Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (Fee Required)
For the fiscal year ended DECEMBER 31, 1995
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (No Fee Required)
For the transition period from ____________ to __________
Commission file number 0-18015
CUPERTINO NATIONAL BANCORP
(Exact name of registrant as specified in its charter)
CALIFORNIA 33-0060898
(State of incorporation) (IRS employer identification number)
20230 STEVENS CREEK BOULEVARD, CUPERTINO, CA 95014
(Address of principal executive offices)
(408) 996-1144
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
NONE NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, NO PAR VALUE
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained herein, 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 the
registrant, based upon the closing sale price of the Common Stock on March 15,
1996, as reported on the NASDAQ National Market System, was approximately
$17,688,283. Shares of Common Stock held by each officer, director and holder
of 5% or more of the outstanding Common Stock have been excluded in that such
persons may be deemed to be affiliates. This determination of affiliate status
is not necessarily a conclusive determination for other purposes.
The number of shares of COMMON STOCK, NO PAR VALUE, of registrant outstanding as
of March 15, 1996 was 1,857,105.
_______________
DOCUMENTS INCORPORATED BY REFERENCE
Parts of the following documents are incorporated by reference into Parts I, II,
III, and IV of this Form 10-K Report: (1) Proxy Statement for registrant's
Annual Meeting of Shareholders to be held May 16, 1996 (Part III), and (2)
registrant's Annual Report to Shareholders for the year ended December 31, 1995
(Parts I, II and IV).
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PART I
ITEM 1. BUSINESS
GENERAL
Cupertino National Bancorp (the "Company") is a California corporation
and bank holding company. Cupertino National Bank & Trust ("CNB"), a wholly-
owned subsidiary of the Company, is a national bank conducting a commercial
banking business. The Company was organized in August 1984, and CNB began
operations in May 1985. The Company and CNB have their principal offices at
20230 Stevens Creek Boulevard, Cupertino CA 95014. The Company's current
activities are principally acting as the holding company for CNB and as the
lessee and sublessor to CNB of the premises on which CNB's headquarters is
located.
CNB provides a wide range of commercial banking services to small and
medium-sized businesses, real estate firms, business executives, professionals
and other individuals. Trust services are provided by a separate department of
the Bank to support the trust needs of its clients. CNB's strategy emphasizes
acquiring and developing relationships with clients in the Bank's service area.
Personal service officers are assigned to each borrowing client to provide
continuity to the relationship.
CNB provides commercial loans for working capital and business
expansion to small and medium-sized businesses with annual revenues in the range
of $1 million to $35 million. Commercial loans typically include revolving
lines of credit collateralized by inventory, accounts receivable or leasehold
improvements, loans to purchase equipment, and loans for general working capital
purposes, collateralized by equipment. CNB's commercial customers are drawn
from a wide variety of manufacturing, wholesale and service businesses, and are
not concentrated in any one particular industry. Loans to real estate
construction and development companies are primarily for construction of single-
family residences in CNB's primary service area. Such loans typically range
between approximately $200,000 and $3,400,000. Loans to professional and other
individual clients, whose income typically equals or exceeds the median income
for CNB's service area, cover a full range of consumer services, such as
automobile, aircraft, home improvement and home equity loans, and other secured
and unsecured lines of credit, including credit cards.
CNB has a Small Business Administration ("SBA") department which makes
loans to assist smaller clients and those who are starting new businesses in
obtaining financing. The loans are generally 65% to 80% guaranteed by the SBA.
In 1994, CNB was named a Preferred Lender by the SBA. Preferred Lender status
is awarded by the SBA to lenders who have demonstrated superior ability to
generate, underwrite and service loans guaranteed by the SBA, and results in
more rapid turn around of loan applications submitted to the SBA for approval.
In May 1994, CNB opened its Emerging Growth Industries department,
which evolved in 1995 into the Venture Lending group to serve the needs of
companies in their start-up and development phase. This unit was developed to
meet the needs of clients in CNB's service area by allowing them to access a
banking relationship early in their development. The loans to this target group
of clients are generally secured by the accounts receivable, inventory and
equipment of the companies. The financial strength of these companies also
tends to be bolstered by the presence of venture capital investors among the
shareholders.
CNB is a member of the Federal Reserve System and the deposits of the
Bank's clients are insured up to $100,000 by the Federal Deposit Insurance
Corporation ("FDIC"). In 1992, CNB became a member of the Federal Home Loan
Bank of San Francisco ("FHLB") in order to enhance its ability to service its
loan clients. This membership allows CNB to enhance its funding sources as the
FHLB allows members to borrow funds by pledging securities and mortgage loans as
collateral.
