SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
Quarterly Report Under Section 13 or 15 (d)
of the Securities Exchange Act of 1934
For Quarterly Period Ended September 30, 1995
Commission File # 2-76555
SDN BANCORP, INC.
- --------------------------------------------------------------------
(Exact name of small business issuer in its charter)
Delaware 95-3683748
- ------------------------------- -------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
135 Saxony Road, Encinitas, California 92024-0905
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code 619-436-6888
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the past
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
------ ----
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock, $.01 par value 895,467
- ---------------------------- ---------------------------------
Class Outstanding on September 30, 1995
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SDN BANCORP, INC. AND SUBSIDIARY
SECURITIES AND EXCHANGE COMMISSION FORM 10-QSB
INDEX
Page
PART I - Financial Information
Item 1. Financial Statements
Condensed Consolidated Statements of Condition - 3
September 30, 1995 and December 31, 1994
Condensed Consolidated Statements of Operations 4
For the nine months ended September 30, 1995 and 1994 and
Three months ended September 30, 1995 and 1994
Condensed Consolidated Statements of Cash Flows - 5
For the nine months ended September 30, 1995 and 1994
Condensed Consolidated Statements of Shareholder's Equity
For the year ended December 31, 1994 and the nine months
ended September 30, 1995. 6
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial 14
Condition and Results of Operations
PART II -Other Information
Item 4. Submission of Matters to a vote of Security Holders 29
Item 5. Other 29
Item 6. Exhibits and Reports on Form 8-K 30
Signatures 31
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SDN BANCORP, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Condition
September 30, 1995 and December 31, 1994
(Dollars in thousands)
(Unaudited)
September 30, December 31,
1995 1994 ------------ -----------
------------ -----------
Assets
Cash and due from banks $ 3,606 $2,842
Federal funds sold 6,000 -
Interest bearing deposits with
financial institutions 493 1,078
Held to maturity investment securities:
at amortized cost, approximate
market value 1995 - $4,453,000;
1994 - $4,450,000 4,425 4,535
Loans 40,200 46,313
Less allowance for loan losses 852 821
------ ------
Loans, net 39,348 45,492
Premises and equipment, net 643 779
Real estate acquired through foreclosure 1,682 1,288
Accrued interest receivable
and other assets 1,603 1,672
-------- ---------
$ 57,800 $ 57,686
======== =========
Liabilities and Shareholders' Equity
Deposits:
Demand:
Non-interest bearing $11,748 $12,570
Interest bearing 10,530 10,206
Savings:
Regular 5,087 6,110
Money market 8,351 10,234
Time:
Under $100,000 13,976 12,212
$100,000 or more 3,333 4,544
------- ------
Total deposits 53,025 55,876
Accrued expenses and other liabilities 744 864
Notes payable - 675
Mandatory Convertible Debentures 537 1,219
------- ------
Total liabilities 54,306 58,634
Shareholders' equity (deficit):
Preferred stock, $.01 par value; 1,000,000 shares
authorized, no shares issued and outstanding at
September 30, 1995 and December 31, 1994 - -
Common stock, $.01 par value; 6,000,000 shares
authorized; 895,467 issued and outstanding
(564,145 at December 31, 1994; no par value) 9 -
Additional paid-in capital 7,607 2,951
Accumulated deficit (4,122) (3,899)
-------- -------
Total shareholders' equity (deficit) 3,494 (948)
-------- ---------
$ 57,800 $ 57,686
======== ========
See accompanying notes to condensed consolidated financial statements.
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SDN BANCORP, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Operations
Nine months ended September 30, 1995 and 1994
Three months ended September 30, 1995 and 1994
(Dollars in thousands, except for per share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
1995 1994 1995 1994
---- ---- ---- ----
C>
Interest Income:
Interest and fees on loans $ 1,012 $ 1,028$ 3,119 $ 2,991
Interest on Federal funds sold 27 27 74 43
Interest on deposits with
financial institutions 13 10 43 29
Interest and dividends on
investment securities 71 58 209 185
----- ----- ----- -----
Total interest income 1,123 1,123 3,445 3,248
Interest Expense:
Deposits 401 347 1,227 995
Other borrowed funds 55 48 165 133
----- ---- ----- -----
Total interest expense 456 395 1,392 1,128
----- ---- ----- -----
Net interest income 667 728 2,053 2,120
Provision for loan losses 145 125 245 433
----- ---- ----- -----
Net interest income after
provision for loan losses 522 603 1,808 1,687
Non-interest income 154 243 418 540
Non-interest expense 1,361 954 3,361 2,981
----- ---- ----- -----
Net loss before extraordinary item $ (685)$ (108) $(1,135)$ (754)
Extraordinary Item:
Gain from extinguishment of debt 1,068 - 1,068 -
----- ----- ----- ------
Net Income (loss) 383 (108) (67) (754)
===== ===== ====== =====
Income (loss) per Common Share:
Income (loss) before
extraordinary item $ (10.89) $(2.01)$ (19.98)$ (14.03)
Extraordinary item - gain from
extinguishment of debt 16.98 - 18.80 -
-------- ------- ------- ------
Net Income (loss) $ 6.09 $(2.01) $ (1.18)$ (14.03)
======== ======= ======= ======
See accompanying notes to condensed consolidated financial statements.
