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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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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
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ELDORADO BANCSHARES, INC.
(Exact name of small business issuer in its charter)
DELAWARE 33-0720548
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization No.)
24012 CALLE DE LA PLATA, SUITE 150, 92653
LAGUNA HILLS, CA (Zip Code)
(Address of principal executive offices)
Issuer's telephone number, including area code: (949) 699-4344
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Securities registered pursuant to Section 12(b) of the Exchange Act:
None
Securities registered pursuant to Section 12(g) of the Exchange Act:
None
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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 9,173,698 shares of Common Stock outstanding at March 14, 1998
(restated to reflect the one-for-two reverse split effective September 4, 1998).
The aggregate market value of Common Stock held by non-affiliates at March 14,
1998 was approximately $4,224,000 based upon the last known trade of $12.00 per
share on October 23, 1997.
Documents incorporated by reference: None
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TABLE OF CONTENTS
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PART I
Item 1. Business...................................................................................... 3
Item 2. Properties.................................................................................... 35
Item 3. Legal Proceedings............................................................................. 36
Item 4. Submission of Matters to a Vote of Security Holders........................................... 37
PART II
Item 5. Market for Issuer's Common Stock and Related Stockholders Matters............................. 38
Item 6. Selected Financial Data....................................................................... 40
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations......... 42
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.................................... 58
Item 8. Financial Statements.......................................................................... 62
Item 9. Disagreements on Accounting and Financial Disclosure.......................................... 62
PART III
Item 10. Directors and Executive Officers of the Registrant............................................ 63
Item 11. Executive Compensation........................................................................ 66
Item 12. Security Ownership of Certain Beneficial Owners and Management................................ 73
Item 13. Certain Transactions and Related Transactions................................................. 77
Signatures................................................................................................. 81
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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
GENERAL
Through its sole operating subsidiary, Eldorado Bank (the "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 located primarily in the Orange County, San Diego County and Sacramento
areas of California. The Bank also operates nine loan production offices, five
of which are located in California and four of which are located in contiguous
states. See "--Market." The Company's products include commercial, consumer and
real estate loans, a broad range of deposit products and other non-deposit
banking services. In addition, the Company augments its traditional banking
products and services with specialized products including Small Business
Administration ("SBA") loans, residential mortgage loans originated through nine
loan production offices and a regional network of wholesale brokers for resale
into the secondary market, and equipment leases to small and medium-sized
businesses that are originated through a national network. The Company's only
significant asset is the stock of 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").
It also is a member of the Federal Reserve System. The Bank's deposits are
insured up to applicable limits by the FDIC. See "Supervision and Regulation."
STRATEGIC PLAN
The key elements of the Company's strategic plan have been and continue to
be the establishment and enhancement of an attractive commercial banking
franchise through the acquisition of community banks primarily, but not
exclusively, in and around its Southern California base, improving core
profitability and maintaining a strong balance sheet. Since 1995, the Company
has acquired three community banks with total assets of approximately $779
million.
BUILDING AND ENHANCING AN ATTRACTIVE COMMUNITY BANK FRANCHISE. The
Company is continually engaged in the identification and evaluation of
potential acquisitions of community banks in California. The Company focuses
primarily on community banks that have underperformed relative to their peer
group but have strong lending franchises, niche business lines or low cost
deposits that would complement the Company's existing operations and branch
network and also provide opportunities
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for cost savings through branch overlap and back-office consolidation. In
particular, the Company seeks to acquire and develop both traditional and
non-traditional community banking businesses that provide opportunities for
multiple relationships with small and medium-sized business customers. As an
integral part of this strategy, the Company emphasizes building a solid
management team through a combination of senior officers retained from
acquired banks and experienced specialists hired to enhance the Company's
competency in various areas, such as mortgage banking and equipment leasing.
IMPROVING CORE PROFITABILITY. The Company's strategy to increase
profitability is premised primarily on (i) increasing the sources and volume
of fee income, including fees derived from originating and servicing SBA
loans, selling and servicing equipment leases, and originating and selling
residential mortgage loans, (ii) maintaining and diversifying its base of
relatively low cost funds, (iii) utilizing its asset generation capability
to increase the volume of commercial loans and leases that it retains in its
portfolio, particularly SBA loans, equipment leases and commercial loans to
its small business customers, and (iv) actively seeking to improve operating
efficiencies.
MAINTAINING A STRONG BALANCE SHEET. The Company seeks to maintain a
strong balance sheet by managing the risk of credit-related losses and by
striving to maintain a capital base sufficient to support its strategic
plan. The Company seeks to improve the asset quality of the banks it
acquires by implementing underwriting standards in such banks' loan and
lease origination programs that place greater emphasis on cash flow than
collateral coverage as the primary source of repayment on its loans. See
"--Underwriting and Credit Administration," below. To maintain a capital
base sufficient to support the Company's existing businesses and to permit
it to continue to expand through acquisitions, the Company's plan is to
continue to meet the "well capitalized" regulatory standards. At December
31, 1997 the Company was well capitalized for regulatory purposes, with Tier
1 and Total Risk-Weighted Ratios (as defined herein) of 8.9% and 10.2% and a
Tier 1 Leverage Ratio (as defined herein) of 6.6%. See "Supervision and
Regulation--Capital Adequacy Requirements."
The Company routinely reviews suitable strategic acquisition opportunities,
which if consummated, may constitute a material acquisition for the Company.
Although discussions at various stages with respect to such transactions are
ongoing, the Company believes that, as of the date of this Annual Report, it is
not probable that the Company will enter into an agreement with respect to any
such transaction.
The Company's three acquisitions were primarily funded with cash. Although
the Company expects to continue to consider cash acquisitions, the Company
believes that the boards of directors and shareholders of many prospective
acquisition candidates prefer stock acquisitions, because the shareholders who
receive stock are allowed to retain an equity interest in the combined company
and to defer recognition of federal income tax. There can be no assurance,
however, that an active trading market for the Common Stock will develop or,
even if such a market does develop, that the Company will be able or determine
that it is in its best interests to acquire businesses in stock-for-stock
transactions.
PRIOR ACQUISITIONS
Prior to September 1995, the Company's predecessor, SDN Bancorp, Inc.
("SDN"), owned a single bank--San Dieguito National Bank ("San Dieguito")--with
approximately $56 million in assets. San Dieguito was then categorized as
"critically undercapitalized" by federal regulators. In September 1995, SDN and
San Dieguito were recapitalized by Dartmouth Capital Group, L.P. ("DCG"), a bank
holding company organized by Mr. Keller. Following that recapitalization, Mr.
Keller assumed control of the Company, installed new management and began
implementing policies to improve asset quality and operating performance.
Since September 1995, the Company has completed three acquisitions in
California with combined assets of approximately $779 million. The following
table summarizes certain data regarding those
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acquisitions, including the asset size of the acquired bank as of the end of the
quarter immediately preceding the acquisition:
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DATE OF PRINCIPAL COUNTY
ACQUIRED BANK/PENDING ACQUISITION ACQUISITION OF ACQUIRED BANK
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BANK(1)
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(IN MILLIONS)
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Liberty National Bank................................. March 31, 1996 Orange $ 146
Commerce Security Bank................................ September 1, 1996 Sacramento 229
Eldorado Bank......................................... June 6, 1997 Orange 404
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(1) At date of acquisition
Each acquisition was accounted for using the purchase method of accounting
for business combinations, and therefore, the operating results of those banks
are reflected in the Company's financial statements only from the date of
acquisition. Consequently, the Company's historical operating results prior to
June 1997 are of limited relevance in evaluating the Company's historical
financial performance or predicting its future operating results.
Within the relatively recent past, Commerce Security Bank ("CSB"), Liberty
National Bank ("Liberty") and San Dieguito were adversely affected by a variety
of factors, including high levels of nonperforming assets, reliance on high-cost
brokered deposits and excessive overhead costs. The high levels of nonperforming
assets and related overhead costs were partly attributable to adverse economic
conditions, including declining real estate values, that California experienced
during the early to mid-1990s. Liberty incurred net losses of $1.3 million and
$1.5 million in 1994 and 1993, respectively; San Dieguito incurred net losses of
$1.1 million, $1.0 million and $2.0 million in 1995, 1994 and 1993,
respectively; and CSB incurred net losses of $431,000 and $371,000 for the three
months ended December 31, 1996 and March 31, 1997, respectively. As a
consequence of their poor financial performance, each of Liberty, San Dieguito
and CSB was required to enter into a memorandum of understanding with its
supervising regulators. Those memoranda of understanding were subsequently
terminated contemporaneously with or, in Liberty's case, prior to Mr. Keller's
assumption of managerial control.
Following each acquisition, the Company implemented various elements of its
strategic plan described above. See "--Strategic Plan." As a result of those
efforts, together with a favorable economic climate in California, the Company's
efficiency ratio decreased from 90.3% for the three months ended December 31,
1996 to 70.8% for the three months ended December 31, 1997. Additionally, the
Company was able to reduce its reliance on high-cost brokered deposits by
utilizing excess liquidity at Eldorado Bank to fund loans and leases generated
by its other subsidiary banks. Partly as a consequence of that strategy, the
average cost of the Company's deposit liabilities decreased from 3.4% for the
three months ended March 31, 1997 to 3.3% for the three months ended September
30, 1997.
Effective June 30, 1997, the Company consolidated into Eldorado Bank the
respective operations of CSB, Liberty and San Dieguito (as so consolidated, the
"Bank"), although the Bank continues to operate under the name "Commerce
Security Bank" in the Sacramento area because of another bank's competing claim
to the tradename "Eldorado Bank." See "--Market."
MARKET
The Company operates primarily in Orange County in Southern California and
the Sacramento area in Northern California. The Company's executive office is
located in Laguna Hills, a residential community in southern Orange County,
approximately 50 miles south of Los Angeles. The Company currently operates a
total of 16 full-service banking offices in Southern California, covering a
geographic market ranging from the north coastal area of San Diego County in the
south, to Long Beach in Los Angeles County in the north, and to San Bernardino
and Riverside Counties in the east. The counties of Orange, Los Angeles, San
Bernardino and Riverside are located in the Los Angeles-Riverside-Orange County
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Metropolitan Statistical Area ("MSA"), which is the second most populous MSA in
the United States, with a population of 15.5 million in 1996, according to an
estimate published by the U.S. Bureau of the Census.
In Northern California, the Company operates one full-service banking
office, located in Sacramento, and four mortgage loan production offices located
in Fairfield, Sacramento, Stockton and Walnut Creek. Sacramento, the capital of
California, is located in the Sacramento MSA, which had a population of 1.5
million in 1996, according to an estimate published by the U.S. Bureau of the
Census. The Bank also operates one SBA loan production office in Orinda,
California, which is located east of San Francisco.
The Bank currently has residential mortgage loan production offices in San
Diego, California; Bellevue, Washington; Las Vegas, Nevada; Phoenix, Arizona and
Portland, Oregon and expects to open an office in Denver, Colorado during the
quarter ending September 30, 1998.
PRODUCTS AND SERVICES
The Company markets its products and services through three divisions:
- COMMUNITY BANKING DIVISION--focusing primarily on small and medium-sized
businesses located in the Company's California markets. Products include
commercial, consumer and real estate loans (with a particular emphasis on
the origination and servicing of SBA loans), and a broad range of deposit
products and other non-deposit banking services.
- MORTGAGE BANKING DIVISION--originating residential mortgage loans in
California, Arizona, Nevada and Oregon through nine loan production
offices and a network of wholesale brokers for sale in the secondary
market.
- EQUIPMENT LEASING DIVISION--generating equipment leases primarily through
wholesale sources located throughout the United States, servicing those
leases and from time to time selling blocks of leases to other
institutions.
The Company's marketing strategy is to maximize cross-selling opportunities by
emphasizing the complementary nature of its products and services, particularly
for the small to medium-sized business, which the Company defines as a business
with annual revenue up to $50 million. The Company is also seeking to exploit
synergies among its divisions by establishing lease and mortgage loan offices in
several of the locations now used exclusively as branches or loan production
offices. In addition, the Company plans to house SBA loan production officers in
several of its established mortgage origination offices. Each of the Company's
divisions is described in more detail below.
COMMUNITY BANKING DIVISION. The Community Banking Division provides a broad
range of banking products and services to small and medium-sized businesses and
retail customers, including commercial, real estate and consumer loans, checking
and savings products and non-depository services.
At December 31, 1997, approximately 80% of the Company's loans and leases
held for investment were loans to businesses. For regulatory and financial
reporting purposes, the Company categorizes commercial loans that are secured in
whole or part by real estate as commercial real estate loans. Consequently, at
December 31, 1997, commercial real estate loans constituted 45% of the Company's
loans and leases held for investment. The Company believes such categorization
overstates the Company's emphasis on real estate lending, because, for example,
all SBA loans are secured by real estate and thus categorized as commercial real
estate loans.
The origination and servicing of SBA loans are important elements of the
Community Banking Division's business. The Company originates two types of loans
under SBA programs. The majority of SBA loans that the Company originates are
guaranteed by the United States Government to the extent of 75% to 90% of the
principal and interest due on such loans ("SBA 7(a)" loans). The Company also
originates SBA loans in which the Company takes a first trust deed (a senior
security position which is generally sold by the Company) and another unrelated
entity assumes a second trust deed (a subordinated security
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position) that is guaranteed by the SBA (the "SBA 504" loans). Generally, the
Company sells the government guaranteed portion of the SBA 7(a) loans to
participants in the secondary market and retains servicing responsibilities and
the unguaranteed portion of the loans. The government guaranteed portion of the
SBA 7(a) loans are sold at a premium, a portion of which is immediately
recognized as income. The balance of the premium, representing estimated
servicing fees is treated as a yield adjustment on the portion of the SBA 7(a)
loan retained by the Company, and is capitalized and recognized as income over
the estimated life of the loan. The Company had a total of $105.7 million of SBA
loans in its portfolio at December 31, 1997, comprised of $89.9 million of the
unguaranteed portions of the SBA 7(a) loans being serviced by the Company and
$15.8 million of SBA 504 loans. The total SBA 7(a) loan portfolio serviced by
the Company at December 31, 1997 was $302.6 million, all of which had been
originated by the Company.
Both Eldorado Bank and Liberty had substantial experience originating SBA
loans prior to the Company's acquisition of those banks. Since 1994, the Bank
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. The Company believes that its status as a Preferred Lender
gives it a competitive advantage relative to other non-Preferred SBA originators
by allowing the Company to process such loans on an expedited basis. The Company
believes that all of the leading SBA originators in the Company's principal
market are Preferred Lenders.
Historically, the Company has made SBA loans primarily to businesses located
in California through origination from its Southern California branches as well
as from the Company's SBA loan production office located in Orinda, California.
Subject to receipt of SBA approval, which the Company expects will be received,
the Company intends to expand its SBA market area during the next 12 months by
hiring SBA loan originators based in or near Phoenix, Arizona; Portland, Oregon
and Bellevue, Washington. The Company intends to place those originators in the
Company's existing loan production facilities for the Mortgage Banking Division
located in those areas.
With respects to deposit products and related services, the Company believes
the Community Banking Division has a competitive advantage as a result of
certain deposit accounting services that were developed at CSB specifically for
title and escrow companies. As a result of those services, which include
specialized sub-accounting, reconciliation and reporting features, a significant
percentage of the Company's deposit liabilities are obtained from title and
escrow companies (collectively, "Title and Escrow Deposits"). Actual balances of
Title and Escrow Deposits tend to vary widely during a month, with the highest
balances usually occurring at the end of the month when residential real estate
closings are generally scheduled to occur. Title and Escrow Deposits are also
subject to seasonal fluctuations, tending to decrease during those seasons when
the volume of residential real estate transactions is lower.
The Company considers Title and Escrow Deposits to be volatile because of
the fluctuation in deposit amounts and the concentration of control over those
deposits with a limited number of customers. The Company believes, however, that
its relationships with its principal Title and Escrow Deposit customers and its
specialized deposit services partially mitigate the risk that such customers may
terminate or significantly reduce their deposits with the Company. As a
consequence of that potential volatility, the Company utilizes Title and Escrow
Deposits solely to fund short-term assets, primarily consisting of residential
mortgages held for sale, which are generally sold within 30 days after such
mortgage loans are funded. If a substantial portion of the Title and Escrow
Deposits were withdrawn suddenly, the Company believes that it has sufficient
alternative sources of liquidity to fund its mortgage pipeline during a
transition period. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity."
The Company's expertise in servicing Title and Escrow Deposits has also
enabled it to attract deposits from homeowners' associations, property managers
and similar customers. The services provided to those customers include (i)
lockbox deposit arrangements, (ii) sub-account reconciliation and reporting,
(iii) electronic payment and remittance processing through the Automated
Clearing House or ACH
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Network, and (iv) electronic balance reporting. Those specialized payment
handling systems also complement the Company's other traditional cash management
products.
Historically, the relationships with Title and Escrow Deposit customers, as
well as the relationships with other deposit customers utilizing the Company's
sub-accounting systems, have been managed by the Company's Sacramento branch.
The Company is actively seeking, however, to cross-sell those services to
customers of its Southern California branches.
MORTGAGE BANKING DIVISION. The Company entered the mortgage banking
business upon the acquisition of CSB in September 1996. CSB had been engaged in
the mortgage business since 1988. The Company originates and sells first and
second lien mortgage loans secured by single family residences. As a matter of
normal practice, the Company sells to the secondary market all of the loans that
it originates. The Mortgage Banking Division's operating results can be and have
been affected materially by changes in interest rates, new home construction and
existing home sales. See "Risk Factors--Potential Impact of Changes in Interest
Rates."
The Company originates loans through two primary sources: (i) the wholesale
market, which represents loans generated through a network of mortgage brokers
approved by the Company, and (ii) the retail market, which represents loans
generated by eight loan production offices staffed with commission-based loan
officers who solicit loans directly from real estate brokers, home builders and
on personal referral. All loans originated from those two sources are
underwritten and closed by the Company.
The Company originates primarily fixed-rate mortgage loan products under a
variety of programs including (i) conventional fixed-rate mortgage loans under
programs offered by the Federal Home Loan Mortgage Corporation ("Freddie Mac")
or the Federal National Mortgage Association ("Fannie Mae"), (ii) so-called
"nonconforming" mortgage loans that do not meet Freddie Mac or Fannie Mae
criteria, including "jumbo loans" that exceed the maximum principal amount under
those programs, which the Company underwrites to satisfy the individual
guidelines of the private investors to which those loans are sold in the
ordinary course, and (iii) mortgage loans insured by the Federal Housing
Administration ("FHA loans") and mortgage loans guaranteed by the Veterans
Administration ("VA loans"). FHA loans and VA loans are underwritten to enable
them to be pooled as loans offered by the Government National Mortgage
Association ("Ginnie Mae loans").
The Company has historically sold conforming Freddie Mac and Fannie Mae
loans under private sale agreements to conduits such as Countrywide Home Loans.
FHA and VA mortgage loans that the Company originates either are sold
individually to private conduits or are bundled and sold as Ginnie Mae pools to
private investors.
The Company also sells the right to service such mortgage loans, which
includes the collection and remittance of principal and interest payments. Such
servicing rights either are sold to the purchaser of the loan or, in the case of
Ginnie Mae loans, are aggregated and sold in bulk at least quarterly, which the
Company believes increases the value of those servicing rights. The purchasers
of mortgage loans or servicing rights do not have recourse against the Company
for the payment defaults of the borrowers, except for (i) customary recourse if
the borrower fails to make the first payment due under the loan and (ii)
recourse obligations that were incurred in connection with CSB's bulk sales of
servicing for VA loans that was effected prior to the Company's acquisition of
CSB. Such recourse exposure for VA loans will expire in November 1998. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
The Company relies on various short-term funding sources--including Title
and Escrow Deposits and lines of credit with various financial institutions--to
provide liquidity to its Mortgage Banking Division between the time when the
Division originates a mortgage loan and the time when such loan is sold in the
secondary market.
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"Forward commitments" and "put options" on mortgage-backed securities are
used to reduce interest rate risk (i.e., hedging) on a portion of loans held for
sale and on certain loans anticipated to fund. Forward commitments to sell and
put options on mortgage-backed securities that hedge anticipated loan funding
are off-balance sheet items and not reflected in the Company's Consolidated
Statement of Financial Condition. The aggregate outstanding "forward
commitments" and "put options" were $26 million and $10 million at December 31,
1997, respectively.
Although the Mortgage Banking Division historically provided a substantial
amount of CSB's earnings, the Division generated losses during each month of
1996 and during nine out of 12 months of 1997. Since the Company acquired CSB in
September 1996, the Company has undertaken a variety of measures to improve the
Division's operating results, including the renegotiation of the terms under
which the Company sells loans to the secondary market, the packaging of Ginnie
Mae pools, the elimination of certain recourse liability in connection with the
sale of VA loan servicing rights, and the achievement of various operational
efficiencies. In addition, the Company has made several managerial changes at
the Mortgage Banking Division, the most significant of which was the February
1998 hiring of William D. Rast to serve as its Executive Vice President and head
of the Division. Mr. Rast has approximately 21 years of experience in mortgage
banking, including four years as President and Chief Operating Officer of
Hamilton Financial Services Corp., a financial services company that focused
primarily on mortgage lending, and 10 years with First California Mortgage,
where his last position was Senior Vice President responsible for retail and
wholesale production.
The Company believes that those initiatives have substantially improved the
Mortgage Banking Division's performance. The Company has also used the increase
in mortgage origination volume to manage its level of earning assets by
increasing from time to time the duration that it will hold mortgage loans prior
to selling such loans into the secondary market. Although the Company believes
that it has hedged such mortgage loans to substantially mitigate the interest
rate risk associated with the longer holding period, some interest rate risk may
remain.
During the next 12 months, the Mortgage Banking Division intends to continue
to increase its origination volume by, among other things, (i) further refining
its network of wholesale brokers, (ii) more actively cross-selling its products
to the Company's retail customers, and (iii) extending its range of products to
include loans to relatively high quality subprime borrowers (which loans are
sometimes referred to as "B" grade credits). The Company expects that the
Mortgage Banking Division's cross-selling efforts will focus primarily on
developing relationships with internal and external referral sources in the
Company's Southern California market. Among other things, the Mortgage Banking
Division intends to place mortgage loan officers in the Company's branches
located in Carlsbad (San Diego County), Huntington Beach (Orange County) and San
Bernardino (San Bernardino County).
EQUIPMENT LEASING DIVISION. The Company entered the leasing business upon
the acquisition of CSB in September 1996. CSB had been engaged in leasing since
1990, focusing primarily on acquiring leases of equipment to small businesses
with an average lease size of less than $50,000. Currently, the production of
new leases is derived primarily from the wholesale sector through a network of
brokers located throughout the United States, although a majority of the
Division's leases are made to borrowers located in the mid-western and western
states. The Company makes no consumer leases and leases automobiles and other
vehicles only to businesses. The Company seeks to limit the residual risk with
respect to the collateral it leases by purchasing leases that permit the lessee
to acquire the equipment for a nominal purchase price at the end of the lease
term or by stipulating that the originating broker will retain the residual
risk. Historically, the Company has generally retained for investment the
majority of leases that it purchases, although in 1997, the Company sold $24.8
million of leases to other banks while retaining the right to service those
leases.
