SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 8-K/A CURRENT REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 Date of Report (Date of earliest event reported): October 20, 1997 United Security Bancorporation (Exact Name of Registrant as Specified in Charter) Washington 0-18561 91-1259511 ---------- ------- ---------- (State or other jurisdiction (Commission (IRS Employer Identi- of incorporation) File Number) fication Number) 9506 North Newport Highway, Spokane, Washington 99218- 1200 ----------------------------------------------------- - ----- (Address of principal executive offices/Zip Code) Registrant's telephone number, including area code: (509) 467-6949 --------------------------------------------------------- - ---------- Item 7. Financial Statements and Exhibits. On October 20, 1997 United Security Bancorporation acquired Community Ban Corporation and its wholly-owned subsidiary Bank of Pullman (Pullman). The agreement and plan of merger and news release of October 21, 1997 were filed as a Form 8- K under Item 2. Acquisition or Disposition of Assets on October 31, 1997. The financial statements required by this item are included with this amendment filing. As disclosed in the included pro forma financial information United Security Bancorporation obtained an $8 million borrowing line from Key Bank of Washington as a portion of the sources of funds used to complete the acquisition of Pullman. SIGNATURES Pursuant to the requirements of the Security Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Dated: November 6, 1997 UNITED SECURITY BANCORPORATION By: /s/ Chad Galloway ------------------------------ Name: Chad Galloway Title: Vice President and Chief Financial Officer 1 Consolidated Financial Statements and Independent Auditors' Report December 31, 1996 Community Bancorporation and Subsidiary Contents Page Independent Auditors' Report 3 Consolidated Financial Statements: Consolidated balance sheet 4-5 Consolidated statement of income 6 Consolidated statement of stockholders' equity 7 Consolidated statement of cash flows 8-9 Notes to consolidated financial statements 10-22 2 Community Bancorporation and Subsidiary INDEPENDENT AUDITORS' REPORT Board of Directors Community Bancorporation Pullman, Washington We have audited the accompanying consolidated balance sheet of Community Bancorporation and Subsidiary as of December 31, 1996, and the related consolidated statements of income, stockholders' equity, and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. 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 audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Community Bancorporation and Subsidiary as of December 31, 1996, and the results of their operations and their and their cash flows for the year then ended in conformity with generally accepted accounting principles. /s/ LeMaster & Daniels PLLC Spokane, Washington July 25, 1997 3 Community Bancorporation and Subsidiary Consolidated Balance Sheet, December 31, 1996 CASH AND CASH EQUIVALENTS: Cash and due from banks $ 2,662,171 Federal funds sold 775,000 - - ---------- Total cash and cash equivalents 3,437,171 SECURITIES: Available-for-sale $18,064,399 Held-to-maturity 3,759,757 ----------- 21,824,156 LOANS: Commercial and industrial 13,639,321 Agricultural 6,944,558 Real estate mortgage and construction 8,774,674 Installment 1,994,173 Municipal 44,277 Credit cards 633,291 Other 166,764 ---------- Total loans 32,197,058 Less: Deferred loan fees 64,070 Unearned income 6,535 Allowance for loan losses 606,545 ---------- 31,519,908 ACCRUED INTEREST RECEIVABLE 696,095 PREMISES AND EQUIPMENT 243,923 OTHER ASSETS 394,303 - - ---------- $58,115,556 =========== See accompanying notes to consolidated financial statements. 4 Community Bancorporation and Subsidiary Consolidated Balance Sheet (Continued), December 31, 1996 LIABILITIES: Deposits: Interest bearing: Demand $ 6,162,314 Savings 26,353,040 Time (including time deposits over $100,000 of $446,053) 4,692,767 Noninterest bearing, demand 13,668,788 - - ---------- Total deposits 50,876,909 Accrued interest payable 75,055 Other liabilities 431,809 - - ---------- Total liabilities 51,383,773 COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Common stock--authorized 1,000,000 shares of no par value; 300,000 shares issued and outstanding $ 621,425 Retained earnings 6,127,443 Unrealized loss on securities available-for-sale, less applicable deferred income tax (17,085) ----------- Total stockholders' equity 6,731,783 - - ---------- $58,115,556 =========== See accompanying notes to consolidated financial statements. 5 Community Bancorporation and Subsidiary Consolidated Statement of Income, Year Ended December 31, 1996 INTEREST INCOME: Interest and fees on loans $3,414,755 Interest on investment securities: Taxable 832,451 Tax-exempt 323,175 Interest on federal funds sold 93,138 ------ - ---- 4,663,519 INTEREST EXPENSE: Interest on deposits $ 1,653,170 Other 32,956 ----------- 1,686,126 ------ - ---- Net interest income 2,977,393 PROVISION FOR LOAN LOSSES - - ------ - ---- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 2,977,393 NONINTEREST INCOME: Service charges on deposit accounts 222,860 Escrow fees 19,422 Other 137,132 ---------- 379,414 NONINTEREST EXPENSES: Salaries 984,758 Employee benefits 207,104 Occupancy expense 139,338 Equipment expense 179,665 Other operating expense 671,333 2,182,198 ------ - ---- INCOME BEFORE INCOME TAX 1,174,609 FEDERAL INCOME TAX (BENEFIT): Current 327,000 Deferred (6,000) 321,000 ------ - ---- NET INCOME $ 853,609 ========== NET INCOME PER SHARE OF COMMON STOCK $ 2.85 See accompanying notes to consolidated financial statements. 6 Community Bancorporation and Subsidiary Consolidated Statement of Stockholders' Equity Unrealized Gain (Loss) on Securities Common Stock Retained Available- Shares Amount Earnings For-Sale Total ------- ------- ---------- ----------- --- - ------ BALANCES, DECEMBER 31, 1995 300,000 $621,425 $5,372,834 $ 49,767 6,044,026 ADD (DEDUCT): Net income for 1996 - - 853,609 - 853,609 Cash dividends declared ($.33 per share) - - (99,000) - (99,000) Net changes in unrealized gain (loss) on available-for-sale securities, net of tax benefit of $34,439 - - - (66,852) (66,852) ------- -------- ---------- -------- --- - ------- BALANCES, DECEMBER 31, 1996 300,000 $621,425 $6,127,443 $(17,085) $6,731,783 ======= ======== ========== ======== ========== See accompanying notes to consolidated financial statements. 7 Community Bancorporation and Subsidiary Consolidated Statement of Cash Flows, Year Ended December 31, 1996 Increase (Decrease) in Cash and Cash Equivalents CASH FLOWS FROM OPERATING ACTIVITIES: Interest and fees received on loans and investments $4,615,930 Other fees and commissions received 371,321 Interest paid (1,652,737) Cash paid to suppliers and employees (2,132,246) Income taxes paid (183,143) ---- - ------ Net cash provided by operating activities 1,019,125 CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from maturities of held-to-maturity securities$1,750,000 Purchases of available-for-sale securities (8,857,100) Proceeds from sales or maturities of available-for-sale securities 6,352,370 Net increase in loans (1,096,756) Purchase of premises and equipment (55,331) ---------- Net cash used in investing activities (1,906,817) CASH FLOWS FROM FINANCING ACTIVITIES: Net decrease in deposits (2,667,476) Cash dividends paid (90,000) Net cash used in financing activities (2,757,476) ---- - ------ NET DECREASE IN CASH AND CASH EQUIVALENTS (3,645,168) CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 7,082,339 ---- - ------ CASH AND CASH EQUIVALENTS, END OF YEAR $3,437,171 ========== See accompanying notes to consolidated financial statements. 8 Community Bancorporation and Subsidiary Consolidated Statement of Cash Flows (Continued), Year Ended December 31, 1996 Reconciliation of Net Income to Net Cash Provided by Operating Activities: Net income $ 853,609 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization $121,434 Amortization of investment security discounts (14,544) Accretion of investment security premiums 26,147 Gains on disposition of assets, net (8,093) Deferred income tax (6,000) (Increase) decrease in assets: Accrued interest receivable (75,211) Deferred loan fees 21,090 Unearned income (5,071) Other assets 72,744 Increase (decrease) in liabilities: Accrued interest payable 33,389 Other liabilities (369) -------- Total adjustments 165,516 --- - ------- Net cash provided by operating activities $1,019,125 ========== See accompanying notes to consolidated financial statements. 