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MARKET AREA AND CLIENT BASE
CNB concentrates on providing service to clients in Santa Clara County
and San Mateo County. CNB is headquartered in Cupertino, California which is in
the center of the geographical area which is referred to as "Silicon Valley".
The City of Cupertino has a population of approximately 51,300 and its average
annual household income exceeds $97,200. Among metropolitan areas, Santa Clara
County ranks third in California in median household income.
The commercial base of Santa Clara County is diverse and includes
computer and semiconductor manufacturing, professional services, printing and
publishing, aerospace, defense, real estate construction, and wholesale and
retail trade. CNB has not concentrated on attracting commercial clients from
any single industry, although it has in the past emphasized lending to the
residential real estate construction industry in its service area.
In March 1991, CNB opened its first regional office in downtown San
Jose. This office was established to better serve existing clients of CNB, as
well as to gain new relationships from clients based in the growing financial
center in the southern portion of Santa Clara County. In May 1992, CNB opened
a second regional office in Palo Alto to better serve its clients in Northern
Santa Clara and Southern San Mateo County. CNB intends to open its fourth
office in downtown Palo Alto, in the spring of 1996.
Many of the directors of the Company and CNB, and their affiliates,
maintain deposit and loan relationships with the Bank. See Note 11 of Notes to
Consolidated Financial Statements in the Company's 1995 Annual Report,
incorporated herein by reference, for information regarding loans to affiliates
and other significant related party transactions.
SOURCES OF FUNDS
Most of CNB's deposits are obtained from small and medium-sized
businesses, business executives, professionals and other individuals. At
December 31, 1995, CNB had a total of 7,621 deposit accounts, representing 2,894
non-interest-bearing deposit (checking) accounts with an average balance of
approximately $16,372 each, 3,726 interest-bearing demand, money market demand,
and savings accounts with an average balance of approximately $28,176 each, and
1,001 time deposit accounts with an average balance of approximately $45,267
each. Rates paid on deposits vary among the categories of deposits due to
different terms, the size of the individual deposit, and rates paid by
competitors on similar deposits.
CNB has one deposit relationship with a title company, in which three
of the directors of CNB serve as directors (one CNB director is also the
principal shareholder and chief executive officer of the title company).
Deposit balances from this client in both non-interest-bearing demand accounts
and money market accounts totaled $775,000 on December 31, 1995 and ranged
between $7,000 and $8.5 million during 1995.
LENDING ACTIVITIES
CNB's loan portfolio is centered in commercial lending to small and
medium-sized businesses in the manufacturing and service industries. CNB has
also been an active lender in residential real estate construction.
Approximately 54% of CNB's portfolio was in commercial loans at
December 31, 1995 and real estate construction loans represented approximately
15% of total loans, primarily for residential projects. In addition, 14% of
CNB's loans were real estate term loans, which are primarily secured by
commercial properties. The balance of the portfolio consists of consumer loans.
CNB's loan clients are primarily located in Cupertino, San Jose, Palo Alto and
the surrounding communities in Santa Clara County and San Mateo County.
The majority of loans are collateralized. Generally, real estate loans
are secured by real property, and commercial and other loans are secured CNB
deposits or business and personal assets. Repayment is generally expected from
the sale of the related property for real estate construction loans, and from
the cash flow of the borrower for commercial and other loans.
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The interest rates charged for the loans made by CNB vary with the
degree of risk, size and maturity of the loans. Rates are generally affected by
competition, associated factors stemming from the client's deposit relationship
with CNB and CNB's cost of funds. A majority of the loans in CNB's portfolio
have a floating rate.
In its commercial loan portfolio, CNB provides personalized financial
services to the diverse commercial and professional businesses in its market
area, but does not concentrate on any particular industry. Commercial loans
consist chiefly of short-term loans (normally with a maturity of under one year)
for working capital. Significant emphasis is placed on the borrower's earnings
history, capitalization, secondary sources of repayment (such as accounts
receivable), and in some instances, third party guarantees or highly liquid
collateral (e.g., time deposits). Commercial loan pricing is generally at a
rate tied to the prime rate (as quoted in the Wall Street Journal) or the
Bank's reference rate.