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SDN BANCORP, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Cash Flows
For the Nine Months Ended September 30, 1995 and 1994
(Dollars in thousands)
(Unaudited)
1995 1994
---- ----
Operating Activities:
Net loss $ (67) $(754)
Adjustments to reconcile net loss to net
cash used by operating activities:
Provision for loan losses 245 433
Depreciation and amortization 146 154
Increase in accrued interest receivable (16) (52)
Decrease (increase) in accrued interest payable (115) 86
Provision for OREO 445 131
Gain from extinguishment of debt (1,068) -
Other - net 447 (59)
----- -----
Net cash used by operating activities 17 (61)
----- -----
Investing Activities:
Net decrease in interest bearing deposits
other financial institutions 585 290
Purchases of investment securities (1,500) (2,066)
Proceeds from maturities of investment securities 1,610 2,031
Net decrease in loans 4,847 2,007
Purchases of premises and equipment (10) (55)
Proceeds from sale of real estate acquired
through foreclosures 213 1,101
------ -----
Net cash provided by investing activities 5,745 3,308
Financing Activities:
Net decrease in deposits (2,851) (1,210)
Repayment of notes payable (656) -
Net proceeds from issuance of notes payable - 14
Net Proceeds from issuance of common stock 4,509 -
------ -------
Net cash provided (used) by financing activities 1,002 (1,196)
----- -------
Net increase in cash and cash equivalents 6,764 2,051
Cash and cash equivalents at January 1, 1995
and 1994 2,842 4,183
Cash and cash equivalents at September 30, 1995 ------- -------
and 1994 $ 9,606 $ 6,234
Supplemental disclosure of cash flow activities:
Cash paid for income taxes $ 2 $ 2
------- -------
Cash paid for interest $ 1,245 $ 1,156
------- -------
Supplemental disclosure of non-cash flow activities:
Other real estate sold and financed by Bank $ 115 $ 215
------- -------
See accompanying notes to condensed consolidated financial statements.
SDN BANCORP, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Shareholder's (Deficit) Equity
For the Year Ended December 31, 1994 and
the Nine Months Ended September 30, 1995
(Dollars in thousands)
(Unaudited)
Number Additional
of Common Paid-in Accumulated
Shares Stock Capital Deficit Total
Balance at January 1, 1994 564,145 $- $2,951 $(2,910) 41
Net loss - - - (989) (989)
------- ------- ------ ------- ---------
Balance at December 31, 1994 564,145 - 2,951 (3,899) (948)
Reverse stock split
(21 for 1) and change
in par value (537,281) - - - -
Stock dividend 26,864 1 155 (156) -
Issuance of common stock 841,739 8 4,501 - 4,509
Net loss - - - (67) (67)
------- ------ ------- ------- ------
Balance at September 30, 1995 895,467 $ 9 $7,607 $ (4,122) $ 3,494
======= ====== ======= ========= =====
See accompanying notes to condensed financial statements.
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SDN BANCORP, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1995
(Unaudited)
NOTE 1:
The condensed consolidated financial statements include the accounts of SDN
Bancorp, Inc., a Delaware corporation, a Bank holding company, ("Bancorp" or
the "Company"), and its wholly-owned subsidiary, San Dieguito National Bank
("Bank"). In the opinion of management, the accompanying unaudited interim
condensed consolidated financial statements contain all adjustments,
consisting of only normal recurring accruals, necessary to present fairly the
financial position as of September 30, 1995 and the results of operations and
statements of cash flows for the nine months ended September 30, 1995 and 1994.
While management believes that the disclosures presented are adequate to make
the information not misleading, it is recommended that these financial
statements be read in conjunction with the financial statements and the notes
included in Bancorp's 1994 annual report.
NOTE 2:
As of September 30, 1995, Bancorp completed the recapitalization (the
"Recapitalization") contemplated by the July 21, 1995 Stock Purchase Agreement
(the "Stock Purchase Agreement") by and among SDN Bancorp, a California
corporation, ("Bancorp--CA"), the Bank and Dartmouth Capital Group, L.P.
(the "Partnership").
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The first step of the Recapitalization occurred as of September 27, 1995, when
Bancorp--CA reincorporated under Delaware law through its merger (the "Merger")
with and into SDN Bancorp, Inc., a newly-formed subsidiary that was
incorporated under Delaware law ("Bancorp" or the"Company"), with Bancorp
constituting the surviving corporation. In the Merger, each Bancorp--CA
shareholder received one share of common stock, $.01 par value per share (the
"Common Stock") of Bancorp for every twenty-one shares of common stock,
no par value per share, that theshareholder held in Bancorp--CA.
In accordance with the terms of the Stock Purchase Agreement, effective as of
September 30,1995, the Company issued and sold a total of 841,739 shares
(the "Shares") of Common Stock to the Partnership and certain investors in
the Partnership (collectively, the "New Investors"). The aggregate
consideration paid for the Shares was $4,900,000 million in cash. After
transaction costs of $391,000, Bancorp realized net proceeds of $4,509,000.