Following the 1997 departure of the former CSB employee who was then
responsible for the Equipment Leasing Division, the Company made a strategic
decision to increase the resources devoted to
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the Division. Since August 1997, the Company has implemented several initiatives
designed to improve the Equipment Leasing Division's operations. Among other
things, the Company has centralized the underwriting decisions for leases,
thereby eliminating the salesperson's involvement in the underwriting decision.
The Company believes that those initiatives have substantially improved the
Equipment Leasing Division's performance. During the next 12 months, the
Equipment Leasing Division intends to continue to increase its origination
volume by focusing on improving the overall quality of the Company's network of
wholesale brokers and by expanding the number of full-time representatives. To
avoid an excess concentration of leases as a percentage of interest-earning
assets, the Company intends to sell all or substantially all of the incremental
lease volume to nonbank financial institutions while retaining the right to
service those leases.
UNDERWRITING AND CREDIT ADMINISTRATION
UNDERWRITING. Although the Bank accepts applications for various types of
commercial and consumer loans at all of its branches, all loans are subject to
centralized underwriting and processing, with the exception of commercial loans
less than $50,000 and residential mortgage loans which may also be approved at
one of two loan production offices in Northern California.
The Company generally does not make individual loans larger than $8.0
million, although the applicable legal lending limit is substantially higher
(for secured loans, 25% of the Bank's equity plus its allowance for loan and
lease losses, or $20.6 million at December 31, 1997). Senior loan officers at
the Community Banking Division may approve loans up to $250,000 for non-SBA
loans and up to $1.0 million for SBA loans, and the Bank's senior credit officer
has the authority to approve loans up to $1.0 million. Loans in excess of $1.0
million but less than $2.0 million must be approved by the Bank's senior credit
officer and the Bank's President, and loans in excess of $2.0 million but less
than $4.0 million must also be approved by an Officer Loan Committee, of which
the senior credit officer and the Bank's President are members. Loans in excess
of $4.0 million but less than $8.0 million must also be approved by the Loan
Committee of the Bank's Board of Directors, and loans in excess of $8.0 million
must also be approved by the Board of Directors of the Bank.
The Company's commercial loans are generally underwritten in the Company's
primary market area on the basis of the borrower's ability to service such debt
from income. As a general practice, the Company takes as collateral a lien on
any available real estate, equipment or other assets and obtains a personal
guaranty. Working capital loans are primarily collateralized by short-term
assets and term loans are primarily collateralized by long-term assets.
In addition to commercial loans secured by real estate, the Company makes
commercial mortgage loans to finance the purchase of owner-occupied real
property, which generally consists of real estate on which structures have
already been completed. The Company's commercial mortgage loans are secured by
first liens on real estate, typically have variable interest rates and amortize
over a 20-year period with balloon payments due at the end of ten years. In
underwriting commercial mortgage loans, consideration is given to the property's
operating history, future operating projections, current and projected
occupancy, location and physical condition. The underwriting analysis also
includes credit checks, appraisals and a review of the financial condition of
the borrower.
The Company makes loans to finance the construction of residential
properties, the majority of which are owner-occupied and, to a limited extent,
owner-occupied nonresidential properties. Construction loans generally are
secured by first liens on real estate. The Company conducts periodic
inspections, either directly or through an agent, prior to approval of periodic
draws on these loans. Underwriting guidelines similar to those described above
are also used in the Company's construction lending activities.
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Consumer loans made by the Company include home improvement loans,
automobile loans, recreational vehicle loans, boat loans, personal loans
(collateralized and uncollateralized) and deposit account collateralized loans.
The terms of these loans typically range from 12 to 84 months and vary based
upon the nature of collateral and size of loan.
Two of the Company's equipment lease underwriters have individual authority
to approve leases up to $75,000 and authority to approve jointly leases up to
$150,000. Leases in excess of $150,000 must also be approved by the Company's
senior credit officer. The Company generally does not make leases in excess of
$150,000. Since the Company's acquisition of CSB, the Company has not made a
lease in excess of $500,000.
The head of the Mortgage Banking Division has authority to approve
residential loans of up to $1.0 million. Residential loans in excess of $1.0
million are subject to the same approval criteria required with respect to
commercial loans.
CREDIT ADMINISTRATION AND NONPERFORMING ASSETS. The Company has several
procedures in place to assist it in maintaining the overall quality of its loan
and lease portfolio, as described below. There can be no assurance, however,
that the Company's loan and lease portfolio will not become subject to
increasing pressures from deteriorating borrower credit due to general economic
conditions.
With the exception of the Equipment Leasing Division, which administers and
collects the leases that it services, the Company has a centralized Credit
Administration Department. The Department is responsible for supervising the
Company's loan review function and its Special Asset Group, which focuses
exclusively on the collection or other resolution of nonaccrual loans and OREO.
The Company's loan review function evaluates additional loans which are
potential problem loans as to risk exposure in determining the adequacy of the
allowance for loan losses. The Company obtains updated appraisals from time to
time on loans secured by real estate, particularly those categorized as
nonperforming loans and potential problem loans. In instances where updated
appraisals reflect reduced collateral values, an evaluation of the borrower's
overall financial condition is made to determine the need, if any, for possible
writedowns or appropriate additions to the allowance for loan losses.
The Company generally places a loan on nonaccrual status and ceases accruing
interest when loan payment performance is deemed unsatisfactory. All loans past
due 90 days, however, are placed on nonaccrual status, unless the loan is both
well-secured and in the process of collection or renewal. Cash payments received
while a loan is classified as nonaccrual are recorded as a reduction of
principal as long as doubt exists as to collection.
The Company is sometimes required to revise a loan's interest rate or
repayment terms in a troubled debt restructuring. A loan is considered a
restructured loan if, as a result of the borrower's financial condition, the
Company has elected to modify it by accepting below market terms either by
granting an interest rate concession or deferring principal or interest payments
or both. In order for a restructured loan to be eligible to be reclassified as a
fully performing loan, the following must be satisfied: (i) the borrower must
generally have been current in meeting the restructured terms for at least six
consecutive months, and (ii) the restructured loan must have an interest rate
and other features that are at least equivalent to market terms. Inevitably, not
all restructured loans will be viable as restructured, and it may be necessary
for the Company to make further concessions or to transfer the loan to
nonaccrual status or OREO. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations." The Company records OREO at fair
value at the time of acquisition, less estimated costs of sale.
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 the competition for
deposits are interest rates, personalized services, the quality and range of
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financial services, convenience of office locations and office hours. The
Company competes for deposits primarily with other commercial banks, savings
institutions, credit unions, money market funds and other investment
alternatives. The primary factors in the competition for loans are interest
rates, loan origination fees, the quality and range of lending services and
personalized services. The Company competes for loans, primarily with 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 that have opened loan production
offices or that 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, as a consequence of recent bank acquisitions and mergers
in the Company's market, 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. Moreover,
recent developments in technology and mass marketing have permitted larger
institutions to market loans more aggressively to small business borrowers.
Recent federal legislation has eased membership limits on credit unions,
which previously have been permitted to serve only members that share a single,
common bond. Specifically, the legislation provides that occupation-based credit
unions may serve unrelated companies as long as such companies have fewer than
3,000 employees. The Company expects that such legislation will increase the
ability of credit unions to compete with community banks, such as the Bank, for
both deposits and loans.
The Company competes principally on the basis of personalized attention and
special services that it provides its customers, principally individuals and
small to medium-sized businesses. Its marketing activity focuses primarily on
promotional activities by and referrals from the Bank'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 16 of its locations, and is a member of Instant Teller
network and Plus System network, which link bank ATMs nationwide.
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.
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
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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
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
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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. 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
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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 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.
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
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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.
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.
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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.
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.
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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 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
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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, under
pre-existing law, the FDIC is now permitted to reduce the normal, periodic
deposit insurance premiums charged to SAIF-insured institutions to levels
consistent with those charged to BIF-insured institutions. For well capitalized
and well managed institutions, those rates can be as low as a statutory minimum
of $2,000 per year.
Under the SAIF legislation, however, the FDIC is also obligated to levy
ongoing special assessments on both SAIF-insured institutions and BIF-insured
institutions in order to pay debt service on certain bonds issued in connection
with the resolution of financially troubled savings associations prior to 1989.
Through 1999, SAIF institutions will pay those special assessments at an annual
rate five times that paid by BIF institutions. While the precise rate will vary
from period to period, initially the rate for SAIF institutions will be $.064
per $100 of deposits and the rate for BIF institutions will be $.0128 per $100
of deposits. Beginning in January 2000, the rates paid by institutions insured
by each fund will be equalized. Unlike the one-time special assessment discussed
above, it is expected that those ongoing special assessments will be recorded as
expenses during the period for which they are assessed.
As a result of the passage of the SAIF legislation, effective January 1,
1997, the deposit assessment matrix for both SAIF-assessable and BIF-assessable
depository institutions, is as follows (in cents per $100 of deposits):
<TABLE>
<CAPTION>
SUPERVISORY SUBGROUP
--------------------
B C
A -- --
------
<S> <C> <C> <C>
MEETS NUMERICAL STANDARDS FOR:
Well capitalized........................................................... 0(a) 3 17
Adequately capitalized..................................................... 3 10 24
Undercapitalized........................................................... 10 24 27
</TABLE>
- ------------------------
(a) Subject to a statutory minimum annual assessment of $2,000.
For purposes of the assessments of FDIC insurance premiums that were paid
during the second half of 1997, which were based on the Bank's capital level as
of June 30, 1997 after giving effect to the Bank Mergers, the Bank was "well
capitalized." FDIC regulations prohibit disclosure of the "supervisory subgroup"
to which an insured institution is assigned. The Bank's insurance assessment
paid during the six months ended December 31, 1997 (which were based on capital
levels as of June 30, 1997) was $133,000.
RESTRICTIONS ON CHANGES OF CONTROL
Subject to certain limited exceptions, no company (as defined in the BHC
Act) or individual can acquire control of a bank holding company, such as the
Company, without the prior approval or non-disapproval, as the case may be, of
the FRB. Prior approval of the FRB would be required for 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
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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 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,
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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 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"
21
<PAGE>
aspect that requires the collection and disclosure of data about applicant and
borrower characteristics as a way of identifying possible discriminatory lending
patterns and enforcing anti-discrimination statutes. The HMDA requires
institutions to report data regarding applications for one-to-four family loans,
home improvement loans, and multifamily loans, as well as information concerning
originations and purchases of such types of loans. Federal bank regulators rely,
in part, upon data provided under the HMDA to determine whether depository
institutions engage in discriminatory lending practices.
Compliance with the HMDA and implementing regulations is enforced by the
appropriate federal banking agency, or in some cases, by HUD. Administrative
sanctions, including civil money penalties, may be imposed by supervisory
agencies for violations. The HMDA requires depository institutions to compile
and disclose certain information with respect to mortgage loans, including the
census tract, income level, racial characteristics and gender of the borrower or
potential borrower. In addition, the HMDA data may have a material effect on the
regulators' assessment of an institution, particularly in connection with an
institution's application to enter into a merger or to acquire one or more
branches.
THE REAL ESTATE SETTLEMENT PROCEDURES ACT. RESPA, enacted into law in 1974,
requires lenders to provide borrowers with disclosures regarding the nature and
cost of real estate settlements. Also, RESPA prohibits certain abusive
practices, such as kickbacks, and places limitations on the amount of escrow
accounts. Violations of RESPA may result in imposition of the following
penalties: (1) civil liability equal to three times the amount of any charge
paid for the settlement services; (2) the possibility that court costs and
attorneys' fees can be recovered; and (3) a fine of not more than $10,000 or
imprisonment for not more than one year, or both. Recently, a significant number
of individual claims and purported consumer class action claims have been
commenced against a number of financial institutions, their subsidiaries, and
other mortgage lending companies alleging violations of RESPA's escrow account
rules and seeking civil damages, court costs, and attorneys' fees.
CERTAIN OTHER ASPECTS OF FEDERAL AND STATE LAW
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.
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.
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<PAGE>
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.
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.
23
<PAGE>
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 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
24
<PAGE>
California legislature and before various bank regulatory and other professional
agencies. For example, legislation was introduced in Congress which would repeal
the current statutory restrictions on affiliations between commercial banks and
securities firms. Under the proposed legislation, bank holding companies would
be allowed to control both a commercial bank and a securities affiliate, which
could engage in the full range of investment banking activities, including
corporate underwriting. The likelihood of any major legislative changes and the
impact such changes might have on the Company are impossible to predict. (See
"Business--Supervision and Regulation" herein.)
RELIANCE ON SBA PROGRAMS. 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.
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<PAGE>
RISK FACTORS
AN INVESTMENT IN SECURITIES ISSUED BY THE COMPANY INVOLVES VARIOUS RISKS.
EXISTING AND PROSPECTIVE INVESTORS IN ANY SECURITIES ISSUED BY THE COMPANY
SHOULD CONSIDER CAREFULLY THE FACTORS SUMMARIZED BELOW, AS WELL AS THE OTHER
INFORMATION CONTAINED IN THIS ANNUAL REPORT, IN MAKING A DECISION WHETHER TO
BUY, SELL OR HOLD SUCH SECURITIES. IN ADDITION, THIS ANNUAL REPORT CONTAINS
CERTAIN FORWARD-LOOKING STATEMENTS REGARDING THE COMPANY'S FUTURE PLANS,
OPERATIONS AND PROSPECTS, WHICH INVOLVE RISKS AND UNCERTAINTIES. THOSE
FORWARD-LOOKING STATEMENTS ARE INHERENTLY UNCERTAIN, AND ACTUAL RESULTS MAY
DIFFER SIGNIFICANTLY FROM THE COMPANY'S EXPECTATIONS. RISK FACTORS THAT COULD
AFFECT CURRENT AND FUTURE PERFORMANCE INCLUDE BUT ARE NOT LIMITED TO THOSE
DESCRIBED IN THIS SECTION. CAPITALIZED TERMS USED AND NOT OTHERWISE DEFINED IN
THIS SECTION HAVE THE RESPECTIVE MEANINGS SET FORTH ELSEWHERE IN THIS ANNUAL
REPORT.
EFFECT OF RECENT ACQUISITIONS
Since September 1995, when Dartmouth Capital Group, L.P. ("DCG") acquired
control of SDN Bancorp, Inc., the Company's predecessor, the Company's
operations have changed substantially. During the past three years, the Company
has acquired three banks with a total of approximately $779 million in assets.
Those acquisitions, including the acquisition of Eldorado Bancorp in June 1997,
resulted in a fourteenfold increase of the Company's assets. The acquisition of
Eldorado Bancorp, itself, nearly doubled the Company's assets. The Company used
the purchase method of accounting for each acquisition. Therefore, the operating
results of each acquired company are included in the Company's financial
statements only from the date of acquisition. Because of the Company's recent
acquisitions and its use of the purchase method of accounting, its historical
operating results before June 30, 1997 are of limited relevance in evaluating
the Company's historical financial performance and predicting its future
operating results.
GEOGRAPHIC CONCENTRATION
Substantially all of the Company's business is located in California, with a
particular concentration in Southern California. As a result, the Company's
financial condition and operating results are subject to changes in economic
conditions in that region. In the early to mid-1990s, California experienced a
significant and prolonged downturn in its economy, which adversely affected
financial institutions, including the Company and its predecessors. Although the
general economy in California has recovered from that prolonged recession, the
Company is subject to changes in economic conditions in that region. We can
provide no assurance that conditions in the California economy will not
deteriorate in the future and that such deterioration will not adversely effect
the Company.
Among other factors, the California economy may be adversely affected by
prolonged weakness in one or more of the Asian economies. In 1997, California's
Gross State Product exceeded $1.0 trillion, with exports to foreign countries
totaling $110 billion or 10.7% of the Gross State Product. California, with its
greater dependence on Asian trade and investment, is more at risk from Asia's
economic problems than the rest of the United States. Exports to Asian countries
represented 47% of California's total exports, compared to 29% for the U.S. as a
whole. Weaker Asian demand for California products and services could
potentially result in job losses, primarily in the high-tech manufacturing,
engineering, travel and entertainment industries. The Los Angeles area is among
the particularly vulnerable regions in California with its relatively heavy
concentration of high-tech, engineering and entertainment firms. We can provide
no assurance that a deterioration of economic conditions in California as a
result of Asia's economic problems will not adversely effect the Company.
In addition, a substantial portion of the Company's assets consist of loans
secured by real estate in California. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations." Historically, California has
experienced, on occasion, significant natural disasters, including earthquakes,
brushfires and, during early 1998, flooding attributed to the weather phenomenon
known as
26
<PAGE>
"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 adversely affect the Company.
PRODUCT CONCENTRATION
The Company makes a significant percentage of its loans and derives a
significant percentage of its revenue under the loan programs of the U.S. Small
Business Administration (the "SBA"). The Company's revenue from SBA loan
programs constituted approximately 17.0% of its total revenue for the year ended
December 31, 1997.
In recent years, Congress has considered proposals that would substantially
reduce
- the scope of various SBA programs,
- the level of SBA funding, and
- the attractiveness of the programs that the SBA may offer to both
borrowers and lenders.
If Congress enacts any such type of proposal, the Company's SBA loan
originations and its revenue derived from originating and servicing such loans
could be adversely affected. See "Supervision and Regulation--Effect of
Governmental Policies and Legislation--Reliance on SBA Programs."
COMPETITION
There is intense competition in California and elsewhere in the United
States for banking customers. The Company experiences competition for deposits
from many sources, including credit unions, insurance companies and money market
and other mutual funds, as well as other commercial banks. The Company competes
for loans and leases primarily with other commercial banks, mortgage companies,
commercial finance companies and savings institutions. Recently, certain
out-of-state financial institutions have entered the California market, which
has also enhanced competition. Many of the Company's competitors have greater
financial strength, marketing capability and name recognition than the Company,
and operate on a statewide or nationwide basis. In addition, recent developments
in technology and mass marketing have permitted larger companies to market loans
more aggressively to the Company's small business customers. Such advantages may
give our competitors opportunities to realize greater efficiencies and economies
of scale than the Company. We can provide no assurance that the Company will be
able to compete effectively against such competition.
Federal legislation enacted in August 1998 has eased membership limits on
credit unions, which previously were permitted to serve only members that shared
a single, common bond. The Company expects that such legislation will increase
the ability of credit unions to compete with community banks, such as the Bank,
for both deposits and loans.
POTENTIAL IMPACT OF CHANGES IN INTEREST RATES
The Company's profitability is significantly dependent on its net interest
income. Net interest income is the difference between its interest income on
interest-earning assets, such as loans and leases, and its interest expense on
interest-bearing liabilities, such as deposits. Therefore, changes in general
market interest rates, whether as a result of changes in the monetary policies
of the Federal Reserve or otherwise, can have a significant effect on our net
interest income. The Company's assets and liabilities may react differently to
changes in overall market rates or conditions because of mismatches between the
repricing or maturity characteristics of its assets and liabilities. As a
result, changes in interest rates can affect our net interest income in either a
positive or a negative way.
Changes in the difference between short and long-term interest rates
(commonly known as the "yield curve") may also have an adverse effect the
Company's business. For example, the Company uses short-
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term deposits and borrowings to fund mortgages held by the Company during the
period between the origination of such mortgages and their sale (the "mortgage
warehouse period"). The short-term deposits and borrowings yield short-term
rates. Such mortgages, however, generally yield long-term rates. If the
difference between short-term and long-term interest rates shrinks or
disappears, the Company would earn less interest income during the mortgage
warehouse period.
Changes in interest rates can also have other significant effects on the
Company's mortgage banking business. In periods of rising interest rates (as
occurred in 1994), financial institutions such as the Company typically
originate less mortgage loans, depending on the performance of the overall
economy. In that case, the Company's mortgage banking income may decline. In
periods of declining interest rates, mortgage loan originations typically
increase, particularly those due to refinancings of existing mortgages. Other
effects of fluctuations in interest rates include the following:
- Changes in the revenue received by the Company from the sale of mortgage
loans if there is a change in interest rates between the time the interest
rate on the mortgage is set and the time the Company sells the loan.
- Changes in the revenue received by the Company from the sale of mortgage
servicing rights to third parties. For example, in periods of declining
interest rates, sales of servicing rights related to higher interest rate
loans may be less profitable because of the increased risk of prepayment
than sales of servicing rights related to lower interest rate loans.
The Company retains some risk from changing interest rates until it sells a
mortgage, because our purchase and sale commitments are based on estimates of
loan closings (which are sensitive to interest rate changes). In addition,
because instruments the Company uses to mitigate or hedge interest rate risk may
not respond to changes in interest rates to the same degree as the mortgage
pipeline being hedged, some interest rate risks remain even in a fully hedged
portfolio.
We cannot predict or control fluctuations in interest rates. Although we
believe that we have taken steps to mitigate the impact of changes in interest
rates on the Company's income and portfolio value, we can provide no assurance
that the Company's net interest income or the net value of its assets will not
be affected adversely in a changing rate environment. See "Quantitative and
Qualitative Disclosures about Market Risk."
DEPENDENCE ON KEY PERSONNEL
The Company's future success depends, in large part, upon the continuing
contributions of its key management personnel. Two of its executive officers
have been with the Company for less than a year. If the Company loses the
services of one or more key employees within a short period of time, the Company
could be adversely affected.
The Company's future success is also dependent upon its continuing ability
to attract and retain other highly qualified personnel. Competition for such
employees among financial institutions in California is intense. The Company's
inability to attract and retain additional key personnel could adversely affect
the Company. We can provide no assurance that the Company will be able to retain
any of its key officers and employee or attract and retain qualified personnel
in the future.
Mr. Keller, the Company's President and Chief Executive Officer, has an
employment agreement which expires on September 30, 2000. The agreement will
automatically extend for another year unless Mr. Keller or the Company gives
notice at least one year prior to the expiration date of the agreement. In
addition, the Company is the beneficiary of a key-man life insurance policy on
Mr. Keller with a benefit of approximately $1.3 million. Certain members of the
Company's senior management also have employment or severance agreements with
the Company. See "--Employment Contracts, Change in Control Provisions and
Employee Severance Compensation", "Executive Compensation--Keller Agreement" and
"Executive Compensation--Other Executive Employment Agreements."
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RISKS RELATED TO GROWTH STRATEGY
Since September 1995, the Company has experienced rapid growth through
acquisitions. An important element of the Company's business strategy continues
to involve active and substantial efforts to acquire or combine with additional
financial institutions that would complement the Company's existing businesses.
We can provide no assurance, however, that the Company will be able to identify
additional suitable acquisition targets or consummate any such acquisition.
If the Company is able to identify and consummate future acquisitions, its
ability to manage such future growth will depend primarily on its ability to
- monitor operations,
- control costs,
- maintain positive customer relations,
- maintain regulatory compliance, and
- attract, assimilate and retain additional qualified personnel.
