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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
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
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Page
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Part I
Item 1. Business. . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Part II
Item 6. Selected Financial Data . . . . . . . . . . . . . . . . . . . 38
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations. . . . . . . . . . . . . . . . . . 40
Item 7A. Quantitative and Qualitative Disclosure about Market Risk . . 47
Item 8. Financial Statements. . . . . . . . . . . . . . . . . . . . . 51
Part III
Item 12. Security Ownership of Certain Beneficial Owners
and Management . . . . . . . . . . . . . . . . . . . . . . . 52
Signatures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57
</TABLE>
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Intentionally Left Blank
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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
market. The Leasing Division generates equipment leases primarily through
wholesale sources,
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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 substantially all of its servicing rights, and since
September 1996, CSB has undertaken to sell all
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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 assets (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
---------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Available for Sale:
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)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Securities available-for-sale:
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
loans 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>
The following table indicates management's allocation of the allowance for
each of the following years:
<TABLE>
<CAPTION>
December 31,
-----------------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- ------- ------- -------
(Dollars In Thousands)
<S> <C> <C> <C> <C> <C>
Allocated amount:
Commercial, financial and agricultural $ 799 $ 980 $ 32 $330 $392
Real estate and construction 1,864 1,680 242 205 161
Consumer 602 461 51 89 77
Unallocated 6,130 2,035 314 197 193
------ ------ ---- ---- ----
Total $9,395 $5,156 $639 $821 $823
------ ------ ---- ---- ----
------ ------ ---- ---- ----
As a percent of allowance:
Commercial, financial and agricultural 8.5% 19.0% 5.0% 40.2% 47.6%
Real estate and construction 19.8 32.6 37.9 25.0 19.6
Consumer 6.4 8.9 8.0 10.8 9.4
Unallocated 65.3 39.5 49.1 24.0 23.4
------ ------ ---- ---- ----
Total 100.0% 100.0% 100.0% 100.0% 100.0%
------ ------ ---- ---- ----
------ ------ ---- ---- ----
</TABLE>
In allocating the Company's allowance for possible loan and lease losses,
management has considered the credit risk in the various loan categories in its
portfolio. As such, the allocations of the allowance for possible loan and
lease losses are based upon the average aggregate historical net loan losses
experienced in each of the subsidiary banks. While every effort has been made
to allocate the allowance to specific categories of loans, management believes
that any allocation of the allowance for possible loan and lease losses into
loan categories lends an appearance of exactness which does not exist, in that
the allowance for possible loan and lease losses is utilized a single
unallocated allowance available for losses on all types of loans and leases.
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>
17
<PAGE>
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.
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 all 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
18
<PAGE>
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.
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
19
<PAGE>
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.
20
<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
21
<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.
22
<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
23
<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.
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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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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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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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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):
Supervisory Subgroup
----------------------
A B C
-- -- --
MEETS NUMERICAL STANDARDS FOR:
Well capitalized . . . . . . . . . . . . 0(a) 3 17
Adequately capitalized . . . . . . . . . 3 0 24
Undercapitalized . . . . . . . . . . . . 10 24 27
- ----------------------
(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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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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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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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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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
35
<PAGE>
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.)
36
<PAGE>
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.
37
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
Below are the selected financial data for the Company for the past five
years. Due to the mergers and acquisitions during the recent years the
comparability from period to period of the historical information provided is
limited (See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - Overview" and "FINANCIAL STATEMENT - Note 2 -
Acquisitions and 1996 Reorganization.")
<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
38
<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.
39
<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%,
41
<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 interest-earning assets declined to 9.37% in 1997 from
9.74% in 1996 and the cost of average 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.")
42
<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 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.
43
<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
44
<PAGE>
allowance which was released in 1996, approximately $413,000 was utilized to
offset tax expense related to 1996 operating income, with the additional $1.5
million representing the aforementioned net benefit. The benefit in 1995 was
recognized as an offset to the tax expense of $443,000 relating to the
extraordinary gain from the extinguishment of debt in 1995; on a net basis
the Company recorded no tax expense or benefit in 1995.
CAPITAL RESOURCES
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.
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<PAGE>
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.
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.
46
<PAGE>
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss in a financial instrument arising from
adverse changes in market prices and rates, foreign currency exchange rates,
commodity prices and equity prices.. The Company's market risk arises
primarily from interest rate risk inherent in its lending and deposit taking
activities. To that end, management actively monitors and manages its
interest rate risk exposure. The Company does not have any market risk
sensitive instruments entered into for trading purposes. 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.