CNB's Venture Lending Division works with a variety of technology
companies, ranging from multimedia, software and telecommunications providers to
biotechnology and medical advice firms. Venture Lending provides innovative
financing and other financial services tailored to the needs of startup and
growth-stage companies.
While the commercial loan portfolio of CNB is not concentrated in any
one industry, CNB's service area has a concentration of technology companies,
and accordingly, the ability of any of CNB's borrowers to repay loans may be
affected by the performance of this sector of the economy.
CNB's residential real estate construction loan activity has focused
on providing short-term (less than one year maturity) loans to local
individuals, partnerships and corporations in the local residential real estate
industry for the construction of single family residences. During 1992 through
1993, CNB concentrated its construction loan activity in the market for owner-
occupied custom residences. During 1994, real estate values began to
stabilize and CNB began to cautiously enter the construction loan market for
small townhouse and single family home projects. During 1995, CNB continued to
expand its real estate construction portfolio with the help of the improving
real estate market in northern California, although there can be no assurance
that this trend will continue.
Residential real estate construction loans are typically secured by
first deeds of trust and require guarantees of the borrower. The economic
viability of the project and the borrower's credit-worthiness are primary
considerations in the loan underwriting decision. Generally, these loans
provide an attractive yield, but may carry a higher than normal risk of loss or
delinquency, particularly if general real estate values decline or the loan
underwriting process is based upon inaccurate appraisals. CNB utilizes
independent local appraisers and conservative loan-to-value ratios (e.g. loans
generally not exceeding 65% to 75% of the appraised value of the property). CNB
monitors projects during the construction phase through regular construction
inspections and a disbursement program tied to the percentage of completion of
each project.
CNB's consumer loan portfolio is divided between installment loans for
the purchase of such items as automobiles and aircraft, and home improvement
loans and equity lines of credit which are often secured by residential real
estate. Installment loans tend to be fixed rate and longer-term (one to five
year maturity), while the equity line type loans are generally floating rate,
and are reviewed for renewal on an annual basis. CNB also has a minimal
portfolio of credit card loans, issued as an additional service to its clients.
LOAN ADMINISTRATION
The loan policy of CNB is approved each year by its Board of Directors
and is managed through periodic reviews of such policies in relation to current
economic activity and the degree of risk (both credit and interest rate) in the
current portfolio. The Directors' Loan Committee oversees the lending
activities of the Bank. This committee consists of three outside directors, the
Chairman/Chief Executive Officer, the Executive Vice President-Senior Loan
Officer, Senior Vice President-Venture Lending Division Manager, Senior Vice
President-Commercial Lending and the Senior Vice President-Chief Credit
Officer. The officers in this group make up the Officers' Loan Committee.
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Sole lending authority is granted to officers on a limited basis.
Loan requests exceeding individual officer approval limits are submitted to the
Officers' Loan Committee, and those which exceed its limit are submitted to the
Directors' Loan Committee for final approval. Both of these committees meet on
a regular basis in order to provide timely responses to the Bank's clients.
CNB's credit administration function includes, in addition to internal
reviews, the regular use of an outside loan review firm to review the quality
of the loan portfolio. CNB has an internal asset review committee (IARC) that
meets monthly to review delinquencies, non-performing assets, classified assets
and other pertinent information for the purpose of evaluating credit risk within
CNB's loan portfolio and to recommend general reserve percentages and specific
reserve allocations. The IARC reports to the Board of Directors on a quarterly
basis.
TRUST DEPARTMENT
CNB's Trust Department commenced operations in July 1988 and in 1995,
CNB renewed its focus on the expansion of its trust operations. The Trust
Department offers a full range of fee-based trust services directly to its
clients and administers several types of retirement plans, including corporate
pension plans, 401(k) plans and individual retirement plans, with an emphasis on
the investment management, custodianship and trusteeship of such plans. In
addition, the Trust Department acts as executor, administrator, guardian and/or
trustee in the administration of the estates of individuals. Investment and
custodial services are provided for corporations, individuals and non-profit
organizations. Total assets under management by the Trust Department were
approximately $270 million at December 31, 1995 compared to $157 million at
December 31, 1994 and $118 million at December 31, 1993. The 72% increase in
trust assets is attributable to the addition of several new trust officers and
the new Executive Vice President-Senior Trust Officer. CNB anticipates this
rapid rise to continue in 1996 as we increase our presence in the Palo Alto
marketplace with a new office scheduled to open in the late spring of 1996.
There can be no assurances that the growth will continue at the rate experienced
in 1995.