9 Community Bancorporation and Subsidiary Notes to Consolidated Financial Statements NOTE 1 - Organization and Summary of Significant Accounting Policies: Organization: Community Bancorporation (which includes its wholly-owned subsidiary, Bank of Pullman, and is referred to as the Corporation), a bank holding company, was formed as part of a corporate reorganization under the laws of the state of Washington. Bank of Pullman is a banking corporation originally organized under the laws of the state of Washington. On May 20, 1997, the Bank relocated its charter to the state of Idaho. The Bank operates branches in Pullman, Uniontown, Colton, and Palouse, Washington. A branch opened in Moscow, Idaho subsequent to December 31, 1996. The accounting policies followed by the Corporation conform with generally accepted accounting principles and with prevailing practices of the banking industry. Summary of Significant Accounting Policies: a. Consolidation -- the consolidated financial statements include the accounts of the Corporation and its wholly-owned subsidiary, Bank of Pullman, after eliminating significant intercompany balances and transactions. b. Use of estimates -- the preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates used in preparing these financial statements are those assumed in determining the allowance for loan losses and the fair values of investment securities. Actual results could differ from those estimates. c. Trading securities -- debt and equity securities that are bought and held principally for the purpose of selling them in the near term are reported at fair value, with unrealized gains and losses included in earnings. There are no securities classified as trading securities. Securities held to maturity -- debt securities for which the Corporation has the positive intent and ability to hold to maturity are reported at cost, adjusted for premiums and discounts that are recognized in interest income using the interest method over the period to maturity. Securities available for sale -- debt and equity securities not classified as either held-to-maturity securities or trading securities are reported at fair value. Unrealized holding gains and losses, net of taxes, are excluded from earnings and reported in a separate component of stockholders' equity. Gains and losses on the sale of available-for-sale securities are determined using the specific-identification method. Premiums and discounts are recognized in interest income using the interest method over the period to maturity. 10 Community Bancorporation and Subsidiary Notes to Consolidated Financial Statements NOTE 1 - Organization and Summary of Significant Accounting Policies (continued): d. Loans and allowances for loan losses -- all loans are stated at principal outstanding less allowance for probable loan losses. Interest is credited to income based on the principal outstanding at appropriate rates of interest. Loans are placed on a nonaccrual status when payment has not been received for more than 90 days. Thereafter, no interest is taken into income unless received in cash or until such time as the borrower demonstrates the ability to resume payments of principal and interest. Interest previously accrued but not collected is reversed and charged against income at the time the loan is placed on nonaccrual status. An allowance for losses on loans is maintained at a level deemed by management to be adequate to provide for potential loan losses through charges to operating expense. The allowance is based upon a continuing review of loans which includes consideration of actual net loan loss experience, changes in size and character of the loan portfolio, identification of individual problem situations which may affect the borrower's ability to repay, and evaluation of current economic conditions. Loan losses are recognized through charges to the allowance. e. Deferred loan fees -- loan origination fees and certain direct costs are capitalized and recognized as an adjustment of the yield on the related loans. f. Premises and equipment -- premises and equipment, including leasehold improvements, are stated at cost less accumulated depreciation over estimated useful lives which range from 3 to 31.5 years. Depreciation expense is computed using straight-line and accelerated methods over the respective useful lives. Modified accelerated cost recovery system depreciation methods are used for federal income tax purposes. Normal costs of maintenance and repairs are charged to expense. g. Intangibles -- the costs of an acquired bank subsidiary in excess of the fair value of net assets acquired and core deposit premiums paid are amortized using the straight-line method over nine to fifteen years. Such amounts are included in other assets in the accompanying consolidated balance sheet. h. Advertising -- advertising costs are charged to expense as incurred. For 1996, such expenses totaled $47,000. 11 Community Bancorporation and Subsidiary Notes to Consolidated Financial Statements Note 1 - Summary of Significant Accounting Policies (continued): i. Income tax -- the Corporation and its subsidiary file a consolidated federal income tax return. The income tax related to the individual entities is computed as if each had filed a separate tax return. Income tax is provided for the tax effects of transactions reported in the financial statements and consists of tax currently due plus deferred tax related to differences between the basis of assets and liabilities for financial and income tax reporting. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. The differences relate principally to depreciation of premises and equipment, allowance for loan losses, basis of investment securities, loan fee recognition, basis of covenant not-to-compete, and the market value adjustment for investments available-for-sale (see note 7). j. Earnings per share -- earnings per share have been calculated on the basis of weighted average number of shares outstanding during each year. Such shares totaled 300,000 for 1996. k. Cash equivalents -- cash equivalents include amounts due from banks and federal funds sold. Generally, federal funds are purchased and sold for one-day periods. l. New accounting standards to be adopted in future periods - -- In June 1996, Statement of Financial Standards (SFAS) No. 125, "Accounting for Transfer and Servicing of Financial Assets and Extinguishment of Liabilities" was issued. The statement provides guidance for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings and is effective January 1, 1997. In December 1996, SFAS No. 127 was issued, delaying certain provisions of SFAS No. 125 for one year. Adoption of SFAS No. 125 is not expected to have a material effect on the Corporation's financial statements. NOTE 2 _ FEDERAL FUNDS: The Bank is required to maintain legal cash reserves in a minimum amount, computed by applying prescribed percentages to their various types of deposits. When the Bank's cash reserves are in excess of that required, it may lend the excess to other banks on a daily basis. Conversely, when cash reserves are less than required, the Bank borrows funds on a daily basis. The average month-end amounts of federal funds sold for the year ended December 31, 1996, was $1,786,463. Similarly, the average of federal funds purchased was $189,590 for 1996. 