 and it did not have a material impact on the Company's
financial statements.
17
<PAGE>
In February 1997 the FASB issued SFAS 128, "Earnings per Share." This
Statement established new standards for computing and presenting earnings per
share and requires all prior period earnings per share data be restated to
conform with the provisions of the statement. Basic earnings per share is
computed by dividing net income available to common shareholders by the
weighted average number of shares outstanding during the period, as restated
for shares issued in business combinations accounted for as
poolings-of-interests and stock dividends. Diluted earnings per share is
computed using the weighted average number of shares determined for the basic
computation plus the number of shares of common stock that would be issued
assuming all contingently issuable shares having a dilutive effect on
earnings per share were outstanding for the period.
In June 1997 the FASB issued SFAS 130, "Reporting Comprehensive Income."
This Statement requires enterprises to report comprehensive income as a
measure of overall performance. Comprehensive income is the change to equity
(net assets) of a business during a period. The Statement includes the
guidelines for the calculations and required presentations. For the Company,
this new standard is effective for 1998 and is not expected to have a
material impact on the Company's financial statements.
In June 1997 the FASB issued SFAS 131, "Disclosures About Segments of an
Enterprise and Related Information." This statement will change the way
public companies report information about segments of their business in their
annual financial statements and require them to report selected segment
information in their quarterly reports issued to shareholders. Companies
will be required to disclose segment data based upon how management makes
decisions about allocating resources to segments and measuring performance.
For the Company, this new standard is effective for 1998 and the impact, if
any, is yet to be determined.
In February 1998 the FASB issued SFAS 132, "Employer's Disclosures about
Pensions and other Post-Retirement Benefits." This Statement standardizes the
disclosure requirements for pensions and other post-retirement benefits to
the extent practicable. For the Company, this new standard is effective for
fiscal year 1998.
EMPLOYEES
Collectively, the Company and its subsidiary Bank employed 417 full-time
equivalent individuals as of December 31, 1997. The Company does not have
employees of its own except its President, and its Treasurer and Chief
Financial Officer, each of whom is also an employee of the Bank. Of the
above-mentioned individuals, 60 were officers, who held titles of Vice
President or above, of the Bank. The Company believes its and its Bank's
employee relations are excellent. None of the Company's employees or its
subsidiary's employees are represented by a union or covered under a
collective bargaining agreement.
18
<PAGE>
YEAR 2000 COMPLIANCE
The Company has determined that a few of its computer software
applications will need to be modified or replaced in order to maintain their
functionality as the year 2000 approaches. A comprehensive plan has been
developed, with system conversions and testing to be substantially completed
by December 31, 1998. The Company's noninterest expense for 1997 did not
include any costs associated with the Year 2000 issue and the Company
estimates its total costs over the four year period 1997 - 2000 will be
approximately $250,000. None of these costs, however, are expected to
materially impact the Company's results of operations in any one reporting
period. In addition, a significant portion of these costs are not expected to
be incremental to the Company but instead will constitute a reassignment of
existing internal systems technology resources. The Company believes that its
plans for dealing with the year 2000 issue will result in timely and adequate
modifications of its systems and technology.
Ultimately, the potential impact of the year 2000 issue will depend not
only on the corrective measures the Company and the Bank undertake, but also
on the way in which the year 2000 issue is addressed by governmental
agencies, businesses, and other entities who provide data to, or receive data
from the Bank or whose financial condition or operational capability is
important to the Company such as suppliers or customers. Communications with
significant customers and vendors have been initiated to determine the extent
of risk created by those third parties' failure to remediate their own year
2000 issues. However, it is not possible, at present, to determine the
financial effect if a significant customer and/or vendor remediation efforts
are not resolved in a timely manner.
19
<PAGE>
SUPERVISION AND REGULATION
OVERVIEW
The Company is a registered bank holding company under the BHC Act, and
it is subject to regulation, supervision and periodic examination by the
Federal Reserve.
As a California state-licensed bank, the Bank is subject to regulation,
supervision and periodic examination by the DFI, and as a member of the
Federal Reserve System, the Bank is subject to regulation, supervision and
periodic examination by the Federal Reserve. The Bank's deposits are insured
by the FDIC to the maximum amount permitted by law, which is currently
$100,000 per depositor in most cases. The regulations of those state and
federal bank regulatory agencies govern most aspects of the Bank's business
and operations, including but not limited to, the scope of its business, its
investments, its 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 federal and state banking agencies have broad enforcement powers
over the Company and the Bank, including the power to impose substantial
fines and other civil and criminal penalties, to terminate deposit insurance
and to appoint a conservator or receiver for the Bank under a variety of
circumstances.
LIMITATIONS ON BANK HOLDING COMPANY ACTIVITIES
With certain limited exceptions, the BHC Act requires every bank holding
company to obtain the prior approval of the Federal Reserve 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 Federal Reserve 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 in the public interest by the probable
effect of the transaction in meeting the convenience and needs of the
community to be served. The Federal Reserve 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.
With certain exceptions, the BHC Act 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
20
<PAGE>
subsidiaries. The principal exceptions to those prohibitions involve certain
non-bank activities which, by statute or by Federal Reserve 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 Federal Reserve 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 BHC Act and certain regulations of the Federal
Reserve, a bank subsidiary of a bank holding company is 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, the
Bank may not condition the extension of credit to a customer upon the customer
obtaining other services from the Company or any of its other subsidiaries, or
upon the customer promising not to obtain services from a competitor.
CAPITAL ADEQUACY REQUIREMENTS
The Company and the Bank are subject to regulations of the Federal Reserve
governing capital adequacy, which incorporate both risk-based and leverage
capital requirements. Those risk-based and leverage capital guidelines 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. The maximum amount of supplemental capital which qualifies as Tier 2
capital is limited to 100% of Tier 1 capital, net of goodwill and certain other
intangibles.
Banks and bank holding companies are required to maintain a minimum ratio
of qualifying total capital to risk-weighted assets of 8%, at least one-half of
which must be in the form of Tier 1 capital. Risk-based capital ratios are
calculated with reference to risk-weighted assets, including both on and
off-balance sheet exposures, which are multiplied by certain risk weights
assigned by the Federal Reserve to those assets.
The Federal Reserve has established a minimum leverage ratio of Tier 1
capital to quarterly average assets (the "Tier 1 Leverage Ratio") of 3% for
member banks and bank holding companies that have received the highest composite
regulatory rating and are not anticipating or experiencing any significant
growth. All other institutions are required to maintain a Tier 1 Leverage Ratio
of at least 100 to 200 basis points above the 3% minimum for a minimum of 4% or
5%. If the Company or the Bank fails to maintain the required capital levels,
the Federal Reserve may issue a capital directive to require an increase in
capital levels.
Recently adopted regulations by the Federal Reserve and other 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.
21
<PAGE>
Non-traditional activities are 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 Federal Reserve and other banking agencies 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 the Bank's role as
financial intermediary, it introduces volatility to the Bank's earnings and
to the economic value of the Bank. The banking agencies have addressed this
problem by implementing changes to the capital standards to reflect the
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 the Bank's historical financial performance and its earnings
exposure to interest rate movements, as well as qualitative factors such as
the adequacy of the Bank's internal interest rate risk management. In July,
1996, the banking agencies issued an inter-agency policy statement to provide
guidance to banks on sound practices for managing interest rate risk. The
agencies stated that they have elected not to pursue a standardized measure
and explicit capital charge for interest rate risk.
In certain circumstances, the Federal Reserve may determine that the
capital ratios for a state member bank must be maintained at levels which are
higher than the minimum levels required by the guidelines or the regulations.
In particular, bank holding companies contemplating significant expansion
proposals are expected to maintain capital levels significantly above the
minimum levels required by the guidelines. Neither the Company nor the Bank has
been advised by any bank regulatory agency that it must maintain a specific Tier
1 Leverage Ratio in excess of the minimum levels specified in the capital
guidelines, although in connection with the application to the Federal Reserve
for approval to complete the Eldorado Acquisition, the Company was required to
have a pro forma Tier 1 Leverage Ratio of 6.0%, a Total Risk-Weighted Ratio of
10.0% and a Tier 1 Risk-Weighted Ratio of 6.0%. In addition, in connection with
the Eldorado Acquisition, the Company agreed that it will not incur any debt
without the prior approval of the Federal Reserve.
At the direction of the FDIC and the DFI, CSB's Board of Directors adopted
a resolution in March 1996 requiring CSB to, among other things, (i) maintain a
Tier 1 Leverage 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 and lease 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 DFI until further notice from those regulators. Prior to the
adoption of those resolutions, CSB had operated under a Memorandum of
Understanding entered into with the FDIC and the DFI in 1994 that contained
substantially similar
22
<PAGE>
requirements. The FDIC and the DFI terminated the Memorandum of
Understanding upon adoption by CSB's Board of Directors of the resolutions
described above. The resolutions did not apply to the Bank following the
Bank Mergers.
REGULATORY RESTRICTIONS ON DISTRIBUTIONS TO SHAREHOLDERS
STOCK REDEMPTIONS. Bank holding companies, such as the Company, are
required to give the Federal Reserve 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 Federal Reserve may
disapprove such a purchase or redemption if it determines that the proposal
would violate any law, regulation, Federal Reserve order, directive, or any
condition imposed by, or written agreement with, the Federal Reserve. 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. In
connection with the Eldorado Acquisition, the Company agreed that it will not
redeem, retire or repurchase any of its preferred stock without the prior
approval of the Federal Reserve.
DIVIDENDS. Federal Reserve 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. In connection with the
Eldorado Acquisition, the Company agreed that it will not pay dividends on
Common Stock without the prior approval of the Federal Reserve.
The Company is a legal entity separate and distinct from the Bank.
Substantially all of the Company's revenues and cash flow, including funds
available for the payments of dividends and other operating expenses, consists
of dividends paid to the Company by the Bank. There are statutory and
regulatory limitations on the amount of dividends which may be paid to the
Company by the Bank. Dividends payable by the Bank are restricted under
California law to the lesser of the Bank's retained earnings, or the Bank's net
income for the latest three fiscal years, less dividends previously declared
during that period, or, with the approval of the DFI, to the greater of the
retained earnings of the Bank, the net income of the Bank for its last fiscal
year or the net income of the Bank for its current fiscal year. In connection
with the Eldorado Acquisition, Eldorado Bank paid a dividend of $14 million,
which exceeded the Bank's net income for the latest three fiscal years. As a
result, the Bank will require the approval of the DFI with respect to the
payment of any dividend up to the greater of the Bank's retained earnings, the
net income of the Bank for its last fiscal year and the net income of the Bank
for its current fiscal year. In no event could the Bank issue a dividend in
excess of such amounts.
23
<PAGE>
Federal Reserve regulations also limit the payment of dividends by a state
member bank. Under Federal Reserve regulations, dividends may not be paid
unless both undivided profits and earnings limitations have been met. First, no
dividend may be paid if it would result in a withdrawal of capital or exceed the
bank's undivided profits as reported in its most recent Report of Condition and
Income, without the prior approval of the Federal Reserve and two-thirds of the
shareholders of each class of stock outstanding. Second, a state member bank
may not pay a dividend without the prior written approval of the Federal Reserve
if the total of all dividends declared in one year exceeds the total of net
income for that year, plus its retained net income for the preceding two
calendar years.
The payment of dividends on capital stock by the Company and the Bank
may also be limited by other factors, including applicable regulatory capital
requirements and broad enforcement powers of the federal regulatory agencies.
Both the Federal Reserve and the DFI have broad authority to prohibit the
Company and the Bank from engaging in practices which the banking agency
considers to be unsafe or unsound. It is possible, depending upon the
financial condition of the Bank or the Company and other factors, the
applicable regulator may assert that the payment of dividends or other
payments by the Bank or the Company is an unsafe or unsound practice and,
therefore, implement corrective action to address such a practice. Among
other things, Federal Reserve 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 and tax sharing payments which do not reflect the taxes actually due
and payable.
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 Bank for its cash
needs, including funds for payment of interest and operating expenses and
dividends.
TRANSACTIONS WITH AFFILIATES
The Bank is subject to restrictions under federal law which limit
certain transactions with the Company and its banking and non-banking
affiliates, including extensions of credit, investments or asset purchases.
Extensions of credit and certain other "covered" transactions by any member
bank with any one affiliate are limited in amount to 10% of such member
bank's capital and surplus and with its affiliates, in the aggregate, are
limited in amount to 20% of capital and surplus and such extensions of credit
must be fully secured in accordance with applicable regulations. Federal law
also provides that covered transactions with affiliates must be made on
substantially the same terms as, and in the case of credit transactions
following credit underwriting procedures that are no less stringent than,
those prevailing at the time for comparable transactions involving other
non-affiliated companies, 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, non-affiliates. The purchase of low
quality assets from affiliates is generally prohibited.
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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 (i) the default of any commonly controlled
FDIC-insured depository institution or (ii) any assistance provided by the
FDIC to a commonly controlled FDIC-insured depository 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 to the FDIC. As of the date of this
Annual Report, the Bank was the Company's only insured depository institution
subsidiary.
Federal Reserve 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.
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-Weighted Ratio") of at least 10.0%, a ratio of Tier 1 capital to total
risk-weighted assets ("Tier 1 Risk-Weighted Ratio") of at least 6.0%, a Tier
1 Leverage Ratio of at least 5.0% and is not subject to any written order,
agreement, or directive; an "adequately capitalized" institution has a Total
Risk-Weighted Ratio of at least 8.0%, a Tier 1 Risk-Weighted Ratio of at
least 4.0% and a Tier 1 Leverage 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-Weighted Ratio of less than 6.0%, a Tier 1
Risk-Weighted Ratio of less than 3.0% and/or a Tier 1 Leverage 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.
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<PAGE>
Undercapitalized depository institutions are subject to restrictions on
borrowing from the Federal Reserve. 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.
SAFETY AND SOUNDNESS STANDARDS
The federal banking agencies have adopted safety and soundness standards
for all insured depository institutions. The standards, which were issued in
the form of guidelines rather than regulations, relate to internal controls,
information systems, internal audit systems, loan underwriting and
documentation, compensation, interest rate exposure, asset quality and
earnings. The asset quality and earnings standards are qualitative rather
than quantitative and require monitoring, reporting and preventative or
corrective action appropriate to the size of the institution and the nature
and scope of its activities. Beginning in 1996, Federal Reserve examiners
were instructed to assign a formal supervisory rating to the adequacy of an
institution's risk management processes, including its internal controls. 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.
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. 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
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<PAGE>
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 for
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.
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-Weighted Ratio of at
least 10.0%, a Tier 1 Risk-Weighted Ratio of at least 6.0% and a Tier 1
Leverage Ratio of at least 5.0%. An adequately capitalized institution has at
least an Total Risk-Weighted Ratio of at least 8.0%, a Tier 1 Risk-Weighted
Ratio of at least 4.0% and a Tier 1 Leverage Ratio of at least 4.0%. An
undercapitalized institution is one that does not meet either 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.
In September 1996, legislation (the "SAIF legislation") was enacted to
recapitalize the FDIC's Savings Association Insurance Fund ("SAIF") to
provide for the payment of certain future obligations of SAIF, and ultimately
to merge SAIF and its counterpart, BIF, into a single insurance fund to be
called the Deposit Insurance Fund. The deposits of Eldorado, Liberty and San
Dieguito were insured by BIF; the deposits of CSB were insured by SAIF.
Following the Bank Mergers, the deposits of the Bank are insured by SAIF and
BIF generally in proportion to the pre-Bank Merger allocation of deposits
among the Company's subsidiary banks.
Under the SAIF legislation, each depository institution whose deposits
are insured by SAIF (with limited exceptions) was required to pay a one-time
"special assessment" into SAIF in the amount of approximately $.66 for each
$100 of deposits that the institution had as of a given measurement date.
For CSB, this special assessment totaled $550,000 on an after-tax basis,
which was reserved by CSB prior to the closing of the CSB acquisition and
taken as a charge to CSB's earnings for the third quarter of 1996. The
special assessment was intended to cause, and has caused, SAIF's assets to
reach the targeted "reserve ratio" of 1.25% of insured deposits. As a
consequence,
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<PAGE>
under pre-existing law, the FDIC is now permitted to reduce the normal,
periodic deposit insurance premiums charged to SAIF-insured institutions to
levels consistent with those charged to BIF-insured institutions. For well
capitalized and well managed institutions, those rates can be as low as a
statutory minimum of $2,000 per year.
Under the SAIF legislation, however, the FDIC is also obligated to levy
ongoing special assessments on both SAIF-insured institutions and BIF-insured
institutions in order to pay debt service on certain bonds issued in
connection with the resolution of financially troubled savings associations
prior to 1989. Through 1999, SAIF institutions will pay those special
assessments at an annual rate five times that paid by BIF institutions.
While the precise rate will vary from period to period, initially the rate
for SAIF institutions will be $.064 per $100 of deposits and the rate for BIF
institutions will be $.0128 per $100 of deposits. Beginning in January 2000,
the rates paid by institutions insured by each fund will be equalized.
Unlike the one-time special assessment discussed above, it is expected that
those ongoing special assessments will be recorded as expenses during the
period for which they are assessed.
As a result of the passage of the SAIF legislation, 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):
<TABLE>
<CAPTION>
SUPERVISORY SUBGROUP
--------------------
A B C
--- --- ---
<S> <C> <C> <C>
MEETS NUMERICAL STANDARDS FOR:
Well capitalized . . . . . . . . 0(a) 3 17
Adequately capitalized . . . . . 3 10 24
Undercapitalized . . . . . . . . 10 24 27
</TABLE>
- ---------------------------------
(a) Subject to a statutory minimum annual assessment of $2,000.
For purposes of the assessments of FDIC insurance premiums that were paid
during the second half of 1997, which were based on the Bank's capital level as
of June 30, 1997 after giving effect to the Bank Mergers, the Bank was "well
capitalized." FDIC regulations prohibit disclosure of the "supervisory
subgroup" to which an insured institution is assigned. The Bank's insurance
assessment paid during the six months ended December 31, 1997 (which were based
on capital levels as of June 30, 1997) was $133,000.
RESTRICTIONS ON CHANGES OF CONTROL
Subject to certain limited exceptions, no company (as defined in the BHC
Act) 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
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an acquisition of control of the Company by a "company" as defined in the BHC
Act. 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 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 Securities
Exchange Act of 1934, as amended (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.
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. The Bank 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 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
Bank 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
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<PAGE>
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 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". The
Bank has not been examined for CRA compliance since the Bank Mergers. Each
of the banks that now comprise the Bank were last examined for CRA compliance
by their respective primary regulators within the past 24 months and each has
received a "satisfactory" CRA Assessment Rating with the exception of San
Dieguito which received an "outstanding" 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 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 whom they believe
has discriminated against them. The FH Act provides that the Attorney General
of the United States may
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<PAGE>
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 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
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<PAGE>
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
The 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 Exchange Act. The
Company does not have a class of equity securities registered under Section
12 of the Exchange Act.
RECENT LEGISLATION
Federal and state laws applicable to financial institutions have
undergone significant changes in 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
FDIC and the DFI may affect the business of the Company or the Bank. 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 the Bank.
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<PAGE>
RIEGLE-NEAL INTERSTATE BANKING AND BRANCHING EFFICIENCY ACT OF 1994.
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (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 was 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.
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.
CALDERA, WEGGELAND, AND KILLEA CALIFORNIA INTERSTATE BANKING AND
BRANCHING ACT OF 1995. The Caldera, Weggeland, and Killea California
Interstate Banking and Branching Act of 1995 (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 certain provisions of the California
Financial Code. 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.
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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 Commissioner of Banks (the "Commissioner") to approve such an
interstate acquisition if the Commissioner 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. 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 Commissioner, 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 Commissioner 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 the Bank operates in the
event that out-of-state financial institutions directly or indirectly enter
the Bank's 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
34
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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 Bank, 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.
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, 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.)
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RELIANCE ON SBA PROGRAMS. A significant portion of the Company's
business consists of originating and servicing loans under the programs of
the U.S. Small Business Administration. (See "BUSINESS - Southern California
Operations - SBA Lending Concentration.") 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 guarantee fees charged to borrowers, it is
possible that such a decrease will occur over the long term. In addition,
there can be no assurance that the SBA will not be discontinued in its
entirety in the foreseeable future.
ITEM 2. PROPERTIES
The main executive office for the Company and the Bank is located in
Laguna Hills, California, near the intersection of Interstate 5 and El Toro
Road, where it is physically contiguous to one of the Bank's branches.
The Bank's headquarters is located on a site owned by the Bank at
Seventeenth Street and Prospect Avenue, Tustin, California.
In addition to the Bank's headquarters office and its Laguna Hills
location, the Bank owns six of its branch offices, one of which is subject to
a ground lease and leases the remaining 10 offices. Of the branch offices
which are leased by the Bank, two have remaining lease terms, including
options renewable at the Bank's option, of five years or less, one has a
remaining lease terms of greater than five years and less than 10 years, and
nine have a remaining lease term of 10 years or more. The Bank also leases
several offices for various administrative offices associated with its
Northern California operations, as well as space for the wholesale and retail
loan mortgage loan origination activity.
The Company's aggregate rental expense under such leases was $2.3
million in 1997. At December 31, 1997, the net book value of the property
and leasehold improvements of the offices of the Company amounted to $7.5
million. The Company's properties which are not leased are owned free and
clear of any mortgages. The Company believes that all of its properties are
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appropriately maintained and are suitable for their respective present needs
and operations. For additional information regarding the Company's lease
obligations see Note16 to the Consolidated Financial Statements, included in
Item 8 hereof.
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ITEM 3. LEGAL PROCEEDINGS
As of the date of this Annual Report, no litigation is pending against
the Company itself. The Bank is the plaintiff in an action, originally filed
by CSB in January 1994, seeking (among other things) to restrain a former CSB
loan production office manager from engaging in activities harmful to the
Bank and its employees. In June 1994, the former employee filed a
cross-complaint against the Bank and certain individual employees alleging
wrongful termination, breach of contract, defamation and various other causes
of action. Following a jury trial, judgment was entered against the Bank in
October 1997, and the matter is now on appeal. In conjunction with this
initial judgement the Bank recorded a purchase accounting adjustment for the
CSB Acquisition, and an adverse outcome of the appeal process will not have a
material impact on the Company's results of operations.
The Company is from time to time subject to various legal actions (in
addition to that described above) which are considered to be part of its
normal course of business. Management, after consultation with legal
counsel, does not believe that the ultimate liability, if any, arising from
those other actions will have a materially adverse effect on the financial
position or results of operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted by the Bank or the Company 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, 1997.
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PART II
ITEM 5. MARKET FOR ISSUER'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
MARKET FOR ISSUER'S COMMON STOCK
Trading in 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").