The Shares represent, in the aggregate, 94% of the shares of Common Stock
outstanding immediately after such issuance. The Partnership owns 48% of the
Common Stock. Depending upon the outcome of certain future contingencies
described in the Stock Purchase Agreement, the Partnership could receive
additional shares of the Company Common Stock currently being held in escrow,
thereby increasing its interest to as much as 51% of the outstanding shares
of common stock of the Company. Alternatively, also depending upon the
outcome of those contingencies, the shares of Company Common Stock now in
escrow will be distributed to the holders of the Shares of Company
Common Stock that were outstanding as of September 28, 1995.
As contemplated by the Stock Purchase Agreement, the purchase of the Shares
was conditioned upon, among other things, the prior consummation of the
Merger and forgiveness of a total of
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$1,068,000 of principal and accrued interest with respect to certain of the
Company's subordinated debentures and senior debt. This amount has been
reflected as an extraordinary gain in the Statement of Operations.
Prior to September 30, 1995, the Bank was considered "significantly
undercapitalized" under the Prompt Corrective Action provisions of the Federal
Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") and would
have been considered "critically undercapitalized" if its ratioof tangible
equity to total assets were equal to or less than 2%. At August 31, 1995, the
Bank's ratio was 2.04%. As part of the Recapitalization, Bancorp contributed
approximately $3.2 million of capital to the Bank. As a result of the infusion
of new capital as of September 30, 1995, Bancorp and the Bank were "well
capitalized" for Federal regulatory purposes, with ratios of Tier1 capital
to adjusted total assets of approximately 6.4% and 6.8%, respectively and
ratios of total capital to risk weighted assets of 10.8% and 10.2%,
respectively. See "Capital Resources" in Item 2 hereto for additional
information.
On September 21, 1992, the Bank entered into an agreement (the "OCC Agreement")
with the Office of the Comptroller of the Currency ("OCC") which, among other
matters, required the Bank to achieve and maintain certain capital ratios. On
October 23, 1992, Bancorp signed a Memorandum of Understanding ("MOU") with the
Federal Reserve Bank ('FRB") to confirm a plan to correct certain concerns.
Upon completion of the Recapitalization as described above, the OCC terminated
the OCC Agreement and the FRB terminated the MOU. See "Administrative
Proceedings" in Item 2 hereto for additional information.
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NOTE 3:
Prior to the Recapitalization, Bancorp had a $250,000 line of credit payable to
a director with an outstanding balance of $250,000 at an interest rate of Wall
Street Journal prime plus 2.5%. This line of credit was due December 30, 1995.
Bancorp also had promissory notes payable to three directors aggregating
$300,000 and promissory notes payable to three shareholders totaling $125,000
each at an interest rate of Wall Street Journal prime plus 2.0%. These notes
were due March 31, 1996.
Bancorp's Mandatory Convertible Debentures outstanding prior to the
Recapitalization totaled $1,219,500. The outstanding Debentures bear interest
at Wall Street Journal prime plus 3.0%, payable quarterly. The Debentures
are not subject to any sinking fund requirements and are subordinated in
right of payment to the obligations of the Bancorp under any other indebtedness.
The Indenture does not provide for a right of acceleration of 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 Debentureholders. Prior to conversion of
the Debentures, a Debentureholder has none of the rights or privileges of a
shareholder of Bancorp.
In January 1994, certain directors began making cash advances to Bancorp to
provide the funds necessary to pay debt service on $700,500 in principal of
Debentures owned by non-directors and on three notes totaling $550,000,
(consisting of the above mentioned $300,000 payable to the Bank and the
$250,000 line of credit payable to a director). Effective April 1, 1994, the
directors continued to advance additional funds sufficient to service the debt
requirements of these three notes totaling $550,000 but not the $700,500 in
principal of Debentures held by non-directors.
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The total of all advances was $105,900 as of September 30, 1995.
In July 1994, the non-director Debentureholders were notified that Bancorp no
longer had the funds to continue paying interest on the Debentures; and
therefore, the quarterly interest payments due for the second, third, and
fourth quarters of 1994 and the first and second quarters of 1995 were not
made. This constituted a payment default under Section 8.02 of the Indenture.
Debentureholders were asked to waive the quarterly payment defaults. According
to the Indenture, such a default in the payment of interest can be waived by a
majority of the principal amount of the Debentures outstanding, not including
the amount owned by Bancorp directors and officers. Signed waivers have been
received from a sufficient number of Debentureholders thus waiving Bancorp's
default in the above mentioned quarterly payments under the Debentures.
On September 30, 1995, upon completion of the Stock Purchase Agreement, certain
of the above Bancorp indebtedness was forgiven or paid as described below. The
$250,000 line of credit payable to a director was satisfied through a principal
payment of $230,810 plus unpaid interest of $6,094 and the forgiveness of the
remaining principal of $19,190 by the holders. The principal portion of the
notes payable to three directors totaling $300,000 and the notes payable to
three shareholders totaling $125,000 were paid in full. The unpaid interest
totaling $97,655 on all six of the notes was forgiven by the holders.