12 Community Bancorporation and Subsidiary Notes to Consolidated Financial Statements Note 3 - Securities: Securities have been classified in the consolidated balance sheet according to management's intent. The carrying amount of securities and their approximate fair values were as follows: Available-for-sale securities: December 31, 1996: Amortized Gross Unrealized Fair Cost Gains Losses Value ----------- ------- --------- ---- - ------- Debt securities: U.S. Treasury securities and obligations of U.S. government agencies $11,846,722 $20,672 $ (81,982) $11,785,412 Mortgage-backed securities 1,006,175 16,377 (7,177) 1,015,375 Obligations of state and political subdivisions 3,389,976 46,029 (18,442) 3,417,563 Other debt securities 1,844,237 731 (2,094) 1,842,874 ----------- ------- --------- ---- - ------- Total debt securities 18,087,110 83,809 (109,695) 18,061,224 Equity securities: Investment in other banks 3,175 - - 3,175 ----------- ------- --------- ---- - ------- Totals $18,090,285 $83,809 $(109,695) $18,064,399 =========== ======= ========= =========== Held-to-maturity securities: December 31, 1996: U.S. Treasury securities and obligations of U.S. government agencies $ 500,000 $ - $ (5,313) $ 494,687 Obligations of state and political subdivisions 3,259,757 38,515 (5,482) 3,292,790 ----------- ------- --------- ---- - ------- Totals $ 3,759,757 $38,515 $ (10,795) $ 3,787,477 =========== ======= ========= =========== 13 Community Bancorporation and Subsidiary Notes to Consolidated Financial Statements Note 3 - Securities (continued) The following is a summary of maturities of securities held-to- maturity and available-for-sale as of December 31, 1996. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities Held-to-Maturity Securities Available-for-Sale Amortized Fair Amortized Fair Cost Value Cost Value --------- ---------- --------- ------ - ----- Amounts maturing in: One year or less $ 485,369 $ 489,262 $ 1,699,012 $ 1,708,688 After one year through five years 2,531,584 2,543,428 12,629,110 12,584,267 After five years through ten years 423,513 433,720 1,444,329 1,451,141 After ten years 213,601 215,128 48,800 48,800 No single maturity date 105,690 105,939 2,269,034 2,271,503 ---------- ---------- ----------- ------ - ----- Totals $3,759,757 $3,787,477 $18,090,285 $18,064,399 ========== ========== =========== =========== During 1996, the Corporation sold securities available-for-sale for total proceeds of approximately $6,352,000, resulting in gross realized gains of approximately $7,788 and gross realized losses of approximately $4,144. Investment securities of $435,000 at December 31, 1996, were pledged to secure public deposits. NOTE 4 _ RELATED-PARTY TRANSACTIONS: Loans to the Corporation's officers and directors are on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than normal risk of collectibility. The aggregate dollar amounts of these loans were approximately $140,000 at December 31, 1996. 14 Community Bancorporation and Subsidiary Notes to Consolidated Financial Statements NOTE 5 _ ALLOWANCE FOR LOAN LOSSES: Changes in the allowance for loan losses were as follows: Balance, beginning of year $591,841 Provision charged to operations - Loans charged off (102,431) Recoveries 117,135 -------- Balance, end of year $606,545 ======== Loans on which the accrual of interest has been discontinued at December 31, 1996, and the related effects on interest income for the year then ended were $174,859 and $65,700, respectively. NOTE 6 _ PREMISES AND EQUIPMENT: Major classifications of premises and equipment are summarized as follows: Premises $ 93,226 Equipment 1,034,347 Leasehold improvements 308,948 ---------- 1,436,521 Less accumulated depreciation 1,192,598 ---------- Totals $ 243,923 ========== 15 Community Bancorporation and Subsidiary Notes to Consolidated Financial Statements NOTE 7 _ FEDERAL INCOME TAX: The components of the net deferred tax asset included in other assets are as follows: Deferred tax assets $ 181,000 Deferred tax asset valuation allowance - Deferred tax liabilities (78,000) --------- Net deferred tax assets $ 103,000 ========= The net deferred tax assets consisted of the following tax effects on significant temporary differences: Assets Liabilities Allowance for loan losses $120,000 $ - - Premises and equipment - 45,000 Investments 27,000 8,000 Intangibles 12,000 21,000 Deferred loan fees 22,000 - - Other - 4,000 -------- ------- - - Totals $181,000 $ 78,000 ======== ======== The effective tax rate differs from the statutory federal tax rate for 1996 as follows: Federal income tax at statutory rate $399,000 Effect of tax-exempt interest income, net (93,000) Effect of nondeductible expenses and other, net 15,000 ------- - - Total federal income tax provision $321,000 ======== 16 Community Bancorporation and Subsidiary Notes to Consolidated Financial Statements NOTE 8 _ FINANCIAL INSTRUMENTS AND CREDIT CONCENTRATIONS: The Corporation, through its bank subsidiary, is engaged in lending activities with borrowers in a variety of industries. A substantial portion of lending is concentrated in the agribusiness industry in the region in which the Bank is located. Collateral on loans, loan commit ments, and standby letters of credit varies and may include accounts receivable, inventories, investment securities, real estate, equipment, and vehicles. The amount and nature of collateral required are based on credit evaluations of the individual customers. The Corporation is a party to financial instruments with off- balance-sheet risk in the normal course of business to meet the financing needs of its banking customers. These financial instruments generally include commitments to extend credit, standby letters of credit, and financial guarantees. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contract amounts of those instruments reflect the extent of involvement the Corporation has in particular classes of financial instruments. The Corporation's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit and financial guarantees written is represented by the contractual amount of those instruments. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on- balance-sheet instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit are issued on behalf of customers in connection with contracts between the customers and third parties. Under a standby letter of credit, the Corporation assures that the third party will receive specified funds if a customer fails to meet his contractual obligation. The liquidity risk to the Corporation arises from its obligation to make payment in the event of a customer's contractual default. The credit risk involved in issuing letters of credit and the Corporation's management of that credit risk are the same as for loans. 17 Community Bancorporation and Subsidiary Notes to Consolidated Financial Statements NOTE 8 _ FINANCIAL INSTRUMENTS AND CREDIT CONCENTRATIONS (continued): The contract amounts of these financial instruments representing credit risk at December 31, 1996, were as follows: Commitments to extend credit $ 9,123,000 Credit card arrangements 1,500,000 Standby letters of credit and financial guarantees written 190,000 The Corporation and its subsidiary maintain due from bank accounts at several financial institutions located in the Northwest. Accounts at each institution are insured by the Federal Deposit Insurance Corporation up to $100,000. Uninsured balances aggregated approximately $1,995,000 at December 31, 1996. NOTE 9 _ COMMITMENTS AND CONTINGENCIES: Community Bancorporation and its bank subsidiary lease their main office and a branch office under noncancellable operating lease agreements with varying terms through 2000. The annual minimum rental commitments under these leases at December 31, 1996, exclusive of taxes and other charges, total approximately $72,500 in 1997 and $59,500 in 1998, 1999, and 2000. Total rental expense amounted to approxi mately $83,500 in 1996. NOTE 10 _ PENSION PLAN: Bank of Pullman sponsors a 401(k) profit-sharing plan that covers all employees meeting minimum eligibility requirements. Under this defined contribution plan, employees may make voluntary contributions to the plan up to 15% of eligible compensation. Employer matching contributions of up to 2.4% (40% of employee contributions up to 6%) are required. In addition, the Bank may also make voluntary profit-sharing contributions annually. Contribu tions by the Bank, consisting of matching contributions, totaled approximately $36,900 in 1996. 