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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997 or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 2-77519-LA
SARATOGA BANCORP
(Exact name of registrant as specified in its charter)
California 94-2817587
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) Identification No.)
12000 Saratoga-Sunnyvale Road
Saratoga, California 95070
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (408)973-1111
Securities registered pursuant to Section 12 (b) of the Act:
Name of each exchange
Title of each class on which registered
NONE NONE
Securities registered pursuant to Section 12 (g) of the Act:
NONE
(Title of class)
Saratoga Bancorp (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, and (2) has been subject to such filing
requirements for the past 90 days. Yes X No .
Indicate by checkmark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant'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]
The aggregate market value of the voting stock held by non-affiliates
of Saratoga Bancorp on March 10, 1998 was $19,421,316
As of March 10, 1998, Saratoga Bancorp had 1,091,967 shares of common
stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The Company's Proxy Statement is incorporated herein by reference in
Part III, Items 10 through 13.
The Index to Exhibits appears on page 62
Page 1 of 64 pages
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PART 1
Item 1. Business
General
Certain matters discussed or incorporated by reference in this Annual
Report on Form 10-K including, but not limited to, matters described in Item 7
- - "Managements Discussion and Analysis of Financial Condition and Results of
Operations," are forward-looking statements that are subject to risks and
uncertainties that could cause actual results to differ materially from those
projected. Changes to such risks and uncertainties, which could impact
future financial performance, include, among others, (1)competitive pressures
in the banking industry; (2)changes in interest rate environment; (3)general
economic conditions, nationally, regionally and in operating market areas;
(4)changes in the regulatory environment; (5)changes in business conditions and
inflation; and (6)changes in securities markets. Therefore, the information
set forth herein should be carefully considered when evaluating the business
prospects of the Company and the Bank.
Saratoga Bancorp (the "Company") is a registered bank holding company whose
principal asset (and only subsidiary) is the common stock of Saratoga National
Bank (the "Bank"). The Company itself does not engage in any business
activities other than the ownership of the Bank and investment of its available
funds. As used herein, the term "Saratoga Bancorp" or the "Company" includes
the subsidiary of the Company unless the context requires otherwise.
The Company was incorporated in California on December 8, 1981. The Bank
commenced operations on November 8, 1982. The Bank provides a variety of
banking services to businesses, governmental units and individuals. The Bank
conducts a commercial and retail banking business, which includes accepting
demand, savings and time deposits and making commercial, real estate and
consumer loans. It also offers installment note collections, issues
cashier's checks, sells traveler's checks and provides other customary
banking services. The Bank's deposits are insured by the Federal Deposit
Insurance Corporation (the "FDIC") up to the legal limits thereupon. The
Bank does not offer trust services nor international banking services and does
not plan to do so in the near future. At December 31, 1997, the Company had
total assets of approximately $131 million and total deposits of approximately
$91 million. At December 31, 1997, the Company had 23 full-time equivalent
employees.
Most of the Bank's deposits are obtained from the Bank's primary service
area. No material portion of the Bank's deposits have been obtained from a
single person or group of related persons, the loss of any one or more of which
would have a materially adverse effect on the business of the Bank, nor is a
material portion of the Bank's loans concentrated within a single industry or
group of related industries. Although real estate construction loans represent
approximately 14% and other real estate loans represent approximately 46% of
total loans, no material portion is located in a single geographic area.
<PAGE 3>
Furthermore, the extent to which the business of the Bank is seasonal is
insignificant. The importance of, and risks attendant to, foreign sources and
application of the Bank's funds is negligible.
For additional information concerning the Company and the Bank, see
Selected Financial Data under Item 6 on page 17.
SUPERVISION AND REGULATION
The stock of the Company is subject to the registration requirements of the
Securities Act of 1933, as amended, and the qualification requirements of the
California Corporate Securities Law of 1968, as amended. The Company is also
subject to the periodic reporting requirements of Section 15(d) of the
Securities Exchange Act of 1934, as amended, which include, but are not limited
to, filing annual, quarterly and other current reports with the Securities
and Exchange Commission.
The Bank is chartered under the national banking laws of the United States
of America, and its deposits are insured by the FDIC. The Bank has no
subsidiaries. Consequently, the Bank is regularly examined by the Office of the
Comptroller of the Currency (the "OCC"), its primary regulator, and is subject
to the supervision of the FDIC and the OCC. Such supervision and regulation
include comprehensive reviews of all major aspects of the Bank's business and
condition, including its capital ratios, allowance for possible loan losses
and other factors. However, no inference should be drawn that such
authorities have approved any such factors. The Company and the Bank are
required to file reports with the OCC, the FDIC and the Board of Governors of
the Federal Reserve System (the "Board of Governors") and provide such
additional information as the Board of Governors, FDIC and OCC may require.
The Company is a bank holding company within the meaning of the Bank
Holding Company Act of 1956, as amended (the "Bank Holding Company Act"), and is
registered as such with, and subject to the supervision of, the Board of
Governors. The Company is required to obtain the approval of the Board of
Governors before it may acquire all or substantially all of the assets of any
bank, or ownership or control of the voting shares of any bank if, after
giving effect to such acquisition of shares, the Company would own or
control more than 5% of the voting shares of such bank. The Bank Holding
Company Act prohibits the Company from acquiring any voting shares of, or
interest in, all or substantially all of the assets of, a bank located outside
the State of California unless such an acquisition is specifically authorized by
the laws of the state in which such bank is located. Any such interstate
acquisition is also subject to the provisions of the Riegle-Neal Interstate
Banking and Branching Efficiency Act of 1994 discussed below. The OCC
regulates the number and locations of the branch offices of a national bank and
may only permit a national bank to maintain branches in locations and under
conditions imposed by state law upon state banks.
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The Company, and any subsidiaries which it may acquire or organize, are
deemed to be "affiliates" of the Bank within the meaning of that term as defined
in the Federal Reserve Act. This means, for example, that there are limitations
(a) on loans by the Bank to affiliates, and (b) on investments by the Bank in
affiliates' stock as collateral for loans to any borrower. The Company and
the Bank are also subject to certain restrictions with respect to engaging in
the underwriting, public sale and distribution of securities.
In addition, regulations of the Board of Governors promulgated under the
Federal Reserve Act require that reserves be maintained by the Bank in
conjunction with any liability of the Company under any obligation
(promissory note, acknowledgement of advance, banker's acceptance or similar
obligation) with a weighted average maturity of less than seven (7) years to
the extent that the proceeds of such obligations are used for the purpose of
supplying funds to the Bank for use in its banking business, or to maintain
the availability of such funds.
The Board of Governors, FDIC and OCC have adopted risk-based capital
guidelines for evaluating the capital adequacy of bank holding companies and
banks. The guidelines are designed to make capital requirements sensitive to
differences in risk profiles among banking organizations, to take into
account off-balance sheet exposures and to aid in making the definition of
bank capital uniform nationally. Under the guidelines, the Company and the
Bank are required to maintain capital equal to at least 8.0% of its assets
and commitments to extend credit, weighted by risk, of which at least 4.0% must
consist primarily of common equity (including retained earnings) and the
remainder may consist of subordinated debt, cumulative preferred stock, or a
limited amount of loan loss reserve.
Assets, commitments to extend credit, and off-balance sheet items are
categorized according to risk and certain assets considered to present less
risk than others permit maintenance of capital at less than the 8% ratio.
For example, most home mortgage loans are placed in a 50% risk category and
therefore require maintenance of capital equal to 4% of such loans, while
commercial loans are placed in a 100% risk category and therefore require
maintenance of capital equal to 8% of such loans.
The guidelines establish two categories of qualifying capital: Tier 1
capital comprising core capital elements, and Tier 2 comprising supplementary
capital requirements. At least one-half of the required capital must be
maintained in the form of Tier 1 capital. Tier 1 capital includes common
shareholders' equity and qualifying perpetual preferred stock. However, no
more than 25% of the Company's total Tier 1 capital may consist of perpetual
preferred stock. The definition of Tier 1 capital for the Bank is the same,
except that perpetual preferred stock may be included only if it is
noncumulative. Tier 2 capital includes, among other items, limited life (and in
the case of banks, cumulative) preferred stock, mandatory convertible
securities, subordinated debt and a limited amount of reserve for credit losses.
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The Board of Governors, FDIC and OCC also adopted minimum leverage ratios
for banking organizations as a supplement to the risk-weighted capital
guidelines. The leverage ratio is generally calculated using Tier 1 capital (as
defined under risk-based capital guidelines) divided by quarterly average net
total assets (excluding intangible assets and certain other adjustments).
The leverage ratio establishes a limit on the ability of banking organizations,
including the Company and the Bank, to increase assets and liabilities
without increasing capital proportionately.
The Board of Governors and OCC emphasized that the leverage ratio
constitutes a minimum requirement for well-run banking organizations having
diversified risk, including no undue interest rate risk exposure, excellent
asset quality, high liquidity, good earnings and a composite rating of 1
under the regulatory rating system for banks and 1 under the regulatory
rating system for bank holding companies. Banking organizations experiencing
or anticipating significant growth, as well as those organizations which do not
exhibit the characteristics of a strong, well-run banking organization described
above, will be required to maintain minimum capital ranging generally from 100
to 200 basis points in excess of the leverage ratio. The FDIC adopted a
substantially similar leverage ratio for state non-member banks which
established (i) a 3 percent Tier 1 minimum capital leverage ratio for highly-
rated banks (those with a composite regulatory rating of 1 and not experiencing
or anticipating significant growth); and (ii) a 4 percent Tier 1 minimum capital
leverage ratio for all other banks, as a supplement to the risk-based capital
guidelines.
The federal banking agencies during 1996 issued a joint agency policy
statement regarding the management of interest-rate risk exposure (interest rate
risk is the risk that changes in market interest rates might adversely affect a
bank's financial condition) with the goal of ensuring that institutions with
high levels of interest-rate risk have sufficient capital to cover their
exposures. This policy statement reflected the agencies' decision at that
time not to promulgate a standardized measure and explicit capital charge for
interest rate risk, in the expectation that industry techniques for measurement
of such risk will evolve.
However, the Federal Financial Institution Examination Counsel
(the "FFIEC") on December 13, 1996, approved an updated Uniform Financial
Institutions Rating System (the "UFIRS"). In addition to the five components
traditionally included in the so-called "CAMEL" rating system which has been
used by bank examiners for a number of years to classify and evaluate the
soundness of financial institutions (including capital adequacy, asset
quality, management, earnings and liquidity), UFIRS includes for all bank
regulatory examinations conducted on or after January 1, 1997, a new rating for
a sixth category identified as sensitivity to market risk. Ratings in this
category are intended to reflect the degree to which changes in interest
rates, foreign exchange rates, commodity prices or equity prices may
adversely affect an institution's earnings and capital. The rating system
henceforth will be identified as the "CAMELS" system.
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At December 31, 1997, the Bank and the Company are in compliance with
the risk-based capital and leverage ratios described above. See Item 7 below
for a listing of the Company's risk-based capital ratios at December 31, 1997
and 1996.
During 1997, the Company's primary source of income was interest income.
In the future, the Company also expects to receive dividends and management fees
from the Bank. The Bank's ability to make such payments is subject to
restrictions established by federal banking law, and subject to approval by
the OCC. Such approval is required if the total of all dividends declared by
the Bank's Board of Directors in any calendar year will exceed the Bank's net
profits for that year combined with its retained net profits for the
preceding two years, less any required transfers to surplus or to a fund for the
retirement of preferred stock. The OCC generally prohibits national banks
from, among other matters, adding the allowance for loan and lease losses to
undivided profits then on hand when calculating the amount of dividends which
may be paid. Additionally, while the Board of Governors has no general
restriction with respect to the payment of cash dividends by an adequately
capitalized bank to its parent holding company, the Board of Governors, FDIC
and/or OCC, might, under certain circumstances, place restrictions on the
ability of a bank to pay dividends based upon peer group averages and the
performance and maturity of that bank, or object to management fees on the
basis that such fees cannot be supported by the value of the services
rendered or are not the result of an arms length transaction. The FDIC may
also restrict the payment of dividends if such payment would be deemed
unsafe or unsound or if after the payment of such dividends, the Bank would be
included in one of the "undercapitalized" categories for capital adequacy
purposes pursuant to the Federal Deposit Insurance Corporation Improvement Act
of 1991. See the discussion of dividends in Item 5 below for additional
information regarding dividends. Under the formulas discussed in Item 5, at
December 31, 1997, approximately $3,080,000 of the Bank's net profits were
available for distribution as dividends without the necessity of any prior
governmental approvals. These net profits constitute part of the capital of the
Bank and sound banking practices require the maintenance of adequate levels of
capital.
COMPETITION
The banking business in Santa Clara County, as it is elsewhere in
California, is highly competitive, and each of the major branch banking
institutions has one or more offices in the Bank's service area. The Bank
competes in the marketplace for deposits and loans, principally against these
banks, independent community banks, savings and loan associations, thrift and
loan companies, credit unions, mortgage banking companies, and other
miscellaneous institutions that claim a portion of the market.
Larger banks may have a competitive advantage because of higher lending
limits and major advertising and marketing campaigns. They also perform
services, such as trust services, international banking, discount brokerage and
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insurance services which the Bank is not authorized or prepared to offer
currently. The Bank has made arrangements with its correspondent banks and
with others to provide such services for its customers. For borrowers
requiring loans in excess of the Bank's legal lending limit, the Bank has
offered, and intends to offer in the future, such loans on a participating basis
with its correspondent banks and with other independent banks, retaining the
portion of such loans which is within its lending limit. As of December 31,
1997, the Bank's legal lending limit to a single borrower and such borrower's
related parties was $1,990,000 based on regulatory capital of $13,266,000.
The Bank's business is concentrated in its service area, which primarily
encompasses Santa Clara County, and also includes, to a lesser extent, the
contiguous areas of Alameda, San Mateo and Santa Cruz counties.
In order to compete with major financial institutions in its primary
service area, the Bank uses to the fullest extent possible the flexibility which
is accorded by its independent status. This includes an emphasis on
specialized services, local promotional activity, and personal contacts by
the Bank's officers, directors and employees. The Bank also seeks to provide
special services and programs for individuals in its primary service area who
are employed in the agricultural, professional and business fields, such as
loans for equipment, furniture, tools of the trade or expansion of practices
or businesses. In the event there are customers whose loan demands exceed
the Bank's lending limit, the Bank seeks to arrange for such loans on a
participation basis with other financial institutions. The Bank also assists
those customers requiring services not offered by the Bank to obtain such
services from correspondent banks.