See "--Dependence on Key Personnel." If the Company fails to achieve those
objectives in an efficient and timely manner, it may experience interruptions
and dislocations in its business. Any such problems could adversely affect the
Company's existing operations, as well as its ability to retain the customers of
the acquired businesses, operate any such businesses profitably or otherwise
implement its growth strategy. In addition, such concerns may cause the
Company's federal and state banking regulators to require the Company to delay
or forgo any proposed acquisition until such problems have been addressed to the
satisfaction of those regulators.
Another risk associated with the Company's growth strategy includes the
possibility that there exists or would exist liabilities assumed in connection
with an acquisition, including the presence of any liabilities unknown to the
Company when it acquired the company, that may adversely affect the Company.
The Company's failure to manage its acquisition strategy effectively would
adversely affect the Company.
RISKS RELATED TO GOODWILL
As of December 31, 1997, the Company had total assets of approximately
$902.4 million, of which $66.8 million, or 7.4% of total assets and 70.5% of
shareholders' equity, was goodwill. The Company's ratios of tangible common
equity to assets and tangible total equity to assets at that date, 1.8% and
3.1%, respectively, were substantially below the average ratios for commercial
banks in the Company's peer group.
We can provide no assurance that the value of such goodwill will ever be
realized by the Company. The Company is amortizing the goodwill associated with
its past acquisitions on a straight-line basis over a 20-year period. The
Company monitors the effect that certain events and circumstances may have that
would indicate that all or a portion of the carrying amount of goodwill may no
longer be recoverable. In such circumstances, an additional charge to earnings
would become necessary to reflect the fact that such goodwill is not
recoverable. Although as of December 31, 1998 and the date of this Annual
Report, we did not consider the goodwill on the Company's balance sheet to be
impaired, we can provide no assurance that it will remain so. Any future
determination requiring the write-off of a significant portion of unamortized
goodwill could adversely affect the Company.
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PRIOR LOSSES AT PREDECESSOR SUBSIDIARY BANKS
Prior to June 30, 1997, the Company conducted its banking operations through
four separate bank subsidiaries: Commerce Security Bank ("Commerce Security"),
Eldorado Bank, Liberty National Bank ("Liberty") and San Dieguito National Bank
("San Dieguito"). Within the relatively recent past, high levels of
nonperforming assets and a reliance on high-cost brokered deposits and excessive
overhead costs, among other factors, adversely affected Commerce Security,
Liberty and San Dieguito. Adverse economic conditions in California, including
declining real estate values during the early to mid-1990s, were partly to blame
for such problems. Liberty incurred net losses of $1.3 million and $1.5 million
in 1994 and 1993, respectively; San Dieguito incurred net losses of $1.1
million, $1.0 million and $2.0 million in 1995, 1994 and 1993, respectively; and
Commerce Security, which the Company acquired on September 1, 1996, incurred net
losses of $431,000 and $371,000 for the three months ended December 31, 1996 and
March 31, 1997, respectively.
As a result of management's efforts, together with an improved California
economy, we believe that substantial progress has been made toward improving its
operating results. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations." We can provide no assurance, however, that
the operating problems experienced by the Company's prior subsidiaries or other
factors will not adversely affect the Company in the future.
SUPERVISION AND REGULATION
The Company and the Bank operate in a highly regulated environment and are
subject to supervision and examination by various federal and state regulatory
agencies. The Company, as a bank holding company, is subject to regulation and
supervision primarily by the Federal Reserve. The Bank, as a
California-chartered commercial bank and a member of the Federal Reserve System,
is subject to supervision and regulation primarily by the California Department
of Financial Institutions (the "DFI") and secondarily by the Federal Reserve.
The Company and the Bank can also be affected by FDIC regulations pertaining to
insured depositary institutions.
Federal and California laws and regulations govern numerous matters
including maintenance of adequate capital and financial condition, permissible
types, amounts and terms of extensions of credit and investments, permissible
non-banking activities, the level of reserves against deposits, and restrictions
on dividend payments. The federal and state regulatory agencies have extensive
discretion and power to prevent or remedy unsafe or unsound practices or
violations of law by banks and bank holding companies. The Company and the Bank
also undergo periodic examinations by one or more regulatory agencies. Following
such examinations, the Company may be required to change its asset valuations,
amounts of required loss allowances and to restrict its operations. Such actions
would result from the regulators' judgments based on information available to
them at the time of their examination. The Bank's operations are also subject to
a wide variety of state and federal consumer protection and similar statues and
regulations. Such federal and state regulatory restrictions limit the manner in
which the Company and the Bank may conduct business and obtain financing. Those
laws and regulations can and do change significantly from time to time, and any
such change could adversely effect the Company. See "Supervision and
Regulation."
As a consequence of the poor financial performance of Commerce Security,
Liberty and San Dieguito during the early and mid-1990s and their resulting
weakened financial condition, each bank was required to enter into a memorandum
of understanding with their respective supervising regulators. Each of those
memoranda was terminated before or at the same time as control of such bank was
acquired by DCG. Neither the Company nor the Bank is subject to any memorandum
of understanding or other extraordinary supervisory agreement with any
regulatory authority. The Company did make certain commitments to the Federal
Reserve in connection with the Eldorado Acquisition, however. Among other
things, those commitments provide that the Company will not redeem, retire or
repurchase any of its preferred stock,
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incur any debt or pay any dividend on the Common Stock without the prior
approval of the Federal Reserve. See "Supervision and Regulation."
NO PRESENT INTENTION TO PAY DIVIDENDS; PROHIBITION ON DIVIDENDS; PROHIBITION ON
DIVIDENDS BY THE BANK TO THE COMPANY WITHOUT PRIOR REGULATORY APPROVAL
The Company has never paid Common Stock dividends and does not plan on
paying a dividend in the foreseeable future. The Company's ability to declare a
dividend on the Common Stock will depend upon, among other things, future
earnings, its operating and financial condition, its capital requirements and
general business conditions, and receipt of regulatory approvals, if then
required.
The Company is a legal entity separate and distinct from the Bank.
Substantially all of the Company's revenue and cash flow, including funds
available for the payments of dividends and other operating expenses, is
dependent upon the payment of dividends to the Company from the Bank. Dividends
payable by the Bank are restricted under California law to (1) 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 (2) 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 $14.0 million, which exceeded the Bank's net income for the latest three
fiscal years. As a result, the Bank currently may not pay a dividend without the
prior approval of the DFI. The DFI may, in its discretion, approve the payment
of a dividend as long as the amount does not exceed the greater of the Bank's
retained earnings (approximately $7.7 million as of June 30, 1998), the net
income of the Bank for its last fiscal year (approximately $5.9 million for the
year ended December 31, 1997), and the net income of the Bank for its current
fiscal year ($6.1 million for the six months ended June 30, 1998).
In addition to California law, under Federal Reserve regulations, the Bank
may not pay a dividend without prior Federal Reserve approval if (1) it would
exceed the Bank's undivided profits as reported in its most recent Report of
Condition and Income (approximately $7.7 million as of June 30, 1998) or (2) the
total of all dividends declared in one year exceeds the total of the Bank's net
income for that year plus the retained net income for the preceding two calendar
years. Under the second of those tests, the Bank is currently prohibited from
paying a dividend without the prior approval of the Federal Reserve. We can
provide no assurance that the DFI and the Federal Reserve will approve the
payment of any dividend by the Bank to the Company, regardless of the amount of
the Bank's earnings. See "Supervision and Regulation."
NO ASSURANCES AS TO ADEQUACY OF ALLOWANCE FOR LOAN AND LEASE LOSSES
We believe that the Company's allowance for loan and lease losses is
maintained at a level adequate to absorb any inherent losses in its loan and
lease portfolio. Depending on changes in economic, operating and other
conditions, including changes in interest rates, that are generally beyond the
Company's control, the Company's actual loan and lease losses could increase
significantly. As a result, such losses could exceed the Company's current
allowance estimates. We can provide no assurance that our allowance is
sufficient to cover actual loan and lease losses should such losses be realized.
In addition, 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 and lease losses or to recognize further loan or
lease charge-offs, based upon judgments different from those of management. Any
increase in the Company's allowance required by the Federal Reserve or the DFI
could adversely effect the Company. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
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RELIANCE ON CERTAIN FUNDING SOURCES
The Company funds loans and leases primarily through the deposits and
various lines of credit of its customers. Among these deposits are deposits
provided by title or escrow companies. We consider such deposits to be volatile
because the deposit amounts increase and decrease significantly throughout the
course of any given period. In addition, only a limited number of the Company's
customers control such deposits, so the decision by any one depositor to
withdraw its funds could have a significant immediate effect on the Company's
total deposits at any given time. Title and escrow deposits tend to increase
significantly at the end of a month, when real estate closings tend to occur.
Such deposits are also subject to seasonal fluctuations, tending to decrease
during those seasons when the volume of residential real estate transactions is
lower.
As a consequence of their potential volatility, the Company utilizes title
and escrow deposits solely to fund short-term assets, including mostly
residential mortgages held for sale, which are generally sold within 30 days
after such mortgage loans are funded. We believe that the Company has adequate
alternative sources of liquidity, such as lines of credit and, to a much lesser
extent, FHLB borrowings, to offset any significant fluctuations in or the
elimination of its title and escrow deposits. We can provide no assurance,
however, that any alternative funding sources will be available at a reasonable
cost if and when needed. The Company would be adversely effected if it is unable
to obtain any necessary replacement funding on reasonable terms. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations"
YEAR 2000 PREPAREDNESS
The Year 2000 issue is a computer programming concern that may adversely
affect the Company's information technology systems, such as its item and data
processing applications, as well as so-called embedded technology, such as
microprocessors that control some of the Company's security systems and
telecommunication equipment. The Company has developed a plan to identify and
remedy the material Year 2000 issues that directly affect the Company's systems.
This plan also includes procedures to evaluate the preparedness of the Company's
key vendors and significant customers in addressing the Year 2000 issue. We
believe that we have taken reasonable steps to address our internal Year 2000
concerns and to inquire about the actions that the Company's vendors and
customers have taken to identify and address the Year 2000 issue. We can provide
no assurance, however, that the impact of the Year 2000 problem on the Company's
vendors and customers will not adversely effect the Company. In particular, it
will be difficult for the Company to implement viable contingency plans for the
effect of the Year 2000 issue on local or national telecommunications systems.
Furthermore, Year 2000 problems may turn out to exist in portions of important
computer programs not now suspected, and we can provide no assurance that the
Company will not be adversely affected by issues it has yet to identify. If the
Company fails to adequately address the Year 2000 issues as it impacts both its
internal operations and that of its customers and vendors, such failure could
have a adversely effect the Company. See "Management's Discussion and Analysis
of Operations and Financial Condition--Year 2000 Preparedness."
In addition, bank regulatory agencies, as part of their supervisory
function, are assessing and will continue to assess Year 2000 readiness. The
failure of a financial institution, such as the Company, to take appropriate
steps to address deficiencies in its Year 2000 project management process may
result in one or more regulatory enforcement actions which could have a material
adverse effect on such institution. Such actions may include the imposition of
fines, or result in the delay or denial of regulatory applications which would
have a material adverse effect on the Company's strategic plan to grow by
acquisition. See "--Risks Related to Growth Strategy."
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CONTROL BY DIRECTORS, EXECUTIVE OFFICERS AND PRINCIPAL SHAREHOLDERS
As of December 31, 1997 and the date of this Annual Report, the Company's
directors, executive officers and principal shareholders, together with their
affiliates, beneficially owned 50.4% of the shares of the voting Common Stock
then outstanding. DCG beneficially owned 36.4% of the shares of voting Common
Stock outstanding as of that date. As a result, if such shareholders take a
common position, they could control the outcome of corporate actions requiring
shareholder approval, including the election of directors and the approval of
significant corporate transactions, such as a merger or sale of all or
substantially all of the Company's assets. We can provide no assurance that the
investment objectives of such shareholders will be the same as the Company's
other shareholders. See "Management" and "Principal and Selling Shareholders."
EMPLOYMENT CONTRACTS, CHANGE IN CONTROL PROVISIONS AND EMPLOYEE SEVERANCE
COMPENSATION
The Company has entered into employment agreements with Mr. Keller and
certain other of the Company's executive officers and severance agreements with
certain executive officers of the Company and the Bank, which agreements will
provide for severance payments if their respective employment arrangements are
terminated in connection with a change in control of the Company or the Bank.
Those provisions may have the effect of increasing the cost of acquiring the
Company, thereby discouraging future attempts to take over the Company or the
Bank. In addition, Mr. Keller's agreement provides for certain severance
payments in the event of his termination for any reason other than resignation,
cause, death or permanent disability. See "Executive Compensation."
POSSIBLE FUTURE SALES OF SHARES
Sales of substantial amounts of Common Stock in the public market under Rule
144 of the Securities Act of 1933, as amended (the "Securities Act"), or
otherwise, or the perception that such sales could occur, may adversely affect
prevailing market prices of the Common Stock. If the prevailing market prices
are affected, such sales could impair the future ability of the Company to raise
capital through an offering of its equity securities or to effect acquisitions
using shares of Common Stock. As of October 23, 1998, all of the shares of
Common Stock that are restricted securities under Rule 144 will have been held
for more than one year. In addition, the Company has entered into agreements
with its principal shareholders and certain other holders of Common Stock may
entitle such holders the Company to register the resale of their Common Stock
under certain circumstances.
LIMITED PRIOR MARKET FOR COMMON STOCK AND POSSIBLE VOLATILITY OF STOCK PRICE
Trading in the Common Stock has been extremely limited prior to the Offering
and cannot be characterized as amounting to an established public trading
market. There can be no assurance that an active public market for the Common
Stock will develop at any time in the future or continue if such a market
develops. If such a public market develops, the market price of the Common Stock
may be subject to significant fluctuations in response to numerous factors,
including variations in the annual or quarterly financial results of the Company
or its competitors, changes by financial research analysts in their estimates of
the earnings of the Company or its competitors or the failure of the Company or
its competitors to meet such estimates, conditions in the economy in general or
the banking industry in particular, or unfavorable publicity affecting the
Company or the industry. In addition, the equity markets have, on occasion,
experienced significant price and volume fluctuations that have affected the
market prices for many companies' securities and have been unrelated to the
operating performance of those companies. Any such fluctuations may adversely
affect the prevailing market price of the Common Stock.
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REGULATION OF CHANGES IN CONTROL OF THE COMPANY
Any individual, acting alone or with others, who is seeking to acquire 10%
or more of the outstanding Common Stock must comply with the Change in Bank
Control Act, which requires prior notice to the Federal Reserve for any such
acquisition. Any entity that wants to acquire 5% or more of the outstanding
Common Stock, or otherwise to control, the Company may need to obtain the prior
approval of the Federal Reserve under the BHC Act. As a result, prospective
investors in Common Stock need to be aware of and to comply with those
requirements, to the extent applicable.
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ITEM 2. PROPERTIES
The main executive office for the Company and the Bank is located in Laguna
Hills, California, near the intersection of Interstate 5 and El Toro Road, where
it is physically contiguous to one of the Bank's branches.
The Bank's headquarters is located on a site owned by the Bank at
Seventeenth Street and Prospect Avenue, Tustin, California.
In addition to the Bank's headquarters office and its Laguna Hills location,
the Bank owns six of its branch offices, one of which is subject to a ground
lease and leases the remaining 10 offices. Of the branch offices which are
leased by the Bank, two have remaining lease terms, including options renewable
at the Bank's option, of five years or less, one has a remaining lease terms of
greater than five years and less than 10 years, and nine have a remaining lease
term of 10 years or more. The Bank also leases several offices for various
administrative offices associated with its Northern California operations, as
well as space for the wholesale and retail loan mortgage loan origination
activity.
The Company's aggregate rental expense under such leases was $2.3 million in
1997. At December 31, 1997, the net book value of the property and leasehold
improvements of the offices of the Company amounted to $7.5 million. The
Company's properties which are not leased are owned free and clear of any
mortgages. The Company believes that all of its properties are appropriately
maintained and are suitable for their respective present needs and operations.
For additional information regarding the Company's lease obligations see Note16
to the Consolidated Financial Statements, included in Item 8 hereof.
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ITEM 3. LEGAL PROCEEDINGS
As of the date of this Annual Report, no litigation is pending against the
Company itself. The Bank is the defendant in an action filed in 1994 by a former
officer of CSB's Stockton, California loan production office, alleging wrongful
termination, breach of contract, defamation and various other causes of action.
A central element of the employee's claim is that CSB terminated him in
retaliation for his reporting of alleged violations of consumer lending laws
committed by another employee of CSB's Stockton office. The Company's position
is that the former officer's claims are without merit and that CSB terminated
him because it reasonably believed he had acted insubordinately by retaliating
against a subordinate who had complained of the former officer's conduct. In
October 1997, a jury awarded the former officer $3.8 million of damages,
including $2.0 million of punitive damages. The trial court subsequently reduced
the award to $2.0 million, including $1.0 million punitive damages, and the Bank
recorded a purchase accounting adjustment for the CSB acquisition in an amount
equal to the reduced judgment. The case is now on appeal.
In addition, the Bank is a defendant in another proceeding involving the
Stockton office. The action was initiated in 1994 by three employees who allege,
among other things, that CSB wrongfully terminated their employment in
connection with a reduction of the Stockton office's workforce in 1994. Similar
to the matter described in the preceding paragraph, their complaint alleges,
among other things, that plaintiffs were terminated as a result of their having
reported alleged violations of consumer lending laws committed by another
employee of the Stockton office and seeks compensatory and punitive damages.
Although the Company believes the Bank has meritorious defenses and intends to
vigorously contest such claims, there can be no assurance that an adverse
outcome in that case will not have a material adverse effect on the Company.
The Company is from time to time subject to various legal actions (in
addition to those described above) that 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.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted by the Bank or the Company to a vote of its security
holders, through the solicitation of proxies or otherwise, during the fourth
quarter of its fiscal year ended on December 31, 1997.
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PART II
ITEM 5. MARKET FOR ISSUER'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
MARKET FOR ISSUER'S COMMON STOCK
Trading in Common Stock has been extremely limited. Such trades cannot be
characterized as amounting to an active trading market. The Common Stock is
registered with the National Association of Securities Dealers ("NASD") and is
traded only over-the-counter (NASD/CBNK), but is not listed on any exchange, and
is not quoted on the National Association of Securities Dealers' Automated
Quotation System ("Nasdaq").
The last known trade of Common Stock was for $12.00 per share on October 23,
1997. No more recent trades in Common Stock have been reported by securities
dealers.
DIVIDEND POLICY
Holders of Common Stock are entitled to receive dividends as and when
declared by the Board of Directors out of funds legally available therefor under
the laws of the State of Delaware. The Company does not expect to pay Common
Stock dividends for the foreseeable future, and certain terms of the "Senior
Securities" that the Company issued to fund a portion of the Eldorado
Acquisition prohibit the payment of Common Stock dividends under various
circumstances. See "--Unregistered Sales of Securities" below.
The Company is not permitted to pay any dividends without the consent of the
Federal Reserve. As a State Member Bank, the Bank is subject to certain
restrictions on the payment of dividends and may require approval of the DFI and
the Federal Reserve. See "Business--Regulatory Restrictions on Distributions to
Shareholders--Dividends".
HOLDERS OF COMMON STOCK
As of March 14, 1998, there were approximately 460 holders of record of
Common Stock.
UNREGISTERED SALES OF SECURITIES
Described below are sales and other issuances of equity securities during
the year ended December 31, 1997 by the Company that were not registered under
the Section 5 of the Securities Act of 1933, as amended (the "Securities Act").
FUNDING FOR ELDORADO ACQUISITION. Approximately $94.8 million of cash was
necessary to pay the cash consideration to holders of Eldorado common stock and
Eldorado stock options and Eldorado Acquisition-related expenses incurred by the
Company. Of that amount, $14.5 million was funded from Eldorado's excess capital
through a dividend by Eldorado Bank and $80.3 million was raised through the
Company's sale, effective June 6, 1997, of Class B Common Stock, Special Common
Stock, a Junior Subordinated Debenture (and, indirectly, Series A Capital
Securities), Series B Preferred Stock and common stock warrants, as described
below. The issuance of such securities was exempt from registration under the
Securities Act by virtue of Regulation D thereunder and/or Section 4(2) thereof.
CLASS B COMMON STOCK. In conjunction with the Eldorado Acquisition
financing, 4,848,715 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 2,124,215
additional shares of Class B Common Stock to various accredited investors for
consideration, net of a 1% commitment fee, of $17,733,115. Of those shares,
1,431,839 were sold to persons who, at the time of issuance, were directors of
the Company, affiliates of directors or nominees to become directors. See
"Certain Transactions And Related Transactions--Certain Transactions."
DCG, the Company's largest shareholder, purchased 506,122 of those shares of
Class B Common Stock for aggregate consideration, net of a 1% commitment fee, of
$4,419,793, of which $4.3 million
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initially was made in the form of a loan to the Company in December 1996 to fund
an escrow account that would have been forfeited to Eldorado if the Company were
unable to consummate the Acquisition financing. Peter H. Paulsen, then a
director of the Company, loaned $200,000 to the Company on the same terms as
DCG. That $4.5 million was converted to shares of Class B Common Stock upon the
consummation of the Acquisition at a purchase price of $8.80 per share less the
1% commitment fee, and the interest on such loan was converted to Class B Common
Stock at a purchase price of $9.62 per share less the 1% commitment fee, which
was the same price at which the remaining shares of Class B Common Stock and the
Special Common Stock were sold by the Company to fund the Eldorado Acquisition.
SPECIAL COMMON STOCK. The Company sold a total of 2,412,859 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 $9.62 per
share, representing an aggregate payment, net of a 1% commitment fee, of
$22,984,570. Neither MDP nor Olympus is an affiliate of the other, and prior to
their investment in the Company, neither was an affiliate of the Company or DCG.
The Special Common will be entitled to a liquidation preference over the
Class B Common if, in the case of a liquidation or a change in control of the
Company, the distribution per share of Common Stock is less than $9.62. With the
exception of 463,913 of Non-Voting Special Common issued to each of MDP and
Olympus, the Special Common will have one vote per share and will vote as a
class with the Class B Common Stock. The Voting Special Common and the Class B
Common Stock are hereinafter sometimes referred to as the "Voting Common Stock."
JUNIOR SUBORDINATED DEBENTURE AND SERIES A CAPITAL SECURITIES. CSBI Capital
Trust I (the "Trust"), a special purpose trust formed by the Company, issued a
total of 27,657 shares of 11 3/4% Series A Capital Securities, $1,000 initial
liquidation value per share (the "Series A Securities"), to DCG, MDP and Olympus
for an aggregate cash payment, net of a 1% commitment fee, of $27,386,368. The
Trust in turn invested the proceeds of the Series A Securities in a Junior
Subordinated Debenture issued by the Company.