Debentures with an aggregated face amount of $682,000 and unpaid interest of
$163,191 were forgiven by the holders. On October 12, 1995, Bancorp paid all
past due interest, plus 1995 third quarter interest, on the $537,500 in
remaining Debentures. This interest totaled $88,868. The $105,900 cash
advances from directors were forgiven by the Directors.
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As a result of the above actions, Bancorp made principal payments of $955,810
and interest payments of $102,313. Principal and advances of $807,090 and
interest of $260,846, for a total of $1,067,936, were forgiven.
NOTE 4:
Per share data is computed by dividing net loss by the weighted average number
of shares of common stock and common stock equivalents outstanding. Per share
data has been restated to reflect the one for twenty-one reverse stock split.
and the $26,864 common stock dividend. The assumed conversion of the Mandatory
Convertible Debentures ("Debentures"), which are not common stock equivalents,
was antidilutive for the nine months ended September 30, 1995 and 1994.
NOTE 5:
Real estate acquired through foreclosure or deed-in-lieu of foreclosure (Other
Real Estate Owned or OREO) is recorded at the lesser of the outstanding loan
amount or market value less estimated cost to sell, at the time of foreclosure.
NOTE 6:
Bancorp adopted the provisions of Statement of Financial Accounting Standards
No. 109, "Accounting for Income Taxes" effective January 1, 1993. On January 1,
1994 Bancorp adopted the provision of Statement of Financial Standards No. 115
"Accounting for Certain Investments in Debt and Equity Securities". There were
no material effects of adoption of either statements.
Effective January 1, 1995 the Bank adopted Statement of Financial Accounting
Standards No.
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114 (SFAS No. 114) "Accounting by Creditors for Impairment of a Loan" as amended
by SFAS No. 118 "Accounting by Creditors for Impairment of a Loan-Income
Recognition and Disclosures".
The balance of impaired loans as defined by SFAS No. 114 was $1,513,000 at
September 30, 1995. At September 30, 1995 $1,513,000 of impaired loans had
related allowance for loan losses of $206,000. The Bank's average investment in
impaired loans was $926,000 during the nine month period ending September 30,
1995. Cash receipts for impaired loans placed on non-accrualstatus are first
applied to reduce principal.
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ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Nine months ended
September 30, 1995
SUMMARY:
As of September 30, 1995, SDN Bancorp, a California corporation ("Bancorp--CA")
completed the recapitalization (the "Recapitalization") contemplated by the July
21, 1995 Stock Purchase Agreement (the "Stock Purchase Agreement") whereby
Bancorp--CA reincorporated under Delaware law through its merger (the "Merger")
with and into SDN Bancorp, Inc., a newly formed corporation under Delaware law
("Bancorp" or the "Company"), with Bancorp constituting the surviving
corporation, and thereafter sold an aggregate of 841,739 shares of Company
Common Stock to Dartmouth Capital Group, L.P., a Delaware limited partnership
(the "Partnership") together with certain of its partners (collectively, the
"New Investors"). As a result of this Recapitalization and Merger, Bancorp is
owned 94% by the New Investors. The Partnership, which owns 48% of the Common
Stock, is controlled by its sole general partner, Dartmouth Capital Group, Inc.,
a Delaware corporation ("DCG, Inc."). The Partnership is actively considering
the acquisition of controlling or substantial equity positions in various other
financial institutions.
Bancorp owns 100% of San Dieguito National Bank ("Bank"). As of September 30,
1995, Bancorp has had no significant business activities independent from the
Bank. Accordingly, the following discussion relates primarily to the operating
results and financial condition of the Bank.
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Average earning assets of the Bank for the first nine months of 1995 were
approximately $50.4 million, a decrease of $3.8 million or 7.0% from the average
for the comparable nine month period in 1994. Average earning assets have
generally decreased since the second quarter of 1992. Total assets of the Bank
were $58.0 at September 30, 1995 compared to total assets of $58.0 at December
31, 1994 and $60.6 at September 30, 1994. Total consolidated assets at
September 30, 1995 were $57.8 million compared to total assets of $57.7 million
at December 31, 1994 and $60.3 million at September 30, 1994. Total assets at
September 30, 1995 included $3.5 million as a result of the Recapitalization.
Average loans for the third quarter of 1995 were approximately $40.9 million, a
decrease of $5.5 million or 11.9% from the average for the third quarter of
1994. Total loans at September 30, 1995 were $40.2 million compared to $46.3
million at December 31, 1994. This $6.1 million decrease was primarily a result
of a $3.1 million decrease in commercial loans and a $2.6 milliondecrease in
real estate loans.
Average deposits for the third quarter of 1995 were approximately $53.4 million
(excluding Bancorp's deposit account which is eliminated in consolidation), a
decrease of $6.0 million or 10.1% from the average for the third quarter of
1994. Total deposits decreased to $53.0 million at September 30, 1995 compared
to $55.9 million at December 31, 1994. This $2.9 million decrease is primarily
due to a $0.5 million decrease in demand deposits plus a $2.9 million decrease
in savings deposits (including money market) offset by a $0.5 million increase
in time certificates of deposit.