Banking is a business which depends on interest rate differentials. In
general, the difference between the interest rate paid by the Bank to obtain its
deposits and its other borrowings and the interest rate received by the Bank on
loans extended to its customers and on securities held in the Bank's
portfolio comprise the major portion of the Bank's earnings.
Commercial banks compete with savings and loan associations, credit unions,
other financial institutions and other entities for funds. For instance, yields
on corporate and government debt securities and other commercial paper affect
the ability of commercial banks to attract and hold deposits. Commercial banks
also compete for loans with savings and loan associations, credit unions,
consumer finance companies, mortgage companies and other lending institutions.
The interest rate differentials of the Bank, and therefore its earnings,
are affected not only by general economic conditions, both domestic and foreign,
but also by the monetary and fiscal policies of the United States as set by
statutes and as implemented by federal agencies, particularly the Federal
Reserve Board. This agency can and does
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implement national monetary policy, such as seeking to curb inflation and combat
recession, by its open market operations in United States government securities,
adjustments in the amount of interest free reserves that banks and other
financial institutions are required to maintain, and adjustments to the
discount rates applicable to borrowing by banks from the Federal Reserve
Board. These activities influence the growth of bank loans, investments and
deposits and also affect interest rates charged on loans and paid on
deposits. The nature and timing of any future changes in monetary policies
and their impact on the Bank cannot be predicted.
On December 19, 1991, President Bush signed the Federal Deposit Insurance
Corporation Improvement Act of 1991 (the "FDICIA"). The FDICIA substantially
revised banking regulations, certain aspects of the Federal Deposit Insurance
Act and established a framework for determination of capital adequacy of
financial institutions, among other matters. Under the FDICIA, financial
institutions are placed into five capital adequacy categories as follows:
(1) well capitalized, (2) adequately capitalized, (3) undercapitalized,
(4) significantly undercapitalized, and (5) critically undercapitalized. The
FDICIA authorized the Board of Governors, the OCC and FDIC to establish
limits below which financial institutions will be deemed critically
undercapitalized, provided that such limits can not be less than two percent
(2%) of the ratio of tangible equity to total assets or sixty-five percent
(65%) of the minimum leverage ratio established by regulation. Financial
institutions classified as undercapitalized or below are subject to limitations
including restrictions related to (i) growth of assets, (ii) payment of interest
on subordinated indebtedness, (iii) capital distributions, and (iv) payment of
management fees to a parent holding company.
The FDICIA requires the Board of Governors, FDIC and OCC to initiate
corrective action regarding financial institutions which fail to meet minimum
capital requirements. Such action may result in orders to augment capital such
as through sale of voting stock, reduction in total assets, and restrictions
related to correspondent bank deposits. Critically undercapitalized
financial institutions may also be subject to appointment of a receiver or
conservator unless the financial institution submits an adequate capitalization
plan.
In 1995 the FDIC, pursuant to Congressional mandate, reduced bank deposit
insurance assessment rates to a range from $0 to $0.27 per $100 of deposits,
dependent upon a bank's risk. The FDIC has continued these assessment rates
through the first semiannual assessment period of 1998. Based upon the above
risk-based assessment rate schedule, the Bank's current capital ratios, the
Bank's current level of deposits, and assuming no further change in the
assessment rate applicable to the Bank during 1998, the Bank estimates that
its annual noninterest expense attributed to assessments will remain
unchanged during 1998.
The Board of Governors, FDIC and OCC adopted regulations effective December
19, 1992, implementing a system of prompt corrective action pursuant to Section
38 of the
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Federal Deposit Insurance Act and Section 131 of the FDICIA. The regulations
establish five capital categories with the following characteristics: (1) "Well
capitalized" - consisting of institutions with a total risk-based capital ratio
of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater and a
leverage ratio of 5% or greater, and the institution is not subject to an
order, written agreement, capital directive or prompt corrective action
directive; (2) "Adequately capitalized" - consisting of institutions with a
total risk-based capital ratio of 8% or greater, a Tier 1 risk-based capital
ratio of 4% or greater and a leverage ratio of 4% or greater, and the
institution does not meet the definition of a "well capitalized" institution;
(3) "Undercapitalized" - consisting of institutions with a total risk-based
capital ratio less than 8%, a Tier 1 risk-based capital ratio of less than 4%,
or a leverage ratio of less than 4%; (4) "Significantly undercapitalized" -
consisting of institutions with a total risk-based capital ratio of less than
6%, a Tier 1 risk-based capital ratio of less than 3%, or a leverage ratio of
less than 3%; (5) "Critically undercapitalized" - consisting of an
institution with a ratio of tangible equity to total assets that is equal to or
less than 2%.
The regulations established procedures for classification of financial
institutions within the capital categories, filing and reviewing capital
restoration plans required under the regulations and procedures for issuance of
directives by the appropriate regulatory agency, among other matters. The
regulations impose restrictions upon all institutions to refrain from certain
actions which would cause an institution to be classified within any one
of the three "undercapitalized" categories, such as declaration of dividends or
other capital distributions or payment of management fees, if following the
distribution or payment the institution would be classified within one of the
"undercapitalized" categories. In addition, institutions which are
classified in one of the three "undercapitalized" categories are subject
to certain mandatory and discretionary supervisory actions. Mandatory
supervisory actions include (1) increased monitoring and review by the
appropriate federal banking agency; (2) implementation of a capital
restoration plan; (3) total asset growth restrictions; and (4) limitation
upon acquisitions, branch expansion, and new business activities without prior
approval of the appropriate federal banking agency. Discretionary
supervisory actions may include (1) requirements to augment capital;
(2) restrictions upon affiliate transactions; (3) restrictions upon deposit
gathering activities and interest rates paid; (4) replacement of senior
executive officers and directors; (5) restrictions upon activities of the
institution and its affiliates; (6) requiring divestiture or sale of the
institution; and (7) any other supervisory action that the appropriate
federal banking agency determines is necessary to further the purposes of
the regulations. Further, the federal banking agencies may not accept a
capital restoration 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. In addition, for a capital restoration plan
to be acceptable, the depository institution's parent holding company must
guarantee that the institution will comply with such capital restoration
plan. The aggregate liability of the parent holding company under the guaranty
is limited to the lesser of (i) an amount equal to 5 percent of the depository
institution's total assets at the time it became
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undercapitalized, and (ii) the amount that is necessary (or would have been
necessary) to bring the institution into compliance with all capital
standards applicable with respect to such institution as of the time it fails to
comply with the plan. If a depository institution fails to submit an acceptable
plan, it is treated as if it were "significantly undercapitalized." The FDICIA
also restricts the solicitation and acceptance of and interest rates payable
on brokered deposits by insured depository institutions that are not "well
capitalized." An "undercapitalized" institution is not allowed to solicit
deposits by offering rates of interest that are significantly higher than the
prevailing rates of interest on insured deposits in the particular
institution's normal market areas or in the market areas in which such
deposits would otherwise be accepted.
Any financial institution which is classified as "critically under-
capitalized" must be placed in conservatorship or receivership within 90 days of
such determination unless it is also determined that some other course of
action would better serve the purposes of the regulations. Critically under-
capitalized institutions are also prohibited from making (but not accruing)
any payment of principal or interest on subordinated debt without the prior
approval of the FDIC and the FDIC must prohibit a critically undercapitalized
institution from taking certain other actions without its prior approval,
including (1) entering into any material transaction other than in the usual
course of business, including investment expansion, acquisition, sale of assets
or other similar actions; (2) extending credit for any highly leveraged
transaction; (3) amending articles or bylaws unless required to do so to
comply with any law, regulation or order; (4) making any material change in
accounting methods; (5) engaging in certain affiliate transactions; (6) paying
excessive compensation or bonuses; and (7) paying interest on new or renewed
liabilities at rates which would increase the weighted average costs of funds
beyond prevailing rates in the institution's normal market areas.
The capital ratio requirements for the "adequately capitalized" category
generally are the same as the existing minimum risk-based capital ratios
applicable to the Company and the Bank.
Under the FDICIA, the federal financial institution agencies have adopted
regulations which require institutions to establish and maintain comprehensive
written real estate policies which address certain lending considerations,
including loan-to-value limits, loan administrative policies, portfolio
diversification standards, and documentation, approval and reporting
requirements. The FDICIA further generally prohibits an insured state bank
from engaging as a principal in any activity that is impermissible for a
national bank, absent FDIC determination that the activity would not pose a
significant risk to the Bank Insurance Fund, and that the bank is, and will
continue to be, within applicable capital standards. Similar restrictions apply
to subsidiaries of insured state banks. The Company does not currently
intend to engage in any activities which would be restricted or prohibited
under the FDICIA.
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The federal financial institution agencies have established safety and
soundness standards for insured financial institutions covering (1) internal
controls, information systems and internal audit systems; (2) loan
documentation; (3) credit underwriting; (4) interest rate exposure; (5) asset
growth; (6) compensation, fees and benefits; (7) excessive compensation for
executive officers, directors or principal shareholders which could lead
to material financial loss. If an agency determines that an institution fails
to meet any standard the agency may require the financial institution to submit
to the agency an acceptable plan to achieve compliance with the standard. If
the agency requires submission of a compliance plan and the institution fails to
timely submit an acceptable plan or to implement an accepted plan, the agency
must require the institution to correct the deficiency. Under the final rule,
an institution must file a compliance plan within 30 days of a request to do
so from the institution's primary federal regulatory agency. The agencies
may elect to initiate enforcement action in certain cases rather than rely on an
existing plan particularly where failure to meet one or more of the standards
could threaten the safe and sound operation of the institution.
The Board of Governors issued final amendments to its risk-based capital
guidelines to be effective December 31, 1994, requiring that net unrealized
holding gains and losses on securities available for sale determined in
accordance with Statement of Financial Accounting Standards (the "SFAS") No. 115
"Accounting for Certain Investments in Debt and Equity Securities," are not to
be included in the Tier 1 capital component consisting of common stock-
holders' equity. Net unrealized losses on marketable equity securities
(equity securities with a readily determinable fair value), however, will
continue to be deducted from Tier 1 capital. This rule has the general effect
of valuing available for sale securities at amortized cost (based on historical
cost) rather than at fair value (generally at market value) for purposes of
calculating the risk-based and leverage capital ratios.
On December 13, 1994, the Board of Governors issued amendments to its
risk-based capital guidelines regarding concentration of credit risk and risks
of non-traditional activities, which were effective January 17, 1995. As
amended, the risk-based capital guidelines identify concentrations of credit
risk and evaluate an institution's ability to manage such risks and the risk
posed by non-traditional activities as important factors in assessing an
institution's overall capital adequacy.
Since 1986, California has permitted California banks and bank holding
companies to be acquired by banking organizations based in other states on a
"reciprocal" basis (i.e., provided the other state's laws permit California
banking organizations to acquire banking organizations in that state on
substantially the same terms and conditions applicable to local banking
organizations). Some increase in merger and acquisition activity among
California and out-of-state banking organizations has occurred as a result of
this law, as well as increased competition for loans and deposits.
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Since October 2, 1995, California law implementing certain provisions of
prior federal law has (1) permitted interstate merger transactions; (2)
prohibited interstate branching through the acquisition of a branch business
unit located in California without acquisition of the whole business unit of
the California bank; and (3) prohibited interstate branching through de novo
establishment of California branch offices. Initial entry into California by
an out-of-state institution must be accomplished by acquisition of or merger
with an existing whole bank which has been in existence for at least five
years.
Community Reinvestment Act (the "CRA") regulations effective as of July
1, 1995 evaluate banks' lending to low and moderate income individuals and
businesses across a four-point scale of "outstanding", "satisfactory", "needs
to improve" and "substantial noncompliance," and are a factor in regulatory
review of applications to merge, establish new branches or form bank holding
companies. In addition, any bank rated in "substantial noncompliance" with
the CRA regulations may be subject to enforcement proceedings.
The Bank has a current rating of "satisfactory" CRA compliance, and is
scheduled for further examination for CRA compliance during 1998.
Recently, the Federal banking agencies, especially the Board of Governors
and the OCC, have taken steps to increase the types of activities in which
national banks and bank holding companies can engage, and to make it easier to
engage in such activities. On November 20, 1996, the OCC issued final
regulations permitting national banks to engage in a wider range of
activities through subsidiaries. "Eligible institutions" (those national
banks that are well capitalized, have a high overall rating and a satisfactory
CRA rating, and are subject to an enforcement order) may engage in activities
related to banking through operating subsidiaries after going through a new
expedited application process. In addition, the new regulations include a
provision whereby a national bank may apply to the OCC to engage in an
activity through a subsidiary in which the bank itself may not engage.
Although the Bank is not currently intending to enter into any new type of
business, this OCC regulation could be advantageous to the Bank if the Bank
determines to expand its operations in the future, depending on the extent to
which the OCC permits national banks to engage in new lines of business and
whether the Bank qualifies as an "eligible institution" at the time of making
application.
Certain legislative and regulatory proposals that could effect the Bank and
the banking business in general are pending or may be introduced before the
United States Congress, the California State Legislature and Federal and state
government agencies. The United States Congress is considering numerous bills
that could reform banking laws substantially. For example, proposed bank
modernization legislation under consideration would, among other matters,
include a repeal of the Glass-Steagall Act restrictions on banks that now
prohibit the combination of commercial and investment banks.
It is not known to what extent, if any, the legislation proposals will be
enacted and
13
what effect such legislation would have on the structure, regulation and
competitive relationships of financial institutions. It is likely, however,
that many of these proposals would subject the Bank to increased regulation,
disclosure and reporting requirements and would increase competition to the Bank
and its cost of doing business.
In addition to pending legislative changes, the various banking regulatory
agencies frequently propose rules and regulations to implement and enforce
already existing legislation. It cannot be predicted whether or in what form
any such rules or regulations will be enacted or the effect that such rules and
regulations may have on the Bank's business.
ACCOUNTING PRONOUNCEMENTS
In October, 1995, the Financial Accounting Standards Board (the "FASB")
issued SFAS No. 123, "Accounting for Stock-Based Compensation." SFAS No. 123
establishes accounting and disclosure requirements using a fair value method of
accounting for stock based employee compensation plans. Under SFAS No. 123, the
Company may either adopt the new fair value based accounting method or continue
the intrinsic value based method and provide proforma disclosures of net income
and earnings per share as if the accounting provisions of SFAS No. 123 had been
adopted. The provisions of SFAS No. 123 became effective January 1, 1996.