When appropriate, management may utilize off balance sheet instruments
such as interest rate floors, caps and swaps to hedge its interest rate
position. A Board of Directors approved hedging policy statement governs use
of these instruments. As of December 31, 1997, the Company had not utilized
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.
The table on the following page sets forth the distribution of repricing
opportunities of the Company's interest-earning assets and interest-bearing
liabilities, the interest rate sensitivity gap (i.e., interest rate
sensitive assets less interest rate sensitive liabilities), cumulative
interest-earning assets and interest-bearing liabilities, the cumulative
interest rate sensitivity gap, the ratio of cumulative interest-earning
assets to cumulative interest-bearing liabilities and the cumulative gap as a
percentage of total assets and total interest-earning assets as of December
31, 1997. The table also sets forth the time periods during which
interest-earning assets and interest-bearing liabilities will mature or may
reprice in accordance with their contractual terms. The interest rate
relationships between the repriceable assets and repriceable liabilities are
not necessarily constant and may be affected by many factors, including the
behavior of customers in response to changes in interest rates. This table
should, therefore, be used only as a guide as to the possible effect changes
in interest rates might have on the net margins of the Company.
47
<PAGE>
<TABLE>
<CAPTION>
December 31, 1997
-----------------------------------------------------------------------------------
Amounts Maturing Or Repricing In
-----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
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)
ASSETS
Cash and due from banks $ - $ - $ - $ - $ 81,030 $ 81,030
Federal funds sold 40,000 - - - - 40,000
Investment securities 11,993 11,844 8,982 34,438 38 67,295
Loans and leases 327,269 43,056 86,270 65,459 - 522,054
Loans held for sale 96,230 - - - - 96,230
Other assets (2) - - - - 95,746 95,746
-------- ------- ------- ------- -------- --------
Total assets $475,492 $54,900 $95,252 $99,897 $176,814 $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 74,607 95,194 11,988 - - 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 $371,264 $95,194 $11,988 $27,657 $396,252 $902,355
-------- ------- ------- ------- -------- --------
-------- ------- ------- ------- -------- --------
Period Gap $104,228 $(40,294) $83,264 $ 72,240 $(219,438)
Cumulative interest earning assets $475,492 $530,392 $625,644 $725,541
Cumulative interest bearing liabilities $371,264 $466,458 $478,446 $506,103
Cumulative Gap $104,228 $ 63,934 $147,198 $219,438
Cumulative interest earning assets
to cumulative interest bearing liabilities 1.28 1.14 1.31 1.43
Cumulative gap as a percent of :
Total assets 11.55% 7.09% 16.31% 24.32%
Interest earning assets 14.37% 8.81% 20.29% 30.24%
</TABLE>
- ------------------
(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.
48
<PAGE>
At December 31, 1997, the Company had $530.4 million in assets and
$466.5 million in liabilities repricing within one year. This means that
$63.9 million more in interest rate sensitive assets than interest rate
sensitive liabilities will change to the then current rate (changes occur due
to the instruments being at a variable rate or because the maturity of
the instrument requires its replacement at the then current rate). The
ratio of interest earning assets to interest bearing liabilities maturing or
repricing within one year at December 31, 1997 is 1.14 and management tries
to maintain this ratio as close to zero as possible while remaining in a
range between .80 and 1.20. Interest income is likely to be affected to a
greater extent than interest expense for any changes in interest rates
within one year from December 31, 1997. If rates were to fall during this
period, interest income would decline by a greater amount than interest
expense and net income would be reduced. Conversely, if rates were to rise,
the reverse would apply.
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. Based upon the Company's
interest rate shock simulations net interest income is expected to rise
approximately 5.6% with a 200 basis point instantaneous increase to interest
rates and decline approximately 3.8% with a 200 basis point instantaneous
decrease in rates. Management has a target of minimizing the decline in net
interest income to no more than 5.0% given a 200 basis point instantaneous
decrease in rates.
The preceding sensitivity analysis does not represent a forecast and
should not be relied upon as being indicative of expected operating results.