The last known trade of Common Stock was for $6.00 per share on October
23, 1997. No more recent trades in Common Stock have been reported by
securities dealers.
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 issued to fund a portion of the Eldorado
Acquisition prohibit the payment of Common Stock dividends under various
circumstances. See "-- Unregistered Sales of Securities" below.
The Company is not permitted to pay any dividends without the consent of
the Federal Reserve. As a State Member Bank, the Bank is subject to certain
restrictions on the payment of dividends and may require approval of the DFI
and the Federal Reserve. See "BUSINESS -- Regulatory Restrictions on
Distributions to Shareholders -- Dividends".
HOLDERS OF COMMON STOCK
As of March 14, 1998, 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, 1997 by the Company that were not
registered under the Section 5 of the Securities Act of 1933, as amended (the
"Securities Act").
FUNDING FOR ELDORADO ACQUISITION. Approximately $94.8 million of cash
was necessary to pay the cash consideration to holders of Eldorado common
stock and Eldorado stock options and Eldorado Acquisition-related expenses
incurred by the Company. Of that amount, $14.5 million was
39
<PAGE>
funded from Eldorado's excess capital through a dividend by Eldorado Bank and
$80.3 million was raised through the Company's sale, effective June 6, 1997,
of Class B Common Stock, Special Common Stock, a Junior Subordinated
Debenture (and, indirectly, Series A Capital Securities), Series B Preferred
Stock and common stock warrants, as described below. The issuance of such
securities was exempt from registration under the Securities Act by virtue of
Regulation D thereunder and/or Section 4(2) thereof.
CLASS B COMMON STOCK. In conjunction with the Eldorado Acquisition
financing, 9,697,430 shares of Company common stock, $.01 par value per share,
outstanding immediately prior to the closing of the Eldorado Acquisition were
redesignated as "Class B Common Stock," and the Company issued 4,248,431
additional shares of Class B Common Stock to various accredited investors for
consideration, net of a 1% commitment fee, of $17,733,115. Of those shares,
1,431,839 were sold to persons who, at the time of issuance, were directors of
the Company, affiliates of directors or nominees to become directors. See
"CERTAIN TRANSACTIONS AND RELATED TRANSACTIONS - Certain Transactions."
DCG, the Company's largest shareholder, purchased 1,012,244 of those
shares of Class B Common Stock for aggregate consideration, net of a 1%
commitment fee, of $4,419,793, of which $4.3 million initially was made in the
form of a loan to the Company in December 1996 to fund an escrow account that
would have been forfeited to Eldorado if the Company were unable to consummate
the Acquisition financing. Peter H. Paulsen, then a director of the Company,
loaned $200,000 to the Company on the same terms as DCG. That $4.5 million was
converted to shares of Class B Common Stock upon the consummation of the
Acquisition at a purchase price of $4.40 per share less the 1% commitment fee,
and the interest on such loan was converted to Class B Common Stock at a
purchase price of $4.81 per share less the 1% commitment fee, which was the same
price at which the remaining shares of Class B Common Stock and the Special
Common Stock were sold by the Company to fund the Eldorado Acquisition.
SPECIAL COMMON STOCK. The Company sold a total of 4,825,718 shares of
Special Common Stock, $.01 par value per share (the "Special Common"), to DCG,
Madison Dearborn Capital Partners II, L.P., ("MDP"), Olympus Growth Fund II,
L.P., ("Olympus I"), and Olympus Executive Fund, L.P., ("Olympus II" and
collectively with Olympus I, "Olympus") at a gross purchase price of $4.81 per
share, representing an aggregate payment, net of a 1% commitment fee, of
$22,984,570. Neither MDP nor Olympus is an affiliate of the other, and prior to
their investment in the Company, neither was an affiliate of the Company or DCG.
The Special Common will be entitled to a liquidation preference over
the Class B Common if, in the case of a liquidation or a change in control of
the Company, the distribution per share of Common Stock is less than $4.81.
With the exception of 927,826 of Non-Voting Special Common issued to each of MDP
and Olympus, the Special Common will have one vote per share and will vote as a
class with the Class B Common Stock. The Voting Special Common and the Class B
Common Stock are hereinafter sometimes referred to as the "Voting Common Stock."
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<PAGE>
JUNIOR SUBORDINATED DEBENTURE AND SERIES A CAPITAL SECURITIES. CSBI
Capital Trust I (the "Trust"), a special purpose trust formed by the Company,
issued a total of 27,657 shares of 11 3/4% Series A Capital Securities, $1,000
initial liquidation value per share (the "Series A Securities"), to DCG, MDP and
Olympus for an aggregate cash payment, net of a 1% commitment fee, of
$27,386,368. The Trust in turn invested the proceeds of the Series A Securities
in a Junior Subordinated Debenture issued by the Company.
SERIES B PREFERRED STOCK. The Company issued a total of 116,593
shares of 11% Series B Preferred Stock, $100 par value per share (the "Series B
Preferred"), to DCG, MDP and Olympus for an aggregate amount of $11,545,210, net
of a 1% commitment fee.
COMMON STOCK WARRANTS. In connection with the purchase of the
Series B Preferred, each of MDP, Olympus and DCG purchased a common stock
warrant (collectively, the "Investor Warrants") that entitles the holder to
purchase shares of Class B Common Stock at an exercise price of $4.81 per share.
An aggregate of 4,000,000 shares of Class B Common Stock are subject to the
Investor Warrants. The Investor Warrants expire on June 6, 2007. The aggregate
purchase price of the Investor Warrants was $40,000.
The Company also issued common stock warrants (collectively, the
"Shattan Warrants") to The Shattan Group, LLC, which acted as the Company's
placement agent for the sale of securities to MDP and Olympus. The Shattan
Warrants, which were issued as of June 6, 1997 and July 15, 1997, respectively,
entitle the holders thereof to purchase an aggregate of 482,433 shares of
Class B Common Stock at an exercise price of $4.81 per share and expire on
June 6, 2000 and July 15, 2002, respectively. The aggregate purchase price of
the Shattan Warrants was $4,824.
KELLER RESTRICTED STOCK. During the year ended December 31, 1997, the
Company issued a total of 375,964 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. This issuance is in
addition to 51,592 shares under the same agreement related to activity in 1996
and reflected in 1997. The Company issuance of those shares was exempt from
registration under the Securities Act by virtue of Regulation D thereunder
and/or Section 4(2) thereof.
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<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
AS OF AND FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
SUMMARY OF CONSOLIDATED OPERATIONS
- ----------------------------------
Net interest income before
provision for possible loan
and lease loss $32,881 $11,708 $ 2,817 $ 2,861 $ 2,994
Provision for possible loan
and lease loss 1,495 515 295 583 1,085
---------- --------- ------ ------ -------
Net interest income after provision
for possible loan and lease loss 31,386 11,193 2,522 2,278 1,909
Net non-interest expense 24,784 10,371 3,595 3,267 3,885
---------- --------- ------ ------ -------
Income (loss) before income taxes
and extraordinary item 6,602 822 (1,073) (989) (1,976)
Income taxes provision (benefit) 3,612 (1,503) (443) - -
---------- --------- ------ ------ -------
Income (loss) before extraordinary item 2,990 2,325 (630) (989) (1,976)
Extraordinary item: Forgiveness of
indebtedness net of $443,000
income taxes - - 625 - -
---------- --------- ------ ------ -------
Net income (loss) $ 2,990 $ 2,325 $ (5) $ (989) $(1,976)
---------- --------- ------ ------ -------
---------- --------- ------ ------ -------
Per share data (1):
Weighted Average shares outstanding
Basic 14,813,125 5,300,773 268,198 53,728 53,728
Dilutive 17,269,302 5,300,773 268,198 53,728 53,728
Basic:
Income (loss) before
extraordinary item $ .15 $ .44 $ (2.35) $(18.41) $(36.78)
Extraordinary item - - 2.33 - -
------- ------- ------- ------- --------
Income (loss) per share $ .15 $ .44 $ (0.02) $(18.41) $(36.78)
Dilutive:
Income (loss) before
extraordinary item $ .13 $ .44 $ (2.35) $(18.41) $(36.78)
Extraordinary item - - 2.33 - -
------- ------- ------- ------- --------
Income (loss) per share $ .13 $ .44 $ (0.02) $(18.41) $(36.78)
</TABLE>
____________________________
(1) Share and per share amounts have been retroactively restated to reflect
change in presentation of EPS as discussed in Note 1 to the consolidated
financial statements
42
<PAGE>
<TABLE>
<CAPTION>
AS OF AND FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED FINANCIAL POSITION
- -------------------------------
Total assets $902,355 $437,060 $55,905 $57,686 $61,916
Total loans, net 605,883 320,958 38,338 45,492 48,179
Total intangibles 66,769 10,736 - - -
Total deposits 765,203 383,031 51,431 55,876 59,651
Total long-term debt 27,657 537 537 1,894 1,894
Total shareholders' equity (deficit) 94,736 40,772 3,541 (948) 41
SELECTED FINANCIAL RATIOS
- -------------------------
Return on average common equity (2) 4.15% 11.23% nm nm (201.43)%
Return on average assets 0.42% 0.96% (0.01)% (1.61)% (2.97)%
Average equity to average assets 10.21% 8.56% (0.14)% (0.09)% 1.47%
Dividend payout ratio - - - - -
</TABLE>
_______________________
(2) Return on average equity is not meaningful as the average equity for 1995
and 1994 was negative.
43
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
This information should be read in conjunction with the audited
consolidated financial statements and the notes thereto of the Company
included in Item 8 of this Annual Report. 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 preamble to this Annual Report.
Prior to September 1995, the predecessor to the Company, SDN Bancorp, Inc.,
owned a single bank, San Dieguito, with approximately $56 million in assets
which was categorized as "critically undercapitalized" by federal regulators.
In September 1995, the Company was recapitalized by DCG. Between September 1995
and December 31, 1997, the Company completed three acquisitions -- Liberty, CSB
and Eldorado - increasing the Company's assets by over $840 million. The
Eldorado Acquisition, which was the most recent such transaction, was completed
on June 6, 1997 and increased the Company's assets by approximately $400
million. The Liberty acquisition was completed as of March 31, 1996, and the
CSB acquisition was completed as of September 1, 1996.
The Liberty, CSB and Eldorado acquisitions were accounted for using the
purchase method of accounting for business combinations (the "Purchase Method.")
The entries to account for these acquisitions using the purchase method were
made using certain estimates and thus the purchase prices are subject to
adjustment based upon receipt of the final valuations. Accordingly, the
following discussion relates to the operating results of San Dieguito, Liberty
and CSB for the twelve months ended December 31, 1997, the operating results of
Eldorado Bank for the seven months ended December 31, 1997. By comparison, the
Company's operating results for the twelve months ended December 31, 1996
reflects the operating results of San Dieguito 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. The Company's operating results for the twelve months ended
December 31, 1995 reflect only the operating results of San Dieguito.
FINANCIAL CONDITION
Total assets of the Company at December 31, 1997 were $902.4 million
compared to total assets of $437.1 million at December 31, 1996. The increase
in total assets since December 31, 1996 is attributed primarily to the Eldorado
Acquisition. Total earning assets of the Company at December 31, 1997 were
$725.6 million compared to total earning assets of $377.8 million at
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<PAGE>
December 31, 1996. Earning assets increased primarily due to the Eldorado
Acquisition and growth in residential mortgage loan originations.
LOANS AND LEASES
Total loans and leases of the Company at December 31, 1997 were $618.3
million, including $96.2 million of mortgage loans held for sale, compared to
$328.6 and $64.9 million, respectively, at December 31, 1996. The increase in
mortgage loans held for sale and the loans and leases acquired in the Eldorado
Acquisition account for the increase in total loans and leases.
The Company holds loans and leases in its portfolio at December 31,
1997, of which loans represented 92.3% and leases represented 7.7% of total
loans and leases. 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, 1997, those
categories accounted for approximately 38.0%, 33.2%, 18.7% and 10.1% of total
loans, respectively. Leases are made to finance small equipment for businesses.
Included among the Company's portfolio of loans are approximately $105.7
million of SBA loans made by the Bank guaranteed by the United States Government
to the extent of 75% to 90% of the principal and interest due on such loans.
The Company is active in originating this type of loan. The Company generally
sells the government guaranteed portion of those loans to investors in the
secondary market and retains servicing responsibilities and the unguaranteed
portion of the loans (See "BUSINESS - Southern California Operations - SBA
Lending Concentration.")
INVESTMENT SECURITIES
Total investments of the Company at December 31, 1997 were $107.3 million
compared to $49.2 million at December 31, 1996. Investment securities increased
largely due to the Eldorado Acquisition. The investment portfolio primarily
consists of U.S. Treasury, U.S. government agencies, state and municipal
securities and mortgage-backed securities that are categorized as available for
sale and totaled $67.3 million, or 65.9% of the total portfolio, at December 31,
1997. The investments of the Company also include Federal funds sold that were
$40.0 million, or 34.1% of the total portfolio at December 31, 1997 (See
"BUSINESS - Investment Securities.")
DEPOSITS
Total deposits were $765.2 million at December 31, 1997 compared to $383.0
million at December 31, 1996. The increase in total deposits since December
31, 1996 is attributed to the addition of deposits acquired in the Eldorado
Acquisition. Non-interest bearing demand accounts were $289.3 million, or 37.8%
of total deposits, at December 31, 1997. 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 $97.4 million, $98.5 million, $98.2 million, $99.7 million
and $82.1 million, respectively, or 12.7%,
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<PAGE>
12.9%, 12.8%, 13.1% and 10.7% of total deposits, respectively, at December
31, 1997. (See "BUSINESS - Deposits.")
RESULTS OF OPERATIONS
NET INCOME.
The Company had net income of $3.0 million for the year ended December
31, 1997 compared to net income of $2.3 million for the year ended December
31, 1996. The increase in net income is due to an increase in net interest
income and non-interest income of $21.2 million and $10.0 million,
respectively, partially offset by increased provision for loan and lease
losses, non-interest expense and income taxes of $980,000, $24.4 million and
$5.1 million, respectively. As noted above, many of these increases are
attributable to the operations of acquired institutions accounted for using
the Purchase Method. Basic net income per share in 1997 was $.15 per share
compared to $.44 in 1996, while diluted net income per share in 1997 was $.13
per share compared to $.44 in 1996.
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 1995 $5,000 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, and non-interest expense of $227,000, and $11.0 million,
respectively. Basic 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, while diluted net income per share in 1996 was $.44 compared to net
loss per share of $.02 (after adjustment for extraordinary item) in 1995.
(See "BUSINESS - Historical Distribution of Assets, Liabilities and
Shareholders' Equity.")
NET INTEREST INCOME AND NET INTEREST MARGIN
The Company's net interest income increased $21.2 million in 1997 due to
an increase of $34.1 million in interest income partially offset by increased
interest expense of $13.0 million. Interest income and interest expense
increased primarily due to an increase in interest earning assets and
liabilities acquired in the Eldorado Acquisition. Decreased yields on
earning assets partially offset interest income due to the higher volume of
earning assets while the cost of interest bearing liabilities remained
constant. The yield on average interest-earning assets declined to 9.37% in
1997 from 9.74% in 1996 and the cost of interest-bearing liabilities remained
stable at 4.64% in 1997 and 1996. As a result of those factors the net yield
on earning assets declined to 5.76% in 1997 from 5.89% in 1996. (See
"BUSINESS - Historical Distribution of Assets, Liabilities and Shareholders'
Equity.")
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<PAGE>
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
those factors the net yield on earning assets rose to 5.89% in 1996 from 5.60%
in 1995. (See "BUSINESS - Historical Distribution of Assets, Liabilities and
Shareholders' Equity.")
Loan fee income increased $1.7 million to $2.9 million in 1997 from $1.2
million in 1996. Much of this increase is attributable to the fees earned on
the sale of SBA loans into the secondary market. Loan fee income increased $1.1
to $1.2 million in 1996 from $104,000 in 1995. Again, much of this increase is
attributable to the fees earned on the sale of SBA loans into the secondary
market.
ALLOWANCE AND PROVISION FOR LOAN AND LEASE LOSSES
The provision for loan and lease losses is an expense charged against
operating income and added to the allowance for loan and lease losses. The
allowance for loan and lease losses represents the amounts which have been
set aside for the specific purpose of absorbing losses which may occur in
the Company's loan and lease portfolios.
The calculation of the adequacy of the allowance for loan and lease losses
requires the use of management estimates. Those 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 Company's lending is
concentrated in Southern California, which has experienced adverse economic
conditions, including declining real estate values. Those factors have
adversely affected borrowers' ability to repay loans. Although management
believes the level of the allowance as of December 31, 1997 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 Company's financial condition
in the future. See also "BUSINESS -- Allowance for Loan and Lease Losses."
The allowance for loan and lease losses was $9.4 million, or 1.8% of gross
portfolio loans at December 31, 1997, compared to $5.2 million or 1.9% of gross
portfolio loans, at December 31, 1996, and $639,000, or 1.6%, of gross portfolio
loans at December 31, 1995. The provision for loan losses for the year ended
December 31, 1997 was $1.5 million compared to $515,000, for the same period
in 1996, and $295,000 for the same period in 1995.
47
<PAGE>
NON-INTEREST INCOME
Non-interest income increase by $10.0 million to $14.9 million in 1997 from
$4.9 million in 1996. The increase was primarily due to income derived from the
Company's mortgage banking activity for twelve months in 1997 compared to only
four months in 1996. Additionally, the fee income generated by operations
acquired in the Liberty and CSB Acquisitions for the full year compared to only
the partial year in 1996 and from the Eldorado Acquisition contributed to this
increase.
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, origination and sale residential mortgages and sale of small equipment
leases.
NON-INTEREST EXPENSE
Non-interest expense increased $24.4 million to $39.7 million in 1997 from
$15.3 million in 1996. The increase in expense is largely attributable to the
expenses associated with the acquired operations in the Liberty and CSB
acquisitions for the full year in 1997 compared to only the partial year in 1996
and from the Eldorado Acquisition with seven months in 1997. Also included in
this increase is the amortization of goodwill, which for 1997 was $2.2 million
compared to $268,000 in 1996.
Non-interest expense increased $11.2 million to $15.3 million in 1996 from
$4.3 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 $2.3 million and
$3.8 million in other non-interest expenses. Included in this increase is the
amortization of goodwill, which for 1996 was $268,000 and none in 1995.
PROVISION FOR INCOME TAXES
The Company recorded a tax provision of $3.6 million in 1997 compared to a
net benefit of $1.5 million recorded in 1996. This increase in taxes resulted
from higher pre-tax earnings in 1997 of $6.6 million compared to $822,000 in
1996 combined with the tax benefit derived in 1996 as described below.
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 increased 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 been
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, 1997 and 1996 and therefore the valuation allowance is no longer
required. Of the $2.0 million total allowance
48
<PAGE>
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
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.
See "SUPERVISION AND REGULATION -- Capital Adequacy Requirements."
The Company and the Bank were well capitalized as of December 31, 1997
for federal regulatory purposes. As of December 31, 1997, the Company had a
leverage ratio of 6.59%, Tier 1 risk-weighted capital ratio of 8.85% and total
risk-weighted capital ratio of 10.18%. The Bank had a leverage ratio of 6.64%,
Tier 1 risk-weighted capital ratio of 8.91% and total risk-weighted capital
ratio of 10.16%.
LIQUIDITY
The Company relies on deposits as its principal source of funds and,
therefore, must be in a position to service depositors' needs as they arise.
Management attempts 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 78% in 1997, 68% in 1996 and 78% in 1995. The
average liquidity ratio was 29% in 1997, 30% in 1996 and 22% in 1995. At
December 31, 1997, the Company's loan-to-deposit ratio was 69% and the liquidity
ratio was 25%. While fluctuations in the balances of a few large depositors
cause temporary increases and decreases in liquidity from time to time, the
Company has 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 Company, other available sources of liquid assets
(secondary liquidity), including the purchase of Federal funds, sale of
securities under agreements to repurchase, sale of loans, and the discount
window borrowing from the Federal Reserve Bank, could be employed. The Company
has relied primarily upon the purchase of Federal funds and the sale of
securities under agreements to repurchase for its secondary source of liquidity.
49
<PAGE>
INTEREST RATE SENSITIVITY
The Company manages its interest rate sensitivity by matching the
repricing opportunities on its earning assets to those on its funding
liabilities. Management uses various asset/liability strategies to manage the
repricing characteristics of its assets and liabilities to ensure that
exposure to interest rate fluctuations is limited within Company guidelines
of acceptable levels of risk-taking. Hedging strategies, including the terms
and pricing of loans and deposits, and managing the deployment of its
securities are used to reduce mismatches in interest rate repricing
opportunities of portfolio assets and their funding sources. The Company
does not utilize any interest rate swaps or other such financial derivatives
to alter its interest rate risk profile.
One way to measure the impact that future changes in interest rates will
have on net interest income is through a cumulative gap measure. The gap
represents the net position of assets and liabilities subject to repricing in
specified time periods. Generally, a liability sensitive gap position
indicates that there would be a net positive impact on the net interest
margin of the Company for the period measured in a declining interest rate
environment since the Company's liabilities would reprice to lower market
rates before its assets would. A net negative impact would result from an
increasing interest rate environment. Conversely, an asset sensitive gap
indicates that there would be a net positive impact on the net interest
margin in a rising interest rate environment since the Company's assets would
reprice to higher market interest rates before its liabilities would.
Since interest rate changes do not affect all categories of assets and
liabilities equally or simultaneously, a cumulative gap analysis alone cannot
be used to evaluate the Company's interest rate sensitivity position. To
supplement traditional gap analysis, the Company performs simulation modeling
to estimate the potential effects of changing interest rates. The process
allows the Company to explore the complex relationships within the gap over
time and various interest rate environments.
The table on the following page analyzes the assets and liabilities of
the Company at December 31, 1997, by interest rate sensitivity, showing the
amount of each category which is subject to repricing over specified time
horizons.