18 Community Bancorporation and Subsidiary Notes to Consolidated Financial Statements NOTE 11 _ DIVIDENDS PAYABLE: The accompanying financial statements include a liability for dividends declared but unpaid at year-end. The Corporation's 1996 financial statements, as previously presented, did not include such liability. Accordingly, these financial statements have been restated, reducing previously reported retained earnings at December 31, 1995 and 1996, by $90,000 and $99,000, respectively. The restatement had no effect on previously reported net income or cash flows. NOTE 12 _ RESTRICTIONS ON DIVIDENDS AND LOANS: The Bank is subject to state banking regulations relating to the payment of dividends and the amount of loans it may extend. The Bank cannot declare or pay any dividends in an amount greater than its retained earnings. Certain loans to any person, including liabilities of a firm or association, cannot exceed twenty percent of the capital and surplus of the Bank. Loans that are secured or covered by guarantees or by commitments or agreements to take over or to purchase the same, made by any federal reserve bank or by the United States or any department, bureau board, commission, or establishment of the United States, are not subject to these restrictions. No loans can be made unless the Bank has more than the minimum funds required by law. NOTE 13_ REGULATORY CAPITAL REQUIREMENTS: Community Bancorporation and its subsidiary, Bank of Pullman, are subject to regulatory capital requirements. Regulated by the Federal Deposit Insurance Corporation (FDIC) and the State of Washington Division of Banking, the Bank is required to maintain minimum levels of regulatory capital as a percentage of regulatory assets. The Bank's total regulatory capital must equal 8% of risk-weighted assets, and one-half of that 8% must consist of core capital. Failure to meet minimum capital requirements can result in actions by regulators that, if taken, could materially affect the consolidated financial statements. Management believes that under the current regulations the Bank meets and will continue to meet all regulatory capital requirements in the foreseeable future. However, events beyond the Bank's control, such as a downturn in the economy of the region, could adversely affect future earnings and regulatory capital. FDIC regulations establish the amount of capital required for each category of institution classification. Depending on the Bank's category, regulators may restrict certain activities of the Bank, including acceptance of brokered deposits or offering interest rates on deposits that are greater than prevailing interest rates. 19 Community Bancorporation and Subsidiary Notes to Consolidated Financial Statements NOTE 13_ REGULATORY CAPITAL REQUIREMENTS (continued): As of January 22, 1996, the most recent notification from the State of Washington Division of Banking categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk- based, Tier I risk-based, 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. The Bank's actual capital amounts and ratios are also presented in the table. To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions Amount Ratio Amount Ratio Amount Ratio ---------- ----- ---------- ------- -------- - -- ----- As of December 31, 1996: Total capital (to risk- weighted assets) $7,101,000 18.2% $3,121,000 >8.0% $3,902,000 >10.0% Tier I capital (to risk- weighted assets) 6,612,000 17.0 1,556,000 >4.0 2,334,000 > 6.0 Tier I capital (to average assets) 6,612,000 11.4 2,314,000 >4.0 2,893,000 > 5.0 NOTE 14 _ PARENT COMPANY STATEMENTS: Community Bancorporation's parent company condensed financial state ments are presented using the equity method of accounting. Accordingly, the separate accounts of the Bank subsidiary are not included and intercompany transactions and balances have not been eliminated. The following are the condensed balance sheet, statement of income, and statement of cash flows for the parent company, Community Bancorporation as of and for the year-ended December 31, 1996: 20 Community Bancorporation and Subsidiary Notes to Consolidated Financial Statements NOTE 14 _ PARENT COMPANY STATEMENTS (continued): Condensed Balance Sheet Assets: Cash $ 7,303 Investment in and advances to Bank subsidiary 6,729,422 Intangible assets (goodwill from purchase of Farmers State Bank) 111,143 ---------- Total assets $6,847,868 ========== Liabilities: Dividends payable $ 99,000 Stockholders' equity 6,748,868 ---------- $6,847,868 ========== CONDENSED STATEMENT OF INCOME Income: Dividends from bank subsidiary $ 30,000 Expenses: Professional fees and other 52,817 Loss before equity in undistributed net income of subsidiary and income tax expense (22,817) Equity in undistributed earnings of bank subsidiary, less dividends paid to parent 876,426 ---------- Net income $ 853,609 ========== Earnings per common share $ 2.85 ========== Weighted average number of shares outstanding 300,000 ========== 21 Community Bancorporation and Subsidiary Notes to Consolidated Financial Statements NOTE 14 _ PARENT COMPANY STATEMENTS (continued): CONDENSED STATEMENT OF CASH FLOWS INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS CASH FLOWS FROM OPERATING ACTIVITIES: Dividends received $ 30,000 Payments to suppliers (40,353) --------- Net cash used in operating activities (10,353) CASH FLOWS FROM FINANCING ACTIVITIES: Dividends paid (90,000) NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (100,353) CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 107,656 -------- CASH AND CASH EQUIVALENTS, END OF YEAR $ 7,303 ======== RECONCILIATION OF NET INCOME TO NET CASH USED IN OPERATING ACTIVITIES: Net income $853,609 Adjustments to reconcile net income to net cash used in operating activities: Amortization of intangible 12,464 Equity in undistributed earnings of subsidiary (876,426) -------- Net cash used in operating activities $(10,353) ======== 22 COMMUNITY BANCORPORATION AND SUBSIDIARY Consolidated Financial Statements (Unaudited) June 30, 1997 Community Bancorporation and Subsidiary Contents Page CONSOLIDATED FINANCIAL STATEMENTS: Consolidated balance sheet 24-25 Consolidated statement of income 26 Consolidated statement of stockholders' equity 27 Consolidated statement of cash flows 28-29 Notes to consolidated financial statements 30-42 23 Community Bancorporation and Subsidiary Consolidated Balance Sheet June 30, 1997 CASH AND CASH EQUIVALENTS: Cash and due from banks $ 3,093,000 Federal funds sold 825,000 ----------- Total cash and cash equivalents 3,918,000 SECURITIES: Available-for-sale 15,068,000 Held-to-maturity 3,507,000 ----------- 18,575,000 LOANS: Commercial and industrial 13,889,000 Agricultural 9,080,000 Real estate mortgage and construction 8,591,000 Installment 2,230,000 Municipal 354,000 Credit cards 643,000 Other 82,000 ---------- Total loans 34,869,000 Less: Deferred loan fees 66,000 Unearned income 4,000 Allowance for loan losses 643,000 ---------- 34,156,000 ACCRUED INTEREST RECEIVABLE 799,000 OTHER REAL ESTATE OWNED 77,000 PREMISES AND EQUIPMENT 416,000 OTHER ASSETS 397,000 ----------- $58,338,000 =========== See accompanying notes to consolidated financial statements. 24 Community Bancorporation and Subsidiary Consolidated Balance Sheet (Continued) Liabilities and Stockholders' Equity June 30, 1997 LIABILITIES: Deposits: Interest bearing: Demand $10,676,000 Savings 25,083,000 Time (including time deposits over $100,000 of $1,809,000) 6,531,000 Noninterest bearing, demand 8,706,000 ----------- Total deposits 50,996,000 Federal funds purchased - Accrued interest payable 66,000 Other liabilities 157,000 ----------- Total liabilities 51,219,000 COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Common stock--1,000,000 shares authorized of no par value; 300,000 shares issued and outstanding 621,000 Retained earnings 6,510,000 Unrealized loss on securities available-for-sale, less applicable deferred income tax (12,000) ----------- Total stockholders' equity 7,119,000 ----------- $58,338,000 =========== See accompanying notes to consolidated financial statements. 