These hypothetical estimates are based upon numerous assumptions including:
the nature and timing of interest rate levels including the yield curve
shape, prepayments on loans and securities, changes in deposit levels,
pricing decisions on loans and deposits, reinvestment/replacement of asset
and liability cashflows and others. While assumptions are developed based
upon current economic and local market conditions, the Company cannot make
any assurances as to the predictive nature of these assumptions including how
customer preferences or competitor influences might change.
Also, as market conditions vary from those assumed in the sensitivity
analysis, actual results will also differ due to: prepayment/refinancing
levels likely deviating from those assumed, the varying impact of interest
rate change caps or floors on adjustable rate loans, depositor early
withdrawals and product preference changes, and other internal/external
variables. Furthermore, the sensitivity analysis does not reflect actions
that management might take in responding to or anticipating changes in
interest rates.
Management has taken several steps to reduce the positive gap of the
Company by lengthening the maturities in its investment portfolio and
originating more fixed rate assets that mature or reprice in balance with its
interest bearing liabilities. Management will continue to
49
<PAGE>
maintain a balance between its interest earning assets and interest bearing
liabilities in order to minimize the impact on net interest income due to
changes in market rates.
The following table sets forth the distribution of the expected
maturities of the Company's interest-earning assets and interest-bearing
liabilities as well as the fair value of these instruments. Expected
maturities are based on contractual payments without effect being given for
the estimated effect of prepayments. Savings accounts and interest-bearing
transaction accounts, which have no stated maturity, are included in the one
year or less maturity category (dollars in thousands).
<TABLE>
<CAPTION>
December 31, 1997
----------------------------------------------------------------------------------------------------
Expected Maturity
----------------------------------------------------------------------------------------------------
1998 1999 2000 2001 2002 Thereafter Total Fair Value
---- ---- ---- ---- ---- ---------- ----- ----------
<C> <S> <S> <S> <S> <S> <S> <S>
Federal funds sold $ 40,000 $ - $ - $ - $ - $ - $ 40,000 $ 40,000
Weighted average rate 5.50 - - - - - 5.50
Investment securities 23,837 1,985 3,980 2,517 500 34,438 67,257 67,257
Weighted average rate 6.10 5.72 6.12 6.50 8.14 7.03 6.60
Fixed rate loans 55,698 19,193 22,331 20,760 23,986 65,459 207,427 210,294
Weighted average rate 10.02 10.96 10.06 10.20 9.56 10.28 10.16
Variable rate loans 109,036 14,958 19,085 22,198 26,832 122,518 314,627 317,442
Weighted average rate 9.50 10.10 10.04 9.91 9.39 10.08 9.81
Loans held for sale 96,230 - - - - - 96,230 97,192
Weighted average rate 7.25 - - - - - 7.25
-------- ------- ------- ------- ------- -------- -------- --------
Total interest earning $324,801 $36,136 $45,396 $45,475 $51,318 $222,415 $725,541 $732,185
assets -------- ------- ------- ------- ------- -------- -------- --------
-------- ------- ------- ------- ------- -------- -------- --------
Interest bearing demand,
money market and savings $294,070 $ - $ - $ - $ - $ - $294,070 $291,129
Weighted average rate 3.59 - - - - 3.59
Time deposits 174,211 7,578 - - - - 181,789 181,946
Weighted average rate 5.67 5.59 - - - - 5.66
Subordinated debentures - - - - - 27,657 27,657 27,657
Weighted average rate - - - - - 11.75 11.75
Other borrowings 2,587 - - - - - 2,587 2,587
Weighted average rate 6.49 - - - - - 6.49
-------- ------- ------- ------- ------- -------- -------- --------
Total interest-bearing $470,868 $7,578 $ - $ - $ - $27,657 $506,103 $503,319
liabilities -------- ------- ------- ------- ------- -------- -------- --------
-------- ------- ------- ------- ------- -------- -------- --------
</TABLE>
50
<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 F6
Consolidated Statements of Cash Flows for the Years ended
December 31, 1997, 1996 and 1995 F7
Notes to Consolidated Financial Statements -
December 31, 1997, 1996 and 1995 F9
51
<PAGE>
PART III
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 . . . . . . . . . . . . 1,090,029 6.6% 1,090,029 5.9%
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.
52
<PAGE>
(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.
(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.
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.
53
<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.
<TABLE>
<CAPTION>
PERCENT
OF SHARES OF
NAME AND TITLE NUMBER OF SHARES VOTING
OF OFFICER AND/OR DIRECTOR BENEFICIALLY OWNED COMMON
-------------------------- ------------------ ------
<S> <C> <C>
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
</TABLE>
54
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
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
Officers as a Group (1)(2)(12) . . 8,311,217 50.4%
</TABLE>
______________________
*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.