50
<PAGE>
<TABLE>
<CAPTION>
AMOUNTS MATURING OR REPRICING IN
-------------------------------------------------------------------
OVER 3
MONTHS OVER 1
3 MONTHS TO 12 YEAR TO OVER NON-
OR LESS MONTHS 5 YEARS 5 YEARS SENSITIVE (1) TOTAL
------- ------ ------- ------- ------------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Cash and due from banks $ - $ - $ - $ - $ 81,030 $ 81,030
Federal funds sold 40,000 - - - - 40,000
Investment securities 11,993 29,459 21,479 4,326 38 67,295
Loans and leases 335,440 53,084 97,286 44,415 - 530,225
Loans held for sale and
and servicing sale receivable - - - - 89,306 89,306
Other assets (2) - - - - 94,499 94,499
-------- ------- -------- ------- -------- --------
Total assets $387,433 $82,543 $118,765 $48,741 $264,873 $902,355
-------- ------- -------- ------- -------- --------
-------- ------- -------- ------- -------- --------
LIABILITIES AND
SHAREHOLDERS' EQUITY
Non-interest bearing
demand deposits $ - $ - $ - $ - $289,344 $289,344
Interest-bearing demand,
Money market and savings 294,070 - - - - 294,070
Time certificates of deposit 59,170 115,041 7,488 90 - 181,789
Short term debt 2,587 - - - - 2,587
Long term debt - - - 27,657 - 27,657
Other liabilities - - - - 12,172 12,172
Shareholders' equity - - - - 94,736 94,736
-------- ------- -------- ------- -------- --------
Total liabilities &
shareholders' equity $355,827 $115,041 $ 7,488 $27,747 $396,252 $902,355
-------- ------- -------- ------- -------- --------
-------- ------- -------- ------- -------- --------
Gap (assets-liabilities and
shareholders' equity) $ 31,606 $(32,498) $111,277 $ 20,994 $(131,379)
Cumulative Gap $ 31,606 $ (892) $110,385 $131,379 -
Cumulative gap as a % of total assets 3.50% (.09%) 12.23% 14.56% -
</TABLE>
ECONOMIC CONSIDERATIONS
The financial condition of the Company has been, and is expected to
continue to be, affected primarily by overall general economic conditions and
the real estate market in California. The commercial banking activity of the
Company concentrates 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 residential mortgage origination
activity is centered in the five western states of the United States, and
originations of small equipment leases are done throughout the country with a
concentration in Northern California.
- -------------------------
(1) Assets or liabilities which are not interest rate-sensitive.
(2) Allowance for possible loan losses of $9.4 million as of December 31,
1997 is included in other assets.
51
<PAGE>
Although the general economy in Southern California has recovered
substantially from the prolonged recession that had adversely affected the
ability of certain borrowers to satisfy their obligations to the Company, the
Company's financial condition and operating results are subject to changes in
economic conditions in that region. Moreover, there can be no assurance that
conditions will not worsen in the future and that such deterioration will not
have a material adverse effect on the Company's financial condition or
results of operations.
In addition, a substantial portion of the Company's assets consist of
loans secured by real estate in Southern California with a lessor
concentration in Northern California. Historically, these areas have
experienced on occasion significant natural disasters, including earthquakes,
brush fires and, recently, flooding attributed to the weather phenomenon
known as "El Nino." Accordingly, the availability of insurance for losses
from such catastrophes is limited. The occurrence of one or more such
catastrophes could impair the value of the collateral for the Company's real
estate secured loans and have a material adverse effect on 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 Company, 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
Company 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 Company, making
collection more difficult for the Company. Rates of interest paid or charged
generally rise if the marketplace believes inflation rates will increase.
52
<PAGE>
ITEM 8. FINANCIAL STATEMENTS
Financial Statements Page No.
-------------------- --------
Report of Independent Accountants F1
Consolidated Statements of Condition as of December 31, 1997 and 1996 F2
Consolidated Statements of Operations for the Years ended
December 31, 1997, 1996 and 1995 F4
Consolidated Statements of Shareholders' Equity for the Years ended
December 31, 1997, 1996 and 1995 F5
Consolidated Statements of Cash Flows for the Years ended
December 31, 1997, 1996 and 1995 F6
Notes to Consolidated Financial Statements -
December 31, 1997, 1996 and 1995 F8
53
<PAGE>
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
54
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table provides certain information with respect to the
directors and executive officers of the Company as of December 31, 1997.
<TABLE>
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
Ernest J. Boch 71 Director
James A. Conroy 37 Director
Edward A. Fox 61 Director
Charles E. Hugel 69 Director
Mitchell A. Johnson 56 Director
Robert P. Keller 60 Director, President and
Chief Executive Officer
K. Thomas Kemp 57 Director
Jefferson W. Kirby 36 Director
John B. Pettway 35 Director
Henry T. Wilson 37 Director
Paul R. Wood 44 Director
Curt A. Christianssen 37 Executive Vice President,
Treasurer and Chief Financial
Officer
Lawrence A. Johnes 54 Executive Vice President --
Leasing Division
William J. Lewis 54 Executive Vice President and
Chief Credit Officer
Richard Korsgaard 56 Executive Vice President --
Construction Loan Division
and CRA Officer
William D. Rast 50 Executive Vice President --
Mortgage Division
Paul F. Rodeno 43 Executive Vice President --
Operations
</TABLE>
ERNEST J. BOCH has been Chairman and Chief Executive Officer of Subaru
of New England, Inc. since 1970. He is also the majority owner of Boch
Oldsmobile, Toyota and Mitsubishi of Norwood as well as founder of Boch
Broadcasting Corporation.
JAMES A. CONROY has been associated since 1990 with Olympus Partners, a
venture capital firm, and since December 1993, Mr. Conroy has been a general
partner of Olympus Growth Fund
55
<PAGE>
II, L.P., which is a principal shareholder of the Company. Prior to 1990 Mr.
Conroy worked in the Private Finance Group of Goldman Sachs and in General
Electric Investment Corporation's Private Placements Division. Mr. Conroy
also serves on the boards of directors of Champion Healthcare Corporation and
Frontier Vision Partners, L.P.
EDWARD A. FOX is the Chairman of the SLM Holding Corp. in Reston, VA.
From 1990 to his retirement in 1994, Mr. Fox served as Dean of the Amos Tuck
School of Business at Dartmouth College in Hanover, New Hampshire. Prior to
1990, Mr. Fox was founding President and Chief Executive Officer of Sallie
Mae. Mr. Fox also currently serves as a director of Delphi Financial Corp.,
Greenwich Capital Management Corp., New England Life Insurance Company.
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.
MITCHELL A. JOHNSON is the President of MAJ Capital Management, Inc.,
which he organized in August 1994 after retiring from Sallie Mae in June
1994. Mr. Johnson joined Sallie Mae in 1973 and served as its Senior Vice
President, Corporate Finance from 1987 until his retirement. Mr. Johnson was
the first President and a founding member of the Washington Association of
Money Managers. Currently, Mr. Johnson serves as trustee of the District of
Columbia Retirement Board and as a director of the Federal Agricultural
Mortgage Corporation (Farmer Mac) and Whitestone Capital Group, Inc.
ROBERT P. KELLER is the President and Chief Executive Officer of the
Company and of the DCG General Partner. 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
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 Haverford Industries, LLC, Pennichuck Corporation and White
Mountains Holdings, Inc.
56
<PAGE>
K. THOMAS KEMP serves as President and Chief Executive Officer of Fund
American Enterprises Holdings, Inc. (formerly Fireman's Fund Corporation) and
Chairman and Chief Executive Officer of White Mountains Holdings, Inc. Mr.
Kemp serves on the boards of directors of Fund American, White Mountains,
Valley Insurance Co., Financial Security Assurance, LTD., Main Street America
Holdings and Haverford Industries, 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.
JOHN PETTWAY is the Manager of the Haverford Group, LLC, an investment
company located in Park City, Utah, and is also the Chief Financial Officer
for both Haverford Industries, LLC and Byrne & sons, l.p. Prior to June
1993, Mr. Pettway was a practicing attorney at the firm of Adams & Associates
in Alexandria, Virginia. Mr. Pettway serves as director of Haverford
Industries, LLC and American Direct Business Insurance Agency, Inc.
HENRY T. WILSON is Managing Director and a member of the board of
directors of Northwood Ventures LLC and Northwood Capital Partners LLC,
private equity investment firms based in Syosset, New York, by whom he has
been employed since 1991. From 1989 to 1991, Mr. Wilson was a Vice President
in the investment banking division of Merrill Lynch & Co. He serves on the
boards of directors of Alliance National, Inc. and the Lion Brewery, Inc.,
both of which are public companies.
PAUL R. WOOD is a Vice President of Madison Dearborn Partners, Inc., a
venture capital firm which is the general partner of Madison Dearborn Capital
Partners II, L.P., a principal shareholder of the Company. Prior to Madison
Dearborn Partners, Mr. Wood was with First Chicago Venture Capital for nine
years. Previously, he spent six years with the venture capital unit of
Continental Illinois Bank. Mr. Wood serves on the boards of directors of
Duo-Tang, Inc., Hines Horticulture, Inc., and Intercontinental Art, Inc.
CURT A. CHRISTIANSSEN is the Executive Vice President, Treasurer and
Chief Financial Officer of the Company and the Bank, and the Treasurer and
Chief Financial Officer of the DCG General Partner. Mr. Christianssen served
as Chief Financial Officer of Liberty from October 1993 until its acquisition
in March 1996 by the Company's predecessor. 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.
57
<PAGE>
LAWRENCE A. JOHNES is the Executive Vice President of the Bank in charge
of the Leasing Division. Mr. Johnes was hired by the Bank in August, 1997.
From 1995 to August, 1997 Mr. Johnes was Senior Vice President in charge of
Sales and Marketing for Mitsui Vendor Leasing which provided manufacturer and
distributor lease financing. From 1993 to 1995 Mr. Johnes was Senior Vice
President and National Sales Manager for Loan Guarantee Investment
Corporation. From 1990 to 1993 Mr. Johnes was a partner in Far West
Acquisitions representing buyers and sellers of service and manufacturing
companies. Previously Mr. Johnes was Executive Vice President and Chief
Financial Officer, then President and Chief Operating Officer of ELLCO
Leasing Corporation, a $1.5 billion company providing direct and vendor lease
financing.
WILLIAM J. LEWIS is an Executive Vice President of the Bank and its
Chief Credit Officer. From July 1994 to June 1997, when Eldorado was
acquired by the Company, Mr. Lewis was an executive officer of Eldorado and
Eldorado Bank. From August 1982 to July 1994, Mr. Lewis served as a senior
loan officer of Sanwa Bank, an $8 billion financial institution headquartered
in Los Angeles. His last position at Sanwa Bank, from 1991 to 1994, was
Senior Vice President and Senior Division Credit Officer.
RICHARD KORSGAARD is the Bank's Executive Vice President responsible for
its Construction Loan Division. Mr. Korsgaard also serves as the Bank's and
CRA Officer. Mr. Korsgaard served as Executive Vice President/Construction
Loan Division and Director of Eldorado Bank and a Director of Eldorado
Bancorp from October 1995 until June 1997 when Eldorado was acquired by the
Company. From June 1982 to October 1995, Mr. Korsgaard served as President,
Chief Executive Officer and Director of Mariners Bank, a $75 million
community bank headquartered in San Clemente. Mariners Bank was acquired by
Eldorado Bancorp in October, 1995.
WILLIAM D. RAST is the Bank's Executive Vice President responsible for
its Mortgage Division. Mr. Rast was hired by the Bank in February, 1998.
From February 1996 to February, 1998, Mr. Rast served as the Chief Executive
Officer of Case Compactors, a small waste management company and was also the
Managing Director of Hamilton Pacific, a firm that specializes in relocating
businesses to China. From May 1992 to May 1996, Mr. Rast served as President
and Chief Operating Officer of Hamilton Financial, a financial services
company primarily focused in mortgage banking. Prior to 1992, Mr. Rast was
employed for 11 years by First California Mortgage, a 33 office mortgage
company closing $2.5 billion in loans annually, with his last position being
Senior Vice President responsible for retail and wholesale production.
PAUL F. RODENO is the Bank's Executive Vice President in charge of its
retail branch system, retail product departments and the bank's marketing
programs. From October 1995 to June 1997, when San Dieguito National Bank
was merged into Eldorado Bank, Mr. Rodeno served as its Executive Vice
President and Chief Operating Officer. Mr. Rodeno served as Executive Vice
President/Loan Administration of San Dieguito National Bank from July 1986
until September 1995, when San Dieguito was acquired by the Company's
predecessor.
58
<PAGE>
Each of the current directors of the Company, other than Mr. Conroy, Mr.
Johnson and Mr. Wood also serves as a director of the General Partner of DCG.
There are no family relationships between any of the Company's directors or
executive officers.
AUDIT COMMITTEE. The 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 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 DCG's recapitalization of SDN Bancorp, Inc., the directors of the
Company 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 in the future. All
directors receive reimbursement of reasonable expenses incurred in attending
Board and committee meetings and otherwise carrying out their duties.
59
<PAGE>
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth information regarding the compensation
received for the three fiscal years ended December 31, 1997 by the Chief
Executive Officer and the other executive officer of the Company (the "Named
Officers"). All cash compensation was paid to the Named Officers by the
Company.
<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 1997 $275,000 - - 375,964 728,600 $4,750
President and Chief 1996 $185,240 - - 51,592 - $1,316
Executive Officer 1995 $ 37,500(1) - - - - $3,918(2)
Richard Korsgaard 1997(3) $176,500 - - - - $4,000
Executive Vice President 1996 $ - - - - - $ -
Construction Lending 1995 $ - - - - - $ -
William L. Lewis 1997(4) $124,000 - - - - $6,125
Executive Vice President 1996 $ - - - - - $ -
and Chief Credit Officer 1995 $ - - - - - $ -
Curt A. Christianssen 1997 $114,167 - - - 50,000 $4,750
Executive Vice President 1996(5) $ 76,875 - - - - $2,316
and Chief Financial 1995 $ - - - - - $ -
Officer
</TABLE>
- --------------
(1) Period from October 1, 1995 to December 31, 1995.
(2) Includes reimbursement for moving expenses.
(3) Includes base pay of $52,083, commission of $51,500 and $3,270 in other
compensation paid prior to or related to services provided to the Bank
prior to the acquisition of Eldorado by the Company and excludes bonuses
and deferred compensation of $77,542 paid by Eldorado prior to the
acquisition.
(4) Includes base pay of $51,667 and $2,125 in other compensation paid prior
to the acquisition of Eldorado by the Company and excludes bonuses and
deferred compensation of $102,398 paid by Eldorado prior to the
acquisition.
(5) Period from April 1, 1996 to December 31, 1996
60
<PAGE>
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.
BASE SALARY. Mr. Keller's base salary under the employment agreement
will depend upon the Company's consolidated assets. Mr. Keller's base
salary currently is $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 Class B 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
and Eldorado acquisitions. 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 DCG 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 to be 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
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<PAGE>
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 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
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<PAGE>
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 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 annually 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.
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<PAGE>
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. 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.
OTHER EXECUTIVE EMPLOYMENT AGREEMENTS
The Company also has entered into employment agreements with William L.
Lewis, Executive Vice President, Richard Korsgaard, Executive Vice President
and Larry Johnes, Executive Vice President.
Mr. Lewis is presently employed with the Bank pursuant an employment
agreement (the "Lewis Agreement") that the Company assumed upon consummation
of the Eldorado Acquisition. The Lewis Agreement provides for a minimum
annual base salary of $118,000 beginning March 1, 1996. The initial term of
each of these Employment Agreements is three years. Each year, the three year
term will automatically be extended for an additional year, unless either of
the parties to the Lewis Agreement gives written notice of non-renewal to the
other, in which event the term of the Lewis Agreement would end on December
31 of the second calendar year following the calendar year in which such
written notice was given. However, the Bank has the right to terminate the
Lewis Agreements at any time prior to their expiration, with or without
cause. If the Bank terminates the Lewis Agreement without cause, Mr. Lewis
will be entitled to receive a termination payment equal to six months of his
base salary then in effect. In the event of a reorganization of the Bank,
Lewis Agreements will be binding on the surviving entity in such
reorganization. If, however, Mr. Lewis is terminated without cause following
a reorganization, or elects to terminate his employment because the surviving
entity has taken any of certain actions, specified in the Lewis Agreement,
that adversely affect his compensation or conditions of employment, he would
become entitled to receive a termination payment equal to one year's base
salary then in effect. Notwithstanding the foregoing, in the event that
proceedings for the liquidation of the Company or the Bank are commenced by
regulatory authorities, Lewis Agreement would be terminated by the Bank, in
which case Mr. Lewis would become entitled to receive an amount equal to the
lesser of six months base salary at the then-applicable rate, or the
remaining balance payable to Mr. Lewis under Lewis Agreement.
Mr. Korsgaard is employed by the Bank as Executive Vice President
pursuant to a three year employment agreement (the "Korsgaard Agreement")
that the Company assumed upon the consummation of the Eldorado Acquisition.
The Korsgaard Agreement establishes a minimum base salary of $125,000. In
the event Mr. Korsgaard is terminated by the Bank or any successor to the
Bank
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<PAGE>
without cause, he is entitled to receive a termination payment in an amount
equal to the greater of the balance payable under the Korsgaard Agreement or
twelve months of his then current base salary. The Korsgaard Agreement may
not be terminated by an acquisition or dissolution of the Bank or the Company
except in the event that proceedings for the liquidation of the Company or
the Bank are commenced by regulatory authorities, in which case the Korsgaard
Agreement, and all rights and benefits thereunder, would be terminated. A
salary continuation program has been established for Mr. Korsgaard, under
which Mr. Korsgaard (or, in the event of his death, his heirs) will receive
$65,000 per year from the Bank for 15 years following his reaching age 65 or
his death or disability, whichever first occurs.
Mr. Johnes is employed by the Bank as Executive Vice President pursuant
to a two year employment agreement (the "Johnes Agreement") that the Company
entered into in August 1997. The Johnes Agreement establishes a minimum base
salary of $130,000. Under the Johnes Agreement, Mr. Johnes is also entitled
to variable compensation calculated and paid quarterly based upon the
profitability of the Leasing Division. In the event Mr. Johnes is terminated
by the Bank or any successor to the Bank without cause, he is entitled to
receive a termination payment in an amount equal to twelve months pay. The
Johnes Agreement may not be terminated by an acquisition or dissolution of
the Bank or the Company except in the event that proceedings for the
liquidation of the Company or the Bank are commenced by regulatory
authorities, in which case the Johnes Agreement, and all rights and benefits
thereunder, would be terminated.
The Bank has entered into Severance Agreements (each a "Severance
Agreement") with those of its executive officers not subject to individual
employment agreements concerning the ramifications of a change in control of
the Company on the continued employment of each such officer. As used in the
Severance Agreement, the term "change in control" has the same definition as
in the Option Plan. Pursuant to and as detailed further in each Severance
Agreement, if the terms of an officer's employment are significantly altered
to the detriment of such officer within two years following a change in
control, and the officer provides the requisite notice to the Bank, or
alternatively, if the Bank terminates the officer without cause within two
years following a change in control, then the officer is entitled to a lump
sum payment equal to one year's salary, less applicable taxes and
withholdings. A precondition to such payment is the execution by the officer
of a general release and confidentiality agreement. The form of Severance
Agreement has been filed as an exhibit hereto.
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<PAGE>
STOCK OPTION PLAN
GENERAL. The Company has adopted the Option Plan pursuant to which the
Company's Board of Directors or the Compensation Committee (the "Committee")
may grant stock options to Mr. Keller and other officers of the Company or
any of its subsidiaries. As of December 31, 1997, there were 1,457,223
shares of Class B Common Stock subject to the Option Plan. The Option Plan
provides only for the issuance of so-called "nonqualified" stock options (as
compared to incentive stock options). As of December 31, 1997, Messrs.
Keller and Christianssen hold options to purchase 728,600 and 50,000 shares
of Class B Common Stock, respectively.
EXERCISE PRICE STRUCTURE. The Option Plan authorizes the Committee to
set the exercise price for each option grant. In the case of option grants
to Mr. Keller, each portion of his award will have a separate, fixed exercise
price as such portion vests over time. The exercise price for each separate
tranche will increase progressively based upon a semi-annual compounding of a
"base rate" using the 5-year U. S. Treasury rate in effect at the date of
grant.
VESTING SCHEDULE AND DURATION. The options granted to Messrs. Keller
and Christianssen, and any future grants, unless the Committee otherwise
decides, will vest over four years, in half-year increments, with the first
portion vesting on the 18-month anniversary of the date of grant. The Option
Plan provides that unless the Committee otherwise determines, the options
will have a six-year term, expiring on the sixth anniversary of the date of
grant.
ACCELERATION EVENT -- EFFECT ON VESTING.
MR. KELLER. Mr. Keller's options will become fully vested in connection
with a change in control, which is defined in the Option Plan, consistent
with the definition of a change in control contained in Mr. Keller's
employment agreement. Mr. Keller's employment agreement provides that a
"change in control" will include the authorization of certain business
combinations by the Company's Board of Directors. In general, a business
combination involving the Company will not be deemed to be a change in
control if the Company's shareholders own at least one-third of the resulting
entity and at least half of the directors of the resulting entity are persons
who were directors of the Company at the time the parties entered into the
definitive agreement. In addition, Mr. Keller's options would become
fully-vested if the Company were to terminate his employment agreement
without cause or if he were to terminate the agreement for cause. Mr.
Keller's options also would become fully-vested if he dies or becomes
permanently disabled.
OTHER OPTION HOLDERS. For all other option holders, the Option Plan
will provide for a "double trigger," unless the Committee otherwise specifies
at the time it awards the option. Under the double trigger approach, the
option would become fully vested if the option holder is actually or
constructively terminated without cause during a two-year period following a
change in control.
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<PAGE>
AGGREGATED FISCAL YEAR-END OPTION VALUES
The following table shows certain information concerning the aggregate
number of unexercised options to purchase Class B Common Stock held by
executive officers as of December 31, 1997. No options were exercised by
executive officers during 1997.
<TABLE>
<CAPTION>
Number of Securities
Underlying Unexercised Value of Unexercised
Options at In-the-Money Options at
December 31, 1997 December 31, 1997
Exercisable/ Exercisable/
Unexercisable Unexercisable
------------- -------------
<S> <C> <C>
Robert P. Keller 0/728,600 (1) 0/$390,276 (2)
President and Chief
Executive Officer
Curt A. Christianssen 0/50,000 (1) 0/$17,083 (2)
Executive Vice President
and Chief Financial Officer
</TABLE>
- --------------
(1) For information on the vesting schedule and exercise price per share see
"Option Grants in Last Fiscal Year"
(2) Assumes the value of Class B Common Stock is $6.00 per share at which
the last known sale of Class B Common Stock occurred (See "MARKET FOR
ISSUER'S COMMON STOCK AND RELATED MATTERS -- Unregistered Sales of
Securities.")
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<PAGE>
OPTION GRANTS IN LAST FISCAL YEAR
The following table contains a summary of the grants of stock options made
during the fiscal year ended December, 31, 1997.