SERIES B PREFERRED STOCK. The Company issued a total of 116,593 shares of
11% Series B Preferred Stock, $100 par value per share (the "Series B
Preferred"), to DCG, MDP and Olympus for an aggregate amount of $11,545,210, net
of a 1% commitment fee.
COMMON STOCK WARRANTS. In connection with the purchase of the Series B
Preferred, each of MDP, Olympus and DCG purchased a common stock warrant
(collectively, the "Investor Warrants") that entitles the holder to purchase
shares of Class B Common Stock at an exercise price of $9.62 per share. An
aggregate of 2,000,000 shares of Class B Common Stock are subject to the
Investor Warrants. The Investor Warrants expire on June 6, 2007. The aggregate
purchase price of the Investor Warrants was $40,000.
The Company also issued common stock warrants (collectively, the "Shattan
Warrants") to The Shattan Group, LLC, which acted as the Company's placement
agent for the sale of securities to MDP and Olympus. The Shattan Warrants, which
were issued as of June 6, 1997 and July 15, 1997, respectively, entitle the
holders thereof to purchase an aggregate of 241,217 shares of Class B Common
Stock at an exercise price of $9.62 per share and expire on June 6, 2002 and
July 15, 2002, respectively. The aggregate purchase price of the Shattan
Warrants was $4,824.
KELLER RESTRICTED STOCK. During the year ended December 31, 1997, the
Company issued a total of 187,982 shares of Common Stock to Robert P. Keller,
President and Chief Executive Officer of the Company, pursuant to the terms of
the Mr. Keller's Employment Agreement with the Company. This issuance is in
addition to 25,796 shares under the same agreement related to activity in 1996
and reflected in 1997. The Company issuance of those shares was exempt from
registration under the Securities Act by virtue of Regulation D thereunder
and/or Section 4(2) thereof.
39
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with the
Consolidated Financial Statements of the Company and the Notes thereto,
appearing elsewhere in this Annual Report, and the information set forth under
"Capitalization," "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and "Unaudited Pro Forma Combined Condensed Financial
Information." As described elsewhere in this Annual Report, due to the three
acquisitions that the Company completed between September 1995 and June 30,
1997, which were accounted for using the purchase method of accounting, the
Company's historical operating results prior to June 30, 1997 are of limited
relevance in evaluating the Company's historical financial performance and
predicting the Company's future operating results. The selected historical
financial data as of and for the five years ended December 31, 1997 are derived
from the Company's Consolidated Financial Statements which have been audited by
independent public accountants.
<TABLE>
<CAPTION>
AS OF AND FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------------------------
1997 1996 1995 1994 1993
----------- ----------- --------- --------- ---------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<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
Noninterest income...................................... 14,904 4,899 696 666 655
Noninterest expenses
Amortization of goodwill and intangibles.............. 2,514 268 -- -- --
Carrying costs and losses on OREO..................... 382 288 531 222 182
Provision for recourse obligations.................... 2,021 -- -- -- --
Other noninterest expense............................. 34,771 14,714 3,760 3,711 4,358
----------- ----------- --------- --------- ---------
Total noninterest expense........................... 39,688 15,270 4,291 3,933 4,540
----------- ----------- --------- --------- ---------
Income (loss) before income taxes and extraordinary
item.................................................. 6,602 822 (1,073) (989) (1,976)
Income tax benefit (provision).......................... (3,612) 1,503 443 -- --
----------- ----------- --------- --------- ---------
Income (loss) before extraordinary item................. 2,990 2,325 (630) (989) (1,976)
Extraordinary item(1)................................... -- -- 625 -- --
----------- ----------- --------- --------- ---------
Net income (loss)....................................... 2,990 2,325 (5) (989) (1,976)
Preferred dividends..................................... 731 -- -- -- --
----------- ----------- --------- --------- ---------
Net income (loss) available to common................... $ 2,259 $ 2,325 $ (5) $ (989) $ (1,976)
----------- ----------- --------- --------- ---------
----------- ----------- --------- --------- ---------
PER SHARE DATA(2):
Weighted average shares outstanding
Basic................................................. 7,406,062 2,650,386 134,099 26,864 26,864
Diluted............................................... 8,634,651 2,650,386 134,099 26,864 26,864
Basic:
Income (loss) before extraordinary item................. $ .31 $ .88 $ (4.70) $ (36.82) $ (73.56)
Extraordinary item...................................... -- -- 4.66 -- --
----------- ----------- --------- --------- ---------
Net income (loss) per share............................. $ .31 $ .88 $ (.04) $ (36.82) $ (73.56)
Net income (loss) per share,excluding goodwill
amortization(3)....................................... $ .64 $ .98 $ (.04) $ (36.82) $ (73.56)
Diluted:
Income (loss) before extraordinary item................. $ .26 $ .88 $ (4.70) $ (36.82) $ (73.56)
Extraordinary item...................................... -- -- 4.66 -- --
----------- ----------- --------- --------- ---------
Net income (loss) per share............................. $ .26 $ .88 $ (.04) $ (36.82) $ (73.56)
Net income (loss) per share, excluding goodwill
amortization(3)....................................... $ .55 $ .98 $ (.04) $ (36.82) $ (73.56)
</TABLE>
- --------------------------
(1) Forgiveness of indebtedness net of $443,000 income tax benefit.
(2) Share and per share amounts have been retroactively restated to reflect (i)
a one-for-two reverse split of the Common Stock effective September 4, 1998
and (ii) changes in the presentation of earnings per share as set forth in
the Notes to the Company's Consolidated Financial Statements.
40
<PAGE>
(3) Excludes the amortization of goodwill and other intangibles. Although such
presentation is not defined by Generally Accepted Accounting Principals
("GAAP"), management believes it to be beneficial to gaining an
understanding of the Company's financial performance in comparison to its
peer group.
<TABLE>
<CAPTION>
AS OF AND FOR THE YEARS ENDED DECEMBER 31,
------------------------------------------------------------
1997 1996 1995 1994 1993
----------- ----------- --------- ------- -------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED FINANCIAL POSITION
Total assets............................................ $ 902,355 $ 437,060 $ 55,905 $57,686 $61,916
Loans and leases, net................................... 605,883 320,958 38,338 45,492 48,179
Goodwill and other intangibles.......................... 66,769 10,736 -- -- --
Deposits................................................ 765,203 383,031 51,431 55,876 59,651
Long-term debt.......................................... 27,657 537 537 1,894 1,894
Common shareholders' equity............................. 83,077 40,772 3,541 (948) 41
Shareholders' equity (deficit).......................... 94,736 40,772 3,541 (948) 41
Average assets.......................................... 706,327 241,866 56,995 61,312 66,515
Average earning assets.................................. 571,091 198,720 50,329 53,873 58,632
Average common equity................................... 65,539 20,698 (81) (572) 981
Per share data(2):
Common shares outstanding............................... 9,173,698 4,848,715 447,734 26,864 26,864
Diluted common shares outstanding....................... 9,652,238 4,848,715 447,734 26,864 26,864
Book value per share.................................... $ 9.06 $ 8.41 $ 7.91 $(35.39) $ 1.53
Diluted book value per share............................ 8.61 8.41 7.91 (35.39) 1.53
Tangible book value per share........................... 1.78 6.19 7.91 (35.39) 1.53
Diluted tangible book value per share................... 1.69 6.19 7.91 (35.39) 1.53
SELECTED PERFORMANCE RATIOS
Return on average assets................................ .42% .96% (.01)% (1.61)% (2.97)%
Return on average assets, excluding goodwill
amortization(3)....................................... .78 1.07 (.01) (1.61) (2.97)
Return on average common equity......................... 3.45 11.23 nm(4) nm(4) (201.43)
Return on average common equity, excluding goodwill
amortization(3)....................................... 7.28 12.53 nm(4) nm(4) (201.43)
Net yield on interest earning assets.................... 5.76 5.89 5.60 5.31 5.10
Noninterest income to average assets.................... 4.66 4.84 4.94 4.67 4.50
Efficiency ratio(5)..................................... 72.77 88.60 107.03 105.22 119.43
SELECTED ASSET QUALITY RATIOS(6)
Nonperforming assets to total portfolio loans and leases
and OREO.............................................. 3.95% 4.73% 7.50% 7.93% 7.60%
Nonperforming assets to total assets.................... 2.30 2.89 5.42 6.55 6.20
Allowance for loan and lease losses to portfolio loans
and leases............................................ 1.80 1.96 1.64 1.77 1.68
Allowance for loan and lease losses to nonperforming
loans and leases...................................... 52.18 57.31 39.44 32.95 34.41
Net charge-offs to average portfolio loans and leases... .29 .26 1.13 1.25 2.10
SELECTED CAPITAL RATIOS
Tier 1 Leverage Ratio................................... 6.59% 6.98% 6.25% nm%(5) 0.07%
Tier 1 Risk-Weighted Ratio.............................. 8.85 9.22 8.67 nm(5) 0.08
Total Risk-Weighted Ratio............................... 10.18 10.64 11.24 nm(5) 0.20
Average common equity to average assets................. 9.28 8.56 nm(5) nm(5) 1.47
</TABLE>
- --------------------------
(4) Not meaningful as the average common equity for 1995 and 1994 and
shareholders' equity for 1994 were negative.
(5) As used in this Annual Report, the term efficiency ratio means the Company's
noninterest expense--excluding goodwill amortization of goodwill and other
intangibles, losses and carrying costs of OREO and provision for recourse
obligations--as a percentage of total revenue. The Company's definition of
its efficiency ratio may not be comparable to that used by its peer group.
(6) Selected Asset Quality Ratios and Selected Capital Ratios are end of period
ratios, except for net charge-offs to average portfolio loans and leases,
average equity to average assets and the leverage ratio. The average ratios
are based on daily averages for the indicated periods and are annualized
where appropriate. The leverage ratio is based on the average daily balances
for the three-month period ended as of the indicated date. Portfolio loans
and leases are exclusive of residential mortgage loans held for sale. For
definitions and information relating to the Company's regulatory capital
requirements, see "Supervision and Regulation."
41
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Liberty, CSB and Eldorado acquisitions were accounted for using the
purchase method of accounting for business combinations. Accordingly, the
following discussion relates to the operating results of San Dieguito, Liberty
and CSB for the year ended December 31, 1997 and the operating results of
Eldorado Bank for the seven months ended December 31, 1997. By comparison, the
Company's operating results for the year ended December 31, 1996 reflect the
operating results of San Dieguito for the year 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 year ended December 31, 1995 reflect only
the operating results of San Dieguito and were affected by a recapitalization
(the "SDN Recapitalization") in connection with DCG's acquisition of control of
SDN.
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 noninterest income of $21.2 million and $10.0 million, respectively,
partially offset by increased provision for loan and lease losses, noninterest
expense and income taxes of $980,000, $24.4 million and $5.1 million,
respectively. Basic net income per share in 1997 was $.31 compared to $.88 in
1996, while diluted net income per share in 1997 was $.26 per share compared to
$.88 in 1996. Excluding the amortization of goodwill and other intangibles,
basic and diluted earnings per share for the year ended December 31, 1997 were
$.64 and $.55, respectively, as compared to $.98 and $.98 for the year ended
December 31, 1996. The Company's return on average assets was .42% and its
return on average common equity was 3.45% for the year ended December 31, 1997,
as compared to .96% and 11.23%, respectively, for the year ended December 31,
1996. Excluding the amortization of goodwill and other intangibles, return on
average assets was .78% and return on average common equity was 7.28% for the
year ended December 31, 1997, as compared to 1.07% and 12.53%, respectively, for
the year ended December 31, 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 net loss is a $625,000 extraordinary gain from
extinguishment of debt, net of tax benefit of $443,000, in connection with the
SDN 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, noninterest
income and tax benefit of $8.9 million, $4.2 million and $1.5 million,
respectively, partially offset by increased provision for loan and lease losses
and noninterest expense of $227,000 and $11.0 million, respectively. Basic net
income per share in 1996 was $.88 per share compared to a net loss per share of
$.04 (after adjustment for extraordinary item) in 1995, while diluted net income
per share in 1996 was $.88 compared to net loss per share of $.04 (after
adjustment for extraordinary item) in 1995. Excluding the amortization of
goodwill and other intangibles, basic and diluted earnings per share for the
year ended December 31, 1996 were $.98 and $.98, respectively. There was no
goodwill amortization for the year ended December 31, 1995. The Company's return
on average assets was .96% and its return on average common equity was 11.23%
for the year ended December 31, 1996. For the year ended December 31, 1995, the
Company's return on average assets was (.01)% and its return on average common
equity was not meaningful, since average common equity was negative for the year
ended December 31, 1995. Excluding the amortization of goodwill and other
intangibles, return on average assets was 1.07% and return on average common
equity was 12.53% for the year ended December 31, 1996.
42
<PAGE>
RESULTS OF OPERATIONS
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 9.4% in 1997 from 9.7% in 1996 and
the cost of average interest-bearing liabilities remained stable at 4.6% in 1997
and 1996. As a result of those factors, the net yield on earning assets declined
to 5.8% in 1997 from 5.9% in 1996.
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 interest-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 9.7% from 9.1% in 1995 and the cost of interest-bearing
liabilities rose to 4.7% from 3.9% in 1995. As a result of those factors, the
net yield on earning assets rose to 5.9% in 1996 from 5.6% in 1995.
Loan fee income increased $1.7 million to $2.9 million in 1997 from $1.2
million in 1996. This increase is primarily attributable to the fees earned on
the sale of SBA loans into the secondary market. See "Business--Products and
Services--Community Banking Division." Loan fee income increased $1.1 to $1.2
million in 1996 from $104,000 in 1995.
The following table 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
43
<PAGE>
expressed in both dollars and rates. Nonaccrual loans are included in the
calculation of the average loans while nonaccrued interest thereon is excluded
from the computation of rates earned.
<TABLE>
<CAPTION>
YEAR ENDED,
---------------------------------------------------------------------------------------
DECEMBER
DECEMBER 31, 1997 DECEMBER 31, 1996 31, 1995
------------------------------------ ------------------------------------ -----------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME OR YIELD OR AVERAGE INCOME OR YIELD OR AVERAGE
BALANCE EXPENSE COST BALANCE EXPENSE COST BALANCE
--------- ----------- ------------ --------- ----------- ------------ -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets:
Loans and leases(1)................... $ 464,788 $ 47,230 10.16% $ 146,743 $ 16,383 11.16% $ 42,272
Investment Securities(2).............. 82,450 4,979 6.04 32,886 1,968 5.98 5,061
Federal funds sold.................... 23,853 1,286 5.39 17,837 934 5.24 2,128
Other earning assets.................. -- -- -- 1,254 67 5.34 868
--------- ----------- --------- ----------- -----------
Total interest-earning assets:.... 571,091 53,495 9.37% 198,720 19,352 9.74% 50,329
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
Money market........................ 68,943 2,336 3.39 18,135 493 2.72 9,176
Savings............................. 106,956 5,117 4.78 28,917 1,150 3.98 5,235
Time................................ 170,809 9,365 5.48 91,987 5,241 5.70 18,394
--------- ----------- --------- ----------- -----------
Total interest-bearing deposits... 415,532 18,143 4.37 163,503 7,570 4.63 43,297
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
--------- ----------- --------- ----------- -----------
Total interest-bearing
liabilities..................... 443,992 20,614 4.64% 164,458 7,644 4.65% 45,073
Noninterest-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
----------- -----------
----------- -----------
Net yield on interest-earning
assets.............................. 5.76% 5.89%
<CAPTION>
INTEREST AVERAGE
INCOME OR YIELD OR
EXPENSE COST
----------- ------------
<S> <C> <C>
ASSETS
Interest-earning assets:
Loans and leases(1)................... $ 4,086 9.67%
Investment Securities(2).............. 311 6.15
Federal funds sold.................... 117 5.50
Other earning assets.................. 54 6.22
-----------
Total interest-earning assets:.... 4,568 9.08%
Non-earning assets:
Cash and demand deposits with banks...
Other assets..........................
Total assets......................
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
Deposits
Interest-bearing demand............. 149 1.42%
Money market........................ 231 2.52
Savings............................. 115 2.20
Time................................ 1,075 5.84
-----------
Total interest-bearing deposits... 1,570 3.63
Short-term borrowing.................. -- --
Long-term debt........................ 181 10.19
-----------
Total interest-bearing
liabilities..................... 1,751 3.88%
Noninterest-bearing liabilities:
Demand deposits.....................
Other liabilities...................
Total liabilities.................
Shareholders' equity..................
Total liabilities and shareholders'
equity..............................
-----------
-----------
Net interest income................... $ 2,817
-----------
-----------
Net yield on interest-earning
assets.............................. 5.60%
</TABLE>
- ------------------------------
(1) 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.
44
<PAGE>
The following table sets forth changes in interest income and interest
expense on the basis of allocation to changes in rates and changes in volume of
the various components. Changes due to a combination of rate and volume are
presented under the column titled "Mix." Nonaccrual loans are included in total
loans outstanding while nonaccrued 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 CHANGE RATE VOLUME MIX NET CHANGE RATE VOLUME
----------- --------- --------- --------- ----------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Interest Income:
Loans and leases.......................... $ 30,847 $ (1,472) $ 35,507 $ (3,188) $ 12,297 $ 633 $ 10,099
Investment securities..................... 3,011 18 2,966 27 1,657 (8) 1,710
Federal funds sold........................ 352 28 315 9 817 (6) 864
Other earning assets...................... (67) -- (67) -- 13 (8) 24
----------- --------- --------- --------- ----------- --------- ---------
Total interest income................... 34,143 (1,426) 38,721 (3,152) 14,784 611 12,697
Interest Expense:
Interest-bearing demand................... 639 (215) 1,244 (390) 537 145 199
Money market.............................. 1,843 121 1,381 341 262 18 226
Savings................................... 3,967 233 3,104 630 1,035 93 520
Time...................................... 4,124 (198) 4,491 (169) 4,166 (27) 4,301
Short-term borrowing...................... 550 (12) 703 (141) 13 -- --
Long-term debt............................ 1,847 3 1,754 90 (120) 21 (127)
----------- --------- --------- --------- ----------- --------- ---------
Total interest expense.................. 12,970 (68) 12,677 361 5,893 250 5,119
----------- --------- --------- --------- ----------- --------- ---------
Net interest income....................... $ 21,173 $ (1,358) $ 26,044 $ (3,513) $ 8,891 $ 361 $ 7,578
----------- --------- --------- --------- ----------- --------- ---------
----------- --------- --------- --------- ----------- --------- ---------
<CAPTION>
MIX
---------
<S> <C>
Interest Income:
Loans and leases.......................... $ 1,565
Investment securities..................... (45)
Federal funds sold........................ (41)
Other earning assets...................... (3)
---------
Total interest income................... 1,476
Interest Expense:
Interest-bearing demand................... 193
Money market.............................. 18
Savings................................... 422
Time...................................... (108)
Short-term borrowing...................... 13
Long-term debt............................ (14)
---------
Total interest expense.................. 524
---------
Net interest income....................... $ 952
---------
---------
</TABLE>
NONINTEREST INCOME
Noninterest income increased 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
Mortgage Banking Division for twelve months in 1997 compared to only four months
in 1996. In addition, the increase was in part the result of (i) the Eldorado
Acquisition, completed in June 1997, and (ii) the inclusion of a full year of
operations for Liberty and CSB in 1997 as compared to the inclusion of only
partial year in 1996. See "Business."
Noninterest 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
noninterest income earned at Liberty and CSB. The sources of this fee income is
primarily derived from the servicing and sale of SBA loans, the origination and
sale residential mortgages and the sale of small equipment leases.
The following table presents for the periods indicated the major categories
of noninterest income:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Service charges on deposit accounts.............................. $ 2,675 $ 760 $ 464
Gains on sale of mortgage loans.................................. 6,887 1,727 --
SBA loan servicing............................................... 2,353 1,519 --
Other income..................................................... 2,989 893 232
--------- --------- ---------
Total noninterest income....................................... $ 14,904 $ 4,899 $ 696
--------- --------- ---------
--------- --------- ---------
</TABLE>
45
<PAGE>
NONINTEREST EXPENSES
Noninterest expense increased by $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 in June 1997. Also included in this increase
is the amortization of goodwill, which for 1997 was $2.2 million compared to
$268,000 in 1996. The Company's efficiency ratio was 72.77% for the year ended
December 31, 1997, a decrease of 15.83%, from 88.60% for 1996. For purposes of
this Annual Report, the efficiency ratio is defined as noninterest
expense--excluding the amortization of goodwill and other intangibles, losses
and carrying costs of OREO and nonrecurring provisions for recourse
obligations--as a percentage of total revenue.
Noninterest expense increased by $11.0 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 categories of salaries
and employee benefits by $5.0 million, occupancy and equipment by $1.9 million
and $4.1 million in other noninterest expenses. Included in this increase is the
amortization of goodwill, which for 1996 was $268,000 and none in 1995. The
Company's efficiency ratio was 88.60% for the year ended December 31, 1996, as
compared to 107.03% for 1995.
The following table presents for the periods indicated the major categories
of noninterest expense:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Salaries and employee benefits.................................................... $ 16,172 $ 6,816 $ 1,811
Non-staff expenses
Occupancy and equipment........................................................... 5,959 2,726 861
Professional, regulatory and other services....................................... 1,230 733 346
Legal............................................................................. 1,437 453 113
Insurance......................................................................... 637 262 114
Losses and carrying costs of OREO................................................. 382 288 531
Provision for recourse obligation................................................. 2,021 -- --
Amortization of goodwill and other intangibles.................................... 2,514 268 --
Other............................................................................. 9,336 3,724 515
--------- --------- ---------
Total non-staff expense......................................................... 23,516 8,454 2,480
--------- --------- ---------
Total noninterest expense..................................................... $ 39,688 $ 15,270 $ 4,291
--------- --------- ---------
--------- --------- ---------
</TABLE>
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 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's effective
tax rate for 1997 (54.7%) is higher than the applicable statutory rate (42.0%)
because the goodwill amortization is a charge to earnings for financial
statement purposes and is not deductible for federal income tax purposes.
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 resulted from the release of the valuation allowance
which had previously been provided against the Company's federal and state
deferred tax assets. That valuation allowance had been provided against the
Company's net operating loss carry forwards and other tax attributes. However,
the Company's operating results adequately supported the realizability of the
deferred tax assets at December 31, 1997 and 1996 and therefore the valuation
allowance was no longer required. Of the $2.0 million total allowance which was
released in 1996,
46
<PAGE>
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.
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 primarily due 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 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 acquisition of loans in the Eldorado
Acquisition account for the increase in total 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 as of the dates indicated.
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------------------
1997 1996 1995 1994 1993
---------- ---------- --------- --------- ---------
(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.................................... 32,132 41,650 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 -- -- --
---------- ---------- --------- --------- ---------
Subtotal (portfolio loans and leases)................... 522,054 263,641 39,022 46,367 49,084
---------- ---------- --------- --------- ---------
Loans and leases held for sale.......................... 96,230 64,917 -- -- --
---------- ---------- --------- --------- ---------
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 and leases.................................... $ 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
47
<PAGE>
maturity and no stated schedule of repayments are reported as due in one year or
less. Residential mortgage loans held for sale are recorded as due after five
years.