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For the nine months ended September 30, 1995, Bancorp had a consolidated net
loss of $67,000 compared to a consolidated net loss of $754,000 for the same
period in 1994. Included in the $67,000 net loss is an extraordinary gain from
extinguishment of debt of $1,068,000. Bancorp's loss before extraordinary item
was $1,135,000 for the nine months ended September 30, 1995 versus $754,000 for
the same period in 1994. The increase in the loss before "extraordinary item"
for the 1995 period is due to a $314,000 increase in the provision for OREO
losses, a $66,000 increase in other non-interest expenses, a $122,000 decrease
in non-interest income, a $67,000 decrease in net interest income, offset by a
$188,000 decrease in the 1995 provision for loan losses.
Net Interest Income and Net Interest Margin
In the first nine months of 1995, Bancorp's net interest income (including loan
fees) decreased $67,000 as the result of a decrease in average earning assets
offset by an increase in interest rates earned on the assets. The prime lending
rate increased five times in 1994 and once in 1995 and then decreased to 8.75%
in July, 1995. See "Economic Considerations".
Comparing the first nine months of 1995 to those of 1994, the yield on average
earning assets increased to 9.1% from 8.0%, while the average cost of interest
bearing liabilities increased to 4.0% from 3.0%. The net interest margin was
5.4% for the first nine months of 1995 compared to 5.2% for the first nine
months of 1994. This higher net interest margin reflects the higher
prime lending rate in 1995 compared to 1994.
Loan fee income decreased $23,000 for the first nine months of 1995 compared to
1994. This decrease reflects the continued decline in local construction
lending as well as difficulties in
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competing for construction loans with a reduced lending limit.
Allowance and Provision for Loan Losses
The allowance for loan losses represents the amounts which have been set aside
for the specific purpose of absorbing losses which may occur in the Bank's loan
portfolio. The provision for loan losses is an expense charged against
operating income and added to the allowance for loan losses. Management of the
Bank continues to carefully monitor the allowance for loan losses in relation
to the size of the Bank's loan portfolio and known risks or problem loans.
The allowance for loan losses was $852,000 at September 30, 1995 compared to
$821,000 at December 31, 1994. The allowance for loan losses was 2.1% of gross
loans at September 30, 1995 and 1.8% at December 31, 1994. During the first
nine months of 1995, the provision for loan losses was $245,000, loan charge-
offs were $271,000 and recoveries were $57,000. This compares favorably to a
provision for loan losses of $433,000, loan charge-offs of $596,000 and
recoveries of $82,000 during the first nine months of 1994.
At September 30, 1995, $29.7 million or 74% of total loans were secured by
deeds of trust on real estate. This includes loans to companies or individuals
for business purposes which are also secured by real estate. The Bank, like
other banks, also makes a number of loans to companies and individuals which are
secured by other collateral or based solely upon the cash flow, income,
character and/or net worth of the borrower. At September 30, 1995, the Bank had
$10.5 million or 26% of total loans in this category. The majority of these
loans are collateralized by business property, personal property and/or
governmental agency guarantees. The collection of these loans is more dependent
upon the borrower's financial capability at maturity than loans that are secured
by real estate.
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Non-performing loans and other real estate owned ("OREO") are summarized as
follows:
(Dollars in Thousands)
September 30, December 31,
1995 1994
Non-performing loans:
Loans past due 90 days or more
and still accruing $ 136 $ 826
Loans on non-accrual 1,513 1,666
----- -----
Non-performing loans $1,649 $2,492
====== ======
As a percent of total loans 4.1% 5.4%
====== ======
OREO $1,682 $1,288
------ ------
Non-performing assets $3,331 $3,780
====== ======
As a percent of total assets 5.7% 6.5%
===== ====
The $1,513,000 in loans on non-accrual at September 30, 1995 consists of
twenty-six loans of which nineteen loans totaling 92% of the total amount are
secured by real estate. The weighted average loan to appraised value ratio of
these nineteen loans, excluding twelve 90% FHA guaranteed loans, is
approximately 64%. At December 31, 1994, the $1,666,000 in loans on non-accrual
consisted of sixteen loans, of which seven loans totaling 88% of the total
dollar amount were secured by real estate.
Using the peer group of all banks headquartered in San Diego County with
total assets less than $500 million as of June 30, 1995, the most recent peer
group data available, the ratio of the allowance for loan losses to non-
performing loans was 59% for such regional peer group compared to the Bank's
ratio of 32%. At September 30, 1995, the same ratio for the Bank was
52% as a result of a $63,000 increase in the allowance for loan losses and a
$743,000 decrease in
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non-performing loans at September 30, 1995 compared to June 30, 1995. This
decrease in non-performing loans was largely due to foreclosure proceedings on
three non-accrual loans totaling $787,000 resulting in OREO. As of June 30,
1995, non-performing loans as a percentage of total loans was 3% for the
regional peer group compared to the Bank's percentage of 6%. The Bank's
percentage decreased to 4% as of September 30, 1995.
The OREO balance of $1,682,000 at September 30, 1995 is composed of six
properties. The increase compared to December 31, 1994 is the result of three
properties with a total carrying value of $1,052,000 added to OREO during the
first nine months of 1995 as a result of foreclosure. One property with a
carrying value of $213,000 was sold in March 1995. Five properties were
written down $445,000. All of the OREO properties are recorded at amounts
which are equal to or less than the market value based on current independent
appraisals reduced by estimated selling costs. The Bank is in compliance with
Statement of Position 92-3.