25 Community Bancorporation and Subsidiary Consolidated Statement of Income Six-Month Period Ended June 30, 1997 INTEREST INCOME: Interest and fees on loans $1,718,000 Interest on investment securities: Taxable 448,000 Tax-exempt 162,000 Interest on federal funds sold 31,000 ---------- 2,359,000 INTEREST EXPENSE: Interest on deposits 841,000 Other 12,000 ---------- 853,000 ---------- Net interest income 1,506,000 PROVISION FOR LOAN LOSSES 7,000 ---------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 1,499,000 ---------- NONINTEREST INCOME: Service charges on deposit accounts 114,000 Escrow fees 13,000 Other 49,000 ---------- 176,000 ---------- NONINTEREST EXPENSES: Salaries 519,000 Employee benefits 114,000 Occupancy expense 77,000 Equipment expense 96,000 Other operating expense 361,000 ---------- 1,167,000 ---------- INCOME BEFORE INCOME TAX 508,000 FEDERAL INCOME TAX (BENEFIT): Current 132,000 Deferred (6,000) ---------- NET INCOME $ 382,000 ========== NET INCOME PER SHARE OF COMMON STOCK $ 1.27 See accompanying notes to consolidated financial statements. 26 Community Bancorporation and Subsidiary Consolidated Statement of Stockholders' Equity Unrealized Gain (Loss) on Securities Common Stock Retained Available- Shares Amount Earnings For-Sale Total ------- ------- ---------- ----------- --- - ------ BALANCES, DECEMBER 31, 1996 300,000 $621,000 $6,128,000 $(17,000) $6,732,000 ADD (DEDUCT): Net income for 1996 - - 382,000 - 382,000 Net changes in unrealized gain (loss) on available-for-sale securities, net of tax benefit of $3,000 - - - 5,000 5,000 ------- -------- ---------- -------- -- - -------- BALANCES, DECEMBER 31, 1996 300,000 $621,000 $6,510,000 $(12,000) $7,119,000 ======= ======== ========== ======== ========== See accompanying notes to consolidated financial statements. 27 Community Bancorporation and Subsidiary Consolidated Statement of Cash Flows Six-Month Period Ended June 30, 1997 Increase (Decrease) in Cash and Cash Equivalents CASH FLOWS FROM OPERATING ACTIVITIES: Interest and fees received on loans and investments $2,256,000 Other fees and commissions received 176,000 Interest paid (862,000) Cash paid to suppliers and employees (1,297,000) Income taxes paid (131,000) --------- - - Net cash provided by operating activities 142,000 CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from maturities of held-to-maturity securities 253,000 Purchases of available-for-sale securities (1,000,000) Proceeds from sales or maturities of available-for-sale securities 4,004,000 Net increase in loans (2,720,000) Purchase of premises and equipment (218,000) --------- - - Net cash used in investing activities 319,000 CASH FLOWS FROM FINANCING ACTIVITIES: Net decrease in deposits 119,000 Cash dividends paid (99,000) --------- - - Net cash used in financing activities 20,000 --------- - - NET DECREASE IN CASH AND CASH EQUIVALENTS 481,000 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 3,437,000 --------- - - CASH AND CASH EQUIVALENTS, END OF YEAR $3,918,000 ========== See accompanying notes to consolidated financial statements. 28 Community Bancorporation and Subsidiary Consolidated Statement of Cash Flows, Six-Month Periods Ended June 30, 1997 Reconciliation of Net Income to Net Cash Provided by Operating Activities: Net income $382,000 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 7,000 Depreciation and amortization 58,000 (Increase) decrease in assets: Accrued interest receivable (103,000) Deferred loan fees 2,000 Unearned income (2,000) Other assets (15,000) Increase (decrease) in liabilities: Accrued interest payable (9,000) Other liabilities (178,000) --- - ----- Total adjustments (240,000) --- - ----- Net cash provided by operating activities $142,000 ======== See accompanying notes to consolidated financial statements. 29 Community Bancorporation and Subsidiary Notes to Consolidated Financial Statements NOTE 1 _ ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Organization: Community Bancorporation (which includes its wholly-owned subsidiary, Bank of Pullman, and is referred to as the Corporation), a bank holding company, was formed as part of a corporate reorganization under the laws of the state of Washington. Bank of Pullman is a banking corporation originally organized under the laws of the state of Washington. On May 20, 1997, the Bank relocated its charter to the state of Idaho. The Bank operates branches in Pullman, Uniontown, Colton, and Palouse, Washington, and (in 1997) Moscow, Idaho. The accounting policies followed by the Corporation conform with generally accepted accounting principles and with prevailing practices of the banking industry. Summary of Significant Accounting Policies: a. Consolidation -- the consolidated financial statements include the accounts of the Corporation and its wholly-owned subsidiary, Bank of Pullman, after eliminating significant intercompany balances and transactions. b. Use of estimates -- the preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates used in preparing these financial statements are those assumed in determining the allowance for loan losses and the fair values of investment securities. Actual results could differ from those estimates. c. Trading securities -- debt and equity securities that are bought and held principally for the purpose of selling them in the near term are reported at fair value, with unrealized gains and losses included in earnings. There are no securities classified as trading securities. Securities held to maturity -- debt securities for which the Corporation has the positive intent and ability to hold to maturity are reported at cost, adjusted for premiums and discounts that are recognized in interest income using the interest method over the period to maturity. Securities available for sale -- debt and equity securities not classified as either held-to-maturity securities or trading securities are reported at fair value. Unrealized holding gains and losses, net of taxes, are excluded from earnings and reported in a separate component of stockholders' equity. Gains and losses on the sale of available-for-sale securities are determined using the specific-identification method. Premiums and discounts are recognized in interest income using the interest method over the period to maturity. 30 Community Bancorporation and Subsidiary Notes to Consolidated Financial Statements NOTE 1 _ ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued): Summary of Significant Accounting Policies (continued): d. Loans and allowances for loan losses -- all loans are stated at principal outstanding less allowance for probable loan losses. Interest is credited to income based on the principal outstanding at appropriate rates of interest. Loans are placed on a nonaccrual status when payment has not been received for more than 90 days. Thereafter, no interest is taken into income unless received in cash or until such time as the borrower demonstrates the ability to resume payments of principal and interest. Interest previously accrued but not collected is reversed and charged against income at the time the loan is placed on nonaccrual status. An allowance for losses on loans is maintained at a level deemed by management to be adequate to provide for potential loan losses through charges to operating expense. The allowance is based upon a continuing review of loans which includes consideration of actual net loan loss experience, changes in size and character of the loan portfolio, identification of individual problem situations which may affect the borrower's ability to repay, and evaluation of current economic conditions. Loan losses are recognized through charges to the allowance. e. Deferred loan fees -- loan origination fees and certain direct costs are capitalized and recognized as an adjustment of the yield on the related loans. f. Premises and equipment -- premises and equipment, including leasehold improvements, are stated at cost less accumulated depreciation over estimated useful lives which range from 3 to 31.5 years. Depreciation expense is computed using straight-line and accelerated methods over the respective useful lives. Modified accelerated cost recovery system depreciation methods are used for federal income tax purposes. Normal costs of maintenance and repairs are charged to expense. g. Intangibles -- the costs of an acquired bank subsidiary in excess of the fair value of net assets acquired and core deposit premiums paid are amortized using the straight-line method over nine to fifteen years. Such amounts are included in other assets in the accompanying consolidated balance sheet. h. Advertising -- advertising costs are charged to expense as incurred. Such expense totaled $18,000 for the six-month period ended June 30, 1997. 