<TABLE>
<CAPTION>
DECEMBER 31, 1997
------------------------
COMMERCIAL REAL ESTATE
----------- -----------
(IN THOUSANDS)
<S> <C> <C>
Aggregate maturities of loans and leases 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>
NONPERFORMING ASSETS
The following table shows the total aggregate principal amount of nonaccrual
and other nonperforming 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 nonaccrual and
those that have been restructured. For the 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.
48
<PAGE>
The following table summarizes the loans and leases for which the accrual of
interest has been discontinued and loans and leases more than 90 days past due
and still accruing interest, including those loans and leases that have been
restructured:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Nonaccrual loans and leases, not restructured.................. $ 10,589 $ 5,483 $ 1,492 $ 616 $ 637
Accruing loans and leases past due 90 days or more............. 4,638 1,314 46 826 150
Restructured loans and leases.................................. 2,779 2,200 82 1,050 1,605
--------- --------- --------- --------- ---------
Total nonperforming loans and leases ("NPLs").............. 18,006 8,997 1,620 2,492 2,392
--------- --------- --------- --------- ---------
Other real estate owned ("OREO")............................... 2,740 3,635 1,411 1,288 1,446
--------- --------- --------- --------- ---------
Total nonperforming assets ("NPAs")........................ $ 20,746 $ 12,632 $ 3,031 $ 3,780 $ 3,838
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Selected ratios:
NPLs to total portfolio loans and leases(1).................. 3.5% 3.4% 4.2% 5.4% 4.9%
NPAs to total portfolio loans and leases and OREO(1)......... 4.0 4.7 7.5 7.9 7.6
NPAs to total assets......................................... 2.3 2.9 5.4 6.6 6.2
</TABLE>
- ------------------------
(1) Excludes residential mortgages held for sale.
Loans aggregating $13.4 million at December 31, 1997 were 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. In calculating the allowance for loan and lease
losses that was required under the Company's internal guidelines, management
determined that a minimun of $1.6 million should be included in the allowance at
December 31, 1997 because of the risk to the loan and lease portfolio
represented by impaired loans. At December 31, 1996, loans aggregating $7.7
million were designated as impaired and management determined that a minimum of
$695,000 should be included in the allowance because of the risk to the loan and
lease portfolio represented by such impaired loans.
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 was acquired in the
Eldorado Acquisition and $3.6 million was acquired as a result of foreclosures.
During 1997, OREO properties with a total carrying value of $3.9 million were
sold and OREO 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 was acquired in total in
the Liberty and CSB acquisitions and $2.3 million was acquired as a result of
foreclosures. OREO properties with a total carrying value of $4.1 million were
sold and properties were written down by approximately $72,000 during 1996.
ALLOWANCE FOR LOAN AND LEASE LOSSES
The allowance for loan and lease losses was $9.4 million, or 1.8% of gross
portfolio loans and leases at December 31, 1997, compared to $5.2 million or
1.9% of gross portfolio loans and leases, at December 31, 1996, and $639,000, or
1.6%, of gross portfolio loans and leases at December 31, 1995. The provision
for loan and leases 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.
49
<PAGE>
The table below summarizes average loans outstanding, gross portfolio loans,
nonperforming 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 and leases outstanding(1)................. $ 464,788 $ 146,743 $ 42,272 $ 46,979 $ 49,243
Gross portfolio loans and leases(1)..................... 522,054 263,641 39,022 46,367 49,084
Nonperforming loans and leases.......................... 18,006 8,997 1,620 2,492 2,392
Allowance for loan and lease losses:
Balance at beginning of period...................... $ 5,156 $ 639 $ 821 $ 823 $ 771
Balance acquired during period...................... 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 1,095
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............... 1,332 380 477 585 1,033
Provision for loan and lease losses............... 1,495 515 295 583 1,085
---------- ---------- --------- --------- ---------
Balance at end of period........................ $ 9,395 $ 5,156 $ 639 $ 821 $ 823
---------- ---------- --------- --------- ---------
---------- ---------- --------- --------- ---------
Selected ratios:
Net charge-offs to average loans and leases
(annualized)........................................ .29% .26% 1.13% 1.25% 2.10%
Provision for loan and lease losses to average
loans............................................... .32 .35 .70 1.24 2.22
Allowance at end of period to gross portfolio loans
and leases outstanding at end of period............. 1.80 1.96 1.64 1.77 1.68
Allowance as percentage of nonperforming loans and
leases.............................................. 52.18 57.31 39.44 32.95 34.41
</TABLE>
- ------------------------
(1) Excludes residential mortgages held for sale.
50
<PAGE>
The following table indicates management's allocation of the allowance for
each of the following years:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------------------
1997 1996 1995
-------------------- -------------------- --------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Allocated amount:
Commercial, financial and agricultural.................. $ 799 8.5% $ 980 19.0% $ 32 5.0%
Real estate and construction............................ 1,864 19.8 1,680 32.6 242 37.9
Consumer................................................ 602 6.4 461 8.9 51 8.0
Unallocated............................................. 6,130 65.3 2,035 39.5 314 49.1
--------- --------- --------- --------- --------- ---------
Total................................................. $ 9,395 100.0% $ 5,156 100.0% $ 639 100.0%
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
</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 acquired subsidiary banks. While the Company has made
a reasonable effort 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
as a single unallocated allowance available for losses on all types of loans and
leases, and actual losses in loan categories may vary from the amounts allocated
to such categories.
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 and 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 62.7% of the total portfolio,
at December 31, 1997. The investments of the Company also include Federal funds
sold that were $40.0 million, or 37.3% of the total portfolio at December 31,
1997.
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>
DECEMBER 31, 1997
------------------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAIN LOSS VALUE
----------- ------------- ------------- -----------
(IN THOUSANDS)
<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>
51
<PAGE>
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
AFTER TEN
WITHIN ONE YEAR WITHIN FIVE YEARS WITHIN TEN YEARS YEARS
---------------------- ---------------------- ---------------------- ---------
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT
--------- ----- --------- ----- --------- ----- ---------
(DOLLARS IN THOUSANDS)
<S> <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
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
--------- --------- --------- ---------
--------- --------- --------- ---------
<CAPTION>
YIELD
-----
<S> <C>
Securities available-for-sale:
U.S. Treasuries..................... -- %
U.S. Government agencies............ --
State and municipal bonds........... --
Mortgage-backed securities.......... 7.44
Corporate debt and other............ --
Total investment portfolio........ 7.44%
</TABLE>
Additional information concerning investment securities is provided in the
notes to the accompanying financial statements.
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 deposits acquired in the Eldorado Acquisition.
Noninterest-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%, 12.9%, 12.8%, 13.1% and 10.7% of total
deposits, respectively, at December 31, 1997. See "Business--Products and
Services."
The following table shows the average balance and average rate paid on the
categories of deposits for each of years indicated:
<TABLE>
<CAPTION>
1997 1996 1995
----------------------- ----------------------- ----------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE RATE BALANCE RATE BALANCE RATE
---------- ----------- ---------- ----------- --------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Noninterest-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>
A significant amount of the Company's interest-bearing deposits are
generated from title and escrow companies that customarily do not deposit funds
with the Bank until mortgage funding occurs, which is typically a month-end
event. See "Risk Factors--Reliance on Certain Funding Sources" and "Business--
Products and Services--Community Banking Division."
52
<PAGE>
The following table shows the maturities of time certificates of deposits of
$100,000, or more at December 31, 1997:
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-----------------
(IN THOUSANDS)
<S> <C>
Due in three months or less................................................ $ 34,153
Due in over three months through six months................................ 40,012
Due in over six months through twelve months............................... 2,508
Due in over twelve months.................................................. 5,403
-------
Total.................................................................... $ 82,076
-------
-------
</TABLE>
BORROWINGS
Borrowings of the Company increased to $30.2 million at December 31, 1997
from $5.0 million at December 31, 1996. The increase in borrowings was primarily
due to the issuance of subordinated debentures to fund a portion of the Eldorado
Acquisition.
CAPITAL RESOURCES
Current 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 adjusted total assets ("Tier 1 Leverage Ratio")
of at least 3%, a ratio of Tier 1 Capital to risk-weighted assets of at least 4%
("Tier 1 Risk-Weighted Ratio"), and a ratio of total capital (which includes
Tier 1 capital plus certain forms of subordinated debt, a portion of the
allowance for loan and lease losses and preferred stock) to risk-weighted assets
("Total Risk-Weighted Ratio") 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 at 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, window borrowing from the Federal
Reserve Bank and, to a lesser extent, borrowings from the FHLB, could be
employed. The Company has relied primarily upon the purchase of Federal funds
and the sale of securities under agreements to repurchase for secondary sources
of liquidity. At December 31, 1997 the Company had $17.0 million of unused
borrowing capacity under FHLB advances. In order to borrow from the Federal
Reserve, the Company would be
53
<PAGE>
required to physically deliver to the Federal Reserve collateral consisting of
marketable Government securities. At December 31, 1997, the Company has no such
collateral at the Federal Reserve. The Company believes that it could deliver to
the Federal Reserve collateral sufficient to support up to $19.0 million of
window borrowings.
YEAR 2000 PREPAREDNESS
The Year 2000 issue is a computer programming concern that may affect many
electronic processing systems. Until relatively recently, in order to minimize
the length of data fields, most computer programs eliminated the first two
digits of the year. This problem could affect computers leaving them unable to
distinguish dates in the twentieth and twenty-first centuries. For example,
date-sensitive calculations that treat "00" as the year 1900, rather than 2000.
Secondly, years that end in "00" are not leap years, except for an anomaly in
the year 2000. This anomaly could result in miscalculations when processing
critical date-sensitive information relating to periods after December 31, 1999.
The Year 2000 issue may adversely affect the Company's information
technology systems, such as its item and data processing applications. The Year
2000 issue also may affect so-called embedded technology, such as
microprocessors that control some of the Company's security systems and
telecommunication equipment.
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. In response, a plan has been developed that provides
for the assessment of its material internal systems, programs and data
processing applications as well as those provided to the Bank by third-party
vendors. The Company expects that system conversions and testing will be
substantially completed by December 31, 1998. Based upon the Company's
evaluation of its Year 2000 preparedness, management does not expect that the
Year 2000 issue as it relates to information systems and embedded technology
that are within the Company's direct control will have a material adverse effect
on the Company's business, financial condition or results of operations.
However, Year 2000 problems may turn out to exist in portions of computer
programs not now suspected, and there can be no assurance that the Company will
not be adversely affected by this problem.
Ultimately, the potential impact of the Year 2000 issue will depend not only
on the corrective measures the Company undertakes, but also on the way in which
the Year 2000 issue is addressed by governmental agencies, businesses and other
entities who provide data to, or receive data from the Bank or whose financial
condition or operational capability is important to the Company such as
significant 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's and/or vendor's remediation efforts are not completed in a timely
manner. The vendor to which the Community Banking Division has outsourced its
data and item processing received a "satisfactory" rating in 1998 from the
Federal Financial Institutions Examination Council ("FFIEC") (the umbrella
organization of federal bank regulators) with respect to the status of that
vendor's preparedness for the Year 2000 issue.
In addition, because the Company's day-to-day operations are heavily
dependent on its ability to communicate information throughout its network of
branches and loan production offices, the Company would be particularly
susceptible to any possible effects that the Year 2000 issue has on local and
national communications systems, including without limitation, telephone and
data lines, because of the difficultly in implementing viable contingency plans.
Any interruption or malfunction of such systems could have a material adverse
effect on the Company.
Furthermore, bank regulatory agencies, as part of their supervisory
function, have recently issued guidance under which they are assessing and will
assess Year 2000 readiness. The failure of a financial institution, such as the
Company, to take appropriate steps to address deficiencies in its Year 2000
project
54
<PAGE>
management process may result in one or more regulatory enforcement actions
which could have a material adverse effect on such institution. Such actions may
include the imposition of civil money penalties, or result in the delay or
denial of regulatory applications. In the latest joint examination of the Bank
by the Federal Reserve and the DFI, the Bank received a "satisfactory" rating
with respect to its Year 2000 plan and level of preparedness.
The Company's noninterest expense for 1997 did not include any costs
associated with the Year 2000 issue. The Company estimates its total costs
during the period from January 1, 1998 through December 31, 1999 will be less
than $500,000, and none of those costs are expected to materially affect the
Company's results of operations in any one reporting period. In light of the
complexity of the Year 2000 problem and its potential effect on both the Company
and third parties that interact with the Company, however, there can be no
assurance that the Company's costs associated with the Year 2000 issue will be
as estimated. The Company does not intend to obtain insurance against any Year
2000 risks.
55
<PAGE>
ECONOMIC CONSIDERATIONS
CALIFORNIA ECONOMY
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,
Sacramento and San Diego. 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 deteriorate 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 1997, California's Gross State Product ("GSP") exceeded $1.0 trillion,
with exports to foreign countries totaling $110 billion or 10.7% of the State's
GSP. California, with its greater dependence on Asian trade and investment, is
more at risk from Asia's economic problems than the rest of the United States.
Exports to Asian countries represented 47% of California's total exports,
compared to 29% for the U.S. as a whole. Despite a moderate (1.8%) drop in
export to Asian countries, California's total exports increased by 6% in 1997
primarily as a result of an increase in growing exports to Mexico, Canada,
Australia and Western Europe. There can be no assurance that the State's economy
will not be adversely affected by prolonged weakness in one or more of the Asian
economies. Weaker Asian demand for products and services could potentially
result in job losses, primarily in the high-tech manufacturing, engineering,
travel and entertainment industries. The Los Angeles area is among the most
vulnerable regions in California with its relatively heavy concentration of
high-tech, engineering and entertainment firms. There can be no assurance that a
deterioration of economic conditions in California as a result of Asia's
economic problems will not have a material adverse effect on the Company's
business, financial condition or result of operations.
In addition, a substantial portion of the Company's assets consist of loans
secured by real estate in Southern California with a lesser 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. See "Risk Factors-- Potential Impact of
Changes in Interest Rates."
56
<PAGE>
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 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 1998.
57
<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.
58
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-----------------------------------------------------------------------
AMOUNTS MATURING OR REPRICING IN
-----------------------------------------------------------------------
OVER 3
MONTHS OVER 1
3 MONTHS TO 12 YEAR TO OVER NON-
OR LESS MONTHS 5 YEARS 5 YEARS SENSITIVE(1) TOTAL
---------- ---------- ---------- ---------- ----------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Cash and due from banks............. $ -- $ -- $ -- $ -- $ 81,030 $ 81,030
Federal funds sold.................. 40,000 -- -- -- -- 40,000
Investment securities............... 11,993 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.
59
<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 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.
60
<PAGE>
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
---------- --------- --------- --------- --------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
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
assets........................ $ 324,801 $ 36,136 $ 45,396 $ 45,475 $ 51,318 $ 222,415 $ 725,541 $ 732,185
---------- --------- --------- --------- --------- ---------- ---------- ----------
---------- --------- --------- --------- --------- ---------- ---------- ----------
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
liabilities................... $ 470,868 $ 7,578 $ -- $ -- $ -- $ 27,657 $ 506,103 $ 503,319
---------- --------- --------- --------- --------- ---------- ---------- ----------
---------- --------- --------- --------- --------- ---------- ---------- ----------
</TABLE>
61
<PAGE>
ITEM 8. FINANCIAL STATEMENTS
Share and per share data reflected in the audited financial statements and
notes thereto have not been adjusted to reflect the 1-for-2 reverse split
effective September 4, 1998.
<TABLE>
<CAPTION>
FINANCIAL STATEMENTS PAGE NO.
- -------------------------------------------------------------------------------------------------------- -------------
<S> <C>
Report of Independent Accountants....................................................................... F-1
Consolidated Statements of Condition as of December 31, 1997 and 1996................................... F-2
Consolidated Statements of Operations for the Years ended December 31, 1997, 1996 and 1995.............. F-4
Consolidated Statements of Shareholders' Equity for the Years ended December 31, 1997, 1996 and 1995.... F-5
Consolidated Statements of Cash Flows for the Years ended December 31, 1997, 1996 and 1995.............. F-6
Notes to Consolidated Financial Statements--December 31, 1997, 1996 and 1995............................ F-8
</TABLE>
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
62
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth the directors of the Company and the
executive officers of the Company and the Bank.
<TABLE>
<CAPTION>
NAME AGE POSITION
- -------------------------------------------- ----------- --------------------------------------------------------------
<S> <C> <C>
Robert P. Keller............................ 60 President, Chief Executive Officer and Director
Curt A. Christianssen....................... 37 Executive Vice President, Treasurer and Chief Financial
Officer
Richard Korsgaard........................... 57 Executive Vice President Construction Loan Division and CRA
Officer
Paul F. Rodeno.............................. 43 Executive Vice President Operations
Ernest J. Boch.............................. 71 Director
James A. Conroy............................. 38 Director
Edward A. Fox............................... 62 Chairman of the Board of Directors
Charles E. Hugel............................ 70 Director
Mitchell A. Johnson......................... 56 Director
K. Thomas Kemp.............................. 57 Director
Jefferson W. Kirby.......................... 36 Director
John B. Pettway............................. 35 Director
Henry T. Wilson............................. 38 Director
Paul R. Wood................................ 44 Director
</TABLE>
ROBERT P. KELLER has served as President and Chief Executive Officer of the
Company and its predecessor since September 1995. Mr. Keller also has served as
Chairman, President and Chief Executive Officer of the Bank since June 1997,
when Commerce Security Bank, Liberty National Bank, San Dieguito National Bank
and Eldorado Bank were consolidated via mergers into the Bank, and Mr. Keller
served in those same capacities at each of those institutions during the period
between their acquisition by the Company and their consolidation into the Bank.
From 1994 to 1995, Mr. Keller was President and Chief Executive Officer of
Independent Bancorp of Arizona, Inc., a Nasdaq-listed bank holding company with
assets of $1.8 billion, which was acquired by Norwest Corporation in February
1995. From October 1991 to June 1994, Mr. Keller served as President and Chief
Executive Officer of New Dartmouth Bank, a privately-owned financial institution
with assets of $1.7 billion, located in Manchester, New Hampshire, which was
acquired by Shawmut National Corporation in 1994. From 1989 to 1991, he served
as Chief Operating Officer of Dartmouth Bancorp, Inc., also located in
Manchester, New Hampshire. During 1988 and 1989, Mr. Keller served as Executive
Vice President and Chief Operating Officer of American Federal Bank in Dallas,
Texas, which was created through the merger of 12 independent thrifts under the
Southwest Plan. Prior to 1988, he served for 13 years as an officer of Indian
Head Banks Inc. of New Hampshire (acquired by the Fleet/Norstar Group Inc. in
1988), most recently as Executive Vice President and Chief
Financial/Administrative Officer. Mr. Keller also serves on the boards of
directors of Haverford Industries, LLC, Pennichuck Corporation and White
Mountains Holdings, Inc. Mr. Keller also serves as the President, Chief
Executive Officer and a director of Dartmouth Capital Group, Inc. ("DCG General
Partner"), the sole general partner of DCG.
CURT A. CHRISTIANSSEN is the Executive Vice President, Treasurer and Chief
Financial Officer of the Company and the Bank, and the Treasurer and Chief
Financial Officer of DCG General Partner. He served as Chief Financial Officer
of Liberty from October 1993 until its acquisition in March 1996 by the
Company's predecessor. From October 1991 to April 1993, Mr. Christianssen served
as an Executive Vice President and Chief Financial and Administrative Officer of
Olympic National Bank. Previously, Mr. Christianssen was with the Resolution
Trust Company as a Vice President responsible for general
63
<PAGE>
accounting and data processing for Gibraltar Savings and Loan Association, a $15
billion institution, and as the Chief Financial Officer for the receiver for
Unity Savings and Loan Association.
RICHARD KORSGAARD is the Bank's Executive Vice President responsible for its
Construction Loan Division. Mr. Korsgaard also serves as the Bank's CRA Officer.
Mr. Korsgaard served as Executive Vice President/Construction Lending Division
and Director of Eldorado Bank and a director of Eldorado Bancorp from October
1995 until June 1997 when Eldorado was acquired by the Company. From June 1982
to October 1995, Mr. Korsgaard served as President, Chief Executive Officer and
Director of Mariners Bank, a $75 million community bank headquartered in San
Clemente, California. Mariners Bank was acquired by Eldorado Bancorp in October
1995.
PAUL F. RODENO is the Bank's Executive Vice President in charge of its
retail branch system, retail product departments and the bank's marketing
programs. From October 1995 to June 1997, when San Dieguito National Bank was
merged into Eldorado Bank, Mr. Rodeno served as its Executive Vice President and
Chief Operating Officer. Mr. Rodeno served as Executive Vice President/Loan
Administration of San Dieguito National Bank from July 1986 until September
1995, when San Dieguito was acquired by the Company's predecessor. Prior to
joining San Dieguito, Mr. Rodeno had years of experience as a commercial loan
officer for First Interstate Bank.
ERNEST J. BOCH has been Chairman and Chief Executive Officer of Subaru of
New England, Inc. since 1970. He is also the majority owner of Boch Oldsmobile,
Toyota and Mitsubishi of Norwood as well as founder of Boch Broadcasting
Corporation.
JAMES A. CONROY has been associated since 1990 with Olympus Partners, a
private equity firm, and since December 1993, Mr. Conroy has been a general
partner of Olympus Growth Fund II, L.P., which is a principal shareholder of the
Company, Olympus Executive Fund, L.P. and other funds affiliated with Olympus
Partners. Prior to 1990, Mr. Conroy was a management consultant with Bain &
Company. Mr. Conroy serves on the board of directors of Frontier Vision
Partners, L.P.
EDWARD A. FOX is the Chairman of SLM Holding Corp. in Reston, Virginia, the
parent of Sallie Mae. From 1990 to his retirement in 1994, Mr. Fox served as
Dean of the Amos Tuck School of Business at Dartmouth College in Hanover, New
Hampshire. Prior to 1990, Mr. Fox was founding President and Chief Executive
Officer of Sallie Mae. Mr. Fox currently serves as a director of Delphi
Financial Corp., Greenwich Capital Management Corp. and New England Life
Insurance Company.
CHARLES E. HUGEL served as Chairman and Chief Executive Officer of
Combustion Engineering, Inc. in Stamford, Connecticut from 1982 to 1990. Prior
to joining Combustion Engineering, Inc., he spent 30 years with AT&T, most
recently as an Executive Vice President. Mr. Hugel also served as a director of
Nabisco, Inc. and its corporate successor, RJR/Nabisco, Inc., from 1978 to 1986.
Mr. Hugel presently serves on the board of directors of Pitney-Bowes, Inc.