A portion of the non-performing loans represents the Bank's willingness to
allow loans to go into default in order to pursue collection efforts rather than
to grant liberal loan renewals. As discussed above, most of the non-performing
loans and OREO are secured by residential real estate.
Given the current local economic conditions and the importance of real
estate values to the Bank's loan portfolio, it is possible the level of non-
performing loans may increase until the local economy improves significantly.
Current collection and foreclosure activities are likely to result
in additional non-accrual and OREO amounts. See "Economic Considerations".
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The calculation of the adequacy of the allowance for loans losses requires
the use ofmanagement estimates. These estimates are inherently uncertain and
depend on the outcome of future events. Management's estimates are based upon
previous loan loss experience, current economic conditions as well as the
volume, growth and composition of the loan portfolio, the estimated value of
collateral and other relevant factors. The Bank's lending is concentrated in
Southern California, which has experienced adverse economic conditions,
including declining real estate values. These factors have adversely affected
borrowers' ability to repay loans. Although management believes the level of
the allowance as of September 30, 1995 is adequate to absorb losses inherent in
the loan portfolio, additional decline in the local economy may result in
increasing losses that cannot reasonably be predicted at this date. The
possibility of increased costs of collection, non-accrual of interest on those
which are or may be placed on non-accrual, and further charge-offs could have an
adverse impact on the Bank's and Bancorp's financial condition in the future.
Non-Interest Income
Non-interest income decreased by $122,000 for the first nine months of 1995
compared to the same period in 1994. This was primarily due to a $22,000
decrease in deposit service charge income in 1995 compared to 1994 plus a gain
on sale of OREO of $103,000 recorded in 1994.
Non-Interest Expenses
Non-interest expenses for the first nine months of 1995 increased $380,000
compared to the first nine months of 1994. This increase is largely comprised
of a $244,000 increase in the provision for OREO and $33,000 of accrued
operational expenses relating to changes
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contemplated as a part of the Recapitalization.
Although the Bank took a number of actions to reduce non-interest expenses
and increase non-interest income in the past, the Bank continues to evaluate
ways to realize even greater efficiency and ways to reduce overhead costs. Since
many of the Bank's costs are fixed, their impact on the overhead ratio cannot be
substantially improved without a significant increase in the Bank's size. The
directors are considering a number of alternatives to address these matters.
Provision for Income Taxes
As a result of a net operating loss for the first nine months of 1995, there
is no provision for Federal or California income tax. Prior to the sale of the
Shares to the New Investors on September 30, 1995 (see "Capital Resources",
below), Bancorp had a substantial Federal net operating loss carryforward
("NOL") available to offset income earned in future periods. As
expected, the sale of the Shares resulted in an "ownership change" for federal
income tax purposes under Section 382 of the Internal Revenue Code, which will
substantially limit Bancorp's ability to utilize that NOL against future income
and will result in higher tax costs during future periods than would have been
incurred had the sale of the Shares not taken place. (The change in control
will have a similar effect on Bancorp's California state tax loss carryforwards,
although the amount of those carryforwards, and the corresponding increased tax
cost, is less significant)
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Capital Resources
As of September 30, 1995, Bancorp completed the Recapitalization
contemplated by the July 21, 1995 Stock Purchase Agreement by and among Bancorp-
- -CA, the Bank and Dartmouth Capital Group, L.P.
The first step of the Recapitalization occurred as of September 27, 1995,
when Bancorp--CA reincorporated under Delaware law through its merger (the
"Merger") with and into SDN Bancorp, Inc., a newly-formed subsidiary that was
incorporated under Delaware law ("Bancorp" or the "Company"), with Bancorp
constituting the surviving corporation. In the Merger, each Bancorp--CA
shareholder received one share of common stock, $.01 par value per share (the
"Common Stock") of Bancorp for every twenty-one shares of common stock, no par
value per share, that the shareholder held in the Bancorp--CA.
In accordance with the terms of the Stock Purchase Agreement, effective as
of September 30, 1995, Bancorp issued and sold a total of 841,739 shares (the
"Shares") of Common Stock to the Partnership and certain investors in the
Partnership (collectively, the "New Investors"). The aggregate consideration
paid for the Shares was $4,900,000 million in cash. After transaction
costs of $391,000, Bancorp realized net proceeds of $4,509,000. The Shares
represent, in the aggregate, 94% of the shares of Common Stock outstanding
immediately after such issuance. Depending upon the outcome of certain future
contingencies described in the Stock Purchase Agreement, the Partnership could
receive additional shares of Bancorp common stock currently being held in
escrow, thereby increasing its collective interest to as much as 97% of the
outstanding shares of common stock of Bancorp. Alternatively, also depending
upon the outcome
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of those contingencies, the Shares of Company Common Stock now in escrow will be
distributed to the holders of the Shares of Company Common Stock. In the latter
event, those shares will be distributed pursuant to the Company's Series A
(Primary) Stock Right, distributed to holders of Company Common Stock as of
September 28, 1995 and "attached" for purposes of trading, to the latter shares.