The Company adopted only the disclosure requirements of SFAS No. 123 and such
adoption had no effect on the Company's consolidated net earnings or cash flows.
In June, 1996, the FASB issued SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishment of Liabilities." SFAS No.
125 establishes accounting and reporting standards for transfers and servicing
of financial assets and extinguishment of liabilities based on a financial-
component approach that focuses on control. Under that approach, after a
transfer of financial assets, an entity recognizes the financial and
servicing assets it controls and the liabilities it has incurred, derecognizes
financial assets when control has been surrendered, and derecognizes
liabilities when extinguished. In December 1996, the FASB reconsidered certain
provisions of SFAS No. 125 and issued SFAS 127, "Deferral of the Effective
Date of Certain Provisions of FASB Statement No. 125" to defer for one year the
effective date of implementation for transactions related to repurchase
agreements, dollar-roll repurchase agreements, securities lending and similar
transactions. Earlier adoption or retroactive application of this statement
with respect to any of its provisions is not premitted. The Company adopted
SFAS 125 effective January 1, 1997. The adoption of SFAS 125 had no effect on
the Company's financial condition or results of operations.
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share." SFAS No.
128 requires restatement of all prior year earnings per share (EPS) and presen-
tation of basic and diluted EPS. Basic EPS is computed by dividing net income
by the weighted average
14
common shares outstanding during the period. Diluted EPS reflects the
potential dilution if securities or other contracts to issue common stock are
exercised or converted to common shares. The Company adopted SFAS 128 during
1997 and all EPS amounts have been retroactively adjusted to comply with SFAS
128.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income," which requires that an enterprise report, by major components and as a
single total, the change in net assets during the period from nonowner sources;
and SFAS No. 131 "Disclosures about Segments of an Enterprise and Related
Information," which establishes annual and interim reporting standards for an
enterprise's business segments and related disclosures about its products,
services, geographic areas and major customers.
Both statements are effective for the Company's 1998 consolidated
financial statements and are not expected to have a material impact on the
Company's financial position and results of operations.
ITEM 2. PROPERTIES
As of December 31, 1997, the Bank had three banking offices located in
Santa Clara County. The first banking office, which is owned by the Bank, is
also the principal executive office of the Company, and is located at 12000
Saratoga-Sunnyvale Road, Saratoga, California, comprising of approximately 5,500
square feet. The office was purchased by the Company in 1988 for $1,800,000.
The foregoing description of the office and purchase of the office is
qualified by reference to the Agreement of Purchase and Sale dated July 27,
1988 attached as Exhibit 10.1 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1988, filed with the Securities and Exchange
Commission on March 27, 1989.
The second banking facility, which is located at 15405 Los Gatos Blvd.,
Suite 103, Los Gatos, California, was opened March 9, 1988. The 3,082 square
foot facility is leased under a noncancellable operating lease which expires in
2003. Current lease payments are $6,387 per month for the building and ground
lease. Effective March, 1998, the lease payments are tied to the Consumer
Price Index. The foregoing description of the lease is qualified by
reference to the lease agreement dated October 19, 1987 attached as Exhibit
10.1 to the Company's Annual Report on Form 10-K for the year ended December 31,
1987, filed with the Securities and Exchange Commission on March 31, 1988.
The third banking facility located at 160 West Santa Clara Street, in San
Jose, California, was opened on October 3, 1989. The lease agreement for the
7,250 square foot location in the downtown area of San Jose is under a
noncancellable operating lease which expires in 1999. Current lease payments
are $10,989 per month for the ground floor and $4,008 for the second floor. The
lease payments for the second floor are tied to the Consumer Price Index with
the increase not to exceed 4% per year. The foregoing description of the
lease is qualified by reference to the lease agreement dated January 17,
15
1989 attached as Exhibit 10.4 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1989, filed with the Securities and Exchange
Commission on March 27, 1990.
ITEM 3. LEGAL PROCEEDINGS
Neither the Company nor the Bank is a party to, nor is any of their
property the subject of, any material pending legal proceedings other than
ordinary routine litigation incidental to their respective businesses, nor are
any such proceedings known to be contemplated by governmental authorities.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not Applicable.
PART II
Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS.
There is limited trading in and no established public trading market for
the Company's Common Stock. The Company's Common Stock is not listed on any
exchange. Hoefer and Arnett, Incorporated, Burford Capital and Sutro and
Company facilitate trades in the Company's Common Stock.
The following table summarizes those trades of which the Company has
knowledge based on information provided by Hoefer and Arnett, Incorporated,
Burford Capital and Sutro and Company, setting forth the approximate high and
low bid prices for the periods indicated. The prices indicated below may not
necessarily represent actual transactions.
Bid Price of
Common Stock (1)
Quarter ended Low High
March 31, 1996................ $7.25 $8.50
June 30, 1996.................. 8.25 9.75
September 30, 1996........ 9.06 13.50
December 31, 1996......... 12.00 12.88
March 31, 1997................ 12.00 15.00
June 30, 1997.................. 14.50 16.50
September 30, 1997........ 15.75 19.00
December 31, 1997......... 16.25 18.25
(1) As estimated by the Company based upon trades of which it was aware, and
not including purchases of stock pursuant to the exercise of employee stock
options.
16
The Company had 294 shareholders of record as of February 10, 1998. The
Company's shareholders are entitled to receive dividends when and as declared
by its Board of Directors, out of funds legally available therefore, subject to
the restrictions set forth in the California General Corporation Law (the
"Corporation Law"). The Corporation Law provides that a corporation may make
a distribution to its shareholders if the corporation's retained earnings
equal at least the amount of the proposed distribution. The Corporation
Law further provides that, in the event that sufficient retained earnings are
not available for the proposed distribution, a corporation may nevertheless make
a distribution to its shareholders if it meets two conditions, which generally
stated are as follows: (i) the corporation's assets equal at least 1-1/4
times its liabilities; and (ii) the corporation's current assets equal at
least its current liabilities or, if the average of the corporation's
earnings before taxes on income and before interest expenses for the two
preceding fiscal years was less than the average of the corporation's interest
expenses for such fiscal years, then the corporation's current assets must equal
at least 1-1/4 times its current liabilities. Funds for payment of any cash
dividends by the Company would be obtained from its investments as well as
dividends and/or management fees from the Bank. The payment of cash
dividends by the Bank may be subject to the approval of the OCC, as well as
restrictions established by federal banking law, the Board of Governors
and the FDIC.
Approval of the OCC is required if the total of all dividends declared by the
Bank's Board of Directors in any calendar year will exceed the Bank's net
profits for that year combined with its retained net profits for the preceding
two years, less any required transfers to surplus or to a fund for the
retirement of preferred stock.
Additionally, the Board of Governors,FDIC and/or OCC, might, under certain
circumstances, place restrictions on the ability of a bank to pay dividends
based upon peer group averages and the performance and maturity of that bank,
or object to management fees on the basis that such fees cannot be supported by
the value of the services rendered or are not the result of an arms length
transaction.
It is the intention of the Company to pay cash and stock dividends, subject to
the restrictions on the payment of cash dividends as described above, depending
upon the level of earnings, management's assessment of future capital needs and
other factors considered by the Board of Directors.
17
ITEM 6. SELECTED FINANCIAL DATA
The following table presents certain consolidated financial information
concerning the business of the Company and the Bank. This information should
be read in conjunction with the Consolidated Financial Statements and the notes
thereto, and Management's Discussion and Analysis of Financial Condition and
Results of Operations contained elsewhere herein.
Operations Year ended December 31,
(in thousands, except per share data)
1997 1996 1995 1994 1993
Interest income $9,346 $7,585 $6,572 $5,446 $4,949
Interest expense (4,273) (3,558) (2,861) (1,929) (1,685)
Net interest income 5,073 4,027 3,711 3,517 3,264
(Credit) provision for
credit losses - (150) - (636) 560
Net interest income
after (credit) provision
for credit losses 5,073 4,177 3,711 4,153 2,704
Other income 477 353 577 405 581
Other expenses (2,978) (2,870) (2,868) (3,523) (2,912)
Income before income
taxes 2,572 1,660 1,420 1,035 373
Provision for income
taxes (976) (559) (539) (377) (128)
Net income $1,596 $1,101 $ 881 $ 658 $ 245
====== ====== ====== ====== ======
Earnings per share(1):
Basic $ 1.52 $ 1.06 $ 0.85 $ 0.64 $ 0.21
Diluted $ 1.39 $ 0.96 $ 0.82 $ 0.59 $ 0.21
====== ====== ====== ====== ======
Cash dividends
declared per
common share $ .20 $ .175 $ 0.10 $ - $ -
====== ====== ====== ====== ======
(1) Earnings per share amounts have been restated to conform with SFAS 128,
"Earnings Per Share" requirements.
Balances at year end December 31,
(in thousands,except per share data)
1997 1996 1995 1994 1993
Total assets $131,044 $121,784 $100,497 $87,536 $79,209
Net loans 63,187 52,033 36,759 32,803 33,685
Total deposits 91,046 89,444 74,949 73,872 65,714
Shareholders' equity 13,605 11,952 11,057 9,627 10,721
Book value per share 12.46 11.53 10.72 9.34 9.17
18
DISTRIBUTION OF AVERAGE ASSETS, LIABILITIES AND SHAREHOLDERS'
EQUITY, INTEREST RATES, AND INTEREST DIFFERENTIAL. The following are the
Company's daily average balance sheets for 1997 and 1996.
1997
(dollars in thousands)
YIELDS INTEREST
AVERAGE OR INCOME/
BALANCE RATES EXPENSE
ASSETS
Interest earning assets:
Loans (1) $54,537 10.2% $5,571
Investment securities (2) 49,579 6.3 3,138
Federal funds sold 11,204 5.4 607
Other 485 6.2 30
Total interest earning assets 115,805 8.1 9,346
Noninterest-earning assets:
Cash and due from banks 4,621
Premises and equipment 2,071
Other assets (3) 2,230
TOTAL $124,727
=======
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest bearing liabilities:
Deposits:
Demand $23,674 3.6 853
Savings 17,547 3.0 530
Time 26,742 5.8 1,539
Total interest bearing deposits 67,963 4.3 2,922
Federal Home Loan Bank
borrowings 21,759 6.2 1,350
Other interest bearing liabilities 10 10.0 1
Total interest bearing liabilities 89,732 4.8 4,273
Noninterest-bearing liabilities:
Demand deposits 21,301
Accrued expenses and other
liabilities 1,124
Shareholders' equity 12,570
TOTAL $124,727
=======
Net interest income $5,073
=====
Net yield on interest earning assets 4.4%
====
(1) Including average non-accrual loans of $60,000 and loan fees of $357,000.
(2) Interest income is reflected on an actual basis, not a fully taxable
equivalent basis. Yields are based on historical cost for held to maturity
securities and fair market value for available for sale securities.
(3) Net of average deferred loan fees of $374,000 and average allowance for
credit losses of $605,000.
19
1996
(dollars in thousands)
YIELDS INTEREST
AVERAGE OR INCOME/
BALANCE RATES EXPENSE
ASSETS
Interest earning assets:
Loans (1) $ 41,313 10.6% 4,395
Investment securities (2) 40,422 6.0 2,419
Federal funds sold 14,555 5.2 761
Other 193 5.2 10
Total interest earning assets 96,483 7.9 7,585
Noninterest-earning assets:
Cash and due from banks 4,190
Premises and equipment 2,186
Other assets (3) 1,802
TOTAL $104,661
=======
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest bearing liabilities:
Deposits:
Demand $17,984 3.6 644
Savings 14,238 2.8 403
Time 28,773 5.8 1,665
Total interest bearing deposits 60,995 4.4 2,712
Federal Home Loan Bank
borrowings 13,253 6.3 841
Other interest bearing liabilities 82 6.1 5
Total interest bearing liabilities 74,330 4.8 3,558
Noninterest-bearing liabilities:
Demand deposits 18,123
Accrued expenses and other
liabilities 877
Shareholders' equity 11,331
TOTAL $104,661
=======
Net interest income $4,027
=====
Net yield on interest earning assets 4.2%
====
(1) Including average non-accrual loans of nil, and loan fees of $383,000.
(2) Interest income is reflected on an actual basis, not a fully taxable
equivalent basis. Yields are based on historical cost for held to maturity
securities and fair market value for available for sale securities.
(3) Net of average deferred loan fees of $318,000 and average allowance for
credit losses of $729,000.
20
INTEREST DIFFERENTIAL - RATE/VOLUME CHANGES
Interest differential is affected by changes in volume, changes in rates and a
combination of changes in volume and rates. Volume changes are caused by
changes in the levels of average earning assets and average interest bearing
deposits and borrowings. Rate changes result from changes in yields earned on
assets and rates paid on liabilities. Changes not solely attributable to
volume or rates have been allocated to the rate component. The following
table shows the effect on the interest differential of volume and
rate changes for the years 1997 and 1996.
1997 over 1996 1996 over 1995
Increase (Decrease) Due Increase (Decrease) Due
to Changes in: to Changes in:
(in thousands)
Net Net
Volume Rate Change Volume Rate Change
Interest earning assets:
Loans(1) $1,402 $ (226) $1,176 $ 798 $(191) $ 340
Securities (2) 550 169 719 196 (140) 56
Federal funds sold (25) (129) (154) 409 (69) 340
Interest bearing
deposits in other
banks 15 5 20 10 - 10
Total 1,942 (181) 1,761 1,413 (400) 1,013
Interest bearing
liabilities:
Demand deposits 208 1 209 110 33 143
Savings deposits 88 39 127 4 33 37
Time deposits (114) (12) (126) 95 (33) 62
Borrowings 536 (27) 509 954 (490) 464
Other liabilities (4) - (4) (9) - (9)
Total 714 1 715 1,154 (457) 697
Interest differential $1,228 $ (182) $1,046 $ 259 $ 57 $ 316
(1)Including non accrual loans.
(2)Interest income is reflected on an actual basis, not a fully taxable
equivalent basis.