31 Community Bancorporation and Subsidiary Notes to Consolidated Financial Statements NOTE 1 _ ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued): Summary of Significant Accounting Policies (continued): i. Income tax -- the Corporation and its subsidiary file a consolidated federal income tax return. The income tax related to the individual entities is computed as if each had filed a separate tax return. Income tax is provided for the tax effects of transactions reported in the financial statements and consists of tax currently due plus deferred tax related to differences between the basis of assets and liabilities for financial and income tax reporting. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. The differences relate principally to depreciation of premises and equipment, allowance for loan losses, basis of investment securities, loan fee recognition, basis of covenant not-to-compete, and the market value adjustment for investments available-for-sale (see note 7). j. Earnings per share -- earnings per share have been calculated on the basis of weighted average number of shares outstanding during each year. Such shares totaled 300,000. k. Cash equivalents -- cash equivalents include amounts due from banks and federal funds sold. Generally, federal funds are purchased and sold for one-day periods. NOTE 2 _ FEDERAL FUNDS: The Bank is required to maintain legal cash reserves in a minimum amount, computed by applying prescribed percentages to their various types of deposits. When the Bank's cash reserves are in excess of that required, it may lend the excess to other banks on a daily basis. Conversely, when cash reserves are less than required, the Bank borrows funds on a daily basis. The average month-end amounts of federal funds sold for the six months ended June 30, 1997 was $1,111,000. Similarly, the average of federal funds purchased was $163,000. 32 Community Bancorporation and Subsidiary Notes to Consolidated Financial Statements NOTE 3 _ SECURITIES: Securities have been classified in the consolidated balance sheet according to management's intent. The carrying amount of securities and their approximate fair values were as follows: Available-for-sale securities: June 30, 1997: Amortized Gross Unrealized Fair Cost Gains Losses Value ----------- ------- --------- ---- - ------- Debt securities: U.S. Treasury securities and obligations of U.S. government agencies $10,263,000 $ - $ (51,000) $10,212,000 Mortgage-backed securities 1,023,000 3,000 - 1,026,000 Obligations of state and political subdivisions 3,192,000 29,000 - 3,221,000 Other debt securities 607,000 - - 607,000 ----------- ------- --------- ---- - ------- Total debt securities 15,085,000 32,000 (51,000) 15,066,000 Equity securities: Investment in other banks 2,000 - - 2,000 ----------- ------- --------- ---- - ------- Totals $15,087,000 $32,000 $ (51,000) $15,068,000 =========== ======= ========= =========== Held-to-maturity securities: December 31, 1996: U.S. Treasury securities and obligations of U.S. government agencies $ 500,000 $ - $ (3,000) $ 497,000 Obligations of state and political subdivisions 3,007,000 40,000 - 3,047,000 ----------- ------- --------- ---- - ------- Totals $ 3,507,000 $40,000 $ (3,000) $ 3,544,000 =========== ======= ========= =========== 33 12 Community Bancorporation and Subsidiary Notes to Consolidated Financial Statements NOTE 3 _ SECURITIES (continued): The following is a summary of securities held-to-maturity and available-for-sale as of June 30, 1997. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities Held-to-Maturity Securities Available-for-Sale Amortized Fair Amortized Fair Cost Value Cost Value --------- ---------- --------- ------ - ----- Amounts maturing in: One year or less $ 953,000 $ 950,000 $ 3,465,000 $ 3,460,000 After one year through five years 2,182,000 2,226,000 9,551,000 9,390,000 After five years through ten years 157,000 155,000 2,071,000 2,218,000 After ten years 215,000 213,000 - - - ---------- ---------- ----------- ------ - ----- Totals $3,507,000 $3,544,000 $15,087,000 $15,068,000 ========== ========== =========== =========== During the six-month period ended June 30, 1997, the Corporation sold securities available-for-sale for total proceeds of approximately $4,004,000, resulting in gross realized gains of approximately $13,000 and gross realized losses of approximately $0. Investment securities of $481,000 at June 30, 1997, were pledged to secure public deposits. NOTE 4 _ RELATED-PARTY TRANSACTIONS: Loans to the Corporation's officers and directors are on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than normal risk of collectibility. The aggregate dollar amounts of these loans were approximately $124,000 at June 30, 1997. 34 Community Bancorporation and Subsidiary Notes to Consolidated Financial Statements NOTE 5 _ ALLOWANCE FOR LOAN LOSSES: Changes in the allowance for loan losses were as follows: Balance, beginning of period $606,000 Provision charged to operations 7,000 Loans charged off - Recoveries 30,000 -------- Balance, end of year $643,000 ======== Loans on which the accrual of interest has been discontinued at June 30, 1997, were $433,000. NOTE 6 _ PREMISES AND EQUIPMENT: Major classifications of premises and equipment are summarized as follows: Premises $ 93,000 Equipment 1,176,000 Leasehold improvements 386,000 --------- - - 1,655,000 Less accumulated depreciation 1,239,000 --------- - - Totals $ 416,000 ========== 35 Community Bancorporation and Subsidiary Notes to Consolidated Financial Statements NOTE 7 _ FEDERAL INCOME TAX: The components of the net deferred tax asset included in other assets are as follows: Deferred tax assets $ 187,000 Deferred tax asset valuation allowance - - Deferred tax liabilities (70,000) -------- - - Net deferred tax assets $ 117,000 ========= The net deferred tax assets consisted of the following tax effects on significant temporary differences: Assets Liabilities Allowance for loan losses $120,000 $ - - Premises and equipment - 45,000 Investments 33,000 - - Intangibles 12,000 21,000 Deferred loan fees 22,000 - - Other - 4,000 -------- ------- - - Totals $187,000 $ 70,000 ======== ======== The effective tax rate differs from the statutory federal tax rate for the six-month period ended June 30, 1997 was as follows: Federal income tax at statutory rate $173,000 Effect of tax-exempt interest income, net (55,000) Effect of nondeductible expenses and other, net 8,000 ------- - - Total federal income tax provision $126,000 ======== 36 Community Bancorporation and Subsidiary Notes to Consolidated Financial Statements NOTE 8 _ FINANCIAL INSTRUMENTS AND CREDIT CONCENTRATIONS: The Corporation, through its bank subsidiary, is engaged in lending activities with borrowers in a variety of industries. A substantial portion of lending is concentrated in the agribusiness industry in the region in which the Bank is located. Collateral on loans, loan commit ments, and standby letters of credit varies and may include accounts receivable, inventories, investment securities, real estate, equipment, and vehicles. The amount and nature of collateral required are based on credit evaluations of the individual customers. The Corporation is a party to financial instruments with off- balance-sheet risk in the normal course of business to meet the financing needs of its banking customers. These financial instruments generally include commitments to extend credit, standby letters of credit, and financial guarantees. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contract amounts of those instruments reflect the extent of involvement the Corporation has in particular classes of financial instruments. The Corporation's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit and financial guarantees written is represented by the contractual amount of those instruments. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on- balance-sheet instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit are issued on behalf of customers in connection with contracts between the customers and third parties. Under a standby letter of credit, the Corporation assures that the third party will receive specified funds if a customer fails to meet his contractual obligation. The liquidity risk to the Corporation arises from its obligation to make payment in the event of a customer's contractual default. The credit risk involved in issuing letters of credit and the Corporation's management of that credit risk are the same as for loans. 37 Community Bancorporation and Subsidiary Notes to Consolidated Financial Statements NOTE 8 _ FINANCIAL INSTRUMENTS AND CREDIT CONCENTRATIONS (continued): The contract amounts of these financial instruments representing credit risk at June 30, 1997, were as follows: Commitments to extend credit $ 6,136,000 Credit card arrangements 1,627,000 Standby letters of credit and financial guarantees written 135,000 The Corporation and its subsidiary maintain due from bank accounts at several financial institutions located in the Northwest. NOTE 9 _ COMMITMENTS AND CONTINGENCIES: Community Bancorporation and its bank subsidiary lease their main office and a branch office under noncancellable operating lease agreements with varying terms through 2000. The annual minimum rental commitments under these leases at June 30, 1997, exclusive of taxes and other charges, total approximately $36,000 for the remainder of 1997 and $60,000 in 1998, 1999, and 2000. Total rental expense amounted to approximately $42,000 for the six-month period ended June 30, 1997. NOTE 10 _ PENSION PLAN: Bank of Pullman sponsors a 401(k) profit-sharing plan that covers all employees meeting minimum eligibility requirements. Under this defined contribution plan, employees may make voluntary contributions to the plan up to 15% of eligible compensation. Employer matching contributions of up to 2.4% (40% of employee contributions up to 6%) are required. In addition, the Bank may also make voluntary profit-sharing contributions annually. Contribu tions by the Bank, consisting of matching contributions, totaled approximately $20,000 for the six-month period ended June 30, 1997. 38 Community Bancorporation and Subsidiary Notes to Consolidated Financial Statements Note 11 - RESTRICTIONS ON DIVIDENDS AND LOANS: The Bank is subject to state banking regulations relating to the payment of dividends and the amount of loans it may extend. The Bank cannot declare or pay any dividends in an amount greater than its retained earnings. Certain loans to any person, including liabilities of a firm or association, cannot exceed twenty percent of the capital and surplus of the Bank. Loans that are secured or covered by guarantees or by commitments or agreements to take over or to purchase the same, made by any federal reserve bank or by the United States or any department, bureau board, commission, or establishment of the United States, are not subject to these restrictions. No loans can be made unless the Bank has more than the minimum funds required by law. NOTE 12_ REGULATORY CAPITAL REQUIREMENTS: Community Bancorporation and its subsidiary, Bank of Pullman, are subject to regulatory capital requirements. Regulated by the Federal Deposit Insurance Corporation (FDIC) and the State of Washington Division of Banking, the Bank is required to maintain minimum levels of regulatory capital as a percentage of regulatory assets. The Bank's total regulatory capital must equal 8% of risk-weighted assets, and one-half of that 8% must consist of core capital. Failure to meet minimum capital requirements can result in actions by regulators that, if taken, could materially affect the consolidated financial statements. Management believes that under the current regulations the Bank meets and will continue to meet all regulatory capital requirements in the foreseeable future. However, events beyond the Bank's control, such as a downturn in the economy of the region, could adversely affect future earnings and regulatory capital. FDIC regulations establish the amount of capital required for each category of institution classification. Depending on the Bank's category, regulators may restrict certain activities of the Bank, including acceptance of brokered deposits or offering interest rates on deposits that are greater than prevailing interest rates. 39 Community Bancorporation and Subsidiary Notes to Consolidated Financial Statements NOTE 12_ REGULATORY CAPITAL REQUIREMENTS (continued): As of January 22, 1996, the most recent notification from the State of Washington Division of Banking categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk- based, Tier I risk-based, 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. The Bank's actual capital amounts and ratios are also presented in the table. To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions Amount Ratio Amount Ratio Amount Ratio ---------- ----- ---------- ------- -------- - -- ----- As of June 30, 1997: Total capital (to risk- weighted assets) $7,402,000 18.2% $3,250,000 >8.0% $4,062,000 >10.0% Tier I capital (to risk- weighted assets) 6,893,000 17.0 1,625,000 >4.0 2,437,000 > 6.0 Tier I capital (to average assets) 6,893,000 11.9 2,319,000 >4.0 2,899,000 > 5.0 NOTE 14 _ PARENT COMPANY STATEMENTS: Community Bancorporation's parent company condensed financial statements are presented using the equity method of accounting. Accordingly, the separate accounts of the Bank subsidiary are not included and intercompany transac tions and balances have not been eliminated. The following are the condensed balance sheet, statement of income, and statement of cash flows for the parent company, Community Bancorporation as of and for the six-month period ended June 30, 1997: 40 Community Bancorporation and Subsidiary Notes to Consolidated Financial Statements NOTE 14 _ PARENT COMPANY STATEMENTS (continued): Condensed Balance Sheet Assets: Cash $ 4,000 Investment in and advances to Bank subsidiary 7,022,000 Intangible assets (goodwill from purchase of Farmers State Bank) 105,000 ---------- Total assets $7,131,000 ========== Stockholders' equity $7,131,000 ---------- $7,131,000 ========== CONDENSED STATEMENT OF INCOME Income: Dividends from bank subsidiary $ 120,000 Expenses: Professional fees and other 30,000 Income before equity in undistributed net income of subsidiary 90,000 Equity in undistributed earnings of bank subsidiary, less dividends paid to parent 292,000 ---------- Net income $ 382,000 ========== Earnings per common share $ 1.27 ========== Weighted average number of shares outstanding 300,000 ========== 41 Community Bancorporation and Subsidiary Notes to Consolidated Financial Statements NOTE 14 _ PARENT COMPANY STATEMENTS (continued): Condensed Statement of Cash Flows INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS CASH FLOWS FROM OPERATING ACTIVITIES: Dividends received $ 120,000 Payments to suppliers (24,000) --------- Net cash used in operating activities 96,000 CASH FLOWS FROM FINANCING ACTIVITIES: Dividends paid (99,000) NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (3,000) CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 7,000 -------- CASH AND CASH EQUIVALENTS, END OF YEAR $ 4,000 ======== RECONCILIATION OF NET INCOME TO NET CASH USED IN OPERATING ACTIVITIES: Net income $382,000 Adjustments to reconcile net income to net cash used in operating activities: Amortization of intangible 6,000 Equity in undistributed earnings of subsidiary (292,000) -------- Net cash used in operating activities $ 96,000 ======== 42 United Security Bancorporation PRO FORMA FINANCIAL INFORMATION The following unaudited pro forma condensed combined financial statements reflect consummation of the acquisition of Community Ban Corporation and its subsidiary Bank of Pullman (Pullman) by United Security Bancorporation. The following unaudited pro forma condensed combined statement of financial condition as of June 30, 1997, combines the historical consolidated statements of financial condition of United Security Bancorporation and its subsidiaries (USBN) and Pullman as if the Reorganization had occurred on such date after giving effect to certain pro forma adjustments described in the accompanying notes. The following unaudited pro forma condensed combined statements of operations are presented as if the acquisition had been consummated at the beginning of the earliest period presented. The USBN historical consolidated financial statement date as of and for the six months ended June 30, 1997, have been prepared on the same basis as the historical derived from the audited financial statements, and in the opinion of management, contain all adjustments, consisting only of normal recurring accruals, necessary for the fair presentation of results of operations for such periods. The unaudited pro forma condensed combined financial statements and notes thereto reflect the applications of the purchase method of accounting. The unaudited pro forma condensed combined financial statements included herein are not necessarily indicative of the future results of operations or the future financial positions of the combined entities or the results of operations and financial position of the combined entities that would have actually occurred had the transactions been in effect as of the dates or for the periods presented. 