55
<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.
56
<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: July 2, 1998
By Curt A. Christianssen /s/
- ---------------------------------------
Curt A. Christianssen
Senior Vice President
Chief Financial Officer
Date: July 2, 1998
57
<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.
PRICE WATERHOUSE LLP /s/
F-1
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CONDITION
DECEMBER 31, 1997 AND 1996
<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 AND 1996
<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 OPERATIONS
FOR 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 OPERATIONS (Continued)
FOR YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
<TABLE>
<CAPTION>
For the Years Ended December 31,
--------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Net income available to common shareholders $ 2,260,000 $ 2,325,000 $ (5,000)
Earnings per share (basic) $ 0.15 $ 0.44 $ (0.02)
Earnings per share (dilutive) $ 0.13 $ 0.44 $ (0.02)
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' 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
------------------------------------------
Additional Retained
Number of Common Paid-in Earnings
Shares Stock Capital (Deficit)
------ ----- ------- ---------
<S> <C> <C> <C> <C>
Balance at December 31, 1994 564,145 $ 2,951,000 $ - $(3,899,000)
Merger and reverse stock split
(1 for 21)(Note 2) (537,281) (2,951,000) 2,951,000 -
Stock dividend 26,864 1,000 156,000 (157,000)
Issuance of common stock 841,739 8,000 4,486,000 -
Net loss - - - (5,000)
----------------------------------------- -----------
Balance at December 31, 1995 895,467 9,000 7,593,000 (4,061,000)
Fractional share adjustment 34
Issuance of common stock - Liberty 3,432,105 34,000 13,373,000 -
Issuance of common stock - Commerce 5,369,824 54,000 21,428,000 -
Unrealized gain on securities available
for sale - - - -
Net income - - - 2,325,000
----------------------------------------- -----------
Balance at December 31, 1996 9,697,430 97,000 42,394,000 (1,736,000)
Issuance of preferred stock - Eldorado
Issuance of common stock - Eldorado 3,820,875 38,000 17,966,000 -
Restricted stock issuance 427,556 4,000 2,008,000 -
Compensation expense
Cancellation of shares (Note 12) (424,182) (4,000) (1,677,000) -
Unrealized gain on securities available
for sale - - - -
Net income - - - 2,990,000
Preferred dividends - - - (730,000)
----------------------------------------- -----------
Balance at December 31, 1997 13,521,679 $ 135,000 $60,691,000 $ 524,000
----------------------------------------- -----------
----------------------------------------- -----------
<CAPTION>
Unrealized
Gain on
Securities
Unearned Available
Compensation for Sale Total
------------ ---------- -----
<S> <C> <C> <C>
Balance at December 31, 1994 $ - $ - $ (948,000)
Merger and reverse stock split
(1 for 21)(Note 2) - - 0
Stock dividend - - 0
Issuance of common stock - - 4,494,000
Net loss - - (5,000)
----------- ----------- -----------
Balance at December 31, 1995 - 3,541,000
Fractional share adjustment -
Issuance of common stock - Liberty - - 13,407,000
Issuance of common stock - Commerce - - 21,482,000
Unrealized gain on securities available
for sale - 17,000 17,000
Net income - - 2,325,000
----------- ----------- -----------
Balance at December 31, 1996 17,000 40,772,000
Issuance of preferred stock - Eldorado 11,659,000
Issuance of common stock - Eldorado - - 41,216,000
Restricted stock issuance (2,012,000) - 0
Compensation expense 503,000 - 503,000
Cancellation of shares (Note 12) - - (1,681,000)
Unrealized gain on securities available
for sale - 7,000 7,000
Net income - - 2,990,000
Preferred dividends - - (730,000)
----------- ----------- -----------
Balance at December 31, 1997 ($1,509,000) $ 24,000 $94,736,000
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
See notes to consolidated financial statement
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>
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 3,963,000 (6,700,000) 469,000
------------- ------------- --------------
Net cash used in operating activities (11,578,000) (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-7
<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-8
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996, AND 1995
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.
F-9
<PAGE>
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.
F-10
<PAGE>
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
F-11
<PAGE>
NOTE 1: (Continued)
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 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
F-12
<PAGE>
NOTE 1: (Continued)
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.