21
INVESTMENT PORTFOLIO
The amortized cost and fair values of securities at December 31 are as follows:
December 31,
1997 1996
(in thousands)
Securities Available for Sale
Amortized Fair Amortized Fair
Cost Value Cost Value
U.S. Treasury and agency securities $11,228 $11,152 $11,704 $11,671
Governmental mutual fund 3,128 3,018 3,128 2,958
Federal Home Loan Bank stock 1,864 1,864 3,170 3,170
Bankers Bank stock 150 150 150 150
Total $16,370 $16,184 $18,152 $17,949
====== ====== ====== ======
Securities Held to Maturity
Amortized Fair Amortized Fair
Cost Value Cost Value
U.S. Treasury and agency securities $10,879 $10,845 $ 5,489 $ 5,501
Mortgage-backed securities 15,024 15,124 13,204 13,070
Obligations of states and political
subdivisions 5,159 5,234 5,328 5,354
Federal Reserve Bank stock 90 90 90 90
$31,152 $31,293 $24,111 $24,015
====== ====== ====== ======
As investment securities mature, to the extent that the proceeds are reinvested
in investment securities, management expects that the categories of taxable
investment securities purchased will be in approximately the same proportion as
existed at December 31, 1997. The maturities and yields of the investment
portfolio at December 31, 1997 are shown below.
22
MATURITY AND YIELDS OF INVESTMENT SECURITIES
At December 31, 1997
(Dollars in thousands)
Securities Available for Sale
Estimated After 1 Year, After 5 years
Market Within 1 Year Within 5 Years Within 10 Years After 10 years
Value Amount Yield(1) Amount Yield(1) Amount Yield(1) Amount Yield(1)
U.S. Treas-
ury and
agency
secur-
ities $11,152 $ 999 5.38% $7,018 6.00% $3,135 8.00% $ - - %
Govern-
mental
mutual
fund 3,018 3,018 6.04 - - - - - -
Federal
Home
Loan
Bank 1,864 - - - - - - 1,864 5.09
stock
Bankers
Bank
stock 150 - - - - - - 150 -
$16,184 $4,017 5.90% $7,018 6.00% $3,135 8.00% $2,014 4.71%
====== ====== ===== ===== =====
Securities Held to Maturity
Total After 1 Year, After 5 Years
Carrying Within 1 Year Within 5 Years Within 10 Years After 10 Years
Value Amount Yield(1) Amount Yield(1) Amount Yield(1) AmountYield (1)
U.S. Treas-
ury and
agency
secur-
ities $10,879 $1,998 4.55% $ - - % $ 3,417 6.28% $5,464 7.87%
Obligat-
ions of
States
and
polit-
ical
sub
divis-
ions 5,159 861 4.63% 1,983 6.16 1,786 5.55% 529 5.44
Federal
Reserve
Bank
stock 90 - - - - - - 90 6.00
Total $16,128 $2,859 4.57% $1,983 6.16% $ 5,203 6.03% $6,083 6.00%
====== ===== ===== ====== =====
Mortgage-
backed
secur-
ities 15,024
Total $31,152
======
(1) Yields are actual, not fully taxable equivalent.
Mortgage-backed securities generally have stated maturities of 4 to 15 years but
are subject to likely and substantial prepayments which effectively accelerate
actual maturities.
<PAGE > 23
LOAN PORTFOLIO
The composition of the loan portfolio at December 31, 1997 and 1996 is
summarized in the following table.
December 31,
1997 1996
(in thousands)
Real estate:
Construction $ 8,945 $ 9,249
Other 29,100 21,473
Commercial 21,282 18,242
Installment 1,548 1,861
Lease financing 3,215 2,160
$64,090 $52,985
======= =======
At December 31, 1997, loans were due as follows:
Real Real
Estate Estate Lease
Const. Other Com'l. Install. Financing Total
===== ====== ====== ======= ========= ======
(in thousands)
Due in one year
or less $8,808 $ 1,818 $15,489 $ 1 $ 559 $26,675
Due after one year 137 27,282 5,793 1,547 2,656 37,415
TOTAL $8,945 $29,100 $21,282 $1,548 $3,215 $64,090
===== ====== ====== ====== ===== ======
Of the loans due after one year, $25,512,000 have fixed rates and $11,903,000
have variable interest rates.
RISK ELEMENTS
Nonaccrual loans were $360,000 at December 31, 1997. There were no
nonaccrual loans at December 31, 1996.
At December 31, 1997 and 1996, there were no loans past due 90 days or
more as to principal or interest and still accruing interest. There were no
loans at December 31, 1997 which were troubled debt restructurings ( $187,000
at December 31, 1996).
24
There were five potential problem loans at December 31, 1997 having a
combined principal balance of $305,000 ($1,140,000 at December 31, 1996).
Potential problem loans are loans which are generally current as to principal
and interest but have been identified by the Company as potential problem loans
due either to a decrease in the underlying value of the property securing the
credit or some other deterioration in the creditworthiness of the borrower.
All of the five loans identified as potential problem loans are secured by
real estate and personal property.
The Company does not believe there to be any concentration of loans in
excess of 10% of total loans which is not disclosed above which would cause them
to be similarly impacted by economic or other conditions. See Management's
Discussion and Analysis of Financial Condition and Results of Operations-
Provision for Credit Losses, regarding discussion of California economic
conditions.
SUMMARY OF CREDIT EXPERIENCE
Analysis of the Allowance for Credit Losses
Year Ended December 31,
1997 1996
Beginning balance $628,000 $776,000
Reductions credited
to operations - (150,000)
Charge-offs - Commercial (115,000) (39,000)
Recoveries - Commercial 65,000 41,000
Ending balance $ 578,000 $ 628,000
======== ========
Ratio of net charge-offs
(recoveries) during the period
to average loans outstanding
during the year. .092% (.005)%
======== ========
Ratio of allowance for credit
losses to loans outstanding
at end of year 0.90% 1.19%
======== ========
25
Allocation of the Allowance for Credit Losses
December 31, 1997 December 31, 1996
Percent Percent
of loans in of loans in
each category each category
Amount to total loans Amount to total loans
Real estate-
other $254,000 46% $215,000 41%
Commercial 254,000 33 331,000 34
Real estate-
construction 61,000 14 70,000 18
Installment 9,000 2 12,000 3
Lease financing - 5 - 4
$578,000 100% $628,000 100%
======== === ======== ===
DEPOSITS
The average balance sheets for 1997 and 1996 set forth the average amount and
average interest rate paid for deposits.
At December 31, 1997, time deposits of $100,000 or more have remaining
maturities as follows (in thousands):
3 months or less $ 5,233
Over 3 months to 6 months 1,897
Over 6 months to 12 months 4,033
Over 1 year to 5 years 2,510
Over 5 years 100
TOTAL $13,773
======
RETURN ON EQUITY AND ASSETS
Ratios of profitability, liquidity and capital for the years ended December 31,
are as follows:
1997 1996
Return on average assets 1.3% 1.1%
Return on average equity 12.7% 9.7%
Cash dividends declared per share
to diluted earnings per share 14.4% 18.2%
Average equity to average assets 10.1% 10.8%
26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
Certain matters discussed or incorporated by reference in this Annual
Report on Form 10-K are forward-looking statements that are subject to risks and
uncertainties that could cause actual results to differ materially from those
projected. Such risks and uncertainties include, but are not limited to, matters
described in Item 7 - "Management's Discussion and Analysis of Financial
Condition and Results of Operations." Therefore, the information set forth
therein should be carefully considered when evaluating business prospects of
the Company and the Bank.
OVERVIEW
Net income in 1997 was $1,596,000 ($1.52 basic earnings per share, $1.39
diluted earnings per share) compared to $1,101,000 ($1.06 basic earnings per
share, $0.96 diluted earnings per share) in 1996 and $881,000 ($.85 basic
earnings, $0.82 diluted earnings per share) in 1995. The increase in net
income in 1997 resulted primarily from an increase in the volume and yield of
earning assets, offset, in part by an increase in interest expense due to the
increased volume of interest-bearing liabilities. The increase in net income in
1996 resulted primarily from an increase in the volume of earning assets,
offset, in part, by an increase in the volume of interest-bearing liabilities.
The table below highlights the changes in the nature and sources of income
and expense from 1996 to 1997 and from 1995 to 1996.
Net Net
Income Income
Increase Increase
1997 1996 (Decrease) 1995 (Decrease)
(in thousands)
Net interest income $5,073 $4,027 $1,046 $3,711 $ 316
Provision (credit)
for credit losse - (150) (150) - 150
Noninterest income 477 353 124 577 (224)
Noninterest expenses (2,978) (2,870) (108) (2,868) (2)
Income before
income taxes 2,572 1,660 912 1,420 240
Provision for
income taxes (976) (559) (417) (539) (20)
Net income $1,596 $1,101 $ 495 $ 881 $ 220
===== ===== ===== ====== =====
27
NET INTEREST INCOME
Net interest income is affected by changes in the nature and volume of earning
assets held during the year, the rates earned on such assets and the rates
paid on interest-bearing liabilities. The table below details the average
balances, interest income and expense and the effective yields/rates for earning
assets and interest bearing liabilities.
1997 1996 1995
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
(in thousands, except percentages)
Earning
assets:
Loans $54,537 $5,571 10.2% $41,313 $4,395 10.6% $34,057 $3,788 11.1%
Other 61,268 3,775 6.2 55,170 3,190 5.8 44,658 2,784 6.2
Total
earning
assets $115,805 $96,483 $78,715
======= ======= =======
Interest
bearing
liabil-
ities:
Deposits $ 67,963 2,922 4.3 $60,995 2,712 4.4 $55,649 2,470 4.5
Other
interest
bearing
funds 21,769 1,351 6.2 13,335 846 6.3 5,446 391 7.2
Total
interest
bearing
liabil-
ities $ 89,732 $74,330 $61,095
======== ======= =======
Net
interest
income
and
margin $5,073 4.4% $4,027 4.2% $3,711 4.7%
===== ==== ===== ==== ===== ====
Average earning assets increased $19.3 million or 20%, to $115.8 million during
1997 compared to $96.5 million in 1996. The increase in 1997 was primarily in
SBA and USDA loans which were purchased as a means to diversify the loan
portfolio. In 1996, the increase in loans was primarily in the longer term real
estate loan portfolio. These loans are generally made for a term of between
five and fifteen years and are matched against specific blocks of deposits or
borrowings in order to alleviate interest rate risk. The increase in the
investment portfolio is primarily the result of increased average deposits
and other borrowings. Average interest-bearing liabilities increased $15.4
million, or 21%, during 1997 to $89.7 million from $74.3 million in 1996
primarily due to an increase in Federal Home Loan Bank borrowings which were
matched against specific longer term real estate loans and an increase in
interest bearing checking deposits. Average interest-bearing liabilities
increased $13.4 million, or 22%, to $74.3 million, in 1996 from $61.1
28
million in 1995. This increase was primarily due to an increase in Federal Home
Loan Bank borrowings which were matched against specific longer term real estate
loans.
EARNING ASSETS-LOANS
The average loan portfolio increased $13.2 million, or 32%, from $41.3 million
in 1996 to $54.5 million in 1997. The increase was primarily in SBA and USDA
loans which were purchased in order to diversify the loan portfolio. Average
loans increased $7.2 million from $34.1 million in 1995 to $41.3 million in
1996. The increase was primarily in the longer term real estate loan portfolio
as a result of marketing efforts in that area. The average loan to average
deposit ratio for 1997 was 61% compared to 68% in 1996 and 49% in 1995. The
average yield on loans decreased from 11.1% in 1995 to 10.6% in 1996 and 10.2%
in 1997. The decrease in yield in 1997 is primarily attributable to the
purchase of SBA and USDA loans which generally had lower average yields as
compared to the rest of the loan portfolio. The decrease in yield in 1996
primarily reflects a decrease in interest rates on loans originated during the
year as compared to 1995.
OTHER EARNING ASSETS
Average other earning assets, consisting of Investment securities, Federal funds
sold and interest bearing deposits in other banks, increased $6.1 million or 11%
during 1997 from $55.2 million to $61.3 million. During 1996, average other
earning assets increased $10.5 million from $44.7 million in 1995. The increase
in the securities portfolio in 1997 and 1996 was primarily due to the increased
level of deposits. The yield earned on average other earning assets decreased
from 6.2% in 1995 to 5.8% in 1996 and then increased to 6.2% in 1997.
In 1997, the change in the volume and yields of other earning assets resulted in
an increase in interest income of $585,000 on other earning assets. In 1996,
the change in the volume and yields resulted in an increase in interest
income of $406,000 on other earning assets.
INTEREST BEARING LIABILITIES
Average interest bearing liabilities increased $15.4 million, or 21%, from
$74.3 million in 1996 to $89.7 million in 1997 and increased $13.4 million, or
22%, from $60.9 million in 1995 to $74.3 million in 1996. The increases in 1997
and 1996 were primarily a result of increased Federal Home Loan Bank borrowings
which were matched against certain longer term real estate loans to alleviate
the impact of interest rate risk. Average non-interest bearing deposits
increased $3.2 million, or 18%, in 1996 to $21.3 million and increased $2.8
million, or 19%, to $18.1
<PAGE 29>
million in 1997 from an average of $15.3 million in 1995. Overall rates on
interest bearing deposits decreased from 4.5% in 1995 to 4.4% in 1996 and
4.3% in 1997. The net result of the changes in average balances and rates was an
increase in total interest expense of $715,000 in 1997 from 1996 and an increase
of $697,000 in 1996 from 1995.
NET INTEREST MARGIN
The net interest margin decreased from 4.7% in 1995 to 4.2% in 1996 and then
increased to 4.4% in 1997. The changes in the net interest margin are primarily
attributable to fluctuations in the loan, deposit and borrowing mix and the
relationship between rates charged and rates paid.
PROVISION FOR CREDIT LOSSES
The Bank maintains an allowance for credit losses which is based, in part, on
the Bank's historical loss experience, the impact of forecasted economic
conditions within the Bank's market area, and, as applicable, the State of
California, the value of underlying collateral, loan performance and inherent
risks in the loan portfolio. The allowance is reduced by charge-offs and
increased by provisions for credit losses charged to operating expense and
recoveries of previously charged-off loans. During 1997 and 1995, the Bank did
not provide any additional provision for credit losses. In 1996, $150,000 was
reversed from the allowance for credit losses. The allowance for credit losses
was $578,000 in 1997, compared to $628,000 for 1996 and $776,000 for 1995. At
December 31, 1997, the allowance was approximately 0.9% of total loans, compared
to approximately 1.2% at December 31, 1996. Nonaccrual loans were $360,000 at
December 31, 1997. There were no nonaccrual loans at December 31, 1996.
Interest income foregone on nonaccrual loans during 1997 was $13,000. The
nonaccrual loans consisted of one loan secured by real estate which was paid off
on January 22, 1998.
At December 31, 1997 and 1996, there were no loans past due 90 days or more as
to principal or interest and still accruing interest.