43 United Security Bancorporation Pro Forma Combined Condensed Consolidated Pro Forma Statement of Condition as of June 30, 1997 ($ in thousands) Pro Forma Pro Forma Assets USBN Pullman Adjustments Combined Cash and due from banks $ 10,862 $ 3,093 $ 13,955 Overnight Interest bearing deposits with other banks 620 620 Federal funds sold 7,025 825 (3,955) (a) 3,895 -------- ------- ------ - -------- Cash and cash equivalents 18,507 3,918 (3,955) 18,470 Securities 19,248 18,575 37 (b) 37,860 Loans, net of allowance 183,133 34,156 217,289 Premises and equipment, net 6,051 416 500 (b) 6,967 Foreclosed real estate and other foreclosed assets 599 77 676 Costs in excess of net assets acquired 4,299 (b) 4,299 Other assets 5,617 1,196 6,813 -------- ------- ------ - -------- Total assets $233,155 $58,338 $ 881 $292,374 ======== ======= ====== ======== Liabilities Noninterest-bearing demand deposits $ 29,219 $ 8,706 $ 37,925 Interest-bearing deposits 168,400 42,290 210,690 -------- ------- ------ - -------- Total deposits 197,619 50,996 248,615 Short-term debt 268 268 Long-term debt 2,596 8,000 (c) 10,596 Capital lease obligations 742 742 Other liabilities 2,143 223 2,366 -------- ------- ------ - -------- Total liabilities 203,368 51,219 8,000 262,587 Stockholders' Equity Common stock 21,014 621 (621) (d) 21,014 Retained earnings 9,246 6,510 (6,510) (d) 9,246 Net unrealized loss on securities available-for- sale, net (345) (12) 12 (d) (345) Guaranteed bank loan to Employee Stock Ownership Plan (128) (128) -------- ------- ------ - -------- Total stockholders' equity 29,787 7,119 (7,119) 29,787 -------- ------- ------ - -------- Total liabilities and stockholders' equity $233,155 $58,338 $ 881 $292,374 ======== ======= ====== ======== 44 United Security Bancorporation Explanatory notes: (a) Current funds available to acquire Pullman. (b) To adjust Pullman estimated adjustments from book value to fair value and the intangible asset arising from the use of purchase accounting for the acquisition of Pullman. (c) Funds borrowed from Key Bank of Washington to acquire Pullman. (d) Elimination of Pullman stockholders' equity in the consolidation of the Pro Forma combined Company. Pro Forma Combined Condensed Consolidated Pro Forma Income Statement as of June 30, 1997 ($ in thousands, except per share) Pro Forma Pro Forma USBN Pullman Adjustments Combined Interest and fees on loans $ 9,753 $1,718 $ 262 (a) $11,733 Interest on securities 591 610 1,201 Other interest income 471 31 (109) (b) 393 ------- ------ ----- - - ------ Total interest income 10,815 2,359 153 13,327 ------- ------ ----- - - ------ Interest on deposits 4,140 841 4,981 Other interest expense 139 12 340 (c) 491 ------- ------ ----- - - ------ Total interest expense 4,279 853 340 5,472 ------- ------ ----- - - ------ Net interest income 6,536 1,506 (187) 7,855 Provision for loan losses 321 7 328 ------- ------ ----- - - ------ Net interest income after provision for loan losses 6,215 1,499 (187) 7,527 ------- ------ ----- - - ------ Fees and service charges 583 127 710 Insurance commissions 583 583 Securities gains, net (25) 2 (23) Other 243 47 290 ------- ------ ----- - - ------ Total noninterest income 1,384 176 1,560 ------- ------ ----- - - ------ Salaries and employee benefits 2,886 633 3,519 Occupancy expense, net 304 77 381 Equipment expense 336 96 432 Other operating expense 1,086 361 143 (d) 1,590 ------- ------ ----- - - ------ Total noninterest expense 4,612 1,167 143 5,922 ------- ------ ----- - - ------ Income before tax expense 2,987 508 (330) 3,165 Federal income tax expense 1,017 126 (64) (e) 1,079 ------- ------ ----- - - ------ Net income $ 1,970 $ 382 ($266) $ 2,086 ======= ====== ===== ======= Earnings per common share $ .53 $ 1.27 $ .57 Weighted average share outstanding 3,682,849 300,000 3,682,849 45 United Security Bancorporation Explanatory notes: (a) Increased interest income from an improvement in the loan/deposit ratio of Pullman. (b) Decreased interest income from the reduction in overnight investments. (c) Increased interest expense from the borrowing from Key Bank of Washington. (d) Amortization of the resulting costs in excess of net assets in the Pullman purchase. (e) Resulting tax impact from the above items. Pro Forma Combined Condensed Consolidated Pro Forma Income Statement for 1996 ($ in thousands, except per share) Pro Forma USBN Pullman Combined Interest and fees on loans $18,765 $3,415 $22,180 Interest on securities 1,246 1,155 2,401 Other interest income 708 93 801 ------- ------ ------- Total interest income 20,719 4,663 25,382 ------- ------ ------- Interest on deposits 7,850 1,653 9,503 Other interest expense 297 33 330 ------- ------ ------- Total interest expense 8,147 1,686 9,833 ------- ------ ------- Net interest income 12,572 2,977 15,549 Provision for loan losses 1,006 1,006 ------- ------ ------- Net interest income after provision for loan losses 11,566 2,977 14,543 ------- ------ ------- Fees and service charges 1,109 243 1,352 Insurance commissions 1,200 1,200 Securities gains, net 53 53 Other 619 137 756 ------- ------ ------- Total noninterest income 2,981 380 3,361 ------- ------ ------- Salaries and employee benefits 5,960 1,192 7,152 Occupancy expense, net 618 139 757 Equipment expense 701 180 881 Operational loss 860 860 Other operating expense 1,733 671 2,404 ------- ------ ------- Total noninterest expense 9,872 2,182 12,054 ------- ------ ------- Income before tax expense 4,675 1,175 5,850 Federal income tax expense 1,513 321 1,834 ------- ------ ------- Net income $ 3,162 $ 854 $ 4,016 ======= ====== ======= Earnings per common share $ .86 $ 2.85 $ 1.09 Weighted average share outstanding 3,682,849 300,000 3,682,849 46 United Security Bancorporation Pro Forma Combined Condensed Consolidated Pro Forma Income Statement for Six Months Ended June 30, 1996 ($ in thousands, except per share) Pro Forma USBN Pullman Combined Interest and fees on loans $ 8,857 $1,671 $10,528 Interest on securities 692 600 1,292 Other interest income 253 59 312 ------- ------ ------- Total interest income 9,802 2,330 12,132 ------- ------ ------- Interest on deposits 3,758 844 4,602 Other interest expense 141 10 151 ------- ------ ------- Total interest expense 3,899 854 4,753 ------- ------ ------- Net interest income 5,903 1,476 7,379 Provision for loan losses 267 267 ------- ------ ------- Net interest income after provision for loan losses 5,636 1,476 7,112 ------- ------ ------- Fees and service charges 549 125 674 Insurance commissions 632 632 Securities gains, net 53 8 61 Other 247 39 286 ------- ------ ------- Total noninterest income 1,481 172 1,653 ------- ------ ------- Salaries and employee benefits 2,900 564 3,464 Occupancy expense, net 297 70 367 Equipment expense 368 86 454 Other operating expense 914 320 1,234 ------- ------ ------- Total noninterest expense 4,479 1,040 5,519 ------- ------ ------- Income before tax expense 2,638 608 3,246 Federal income tax expense 859 150 1,009 ------- ------ ------- Net income $ 1,779 $ 458 $ 2,237 ======= ====== ======= Earnings per common share $ .48 $ 1.53 $ .61 Weighted average share outstanding 3,668,108 300,000 3,668,108 47