As contemplated by the Stock Purchase Agreement, the purchase of the Shares
was conditioned upon, among other things, the prior consummation of the Merger
and forgiveness of a total of $1,068,000 of principal and accrued interest with
respect to certain of Bancorp's subordinated debentures and senior debt.
Current risk-based regulatory capital standards generally require banks and
holding companies (except for non-diversified holding companies, such as
Bancorp, with less than $150 million in assets) to maintain a ratio of "core" or
"Tier 1" capital (consisting principally of common equity) to risk-weighted
assets of at least 4%, the ratio of Tier 1 capital to adjusted total
assets (leverage ratio) of at least 3% and a ratio of total capital (which
includes Tier 1 capital plus certain forms of subordinated debt, a portion of
the allowance for loan losses, and preferred stock) to risk-weighted assets of
at least 8%. Risk-weighted assets are calculated by multiplying the
balance in each category of assets according to a risk factor which ranges from
zero for cash assets and certain government obligations to 100% for some types
of loans, and adding the products together.
Prior to September 30, 1995, the Bank was considered "significantly
undercapitalized"
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under the Prompt Corrective Action provisions of the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA") and would be considered
"critically undercapitalized" if its ratio of tangible equity to total assets
should equal or be less than 2%. At August 31, 1995, the Bank's such ratio was
2.04%. See "Administrative Proceedings". As part of the Recapitalization,
Bancorp contributed approximately $3.2 million of capital to the Bank.
The following is a summary of Bancorp's and the Bank's capital ratios at
September 30, 1995.
Bank Regulatory
Only Bancorp Required
---- ------- ---------
Total capital vs. risk adjusted assets 10.2% 10.8% 8.0%
Tier 1 capital vs. risk adjusted assets 9.0 8.3 4.0
Tier 1 capital vs. adjusted total assets
(Leverage) 6.8 6.4 3.0
As of September 30, 1995 the Bank is considered "well capitalized" under
the Prompt Corrective Action Provisions of the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA").
Liquidity
The Bank relies on deposits as its principal source of funds and,
therefore, must be in a position to service depositors' needs as they arise.
Management of the Bank attempts to maintain a loan-to-deposit ratio of not
greater than 80% and a liquidity ratio (liquid investments to deposits
and other short term liabilities) of approximately 20%. The average loan-to-
deposit ratio was 78% for the nine-month period ending September 30, 1995 and
80% for the same period in 1994. The average liquidity ratio was 20% for both
the first nine months of 1995 and 1994. At September 30, 1995, the Bank's
liquidity ratio was 27% as a result of Bancorp's contribution of
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additional capital to the Bank. While fluctuations in the balances of a few
large depositors cause temporary increases and decreases in liquidity from time
to time, the Bank 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 Bank, other available sources of liquid assets (secondary
liquidity), including the purchase of federal funds, sale of repurchase
agreements, sale of loans, and the discount window borrowing from the Federal
Reserve Bank, could be employed. The Bank has rarely used these sources in
the past since its liquidity levels have been maintained primarily through funds
provided by deposits.
Bancorp's liquidity needs are primarily limited to debt service. Bancorp
has sufficient funds in order meet its debt service requirements.
Economic Considerations
Approximately 74% of the Bank's loan portfolio at September 30, 1995
consisted of short-term loans tied to a floating interest rate which changes at
least annually (41% is tied to a daily floating prime rate). This loan
portfolio mix enables the Bank to adjust its yields quickly in a changing
interest rate environment. The Bank's assets are more sensitive to interest
rate changes than its liabilities. This is partly because it has more non-
interest bearing liabilities (demand deposits and capital) than non-interest
earning assets. Given these circumstances and absent other factors, declining
market rates of interest will generally have a negative impact on the Bank's net
interest income, while rising interest rates will have a positive effect.
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The majority of Bancorp's assets and liabilities are monetary items held by
the Bank, 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 Bank that was felt in
many other industries. The small fixed asset investment of Bancorp 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 Bank, making collection more difficult for the Bank. Rates of
interest paid or charged generally rise if the marketplace believes inflation
rates will increase.
The Bank concentrates on serving the needs of small and medium-size
businesses, professionals and individuals located in the San Diego County area
of California. The general economy in this market area, and particularly the
real estate market, is suffering from the effects of a slow recovery from the
prolonged recession that has adversely affected the ability of certain
borrowers of the Bank to perform their obligations to the Bank. In addition,
problems with the Mexican peso may continue to adversely affect cross-border
traffic.
Although the assessment of recent economic reports and the current economic
environment in Bancorp's market areas are encouraging, management believes that
the negative impact of a slow recovery from the prolonged California recession
could continue through the remainder of 1995 and into 1996.
The financial condition of the Bank has been, and is expected to continue
to be, affected
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by overall general economic conditions and the real estate market in California.
The future success of the Bank is dependent, in large part, upon the quality of
its assets. Although management of the Bank has devoted substantial time and
resources to the identification, collection and workout of nonperforming assets,
the real estate markets and the overall economy in California are likely to have
a significant effect on the Bank's assets in future periods and, accordingly,
Bancorp's financial condition and results of operations.