There was no Other Real Estate Owned ("OREO") at December 31, 1997 ($1,252,000
at December 31, 1996). OREO at December 31, 1996 consisted of a 12 lot
subdivision which was sold on June 19, 1997.
30
Nonperforming loans and other real estate owned are summarized below:
December 31, 1997 December 31, 1996
Nonperforming loans:
Past due 90 days or more
and still accruing interest $ - $ -
Nonaccrual 360,000 -
Total 360,000 -
Other real estate owned - 1,252,000
Total nonperforming loans and
other real estate owned $ 360,000 $1,252,000
=========== ==========
Management is of the opinion that the allowance for credit losses is maintained
at a level adequate for known and currently anticipated future risks inherent in
the loan portfolio. However, the Bank's loan portfolio, which includes approx-
imately $38,000,000 in real estate loans, representing approximately 60% of the
portfolio, could be adversely affected if California economic conditions and the
real estate market in the Bank's market area were to weaken. The effect of such
events, although uncertain at this time, could result in an increase in the
level of nonperforming loans and OREO and the level of the allowance for loan
losses, which could adversely affect the Company's and the Bank's future growth
and profitability.
NONINTEREST INCOME
Noninterest income increased $124,000, or 35%, to $477,000 during 1997
compared to $353,000 during 1996. During 1996, noninterest income decreased
$224,000, or 39%, from $577,000 in 1995. The increase in 1997 was primarily
attributable to a net gain on sale of securities of $34,000 and an increase of
$74,000 in charges assessed on deposit accounts. The decrease in 1996 is
primarily attributable to net gain on sale of securities of $72,000 in 1995, a
gain on sale of OREO of $55,000 realized in 1995 and a decrease of $102,000 in
rental income from OREO.
NONINTEREST EXPENSES
Noninterest expenses were approximately $3.0 million in 1997, compared to
approximately $2.9 million in 1996 and 1995.
31
Generally, expenses have grown commensurate with the growth in assets and
increases in the volume of transactions. As a percentage of average earning
assets, noninterest expense decreased to 2.6% in 1997 from 3.0% in 1996. In
1996, noninterest expense as a percentage of earning assets decreased to 3.0%
from 3.6% in 1995. As pressure continues on net interest margins and net asset
growth, management of operating expenses will continue to be a priority.
INCOME TAXES
The Company's effective tax rate was 38.0% for 1997, 33.7% for 1996 and 38.0%
for 1995. See Note 9 to the consolidated financial statements for additional
information on income taxes.
LIQUIDITY/INTEREST RATE SENSITIVITY
The Bank manages its liquidity to provide adequate funds at an acceptable cost
to support borrowing requirements and deposit flows of its customers. At
December 31, 1997 and 1996, liquid assets as a percentage of deposits were 36%
and 46%, respectively. In addition to cash and due from banks, liquid assets
include interest bearing deposits with other banks, Federal funds sold and
securities which are available for sale. The Bank has $10.0 million in Federal
funds lines of credit available with correspondent banks to meet liquidity
needs.
Management regularly reviews general economic and financial conditions, both
external and internal, and determines whether the positions taken with respect
to liquidity and interest rate sensitivity continue to be appropriate. The Bank
also utilizes a monthly "Gap" report which identifies rate sensitivity over the
short- and long-term.
The following table sets forth the distribution of repricing opportunities,
based on contractual terms, of the Company's earning assets and interest-bearing
liabilities at December 31, 1997, the interest rate sensitivity gap (i.e.
interest rate sensitive assets less interest rate sensitive liabilities), the
cumulative interest rate sensitivity gap, the interest rate sensitivity gap
ratio (i.e. interest rate sensitive assets divided by interest rate sensitive
liabilities) and the cumulative interest rate sensitivity gap ratio.
Based on the contractual terms of its assets and liabilities, the Bank is
currently asset sensitive in terms of its short-term exposure to interest rates.
In other words, the Bank's assets reprice faster than its liabilities.
32
DISTRIBUTION OF REPRICING OPPORTUNITIES
At December 31, 1997
(Dollars in thousands)
After Three After Six After One
Within Months But Months But Year But After
Three Within Six Within One Within Five
Months Months Year Five Years Years Total
Federal funds sold $10,500 $ - $ - $ - $ - $ 10,500
Interest bearing
deposits in other
banks - - - 1,489 - 1,489
Municipal securities - 861 1 ,112 871 2,315 5,159
U.S. Treasury and
agency securities 5,017 999 605 14,593 18,859 40,073
FRB/FHLB stock - - - - 2,104 2,104
Loans 34,583 1,006 2,439 9,513 16,549 64,090
Total
earning assets $50,100 $2,866 $4,156 $26,466 $39,827 $123,415
Interest bearing
demand accounts $22,789 $ - $ - $ - $ - $ 22,789
Savings accounts 14,092 - - - - 14,092
Time certificates
of deposit of
$100,000 or more 5,233 1,897 4,033 2,510 100 13,773
Other time deposits 2,965 3,336 5,930 2,705 - 14,936
Federal funds
purchased 2,000 - - - - 2,000
Other borrowings 5,000 - - 7,038 10,946 22,984
Total interest-
bearing
liabilities $52,079 $ 5,233 $9,963 $12,253 $11,046 $ 90,574
Interest rate
sensitivity gap $ (1,979)$(2,367) $(5,807) $14,213 $28,781 $ 32,841
====== ====== ====== ====== ====== =======
Cumulative interest
rate sensitivity
gap $ (1,979)$(4,346) $(10,153) $ 4,060 $32,841
======= ====== ======= ======= ======
Interest rate
sensitivity gap
ratio 0.96% 0.55% 0.42% 2.16% 1.38%
==== ==== ==== ==== ====
Cumulative interest
rate sensitivity
gap ratio 0.96% 0.92% 0.85% 1.05 % 1.36%
==== ==== ==== ==== ====
33
INFLATION
The impact of inflation on a financial institution differs significantly from
that exerted on manufacturing, or other commercial concerns, primarily because
its assets and liabilities are largely monetary. In general, inflation
primarily affects the Company indirectly through its effect on the ability of
its customers to repay loans, or its impact on market rates of interest, and
thus the ability of the Bank to attract loan customers. Inflation affects the
growth of total assets by increasing the level of loan demand, and potentially
adversely affects the Company's capital adequacy because loan growth in inflat-
ionary periods may increase more rapidly than capital. Interest rates in
particular are significantly affected by inflation, but neither the timing nor
the magnitude of the changes coincides with changes in the Consumer Price Index,
which is one of the indicators used to measure the rate of inflation.
Adjustments in interest rates may be delayed because of the possible imposition
of regulatory constraints. In addition to its effects on interest rates,
inflation directly affects the Company by increasing the Company's operating
expenses. The effect of inflation during the three-year period ended December
31, 1997 has not been significant to the Company's financial position or results
of operations.
CAPITAL RESOURCES
The Company's capital resources consist of shareholders' equity and (for regul-
atory purposes) the allowance for credit losses. During the year ended December
31, 1997, the Company's regulatory capital increased $1,603,000. Tier 1 capital
increased $1,653,000 due primarily to the retention of earnings and sale of
stock. Tier 2 capital decreased $50,000 due to the decrease in the allowance
for credit losses.
The Company and the Bank are subject to capital adequacy guidelines issued by
the Board of Governors and the OCC. The Company and the Bank are required to
maintain total capital equal to at least 8% of assets and commitments to extend
credit, weighted by risk, of which at least 4% must consist primarily of common
equity including retained earnings (Tier 1 capital) and the remainder may
consist of subordinated debt, cumulative preferred stock or a limited amount of
loan loss reserves. Certain assets and commitments to extend credit present
less risk than others and will be assigned to lower risk-weighted categories
requiring less capital allocation than the 8% total ratio. For example, cash
and government securities are assigned to a 0% risk-weighted category, most home
mortgage loans are assigned to a 50% risk-weighted category requiring a 4%
capital allocation and commercial loans are assigned to a 100% risk-weighted
category requiring an 8% capital allocation. As of December 31, 1997, the
Company's total risk-based capital ratio was approximately 18.1% (approximately
17.0% for the Bank) compared to approximately 18.1% (approximately 17.1% for the
Bank) at December 31, 1996.
The Board of Governors and the OCC adopted a 3% minimum leverage ratio for
banking organizations as a supplement to the risk-weighted capital guidelines.
The minimum
34
leverage ratio is intended to limit the ability of banking organizations to
leverage their equity capital base by increasing assets and liabilities without
increasing capital proportionately. The 3% minimum leverage ratio constitutes a
minimum ratio for well-run banking organizations. Organizations experiencing or
anticipating significant growth or failing to meet certain Board of Governors
standards will be required to maintain a minimum leverage ratio ranging from 100
to 200 basis points in excess of the 3% ratio.
The following table reflects the Company's Leverage, Tier 1 and total risk-based
capital ratios for the three year period ended December 31, 1997.
1997 1996 1995
Leverage ratio 10.9% 10.5% 11.7%
Tier 1 capital ratio 17.4% 18.1% 20.8%
Total risk-based capital ratio 18.1% 18.1% 22.0%
On December 19, 1991, President Bush signed the Federal Deposit Insurance
Corporation Improvement Act of 1991 (the "FDICIA"). The FDICIA, among other
matters, substantially revised banking regulations and established a framework
for determination of capital adequacy of financial institutions. Under the
FDICIA, financial institutions are placed into one of five capital adequacy
catagories as follows: (1) "Well capitalized" - consisting of institutions with
a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital
ratio of 6% or greater and a leverage ratio of 5% or greater, and the instit-
ution is not subject to an order, written agreement, capital directive or prompt
corrective action directive; (2) "Adequately capitalized" - consisting of
institutions with a total risk-based capital ratio of 8% or greater, a Tier 1
risk-based capital ratio of 4% or greater and a leverage ratio of 4% or greater,
and the institution does not meet the definition of a "well capitalized"
institution; (3) "Undercapitalized" - consisting of institutions with a total
risk-based capital ratio less than 8%, a Tier 1 risk-based capital ratio of less
than 4%, or a leverage ratio of less than 4%; (4) "Significantly under-
capitalized" - consisting of institutions with a total risk-based capital ratio
of less than 6%, a Tier 1 risk-based capital ratio of less than 3%, or a
leverage ratio of less than 3%; (5) "Critically undercapitalized" - consisting
of an institution with a ratio of tangible equity to total assets that is equal
to or less than 2%.
Financial institutions classified as undercapitalized or below are subject to
various limitations including, among other matters, certain supervisory actions
by bank regulatory authorities and restrictions related to (i) growth of assets,
(ii) payment of interest on subordinated indebtedness, (iii) payment of
dividends or other capital distributions, and (iv) payment of management fees to
a parent holding company. The FDICIA requires the bank regulatory authorities
to initiate corrective action regarding financial institutions which fail
to meet minimum capital requirements. Such action may result in orders to,
among other matters, augment capital and reduce total assets. Critically under-
capitalized financial institutions may also be subject to appointment of a
receiver or implementation of a capitalization plan.
35
OTHER MATTERS
From time to time, the Company's Board of Directors reviews and consults
with advisors, including investment banking, accounting and legal advisors,
regarding banking industry trends and developments, as well as internal and
external opportunities to maximize shareholder value. Such reviews and consul-
tations include evaluating and comparing internal results of operations
projections and external opportunities for mergers, acquisitions,
reorganizations, or other transactions with third parties which may be in the
interests of the Company's shareholders. The Company's Board of Directors
considers such periodic review and consultation to be important as part of their
analysis of the Company's value and prospects in the changing banking environ-
ment and in view of the current consolidation activity within the banking
industry.
YEAR 2000
As the year 2000 approaches, a critical issue has emerged regarding how
existing application software programs and operating systems can accommodate
this date value. In brief, many existing application software products were
designed to only accommodate a two digit date position which represents the year
(e.g. "97" is stored on the system and represents the year 1997). As a result,
the year 1999 (i.e. "99", could be the maximum date value these systems will be
able to accurately process. This is not just a banking problem, as corporations
around the world and in all industries are similarly impacted. Management is
in the process of working with its software vendors to assure that the
Company is prepared for the year 2000. The Company has put procedures in place
to inquire whether the systems of key borrowers are year 2000 compliant. At
present the Company has not identified any special problems and does not have an
estimate of the total cost of evaluating and fixing any potential year 2000
problems.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT RISK
Disclosures under this item are not required for the current fiscal year as the
Company qualifies as a "Small Business" filer.
36
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Independent Auditors' Report 37
Consolidated Balance Sheets, December 31, 1997 and 1996 38
Consolidated Income Statements for the years ended
December 31, 1997, 1996, and 1995 39
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 1997, 1996 and 1995 40
Consolidated Statements of Cash Flows for the years
ended December 31, 1997, 1996 and 1995 41
Notes to Consolidated Financial Statements 42-56
All schedules have been omitted since the required information is not present or
not present in amounts sufficient to require submission of the schedule or
because the information required is included in the Consolidated Financial
Statements or notes thereto.
37
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders
of Saratoga Bancorp:
We have audited the accompanying consolidated balance sheets of Saratoga
Bancorp and subsidiary as of December 31, 1997 and 1996, and the related
consolidated statements of income, shareholders' equity and cash flows
for each of the three years in the period ended December 31, 1997. 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 in accordance with generally accepted auditing
standards. Those standards 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 state-
ments. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Saratoga Bancorp and
subsidiary as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 1997 in conformity with generally accepted accounting
principles.