<TABLE>
<CAPTION>
Potential Realizable
Value at Assumed Rate
of Stock Price
Appreciation for
Individual Grants Option Term (1)
------------------------------------------------------------------------- -----------------------
% of Total
Number of Options
Securities Granted to
Underlying Employees Exercise
Options in Fiscal Price Expiration
Name Granted Year ($/Sh)(2) Date 5% ($) 10% ($)
--------------------- ---------- ------------ ------------ ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Robert P. Keller 309,500 39.7% 4.82/51,583 2/3/2003 $83,867 $190,919
President and 4.97/51,583 76,129 183,182
Chief Executive 5.12/51,583 68,392 175,445
Officer 5.27/51,583 60,654 167,707
5.43/51,583 52,401 159,454
5.60/51,585 43,634 150,691
419,100 53.9% 5.26/69,850 7/14/2003 82,832 227,795
5.42/69,850 71,656 216,619
5.59/69,850 59,782 204,745
5.75/69,850 48,606 193,569
5.93/69,850 36,033 180,996
6.10/69,850 24,158 169,121
Curt A. Christianssen 50,000 6.4% 5.26/8,333 6/30/2003 9,882 27,176
Executive Vice 5.42/8,333 8,548 25,842
President and Chief 5.59/8,333 7,132 24,426
Financial Officer 5.75/8,333 5,799 23,092
5.93/8,333 4,299 21,593
6.10/8,335 2,883 20,181
</TABLE>
- --------------
(1) The market price at the date of grant was $4.81, based upon the price at
which Class B Common Stock was issued in connection with the Eldorado
Acquisition.
(2) Absent a change in control of the Company, as defined in the Option
Plan, each tranche of option shares will vest in successive six-month
increments. Upon a change in control, the exercisability of the option is
accelerated to such date. Following a change in control, the exercise price
with respect to any option shares exercised prior to their original vesting
date shall equal the exercise price for those option shares that had a
scheduled vesting date that was on or next preceding such exercise date.
OTHER BENEFIT PLANS
The Company's executive officers are also entitled to short term
disability, life, medical and dental insurance as well as participation in
the Company's 401(k) retirement plan.
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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
GENERAL. The following table sets forth certain information as of
December 31, 1997 about persons who are beneficial owners of more than 5% of
the outstanding equity securities of the Company.
<TABLE>
<CAPTION>
VOTING SECURITIES ALL EQUITY SECURITIES
------------------------------------ -----------------------------
BENEFICIALLY PERCENTAGE OF BENEFICIALLY PERCENTAGE
INVESTOR OWNED VOTING SECURITIES OWNED OF CLASS(1)
-------- ------------ ----------------- ------------ -----------
<S> <C> <C> <C> <C>
Dartmouth Capital Group, L.P.(2)
Dartmouth Capital Group, Inc.
Class B Common Stock . . . . . . . 6,001,235 36.4% 6,001,235 32.7%
Special Common Stock . . . . . . . -- -- -- --
Series A Capital Securities . . . . -- -- -- --
Series B Preferred Stock . . . . . -- -- -- --
Madison Dearborn Capital Partners II, L.P.(3)
Class B Common Stock(4) . . . . . . 146,000 0.9% 146,000 .8%
Special Common Stock(1) . . . . . . 1,485,033 9.0% 2,412,859 13.2%
Series A Capital Securities . . . . -- -- -- --
Series B Preferred Stock . . . . . -- -- 58,296 50.0%
Olympus Growth Fund II, L.P.(5)
Olympus Executive Fund, L.P.
Class B Common Stock(6) . . . . . . 146,000 0.9% 146,000 .8%
Special Common Stock(1) . . . . . . 1,485,033 9.9% 2,412,859 13.2%
Series A Capital Securities . . . . -- -- -- --
Series B Preferred Stock . . . . . -- -- 58,296 50.0%
Ernest J. Boch(7)
Class B Common Stock . . . . . . . 2,397,628 14.5% 2,260,828 13.1%
F. M. Kirby(8)
Class B Common Stock . . . . . . . 1,401,029 8.5% 1,401,029 7.6%
Shareholders of DCG General Partner
as a Group (11 shareholders)(9)(10)
Class B Common Stock . . . . . . . 5,339,751 32.4% 5,339,571 29.1%
</TABLE>
- ----------------------
(1) For purposes of computing the percentage of each class of equity securities
beneficially owned by each principal shareholder, the Class B Common Stock
and Special Common are treated as a single class of securities.
(2) As the sole general partner of DCG, the DCG General Partner exercises sole
control over the voting and disposition of the shares of Common Stock held
of record by DCG. DCG and the DCG General Partner each have a business
address c/o Commerce Security Bancorp, Inc., 24012 Calle de la Plata, Suite
150, Laguna Hills, CA 92653.
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<PAGE>
(3) MDP's sole general partner is Madison Dearborn Partners II, L.P., whose
sole general partner is Madison Dearborn Partners, Inc. MDP's address is
Three First National Plaza, Suite 3900, Chicago, IL 60602.
(4) Does not include a currently-exercisable warrant to purchase an additional
2,000,000 shares of Common Stock which, subject to the terms of such
warrant, would be exercisable for non-voting shares of Common Stock (i.e.,
Class C Common Stock) if MDP's percentage ownership of all outstanding
voting securities would exceed 9.9%.
(5) Presentation has been combined for Olympus Growth Fund II, L.P. and Olympus
Executive Fund, L.P., as the general partners of the limited partnerships
(OGF II, L.P. and OEF, L.P., respectively) are under common control.
Olympus's address is Metro Center, One Station Place, Stamford, CT 06902.
(6) Does not include currently-exercisable warrants to purchase an additional
2,000,000 shares of Common Stock which, subject to the terms of such
warrants, would be exercisable into non-voting shares of Common Stock
(i.e., Class C Common Stock) if Olympus's percentage ownership of all
outstanding voting securities would exceed 9.9%.
(7) Mr. Boch's address is Subaru of New England, Inc., 95 Morse Street,
Norwood, MA 02062.
(8) Mr. Kirby's address is 17 DeHart Street, Morristown, NJ 07963.
(9) Includes, in one case, shares held by an affiliate of the shareholder.
(10) In the case of Robert P. Keller, a shareholder of DCG, includes 427,556
shares of restricted Common Stock issued to Mr. Keller pursuant to the
terms of his employment agreement, but excludes 728,600 shares of Common
Stock subject to employee stock options which are not exercisable within 60
days.
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<PAGE>
DARTMOUTH CAPITAL GROUP. DCG 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 BHC Act.
As of the date of this Annual Report, DCG's sole investment and principal
asset is a controlling equity investment in the Company.
The DCG General Partner has complete control of the management and
conduct of the DCG, including all actions pertaining to its investment in the
Company. Ultimate control over DCG rests with the shareholders of the DCG
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 DCG General Partner.
Rights to designate directors may from time to time also be granted to third
parties, including limited partners of DCG who are not shareholders of the
DCG General Partner. As of the date of this Annual Report, there are 11
shareholders of the DCG General Partner, each of whom is a limited partner
(or an affiliate of a limited partner) of DCG. As of the date of this report,
the DCG General Partner has eight directors, each of whom is a director of
the Company.
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<PAGE>
SECURITY OWNERSHIP OF MANAGEMENT
The following table sets forth certain information regarding ownership
of securities of the Company as of December 31, 1997 with respect to each
executive officer and director of the Company, and all executive officers and
directors as a group.
PERCENT
OF SHARES OF
NAME AND TITLE NUMBER OF SHARES VOTING
OF OFFICER AND/OR DIRECTOR BENEFICIALLY OWNED COMMON
-------------------------- ------------------ ------
Robert P. Keller(1)(2)............. 464,569 2.8%
Director, President and
Chief Executive Officer
Ernest J. Boch(1).................. 2,397,628 14.5%
Director
James A. Conroy(3)................. 1,631,033 9.9%
Director
Mitchell Johnson................... 97,183 *%
Director
Edward A. Fox(1)................... 463,496 2.8%
Director
Jefferson W. Kirby(1)(4)........... 409,400 2.5%
Director
Charles E. Hugel(1)................ 337,725 2.0%
Director
K. Thomas Kemp(1).................. 42,860 *%
Director
John B. Pettway(5)................. 434,594 2.6%
Director
Henry T. Wilson(6)................. 400,540 2.4%
Director
Paul R. Wood(7).................... 1,631,033 9.9%
Director
Curt A. Christianssen(8)........... 1,000 *%
Senior Vice President
and Chief Financial
Officer
Lawrence A. Johnes(9).............. -0- -
Executive Vice President
Leasing Division
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<PAGE>
William J. Lewis(10)............... -0- -
Executive Vice President
and Chief Credit Officer
William D. Rast.................... -0- -
Executive Vice President
Mortgage Division
Paul F. Rodeno(11)................. 156 *%
Executive Vice President
Operations
All Directors and Executive........ 8,311,217 50.4%
Officers as a Group(1)(2)(12)
- ---------------------------
*Less than 1%
(1) Excludes shares beneficially owned by the DCG General Partner. Each of
Messrs. Keller, Boch, Fox, Hugel, Kemp and Kirby is a principal shareholder
and director of the DCG General Partner, and pursuant to the terms of a
shareholder agreement, each has a right to designate a director of DCG
General Partner. Messrs. Boch, Keller, Fox, Hugel, Kemp and Kirby disclaim
beneficial ownership of shares of Common Stock beneficially owned by the
DCG General Partner.
(2) Includes 427,556 shares of restricted stock issued to Mr. Keller pursuant
to the terms of his employment agreement, but excludes 728,600 shares of
Class B Common Stock subject to employee stock options which are not
exercisable within 60 days.
(3) Includes 1,485,033 shares of voting Special Common Stock and 146,000 shares
of Class B Common Stock owned in the aggregate by Olympus Growth Fund II,
L.P. and Olympus Executive Fund, L.P. (collectively, "Olympus"). Mr.
Conroy is a general partner of such entities. Mr. Conroy disclaims
beneficial ownership of the shares of voting securities owned by Olympus.
(4) Jefferson W. Kirby, the adult son of F. M. Kirby, disclaims any beneficial
ownership interest in the shares of Class B Common Stock owned by his
father. F. M. Kirby is a principal shareholder of the Company. See "--
Security Ownership of Certain Beneficial Owners" above.
(5) Includes 434,594 shares of Class B Common Stock held by Byrne & sons, l.p.,
of which Mr. Pettway is the Chief Financial Officer.
(6) Includes 320,412 shares and 80,128 shares of Class B Common Stock held by
Northwood Ventures LLC and Northwood Capital Partners LLC, respectively, of
which Mr. Wilson is a Managing Director.
(7) Includes 1,485,033 shares of Voting Special Common Stock and 146,000 shares
of Class B Common Stock owned by Madison Dearborn Capital Partners II, L.P.
("MDP"). MDP's sole general partner is Madison Dearborn Capital Partners
II, whose sole general partner is Madison Dearborn Partners, Inc. Mr. Wood
is an executive officer of Madison Dearborn Partners, Inc.
(8) Excludes 60,000 shares of Class B Common Stock subject to employee stock
options that are not exercisable within 60 days.
(9) Excludes 10,000 shares of Class B Common Stock subject to an employee stock
option that is not exercisable within 60 days.
73
<PAGE>
(10) Excludes 60,000 shares of Class B Common Stock subject to an employee stock
option that is not exercisable within 60 days.
(11) Excludes 30,000 shares of Class B Common Stock subject to an employee stock
option that is not exercisable within 60 days.
(12) Excludes 988,600 shares of Class B Common Stock subject to employee stock
options that are not exercisable within 60 days.
74
<PAGE>
ITEM 13. CERTAIN TRANSACTIONS AND RELATED 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 more than 5% of the
Common Stock, or the immediate family or associates of any of the foregoing
persons.
FINANCING FOR ELDORADO ACQUISITION
In December 1996, DCG and Peter H. Paulsen, a former 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 amount of such loans was converted to 47,081 shares of
Class B common stock upon the consummation of the Eldorado Acquisition at a
price of $4.40 per share, and interest on such loans was converted to Class B
Common Stock at a purchase price of $4.81 per share less the 1% commitment fee,
which was the same price at which the remaining shares of Class B Common Stock
and the Special Common were sold by the Company to fund the Eldorado
Acquisition. See "ITEM 5. MARKET FOR ISSUER'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS."
Also in December 1996, certain directors of the Company and other investors
in DCG agreed to purchase up to approximately $15.2 million of Class B common
Stock at a price of $4.81 per share, less a 1% commitment fee, to fund a portion
of the Eldorado Acquisition. Approximately $12.4 million of this commitment was
invested by such investors with 3,061,928 shares issued at the $4.81 per share
price (less a 1% commitment fee), as described in more detail elsewhere in this
report. See "ITEM 5. MARKET FOR ISSUER'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS." Of those shares, the following numbers of shares were purchased by
persons who were then directors of the Company, affiliates of directors or
nominees to become directors: (i) Ernest J. Boch (1,101,828 shares), Edward A.
Fox (50,096 shares), Charles E. Hugel (17,425 shares), Robert P. Keller (11,913
shares), K. Thomas Kemp (11,460 shares), each of whom was a director of the
Company in December 1996; (ii) Byrne & sons, l.p. (111,794 shares);
(iii) Northwood Ventures LLC and Northwood Capital Partners LLC (a total of
35,640 shares); and (iv) Mitchell A. Johnson (91,683 shares). John B. Pettway
and Henry T. Wilson are directors of the Company and in December 1996 were
directors of the DCG General Partner. Mr. Pettway is the Chief Financial
Officer of Byrne & sons, l.p., and Mr. Wilson is a Managing Director of
Northwood Ventures LLC and Northwood Capital Partners LLC. Mr. Johnson became a
director of the Company in 1997 contemporaneously with the closing of the
Eldorado Acquisition.
DCG also had agreed to purchase up to $6.8 million of Senior Securities (as
defined elsewhere in this report) under certain circumstances. DCG invested
$10.0 million at the consummation of the Eldorado Acquisition, which were sold
in conjunction with a secondary offering of the Series A Capital Securities on
July 15, 1997. See "ITEM 5. MARKET FOR ISSUER'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS."
75
<PAGE>
SETTLEMENT WITH FORMER MAJORITY SHAREHOLDER
In October 1997, the Company settled litigation that it had brought against
the former majority shareholder of CSB, and certain other directors and officers
of CSB arising out of the Company's acquisition of CSB in September 1996. At
the time the Company commenced the litigation, the former majority shareholder
was the beneficial owner of more than 5% the Class B Common Stock. As part of
that settlement, the former majority shareholder returned to the Company and the
Company canceled 424,182 shares of Class B Common Stock. Prior to that
settlement, the Company's principal shareholders and certain directors and other
shareholders purchased $1.0 million shares of Class B Common Stock from the
former majority shareholder for an aggregate purchase price of $6.0 million or
$6.00 per share. Taken together, those transactions eliminated the former
majority shareholder's ownership interest in the Company.
OTHER MATTERS
Some of the directors and executive officers of the Company's Bank
subsidiary 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 Bank in the ordinary course of the Bank's
business and the Bank expects to have such ordinary banking transactions with
such persons in the future. In the opinion of management of the Company and the
Bank, 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 Bank does 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 Bank's lending policies and statutory lending
limits. There were no loans to executive officers and directors at December 31,
1997.
76
<PAGE>
PART IV
ITEM 14. 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)
77
<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)
10.13 Form of Severance Agreement (filed as Exhibit 10.1 to this Annual
Report on Form 10-K)
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
78
<PAGE>
(b) Reports on Form 8-K.
1) None.
79
<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: March 30, 1998
By Curt A. Christianssen /s/
- ---------------------------------------
Curt A. Christianssen
Senior Vice President
Chief Financial Officer
Date: March 30, 1998
80
<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.
<TABLE>
<CAPTION>
<S> <C> <C>
Signature Title Date
--------- ----- ----
Robert P. Keller /s/ Director, President March 30, 1998
- ------------------------- and Chief Executive
Robert P. Keller Officer
Ernest J. Boch /s/ Director
- -------------------------
Ernest J. Boch
James Conroy /s/ Director
- -------------------------
James Conroy /s/
Edward A. Fox /s/ Director March 30, 1998
- -------------------------
Edward A. Fox
Charles E. Hugel /s/ Director March 30, 1998
- -------------------------
Charles E. Hugel
K. Thomas Kemp /s/ Director March 30, 1998
- -------------------------
K. Thomas Kemp
Jefferson W. Kirby /s/ Director March 30, 1998
- -------------------------
Jefferson W. Kirby
John B. Pettway /s/ Director
- -------------------------
John B. Pettway
Mitchell A. Johnson /s/ Director
- -------------------------
Mitchell A. Johnson
</TABLE>
81
<PAGE>
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
82
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Number Description Page
------ ----------- ----
<S> <C> <C>
10.1 Form of Severance Agreement 84
</TABLE>
83
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
March 27, 1998
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 (the "Company") at
December 31, 1997 and 1996, 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.
F-1
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CONDITION
DECEMBER 31, 1997, 1996 AND 1995
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
December 31,
--------------------
1997 1996
---- ----
<S> <C> <C>
Assets
Cash and due from banks $ 81,030,000 $ 32,522,000
Federal funds sold 40,000,000 13,700,000
Interest bearing deposits in other financial institutions - 338,000
Held-to-maturity investment securities - 20,025,000
Available-for-sale investment securities 67,295,000 15,175,000
Mortgage loans held for sale 96,230,000 64,917,000
Loans and leases, net 509,653,000 256,041,000
Servicing sale receivable 1,247,000 2,870,000
Premises and equipment, net 11,232,000 3,911,000
Real estate acquired through foreclosure, net 2,740,000 3,635,000
Intangibles arising from acquisitions, net 66,769,000 10,736,000
Accrued interest receivable and other assets 26,159,000 13,190,000
-------------- --------------
Total assets $ 902,355,000 $ 437,060,000
-------------- --------------
-------------- --------------
</TABLE>
See notes to consolidated financial statements.
F-2
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CONDITION (CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
December 31,
-------------------
1997 1996
---- ----
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Demand:
Non-interest bearing $289,344,000 $126,885,000
Interest bearing 97,416,000 38,602,000
Savings:
Regular 98,465,000 42,190,000
Money market 98,189,000 25,662,000
Time:
Under $100,000 99,713,000 123,789,000
$100,000 or more 82,076,000 25,903,000
------------ ------------
Total deposits 765,203,000 383,031,000
Federal funds purchased 2,050,000 -
Due to related parties - 4,500,000
Accrued expenses and other liabilities 12,172,000 8,220,000
Mandatory convertible debentures 537,000 537,000
Subordinated debentures 27,657,000 -
------------ ------------
Total liabilities 807,619,000 396,288,000
Commitments and contingencies (Note 17)
Shareholders' equity:
Preferred stock, $.01 par value, 1,500,000 shares
authorized; 116,593 and -0- issued and outstanding at
December 31, 1997 and 1996, respectively 11,659,000 -
Special common stock, $.01 par value, 9,651,600
shares authorized, 4,825,718 and -0- issued and outstanding
at December 31, 1997 and 1996, respectively 48,000 -
Common stock, $.01 par value, 50,000,000
shares authorized; 13,521,679 issued and
outstanding at December 31, 1997 and 9,697,430
at December 31, 1996 135,000 97,000
Additional paid-in capital 83,855,000 42,394,000
Retained earnings (deficit) 524,000 (1,736,000)
Unearned compensation (1,509,000) -
Unrealized gain on securities available-for-sale 24,000 17,000
------------ ------------
Total shareholders' equity 94,736,000 40,772,000
------------ ------------
Total liabilities and shareholders' equity $902,355,000 $437,060,000
------------ ------------
------------ ------------
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For the Years Ended December 31,
-------------------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Interest income:
Interest and fees on loans $ 43,103,000 $ 14,782,000 $ 4,086,000
Income from lease finance receivables 4,127,000 1,601,000 -
Interest and dividend on securities 4,979,000 1,968,000 311,000
Interest on Federal funds sold 1,286,000 934,000 117,000
Interest on deposits with other financial institutions - 67,000 54,000
---------- ---------- ---------
Total interest income 53,495,000 19,352,000 4,568,000
Interest expense:
Interest bearing demand 1,325,000 686,000 149,000
Money market 2,336,000 493,000 -
Savings 5,117,000 1,150,000 346,000
Time 9,365,000 5,241,000 1,075,000
Debentures 1,908,000 74,000 181,000
Federal funds purchased 563,000 - -
---------- ---------- ---------
Total interest expense 20,614,000 7,644,000 1,751,000
---------- ---------- ---------
Net interest income 32,881,000 11,708,000 2,817,000
Provision for loan and lease losses 1,495,000 515,000 295,000
---------- ---------- ---------
Net interest income after provision for loan and lease losses 31,386,000 11,193,000 2,522,000
Non-interest income:
Service charges on deposit accounts 2,675,000 2,911,000 464,000
Gain on sale of mortgage loans 6,887,000 1,727,000 -
Other income 5,342,000 261,000 232,000
---------- ---------- ---------
Total non-interest income 14,904,000 4,899,000 696,000
Non-interest expense:
Salaries and employee benefits 16,172,000 6,816,000 1,811,000
Occupancy and equipment 5,959,000 2,726,000 861,000
Professional, regulatory and other services 1,230,000 733,000 346,000
Legal 1,437,000 453,000 113,000
Insurance 637,000 262,000 114,000
Losses and carrying cost of OREO 382,000 288,000 531,000
Provision for recourse obligation (Note 6) 2,021,000 - -
Amortization of goodwill and other intangibles 2,514,000 268,000 -
Other 9,336,000 3,724,000 515,000
---------- ---------- ---------
Total non-interest expense 39,688,000 15,270,000 4,291,000
---------- ---------- ---------
Income (loss) before taxes and extraordinary item 6,602,000 822,000 (1,073,000)
Income tax benefit (provision) (3,612,000) 1,503,000 443,000
---------- ---------- ---------
Income (loss) before extraordinary item 2,990,000 2,325,000 (630,000)
Extraordinary item:
Gain on forgiveness of debt, net of income
taxes of $443,000 - - 625,000
---------- ---------- ---------
Net income (loss) $ 2,990,000 $ 2,325,000 $ (5,000)
---------- ---------- ---------
---------- ---------- ---------
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDER'S EQUITY
DECEMBER 31, 1997, 1996, AND 1995
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Preferred Stock Special Common Stock
--------------------------- ---------------------------------------
Additional
Number of Preferred Number of Common Paid-in
Shares Stock Shares Stock Capital
------- ----------- --------- ------- ------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1994 - $ - - $ - $ -
Merger and reverse stock split - - - - -
(1 for 21)(Note 2)
Stock dividend - - - - -
Issuance of common stock - - - - -
Net loss - - - - -
------- ----------- --------- ------- -----------
Balance at December 31, 1995 - - - - -
Fractional share adjustment - - - - -
Issuance of common stock - Liberty - - - - -
Issuance of common stock - Commerce - - - - -
Unrealized gain on securities available
for sale - - - - -
Net income - - - - -
Balance at December 31, 1996 - - - - -
Issuance of preferred stock - Eldorado 116,593 11,659,000
Issuance of common stock - Eldorado - - 4,825,718 48,000 23,164,000
Restricted stock issuance
Compensation expense
Cancellation of shares (Note 12) - - - - -
Unrealized gain on securities available
for sale - - - - -
Net income - - - - -
Preferred dividends - - - - -
------- ----------- --------- ------- -----------
Balance at December 31, 1997 116,593 $11,659,000 4,825,718 $48,000 $23,164,000
------- ----------- --------- ------- -----------
------- ----------- --------- ------- -----------
<CAPTION>
Class B Common Stock Unrealized
------------------------------------- Gain on
Additional Retained Securities
Number of Common Paid-in Earnings Unearned Available
Shares Stock Capital (Deficit) Compensation for Sale Total
------ ----- ------- --------- ------------ -------- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994 564,145 $2,951,000 $ - $(3,899,000) $ - $ - $ (948,000)
Merger and reverse stock split
(1 for 21)(Note 2) (537,281) (2,951,000) 2,951,000 - - - 0
Stock dividend 26,864 1,000 156,000 (157,000) - - 0
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
Issuance of preferred stock - Eldorado 11,659,000
Issuance of common stock - Eldorado 3,820,875 38,000 17,966,000 - - - 41,216,000
Restricted stock issuance 427,556 4,000 2,008,000 - (2,012,000) - 0
Compensation expense 503,000 - 503,000
Cancellation of shares (Note 12) (424,182) (4,000) (1,677,000) - - - (1,681,000)
Unrealized gain on securities available
for sale - - - - - 7,000 7,000
Net income - - - 2,990,000 - - 2,990,000
Preferred dividends - - - (730,000) - - (730,000)
---------- ---------- ----------- ----------- ----------- ------- -----------
Balance at December 31, 1997 13,521,679 $ 135,000 $60,691,000 $ 524,000 $(1,509,000) $24,000 $94,736,000
---------- ---------- ----------- ----------- ----------- ------- -----------
---------- ---------- ----------- ----------- ----------- ------- -----------
</TABLE>
See notes to consolidated financial statement
F-5
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For the Years Ended December 31,
--------------------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Operating Activities:
Net income (loss) $ 2,990,000 $ 2,325,000 $ (5,000)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Provision for loan and lease losses 1,495,000 515,000 295,000
Provision for loss on real estate acquired through foreclosure 176,000 72,000 383,000
Gain on sale of mortgage loans (6,887,000) (1,727,000) -
Loss on sale of premises and equipment 11,000 85,000 -
(Gain) loss on sale of real estate owned 45,000 (135,000) -
Net gain on sale of securities (221,000) - -
Depreciation and amortization 1,702,000 642,000 201,000
Amortization of goodwill and other intangibles 2,514,000 178,000 -
Accretion/amortization related to securities, net 1,103,000 (252,000) -
Amortization of deferred compensation 503,000 - -
Amortization of deferred loan fees and costs (1,209,000) (109,000) (6,000)
Accretion of mortgage servicing asset 32,000 - -
Provision (benefit) of deferred taxes 2,087,000 (1,503,000) (443,000)
Mortgage loans originated for sale (889,175,000) (242,339,000) -
Proceeds from sales of loans and servicing 898,729,000 262,219,000 -
Mortgage servicing rights purchased and originated - (275,000) -
Equity in loss of real estate joint venture 254,000 56,000 -
Extraordinary item-gain on forgiveness of debt - - (1,068,000)
Decrease in servicing sale receivable 1,623,000 - -
Increase in loans held for sale (31,313,000) (47,769,000) -
Other, net 3,964,000 (6,700,000) 469,000
------------ ------------ -----------
Net cash used in operating activities (11,577,000) (34,717,000) (174,000)
------------ ------------ -----------
Investing Activities:
Decrease in interest bearing deposits with other
financial institutions 338,000 1,241,000 89,000
Purchases of investment securities (44,594,000) (32,445,000) (5,890,000)
Proceeds from maturities of investment securities 55,253,000 56,627,000 3,416,000
Proceeds from the sales of investment securities 55,150,000 - -
Loans/leases originated for portfolio, net of principal repayment (29,149,000) (29,022,000) 5,807,000
Purchases of premises and equipment (1,337,000) (860,000) (19,000)
Proceeds from sale of premises and equipment 98,000 56,000 -
Proceeds from sale of real estate acquired through foreclosure 3,901,000 4,188,000 476,000
Capital expenditures for other real estate owned (26,000) (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 -
Purchase of Eldorado Bank, net of cash received (61,299,000) - -
------------ ------------ -----------
Net cash (used in) provided by investing activities (21,665,000) 57,987,000 3,879,000
------------ ------------ -----------
</TABLE>
See notes to consolidated financial statements.