MITCHELL A. JOHNSON is the President of MAJ Capital Management, Inc., which
he organized in August 1994 after retiring from the Student Loan Marketing
Association (Sallie Mae) in June 1994. Mr. Johnson joined Sallie Mae in 1973 and
served as its Senior Vice President, Corporate Finance from 1987 until his
retirement. Mr. Johnson was the first President and a founding member of the
Washington Association of Money Managers. In addition, Mr. Johnson was a trustee
of the District of Columbia Retirement Board. Currently, Mr. Johnson serves as
trustee of the Citizen Investment Trust, a mutual fund company, and as a
director of the Federal Agricultural Mortgage Corporation (Farmer Mac) and
Whitestone Capital Group, Inc.
K. THOMAS KEMP has served as President and Chief Executive Officer of Fund
American Enterprises Holdings, Inc. (formerly Fireman's Fund Corporation) since
October 1997. From January 1991 to October 1997, Mr. Kemp served as Executive
Vice President of Fund American. Mr. Kemp also has served as Chairman and Chief
Executive Officer of White Mountains Holdings, Inc. since March 1997. From
October 1994 to March 1997, Mr. Kemp served as President and Chief Executive
Officer of White
64
<PAGE>
Mountains. Mr. Kemp serves on the boards of directors of Fund American, White
Mountains, Financial Security Assurance, Ltd., Main Street America Holdings
Inc., Murray Lawrence (Bermuda), Ltd. and Haverford Industries, LLC.
JEFFERSON W. KIRBY has been with Alleghany Corporation since 1992 and was
appointed Vice President in 1994. From 1987 to 1990, he was with Bankers Trust
Company, and from 1990 to 1992, he was with BT Securities Corp., each an
affiliate of Bankers Trust New York Corporation. Mr. Kirby also is a director of
Alleghany Asset Management, Inc., Connecticut Surety Corporation, The Covenant
Group, Inc. and The F.M. Kirby Foundation, Inc., a charitable organization, and
a trustee of Lafayette College and the Peck School.
JOHN PETTWAY is the Manager of The Haverford Group, LLC, an investment
company located in Park City, Utah, and is also the Chief Financial Officer for
both Haverford Industries, LLC and Byrne & sons, 1.p., in which capacities he
has served since July 1995. From June 1993 to June 1995, Mr. Pettway served as
the Chief Financial Officer of Cirque Properties, LC. Prior to June 1993, Mr.
Pettway was a practicing attorney at the firm of Adams & Associates in
Alexandria, Virginia. Mr. Pettway serves as director of Haverford Industries,
LLC and American Direct Business Insurance Agency, Inc.
HENRY T. WILSON is the Managing Director of Northwood Ventures LLC and
Northwood Capital Partners LLC, private equity investment firms based in
Syosset, New York, with whom he has been associated since 1991. From 1989 to
1991, Mr. Wilson was a Vice President in the investment banking division of
Merrill Lynch & Co. He serves on the boards of directors of Alliance National,
Inc. and the Lion Brewery, Inc.
PAUL R. WOOD has served since January 1993 as Vice President of Madison
Dearborn Partners, Inc., a venture capital firm which is the general partner of
Madison Dearborn Capital Partners II, L.P., a principal shareholder of the
Company. Mr. Wood was with First Chicago Venture Capital from August 1983 to
January 1993, and the venture capital unit of Continental Illinois Bank from
January 1978 to August 1983. Mr. Wood serves on the boards of directors of Hines
Horticulture, Inc., Intercontinental Art, Inc. and Woods Equipment Company.
Each of the members of the Board of Directors is generally elected at the
Company's Annual Meeting of Shareholders to serve until the next Annual Meeting
or until his successor is duly qualified and elected.
COMMITTEES OF THE BOARD OF DIRECTORS
AUDIT COMMITTEE. The members of the Company's Audit Committee are Jefferson
W. Kirby (Chairman), Edward A. Fox and K. Thomas Kemp. The Audit Committee
functions include reviewing the financial statements of the Company and its
subsidiaries and the scope of the annual audit by the Company's independent
certified public accountants, and appointing the independent certified public
accountant on an annual basis. The Committee also monitors the Company's
internal financial and accounting controls.
COMPENSATION COMMITTEE. The members of the Company's Compensation Committee
are K. Thomas Kemp (Chairman), Edward A. Fox and Charles E. Hugel. The
Compensation Committee reviews and makes recommendations to the Board of
Directors on matters concerning the salaries and other employee benefits for the
Company's officers. Mr. Kemp is the Chairman and Chief Executive Officer of
White Mountain Holdings, Inc., of which Mr. Keller is a member of the Board of
Directors.
DIRECTOR COMPENSATION
The directors of the Company have not received any compensation for serving
on the Board of Directors or any committee or attending meetings thereof. The
Board of Directors expects to approve the payment of compensation to
non-executive directors beginning January 1, 1999. The Company is currently
reviewing the director compensation levels of banks and bank holding companies
in its peer group. All
65
<PAGE>
directors receive reimbursement of reasonable expenses incurred in attending
Board and committee meetings and otherwise carrying out their duties.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth information regarding the compensation
received for the three fiscal years ended December 31, 1997 by the Chief
Executive Officer and the three other most highly compensated executive officers
of the Company (the "named executive officers"). All cash compensation was paid
to the named executive officers by the Company.
<TABLE>
<CAPTION>
LONG TERM COMPENSATION
ANNUAL AWARDS
COMPENSATION -----------------------
---------------- RESTRICTED SECURITIES
NAME AND BASE STOCK UNDERLYING ALL OTHER
PRINCIPAL POSITION YEAR SALARY AWARDS($) OPTIONS COMPENSATION
- ------------------------------------------------------------ ---- -------- --------- ---------- ------------
<S> <C> <C> <C> <C> <C>
Robert P. Keller ........................................... 1997 $275,000 1,654,241(1) 364,300 $4,750
President and Chief 1996 $185,240 203,788(2) -- $1,316
Executive Officer 1995 $ 37,500(3) -- -- $3,918(4)
Richard Korsgaard .......................................... 1997(5) $176,500 -- -- $4,000
Executive Vice President 1996 $ -- -- -- $--
Construction Lending 1995 $ -- -- -- $--
Curt A. Christianssen ...................................... 1997 $114,167 -- 25,000 $4,750
Executive Vice President 1996(6) $ 76,875 -- -- $2,316
and Chief Financial Officer 1995 $ -- -- -- $--
</TABLE>
- ------------------------
(1) Based upon 187,982 shares issued at an estimated market value of $8.80 per
share. See "Price Range of Common Stock and Dividend Policy." If dividends
are paid on the Common Stock, Mr. Keller's will receive dividends on his
restricted stock. See "--Keller Employment Agreement--Restricted Stock
Awards" for a discussion of both vesting and transferability restrictions.
(2) Based upon 25,796 shares issued at an estimated market value of $7.90 per
share. See "Price Range of Common Stock and Dividend Policy." If dividends
are paid on the Common Stock, Mr. Keller's will receive dividends on his
restricted stock. See "--Keller Employment Agreement--Restricted Stock
Awards" for a discussion of both vesting and transferability restrictions.
(3) Period from October 1, 1995 to December 31, 1995.
(4) Includes reimbursement for moving expenses.
(5) Includes base pay of $52,083, commissions of $51,500 and $3,270 in other
compensation related to services provided to the Bank prior to the Eldorado
Acquisition and excludes bonuses and deferred compensation of $77,542 paid
by Eldorado Bancorp prior to the Eldorado Acquisition.
(6) Period from April 1, 1996 to December 31, 1996.
KELLER EMPLOYMENT AGREEMENT
CAPACITY AND TERM. In July 1996, the Company entered into an employment
agreement with Mr. Keller that was effective retroactive as of October 1, 1995.
The Company has agreed to employ Mr. Keller as the Company's senior most
executive officer, to nominate Mr. Keller to serve as a director of the Company,
and to cause Mr. Keller to be elected as a director of each of the Company's
subsidiaries that is a depository institution or otherwise a "significant
subsidiary," as defined under SEC regulations. Mr. Keller's employment agreement
has a three-year term, ending on September 30, 1999, and will be renewed
automatically for successive one-year periods unless either the Company or Mr.
Keller gives the other notice at least one year prior to the end of the term or
any extension thereof.
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<PAGE>
BASE SALARY. Mr. Keller's base salary under the employment agreement will
depend upon the Company's consolidated assets. Mr. Keller's base salary
currently is $300,000. If the Company's consolidated assets exceed $1.2 billion,
Mr. Keller's base salary will become $350,000. For purposes of Mr. Keller's
employment agreement, the Company's consolidated assets are calculated as of the
end of each of the Company's fiscal quarters and are equal to the Company's
average consolidated assets for the 6-month period then ended calculated on a
daily basis in accordance with GAAP ("Average Consolidated Assets"), except that
if the Company's consolidated assets as of the end of a fiscal quarter vary by
more than 20 percent from the Average Consolidated Assets for the two
consecutive quarters ended as of that date, the Company's consolidated assets as
of that date are used for purposes of determining any adjustment to Mr. Keller's
salary. If, subsequent to an increase in Mr. Keller's base salary, the amount of
Average Consolidated Assets as of the end of any fiscal quarter is less than the
most recently applied asset threshold for determining Mr. Keller's salary, Mr.
Keller's base salary will be decreased, effective as of the beginning of the
quarter next following the measurement date, in accordance with the salary
schedule described above. If the Company's Average Consolidated Assets exceed
$1.8 billion, Mr. Keller may request that the Compensation Committee of the
Company's Board of Directors (the "Committee") consider and make a
recommendation to the Company's Board of Directors whether it is appropriate to
increase his annual salary. Mr. Keller's base salary, as so determined, is
hereinafter referred to as his "Base Salary."
RESTRICTED STOCK AWARDS. Mr. Keller's employment agreement generally
obligates the Company to issue shares of restricted Common Stock (the
"Restricted Stock") to Mr. Keller whenever, during the term of the agreement,
the Company issues Common Stock or a Common Stock Equivalent (as defined in the
employment agreement), including shares of Common Stock issued in the CSB and
Eldorado acquisitions. Pursuant to his employment agreement, Mr. Keller will no
longer be eligible to receive additional shares of Restricted Stock at such time
as the Company has Tier 1 capital in excess of $125.0 million. See "Supervision
and Regulation" for a definition of of Tier 1 capital. In addition, Mr. Keller
will not be entitled to receive any Restricted Stock as a consequence of the
sale of Common Stock or a Common Stock Equivalent to DCG or director qualifying
shares to any director of a subsidiary of the Company or the award of employee
stock options or the issuance of Common Stock upon the exercise thereof.
For so long as he is eligible, the number of shares of Restricted Stock that
will be issued to Mr. Keller will be equal to 3.0 percent of the sum of (x) the
number of shares of Common Stock then to be issued by the Company or, in the
case of the issuance of a Common Stock Equivalent, the number of shares of
Common Stock which such Common Stock Equivalent may be converted into or
exchanged for, and (y) the number of shares of Restricted Stock to be issued to
Mr. Keller at that time.
Subject only to restrictions on transferability and forfeiture conditions
described below, Mr. Keller will have all the rights of a shareholder with
respect to the Restricted Stock, including, without limitation, the right to
vote the Restricted Stock and to receive any dividend or other distribution with
respect thereto. Prior to the end of Restricted Period (described below), Mr.
Keller may not sell, assign, transfer, pledge, hypothecate or otherwise encumber
or transfer the Restricted Stock, except as permitted by the Committee. If Mr.
Keller's employment under the employment agreement is terminated for cause (as
defined in the employment agreement) prior to the end of the Restricted Period,
or if Mr. Keller resigns from the Company during the Restricted Period without
the consent of the Board of Directors of the Company, any Restricted Stock then
outstanding will be forfeited to the Company without any payment to Mr. Keller.
In general, the "Restricted Period" will expire upon the earliest to occur
of the following events: (a) a Change in Control (as defined in Mr. Keller's
employment agreement) of the Company; (b) Mr. Keller's retirement from the
Company after attaining age 62; (c) the effective date of Mr. Keller's
resignation from the Company with the consent of the Board of Directors; (d) the
effective date of the expiration of Mr. Keller's employment agreement pursuant
to notice of non-renewal given by the Company; (e) the effective date of Mr.
Keller's termination of his employment agreement for cause (as defined in the
agreement); (f) the effective date of the termination of Mr. Keller's employment
by the Company due to a
67
<PAGE>
"disability" (as defined in the employment agreement); or (g) Mr. Keller's
death. In the case of Restricted Stock that is issued to Mr. Keller as a
consequence of the Company's issuance of a Common Stock Equivalent, the
Restricted Period will terminate on the later of (x) the date on which such
Common Stock Equivalent first becomes convertible into or exchangeable for
shares of Common Stock and (y) the earliest to occur of the events specified in
the immediately preceding sentence. If any Common Stock Equivalent is redeemed
in whole or in part by the Company prior to the date such Common Stock
Equivalent is convertible into or exchangeable for shares of Common Stock, upon
such redemption there shall be forfeited to the Company, without any payment to
Mr. Keller, a PRO RATA portion of the shares of Restricted Stock issued as a
consequence of the Company's sale of such Common Stock Equivalent.
STOCK OPTION AWARDS. As provided in Mr. Keller's employment agreement, the
Company's Board of Directors has adopted a stock option plan (the "Option Plan")
pursuant to which the Board of Directors or the Committee has granted stock
options to Mr. Keller and other officers of the Company and the Bank.
Mr. Keller's employment agreement provides that promptly following the
adoption of the Option Plan, the Company will grant to Mr. Keller an option
exercisable for a number of shares of Common Stock equal to 50.0% of the shares
in the Option Pool, and that if the Company thereafter increases the number of
shares in the Option Pool (as defined herein), the Company will promptly grant
to Mr. Keller an option exercisable for a number of shares of Common Stock equal
to 50.0% of the amount by which the Company increases the Option Pool.
Mr. Keller's employment agreement also specifies that the exercise price,
vesting schedule and other terms of any stock option granted to him under the
Option Plan will be substantially similar to the terms of any other
contemporaneously granted stock option under the Option Plan, except that any
stock option granted to Mr. Keller will (a) not have an exercise price less than
the fair market value of the Common Stock at the time of grant; (b) to the
extent the stock option has an escalating exercise price or a fixed exercise
price with a premium over the then fair market value of the Common Stock,
reflect an annual percentage increase of not greater than the then current yield
to maturity of the most recently auctioned 5-year U.S. Treasury Notes; (c) vest
over a period of not more than four years from the date of grant; (d) provide
that if Mr. Keller's employment is terminated by the Company other than for
cause (as defined Mr. Keller's employment agreement), the stock option will
continue to be exercisable until such date as it would have expired if Mr.
Keller had continued to be employed by the Company; and (e) provide that upon a
Change in Control of the Company (as defined in Mr. Keller's employment
agreement), any stock option then outstanding will become fully exercisable. See
"--Stock Option Plan" for a discussion of the exercise price and vesting
schedule structure of Mr. Keller's options.
SUPPLEMENTAL RETIREMENT PROGRAM. Mr. Keller's employment agreement
obligates the Company to provide supplemental retirement benefits through a
nonqualified, unfunded arrangement equal up to 35% of Mr. Keller's Average Base
Salary after seven years of service. The supplemental retirement benefit accrues
and vests annually at the rate of 5% per year. The supplemental retirement
benefit will be paid monthly for ten years commencing upon (a) the later of Mr.
Keller's retirement date or age 65 or (b) Mr. Keller's death. Any retirement
benefits remaining unpaid at Mr. Keller's death will be paid to his designated
beneficiary.
BENEFITS UPON TERMINATION. Mr. Keller's employment agreement provides that
if his employment is terminated by the Company without cause or by him due to a
material change in the nature or scope of his responsibilities or duties, or a
material breach by the Company of the employment agreement, the Company
generally will be obligated to pay Mr. Keller his Base Salary for the remainder
of the term of his employment agreement or 18 months, whichever is greater.
During such period, the Company also would be obligated to continue certain
employee benefits, such as life, health, accident and disability insurance
coverage, which Mr. Keller was receiving immediately preceding his termination.
In addition, upon the events described above, Mr. Keller's supplemental
retirement benefits would become fully vested, and
68
<PAGE>
upon his attainment of age 65, the Company would be obligated to pay him an
amount sufficient to assure that he receives the amount to which he would have
been entitled under the Supplemental Retirement Program had he been employed by
the Company for three years, and all options granted to Mr. Keller to purchase
Common Stock will become fully vested and exercisable.
If Mr. Keller's employment is terminated by the Company because Mr. Keller
becomes disabled (as defined in the employment agreement), Mr. Keller will be
entitled to receive not less than 50.0% of his then Base Salary until age 65. In
addition, all of his options to purchase the Company Common Stock will
immediately become fully vested and exercisable.
If Mr. Keller's employment agreement expires following a notice of
non-renewal given by the Company, Mr. Keller would be entitled to the
continuance for a period of six months of his Base Salary and the employee
benefits which Mr. Keller was receiving immediately prior to such termination.
Payments to which Mr. Keller would be entitled upon termination will be
reduced by amounts earned by Mr. Keller for services provided to another party
after such termination. Mr. Keller would have no duty, however, to mitigate such
payments by seeking to provide services to another party. Mr. Keller's
employment agreement also provides that under certain circumstances involving a
change in control, the amount of benefits provided under his employment
agreement would be reduced if, after applying the excise tax provisions to the
payments under the Internal Revenue Code of 1986, as amended, the net economic
benefit to Mr. Keller would be increased by effecting such a reduction.
Mr. Keller's employment agreement provides that a "change in control" will
include the authorization of certain business combinations by the Company's
Board of Directors. In general, a business combination involving the Company
will not be deemed to be a change in control if the Company's shareholders own
at least one-third of the resulting entity and at least half of the directors of
the resulting entity are persons who were directors of the Company at the time
the parties entered into the definitive agreement.
OTHER EXECUTIVE EMPLOYMENT AGREEMENTS
The Company also has entered into an employment agreement with Richard
Korsgaard, Executive Vice President and severance agreements with other
executive officers not subject to individual employment agreements.
Mr. Korsgaard is employed by the Bank as Executive Vice President pursuant
to a three-year employment agreement that expires October 20, 1998 (the
"Korsgaard Agreement") that the Company assumed upon the consummation of the
Eldorado Acquisition. The Korsgaard Agreement establishes a minimum base salary
of $125,000. In the event Mr. Korsgaard is terminated by the Bank or any
successor to the Bank without cause, he is entitled to receive a termination
payment in an amount equal to the greater of the balance payable under the
Korsgaard Agreement or twelve months of his then current base salary. The
Korsgaard Agreement may not be terminated by an acquisition or dissolution of
the Bank or the Company except in the event that proceedings for the liquidation
of the Company or the Bank are commenced by regulatory authorities, in which
case the Korsgaard Agreement, and all rights and benefits thereunder, would be
terminated. A salary continuation program has been established for Mr.
Korsgaard, under which Mr. Korsgaard (or, in the event of his death, his heirs)
will receive $65,000 per year from the Bank for 15 years commencing upon his
reaching age 65 or his death or disability, whichever first occurs.
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<PAGE>
The Bank has entered into Severance Agreements (each a "Severance
Agreement") with those of its executive officers not subject to individual
employment agreements concerning the ramifications of a change in control of the
Company on the continued employment of each such officer. As used in the
Severance Agreement, the term "change in control" has the same definition as in
the Option Plan. Pursuant to and as detailed further in each Severance
Agreement, if the terms of an officer's employment are significantly altered to
the detriment of such officer within two years following a change in control,
and the officer provides the requisite notice to the Bank, or alternatively, if
the Bank terminates the officer without cause within two years following a
change in control, then the officer is entitled to a lump sum payment equal to
one year's salary, less applicable taxes and withholdings. A precondition to
such payment is the execution by the officer of a general release and
confidentiality agreement. The form of Severance Agreement has been filed as an
exhibit hereto.
STOCK OPTION PLAN
GENERAL. The Company has adopted the Option Plan pursuant to which the
Company's Board of Directors or the Compensation Committee (the "Committee") may
grant stock options to Mr. Keller and other officers of the Company or any of
its subsidiaries. The Option Plan provides only for the issuance of so-called
"nonqualified" stock options (as compared to incentive stock options). As of
December 31, 1997, options to purchase 389,300 shares of Common Stock were
outstanding with an average exercise price of $10.25 per share.
OPTION POOL. The maximum number of shares as to which options may be
granted is referred to as the "Option Pool." As of December 31, 1997, the Option
Pool consisted of 728,600 shares of Common Stock. Until such time as the Company
has Tier 1 Capital of $125.0 million or more, if the Company issues any
additional Common Stock or common stock equivalents, the number of shares in the
Option Pool automatically increases such that the number of shares in the Option
Pool will be equal to six percent of the sum of (i) the shares of Common Stock
(and common stock equivalents) issued and outstanding immediately following such
issuance and (ii) the number of shares in the Option Pool.
EXERCISE PRICE STRUCTURE. The Option Plan authorizes the Committee to set
the exercise price for each option grant. In the case of option grants to Mr.
Keller, each portion of his award will have a separate, fixed exercise price as
such portion vests over time. The exercise price for each separate tranche will
increase progressively based upon a semi-annual compounding of a "base rate"
using the 5-year U. S. Treasury rate in effect at the date of grant. See, for
example, "--Option Grants in Last Fiscal Year."
VESTING SCHEDULE AND DURATION. The options granted to Messrs. Keller and
Christianssen, and any future grants, unless the Committee otherwise decides,
will vest over four years, in half-year increments, with the first portion
vesting on the 18-month anniversary of the date of grant. The Option Plan
provides that unless the Committee otherwise determines, the options will have a
six-year term, expiring on the sixth anniversary of the date of grant.
ACCELERATION EVENT EFFECT ON VESTING.
MR. KELLER. Mr. Keller's options will become fully vested in connection
with a change in control, which is defined in the Option Plan consistent with
the definition of a change in control contained in Mr. Keller's employment
agreement. In addition, Mr. Keller's options would become fully-vested if the
Company were to terminate his employment agreement without cause or if he were
to terminate the agreement for cause. Mr. Keller's options also would become
fully-vested if he dies or becomes permanently disabled.
OTHER OPTION HOLDERS. For all other option holders, the Option Plan
provides for a "double trigger," unless the Committee otherwise specifies at the
time it awards the option. Under the double trigger approach, the option would
become fully vested if the option holder is actually or constructively
terminated without cause during a two-year period following a change in control.
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<PAGE>
AGGREGATED FISCAL YEAR-END OPTION VALUES
The following table shows certain information concerning the aggregate
number of unexercised options to purchase Common Stock held by the named
executive officers as of December 31, 1997. No options were exercised by the
named executive officers during 1997.