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.
F-13
<PAGE>
NOTE 1: (Continued)
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.
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
F-14
<PAGE>
NOTE 1: (Continued)
of related income, and gains and losses on their disposition are included in
other non-interest expenses.
INTANGIBLES ARISING FROM ACQUISITIONS
The Company has paid amounts in excess of fair value for CSB's, 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. The recoverability of intangibles arising from acquisitions is
evaluated if events or circumstances indicate a possible inability to realize
the carrying amount. Such evaluation is based upon various analyses, including
undiscounted cash flow projections.
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
F-15
<PAGE>
NOTE 1: (Continued)
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." 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>
F-16
<PAGE>
NOTE 1: (Continued)
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform with the 1997
presentation.
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.
F-17
<PAGE>
NOTE 2: (Continued)
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 not previously been exercised (collectively, the "Eldorado
Options") was canceled in return for 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.
F-18
<PAGE>
NOTE 2: (Continued)
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 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.
F-19
<PAGE>
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
-------------- -------------- -------------- -------------
-------------- -------------- -------------- -------------
<CAPTION>
December 31, 1997
------------------------------------------------------------------
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>
F-20
<PAGE>
NOTE 4: (Continued)
<TABLE>
<CAPTION>
December 31, 1997
------------------------------------------------------------------
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 that had an amortized cost of $15,495,000 and an
unrealized gain of $10,000 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.
F-21
<PAGE>
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>
Years ended December 31,
-------------------------------
1997 1996
------------- --------------
<S> <C> <C>
Furniture minimum lease payments $ 46,797,000 $ 53,508,000
Residuals 796,000 511,000
Initial direct cots 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>
F-22
<PAGE>
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.
F-23
<PAGE>
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 recognized 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, prior to 1997, the Bank sold,
subject to recourse, VA No-Bid loans it originated. 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.
F-24
<PAGE>
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.
F-25
<PAGE>
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.
F-26
<PAGE>
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.
F-27
<PAGE>
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>
F-28
<PAGE>
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.
F-29
<PAGE>
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 - STOCKHOLDERS' 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.
F-30
<PAGE>
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 ACQUISITION
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
F-31
<PAGE>
4,248,431 additional shares of Class B Common Stock to various accredited
investors for consideration of $20,016,000.
NOTE 12: (Continued)
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 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 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
F-32
<PAGE>
Warrants. The Investor Warrants expire on June 6, 2007. The aggregate purchase
price of the Investor Warrants was $40,000.
NOTE 12: (Continued)
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 employment agreements with two executive officers that provide
for a defined benefit pension plan. Under the terms of the employment
agreements, a fixed monthly benefit is payable in 180 equal installments upon
reaching age 65. These employment agreements were acquired in conjunction with
the Eldorado acquisition and the Company had no such plans prior to 1997, the
defined benefit pension plan includes the following pension costs for the year
ended December 31, 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
F-33
<PAGE>
--------------
$ 133,157
--------------
--------------
</TABLE>
F-34
<PAGE>
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. The benefit
obligation is expected to be paid using Company assets upon the executive
officers reaching age 65.
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 held options to purchase 728,600 and 50,000 shares of Class B
Common Stock, respectively. The
F-35
<PAGE>
NOTE 13: (Continued)
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, 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 of 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 options 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
F-36
<PAGE>
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.
F-37
<PAGE>
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.
F-38
<PAGE>
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
F-39
<PAGE>
NOTE 15: (Continued)
specified price. Risks arise from the possible inability of counterparties
to meet the terms of their contracts and from movements in securities' values
and interest rates. The Bank tries to minimize these risks by dealing with
only primary brokers and maintaining correlation with the asset or commitment
being hedged. The Bank monitors its exposure through the use of valuation
models provided by a financial advisory service. The unrealized losses on
open forward contracts to sell mortgage-backed securities were $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.
F-40
<PAGE>
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 $751,799,000 $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
F-41
<PAGE>
NOTE 16: (Continued)
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 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
F-42
<PAGE>
NOTE 16: (Continued)
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.
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
F-43
<PAGE>
NOTE 17: (Continued)
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 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.
F-44
<PAGE>
NOTE 17: (Continued)
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 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
F-45
<PAGE>
NOTE 17: (Continued)
"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.
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>
F-46
<PAGE>
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>
F-47
<PAGE>
NOTE 18: (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>
F-48