DELOITTE & TOUCHE LLP
San Jose, California
January 20, 1998
38
SARATOGA BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
ASSETS 1997 1996
CASH AND DUE FROM BANKS $ 4,760,000 $ 4,543,000
FEDERAL FUNDS SOLD 10,500,000 18,300,000
Total cash and equivalents 15,260,000 22,843,000
INTEREST-BEARING
DEPOSITS IN OTHER BANK 1,489,000 -
SECURITIES AVAILABLE FOR SALE 16,184,000 17,949,000
SECURITIES HELD TO MATURITY 31,152,000 24,111,000
LOANS 63,765,000 52,661,000
ALLOWANCE FOR CREDIT LOSSES (578,000) (628,000)
Loans, net 63,187,000 52,033,000
PREMISES AND EQUIPMENT, Net 1,992,000 2,135,000
OTHER REAL ESTATE OWNED - 1,252,000
ACCRUED INTEREST RECEIVABLE AND
OTHER ASSETS 1,780,000 1,461,000
TOTAL $ 131,044.000 $ 121,784,000
================ ================
LIABILITIES AND
SHAREHOLDERS' EQUITY
DEPOSITS:
Demand, noninterest-bearing $ 25,456,000 $ 22,823,000
Demand, interest-bearing 22,789,000 23,171,000
Savings 14,092,000 13,935,000
Time 28,709,000 29,515,000
Total deposits 91,046,000 89,444,000
FEDERAL FUNDS PURCHASED 2,000,000 1,500,000
OTHER BORROWINGS 22,984,000 18,201,000
ACCRUED INTEREST PAYABLE AND
OTHER LIABILITIES 1,409,000 687,000
Total liabilities 117,439,000 109,832,000
COMMITMENTS (Notes 5 and 11)
SHAREHOLDERS' EQUITY:
Preferred stock, no par value;
authorized 1,000,000 shares;
no shares issued Common stock,
no par value; authorized
20,000,000 shares; outstanding
1,091,967 in 1997 and 1,036,392
shares in 1996. 4,705,000 4,461,000
Retained earnings 9,099,000 7,717,000
Net unrealized loss on
securities available
for sale (199,000) (226,000)
Total shareholders' equity 13,605,000 11,952,000
TOTAL $ 131,044,000 $ 121,784,000
=============== ===============
See notes to consolidated financial statements.
39
SARATOGA BANCORP AND SUBSIDIARY
CONSOLIDATED INCOME STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1997 1996 1995
INTEREST INCOME:
Loans, including fees $ 5,571,000 $ 4,395,000 $ 3,788,000
Securities:
Taxable 2,894,000 2,244,000 2,194,000
Non-taxable 244,000 175,000 169,000
Federal funds sold 607,000 761,000 421,000
Other 30,000 10,000 -
Total interest income 9,346,000 7,585,000 6,572,000
INTEREST EXPENSE:
Deposits 2,922,000 2,712,000 2,470,000
Borrowings 1,350,000 841,000 377,000
Other 1,000 5,000 14,000
Total interest expense 4,273,000 3,558,000 2,861,000
NET INTEREST INCOME BEFORE
CREDIT FOR CREDIT LOSSE 5,073,000 4,027,000 3,711,000
CREDIT FOR CREDIT LOSSES - (150,000) -
NET INTEREST INCOME AFTER
CREDIT FOR CREDIT LOSSE 5,073,000 4,177,000 3,711,000
OTHER INCOME:
Service charges 273,000 199,000 194,000
Rental income from
leased assets 98,000 83,000 119,000
Net gain on sale of
securities available
for sale 34,000 - 72,000
Rental income from other
real estate owned - - 102,000
Net gain on sale of other
real estate owned - - 55,000
Other 72,000 71,000 35,000
Total other income 477,000 353,000 577,000
OTHER EXPENSES:
Salaries and employee
benefits 1,338,000 1,342,000 1,188,000
Occupancy 372,000 348,000 376,000
Professional fees 154,000 158,000 156,000
Furniture and equipment 141,000 138,000 126,000
Depreciation on leased
assets 79,000 65,000 110,000
Data processing 75,000 71,000 45,000
Net cost of other real
estate owned 59,000 5,000 115,000
Insurance 40,000 88,000 161,000
Net loss on sale of
securities available
for sale - 4,000 -
Other 720,000 651,000 591,000
Total other expenses 2,978,000 2,870,000 2,868,000
INCOME BEFORE INCOME TAXES 2,572,000 1,660,000 1,420,000
PROVISION FOR INCOME TAXES 976,000 559,000 539,000
NET INCOME $ 1,596,000 $ 1,101,000 $ 881,000
EARNINGS PER SHARE: ============ =========== ============
BASIC $ 1.52 $ 1.06 $ 0.85
============ =========== ============
DILUTED $ 1.39 $ 0.96 $ 0.82
============ =========== ============
See notes to consolidated financial statements.
40
SARATOGA BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
Net
Unrealized
Loss
On Securities Total
Common Stock Available Retained Shareholders'
Shares Amount for sale Earnings Equity
BALANCES,
JANUARY 1, 1995 1,030,972 $4,427,000 $ (819,000) $6,019.000 $9,627,000
Cash dividend
($0.10 per share) - - - (103,000) (103,000)
Change in net
unrealized loss
on securities
available
for sale - - 652,000 - 652,000
Net income - - - 881,000 881,000
---------- ---------- ----------- --------- -----------
BALANCES,
DECEMBER 31, 1995 1,030,972 4,427,000 (167,000) 6,797,000 1,057,000
Exercise of
stock options 5,420 34,000 - - 34,000
Cash dividend
($.175 per share) - - - (181,000) (181,000)
Change in net
unrealized loss
on securities
available
for sale - - (59,000) - (59,000)
Net income - - - 1,101,000 1,101,000
---------- ---------- ----------- ---------- ---------
BALANCES,
DECEMBER 31, 1996 1,036,392 4,461,000 (226,000) 7,717,000 1,952,000
Exercise of
stock options 55,575 244,000 - - 244,000
Cash dividend
($.20 per share) - - - (214,000) (214,000)
Change in net
unrealized loss
on securities
available
for sale - - 27,000 - 27,000
Net income - - - 1,596,000 1,596,000
---------- ---------- ------------ ---------- ----------
BALANCES,
DECEMBER 31, 1997 1,091,967 $4,705,000 $ (199,000) $9,099,000 $3,605,000
========== ========== ============ ========== ==========
See notes to consolidated financial statements.
41
SARATOGA BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1997 1996 1995
CASH FLOWS FROM OPERATIONS:
Net income $ 1,596,000 $ 1,101,000 $ 881,000
Adjustments to reconcile net
income to net cash provided
by operating activities:
Credit for credit losses - (150,000) -
Depreciation and amortization 179,000 170,000 233,000
Gain on sale of other real
estate owned (7,000) - (55,000)
Gain on sale of leased assets - (22,000) -
Net loss (gain) on sale
of investments (34,000) 4,000 (72,000)
Deferred income taxes (158,000) (86,000) 392,000
Valuation allowance -
other real estate owned - (50,000) 35,000
Accrued interest receivable
and other assets (198,000) (233,000) 514,000
Deferred loan fees 1,000 16,000 78,000
Accrued expenses and other
liabilities 722,000 (216,000) 367,000
Net cash provided by operating
activities 2,101,000 534,000 2,373,000
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of securities
available for sale (20,205,000) (14,065,000) (2,590,000)
Purchases of securities held
to maturity (19,256,000) (6,080,000) (4,885,000)
Proceeds from maturities of
securities available for sale 18,933,000 6,993,000 -
Proceeds from maturities of
securities held to maturity 12,315,000 4,170,000 8,417,000
Proceeds from sale of
securities available for sale 2,923,000 2,496,000 2,625,000
Purchase of interest bearing
deposits (1,489,000) - -
Proceeds from maturity of
interest-bearing
deposits in other banks - 200,000 -
Net increase in loans (11,105,000) (15,142,000) (4,797,000)
Purchases of premises
and equipment (36,000) (450,000) (40,000)
Proceeds from sale of
premises and equipment - 134,000 14,000
Proceeds from sale of other
real estate owned 1,321,000 652,000 735,000
Other - - (238,000)
Net cash used in investing
activities (16,599,000) (21,092,000) (759,000)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 1,602,000 14,495,000 1,077,000
Net increase in federal
funds purchased 500,000 - -
Net increase in other borrowings 4,783,000 6,114,000 10,087,000
Issuance of common stock 244,000 34,000 -
Payment of cash dividends (214,000) (181,000) (103,000)
Net cash provided by
financing activities 6,915,000 20,462,000 11,061,000
NET (DECREASE) INCREASE IN CASH
AND EQUIVALENTS (7,583,000) (96,000) 12,675,000
CASH AND EQUIVALENTS,
BEGINNING OF YEAR 22,843,000 22,939,000 10,264,000
CASH AND EQUIVALENTS, END OF YEAR $15,260,000 $22,843,000 $22,939,000
=========== =========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION -
Cash paid during the year for:
Interest $ 4,212,000 $ 3,518,000 $ 2,703,000
Income taxes $ 541,000 $ 923,000 $ 75,000
See notes to consolidated financial statements.
42
SARATOGA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1. SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of Saratoga Bancorp and subsidiary
conform to generally accepted accounting principles and prevailing practices
within the banking industry.
Business - Saratoga Bancorp ("the Company") is a registered bank holding
company whose principal asset (and only subsidiary) is the common stock of
Saratoga National Bank (the "Bank"). The Bank conducts commercial and retail
banking business, which includes accepting demand, savings and time deposits
and making commercial, real estate and consumer loans. It also offers
installment note collections, issues cashier's checks, sells travelers checks
and provides other customary banking services.
Consolidation - The consolidated financial statements include Saratoga Bancorp
and its wholly-owned subsidiary, Saratoga National Bank (the Bank). All
material intercompany accounts and transactions have been eliminated.
Use of Estimates - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect reported amounts of assets, liabilities,
revenues and expenses as of the dates and for the periods presented. A
significant estimate included in the accompanying financial statements is the
allowance for loan losses. Actual results could differ from those estimates.
Cash and Equivalents - The Bank considers all highly liquid debt instruments
purchased with an original maturity of three months or less to be cash
equivalents.
Securities - At the time of purchase the Company classifies its securities
into two categories, securities available for sale and held to maturity.
Securities available for sale are measured at market value with a
corresponding recognition of the net unrealized holding gain or loss as a
separate component of shareholders' equity, net of income taxes, until
realized. Securities held to maturity are measured at amortized cost based on
the Company's positive intent and ability to hold the securities to maturity.
Any gains and losses on sales of securities are computed on a specific
identification basis.
Loans - Loans are stated at the principal amount outstanding. Interest on
loans is credited to income as earned. The accrual of interest is
discontinued and any accrued and unpaid interest is reversed when the payment
of principal or interest is 90 days past due unless the amount is well secured
and in the process of collection. Income on non accrual loans is recognized
only to the extent that cash is received and where the future collection of
principal is probable.
Loan origination fees and costs are deferred and amortized to income by a
method approximating the effective interest method over the lives of the
underlying loans.
Allowance for Credit Losses - The allowance for credit losses is established
through a provision charged to expense. Loans are charged against the
allowance when management believes that the collection of principal is
unlikely. The allowance is an amount that management believes will be
adequate to absorb losses inherent in existing loans and commitments to
extend credit, based on evaluations of collectibility and prior loss
experience. The evaluations take into consideration such factors as changes
in the composition of the portfolio, overall portfolio quality, loan
43
concentrations, specific problem loans, and current and anticipated economic
conditions that may affect the borrowers' ability to repay. In evaluating the
probability of collection, management is required to make estimates and
assumptions.
Accounting for Impaired Loans - A loan is considered impaired when it is
probable that interest and principal will not be collected according to the
contractual terms of the loan agreement. Impaired loans are required to be
measured based on the present value of expected future cash flows discounted
at the loan's effective interest rate or, as a practical expedient, at the
loan's observable market price or the fair value of the collateral if the loan
is collateral dependent. Income recognition on impaired loans is consistent
with the policy for income recognition on nonaccrual loans described above.
The Bank had no impaired loans as of December 31, 1997 or 1996.
Premises and Equipment - Premises and equipment are stated at cost less
accumulated depreciation and amortization. Depreciation and amortization
are computed on a straight-line basis over the shorter of the lease term or
the estimated useful lives of the assets, which are generally three to fifteen
years for furniture, equipment and leasehold improvements and 35 years for a
building.
Leased Equipment - Leased equipment is stated at cost net of accumulated
depreciation. Depreciation is computed on a straight-line basis over the
lease term to an estimated residual value. Such leases are accounted for
as operating leases. Revenue is recognized when earned and depreciation
expense is recorded as other expense.
Long-lived Assets - The Company adopted Statement of Financial Accounting
Standards (SFAS) No. 121 "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed Of", effective January 1, 1995.
The adoption of this statement had no effect on the Company's financial
condition or results of operations.
Other Real Estate Owned - Other real estate owned is carried at the lower of
cost or fair value less estimated costs to sell. When the property is
acquired through foreclosure any excess of the related loan balance over its
estimated fair value less estimated costs to sell is charged to the allowance
for credit losses. Costs of maintaining other real estate owned and any
subsequent declines in the estimated fair value are charged to other expenses.
Accounting for Financial Assets and Liabilities -.The Company adopted SFAS No.
125 "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities" effective January 1, 1997. The adoption of
this statement had no effect on the Company's financial condition or results
of operations.
Income Taxes - Income taxes are provided at current rates. Deferred income
taxes are provided on income and expense items recognized in different periods
for financial statement and tax reporting purposes.
Net Income per Share - The Company adopted SFAS No. 128 "Earnings per Share"
during the fourth quarter of 1997. SFAS 128 requires presentation of basic
and diluted earnings per share (EPS) and restatement of all prior period EPS
presented. Basic EPS is computed by dividing net income by the weighted
average common shares outstanding during the period. Diluted EPS reflects the
potential dilution is securities or other contracts to issue common stock are
exercised or converted into common stock. The weighted average shares used in
computing earnings per share are as follows:
44
Years ended December 31,
1997 1996 1995
Weighted average shares used in computing:
Basic earnings per share 1,048,747 1,033,809 1,030,972
Diluted potential common shares
from exercise of stock options,
using the treasury stock method 103,159 119,525 32,963
Diluted earnings per share 1,151,906 1,150,497 1,066,772
Stock-Based Awards - The Company accounts for stock-based awards to employees
using the intrinsic value method in accordance with Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees."
2. CASH AND DUE FROM BANKS
At December 31, 1997, average aggregate reserves (in the form of deposits with
the Federal Reserve Bank) of $1,742,000 were maintained, which satisfied
federal regulatory requirements to maintain certain average reserve balances.