F-6
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For the Years Ended December 31,
--------------------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Financing Activities:
Net increase (decrease) in deposits 39,235,000 (22,377,000) (4,445,000)
Issuance of subordinated debentures 27,657,000 - -
Issuance of preferred stock 11,659,000 - -
Issuance of common stock 18,004,000 34,889,000 4,494,000
Issuance of special common stock 23,212,000 - -
Payment of preferred dividends (730,000) - -
Repayment of notes payable to shareholder - - (656,000)
Proceeds from issuance of notes payable to
related parties - 4,500,000 -
Net decrease in other borrowings (10,986,000) - -
------------ ------------ -----------
Net cash (used in) provided by financing
activities 108,051,000 17,012,000 (607,000)
------------ ------------ -----------
Net increase in cash and cash equivalents 74,808,000 40,282,000 3,098,000
Cash and cash equivalents at beginning of period 46,222,000 5,940,000 2,842,000
------------ ------------ -----------
Cash and cash equivalents at end of period $121,030,000 $ 46,222,000 $ 5,940,000
------------ ------------ -----------
------------ ------------ -----------
Supplemental disclosures of cash flow
information:
Cash paid for interest on deposits $ 18,643,000 $ 7,670,000 $ 1,673,000
Cash paid for income taxes 1,525,000 - 2,000
Supplemental disclosures of non-cash investing
activities:
Loans transferred to foreclosed real estate 3,483,000 2,526,000 982,000
Loans originated to finance the sale of real estate - - 371,000
Transfer of securities from held to maturity to
available for sale (Note 4) 15,004,000 - -
Supplemental disclosures of non-cash financing
activities:
Issuance of restricted stock 2,012,000 - -
</TABLE>
See notes to consolidated financial statements.
F-7
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995 Page F-8
- -------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
BASIS OF PRESENTATION
Commerce Security Bancorp, Inc., a Delaware corporation and bank holding
company, and its wholly-owned subsidiaries Eldorado Bank and CSBI Capital
Trust I 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.
Prior to June 1997 and the acquisition of Eldorado Bank, the Company had
three subsidiaries, Commerce Security Bank (CSB), Liberty National Bank
(LNB), and San Dieguito National Bank (SDNB). On June 30, 1997, the Company
merged the then existing three subsidiaries into the newly acquired Eldorado
Bank. The resultant structure is the Company with one wholly owned banking
subsidiary, Eldorado Bank.
BUSINESS
The Bank offers a broad range of commercial banking services in Northern and
Southern California, catering especially to small business. The Bank offers
commercial, real estate, consumer, Small Business Administration-guaranteed
loans as well as checking and savings deposits, corporate cash management,
international banking services, safe deposit boxes, collection, traveler's
checks, notary public and other customary non-deposit banking services.
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-bearing
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.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996 Page F-9
- -------------------------------------------------------------------------------
NOTE 1: (Continued)
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1996 the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities" (SFAS 125). This Statement provides consistent accounting and
reporting standards for the transfers and servicing of financial assets and
the extinguishment of liabilities. The Company adopted SFAS 125 effective
January 1, 1997 and it did not have a material impact on the Company's
financial statements.
In February 1997 the FASB issued SFAS 128, "Earnings per Share." This
Statement established new standards for computing and presenting earnings per
share and requires all prior period earnings per share data be restated to
conform with the provisions of the statement. Basic earnings per share is
computed by dividing net income available to common shareholders by the
weighted average number of shares outstanding during the period, as restated
for shares issued in business combinations accounted for as
poolings-of-interests and stock dividends. Diluted earnings per share is
computed using the weighted average number of shares determined for the basic
computation plus the number of shares of common stock that would be issued
assuming all contingently issuable shares having a dilutive effect on
earnings per share were outstanding for the period.
In June 1997 the FASB issued SFAS 130, "Reporting Comprehensive Income." This
Statement provides that all enterprises report comprehensive income as a
measure of overall performance. Comprehensive income is the change to equity
(net assets) of a business during a period. The Statement includes the
guidelines for the calculations and required presentations. For the Company,
this new standard is effective for 1998 and is not expected to have a
material impact on the Company's financial statements.
In June 1997 the FASB issued SFAS 131, "Disclosures About Segments of an
Enterprise and Related Information." This statement will change the way
public companies report information about segments of their business in their
annual financial statements and require them to report selected segment
information in their quarterly reports issued to shareholders. Companies
will be required to disclose segment data based upon how management makes
decisions about allocating resources to segments and measuring performance.
For the Company, this new standard is effective for 1998 and the impact, if
any, is yet to be determined.
In February 1998 the FASB issued SFAS 132, "Employer's Disclosures about
Pensions and other Post-Retirement Benefits." This Statement standardizes the
disclosure requirements for pensions and other post-retirement benefits to
the extent practicable. For the Company, this new standard is effective for
fiscal year 1998 and is not expected to have a material impact.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-10
- ------------------------------------------------------------------------------
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 are segregated in accordance with management's intention regarding
their retention. Accounting for each group of securities follows the
requirement of SFAS 115. "Accounting for Certain Investments in Debt and
Equity Securities."
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 Company'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 determined on the specific
identification method and are included in other income.
LOANS HELD FOR SALE
Loans held for sale include mortgage loans carried at lower of cost or fair
value on an aggregate basis.
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
deferred and amortized into interest income over the contractual life of the
related loans as a yield adjustment. 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. The production
of new leases comes exclusively from the wholesale sector through a network
of brokers, the Company services these leases and during 1997, began selling
blocks of leases to other institutions. Leases held for resale are carried
at the lower of cost or estimated fair value on an
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-11
- ------------------------------------------------------------------------------
NOTE 1: (Continued)
aggregate basis. Gains and losses on the sale of leases are recognized upon
delivery based on the difference between selling price and carrying value.
NON-ACCRUAL/IMPAIRED LOANS
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.
The Company adopted SFAS 114, "Accounting by Creditors for Impairment of a
Loan," and SFAS 118, "Accounting by Creditors for Impairment of a Loan-Income
Recognition and Disclosures," as of January 1, 1995. SFAS 114 requires that
impaired loans be measured based on the present value of expected future cash
flows discounted at the loan's effective interest rate, the loan's observable
market price, or the fair value of the collateral if the loan is collateral
dependent. When the measure of the impaired loan is less than the recorded
balance of the loan, the impairment is recorded through a valuation allowance
included in the allowance for loan and lease losses. The Company had
previously measured the allowance for loan and lease losses using methods
similar to those prescribed in SFAS 114. As a result, no additional
provision was required by the adoption of this pronouncement.
The Company considers all loans impaired when it is probable that both
interest and principal will not be collected in accordance with the
contractual terms of the agreement. All loans that are ninety days or more
past due, or have been restructured to provide a reduction in the interest
rate or a deferral of interest or principal are automatically included in
this category.
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. The allowance is increased by provisions charged
to expense, increased for recoveries of loans previously charged-off, and
reduced by charge-offs. Loans and leases are charged-off 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. Ultimate losses may differ from current estimates.
Management's estimates are based on historical 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.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-12
- ------------------------------------------------------------------------------
NOTE 1: (Continued)
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 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 consolidated 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.
Loan servicing income represents fees earned for servicing real estate and
construction loan participations owned by investors, net of amortization
expense. The fees are generally calculated on the outstanding principal
balances of the loans serviced and are recorded as income when collected.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-13
- ------------------------------------------------------------------------------
NOTE 1: (Continued)
SBA LENDING
The Company is qualified as a "Preferred Lender" under the SBA programs,
allowing it to originate SBA loans based on its 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 fee retained by the Company, is
capitalized and recognized as income over the estimated life of the loan.
LOAN SERVICING RIGHTS
Loan servicing rights are accounted for under the provisions of SFAS No. 125,
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," which became effective January 1, 1997.
SFAS 125 superseded SFAS 122, "Accounting for Mortgage Servicing Rights,"
but did not significantly change the methodology used to account for
servicing rights. The servicing rights currently capitalized, included in
other assets, are the result of servicing rights retained on sold SBA loans
and are being amortized in proportion to and over the period of estimated
servicing income. Management stratifies servicing rights based on
origination period and interest rate and evaluates the recoverability in
relation to the impact of actual and anticipated loan portfolio prepayment,
foreclosure, and delinquency experience. The Company did not have a valuation
allowance associated with the servicing rights portfolio as of December 31,
1997.
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
Real estate acquired in settlement of loans is recorded at the lower of the
unpaid balance of the loan at settlement date or the fair value less
estimated costs to sell. 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.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-14
- ------------------------------------------------------------------------------
NOTE 1: (Continued)
INTANGIBLES ARISING FROM ACQUISITIONS
The Company has paid amounts in excess of fair value for CSB's, LNB's, and
Eldorado's core deposits and tangible assets. Such amounts are being
amortized by systematic charges to income (primarily for periods from 10 to
25 years) 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 an impairment is recognized in
operations if a permanent loss of value occurs.
FEDERAL AND STATE TAXES
The Company provides for income taxes under the provisions of SFAS 109,
"Accounting for Income Taxes." Under the liability method which is
prescribed by SFAS 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.
SFAS 109 also requires the establishment of a valuation allowance, if
necessary, to reflect the likelihood of the 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.
STOCK-BASED COMPENSATION
On January 1, 1997, the Company adopted SFAS 123, "Accounting for
Stock-Based Compensation", which permits entities to recognize as expense
over the vesting period, the fair value of all stock-based awards on the date
of grant. Alternatively, SFAS 123 also allows entities to continue to apply
the provisions of Accounting Principles Board (APB ) Opinion 25 and provide
pro forma net income and pro forma earnings per share disclosures for
employee stock option grants made in 1995 and future years as if the fair-
value-based method defined in SFAS 123 had been applied. The Company has
elected to continue to apply the provisions of APB Opinion 25, which requires
compensation expense be recorded on the date of grant only if the current
market price of the underlying stock exceeds the exercise price, and provide
the pro forma disclosure provisions of SFAS 123. See Note 13 of the Notes to
Consolidated Statements for the pro forma net income and pro forma earnings
per share disclosures.
PER SHARE DATA
All earnings per share amounts reflect the implementation of SFAS 128,
"Earnings per Share."
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-15
- ------------------------------------------------------------------------------
NOTE 1: (Continued)
The weighted average number of common shares outstanding for basic and diluted
earnings per share computations are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
NUMERATOR:
Net income (loss) before extraordinary item $ 2,990,000 $2,325,000 $(630,000)
Less: preferred stock dividend (730,000) - -
------------ ----------- ----------
Net income (loss) before extraordinary item
applicable to common shares (Basic) 2,260,000 2,325,000 (630,000)
Extraordinary item - - 625,000
------------ ----------- ----------
Net income (loss) applicable to common shares 2,260,000 2,325,000 (5,000)
Effect of dilutive securities - - -
------------ ----------- ----------
Net income (Dilutive) $ 2,260,000 $2,325,000 $ (5,000)
------------ ----------- ----------
------------ ----------- ----------
DENOMINATOR:
Weighted average common shares outstanding
(Basic) 14,813,125 5,300,773 268,198
Dilutive options and warrants 2,456,177 - -
------------ ----------- ----------
Weighted average common stock outstanding
(Dilutive) 17,269,302 5,300,773 268,198
------------ ----------- ----------
------------ ----------- ----------
EARNINGS (LOSS) PER SHARE:
Basic:
Net income (loss) before extraordinary item $ 0.15 $ 0.44 $ (2.35)
Extraordinary item - - 2.33
------------ ----------- ----------
Net income (loss) $ 0.15 $ 0.44 $ (0.02)
------------ ----------- ----------
------------ ----------- ----------
Dilutive:
Net income (loss) before extraordinary item $ 0.13 $ .044 $ (2.35)
Extraordinary item - - 2.33
------------ ----------- ----------
Net income (loss) $ 0.13 $ 0.44 $ (0.02)
------------ ----------- ----------
------------ ----------- ----------
</TABLE>
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform with the 1997
presentation.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-16
- --------------------------------------------------------------------------------
NOTE 1: (Continued)
ESTIMATES
The preparation of consolidated 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 consolidated financial statements. Actual results could
differ from those estimates.
NOTE 2 - ACQUISITIONS AND 1996 REORGANIZATION:
A key element of the Company's strategic plan includes building profitability
through acquisitions of community banks principally, but not exclusively, in
and around its Southern California base, including bank's which are or recently
were in troubled condition, and seeking to increase the earnings of the banks
it has acquired through a combination of expense reduction programs, merger
synergies, improvements in asset quality and strengthening of capital position.
Since September 1995, the Company has completed three acquisitions, increasing
the Company's assets by over $840 million, including the acquisition, completed
on June 6, 1997, of Eldorado Bancorp ("Eldorado") and its bank subsidiary,
Eldorado Bank, a community bank based in Tustin, California with approximately
$400 million in total assets (collectively with the financing related thereto,
the "Eldorado Acquisition"). Effective June 30, 1997, the Company consolidated
via mergers (collectively, the "Bank Mergers") into Eldorado Bank the
respective operations of its other subsidiaries - LNB, SDNB, and CSB.
On March 31, 1996, SDN Bancorp, Inc. ("SDN") completed its acquisition of LNB
(the "Liberty Acquisition") for approximately $15.1 million in cash. LNB had
total assets of approximately $150 million as of the acquisition date.
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. Pursuant to the Agreement, holders of CSB common
stock received approximately $14.1 million and a total of 1,543,691 shares of
the Company. CSB had total assets of approximately $220 million at September
1, 1996.
Effective June 6, 1997, the Company completed the Eldorado Acquisition. The
Acquisition was effected pursuant to an Agreement and Plan of Merger entered
into between the Company and Eldorado on December 24, 1996 (the "Acquisition
Agreement"). Pursuant to the Acquisition Agreement, the Company acquired
100% of the outstanding stock of Eldorado for cash consideration of $23.00
per share. Contemporaneously with the Acquisition, each Eldorado stock
option that had
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-17
- --------------------------------------------------------------------------------
NOTE 2: (Continued)
not previously been exercised (collectively, the "Eldorado Options") was
canceled in return for the payment by Eldorado of the difference between the
$23.00 price per share and the exercise price thereof. The aggregate
consideration paid to holders of Eldorado common stock and Eldorado Options
(net of the tax benefit arising out of the Eldorado Options) was approximately
$90.3 million. Eldorado had total assets of approximately $400 million at June
6, 1997.
The Liberty, Commerce, and Eldorado Acquisition's were accounted for using the
purchase method of accounting in accordance with APB Opinion 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, CSB, and Eldorado from the date of
acquisition. Intangibles arising from the transactions totaled approximately
$3.8 million in the Liberty Acquisition, $7.2 million in the Commerce
Acquisition and approximately $50.2 million in the Eldorado Acquisition.
Certain preacquistion contingency reserves were established as of the
acquisition dates that are subject to adjustment during the "allocation period"
in accordance with SFAS 38 "Accounting for Preacquisition Contingencies." The
fair value of CSB has been adjusted to reflect the resolution of these
contingencies established relating to certain litigation, writedowns of real
estate owned and a settlement with the principal shareholder of CSB.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-18
- --------------------------------------------------------------------------------
The following table sets forth selected pro forma combined financial
information of SDN, LNB, CSB, and Eldorado for the years ended December 31,
1997 and 1996. The pro forma operating data reflects the effect of the
Liberty Acquisition, the Commerce Acquisition and the Eldorado Acquisition
for periods prior to 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
Years Ended December 31,
------------------------
1997 1996
(Unaudited) (Unaudited)
----------- -----------
<S> <C> <C>
Interest Income $65,648,000 $60,876,000
Interest Expense 25,182,000 24,483,000
----------- -----------
Net interest income 40,466,000 36,393,000
Provision for loan and lease losses 1,495,000 1,158,000
----------- -----------
Net interest income after provision
for loan and lease losses 38,971,000 35,235,000
Non-interest income 16,667,000 14,956,000
Non-interest expense 48,407,000 53,508,000
----------- -----------
Income (loss) before taxes 7,231,000 (3,317,000)
Income before taxes
Income tax (benefit) provision 4,141,000 (2,231,000)
----------- -----------
Net income (loss) $ 3,090,000 $(1,086,000)
----------- -----------
----------- -----------
</TABLE>
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 $1,779,000
and $1,775,000 at December 31, 1997 and 1996, respectively.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-19
- --------------------------------------------------------------------------------
NOTE 4 - INVESTMENT SECURITIES:
At December 31, 1997 and 1996, the Company's investment portfolio is as
follows:
<TABLE>
<CAPTION>
December 31, 1997
--------------------------------------------------------------
Estimated
Amortized Gross Unrealized Market
Cost Gains Losses Value
---- ----- ------ -----
<S> <C> <C> <C> <C>
Available for Sale:
U.S. Treasury $ 21,415,000 $ 51,000 $ - $ 21,466,000
U.S. Government agencies 13,460,000 - - 13,460,000
State and municipal securities 615,000 - - 615,000
Mortgage-backed securities 30,725,000 - (9,000) 30,716,000
Corporate bonds 1,038,000 - - 1,038,000
------------- --------- ---------- -------------
Total $ 67,253,000 $ 51,000 $ (9,000) $ 67,295,000
------------- --------- ---------- -------------
------------- --------- ---------- -------------
December 31, 1996
--------------------------------------------------------------
Estimated
Amortized Gross Unrealized 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>
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-20
- --------------------------------------------------------------------------------
NOTE 4: (Continued)
<TABLE>
<CAPTION>
December 31, 1996
---------------------------------------------------------
Estimated
Amortized Gross Unrealized 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>
In conjunction with the Bank Mergers the Company changed its intent to hold to
maturity those securities classified as such. Accordingly, the Company
reclassified those securities to available-for-sale and recorded them at
estimated fair value.
Amortized cost and estimated market value of debt securities at December 31,
1997, by contractual maturity, are shown below.