<TABLE>
<CAPTION>
NUMBER OF
SECURITIES VALUE OF
UNDERLYING UNEXERCISED IN-
UNEXERCISED THE-MONEY OPTIONS
OPTIONS AT AT DECEMBER 31,
DECEMBER 31, 1997 1997
----------------- -----------------
<S> <C> <C>
EXERCISABLE/ EXERCISABLE/
UNEXERCISABLE UNEXERCISABLE
Robert P. Keller ...................................... 0/364,300(1) 0/$390,276(2)
President and Chief Executive Officer
Curt A. Christianssen ................................. 0/25,000(1) 0/$17,083(2)
Senior Vice President
</TABLE>
- ------------------------
(1) For information on the vesting schedule and exercise price per share see
"Option Grants in Last Fiscal Year"
(2) Because of the lack of an active trading market in the Common Stock, such
calculation assumes a Common Stock value of $12.00 per share at which the
last known sale of Class B Common Stock occurred (See "Market for Issuer's
Common Stock and Related Matters--Unregistered Sales of Securites.")
71
<PAGE>
OPTION GRANTS IN LAST FISCAL YEAR
The following table contains a summary of the grants of stock options made
during the fiscal year ended December 31, 1997.
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
----------------------------------------------------- POTENTIAL REALIZABLE
% OF TOTAL VALUE AT ASSUMED
NUMBER OF OPTIONS RATE OF STOCK PRICE
SECURITIES GRANTED TO APPRECIATION FOR
UNDERLYING EMPLOYEES OPTION TERM(1)
OPTIONS IN FISCAL EXERCISE PRICE EXPIRATION --------------------
NAME GRANTED YEAR ($/SH)(2) DATE 5% ($) 10% ($)
- --------------------------------------- ----------- ----------- -------------- ----------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Robert P. Keller ...................... 154,750 39.7% 9.64/25,791 2/3/2003 83,867 190,919
President and Chief Executive Officer 9.94/25,791 76,129 183,182
10.24/25,791 68,392 175,445
10.54/25,791 60,654 167,707
10.86/25,791 52,401 159,454
11.20/25,795 43,634 150,691
209,550 53.9% 10.52/34,925 7/14/2003 82,832 227,795
10.84/34,925 71,656 216,619
11.18/34,925 59,782 204,745
11.50/34,925 48,606 193,569
11.86/34,925 36,033 180,996
12.20/34,925 24,158 169,121
Curt A. Christianssen ................. 25,000 6.4% 10.52/4,166 6/30/2003 9,882 27,176
Senior Vice President 10.84/4,166 8,548 25,842
11.18/4,166 7,132 24,426
11.50/4,166 5,799 23,092
11.86/4,166 4,299 21,593
12.20/4,170 2,883 20,181
</TABLE>
- ------------------------
(1) The market price at the date of grant was $9.62, based upon the price at
which Common Stock was issued in connection with the Eldorado Acquisition.
(2) Absent a change in control of the Company, as defined in the Option Plan,
each tranche of option shares will vest in successive six-month increments.
Upon a change in control, the exercisability of the option is accelerated to
such date. Following a change in control, the exercise price with respect to
any option shares exercised prior to their original vesting date shall equal
the exercise price for those option shares that had a scheduled vesting date
that was on or next preceding such exercise date.
OTHER BENEFIT PLANS
The Company's executive officers are also entitled to short term disability,
life, medical and dental insurance as well as participation in the Company's
401(k) retirement plan.
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<PAGE>
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 OF
INVESTOR OWNED VOTING SECURITIES OWNED CLASS(1)
- ---------------------------------------------------------- ----------- ------------------- ----------- -------------
<S> <C> <C> <C> <C>
Dartmouth Capital Group, L.P.(2)
Dartmouth Capital Group, Inc.
Class B Common Stock.................................... 3,000,617 36.4% 3,000,617 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)................................. 73,000 0.9% 73,000 .8%
Special Common Stock(1)................................. 742,516 9.0% 1,206,429 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)................................. 73,000 0.9% 73,000 .8%
Special Common Stock(1)................................. 742,516 9.9% 1,206,429 13.2%
Series A Capital Securities............................. -- -- -- --
Series B Preferred Stock................................ -- -- 58,296 50.0%
Ernest J. Boch(7)
Class B Common Stock.................................... 1,198,814 14.5% 1,198,814 13.1%
F. M. Kirby(8)
Class B Common Stock.................................... 545,014 6.6% 545,014 5.9%
Shareholders of DCG General Partner as a Group (11
shareholders)(9)(10)
Class B Common Stock.................................... 2,669,785 32.4% 2,669,785 29.1%
</TABLE>
- ------------------------
(1) For purposes of computing the percentage of each class of equity securities
beneficially owned by each principal shareholder, the Class B Common Stock
and Special Common are treated as a single class of securities.
(2) As the sole general partner of DCG, the DCG General Partner exercises sole
control over the voting and disposition of the shares of Common Stock held
of record by DCG. DCG and the DCG General Partner each have a business
address c/o Commerce Security Bancorp, Inc., 24012 Calle de la Plata, Suite
150, Laguna Hills, CA 92653.
(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%.
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<PAGE>
(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.
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<PAGE>
SECURITY OWNERSHIP OF MANAGEMENT
The following table sets forth certain information regarding ownership of
securities of the Company as of December 31, 1997 with respect to each executive
officer and director of the Company, and all executive officers and directors as
a group.
<TABLE>
<CAPTION>
NUMBER OF SHARES PERCENT
NAME AND TITLE BENEFICIALLY OF SHARES OF
OF OFFICER AND/OR DIRECTOR OWNED VOTING COMMON
--------------------------- ----------------- --------------
<S> <C> <C>
Robert P. Keller(1)(2) ...................................... 232,284 2.8%
Director, President and Chief Executive Officer
Ernest J. Boch(1) ........................................... 1,198,814 14.5%
Director
James A. Conroy(3) .......................................... 815,516 9.9%
Director
Mitchell Johnson ............................................ 48,591 *%
Director
Edward A. Fox(1) ............................................ 231,748 2.8%
Director
Jefferson W. Kirby(1)(4) .................................... 204,700 2.5%
Director
Charles E. Hugel(1) ......................................... 168,862 2.0%
Director
K. Thomas Kemp(1) ........................................... 21,430 *%
Director
John B. Pettway(5) .......................................... 217,297 2.6%
Director
Henry T. Wilson(6) .......................................... 200,270 2.4%
Director
Paul R. Wood(7) ............................................. 815,516 9.9%
Director
Curt A. Christianssen(8) .................................... 500 *%
Senior Vice President and Chief Financial Officer
Paul F. Rodeno(11) .......................................... 78 *%
Executive Vice President Operations
All Directors and Executive Officers as a Group(1)(2)(12).... 4,155,606 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.
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<PAGE>
(2) Includes 213,778 shares of restricted stock issued to Mr. Keller pursuant
to the terms of his employment agreement, but excludes 364,300 shares of
Class B Common Stock subject to employee stock options which are not
exercisable within 60 days.
(3) Includes 742,517 shares of voting Special Common Stock and 73,000 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 217,297 shares of Class B Common Stock held by Byrne & sons, 1.p.,
of which Mr. Pettway is the Chief Financial Officer.
(6) Includes 160,206 shares and 40,064 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 742,517 shares of Voting Special Common Stock and 73,000 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 30,000 shares of Class B Common Stock subject to employee stock
options that are not exercisable within 60 days.
(9) Excludes 15,000 shares of Class B Common Stock subject to an employee stock
option that is not exercisable within 60 days.
(10) Excludes 494,300 shares of Class B Common Stock subject to employee stock
options that are not exercisable within 60 days.
76
<PAGE>
ITEM 13. CERTAIN TRANSACTIONS AND RELATED TRANSACTIONS
Except as described in this Section, there are no existing or proposed
material transactions between the Company or the Banks and any of the Company's
executive officers, directors, or beneficial owners of more than 5% of the
Common Stock, or the immediate family or associates of any of the foregoing
persons.
FINANCING FOR ELDORADO ACQUISITION
In December 1996, DCG and Peter H. Paulsen, a former director of the
Company, loaned $4.3 million and $200,000, respectively, to fund the deposit
that the Company was required to make prior to entering into the Eldorado
Agreement. The principal amount of such loans was converted to 23,540 shares of
Class B common stock upon the consummation of the Eldorado Acquisition at a
price of $8.80 per share, and interest on such loans was converted to Class B
Common Stock at a purchase price of $9.62 per share less the 1% commitment fee,
which was the same price at which the remaining shares of Class B Common Stock
and the Special Common were sold by the Company to fund the Eldorado
Acquisition. See "Market for Issuer's Common Stock and Related Stockholder
Matters."
Also in December 1996, certain directors of the Company and other investors
in DCG agreed to purchase up to approximately $15.2 million of Class B common
Stock at a price of $9.62 per share, less a 1% commitment fee, to fund a portion
of the Eldorado Acquisition. Approximately $12.4 million of this commitment was
invested by such investors with 1,530,964 shares issued at the $9.62 per share
price (less a 1% commitment fee), as described in more detail elsewhere in this
report. See "Market for Issuer's Common Stock and Related Stockholder Matters."
Of those shares, the following numbers of shares were purchased by persons who
were then directors of the Company, affiliates of directors or nominees to
become directors: (i) Ernest J. Boch (550,914 shares), Edward A. Fox (25,048
shares), Charles E. Hugel (8,712 shares), Robert P. Keller (5,956 shares), K.
Thomas Kemp (5,730 shares), each of whom was a director of the Company in
December 1996; (ii) Byrne & sons, 1.p. (55,897 shares); (iii) Northwood Ventures
LLC and Northwood Capital Partners LLC (a total of 17,820 shares); and (iv)
Mitchell A. Johnson (45,841 shares). John B. Pettway and Henry T. Wilson are
directors of the Company and in December 1996 were directors of the DCG General
Partner. Mr. Pettway is the Chief Financial Officer of Byrne & sons, 1.p., and
Mr. Wilson is a Managing Director of Northwood Ventures LLC and Northwood
Capital Partners LLC. Mr. Johnson became a director of the Company in 1997
contemporaneously with the closing of the Eldorado Acquisition.
DCG also had agreed to purchase up to $6.8 million of Senior Securities (as
defined elsewhere in this report) under certain circumstances. DCG invested
$10.0 million at the consummation of the Eldorado Acquisition, which were sold
in conjunction with a secondary offering of the Series A Capital Securities on
July 15, 1997. See "Market for Issuer's Common Stock and Related Stockholder
Matters."
SETTLEMENT WITH FORMER MAJORITY SHAREHOLDER
In October 1997, the Company settled litigation that it had brought against
the former majority shareholder of CSB, and certain other directors and officers
of CSB arising out of the Company's acquisition of CSB in September 1996. At the
time the Company commenced the litigation, the former majority shareholder was
the beneficial owner of more than 5% the Class B Common Stock. As part of that
settlement, the former majority shareholder returned to the Company and the
Company canceled 212,091 shares of Class B Common Stock. Prior to that
settlement, the Company's principal shareholders and certain directors and other
shareholders purchased 500,000 shares of Class B Common Stock from the former
majority shareholder for an aggregate purchase price of $6.0 million or $12.00
per share. Taken together, those transactions eliminated the former majority
shareholder's ownership interest in the Company.
77
<PAGE>
OTHER MATTERS
Some of the directors and executive officers of the Company's Bank
subsidiary and their immediate families, as well as the companies with which
such directors and executive officers are associated, are customers of, and have
had banking transactions with the Bank in the ordinary course of the Bank's
business and the Bank expects to have such ordinary banking transactions with
such persons in the future. In the opinion of management of the Company and the
Bank, all loans and commitments to lend included in such transactions were made
in compliance with applicable laws on substantially the same terms, including
interest rates and collateral, as those prevailing for comparable transactions
with other persons of similar creditworthiness and did not involve more than a
normal risk of collectibility or present other unfavorable features. Although
the Bank does not have any limits on the aggregate amount it would be willing to
lend to directors and officers as a group, loans to individual directors and
officers must comply with the Bank's lending policies and statutory lending
limits. There were no loans to executive officers and directors at December 31,
1997.
78
<PAGE>
PART IV
ITEM 14. EXHIBITS AND REPORTS ON 8-K
(a) Exhibit Index
<TABLE>
<C> <S>
2.1 Agreement and Plan of Merger dated December 24, 1996 between Commerce Security
Bancorp, Inc. (the "Company") and Eldorado Bancorp ("Eldorado") (filed as Exhibit
2.1 to the Company's Current Report on Form 8-K dated December 24, 1996 and
incorporated by reference herein)
2.2 Stock Option Agreement dated December 24, 1996 between the Company and Eldorado
(filed as Exhibit 2.2 to the Company's Current Report on Form 8-K dated December
24, 1996 and incorporated by reference herein)
3.1 Certificate of Incorporation of (filed as Exhibit 10.3 to the Company's Quarterly
Report on Form 10-QSB for the quarter ended September 30, 1996 and incorporated by
reference herein)
3.2 Bylaws of the Company, (filed as Exhibit 10.2 to the Company's Quarterly Report on
Form 10-QSB for the quarter ended September 30, 1996 and incorporated by reference
herein)
4.1 Indenture with respect to Mandatory Convertible Debentures of SDN Bancorp, Inc.
("SDN") due 1998 (filed as Exhibit 4 to SDN's Registration Statement on Form S-1,
File No. 33-4045 filed March 17, 1986 and incorporated by reference herein)
10.1 Form of Loan/Subscription Agreement dated December 1996 between the Company and
Dartmouth Capital Group, L.P. (the "Dartmouth Partnership") and Peter H. Paulsen
10.2 Form of Common Stock Subscription Agreement dated December 21, 1996 ("1996
Subscription Agreement") between the Company and the various subscribers thereto,
including certain directors of the Company
10.3 Form of Amendment to 1996 Subscription Agreement
10.4 Form of Commitment Letter dated March 21, 1997 between the Dartmouth Partnership and
the Company
10.5 Lease for 135 Saxony Road, Encinitas, California (filed as Exhibit 10.4 to SDN's
Registration Statement on Form S-14, File No. 2-76555 filed March 18, 1982 and
incorporated by reference herein)
10.6 Lease for 6354 Corte del Abeto, Carlsbad, California (filed as Exhibit 10.6 to the
Company's Annual Report on Form 10-K for the year ended December 31, 1984 and
incorporated by reference herein).
10.7 Lease Agreement between Sheryl L. Bullock as Trustee, as Landlord, and San Dieguito
National Bank, as tenant, dated July 27, 1990 (filed as Exhibit 10.1 to SDN's Form
10-Q for the quarter ended June 30, 1990 and incorporated by reference herein)
10.8 Lease Agreement for 7777 Center Avenue, Huntington Beach, California between Alvamij
Huntington Beach, Inc. as Landlord, and Liberty National Bank, as Tenant, dated
August 20, 1981 and amended February 14, 1986 (filed as Exhibit 10.3 to SDN's
report on Form 10-Q for the quarter ended March 31, 1996)
10.9 Lease Agreement for 17011 Beach Boulevard, Huntington Beach, California between Liu
Corp., as Landlord, and Liberty National Bank, as Tenant, dated December 15, 1995
(filed as Exhibit 10.4 to SDN's report on Form 10-Q for the quarter ended March 31,
1996)
</TABLE>
79
<PAGE>
<TABLE>
<C> <S>
10.10 Employment Agreement between Liberty National Bank and Philip S. Inglee dated July
20, 1995 (filed as Exhibit 10.5 to SDN's report on Form 10-Q for the quarter ended
March 31, 1996)
10.11 Employment Agreement between Liberty National Bank and Catherine C. Clampitt dated
April 1, 1995 (filed as Exhibit 10.8 to SDN's report on Form 10-Q for the quarter
ended March 31, 1996)
10.12 Employment Agreement dated October 1, 1995 between Robert P. Keller and the Company*
(filed as Exhibit 10.1 to the Company's Form 10-Q for the quarter ended September
30, 1996 and incorporated by reference herein)
10.13 Form of Severance Agreement (filed as Exhibit 10.1 to this Annual Report on Form
10-K)
20. Terms of Primary Stock Right dated September 28, 1995 (filed as Exhibit 20.1 to SDN's
Annual Report on Form 10-KSB for the year ended December 31, 1995 and incorporated
by reference herein)
21. Subsidiaries of the Registrant (filed as Exhibit 22 to SDN's Registration Statement
on Form S-1, File No. 33-4045 filed March 17, 1986 and incorporated by reference
herein)
</TABLE>
- ------------------------
* Denotes Executive Compensation Plan or Arrangement
(b) Reports on Form 8-K.
1) None.
80
<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.
<TABLE>
<S> <C> <C>
COMMERCE SECURITY BANCORP, INC.
Date: October 13, 1998 By /s/ ROBERT P. KELLER
------------------------------------------
Robert P. Keller
PRESIDENT, CHIEF EXECUTIVE OFFICER
Date: October 13, 1998 By /s/ CURT A. CHRISTIANSSEN
------------------------------------------
Curt A. Christianssen
SENIOR VICE PRESIDENT
</TABLE>
81
<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.
/s/ PRICE WATERHOUSE LLP
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 OF 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)
----------- ----------- ------------
----------- ----------- ------------
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-4
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
DECEMBER 31, 1997, 1996, AND 1995
<TABLE>
<CAPTION>
CLASS B
PREFERRED COMMON
STOCK SPECIAL COMMON STOCK STOCK
------------------- -------------------------------- ----------
NUMBER ADDITIONAL
OF PREFERRED NUMBER OF COMMON PAID-IN NUMBER OF
SHARES STOCK SHARES STOCK CAPITAL SHARES
------- ----------- --------- ----------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994....... -- $ -- -- $ -- $ -- 564,145
Merger and reverse stock split (1
for 21)(Note 2).................. -- -- -- -- -- (537,281)
Stock dividend..................... -- -- -- -- -- 26,864
Issuance of common stock........... -- -- -- -- -- 841,739
Net loss........................... -- -- -- -- -- --
------- ----------- --------- ----------- ---------- ----------
Balance at December 31, 1995....... -- -- -- -- -- 895,467
Fractional share adjustment........ -- -- -- -- -- 34
Issuance of common
stock--Liberty................... -- -- -- -- -- 3,432,105
Issuance of common
stock--Commerce.................. -- -- -- -- -- 5,369,824
Unrealized gain on securities
available for sale............... -- -- -- -- -- --
Net income......................... -- -- -- -- -- --
------- ----------- --------- ----------- ---------- ----------
Balance at December 31, 1996....... -- -- -- -- -- 9,697,430
Issuance of preferred
stock--Eldorado.................. 116,593 11,659,000
Issuance of common stock--Eldorado -- -- 4,825,718 48,000 23,164,000 3,820,875
Restricted stock issuance.......... 427,556 4,000
Compensation expense...............
Cancellation of shares (Note 12)... -- -- -- -- -- (424,182)
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 13,521,679
------- ----------- --------- ----------- ---------- ----------
------- ----------- --------- ----------- ---------- ----------
<CAPTION>
UNREALIZED
GAIN ON
SECURITIES
ADDITIONAL RETAINED AVAILABLE
COMMON PAID-IN EARNINGS UNEARNED FOR
STOCK CAPITAL (DEFICIT) COMPENSATION SALE TOTAL
------------ ----------- ----------- ------------ ------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994....... $ 2,951,000 $ -- $(3,899,000) $ -- $-- $ (948,000)
Merger and reverse stock split (1
for 21)(Note 2).................. (2,951,000) 2,951,000 -- -- -- 0
Stock dividend..................... 1,000 156,000 (157,000) -- -- 0
Issuance of common stock........... 8,000 4,486,000 -- -- -- 4,494,000
Net loss........................... -- -- (5,000) -- -- (5,000)
------------ ----------- ----------- ------------ ------- -----------
Balance at December 31, 1995....... 9,000 7,593,000 (4,061,000) -- -- 3,541,000
Fractional share adjustment........ --
Issuance of common
stock--Liberty................... 34,000 13,373,000 -- -- -- 13,407,000
Issuance of common
stock--Commerce.................. 54,000 21,428,000 -- -- -- 21,482,000
Unrealized gain on securities
available for sale............... -- -- -- -- 17,000 17,000
Net income......................... -- -- 2,325,000 -- -- 2,325,000
------------ ----------- ----------- ------------ ------- -----------
Balance at December 31, 1996....... 97,000 42,394,000 (1,736,000) 17,000 40,772,000
Issuance of preferred
stock--Eldorado.................. 11,659,000
Issuance of common stock--Eldorado 38,000 17,966,000 -- -- -- 41,216,000
Restricted stock issuance.......... 2,008,000 -- (2,012,000) -- 0
Compensation expense............... 503,000 -- 503,000
Cancellation of shares (Note 12)... (4,000) (1,677,000) -- -- -- (1,681,000)
Unrealized gain on securities
available for sale............... -- -- -- -- 7,000 7,000
Net income -- -- -- 2,990,000 -- 2,990,000
Preferred dividends -- -- (730,000) -- -- (730,000)
------------ ----------- ----------- ------------ ------- -----------
Balance at December 31, 1997 $ 135,000 $60,691,000 $ 524,000 ($1,509,000) $24,000 $94,736,000
------------ ----------- ----------- ------------ ------- -----------
------------ ----------- ----------- ------------ ------- -----------
</TABLE>
See notes to consolidated financial statement
F-5
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------------
1997 1996 1995
-------------- -------------- ------------
<S> <C> <C> <C>
Operating Activities:
Net income (loss)................................................... $ 2,990,000 $ 2,325,000 $ (5,000)
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Provision for loan and lease losses............................... 1,495,000 515,000 295,000
Provision for loss on real estate acquired through foreclosure.... 176,000 72,000 383,000
Gain on sale of mortgage loans.................................... (6,887,000) (1,727,000) --
Loss on sale of premises and equipment............................ 11,000 85,000 --
(Gain) loss on sale of real estate owned.......................... 45,000 (135,000) --
Net gain on sale of securities.................................... (221,000) -- --
Depreciation and amortization..................................... 1,702,000 642,000 201,000
Amortization of goodwill and other intangibles.................... 2,514,000 178,000 --
Accretion/amortization related to securities, net................. 1,103,000 (252,000) --
Amortization of deferred compensation............................. 503,000 -- --
Amortization of deferred loan fees and costs...................... (1,209,000) (109,000) (6,000)
Accretion of mortgage servicing asset............................. 32,000 -- --
Provision (benefit) of deferred taxes............................. 2,087,000 (1,503,000) (443,000)
Mortgage loans originated for sale................................ (889,175,000) (242,339,000) --
Proceeds from sales of loans and servicing........................ 898,729,000 262,219,000 --
Mortgage servicing rights purchased and originated................ -- (275,000) --
Equity in loss of real estate joint venture....................... 254,000 56,000 --
Extraordinary item-gain on forgiveness of debt.................... -- -- (1,068,000)
Decrease in servicing sale receivable............................. 1,623,000 -- --
Increase in loans held for sale................................... (31,313,000) (47,769,000) --
Other, net........................................................ 3,963,000 (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-6
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------------
1997 1996 1995
-------------- ------------- ------------
<S> <C> <C> <C>
Financing Activities:
Net increase (decrease) in deposits................................. 39,235,000 (22,377,000) (4,445,000)
Issuance of subordinated debentures................................. 27,657,000 -- --
Issuance of preferred stock......................................... 11,659,000 -- --
Issuance of common stock............................................ 18,004,000 34,889,000 4,494,000
Issuance of special common stock.................................... 23,212,000 -- --
Payment of preferred dividends...................................... (730,000) -- --
Repayment of notes payable to shareholder........................... -- -- (656,000)
Proceeds from issuance of notes payable to related parties.......... -- 4,500,000 --
Net decrease in other borrowings.................................... (10,986,000) -- --
-------------- ------------- ------------
Net cash (used in) provided by financing activities........... 108,051,000 17,012,000 (607,000)
-------------- ------------- ------------
Net increase in cash and cash equivalents............................. 74,808,000 40,282,000 3,098,000
Cash and cash equivalents at beginning of period...................... 46,222,000 5,940,000 2,842,000
-------------- ------------- ------------
Cash and cash equivalents at end of period............................ $ 121,030,000 $ 46,222,000 $ 5,940,000
-------------- ------------- ------------
-------------- ------------- ------------
Supplemental disclosures of cash flow information:
Cash paid for interest on deposits.................................. $ 18,643,000 $ 7,670,000 $ 1,673,000
Cash paid for income taxes.......................................... 1,525,000 -- 2,000
Supplemental disclosures of non-cash investing activities:
Loans transferred to foreclosed real estate......................... 3,483,000 2,526,000 982,000
Loans originated to finance the sale of real estate................. -- -- 371,000
Transfer of securities from held to maturity to available for sale
(Note 4).......................................................... 15,004,000 -- --
Supplemental disclosures of non-cash financing activities:
Issuance of restricted stock........................................ 2,012,000 -- --
</TABLE>
See notes to consolidated financial statements.