3. SECURITIES
The amortized cost and estimated market values of securities at December 31
are as follows:
1997
Gross Gross Estimated
Carrying Unrealized Unrealized Market
Amount Gains Losses Value
SECURITIES AVAILABLE FOR SALE
U. S. Treasury and agency
securities $11,228,000 $ 27,000 $(103,000) $11,152,000
Governmental mutual fund 3,128,000 - (110,000) 3,018,000
Federal Home Loan Bank Stock 1,864,000 - - 1,864,000
Bankers Bank Stock 150,000 - - 150,000
----------- -------- --------- -----------
Total $16,370,000 $ 27,000 $(213,000) $16,184,000
=========== ======== ========= ===========
SECURITIES HELD TO MATURITY
U. S. Treasury and agency
securities $10,879,000 $ 94,000 $(128,000) $10,845,000
Mortgage-backed securities 15,024,000 128,000 (28,000) 15,124,000
Obligations of states and
political subdivisions 5,159,000 75,000 - 5,234,000
Federal Reserve Bank Stock 90,000 - - 90,000
----------- -------- --------- -----------
Total $31,152,000 $297,000 $(156,000) $31,293,000
=========== ======== ========= ===========
45
1996
Gross Gross Estimated
Carrying Unrealized Unrealized Market
Amount Gains Losses Value
SECURITIES AVAILABLE FOR SALE
U. S. Treasury and agency
securities $11,704,000 $ 12,000 $ (45,000) $11,671,000
Governmental mutual fund 3,128,000 - (170,000) 2,958,000
Federal Home Loan Bank Stock 3,170,000 - - 3,170,000
Bankers Bank Stock 150,000 - - 150,000
----------- -------- --------- -----------
Total $18,152,000 $ 12,000 $(215,000) $17,949,000
=========== ======== ========= ===========
SECURITIES HELD TO MATURITY
U. S. Treasury and agency
securities $ 5,489,000 $ 51,000 $ (39,000) $ 5,501,000
Mortgage-backed securities 13,204,000 14,000 (148,000) 13,070,000
Obligations of states and
political subdivisions 5,328,000 33,000 (7,000) 5,354,000
Federal Reserve Bank Stock 90,000 - - 90,000
----------- -------- --------- -----------
Total $24,111,000 $ 98,000 $(194,000) $24,015,000
=========== ======== ========= ===========
The amortized cost and estimated market value of debt securities at December
31, 1997, by contractual maturity, are as follows:
Available for Sale Held to Maturity
Estimated Estimated
Carrying Market Carrying Market
Amount Value Amount Value
Due in one year or less $ 997,000 $ 999,000 $ 2,859,000 $ 2,865,000
Due after one year
through five years 6,994,000 7,018,000 1,983,000 2,016,000
Due after five years
through ten years 3,237,000 3,135,000 11,196,000 11,198,000
Mortgage-backed securities - - 15,024,000 15,024,000
Governmental mutual fund 3,128,000 3,018,000 - -
----------- ----------- ----------- -----------
Total $14,356,000 $14,170,000 $31,062,000 $31,203,000
=========== =========== =========== ===========
Sale of investments resulted in gross realized gains of $69,000 for 1997,
($1,000 in 1996 and $148,000 in 1995) and gross realized losses of $35,000
in 1997, $5,000 in 1996 and $76,000 in 1995. During 1994, the Company
transferred investments from available for sale to held to maturity.
The net unrealized loss at the date of transfer of $214,000 is being amortized
over the remaining maturities of the investments. The unamortized portion of
the loss is $135,000 at December 31, 1997.
Mortgage-backed securities generally have stated maturities of four to fifteen
years, but are subject to substantial prepayments which effectively accelerate
actual maturities. The Company's investment in governmental mutual funds has
no fixed maturity. At December 31, 1997 investments with an amortized cost
of $26,491,000 were pledged to secure public and certain other deposits as
required by law or contract.
46
4. LOANS AND ALLOWANCE FOR CREDIT LOSSES
Loans at December 31, are comprised of the following:
1997 1996
Real estate:
Construction $ 8,945,000 $ 9,249,000
Other 29,100,000 21,473,000
Commercial 21,282,000 18,242,000
Installment 1,548,000 1,861,000
Lease financing 3,656,000 2,535,000
Unearned income on lease financing (441,000) (375,000)
------------ ------------
Total loans 64,090,000 52,985,000
Deferred loans fees (325,000) (324,000)
------------ ------------
Loans, net of deferred loan fees $63,765,000 $52,661,000
=========== ===========
The activity in the allowance for credit losses is summarized as follows:
1997 1996 1995
Balance, beginning of year $ 628,000 $ 776,000 $ 738,000
Provision credited to expense - (150,000) -
Write-offs (115,000) (39,000) (45,000)
Recoveries 65,000 41,000 83,000
-------- -------- --------
Balance, end of year $ 578,000 $ 628,000 $ 776,000
======== ======== ========
Nonaccrual loans were $360,000 at December 31, 1997. There were no nonaccrual
loans at December 31, 1996 and 1995. The reduction in interest income
associated with these loans in 1997 was $13,000. Interest income recognized
on such loans in 1997 was $26,000.
5. PREMISES AND EQUIPMENT
Premises and equipment at December 31, are comprised of the following:
1997 1996
Land $ 948,000 $ 948,000
Building and leasehold improvements 1,194,000 1,194,000
Furniture and equipment 982,000 945,000
Equipment held for lease 365,000 365,000
----------- ------------
Total 3,489,000 3,452,000
Accumulated depreciation and amortization (1,497,000) (1,317,000)
----------- ------------
Premises and equipment, net $ 1,992,000 $ 2,135,000
=========== ============
47
The Company's Los Gatos and San Jose branches are leased under noncancellable
operating leases which expire in 1998 and 1999, respectively. The Bank has
renewal options with adjustments to the lease payments based on changes in the
consumer price index. Future minimum annual lease payments are as follows:
1998 $ 188,000
1999 176,000
------------
Tota $ 364,000
============
Rental expense under operating leases was $227,000 in 1997 and $236,000 in
1996 and 1995.
6. OTHER REAL ESTATE OWNED
There was no Other real estate owned at December 31, 1997 ( $1,252,000 at
December 31, 1996 net of valuation allowance of $143,000). The net cost
of operation of other real estate owned is as follows:
1997 1996 1995
Decreases (increases) in valuation
allowance to reflect increases and
decreases in estimated fair value $ - $ 50,000 $ (35,000)
Net holding costs (59,000) (55,000) (80,000)
--------- -------- ---------
Total $ (59,000) $ (5,000) $(115,000)
========= ======== =========
7. DEPOSITS
The amount of short-term jumbo time deposits, each with a minimum
denomination of $100,000, was approximately $13,773,000 and 12,429,000 in 1997
and 1996, respectively.
At December 31, 1997, the scheduled maturities of these time deposits are as
follows:
1998 $11,163,000
1999 1,695,000
2000 815,000
2003 100,000
$13,773,000
===========
8. OTHER BORROWINGS
Other borrowings consist of borrowings from the Federal Home Loan Bank
which are due as follows:
1998 $ 5,000,000
2000 2,149,000
2001 4,133,000
2002 756,000
2003 2,681,000
Thereafter 8,265,000
$22,984,000
===========
48
At December 31, 1997 other borrowings consisted of borrowings from the Federal
Home Loan Bank of $22,984,000. Borrowings from the Federal Home Loan Bank are
secured by U.S. Government and Agency Securities and bear interest at rates
between 5.565% and 7.25%.
9. INCOME TAXES
The provision for income taxes is comprised of the following:
Years Ended December 31,
1997 1996 1995
<S >
Current:
Federal $ 896,000 $478,000 $ 68,000
State 238,000 167,000 79,000
--------- -------- ---------
Total current 1,134,000 645,000 147,000
---------- -------- ---------
Deferred:
Federal (168,000) (75,000) 345,000
State 10,000 (11,000) 47,000
---------- -------- ---------
Total deferred (158,000) (86,000) 392,000
---------- -------- ---------
Total $976,000 $559,000 $539,000
========== ======== ========
The effective tax rate differs from the federal statutory rate as follows:
Years Ended December 31,
1997 1996 1995
Federal statutory rate 35.0% 35.0% 35.0%
State income tax, net of federal effect 6.3 6.2 6.0
Tax exempt income (2.8) (3.1) (3.6)
Officer's life insurance - - 1.3
Other, net (0.5) (4.4) (0.7)
----- ----- -----
Total 38.0% 33.7% 38.0%
===== ===== =====
49
The Company's net deferred tax asset at December 31 is comprised of the
following:
1997 1996
Deferred tax assets:
Provision for credit losses $ 132,000 $ 197,000
Deferred compensation 133,000 93,000
Unrealized loss on investments
available for sale 122,000 138,000
State income taxes 72,000 -
Depreciation & amortization 43,000 -
Deferred gain on sale of other real
estate owned 29,000 -
Deferred rent 24,000 36,000
Provision for other real estate owned - 59,000
--------- ---------
Total deferred assets 555,000 523,000
--------- ---------
Deferred tax liabilities:
Federal Home Loan Bank stock (69,000) -
Depreciation and amortization - (183,000)
Other (32,000) (28,000)
--------- ---------
Total deferred liabilities 101,000 211,000
--------- ---------
Net deferred tax asset $ 454,000 $ 312,000
========= =========
There was no valuation allowance at December 31, 1997 and 1996.
10. STOCK OPTION PLANS
The Company's stock option plans authorize the issuance to employees, officers
and directors of incentive and nonstatutory options to purchase common stock.
The Company's 1982 Amended Stock Option Plan (the "1982 Plan") expired on
October 26, 1992, therefore, no options were granted by the Company during
1995, 1996 or 1997 under the 1982 Plan. Prior to expiration of the 1982 Plan,
options were granted to key officers and employees of the Company and its
subsidiary. Options granted under the 1982 Plan were either incentive options
or nonstatutory options and became exercisable in accordance with a vesting
schedule established at the time of grant. Vesting may not extend beyond ten
years from the date of grant. Upon a change in control of the Company, all
outstanding options under the 1982 Plan will become fully vested and
exercisable. Options granted under the 1982 plan are adjusted to protect
against dilution in the event of certain changes in the Company's capital-
ization, including stock splits and stock dividends.
The Company's 1994 Stock Option Plan (the "1994 Plan") is substantially
similar to the 1982 Plan regarding provisions related to option grants,
vesting and dilution. Upon a change in control, options do not become fully
vested and exercisable, but may be assumed or equivalent options may be
substituted by a successor corporation.
50
Option activity is summarized as follows:
Outstanding Options
---------------------------
Number of Weighted Average
Shares Exercise Price
Balances, January 1, 1995 267,177 $6.06
Granted (weighted average value of $1.26) 31,750 6.88
Canceled (6,200) 6.46
------- ------
Balances, December 31, 1995 292,727 6.14
Granted (weighted average value of $1.93) 4,500 10.17
Exercised (5,420) 6.31
Canceled (24,856) 7.09
------- ------
Balances, December 31, 1996 266,951 6.12
(245,728 exercisable at weighted average
price of $5.89)
Exercised (61,854) 4.45
Canceled (2,050) 8.12
------- ------
Balances, December 31, 1997 203,046 $6.61
(196,133 exercisable at weighted average
price of $6.26) ======= =======
At December 31, 1997, 38,544 shares are available for future grant.
The Company continues to account for its stock-based awards using the
intrinsic value method in accordance with Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees" and its related
interpertations. Accordingly, no compensation expense has been recognized in
the financial statements for employee stock arrangements.
SFAS No. 123, "Accounting for Stock-Based Compensation" requires the
disclosure of proforma net income and earnings per share had the Company
adopted the fair value method as of the beginning of fiscal 1995. Under
SFAS 123, the fair value of stock-based awards to employees is calculated
through the use of option pricing models, even though such models were
developed to estimate the fair value of freely tradable, fully transferrable
options without vesting restriction, which significantly differ from the
Company's stock option awards. These models also require subjective
assumptions, including future stock price volatility and expected time to
exercise, which greatly affect the calculated values. The Company's
calculations were made using the Black-Scholes option pricing model with
the following weighted average assumptions: expected life, 114 months; stock
volatility, 19%; risk free interest rates, not applicable in 1997, 6.54% and
6.68% in 1996 and 5.85%, 6.15% and 7.66% in 1995; and a dividend yield of
5.50% as they occur. If the computed fair values of the 1997, 1996 and 1995
awards had been amortized to expense over the vesting period of the awards,
pro forma net income would have been as follows:
51
Years ended December 31,
1997 1996 1995
Pro forma net income $1,587,000 $1,090,000 $868,000
Pro forma earnings per share
Basic $1.51 $1.06 $0.84
Diluted $1.38 $0.95 $0.81
11. COMMITMENTS AND CONTINGENT LIABILITIES
The Bank is party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include loan commitments of $24,435,000 and standby
letters of credit of $25,000 at December 31, 1997. The Bank's exposure to
credit loss is limited to amounts funded or drawn; however, at December 31,
1997, no losses are anticipated as a result of these commitments.
Loan commitments are typically contingent upon the borrower's meeting certain
financial and other covenants and such commitments typically have fixed
expiration dates and require payment of a fee. As many of these commitments
are expected to expire without being drawn upon, the total commitments do not
necessarily represent future cash requirements. The Bank evaluates each
potential borrower and the necessary collateral on an individual basis.
Collateral varies, and may include real property, bank deposits, or business
or personal assets.
Standby letters of credit are conditional commitments written by the Bank to
guarantee the performance of a customer to a third party. These guarantees
are issued primarily relating to inventory purchases by the Bank's commercial
customers and such guarantees are typically short-term. Credit risk is
similar to that involved in extending loan commitments to customers and the
Bank, accordingly, uses evaluation and collateral requirements similar to
those for loan commitments. Virtually all of such commitments are
collateralized.
Officers of the Company have severance agreements which provide, in the event
of a change in control meeting certain criteria, severance payments based on
a multiple of their current compensation. At December 31, 1997, these
payments would have aggregated up to $348,000.
12. LOAN CONCENTRATIONS
The Bank's customers are primarily located in Santa Clara County, which is
located in the southern portion of the San Francisco Bay Area. Many of the
Bank's customers are employed by or are otherwise dependent on the high tech-
nology and real estate development industries and, accordingly, the ability
of the Bank's borrowers to repay loans may be affected by the performance of
these sectors of the economy. Virtually all loans are collateralized.
Generally, real estate loans are secured by real property and commercial and
other loans are secured by business or personal assets. Repayment is
generally expected from refinancing or sale of the related property for real
estate construction loans and from cash flows of the borrower for all other
loans.
52
The composition of the loan portfolio at December 31, 1997 and 1996 is
summarized in the following table.
1997 1996
Real estate:
Construction:
Single family construction 11% 15%
Land Development 3 2
Other 46 41
Commerical 38 34
Installment 2 8
--- ---
100% 100%
=== ===
13. DISCLOSURE OF FAIR VALUE OF FINANCIAL INSTRUMENTS
The following estimated fair value amounts have been determined by using
available market information and appropriate valuation methodologies.
However, considerable judgment is required to interpret market data to develop
the estimates of fair value. Accordingly, the estimates presented are not
necessarily indicative of the amounts that could be realized in a current
market exchange. The use of different market assumptions and/or estimation
techniques may have a material effect on the estimated fair value amounts.