<TABLE>
<CAPTION>
Estimated
Amortized Market
Cost Value
----------- -----------
<S> <C> <C>
Due in one year or less $23,825,000 $23,875,000
Due after one year through five years 8,980,000 8,982,000
Due after five years through ten years 25,867,000 25,861,000
Due after ten years 8,581,000 8,577,000
----------- -----------
Subtotal $67,253,000 $67,295,000
----------- -----------
</TABLE>
For purposes of the maturity table, mortgage-backed securities, which are not
due at a single maturity date, have been allocated over maturity groupings
based on the weighted-average contractual maturities of the underlying
collateral. The mortgage-backed securities may mature earlier than their
weighted-average contractual maturities because of principal prepayments.
Investment securities with an amortized cost of $15,019,000 and $8,963,000 and
an estimated market value of $15,035,000 and $8,849,000 at December 31, 1997
and 1996, respectively, were pledged to secure public deposits and for other
purposes required or permitted by law.
Proceeds from sales and maturities of debt securities during 1997, 1996, and
1995 were $110,403,000, $56,627,000, and $3,416,000, respectively. Gross gains
of $308,000, $-0-, and $-0- were realized on those transactions. Gross losses
on sales totaled $87,000, $4,000, and $-0- for 1997, 1996, and 1995,
respectively.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-21
- --------------------------------------------------------------------------------
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 by major type are as follows:
<TABLE>
<CAPTION>
December 31,
-----------------------------
1997 1996
------------- -------------
<S> <C> <C>
Commercial real estate $235,244,000 $ 86,397,000
Residential real estate 128,362,000 106,567,000
Real estate construction 30,651,000 12,352,000
Consumer 62,323,000 22,512,000
Commercial 115,919,000 47,772,000
Land 4,966,000 6,460,000
Direct financing leases 40,819,000 46,498,000
-------------- -------------
618,284,000 328,558,000
Less:
Allowance for loan and lease losses (9,395,000) (5,156,000)
Deferred loan fees and costs (3,006,000) (2,444,000)
-------------- -------------
Loans and leases, net $605,883,000 $320,958,000
-------------- -------------
-------------- -------------
</TABLE>
The components of the Bank's leases receivable are summarized below:
<TABLE>
<CAPTION>
December 31,
-----------------------------
1997 1996
------------- -------------
<S> <C> <C>
Future minimum lease payments $46,797,000 $53,508,000
Residuals 796,000 511,000
Initial direct costs 1,363,000 1,018,000
Unearned income (8,137,000) (8,539,000)
------------ -------------
Total $40,819,000 $46,498,000
------------ -------------
------------ -------------
</TABLE>
An analysis of the activity in the allowance for loan and lease losses is as
follows:
<TABLE>
<CAPTION>
Years ended December 31,
-------------------------
1997 1996
---------- ----------
<S> <C> <C>
Balance at beginning of year $5,156,000 $ 639,000
Balance acquired 4,076,000 4,382,000
Provision for loan and lease losses 1,495,000 515,000
Loans charged off (2,503,000) (650,000)
Loan recoveries 1,171,000 270,000
----------- -----------
Balance at end of year $9,395,000 $5,156,000
----------- -----------
----------- -----------
</TABLE>
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-22
- --------------------------------------------------------------------------------
NOTE 5: (Continued)
At December 31, 1997, future minimum lease payments receivable are as follows:
<TABLE>
<S> <C>
1998 $25,348,000
1999 13,730,000
2000 5,970,000
2001 1,653,000
2002 94,000
Thereafter 2,000
-----------
Total $46,797,000
-----------
-----------
</TABLE>
There are no contingent rental payments included in income for the year ended
December 31, 1997.
As of December 31, 1997 there were no loans outstanding to directors, officers
or entities with which each of these individuals are associated, which in
aggregate exceed $60,000 per individual, and there were $2,043,000 as of
December 31, 1996. 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.
The following table represents information relating to nonperforming and past
due loans:
<TABLE>
<CAPTION>
December 31,
----------------------------
1997 1996
------------ ------------
<S> <C> <C>
Nonaccrual, not restructured $10,589,000 $5,483,000
90 days or more past due, not on nonaccrual 4,638,000 1,314,000
Restructured loans 2,779,000 2,200,000
------------ -----------
Total $18,006,000 $8,997,000
------------ -----------
------------ -----------
</TABLE>
At December 31, 1997 and 1996, loans aggregating $13,368,000 and $7,683,000,
respectively, have been designated as impaired. The total allowance for loan
losses related to these loans was $1,585,000 and $695,000 at December 31, 1997
and 1996, respectively.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-23
- --------------------------------------------------------------------------------
NOTE 5: (Continued)
The average balance of impaired loans during 1997 and 1996 was $10,594,000
and $5,193,000, 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:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1997 1996
--------- ---------
<S> <C> <C>
Non-accrual loans:
Income recognized $ 0 $ -0-
Income foregone 980,000 474,000
Restructured loans:
Income recognize 250,000 38,000
Income foregone 49,000 5,000
</TABLE>
NOTE 6 - MORTGAGE BANKING ACTIVITIES:
The Bank originates and sells residential mortgage loans to secondary market
investors subject to certain recourse provisions. At December 31, 1997 and
1996, the Bank had sold loans with recourse with an unpaid principal balance of
$61,512,000 and $27,118,000, respectively. The Bank had recorded a reserve of
$316,000 and $436,000, in connection with such sales at December 31, 1997 and
1996, respectively.
As part of its mortgage banking activities, the Bank sold, subject to
recourse, VA No-bid loans it originated prior to 1997. At December 31, 1997
and 1996, the Bank had limited recourse, on loans previously sold, with
unpaid principal balances of approximately $25,106,000 and $31,997,000,
respectively. The Bank has recorded reserves of $760,000 and $264,000
relating to these recourse provisions as of December 31, 1997 and 1996,
respectively. During 1997, the Bank added to this reserve approximately
$2,021,000 and charged off approximately $1,525,000 to this account related
to these repurchase obligations. In management's opinion, these reserves are
adequate to absorb losses inherent in the outstanding recourse obligations.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-24
- --------------------------------------------------------------------------------
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, 1997 and 1996 is as follows:
<TABLE>
<CAPTION>
December 31,
-------------------------
1997 1996
---------- ----------
<S> <C> <C>
Balance at the beginning of year $ 485,000 $ 320,000
Balance acquired 0 576,000
Provision charged to expense 176,000 72,000
Balances related to properties sold (209,000) (483,000)
Charge-offs 0 -
---------- ----------
Balance at the end of year $ 452,000 $ 485,000
---------- ----------
---------- ----------
</TABLE>
NOTE 8 - PREMISES AND EQUIPMENT:
Premises and equipment are summarized as follows:
<TABLE>
<CAPTION>
December 31,
--------------------------
1997 1996
------------- ------------
<S> <C> <C>
Land $ 2,671,000 $ 204,000
Buildings 6,161,000 369,000
Furniture, fixtures and equipment 12,822,000 8,606,000
Leasehold improvements 5,007,000 2,694,000
Leasehold interests 732,000 -
------------- ------------
27,393,000 11,873,000
Less: Accumulated depreciation
and amortization (16,161,000) (7,962,000)
------------- ------------
Premises and equipment, net $ 11,232,000 $ 3,911,000
------------- ------------
------------- ------------
</TABLE>
Depreciation and amortization of premises and equipment included in operating
expense amounted to $1,702,000, $642,000, and $201,000 in 1997, 1996 and 1995,
respectively.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-25
- ------------------------------------------------------------------------------
NOTE 9 - DEPOSITS:
A summary of deposits is as follows:
<TABLE>
<CAPTION>
December 31,
---------------------------
1997 1996
------------ ------------
<S> <C> <C>
Noninterest bearing:
Checking $205,998,000 $ 63,373,000
Bank controlled 6,391,000 4,211,000
Title and escrow 76,670,000 58,141,000
Custodial 285,000 1,160,000
------------ ------------
289,344,000 126,885,000
Interest bearing:
Passbook 98,465,000 42,190,000
NOW and Super NOW 97,416,000 38,602,000
Money market 98,189,000 25,662,000
Certificates of deposit $100,000 or greater 82,076,000 25,903,000
Other certificates 99,713,000 123,789,000
------------ ------------
475,859,000 256,146,000
------------ ------------
Total deposits $765,203,000 $383,031,000
------------ ------------
------------ ------------
</TABLE>
A summary of certificates of deposit maturities is as follows:
<TABLE>
<CAPTION>
December 31,
---------------------------
1997 1996
------------ ------------
<S> <C> <C>
1998 $171,491,000 $138,142,000
1999 10,134,000 11,400,000
2000 99,000 60,000
2001 65,000 90,000
2002 - -
Thereafter - -
------------ ------------
$181,789,000 $149,692,000
------------ ------------
------------ ------------
</TABLE>
Interest expense for certificates of deposit in amounts of $100,000 or more
was $4,710,000, $677,000, and $218,000 for the years ended December 31, 1997,
1996, and 1995, respectively.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-26
- ------------------------------------------------------------------------------
NOTE 10 - BORROWINGS
MANDATORY CONVERTIBLE DEBENTURES
In conjunction with the Bank Mergers on June 30, 1997, the Company assumed
certain obligations of its subsidiary SDN Bancorp. Among these obligations
were mandatory convertible debentures that total approximately $537,000. The
mandatory convertible debentures bear interest at Wall Street Journal prime
plus 3.0%, payable quarterly. The debentures are mandatorily convertible at
March 30, 1998 into the Company's 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 the Company's Board of Directors to reduce the conversion
price), or (ii) the then current fair market value per share of the Company's
common stock. Prior to March 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 the Company,
at a price of $52.50 per share (subject to certain anti-dilutive adjustments
and the power of the Company's Board of Directors to reduce the conversion
price).
The debentures are not subject to any sinking fund requirements and are
subordinated in right of payment to the obligations of the Company under any
other indebtedness. At the Company's option, the debentures are redeemable,
subject to Federal Reserve Bank approval, at 100% of par. 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 the Company. The Company has provided the debenture holders
with a Notice of Redemption and these debentures will be redeemed as of March
27, 1998.
SUBORDINATED DEBENTURES
In June 1997, CSBI Capital Trust I (the "subsidiary trust"), issued
$27,657,000 of 11 3/4% Trust Originated Preferred Securities (the "preferred
securities"). In connection with the subsidiary trust's issuance of the
preferred securities, the Company issued to the subsidiary trust $27,657,000
principal amount of its 11 3/4% subordinated debentures, due June 6, 2027
(the "subordinated debentures"). The sole assets of the subsidiary trust are
and will be the subordinated debentures. The Company's obligation under the
subordinated debentures and related agreements, taken together, constitute a
firm and unconditional guarantee by the Company of the subsidiary trust's
obligation under the preferred securities.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-27
- ------------------------------------------------------------------------------
NOTE 11 - INCOME TAXES:
The components of the income tax provisions (benefits) for the years
ended December 31 are as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------------
1997 1996 1995
---------- ----------- ---------
<S> <C> <C> <C>
Current:
Federal $1,934,000 $ (38,000) $ -
State 819,000 5,000 -
---------- ----------- ---------
Total current provision (benefit) 2,753,000 (33,000) -
---------- ----------- ---------
Deferred:
Federal 835,000 (1,276,000) (322,000)
State 24,000 (194,000) (121,000)
---------- ----------- ---------
Total deferred provision (benefit) 859,000 (1,470,000) (443,000)
---------- ----------- ---------
Total income tax provision (benefit) $3,612,000 $(1,503,000) $(443,000)
---------- ----------- ---------
---------- ----------- ---------
</TABLE>
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-28
- ------------------------------------------------------------------------------
NOTE 11: (Continued)
The amount of deferred tax assets (liabilities) resulting from each type of
temporary difference are as follows:
<TABLE>
<CAPTION>
December 31,
--------------------------
1997 1996
----------- -----------
<S> <C> <C>
Deferred tax liabilities:
FHLB stock dividends $ (216,000) $ (174,000)
Depreciation (575,000) (172,000)
Bad debt reserve recapture (1,860,000) 0
Deferred loan costs (462,000) (679,000)
State taxes (17,000) (223,000)
Deferred lease acquisition cost (611,000) 0
Core deposits (525,000) 0
Other (45,000) 0
----------- -----------
Total deferred tax liabilities (4,311,000) (1,248,000)
----------- -----------
Deferred tax assets:
Provision for loan losses $ 4,216,000 $ 1,202,000
Accrued expenses 181,000 51,000
Other reserves 248,000 645,000
Real estate acquired through foreclosure 143,000 88,000
NOL carryforward 1,363,000 1,509,000
General business credit 77,000 77,000
AMT credit 104,000 104,000
Salary continuation payable 375,000 0
Restricted stock 226,000 0
Accrued Legal 1,134,000 0
Refinance reserve 341,000 0
Other 0 336,000
----------- -----------
Total deferred tax assets 8,408,000 4,012,000
----------- -----------
Net deferred tax asset $ 4,097,000 $ 2,764,000
----------- -----------
</TABLE>
As of December 31, 1997, no valuation allowance has been established against
the recorded net deferred tax asset as, in management's opinion, it is more
likely than not that such asset will be realized.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-29
- ------------------------------------------------------------------------------
NOTE 11: (Continued)
The income tax provisions (benefits) varied from the federal statutory rate of
34% for 1997, 1996 and 1995, for the following reasons:
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Statutory federal expected tax rate 34.0% 34.0% 34.0%
Increase in income taxes resulting from:
State franchise tax (net of federal benefit) 8.4 7.5 7.5
Goodwill 10.5 18.9 -
Other 1.8 (0.4) (0.3)
---- ---- ----
Effective tax rate 54.7 60.0 41.2
Release of valuation allowance - (242.8) -
---- ---- ----
Total effective tax rate 54.7% (182.8)% 41.2%
---- ---- ----
---- ---- ----
</TABLE>
At December 31, 1997 the Bank had federal net operating loss carryforwards
of approximately $3,862,000, which expire in the years 2009 through 2011 and
California net operating loss carryforwards of approximately $1,200,000 which
will expire in the years 1999 through 2001.
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 change in
ownership. These limitations are not expected to impact the Company's ability
to utilize these NOLs.
NOTE 12 - STOCKHOLDER'S EQUITY:
LIBERTY ACQUISITION
As of March 27, 1996, Dartmouth Capital Group, L.P. ("Partnership" or "DCG"),
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 Liberty Acquisition and an additional 1,400 shares were issued
to the directors of Liberty at a price of $5.l85 per share.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-30
- ------------------------------------------------------------------------------
NOTE 12: (Continued)
1996 REORGANIZATION
As of September 1, 1996, the Company completed the 1996 Reorganization
contemplated by 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.
COMMERCE ACQUISTION
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 161,357 shares were issued to
other direct investors who invested in conjunction with the 1996
Reorganization and investment bankers involved in the 1996 Reorganization.
ELDORADO ACQUISITION.
Approximately $94.8 million of cash was necessary to pay the cash
consideration to holders of Eldorado common stock and Eldorado stock options
and Eldorado Acquisition-related expenses incurred by the Company, of which
$14.5 million was funded from Eldorado's excess capital and $80.3 million was
raised through the Company's sale, effective June 6, 1997, of Class B Common
Stock, Special Common Stock, a Junior Subordinated Debenture (and,
indirectly, Series A Capital Securities), Series B Preferred Stock and common
stock warrants, as described below.
CLASS B COMMON STOCK. In conjunction with the Eldorado Acquisition
financing, the 9,697,430 shares of Company common stock, $.01 par value per
share, outstanding immediately prior to the closing of the Eldorado
Acquisition were redesignated as "Class B Common Stock," and the Company
issued
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-31
- ------------------------------------------------------------------------------
NOTE 12: (Continued)
4,248,431 additional shares of Class B Common Stock to various accredited
investors for consideration of $20,016,000.
DCG, the Company's largest shareholder, purchased 1,012,244 of those shares
of Class B Common Stock for aggregate consideration of $4,795,000, of which
$4.3 million initially was made in the form of a loan to the Company in
December 1996 to fund an escrow account that would have been forfeited to
Eldorado if the Company were unable to consummate the Acquisition financing.
Peter H. Paulsen, a director of the Company, loaned $200,000 to the Company
on the same terms as DCG. That $4.5 million was converted to shares of Class
B Common Stock upon the consummation of the Acquisition at a purchase price
of $4.40 per share less a 1% commitment fee.
SPECIAL COMMON STOCK. The Company sold a total of 4,825,718 shares of
Special Common Stock, $.01 par value per share (the "Special Common"), to
DCG, Madison Dearborn Capital Partners II, L.P., ("MDP"), Olympus Growth Fund
II, L.P., ("Olympus I"), and Olympus Executive Fund, L.P., ("Olympus II" and
collectively with Olympus I, "Olympus") at a gross purchase price of $4.81
per share, representing an aggregate payment of $23,212,000. Neither MDP nor
Olympus is an affiliate of the other, and prior to their investment in the
Company, neither was an affiliate of the Company or DCG.
The Special Common Stock will be entitled to a liquidation preference over
the Class B Common Stock , in the case of a liquidation or a change in
control of the Company the distribution per share of Common Stock is less
than $4.81. With the exception of 927,826 shares of Non-Voting Special Common
Stock issued to each of MDP and Olympus, the Special Common Stock will have
one vote per share and will vote as a class with the Class B Common Stock.
The Voting Special Common and the Class B Common Stock are hereinafter
sometimes referred to as the "Voting Common Stock."
SUBORDINATED DEBENTURE AND SERIES A CAPITAL SECURITIES. CSBI Capital Trust I
(the "Trust"), a special purpose trust formed by the Company, issued a total
of 27,657 shares of 11% Series A Capital Securities, $1,000 initial
liquidation value per share (the "Series A Securities"), to DCG, MDP and
Olympus for an aggregate cash payment of $27,657,000. The Trust in turn
invested the proceeds of the Series A Securities in a Junior Subordinated
Debenture issued by the Company.
SERIES B PREFERRED STOCK. The Company issued a total of 116,593 shares of
11.0% Series B Preferred Stock, $100 par value per share (the "Series B
Preferred"), to DCG, MDP and Olympus for an aggregate amount of $11,545,210,
net of a 1% commitment fee.
COMMON STOCK WARRANTS. In connection with the purchase of the Series B
Preferred Stock, each of MDP, Olympus and DCG purchased a common stock
warrant (collectively, the "Investor Warrants") that entitles the holder to
purchase shares of Class B Common Stock at an exercise price of $4.81 per
share. An aggregate of 4,000,000 shares of Class B Common Stock are subject
to the Investor
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-32
- ------------------------------------------------------------------------------
NOTE 12: (Continued)
Warrants. The Investor Warrants expire on June 6, 2007. The aggregate
purchase price of the Investor Warrants was $40,000.
The Company also issued common stock warrants (collectively, the "Shattan
Warrants") to The Shattan Group, LLC, which acted as the Company's placement
agent for the sale of securities to MDP and Olympus. The Shattan Warrants,
which were issued as of June 6, 1997 and July 15, 1997, respectively, entitle
the holders thereof to purchase an aggregate of 482,433 shares of Class B
Common Stock at an exercise price of $4.81 per share and expire on June 6,
2000 and July 15, 2002, respectively. The aggregate purchase price of the
Shattan Warrants was $4,824.
CANCELLATION OF COMMON STOCK
In October 1997, the Company settled litigation that it had brought against
the former majority shareholder of CSB, and certain other directors and
officers of CSB arising out of the Company's acquisition of CSB in September
1996. As part of that settlement, the Company canceled 424,182 shares of
Class B Common Stock that was recorded as a purchase price adjustment.
NOTE 13. EMPLOYEE BENEFIT PLANS:
401 (k) RETIREMENT PLAN
The Company has a retirement plan under Section 40l(k) of the Internal
Revenue Code. All employees of the Company are eligible to participate in
the 40l(k) plan if they are twenty-one years of age or older and have
completed 500 hours of service. Under the plan, eligible employees are able
to contribute up to 10% of their compensation (some limitations apply to
highly compensated employees). Company contributions are discretionary and
are determined annually by the Board of Directors. The Company's
contribution was approximately $310,000 for 1997 and -0- for 1996.
DEFINED BENEFIT PENSION PLAN
The Company has an employment agreement with certain executive officers that
provides for a defined benefit pension plan that includes the following
pension costs for the year ended December 31, 1997. These employment
agreements were acquired in conjunction with the Eldorado acquisition and
the Company had no such plans prior to 1997:
<TABLE>
<S> <C>
Service cost of benefits earned during the year $ 43,342
Interest costs of projected benefit obligation 66,815
Net amortization and deferral 23,000
-------------
$133,157
-------------
-------------
</TABLE>
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-33
- ------------------------------------------------------------------------------
NOTE 13: (Continued)
The funded status of the plan at December 31, 1997 was as follows:
<TABLE>
<S> <C>
Actuarial present value of vested benefit obligation $1,073,749
------------
------------
Accumulated and projected benefit obligation $1,073,749
Plan assets at fair value (0)
------------
Projected benefit obligation in excess of plan assets 1,073,749
Unrecognized net (loss) gain (114,917)
Unrecognized prior service cost (11,499)
------------
Accrued pension and retirement cost included
in accompanying consolidated financial statements 947,333
Additional minimum liability 126,416
------------
Required minimum liability $1,073,749
------------
------------
</TABLE>
The projected benefit obligation was determined using a weighted-average
assumed discount rate of 7.00% for the year ended December 31, 1997.
RESTRICTED STOCK PLAN
During 1997, the Company's shareholders approved the adoption of a Restricted
Stock Plan, providing for the issuance of common stock to the Company's
president, subject to restrictions on sale or transfer. The restrictions on
sale or transfer expire over a period of four years which coincides with the
president's retirement. Under this plan 427,556 restricted shares were
issued with a market value of $2,012,000. This amount was recorded as
unearned compensation and is shown as a separate component of shareholders'
equity. Unearned compensation is being amortized to expense over the four
year vesting period with expense of $503,000 recorded for 1997.
STOCK OPTION PLAN
In January 1997 the Company adopted the Option Plan pursuant to which the
Company's Board of Directors or the Compensation Committee (the "Committee")
may grant stock options to the Company's president and other officers of the
Company or any of its subsidiaries. There are currently 1,457,200 shares
of Class B Common Stock subject to the Option Plan. The Option Plan provides
only for the issuance of so-called "nonqualified" stock options (as compared
to incentive stock options). At December 31, 1997 the Company's president
and chief financial officer hold options to purchase 728,600 and 50,000
shares of Class B Common Stock, respectively. The president had 309,500
options granted on February 4, 1997 and 419,100 options granted on July 15,
1997. The chief financial officer's options were granted on June 6,
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-34
- ------------------------------------------------------------------------------
NOTE 13: (Continued)
1997. In February 1998, the Company granted an additional 210,000 options to
purchase Class B Common Stock under the 1997 Plan to certain officers and
directors of the Bank. The exercise price for each separate tranche is fixed
based upon a semi-annual compounding of a "base rate" using the 5-year U. S.