F-7
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996, AND 1995
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.
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.
F-8
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
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.
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
F-9
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
worthiness or a significant change in tax-exempt status or statutory or
regulatory requirements, securities classified as held-to-maturity may be sold
or transferred to another classification.
Investment securities classified as available-for-sale may be held for
indefinite periods of time and may be sold to implement the Company's
asset/liability management strategies and in response to changes in interest
rates and/or prepayment risk and similar factors. These securities are recorded
at estimated fair value. Unrealized gains and losses are reported as a separate
component of shareholders' equity, net of income taxes.
Gains and losses on investment securities are determined on the specific
identification method and are included in other income.
LOANS HELD FOR SALE
Loans held for sale include mortgage loans carried at lower of cost or fair
value on an aggregate basis.
LOANS AND LEASES
Loans are stated at principal amounts outstanding, net of unearned income,
including discounts and fees. Net deferred fees and costs are generally deferred
and amortized into interest income over the contractual life of the related
loans as a yield adjustment. Direct financing leases, which include estimated
residual values of leased equipment, are carried net of unearned income. Income
from these leases is recognized on a basis which produces a level yield on the
outstanding net investment in the lease. The production of new leases comes
exclusively from the wholesale sector through a network of brokers, the Company
services these leases and during 1997, began selling blocks of leases to other
institutions. Leases held for resale are carried at the lower of cost or
estimated fair value on an 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.
F-10
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
The Company considers all loans impaired when it is probable that both
interest and principal will not be collected in accordance with the contractual
terms of the agreement. All loans that are ninety days or more past due, or have
been restructured to provide a reduction in the interest rate or a deferral of
interest or principal are automatically included in this category.
ALLOWANCE FOR ESTIMATED LOAN AND LEASE LOSSES
A provision for estimated loan and lease losses is charged to expense when,
in the opinion of management, such losses are expected to be incurred or are
inherent in the portfolio. The allowance is increased by provisions charged to
expense, increased for recoveries of loans previously charged-off, and reduced
by charge-offs. Loans and leases are charged-off when management believes that
the collectibility of the principal is unlikely. Management's estimates are used
to determine the allowance that is considered adequate to absorb losses inherent
in the existing loan and lease portfolio. These estimates are inherently
uncertain and their accuracy depends on the outcome of future events. Ultimate
losses may differ from current estimates. Management's estimates are based on
historical loan loss experience, specific problem loans and leases, current
economic conditions that may impact the borrower's ability to pay, volume,
growth and composition of the loan portfolio, value of the collateral and other
relevant factors.
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.
F-11
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
In 1996, the Company sold its portfolio of loan servicing and no longer
services mortgage loans for others. Previously, the Company capitalized the cost
of acquiring mortgage servicing rights through either purchase or origination of
mortgage loans if it sold or securitized those loans, and retained the
servicing. The Company allocated the cost of the mortgage loans to the mortgage
servicing rights and the loans (without the servicing rights) based on
observable market prices. Capitalized mortgage servicing rights were amortized
in proportion to, and over the period of, estimated net servicing income.
Loan servicing income represents fees earned for servicing real estate and
construction loan participations owned by investors, net of amortization
expense. The fees are generally calculated on the outstanding principal balances
of the loans serviced and are recorded as income when collected.
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
F-12
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
costs associated with foreclosed property under construction are capitalized and
considered in determining the fair value of the property. Operating expenses of
such properties, net of related income, and gains and losses on their
disposition are included in other non-interest expenses.
INTANGIBLES ARISING FROM ACQUISITIONS
The Company has paid amounts in excess of fair value for CSB's, 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 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.
F-13
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
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>
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
F-14
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
of assets, liabilities and disclosures in the consolidated financial statements.
Actual results could differ from those estimates.
NOTE 2--ACQUISITIONS AND 1996 REORGANIZATION:
A key element of the Company's strategic plan includes building
profitability through acquisitions of community banks principally, but not
exclusively, in and around its Southern California base, including bank's which
are or recently were in troubled condition, and seeking to increase the earnings
of the banks it has acquired through a combination of expense reduction
programs, merger synergies, improvements in asset quality and strengthening of
capital position. Since September 1995, the Company has completed three
acquisitions, increasing the Company's assets by over $840 million, including
the acquisition, completed on June 6, 1997, of Eldorado Bancorp ("Eldorado") and
its bank subsidiary, Eldorado Bank, a community bank based in Tustin, California
with approximately $400 million in total assets (collectively with the financing
related thereto, the "Eldorado Acquisition"). Effective June 30, 1997, the
Company consolidated via mergers (collectively, the "Bank Mergers") into
Eldorado Bank the respective operations of its other subsidiaries - LNB, SDNB,
and CSB.
On March 31, 1996, SDN Bancorp, Inc. ("SDN") completed its acquisition of
LNB (the "Liberty Acquisition") for approximately $15.1 million in cash. LNB had
total assets of approximately $150 million as of the acquisition date.
As of September 1, 1996, the Company completed the plan of reorganization
(the "1996 Reorganization") contemplated by the Agreement and Plan of
Reorganization dated April 23, 1996 (the "Agreement") between SDN and CSB. As
part of the 1996 Reorganization, SDN became a subsidiary of the Company,
effective August 31, 1996, in a transaction in which SDN shareholders received
shares of the Company's common stock in exchange for all of the outstanding
shares of SDN common stock. As of September 1, 1996, the Company completed the
acquisition of CSB (the "Commerce Acquisition") in which the Company acquired
all of the outstanding shares of CSB. Pursuant to the Agreement, holders of CSB
common stock received approximately $14.1 million and a total of 1,543,691
shares of the Company. CSB had total assets of approximately $220 million at
September 1, 1996.
Effective June 6, 1997, the Company completed the Eldorado Acquisition. The
Acquisition was effected pursuant to an Agreement and Plan of Merger entered
into between the Company and Eldorado on December 24, 1996 (the "Acquisition
Agreement"). Pursuant to the Acquisition Agreement, the Company acquired 100% of
the outstanding stock of Eldorado for cash consideration of $23.00 per share.
Contemporaneously with the Acquisition, each Eldorado stock option that had 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
F-15
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 2--ACQUISITIONS AND 1996 REORGANIZATION: (CONTINUED)
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.
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-16
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 4--INVESTMENT SECURITIES:
At December 31, 1997 and 1996, the Company's investment portfolio is as
follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1997
---------------------------------------------
GROSS UNREALIZED ESTIMATED
AMORTIZED ------------------ 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
----------- ------- --------- -----------
----------- ------- --------- -----------
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1997
---------------------------------------------
GROSS UNREALIZED ESTIMATED
AMORTIZED ------------------ MARKET
COST GAINS LOSSES VALUE
----------- ------- --------- -----------
<S> <C> <C> <C> <C>
Available for Sale:
U.S. Treasury................................... $14,394,000 $25,000 $ (9,000) $14,410,000
State and municipal securities.................. 761,000 4,000 -- 765,000
----------- ------- --------- -----------
Total......................................... $15,155,000 $29,000 $ (9,000) $15,175,000
----------- ------- --------- -----------
----------- ------- --------- -----------
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1997
----------------------------------------------
GROSS UNREALIZED ESTIMATED
AMORTIZED ------------------- MARKET
COST GAINS LOSSES VALUE
----------- ------- ---------- -----------
<S> <C> <C> <C> <C>
Held to Maturity:
U.S. Treasury..................................... $ 499,000 $ 3,000 $ -- $ 502,000
U.S. Government agencies.......................... 19,226,000 30,000 (150,000) 19,106,000
State and municipal securities.................... 300,000 3,000 (1,000) 302,000
----------- ------- ---------- -----------
Total............................................. $20,025,000 $36,000 $ (151,000) $19,910,000
----------- ------- ---------- -----------
----------- ------- ---------- -----------
</TABLE>
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.
F-17
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 4--INVESTMENT SECURITIES: (CONTINUED)
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.
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>
F-18
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 5--LOANS AND LEASES: (CONTINUED)
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>
At December 31, 1997, future minimum lease payments receivable are as
follows:
<TABLE>
<CAPTION>
<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.
F-19
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 5--LOANS AND LEASES: (CONTINUED)
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.
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
F-20
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 6--MORTGAGE BANKING ACTIVITIES: (CONTINUED)
$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.
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-21
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
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.
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),
F-22
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 10--BORROWINGS: (CONTINUED)
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.
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-23
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 11--INCOME TAXES: (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-24
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 11--INCOME TAXES: (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.
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.
F-25
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 12--STOCKHOLDERS' EQUITY: (CONTINUED)
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 4,248,431
additional shares of Class B Common Stock to various accredited investors for
consideration of $20,016,000.
DCG, the Company's largest shareholder, purchased 1,012,244 of those shares
of Class B Common Stock for aggregate consideration of $4,795,000, of which $4.3
million initially was made in the form of a loan to the Company in December 1996
to fund an escrow account that would have been forfeited to Eldorado if the
Company were unable to consummate the Acquisition financing. Peter H. Paulsen, a
director of the Company, loaned $200,000 to the Company on the same terms as
DCG. That $4.5 million was converted to shares of Class B Common Stock upon the
consummation of the Acquisition at a purchase price of $4.40 per share less a 1%
commitment fee.
SPECIAL COMMON STOCK. The Company sold a total of 4,825,718 shares of
Special Common Stock, $.01 par value per share (the "Special Common"), to DCG,
Madison Dearborn Capital Partners II, L.P., ("MDP"), Olympus Growth Fund II,
L.P., ("Olympus I"), and Olympus Executive Fund, L.P., ("Olympus II" and
collectively with Olympus I, "Olympus") at a gross purchase price of $4.81 per
share,
F-26
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 12--STOCKHOLDERS' EQUITY: (CONTINUED)
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 Warrants. The Investor Warrants expire on June 6, 2007. The aggregate
purchase price of the Investor Warrants was $40,000.
The Company also issued common stock warrants (collectively, the "Shattan
Warrants") to The Shattan Group, LLC, which acted as the Company's placement
agent for the sale of securities to MDP and Olympus. The Shattan Warrants, which
were issued as of June 6, 1997 and July 15, 1997, respectively, entitle the
holders thereof to purchase an aggregate of 482,433 shares of Class B Common
Stock at an exercise price of $4.81 per share and expire on June 6, 2000 and
July 15, 2002, respectively. The aggregate purchase price of the Shattan
Warrants was $4,824.
CANCELLATION OF COMMON STOCK
In October 1997, the Company settled litigation that it had brought against
the former majority shareholder of CSB, and certain other directors and officers
of CSB arising out of the Company's acquisition of CSB in September 1996. As
part of that settlement, the Company canceled 424,182 shares of Class B Common
Stock that was recorded as a purchase price adjustment.
NOTE 13--EMPLOYEE BENEFIT PLANS:
401(K) RETIREMENT PLAN
The Company has a retirement plan under Section 40l(k) of the Internal
Revenue Code. All employees of the Company are eligible to participate in the
40l(k) plan if they are twenty-one years of age or older and have completed 500
hours of service. Under the plan, eligible employees are able to
F-27
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 13--EMPLOYEE BENEFIT PLANS: (CONTINUED)
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
--------
$133,157
--------
--------
</TABLE>
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.
F-28
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 13--EMPLOYEE BENEFIT PLANS: (CONTINUED)
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 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>
WEIGHTED
AVAILABLE AVERAGE
FOR GRANT OUTSTANDING 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
F-29
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 13--EMPLOYEE BENEFIT PLANS: (CONTINUED)
estimated on the date of grant using the Black-Scholes option-pricing model with
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-30
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 14--CAPITAL ADEQUACY: (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-31
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 15--FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK: (CONTINUED)
The contract or notional amounts of those instruments reflect the extent of
the Company's involvement in particular classes of financial instruments. The
following is a summary of the notional amounts of various off-balance sheet
financial instruments entered into by the Company as of December 31, 1997:
<TABLE>
<S> <C>
Commitments to extend credit...................... $173,801,000
Standby letters of credit......................... 2,028,000
Put options to sell mortgage-backed securities.... 10,000,000
Forward commitments to sell mortgage-backed
securities...................................... 26,000,000
</TABLE>
The Company is principally engaged in providing commercial loans and leases
with interest rates that fluctuate with the various market indices and
variable-rate real estate loans. These loans are primarily funded through
short-term demand deposits and certificates of deposit with fixed rates. The
contractual amounts of commitment to extend credit, standby and commercial
letters of credit represent the amount of credit risk. Since many of the
commitments and letters of credit are expected to expire without being drawn,
the contractual amounts do not necessarily represent future cash requirements.
Commitments to extend credit are agreements to lend to a customer as long as
there are no violations of any conditions established in the contract. The
Company evaluates the creditworthiness of each customer. The amount of
collateral obtained, if deemed necessary by the Company upon the extension of
credit, is based upon management's evaluation. Collateral varies, but may
include securities, accounts receivable, inventory, personal property,
equipment, income property, commercial and residential property. Commitments
generally have fixed expiration dates or other terminal clauses and may require
the payment of fees. The Company experiences interest rate risk on commitments
to extend credit which are at fixed rates. There were no fixed rate commitments
at December 31, 1997 or 1996.
Standby letters of credit are written conditional commitments issued by the
Company to guarantee the performance of a customer to a third party, generally
in the production of goods and services or under contractual commitments in the
financial market. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
The Bank uses the same underwriting policies as if a loan were made.
The Bank's policy is to hedge a portion of its loans held for sale and its
commitments to originate loans against interest rate risk with forward
commitments to sell, or put options on, mortgage-backed securities. Forward
commitments are contracts for delayed delivery of securities in which the Bank
agrees to make delivery at a specified future date of a specified security, at a
specified price or yield. Put options convey to the Bank the right, but not the
obligation, to sell the securities at a contractually specified price. Risks
arise from the possible inability of counterparties to meet the terms of their
contracts and from movements in securities' values and interest rates. The Bank
tries to minimize 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
F-32
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 15--FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK: (CONTINUED)
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.
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 CARRYING
VALUE FAIR VALUE 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
F-33
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 16--DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS: (CONTINUED)
is conducted on the adequacy for the allowance for loan and lease losses and
should be a reasonable proxy for this credit risk component.
Fixed rate commercial and consumer loans are valued using a discounted cash
flow model that assumes a prepayment rate of 10% and a discount rate of prime
plus 50 basis points. These commercial and consumer loans were grouped into
categories and the weighted average maturity and rate were used in computing the
future cash flows. Leases are regularly sold into the secondary market and on
average have sold at a premium of approximately 3 percent. To determine the fair
value of leases, this potential sale premium was discounted to par to account
for the delinquent leases that would not garner the same sale premium. Fixed
rate residential mortgage loans were valued at par realizing that any premiums
attributable to the performing portfolio would be offset by discounts in the
delinquent portion of the portfolio.
Variable rate loans were broken down by loan type and evaluated based upon
the current weighted average rate of the loans in comparison to current market
conditions. Premiums of up to 2 percent were applied to those groups of loans
that had higher than market rates while loans at or below market were
discounted.
SERVICING SALE RECEIVABLE
The amounts recorded are generally collected within 90 days, and as such the
carrying amount is a reasonable estimate of the fair value.
MORTGAGE LOANS HELD FOR SALE
Loans held for sale are valued at a premium of 1%. These loans consist of
residential mortgage loans and are largely a fixed rate product. The premium
used approximates the gain that would be recognized on the sale of these loans,
discounted for hedging and sales costs.
DEPOSITS
Deposits consist of both non-interest and interest bearing accounts. Each
type of account has been valued differently as described below.
Non-interest bearing demand--Core non-interest bearing deposits are a
premium account for commercial banks and as such have been valued with a factor
of .95. Non-core type accounts such as title company deposits and custodial
accounts have been valued at par due to their temporary and volatile nature.
Interest bearing demand, savings and money market accounts--These accounts
are all priced competitively in the marketplace and are low cost funds for the
Bank. As such, these deposits have also been ascribed as premium accounts and
value with a factor of .99.
Certificates of deposit--Certificates of deposit accounts ("CD") were marked
to market utilizing current CD rates compared to rates being paid. CDS were
grouped based upon their remaining maturities and the weighted average maturity
and rates were grouped based upon their remaining maturities and the weighted
average maturity and rates were utilized in the analysis. Current rates for CD's
were determined utilizing the Treasury rates for comparable maturities less 25
basis points.
F-34
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 16--DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS: (CONTINUED)
Generally, rates currently being paid are higher than current market rates
which results in these accounts having a lower fair value.
BORROWINGS
Federal funds purchased are over-night investments and the carrying value is
a reasonable estimate of fair value. For subordinated debentures, having been
recently priced at the issuance in 1997, the carrying value is a reasonable
estimate of fair value. The mandatory convertible debentures will be redeemed at
par in March 1998, and as such the carrying value is also a reasonable estimate
of its fair value.
DUE TO RELATED PARTIES
Notes payable to related parties have a maturity of less than one year and
are stated at cost.
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
Commitments to Extend Credit and Standby Letters of Credit--The fair value
of commitments is estimated using the fees currently charged to enter into
similar agreements, taking into account the remaining terms of the agreements
and the present credit worthiness of the counterparties. The fair value of
letters of credit is based on fees currently charged for similar agreements or
on the estimated cost to terminate them or otherwise settle the obligations with
the counterparties at the reporting date. The fair value of commitments to
extend credit and standby letters of credit is not material.
Forward Commitments to Sell Mortgage-Backed Securities--Fair value is based
on quoted prices for financial instruments with identical or similar terms. The
fair value of forward commitments to sell mortgage-backed securities is not
material.
Put Options to Sell Mortgage-Backed Securities--Fair value is derived from
active exchange quotations. The fair value of put options to sell
mortgage-backed securities is not material.
NOTE 17--COMMITMENTS AND CONTINGENCIES:
LITIGATION
As of December 31, 1997, no litigation is pending against Commerce Security
Bancorp, Inc. The Bank is the plaintiff in an action, originally filed by CSB in
January 1994, seeking (among other things) to restrain a former CSB loan
production office manager from engaging in activities harmful to the Bank and
its employees. In June 1994, the former employee filed a cross-complaint against
the Bank and certain individual employees alleging wrongful termination, breach
of contract, defamation and various other causes of action. Following a jury
trial, judgment was entered against the Bank in 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.
F-35
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 17--COMMITMENTS AND CONTINGENCIES: (CONTINUED)
A summary of noncancellable future operating lease commitments at December
31, 1997 is as follows:
<TABLE>
<S> <C>
1998.................................... $2,077,000
1999.................................... 1,780,000
2000.................................... 1,383,000
2001.................................... 855,000
2002.................................... 750,000
Thereafter.............................. 2,918,000
----------
$9,763,000
----------
----------
</TABLE>
It is expected that in the normal course of business, expiring leases will
be renewed or replaced.
Rent expense under all noncancellable operating lease obligations aggregated
$2,302,000, $1,101,000 and $417,000 for the years ended December 31, 1997, 1996
and 1995, respectively.
DIVIDEND RESTRICTIONS
Federal Reserve policies declare that a bank holding company may not pay
cash dividends on its common stock unless its net income is sufficient to fund
fully such dividend, and its prospective rate of earnings retention after the
payment of such dividend appears consistent with its capital needs, asset
quality and overall financial condition. In connection with the Eldorado
Acquisition, the Company agreed that it will not pay dividends on common stock
without the prior approval of the Federal Reserve.
The Company is a legal entity separate and distinct from the Bank. Substantially
all of the Company's revenues and cash flow, including funds available for the
payments of dividends and other operating expenses, consists of dividends paid
to the Company by the Bank. There are statutory and regulatory limitations on
the amount of dividends which may be paid to the Company by the Bank. Dividends
payable by the Bank are restricted under California law to the lesser of the
Bank's retained earnings, or the Bank's net income for the latest three fiscal
years, less dividends previously declared during that period, or, with the
approval of the DFI, to the greater of the retained earnings of the Bank, the
net income of the Bank for its last fiscal year or the net income of the Bank
for its current fiscal year. In 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.
F-36
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 17--COMMITMENTS AND CONTINGENCIES: (CONTINUED)
The payment of dividends on capital stock by the Company and the Bank may
also be limited by other factors, including applicable regulatory capital
requirements and broad enforcement powers of the federal regulatory agencies.
Both the Federal Reserve and the DFI have broad authority to prohibit the
Company and the Bank from engaging in practices which the banking agency
considers to be unsafe or unsound. It is possible, depending upon the financial
condition of the Bank or the Company and other factors, that the applicable
regulator may assert that the payment of dividends or other payments by the Bank
or the Company is an unsafe or unsound practice and, therefore, implement
corrective action to address such a practice. Among other things, Federal
Reserve policies forbid the payment by bank subsidiaries to their parent
companies of management fees which are unreasonable in amount or exceed the fair
market value of the services rendered and tax sharing payments which do not
reflect the taxes actually due and payable.
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA")
generally prohibits a depository institution from making any capital
distribution (including payment of a dividend) or paying any management fee to
its holding company if the depository institution would thereafter be
"undercapitalized" for regulatory purposes. Those regulations and restrictions
may limit the Company's ability to obtain funds from the Bank for its cash
needs, including funds for payment of interest and operating expenses and
dividends.
F-37
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
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-38
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 18--CONDENSED FINANCIAL INFORMATION PARENT COMPANY: (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-39
<PAGE>
COMMERCE SECURITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
NOTE 18--CONDENSED FINANCIAL INFORMATION PARENT COMPANY: (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-40