The following table presents the carrying amount and estimated fair value of
certain assets and liabilities of the Company at December 31, 1997. The
carrying amounts reported in the consolidated balance sheets approximate fair
value for the following financial instruments: cash and due from banks,
federal funds sold, interest bearing deposits in other banks, demand and
savings deposits, federal funds purchased and other borrowings (See Note 3
for information regarding securities).
December 31, 1997
--------------------------------
Carrying Estimated Fair
Amount Value
Loans, net $63,187,000 $62,284,000
Time deposits $28,709,000 $28,644,000
December 31, 1996
--------------------------------
Carrying Estimated Fair
Amount Value
Loans, net $52,033,000 $52,202,000
Time deposits $29,515,000 $29,590,000
LOANS
The fair value of loans with fixed rates is estimated by discounting the
future cash flows using current rates at which similar loans would be made
to borrowers with similar credit ratings. For loans with variable rates
which adjust with changes in market rates of interest, the carrying amount
is a reasonable estimate of fair value.
53
TIME DEPOSITS
The fair value of fixed maturity certificates of deposit is estimated using
rates currently offered for deposits of similar remaining maturities.
COMMITMENTS TO EXTEND CREDIT AND STANDBY LETTERS OF CREDIT
Commitments to extend credit and standby letters of credit are issued in the
normal course of business by the Bank. Commitments to extend credit are
issued with variable interest rates tied to market interest rates at the time
the commitment is funded and the amount of the commitment equals their fair
value. Standby letters of credit are supported by commitments to extend
credit with variable interest rates tied to market interest rates at the
time the commitments are funded and the amount of standby letters of credit
equals their fair value.
14. REGULATORY MATTERS
The Company and the Bank are subject to various regulatory capital
requirements administered by 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 Company's financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, the Company and the Bank must meet specific capital guidelines that
involve quantitative measures of the Company's and the Bank's assets,
liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices. The Company's and the Bank's capital amounts
and classification are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and 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 and 1996, that the Company and the Bank meet all capital adequacy
requirements to which they are subject.
As of December 31, 1997, the most recent notification from the Office of the
Comptroller of the Currency categorized the Company and 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 I risk-based, and Tier I leverage ratios as set forth in the
table. There are no conditions or events since that notification that
management believes have changed the institution's category.
54
The following table shows the Company's and the Bank's actual capital amounts
and capital ratios at December 31, 1997 and 1996 as well as the minimum
capital ratios required to be deemed "well capitalized" under the regulatory
framework.
To Be Well
Capitalized Under
Bancorp Bank Only For Capital Prompt Corrective
Actual Actual Adequacy Purposes: Action Provisions:
Amount Ratio Amount Ratio Amount Ratio Amount Ratio
--------------- ---------------- ---------------- ----------------
As of
December
31, 1997
Total
Capital
(to Risk
Weighted
Assets)$14,183,000 18.1% $13,266,000 17.0% >$6,232,000 >8.00% >$7,790,000>10.0%
Tier I
Capital
(to Risk
Weighted
Assets)$13,605,000 17.4% $12,688,000 16.3% >$3,116,000 >4.00% >$4,716,000> 6.0%
Tier I
Capital
(to
Average
Assets)$13,605,000 10.9% $12,688,000 10.2% >$4,989,000 >4.00% >$6,236,000> 5.0%
As of
December
31, 1996
Total
Capital
(to Risk
Weighted
Assets)$12,580,000 18.1% $11,826,000 17.1% >$5,602,000 >8.00% >$7,003,000>10.0%
Tier I
Capital
(to Risk
Weighted
Assets)$11,952,000 18.1% $11,198,000 16.2% >$2,802,000 >4.00% >$4,202,000 >6.0%
Tier I
Capital
(to
Average
Assets)$11,952,000 10.5% $11,198,000 9.8% >$4,614,000 >4.00% >$5,767,000 >5.0%
15. CONDENSED FINANCIAL INFORMATION OF SARATOGA BANCORP (PARENT ONLY)
The condensed financial statements of Saratoga Bancorp are as follows:
CONDENSED BALANCE SHEETS
December 31,
1997 1996
ASSETS:
Cash-interest bearing account with Bank $ 185,000 $ 102,000
Real estate loans 660,000 764,000
Investment in Bank 12,688,000 11,078,000
Other assets 79,000 8,000
----------- ----------
Total $13,612,000 $11,952,000
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Other liabilities $ 7,000 $ -
Common stock 4,705,000 4,461,000
Retained earnings 9,099,000 7,717,000
Net unrealized loss on investments
available for sale (199,000) (226,000)
----------- -----------
Total $13,612,000 $11,952,000
=========== ===========
55
CONDENSED INCOME STATEMENTS
Years Ended December 31,
----------------------------------
1997 1996 1995
Interest income $ 73,000 $ 26,000 $ 8,000
Dividend from subsidiary - 861,000 -
Other expenses (53,000) (50,000) (50 000)
---------- ---------- ----------
Income (loss) before income taxes
and equity in undistributed net
income of Bank 20,000 837,000 (42,000)
Income tax (expense) benefit ( 7,000) ( 9,000) 16,000
---------- ---------- ----------
Income(loss) before equity in
undistributed net income of Bank 13,000 846,000 (26,000)
Equity in undistributed net income
of Bank 1,583,000 255,000 907,000
---------- ---------- ----------
Net income $1,596,000 $1,101,000 $ 881,000
========== ========== ==========
CONDENSED STATEMENTS OF CASH FLOWS
Years ended December 31,
-------------------------------------
1997 1996 1995
Cash flows from operations:
Net income $1,596,000 $1,101,000 $ 881,000
Adjustments to reconcile net
income to net cash (used in)
provided by operating activities:
Equity in undistributed net
income of Bank (1,583,000) (255,000) (907,000)
Credit for credit losses - - (16,000)
Change in other assets (1,000) 19,000 -
Change in other liabilities (63,000) (1,000) -
----------- ---------- ----------
Net cash (used in) provided by
operating activities (51,000) 864,000 (42,000)
Cash flows from investing activities -
Net change in loans 104,000 (764,000) 36,000
----------- ----------- ----------
Cash flows from financing activities:
Cash dividend (214,000) (181,000) (103,000)
Issuance of common stock 244,000 34,000 -
----------- ---------- ----------
Net cash provided by (used in)
financing activities 30,000 (147,000) (103,000)
----------- ---------- ----------
Net increase (decrease) in cash 83,000 (47,000) (109,000)
Cash, beginning of year 102,000 149,000 258,000
----------- ---------- ----------
Cash, end of year $ 185,000 $ 102,000 $ 149,000
=========== ========== ==========
56
The ability of the Company to pay future dividends will largely depend upon
the dividends paid to it by the Bank. Under federal law regulating national
banks, dividends declared by the Bank in any calendar year may not exceed the
lesser of its undistributed net income for the most recent three fiscal years
or its retained earnings. As of December 31, 1997, the amount available for
distribution from the Bank to the Company was approximately $3,080,000,
subject to approval by the Office of the Comptroller of the Currency. The Bank
is also restricted as to the amount and form of loans, advances or other
transfers of funds or other assets to the Company.
16. NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board adopted SFAS No. 130
"Reporting Comprehensive Income", which requires that an enterprise report,
by major components and as a single total, the change in its net assets during
the period from nonowner sources; and SFAS No. 131 "Disclosure about Segments
of an Enterprise and Related Information", which establishes annual and interim
reporting standards for an enterprise's business segments and related
disclosures about its products, services, geographic areas and major customers.
Both statements are effective for the Company's 1998 consolidated financial
statements and are not expected to have a material impact on the Company's
financial position and results of operations.
* * * * *
57
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not applicable.
PART III
Item 10. Directors and Executive Officers of the Registrant.
The information required hereunder is incorporated by reference from the
Company's definitive proxy statement for the Company's 1998 Annual Meeting of
Shareholders (to be filed pursuant to Regulation 14A).
Item 11. Executive Compensation.
The information required hereunder is incorporated by reference from the
Company's definitive proxy statement for the Company's 1998 Annual Meeting of
Shareholders (to be filed pursuant to Regulation 14A).
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required hereunder is incorporated by reference from the
Company's definitive proxy statement for the Company's 1998 Annual Meeting of
Shareholders (to be filed pursuant to Regulation 14A).
Item 13. Certain Relationships and Related Transactions.
The information required hereunder is incorporated by reference from the
Company's definitive proxy statement for the Company's 1998 Annual Meeting of
Shareholders (to be filed pursuant to Regulation 14A).
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) (1) Financial Statements. This information is listed and included in
Part II, Item 8.
(a) (2) Financial Statement Schedules. All schedules have been omitted
since the required information is not present or is not present
in amounts sufficient to require submission of the schedule or
because the information required is included in Consolidated
Financial Statements or notes thereto.
58
(a) (3) Exhibits. The exhibits listed on the accompanying Exhibit Index
are filed as part of this report.
(3.1) Articles of Incorporation, as amended, are incorporated by
reference herein to Exhibit 3.1 of Registrant's Annual Report on
Form 10-K for the fiscal year ended December 31, 1988, as filed
with the Securities and Exchange Commission on March 27, 1989.
(3.2) By-laws, as amended, are incorporated by reference herein to
Exhibit 3.2 of Registrant's Annual Report on Form 10-K for the
fiscal year ended December 31, 1993 as filed with the Securities
and Exchange Commission on March 29, 1994.
(4.1) Specimen stock certificate is incorporated by reference to
Exhibit 4.1 of Registrant's Annual Report on Form 10-K for
the fiscal year ended December 31, 1994 as filed with the
Securities and Exchange Commission on March 30, 1995.
(10.1) Lease agreement dated 10/19/87 for 15405 Los Gatos Blvd.,
Suite 103, Los Gatos, CA is incorporated by reference herein
to Exhibit 10.1 of Registrant's Annual Report on Form 10-K for
the fiscal year ended December 31, 1987 as filed with the
Securities and Exchange Commission on March 31, 1988.
(10.2) Agreement of Purchase and Sale dated July 27, 1988 for 12000
Saratoga-Sunnyvale Road, Saratoga, CA is incorporated by refer-
ence herein to Exhibit 10.1 of Registrant's Annual Report on Form
10-K for the fiscal year ended December 31, 1988, as filed with
the Securities and Exchange Commission on March 27, 1989.
*(10.3) Indemnification Agreements with directors and Executive Officers
of the Registrant are incorporated by reference herein to Exhibit
10.2 of Registrant's Annual Report on Form 10-K for the fiscal
year ended December 31, 1988, as filed with the Securities and
Exchange Commission on March 27, 1989.
(10.4) Lease agreement dated 1/17/89 for 160 West Santa Clara Street,
San Jose, California is incorporated by reference herein to
Exhibit 10.4 of Registrant's Annual Report on Form 10-K for the
fiscal year ended December 31, 1989, as filed with the Securities
and Exchange Commission on March 27, 1990.
(10.5) Bank of the West Master Profit Sharing and Savings Plan and
Amendment, amended as of March, 1990 are incorporated by
59
reference herein to Exhibit 10.5 of Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 1990, as
filed with the Securities and Exchange Commission on March 20,
1991.
*(10.6) Employment Agreement and Management Continuity Agreement and
Chief Executive Officer Compensation Plan/Richard L. Mount is
incorporated by reference herein to Exhibit 10.6 of Registrant's
Annual Report on Form 10-K for the fiscal year ended December
31, 1990, as filed with the Securities and Exchange Commission
on March 20, 1991.
(10.7) Saratoga Bancorp 1982 Stock Option Plan is incorporated by
reference herein to the exhibits to Registration Statement
No. 33-34674 on Form S-8 as filed with the Securities and
Exchange Commission on May 7, 1990.
(10.8) Saratoga National Bank Savings Plan dated June 19, 1995 is
incorporated by reference herein to Exhibit 10.8 of Registrant's
Annual Report on Form 10-K for the fiscal year ended December
31, 1995, as filed with the Securities and Exchange Commission on
March 27, 1996.
(10.9) Saratoga Bancorp 1994 Stock Option Plan dated March 18, 1994 is
incorporated by referencce herein to Appendix A of Proxy
Statement dated April 19, 1994 filed as with the Securities and
Exchange Commission on April 27, 1994.
(10.10) Forms of Incentive Stock Option Agreement, Non-Statutory Stock
Option Agreement and Non-Statutory Agreement for Outside
Directors, as amended is incorporated by reference herein to
Exhibit 10.8 of Registrant's Quarterly Report on Form 10-Q
for the Quarter ended June 30, 1994 as filed with the Securities
and Exchange Commission on August 15, 1994.
(21) Subsidiaries of the registrant: Registrant's only subsidiary is
Saratoga National Bank, a national banking association, which
operates a commercial and retail banking operation in California.
(23) Independent Auditors' consent
(27) Financial Data Schedule
* Denotes management contracts, compensatory plans or arrangements.
60
(b) Reports on Form 8-K
Registrant filed no reports on Form 8-K for the three month
period ended December 31, 1997.
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED
PURSUANT TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE
NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT.
No annual report or proxy material has been sent to security holders. The
Company shall furnish copies of such material to the Commission when it is
sent to security holders.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
SARATOGA BANCORP
Richard L. Mount
By_______________________________
Richard L. Mount, President
(Principal Executive Officer)
March 25, 1998
Date_____________________________
Mary Page Rourke
By_______________________________
Mary Page-Rourke, Treasurer
(Principal Financial and
Accounting Officer)
March 25, 1998
Date_____________________________
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
61
Name Title Date
Victor Aboukhater March 25, 1998
__________________ Director _______________
Victor Aboukhater
Robert G. Egan March 25, 1998
__________________ Director _______________
Robert G. Egan
William D. Kron March 25, 1998
__________________ Director ______________
William D. Kron
John F. Lynch III March 25, 1998
__________________ Director ______________
John F. Lynch III
V. Ronald Mancuso March 25, 1998
__________________ Director ______________
V. Ronald Mancuso
Richard L. Mount Chairman of the Board March 25, 1998
__________________ President and Director ______________
Richard L. Mount (Principal Executive Officer)
Mary Page Rourke March 25, 1998
__________________ Treasurer ______________
Mary Page-Rourke (Principal Financial and
Accounting Officer)
62
INDEX TO EXHIBITS
Sequentially
Numbered
Number Exhibits Page
33.1 Independent Auditors' Consent 63
27.1 Financial Data Schedule 64