Treasury rate in effect at the date of grant. The options granted will vest
over four years, in half-year increments, with the first portion vesting on
the 18-month anniversary of the date of grant. The Option Plan provides that
unless the Committee otherwise determines, the options will have a six-year
term, expiring on the sixth anniversary of the date of grant.
The president's options will become fully vested in connection with a change
in control, termination his employment agreement by the Company without cause,
or if he dies or becomes permanently disabled.
For all other option holders, the options would become fully vested if the
option holder is actually or constructively terminated without cause during a
two-year period following a change in control.
A summary of transactions in the Option Plans for the year ended December 31,
1997 follows:
<TABLE>
<CAPTION>
Available Weighted
for Grant Outstanding Average Price
<S> <C> <C> <C>
Shares authorized under the 1997 plan 1,457,200 - -
Options granted (778,600) 778,600 $5.13
---------- --------- ------------
Balance at December 31, 1997 678,600 778,600 $5.13
---------- --------- ------------
---------- --------- ------------
Exercise Price $4.81-$6.10
------------
------------
</TABLE>
The Company did not have any options outstanding prior to 1997.
Additionally, there were no options canceled or exercised during 1997.
The Company applies APB Opinion 25 in accounting for its Options Plan
and, accordingly, no compensation cost has been recognized for its stock
options in the consolidated financial statements. Had the Company determined
compensation cost based on the fair value at the grant date for its stock
options under the methodology prescribed under SFAS 123, the Company's net
earnings and earnings per share for 1997 would have been reduced to the pro
forma amounts indicated below. The per share weighted-average fair value of
the stock optons granted during 1997 was $1.23. The fair value of each
option grant is estimated on the date of grant using the Black-Scholes
option-pricing model with
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-35
- ------------------------------------------------------------------------------
NOTE 13: (Continued)
the following assumptions: expected dividend yield 0.0%, risk-free interest
rate of 5.5%, an expected life of 6 years and expected volatility of 20%.
<TABLE>
<S> <C>
Net earnings:
As reported $2,990,000
Pro forma $2,434,000
Basic earnings per share:
As reported $0.15
Pro forma $0.11
Diluted earnings per share:
As reported $0.13
Pro forma $0.09
</TABLE>
NOTE 14 - CAPITAL ADEQUACY:
The Bank is 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 the Bank's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Bank must meet specific capital guidelines that involve quantitative measures
of the Bank's assets, liabilities and certain off-balance sheet items as
calculated under regulatory accounting practices. The Bank's capital
amounts and classifications are also subject to qualitative judgment by the
regulators about components, risk weighting, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the
table below) of total and Tier 1 capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier I capital (as defined) to
average assets (as defined). Management believes, as of December 31, 1997,
that the Bank meets all capital adequacy requirements to which it is subject.
As of December 31, 1997, the most recent notification from the Department of
Financial Institutions (DFI) categorized the Bank as well capitalized under
the regulatory framework for prompt corrective action. To be categorized as
well capitalized the Bank must maintain minimum total risk-based, Tier 1
risk-based, and Tier 1 leverage ratios as set forth in the table. There are
no conditions or events since that notification that management believes have
changed the Bank's category.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-36
- ------------------------------------------------------------------------------
NOTE 14: (Continued)
The Bank's actual capital amounts and ratios are presented in the table below
(dollars in thousands):
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996
------------------------------------------ ---------------------------------------
Minimum Capital Minimum Capital
Actual Adequacy Actual Adequacy
-------------------- -------------------- ------------------ -------------------
Ratio Amount Ratio Amount Ratio Amount Ratio Amount
-------- --------- ------- ---------- -------- -------- ------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Tier 1 Capital:
CSB, Inc. (1) 8.85% $55,600 4.0% $25,129 9.22% $29,867 4.0% $12,953
EB 8.91 55,886 4.0 25,089 - - - -
CSB (1) - - - - 6.90 12,069 4.0 6.999
LNB - - - - 8.68 9,131 4.0 4,208
SDNB - - - - 14.52 6,174 4.0 1,700
Leverage Capital:
CSB, Inc. (1) 6.59% $55,600 3.0% $25,311 6.98% $29,867 3.0% $12,845
EB 6.64 55,886 3.0 25,250 - - - -
CSB (1) - - - - 4.99 12,069 3.0 7,251
LNB - - - - 6.19 9,131 3.0 4,428
SDNB - - - - 11.05 6,174 3.0 1,676
Total Capital:
CSB, Inc. (1) 10.18% $64,014 8.0% $50,306 10.64% $34,466 8.0% $25,906
EB 10.16 63,749 8.0 50,196 - - - -
CSB (1) - - - - 8.15 14,263 8.0 13,999
LNB - - - - 9.97 10,483 8.0 8,416
SDNB - - - - 15.78 6,708 8.0 3,401
</TABLE>
(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 15 - 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 consolidated statement of financial condition.
These financial instruments carry various degrees of credit and market risk.
Credit risk is defined as the possibility that a loss may occur from the
failure of another party to perform according to the terms of the contract.
Market risk is the possibility that future changes in market prices will make
a financial instrument less valuable. Management does not anticipate that
the settlement of these financial instruments will have a material adverse
effect on the Company's financial position or results of operations.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-37
- ------------------------------------------------------------------------------
NOTE 15: (Continued)
The contract or notional amounts of those instruments reflect the extent of
the Company's involvement in particular classes of financial instruments.
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,
1997:
<TABLE>
<S> <C>
Commitments to extend credit $173,801,000
Standby letters of credit 2,028,000
Put options to sell mortgage-backed securities 10,000,000
Forward commitments to sell mortgage-backed securities 26,000,000
</TABLE>
The Company is principally engaged in providing commercial loans and leases
with interest rates that fluctuate with the 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. The
contractual amounts of commitment to extend credit, standby and commercial
letters of credit represent the amount of credit risk. Since many of the
commitments and letters of credit are expected to expire without being drawn,
the contractual amounts do not necessarily represent future cash requirements.
Commitments to extend credit are agreements to lend to a customer as long as
there are no violations of any conditions established in the contract. The
Company evaluates the creditworthiness of each customer. The amount of
collateral obtained, if deemed necessary by the Company upon the extension of
credit, is based upon management's evaluation. Collateral varies, but may
include securities, accounts receivable, inventory, personal property,
equipment, income property, commercial and residential property. Commitments
generally have fixed expiration dates or other terminal clauses and may
require the payment of fees. The Company experiences interest rate risk on
commitments to extend credit which are at fixed rates. There were no fixed
rate commitments at December 31, 1997 or 1996.
Standby letters of credit are written conditional commitments issued by the
Company to guarantee the performance of a customer to a third party,
generally in the production of goods and services or under contractual
commitments in the financial market. 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.
The Bank's policy is to hedge a portion of its loans held for sale and its
commitments to originate loans against interest rate risk with forward
commitments to sell, or put options on, mortgage-backed securities. Forward
commitments are contracts for delayed delivery of securities in which the
Bank agrees to make delivery at a specified future date of a specified
security, at a specified price or yield. Put options convey to the Bank the
right, but not the obligation, to sell the securities at a 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
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-38
- ------------------------------------------------------------------------------
NOTE 15: (Continued)
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 $44,000 and $4,000 as of December 31, 1997 and 1996,
respectively. There were no unrealized losses on open put options to sell
mortgage-backed securities as of December 31, 1997 and 1996.
Commitments to sell loans are agreements to sell loans originated by the Bank
to investors. These commitments may be optional or mandatory. Under an
optional commitment, a commitment fee is paid and the Bank carries no risk in
excess of the loss of such fee in the event that the Bank is unable to
deliver the loans into the commitment. Mandatory commitments may entail
possible financial risk to the Bank if it is unable to deliver the loans in
sufficient quantity or at sufficient rates for commitments which are at a
fixed rate. There were commitments of $26,000,000 and $17,161,000 at December
31, 1997 and 1996. At December 31, 1997 the commitments were a combination of
fixed and adjustable rate loans with coupons ranging from 5.5% to 7.50% and
with settlement dates ranging from February 12, 1998 to February 24, 1998.
The Bank had closed loans at December 31, 1997 of $8,224,000 with which to
satisfy those commitments and a pipeline of unclosed loans of $43,507,000
that in management's opinion, will be sufficient to fulfill the balance of the
commitment.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-39
- ------------------------------------------------------------------------------
NOTE 16 - DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS:
Fair values for each class of financial instruments are as follows:
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996
----------------------------- -----------------------------
Carrying Value Fair Value Carrying Value Fair Value
---------------- ------------ ---------------- ------------
<S> <C> <C> <C> <C>
Financial Assets:
Cash and federal funds sold $121,030,000 $121,030,000 $46,560,000 $46,560,000
Investment securities 67,295,000 67,295,000 35,200,000 35,085,000
Loans and leases receivable 522,054,000 527,736,000 263,641,000 265,235,000
Servicing sale receivable 1,247,000 1,247,000 2,870,000 2,870,000
Mortgage loans held for sale 96,230,000 97,192,000 64,917,000 65,025,000
Financial Liabilities:
Deposits $765,203,000 $751,799,00 $383,031,000 $379,544,000
Federal funds purchased 2,050,000 2,050,000 -- --
Due to related parties - - 4,500,000 4,500,000
Mandatory convertible debentures 537,000 537,000 537,000 537,000
Guaranteed preferred beneficial
interest in the Company's junior
subordinated debentures 27,657,000 27,657,000 - -
</TABLE>
CASH AND FEDERAL FUNDS SOLD
For cash and Federal funds sold the carrying amount is a reasonable estimate
of fair value.
INVESTMENT SECURITIES
All investment securities are marketable and have an easily determined market
value. Market quotes are used in determining the fair value.
LOANS AND LEASES RECEIVABLE
Loans were broken into fixed and variable rate loans for this analysis. The
credit risk component of the fair value analysis is assumed to be
approximated by the loan and lease loss reserve. A 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 commercial and consumer loans are valued using a discounted cash
flow model that assumes a prepayment rate of 10% and a discount rate of prime
plus 50 basis points. These commercial and consumer loans were grouped into
categories and the weighted average maturity and rate were used in computing
the future cash flows. Leases are regularly sold into the secondary
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-40
- ------------------------------------------------------------------------------
NOTE 16: (Continued)
market and on average have sold at a premium of approximately 3 percent. To
determine the fair value of leases, this potential sale premium was
discounted to par to account for the 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 were broken down by loan type and evaluated based upon
the current weighted average rate of the loans in comparison to current
market conditions. Premiums of up to 2 percent were applied to those groups
of loans that had higher than market rates while loans at or below market
were discounted.
SERVICING SALE RECEIVABLE
The amounts recorded are generally collected within 90 days, and as such the
carrying amount is a reasonable estimate of the fair value.
MORTGAGE LOANS HELD FOR SALE
Loans held for sale are valued at a premium of 1%. These loans consist of
residential mortgage loans and are largely a 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.
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 value 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 CD's were determined utilizing the Treasury rates for comparable
maturities less 25 basis points.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-41
- ------------------------------------------------------------------------------
NOTE 16: (Continued)
Generally, rates currently being paid are higher than current market rates
which results in these accounts having a lower fair value.
BORROWINGS
Federal funds purchased are over-night investments and the carrying value is
a reasonable estimate of fair value. For subordinated debentures, having
been recently priced at the issuance in 1997, the carrying value is a
reasonable estimate of fair value. The mandatory convertible debentures will
be redeemed at par in March 1998, and as such the carrying value is also a
reasonable estimate of its fair value.
DUE TO RELATED PARTIES
Notes payable to related parties have a maturity 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 - Fair value 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 - Fair value is derived from
active exchange quotations. The fair value of put options to sell
mortgage-backed securities is not material.
NOTE 17 - COMMITMENTS AND CONTINGENCIES:
LITIGATION
As of December 31, 1997, no litigation is pending against Commerce Security
Bancorp, Inc.. The Bank is the plaintiff in an action, originally filed by
CSB in January 1994, seeking (among other things) to restrain a former CSB
loan production office manager from engaging in activities harmful to the
Bank and its employees. In June 1994, the former employee filed a
cross-complaint against the Bank and certain individual employees alleging
wrongful termination, breach of contract, defamation and various other causes
of action. Following a jury trial, judgment was entered against the Bank in
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-42
- ------------------------------------------------------------------------------
NOTE 17: (Continued)
October 1997, and this matter is now on appeal. In conjunction with this
initial judgment, the Bank recorded a reserve for the full amount of the
judgment.
The Company is from time to time subject to various legal actions (in
addition to that described above) which are considered to be part of its
normal course of business. Management, after consultation with legal
counsel, does not believe that the ultimate liability, if any, arising from
those other actions will have a materially adverse effect on the financial
position or results of operations of the Company.
A summary of noncancellable future operating lease commitments at December
31, 1997 is as follows:
<TABLE>
<S> <C>
1998 $2,077,000
1999 1,780,000
2000 1,383,000
2001 855,000
2002 750,000
Thereafter 2,918,000
----------
$9,763,000
----------
----------
</TABLE>
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
$2,302,000, $1,101,000 and $417,000 for the years ended December 31, 1997,
1996 and 1995, respectively.
DIVIDEND RESTRICTIONS
Federal Reserve policies declare that a bank holding company may not pay cash
dividends on its common stock unless its net income is sufficient to fund
fully such 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. In connection with the Eldorado
Acquisition, the Company agreed that it will not pay dividends on common
stock without the prior approval of the Federal Reserve.
The Company is a legal entity separate and distinct from the Bank.
Substantially all of the Company's revenues and cash flow, including funds
available for the payments of dividends and other operating expenses,
consists of dividends paid to the Company by the Bank. There are statutory
and regulatory limitations on the amount of dividends which may be paid to
the Company by the Bank. Dividends payable by the Bank are restricted under
California law to the lesser of the Bank's retained earnings, or the Bank's
net income for the latest three fiscal years, less dividends previously
declared during that period, or, with the approval of the DFI, to the greater
of the retained earnings of the Bank, the net income of the Bank for its last
fiscal year or the net income of the Bank for its current fiscal year. In
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-43
- ------------------------------------------------------------------------------
NOTE 17: (Continued)
connection with the Eldorado Acquisition, Eldorado Bank paid a dividend of
$14 million, which exceeded the Bank's net income for the latest three fiscal
years. As a result, the Bank must obtain the approval of the DFI with
respect to the payment of any dividend up to the greater of the Bank's
retained earnings, the net income of the Bank for its last fiscal year and
the net income of the Bank for its current fiscal year. In no event can the
Bank issue a dividend in excess of such amounts.
Federal Reserve regulations also limit the payment of dividends by a state
member bank. Under Federal Reserve regulations, dividends may not be paid
unless both undivided profits and earnings limitations have been met. First,
no dividend may be paid if it would result in a withdrawal of capital or
exceed the bank's undivided profits as reported in its most recent Report of
Condition and Income, without the prior approval of the Federal Reserve and
two-thirds of the shareholders of each class of stock outstanding. Second, a
state member bank may not pay a dividend without the prior written approval
of the Federal Reserve if the total of all dividends declared in one year
exceeds the total of net income for that year plus its retained net income
for the preceding two calendar years.
The payment of dividends on capital stock by the Company and the Bank may
also be limited by other factors, including applicable regulatory capital
requirements and broad enforcement powers of the federal regulatory agencies.
Both the Federal Reserve and the DFI have broad authority to prohibit the
Company and the Bank from engaging in practices which the banking agency
considers to be unsafe or unsound. It is possible, depending upon the
financial condition of the Bank or the Company and other factors, that the
applicable regulator may assert that the payment of dividends or other
payments by the Bank or the Company is an unsafe or unsound practice and,
therefore, implement corrective action to address such a practice. Among
other things, Federal Reserve 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 and tax sharing payments which do not reflect the taxes actually due
and payable.
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 Bank
for its cash needs, including funds for payment of interest and operating
expenses and dividends.
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-44
- ------------------------------------------------------------------------------
NOTE 18 - CONDENSED FINANCIAL INFORMATION PARENT COMPANY:
The following are condensed unconsolidated financial statements of Commerce
Security Bancorp, Inc.. The Company began operations in 1996, and thus the
statements of operations and cash flows are presented only for 1996 and 1997.
CONDENSED STATEMENT OF CONDITION
<TABLE>
<CAPTION>
December 31,
---------------------------
1997 1996
------------ ------------
<S> <C> <C>
Assets
Cash and due from banks $ 262,000 $ 4,644,000
Investments 38,000 408,000
Investment in subsidiary 73,779,000 39,617,000
Goodwill and other intangibles 49,756,000 429,000
Receivables and other assets 176,000 210,000
------------ ------------
Total assets $124,011,000 $ 45,308,000
------------ ------------
------------ ------------
Liabilities and Shareholders' Equity
Guaranteed preferred beneficial interest
in the Company's junior subordinated
debentures $ 28,513,000 $ -
Accrued expenses 225,000 -
Mandatory convertible debentures 537,000 -
Due to subsidiary - 36,000
Notes payable to shareholders - 4,500,000
------------ ------------
Total liabilities 29,275,000 4,536,000
------------ ------------
Shareholders' equity
Preferred stock 11,659,000 -
Common stock 183,000 97,000
Additional paid-in-capital 83,855,000 42,394,000
Retained earnings (deficit) 524,000 (1,736,000)
Unearned compensation (1,509,000) -
Unrealized gain on investments, net of tax 24,000 17,000
------------ ------------
Total shareholders' equity 94,736,000 40,772,000
------------ ------------
Total liabilities and shareholders' equity $124,011,000 $ 45,308,000
------------ ------------
------------ ------------
</TABLE>
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-45
- ------------------------------------------------------------------------------
NOTE 18: (Continued)
CONDENSED STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
For the Years Ended December 31,
--------------------------------
1997 1996
----------- ----------
<S> <C> <C>
Income:
Dividend from Bank $ 1,700,000 $ -
Interest income 51,000 8,000
Non-interest income 866,000 154,000
----------- ----------
Total Income 2,617,000 162,000
Expenses:
Interest expense 1,959,000 -
Amortization of goodwill and intangibles 1,537,000 6,000
Non-interest expense 1,453,000 156,000
----------- ----------
Total expense 4,949,000 162,000
Loss before taxes and equity in undistributed
earnings of subsidiary (2,332,000) -
Income tax benefit 1,161,000 -
----------- ----------
Loss before equity in undistributed earnings
of subsidiary (1,171,000) -
Equity in undistributed earnings of subsidiary 4,161,000 2,325,000
----------- ----------
Net income $ 2,990,000 $2,325,000
----------- ----------
----------- ----------
</TABLE>
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
Page F-46
- ------------------------------------------------------------------------------
NOTE 17: (Continued)
CONDENSED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
For the Years Ended December 31,
--------------------------------
1997 1996
------------ -----------
<S> <C> <C>
Operating activities:
Net income $ 2,990,000 $ 2,325,000
Adjustments to reconcile net income to net
cash (used in) provided by operating activities:
Equity in earnings of subsidiary (5,861,000) (2,325,000)
Accretion/amortization related to securities - 1,000
Dividends from subsidiary 1,700,000 -
Loss on sale of securities, net 7,000 -
Amortization of goodwill and other intangibles 1,537,000 -
Amortization of compensation expense 503,000 -
Income taxes 110,000 -
(Increase) decrease in other assets 163,000 (639,000)
Increase (decrease) in other liabilities (443,000) 35,000
------------ -----------
Net cash (used in) provided by operating activities 706,000 (603,000)
------------ -----------
Investing activities:
Purchase of investment securities - (409,000)
Purchase of CSB - (20,327,000)
Purchase of SDN Bancorp - (21,008,000)
Merger of SDN Bancorp, net of cash received 22,000 -
Purchase of Eldorado, net of cash received (80,815,000) -
Maturities/Sales of investment securities 404,000 -
------------ -----------
Net cash used in investing activities (80,389,000) (41,744,000)
------------ -----------
Financing activities:
Issuance of capital securities 27,657,000 -
Issuance of preferred stock 11,659,000 -
Issuance of Class B common stock 18,004,000 42,491,000
Net proceeds from issuance of notes payable - 4,500,000
Issuance of senior common stock 23,212,000 -
Payment of dividends (730,000) -
Other borrowings (4,500,000) -
------------ -----------
Net cash provided by financing activities 75,301,000 46,991,000
------------ -----------
Net increase (decrease) in cash (4,382,000) 4,644,000
Cash at beginning of year 4,644,000 -
------------ -----------
Cash at end of year $ 262,000 $ 4,644,000
------------ -----------
------------ -----------
</TABLE>
<PAGE>
SEVERANCE AGREEMENT
THIS SEVERANCE AGREEMENT ("Agreement") is made and entered into as of the
______ day of ___________, 1998, by and among ELDORADO BANK, a California
banking corporation (the "Bank"), and ________________, the [OFFICE] of the
Bank ("Officer").
R E C I T A L S :
A. WHEREAS, the Bank is a wholly owned subsidiary of Commerce Security
Bancorp, Inc., a Delaware corporation (the "Company");
B. WHEREAS, Officer is the [OFFICE] and a current employee of the
Bank; and
C. WHEREAS, it is deemed to be in the best interest of the Bank and
the Company to take appropriate steps to provide severance arrangements under
certain circumstances to certain officers who remain employees of the Bank;
AGREEMENT
NOW, THEREFORE, in consideration of the foregoing and of the respective
covenants and agreements of the parties herein contained, it is agreed as
follows:
1. DEFINITIONS. For purposes of this Agreement, the following terms
when used in this Agreement shall have the meanings set forth below:
(a) "CAUSE" shall mean Officer, after the date of this Agreement,
(i) has been convicted by a court of competent jurisdiction of any
criminal offense involving dishonesty, breach of trust or
misappropriation, or has entered a plea of NOLO CONTENDERE to such an
offense; or (ii) has committed an act of fraud, embezzlement, theft, or
any act which would cause termination of coverage under the Bank's
Banker's Blanket Bond as to Officer (as distinguished from termination of
coverage as to the Bank as a whole); or (iii) has committed a willful
violation of the Bank's Code of Conduct or any law, rule or regulation
governing the operation of the Bank or any of its affiliates or the
insurance of deposits held by the Bank (A) which is a felony or
misdemeanor, or (B) which the Board of Directors of the Bank determines in
good faith will likely have or has had a material adverse effect on the
business, interests or reputation of the Bank or any of its affiliates; or
(iv) has committed a willful and unauthorized disclosure of material
confidential information regarding the Bank or any of its subsidiaries or
affiliates, which disclosure the Board of Directors of the Company
determines in good faith will likely have or has had a material adverse
effect on the Bank or any of its subsidiaries or affiliates.