Administrative Proceedings
On September 21, 1992, the Bank entered into an agreement with the OCC (the
"OCC Agreement") to address certain matters arising from an examination of the
Bank's condition conducted by the OCC as of January 31, 1992. In addition,
following notification as of December 31, 1993 from the OCC that the Bank was
deemed to be "significantly undercapitalized" under the prompt corrective action
provisions of FDICIA, the Bank submitted to the OCC a capital restoration plan
(including several subsequent revisions thereof), which contemplated the Bank's
obtaining additional capital from an investor or purchaser. Bancorp--CA
submitted to the OCC a guaranty of the Bank's capital restoration plan.
On October 23, 1992, Bancorp--CA signed a Memorandum of Understanding
("MOU") with the Federal Reserve Bank (the "FRB") to confirm a plan to correct
concerns arising from their inspection of the condition of Bancorp--CA as of
March 31, 1992. In accordance with the MOU, Bancorp also submitted a plan to
the FRB which set forth its plan to increase the capital of Bancorp and address
other procedural matters.
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Pursuant to agreements reached with the OCC and the FRB prior to the
execution of the July 21, 1995 Stock Purchase Agreement, the OCC terminated the
OCC Agreement and the FRB terminated the MOU both as of the closing of the
Recapitalization on September 30, 1995 as described above under "Capital
Resources".
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PART II
ITEM 4. Submission of Matters to a Vote of Security Holders
On September 27, 1995, Bancorp--CA held its annual meeting of
shareholders at which the following items were voted on and approved:
1. The following Directors were elected by a vote of 400,499 given
and 2,730 withheld:
Leonard R. Cory
J. Peter Fitzpatrick, D.D.S.
Robert E. Grice
M. Tamie Kimura
James E. O'Neal
Paul E. Schedler
Robert O. Weston
2. The Shareholders approved Bancorp--CA reincorporation from
California to Delaware by means of a merger of Bancorp--CA with
and into a Delaware corporation organized as a subsidiary of
Bancorp--CA (SDN Bancorp, Inc.) by a vote of 402,399 for, 420
against and 410 abstain.
As of the closing of the Recapitalization on September 30, 1995, and
as contemplated by the Stock Purchase Agreement, the Board of
Directors elected, as new Directors, nominees of Dartmouth Capital
Group, L.P. and each of the Directors named in paragraph 1 above
resigned. See Item 5, "Management Changes", below.
ITEM 5. Other
(a) Management Changes
As contemplated by the July 21, 1995 Stock Purchase Agreement among
Bancorp--CA, the Bank and the Partnership, all of Bancorp's Directors,
the President and the Secretary of Bancorp, and the President of the
Bank, resigned immediately following the closing on September 30,
1995. Prior to their resignations, they elected nominees of the
Partnership to fill each of those positions. Currently, management of
Bancorp consists of the following persons:
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Directors: Edward A. Fox
Charles E. Hugel
Robert P. Keller
K. Thomas Kemp
Jefferson W. Kirby
President and Chief
Executive Officer:Robert P. Keller
Robert P. Keller has also been elected a Director and President and
Chief Executive Officer of the Bank. The Other members of the
Bank's Boarad of Directors remain unchanged.
(b) Subsequent Event: Merger Agreement with Liberty National
Bank
Bancorp, the Partnership and Liberty National Bank ("Liberty")
entered into an Agreement and Plan of Merger (the "Merger
Agreement") dated as of October 26, 1995, providing for the aquisi-
tion of Liberty by Bancorp. Liberty is based in Huntington Beach
California and at September 30, 1995 had total assets of $146 million
and total deposits of $130 million. The acquisition will be
affected through a consolidation of Liberty and a subsidiary of
Bancorp in which Liberty's stockholders receive cash for their
shares. The Partnership has agreed to fund the transaction for
Bancorp. The Merger Agreement provides that Liberty stockholders
will receive the greater of $14.80 per share or 130% of Liberty's
book value (subject to certain adjustments) shortly prior to the
closing, calculated on a fully diluted basis, in each case subject to
possible small upward adjustments depending upon the time of the
closing. There are currently 978,160 shares of Liberty common stock
outstanding, resulting in a minimum agregate purchase price of
approximately $14.5 million.
ITEM 6. Exhibits and Reports on form 8-K
(a) Exhibits:
Agreement and Plan of Merger with Liberty National Bank,
attached as Exhibit 2. to Form 8-K as of October 26, 1995
incorporated by reference.
(b) Reports on Form 8-K:
As of September 30, 1995, SDN Bancorp, Inc. reported change in
control of Restrant and the Recapitalization described under
Part I, Item 2, "Capital Resources".
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SDN BANCORP, INC AND SUBSIDIARY
SECURITIES AND EXCHANGE COMMISSION FORM 10-QSB
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of of 1934, the
Issuer has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
SDN BANCORP, INC.
DATE: NOVEMBER 14, 1995 Robert P. Keller /s/
-------------------------------
Robert P. Keller
President and Chief Executive Officer
DATE: NOVEMBER 14, 1995 Cathy J. Wingenbach /s/
------------------------------
Cathy J. Wingenbach
Principal Accounting Officer