<PAGE>
(b) "CHANGE OF CONTROL" shall mean any transaction or series of
related transactions as a result of which
(i) the Company consummates a reorganization, merger or
consolidation of the Company, or sale or other disposition of all or
substantially all of the assets of the Company (each a "Business
Combination"), in each case UNLESS immediately following the
consummation of such Business Combination all of the following
conditions are satisfied: (x) Persons, who, immediately prior to
such Business Combination, were the beneficial owners of the voting
securities entitled to vote generally in the election of directors of
the Company (the "Outstanding Voting Securities"), beneficially own
(within the meaning of Rule 13d-3 promulgated under the Securities
Exchange Act of 1934, as amended (the "1934 Act"), directly or
indirectly, more than one-third (_) of, respectively, the then
outstanding shares of common stock and the combined voting power of
the then Outstanding Voting Securities entitled to vote generally in
the election of directors, as the case may be, of the entity (the
"Resulting Entity") resulting from such Business Combination
(including, without limitation, an entity which as a result of such
transaction owns the Company or all or substantially all of the
Company's assets either directly or through one or more
subsidiaries); (y) no Person (other than any limited partner of
Dartmouth Capital Group, L.P. or shareholder of Dartmouth Capital
Group, Inc., any employee benefit plan (or related trust) of the
Company or the Resulting Entity) beneficially owns (within the
meaning of Rule 13d-3), directly or indirectly, more than twenty
percent (20.0%) of, respectively, the then outstanding shares of
common stock of the Resulting Entity or the combined voting power of
the then Outstanding Voting Securities of the Resulting Entity,
except to the extent that such Person's beneficial ownership of the
Company immediately prior to the Business Combination exceeded such
threshold; and (z) at least one-half (1/2) of the members of the board
of directors of the Resulting Entity were members of the Board of
Directors of the Company at the time the Company's Board of Directors
authorized the Company to enter into the definitive agreement
providing for such Business Combination; or
(ii) any Person (other than a limited partner of Dartmouth
Capital Group, L.P. or a shareholder of Dartmouth Capital Group,
Inc.) acquires beneficial ownership (within the meaning of Rule 13d-
3) of more than twenty percent (20.0%) of the combined voting power
(calculated as provided in Rule 13d-3 in the case of rights to
acquire securities) of the then Outstanding Voting Securities of the
Company; PROVIDED, HOWEVER, that for purposes of this clause, the
following acquisitions shall not constitute a Change of Control: (x)
any acquisition directly from the Company, (y) any acquisition by the
Company and (z) any acquisition by any employee benefit plan (or
related trust) sponsored or maintained by the Company or any entity
controlled by the Company.
-2-
<PAGE>
(c) "DISABILITY OF OFFICER" shall mean if Officer is Disabled and
such disability continues for a period of any six (6) months out of a one
(1) year period. "DISABLED" shall mean Officer's inability, through
physical or mental illness or other cause, to perform normal and customary
duties which Officer is required to perform for the Bank. In determining
whether Officer is Disabled, the Bank may rely upon the written statement
provided by a licensed physician acceptable to the Bank. Officer shall
allow examination from time to time by any licensed physician selected by
the Bank and agreed to by Officer. All such examinations will be
conducted within a reasonable time period.
(d) "GOOD REASON" shall mean the occurrence of Officer (i) being
delegated or assigned duties by the Board of Directors (the "Board") of
the Bank or the Chief Executive Officer of the Bank by a communication in
writing which are substantially inconsistent with the position and status
held by Officer immediately prior to the effective date of the Change of
Control; or (ii) having had removed by the Board or the Chief Executive
Officer by a communication in writing such authority and responsibility
which is necessary to carry out the duties of the position held by Officer
immediately prior to the effective date of the Change of Control; or
(iii) having a substantial and adverse alteration in the nature, status,
or prestige of Officer's responsibilities due to the action of the Board
or the Chief Executive Officer, which is verifiable by tangible evidence;
or (iv) being relocated to an office more than twenty-five (25) miles from
the location of the Bank's executive offices as in effect immediately
prior to the effective date of the Change of Control; or (v) having his or
her base compensation reduced by ten percent (10%) or more from such base
compensation in effect on the date immediately preceding the effective
date of the Change of Control. In addition, without limiting the scope of
the immediately preceding sentence, any action by the Bank which would
constitute a termination without cause within the meaning of the Company's
1997 Stock Option Plan shall also constitute "Good Reason" for purposes of
this Agreement.
(e) "PERSON" shall have the meaning ascribed to such term in Section
3(a)(9) of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), which definition shall include a "person" within the meaning of
Section 13(d)(3) of the Exchange Act.
(f) "WITHOUT CAUSE" shall mean any termination of Officer by the
Bank except for a termination (i) for Cause, (ii) as a result of the
death of Officer, or (iii) as a result of the Disability of Officer.
2. SEVERANCE PAYMENT.
(a) Except as provided in Section 2(b), if (i) Good Reason exists
within two
-3-
<PAGE>
(2) years following a Change of Control, and Officer gives written
notice to the Bank within ninety (90) days after the occurrence of
such Good Reason that Officer is terminating his or her employment with
the Bank for Good Reason, or (ii) the Bank terminates Officer Without
Cause within two (2) years following a Change of Control, and, in either
event, provided that Officer has delivered to Bank a General Release and
Confidentiality Agreement in the form of EXHIBIT "A" attached hereto (the
"Waiver and Release"), the Bank will pay Officer in a lump sum an amount
(the "Severance Payment") equal to twelve (12) times Officer's base
monthly salary as in effect either at the time of termination or, if
greater, immediately prior to the effective date of the Change of Control.
The Severance Payment shall be reduced by required deductions for
applicable taxes and other withholdings and for any outstanding
obligations owed by Officer to the Bank that are then due and payable,
which deductions and withholdings are specifically authorized by Officer.
The Severance Payment shall be in addition to any sums to which Officer
would be entitled without signing the Waiver and Release. The Severance
Payment will be paid not more than five (5) calendar days after the
"Effective Date" of the Waiver and Release as provided therein. Each
Change of Control and each Good Reason following a Change of Control shall
give Officer a separate right to give the notice set forth in the first
sentence of this paragraph 2.
(b) Notwithstanding any other provision of this Agreement, the bank
shall have no obligations to make the Severance Payment if such Severance
Payment is prohibited by applicable federal or state law, including
without limitation Part 359 of the regulations of the Federal Deposit
Insurance Corporation (12 CFR Section 359 et seq.) or any successor
provision.
3. IRC PROVISIONS. Notwithstanding any other provision of this
Agreement, in the event it is determined by the Bank in its reasonable
discretion that the payment of the Severance Amount to Officer would be
nondeductible by the Bank for federal income tax purposes because of Section
280G of the Internal Revenue Code of 1986, as amended (the "Code"), the
Severance Payment shall be reduced to an amount which maximizes the Severance
Payment without causing any portion of the same to be nondeductible by the
Bank because of Section 280G of the Code. Any such reduction shall be
applied to the Severance Payment or the other amounts due to Officer in such
manner as Officer may reasonably specify within thirty (30) days following
notice from the Bank of the need for such reduction or, if Officer fails to
so specify timely, as determined by the Bank.
4. EMPLOYEE BENEFITS. All employee benefits provided by the Bank
shall cease upon termination of Officer's employment, whether for Good
Reason, Without Cause, or for any other reason, and the Bank shall have no
further responsibility with respect thereto after such termination; PROVIDED,
HOWEVER, that nothing contained in this Agreement shall affect any right
Officer may have pursuant to the Federal entitlement to continued group
health care coverage as provided in the Consolidated Omnibus Budget
Reconciliation Act of 1985 ("COBRA") or any successor legislation or
comparable state law; and PROVIDED FURTHER that if
-4-
<PAGE>
Officer is entitled to receive a Severance Payment pursuant to paragraph 2
hereof, and if Officer elects under COBRA to continue to receive any benefits
thereunder, the Bank shall reimburse Officer for the amount of such Officer's
COBRA payments for the first six months after such termination.
5. TERM. The term of this Agreement shall be a rolling twelve (12)
months, with the Bank being able to terminate the Agreement upon twelve (12)
months prior written notice to the Officer; PROVIDED, HOWEVER, that if a
Change of Control has occurred, no such termination shall be effective prior
to the ninetieth (90th) day after the second (2nd) anniversary of the Change
of Control.
6. EMPLOYMENT "AT WILL". Neither this Agreement nor the Severance
Payment payable hereunder shall be deemed to limit, replace or otherwise
affect the "at will" nature of Officer's employment with the Bank. Officer's
employment with the Bank continues to be for an unspecified term and may be
terminated at will at any time with or without cause or notice by either the
Bank or Officer. This at-will relationship cannot be changed absent an
express intent as set forth in an individualized written employment contract
signed by both Officer and the Chief Executive Officer of the Bank.
7. ARBITRATION. (a) It is the intention and agreement of the parties
hereto that no dispute, disagreement, claim or controversy (collectively a
"Controversy") arising in connection with this Agreement, Officer's
employment or the termination of that employment, be subject to civil
litigation or other judicial process (other than to compel compliance with
this paragraph or to enforce an award issued as a result of a proceeding
hereunder). Therefore, to the fullest extent allowed by law, any Controversy
arising out of or relating to this Agreement, the breach of this Agreement,
the facts and circumstances preceding the execution of this Agreement, the
interpretation of any provision of this Agreement, Officer's employment or
the termination of that employment, which cannot be resolved through
agreement of the parties, shall be settled by means of binding arbitration
conducted in accordance with the procedures set forth in paragraph 9 of the
Waiver and Release. The matters subject to binding arbitration shall include,
but not be limited to, any Controversy regarding wrongful termination,
employment discrimination, and harassment of any kind, and shall include
statutory claims arising under laws such as Title VII of the Civil Rights
Act, the Age Discrimination in Employment Act, and the California Fair
Employment and Housing Act.
8. MITIGATION. Officer shall have no obligation to mitigate damages
based upon Officer's termination pursuant to paragraph 2 above, and the
Severance Payment shall not be reduced as a result of Officer obtaining other
employment within twelve (12) months of Officer's termination.
9. CONFIDENTIALITY. Officer understands and agrees (a) that Officer
will maintain all proprietary and confidential information of the Bank as
proprietary and confidential at all times during and after his/her
employment, (b) that Officer will not disclose or communicate such
-5-
<PAGE>
information to any third party or make use of it on his/her own behalf or on
behalf of any third party, and (c) upon his/her termination, that Officer
will deliver all tangible forms or media which Officer may have containing
such information to the Bank. For purposes of this Paragraph 9, "information"
includes trade secrets and all non-public records, practices, letters, plans,
drawings, computer programs and data, technical data, financial and other
business data pertaining to the Bank or any of its affiliates, customers,
vendors or other persons associated with the Bank. Officer acknowledges and
further agrees that the disclosure of such information would be a material
breach of this Agreement for which the Bank shall be entitled to any remedies
available to it in law or in equity.
10. COVENANT NOT TO DISRUPT BUSINESS. Officer hereby covenants and
agrees that he or she will not now, or for a period of one (1) year after the
effective date of Officer's termination of employment, whether or not
following a Change of Control, disrupt, damage, impair or interfere with the
business of the Bank, whether by way of interfering with or soliciting its
employees, or disrupting its relationships with customers, loan packagers,
representatives, vendors, brokers or otherwise. After termination of
employment, Officer is not, however, restricted from being employed by or
engaged in a competing business.
11. COUNTERPARTS. This Agreement may be executed in any number of
counterparts, each of which shall be deemed an original, and all of which,
together, shall constitute one and the same instrument.
12. PARTIAL INVALIDITY. Any provision of this Agreement which shall
prove to be invalid, void or illegal shall in no way affect, impair or
invalidate any other provision hereof, and such other provisions shall remain
in full force and effect.
13. TIME. Time is of the essence with respect to the performance of
every provision of this Agreement.
14. GOVERNING LAW. The terms and provisions of this Agreement shall be
governed and construed pursuant to the laws of the State of California except
to the extent governed by Federal law.
15. CONSTRUCTION. Headings at the beginning of each paragraph are
solely for the convenience of the parties and are not a part of this
Agreement. Whenever required by the context of this Agreement, the singular
shall include the plural and the masculine shall include the feminine and
vice versa. This Agreement shall not be construed as if it had been prepared
by one of the parties, but rather as if both parties had prepared the same.
Unless otherwise indicated, all references to paragraphs are to this
Agreement. The exhibit referred to in this Agreement is attached and
incorporated by this reference.
16. INTEGRATION. This Agreement represents the entire and integrated
agreement between the Bank and Officer regarding the subject matter hereof
and supersedes all prior
-6-
<PAGE>
negotiations, representations or agreements, either written or oral. If the
Officer receives a severance payment pursuant to this Agreement, the Officer
shall not be eligible to receive any severance benefit under the Company's
Severence Pay Plan or any successor plan. Not withstanding the immediately
preceding sentence, if Officer is subject to a "Covered Termination" (as
defined in the Company's Severence Pay Plan), in circumstances not involving
a change of control, Officer shall be eligible to receive severance benefits
if and to the extent provided in the Company's Severance Pay Plan.
17. SUCCESSORS AND ASSIGNS. The terms, covenants and conditions herein
contained shall be binding upon and shall inure to the benefit of the heirs,
successors and assigns of the parties hereto.
18. NO WAIVER. No waiver by either party of any breach or default
hereunder shall be deemed a waiver of any other breach or default, and no
delay or forbearance by either party hereunder in enforcing any of its rights
or remedies shall be deemed a waiver of any such rights or remedies, unless
such waiver is embodied in a writing signed by the authorized representative
of the party to be bound.
IN WITNESS WHEREOF, this Agreement has been executed effective on the
day and year hereinabove set forth.
"BANK" ELDORADO BANK
By:
---------------------------
Its:
-----------------------
"OFFICER"
------------------------------
-7-
<PAGE>
EXHIBIT "A"
GENERAL RELEASE AND CONFIDENTIALITY AGREEMENT
---------------------------------------------
This General Release and Confidentiality Agreement ("Waiver and
Release"), including a release of severance pay claims, is entered into this
____ day of _____, 199__, by and between _____________("Officer") and
Eldorado Bank (the "Bank").
1. Within ten (10) calendar days of the "Effective Date" of this Waiver
and Release, as defined in Paragraph 4 below, and assuming Officer is
otherwise eligible for benefits under the terms of his/her Severance
Agreement, dated November __, 1997 ("Agreement"), the Bank agrees to pay
Officer the Severance Payment as provided in Paragraph 2 of the Agreement.
The Severence Payment shall be in addition to any sums to which
Officer would be entitled without signing this Waiver and Release.
2. In consideration of such Severance Payment and the promises
contained in this Waiver and Release, Officer, for himself/herself and for
his/her heirs, executors, administrators, successors and assigns (the
"Releasors"), hereby waives, releases and forever discharges the Bank and its
officers, directors, employees, agents, insurers, underwriters, subsidiaries,
parents, holding companies (including, but not limited to, Commerce Security
Bancorp, Inc.) affiliates (including, but not limited to, Dartmouth Capital
Group, L.P. and Dartmouth Capital Group, Inc.), successors and assigns (the
"Releasees") from, and agrees to the extent permitted by law not in any
manner to institute, prosecute or pursue, any and all complaints, charges,
claims, obligations, demands, suits, costs, losses, liabilities, damages,
actions or causes of action of any nature whatsoever, whether in law or in
equity known or unknown, suspected or claimed, which Releasors, or any of
them, have or may have against the Releasees, or any of them, concerning any
matter, cause or thing, including without limitation, any claim related to or
arising out of (a) Officer's employment with the Bank or the cessation of
that employment; (b) any common law or statutory tort; (e) any federal,
state, or governmental constitution, statute, regulation or ordinance,
including, without limitation, Title VII of the Civil Rights Act of 1964, the
Age Discrimination in Employment Act, the Employee Retirement Income Security
Act of 1974, as amended, the California Fair Employment and Housing Act, the
California Labor Code, the Equal Pay Act, the Americans With Disabilities
Act, the Rehabilitation Act of 1973, the Racketeer Influenced and Corrupt
Organizations Act, the Financial Reform Recovery and Enforcment Act of 1989,
and/or Section 1981 of Title 42 of the United States Code; and (d) any
agreement, oral or written, express or implied, between Officer and the Bank,
including any employment agreement. This Waiver and Release does not waive
rights or claims that may arise after the date this Waiver and Release is
executed by Officer.
3. As further consideration and inducement for this Waiver and Release,
it is understood and agreed that the Releasors' general release herein
extends to all known and unknown claims and that Releasors waive and release
any and all rights under Section 1542 of
A-1
<PAGE>
the California Civil Code or any analogous state, local or federal law,
statute, rule, order or regulation. CALIFORNIA CIVIL CODE SECTION 1542 READS
AS FOLLOWS:
"A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH
THE CREDITOR DOES NOT KNOW OR SUSPECT TO EXIST IN HIS
FAVOR AT THE TIME OF EXECUTING THE RELEASE, WHICH IF
KNOWN BY HIM MUST HAVE MATERIALLY AFFECTED HIS
SETTLEMENT WITH THE DEBTOR."
4. Officer acknowledges and agrees that (a) he/she has been given a
period of at least twenty-one (21) calendar days to consider this Waiver and
Release and whether or not to sign it, and (b) for a period of seven (7)
calendar days after he/she signs this Waiver and Release, he/she has the
right to revoke it. This Waiver and Release shall not become effective or be
enforceable until such seven (7) calendar day revocation period has expired,
such expiration date being referred to herein as the "Effective Date".
5. Officer executes this Waiver and Release voluntarily without
reliance on any representation by the Bank other than that set forth in this
Waiver and Release. Officer acknowledges that he/she has read and understands
the provisions of the release set forth in Paragraphs 2 and 3 of this Waiver
and Release. The Bank advises Officer to consult with an attorney before
executing this Waiver and Release, and to consider all of its provisions
carefully before signing it.
6. Officer understands and agrees (a) that he/she will maintain all
proprietary and confidential information of the Bank as proprietary and
confidential at all times during and after his/her employment, (b) that
he/she will not disclose or communicate such information to any third party
or make use of it on his/her own behalf or on behalf of any third party, and
(c) upon his/her termination, that he/she will deliver all tangible forms or
media which he/she may have containing such information to the Bank. For
purposes of this Paragraph 6, "information" includes trade secrets and all
non-public records, practices, letters, plans, drawings, computer programs
and data, technical data, financial and other business data pertaining to the
Bank or any of its affiliates, customers, vendors or other persons associated
with the Bank. Officer acknowledges and further agrees that the disclosure of
such information would be a material breach of this Waiver and Release for
which the Bank shall be entitled to recover payments made under this Waiver
and Release in addition to other remedies in law and in equity.
7. This Waiver and Release does not constitute, and shall not be
admissable as evidence of, an admission by the Bank as to any fact or matter.
8. Officer hereby covenants and agrees that he/she will not now, or for
a period of one (1) year after the Effective Date, disrupt, damage, impair or
interfere with the business of the Bank, whether by way of interfering with
or soliciting its employees, or disrupting its
A-2
<PAGE>
relationships with customers, loan packagers, representatives, vendors,
brokers or otherwise. After termination of employment, Officer is not,
however, restricted from being employed by or engaged in a competing business.
9. (a) AGREEMENT TO ARBITRATE. It is the intention and agreement of
the Bank and Officer that no dispute, disagreement, claim or controversy
(collectively a "Controversy") arising in connection with this Waiver
and Release or the Agreement, Officer's employment or the termination of
that employment, be subject to civil litigation or other judicial
process (other than to compel compliance with this paragraph or to
enforce an award issued as a result of a proceeding hereunder).
Therefore, to the fullest extent allowed by law, any Controversy
arising out of or relating to this Waiver and Release or the Agreement,
the breach of this Waiver and Release or the Agreement, the facts and
circumstances preceding the execution of this Waiver and Release or the
Agreement, the interpretation of any provision of this Waiver and
Release or the Agreement, Officer's employment or the termination of
that employment, which cannot be resolved through agreement of the
Releasors and Releasees, shall be settled in accordance with the
procedures set forth in this paragraph 9. This shall include, but not be
limited to, any Controversy regarding wrongful termination, employment
discrimination, and harassment of any kind, and shall include statutory
claims arising under laws such as Title VII of the Civil Rights
Act, the Age Discrimination in Employment Act, and the California Fair
Employment and Housing Act.
(b) NOTICE OF INTENT TO ARBITRATE. Any Releasee or Releasor
("Claimant") desiring to invoke the procedures of this paragraph shall
give written notice to the other of Claimant's intent to institute the
procedures herein provided. Such notice of Controversy shall identify
each and every claim asserted by Claimant, the party involved in the
Controversy, and whether the Controversy is directed against the Bank.
The notice shall further state the nature of the relief sought.
(c) BINDING RESOLUTION. The parties agree to resolve the matter in
Controversy by final and binding arbitration according to the National
Rules for the Resolution of Employment Disputes ("Rules") of the
American Arbitration Association ("AAA").
(d) ENFORCEMENT OF DISPUTE/RESOLUTION. Any party may seek to compel
the other to comply with this arbitration provision by petition to any
court of general jurisdiction. In the case of a judgment on an
arbitrator's award, any party may seek to have the arbitrator's award
entered by any court having jurisdiction thereof.
(e) FEES AND COSTS. The parties agree that the fees and costs
incurred for the Arbitrator shall be assessed equally to Officer and the
Bank. Each party shall bear its own attorney's fees and costs in
connection with its own representation.
A-3
<PAGE>
(f) ALTERNATE MEDIATION/ARBITRATION SERVICE. In the event AAA is
not in business at the time this dispute resolution procedure is
initiated, the parties agree to select an alternative arbitration
service in the place of AAA. The Rules of Practice and Procedure to be
followed shall be those of the successor arbitration service. In the
event the parties are unable to agree on an alternative arbitration
service within thirty (30) days of the initiation of this dispute
resolution procedure, then either party may petition the Superior Court
of Orange County to appoint a retired judge to serve as arbitrator
pursuant to the AAA's Rules in effect at the time AAA ceased doing
business.
IN WITNESS WHEREOF, this GENERAL RELEASE AND CONFIDENTIALITY AGREEMENT
has been executed on the day and year hereinabove set forth.
"OFFICER"
Dated:
-------------------------------------------------------------
On [DATE] , before me personally appeared [OFFICER],
------------------------
personally known to me (or proved to me on the basis of satisfactory
evidence) to be the person who is named in the foregoing GENERAL RELEASE AND
CONFIDENTIALITY AGREEMENT and acknowledged to me that he executed the same,
and that by his signature [OFFICER] duly executed the GENERAL RELEASE AND
CONFIDENTIALITY AGREEMENT.
----------------------------
Notary Public
A-4
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 81,030
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 40,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 67,295
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0
11,659
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</TABLE>