MORTGAGE BANKING DIVISION
CNB opened a Mortgage Banking Division in July 1992. The purpose of
this division was to originate residential mortgage loans for sale on the
secondary market. The primary revenue of this division was from the premium
received on the sale of such mortgage loans and their related servicing rights.
CNB funded both loans which were originated directly by a mortgage banking
officer and loans purchased through a network of mortgage brokers. CNB was
selling both the loans and the related servicing rights through a correspondent.
During 1993, CNB was designated as an approved seller/servicer by the Federal
National Mortgage Association and the Federal Home Loan Corporation, known in
the industry as Fannie Mae and Freddie Mac, respectively. During 1994, the
increased upward pressure on interest rates caused mortgage refinancing and home
purchases to significantly decline. This required CNB in June 1994 to
restructure its mortgage operations and focus all of its efforts on the
wholesale mortgage market. This change reduced the operating costs within the
mortgage business unit; however, the operating results for the last half of 1994
did not return to acceptable levels of return on investment corresponding to the
risks involved. Based on these factors, CNB determined to close its mortgage
operations effective March 31, 1995. In connection with this action, CNB
incurred a $180,000 after tax charge related to this operation in the first
quarter of 1995.
COMPETITION
The banking business in CNB's service area is highly competitive, as
it is throughout California. Many of the major branch banking institutions in
California have one or more offices in CNB's service area. CNB competes in the
marketplace for deposits and loans, principally against these banks, other
independent community banks, savings and loan associations, credit unions and
other financial institutions.
The major advantages that larger branch institutions have over CNB are
their ability to provide wide ranging advertising programs; to allocate their
investment assets in areas of higher yields and demands; and, by virtue of their
greater total capitalization, to utilize substantially higher lending limits
than CNB. These banks can also offer certain services, such as international
banking, which are not offered directly by CNB. However, CNB is able to offer
most of these services
5
indirectly, through its correspondent institutions. Smaller independent banks,
including CNB, have found a market niche by providing specialized services, and
by targeting clients whose credit needs are below levels generally sought by the
major branch banks.
CNB defines its service area as the cities of Cupertino, San Jose,
Palo Alto, and the surrounding cities in Santa Clara County and San Mateo
County. To compete with the major financial institutions in its service area,
CNB relies upon customized services and direct personal contacts by its
officers, directors and staff. For clients whose loan demands exceed CNB's
legal lending limit, CNB seeks to arrange such loans on a participation basis
with other lenders, primarily other community banks in the San Francisco Bay
Area.
EFFECT OF GOVERNMENTAL POLICIES AND LEGISLATION
Banking is a business in which profitability depends primarily on
interest rate differentials. In general, the difference between the interest
rates paid by CNB on its deposits and its other borrowings and the interest
rates received by CNB on loans extended to its clients and on securities held in
its investment portfolio will be the principal factor affecting CNB's earnings.
The interest rates paid and received by CNB are sensitive to many factors which
are beyond CNB's control, including the influence of domestic and foreign
economic conditions. The earnings and growth of CNB and the Company will also
be affected not only by general economic conditions, including inflation,
recession and unemployment, but also by monetary and fiscal policies of the
United States and federal agencies, particularly the Board of Governors of the
Federal Reserve System (the "Federal Reserve Board"). The Federal Reserve Board
implements national monetary policy, such as seeking to curb inflation and/or
combat recession, by its open market operations in United States Government
securities, by its control of the discount rates applicable to borrowing by
banks from the Federal Reserve System and by its establishment of reserve
requirements for financial institutions subject to its regulation. The actions
of the Federal Reserve Board in these areas influence the growth of bank loans,
investments and deposits, and also affect the interest rates charged on loans
and paid on deposits. Changes in the financial services industry as a result of
such governmental policies and regulations have often contributed to increases
in the cost of funds of banks and other depository institutions and may continue
to affect such cost, and consequently the earnings of such institutions.
However, the degree, timing and full extent of the impact of the laws or of
possible changes to the laws on banking in general, and the business of the Bank
in particular, presently cannot be predicted.
SUPERVISION AND REGULATION
The following information is qualified in its entirety by reference to
the complete statutory and regulatory provisions that are summarized below,
which statutes and regulations are subject to change at any time. Several
initiatives to revise the powers and supervision of financial institutions have
been proposed and it is not possible to determine which, if any, of these
changes will be adopted.
The Bank Holding Company
The Company is a bank holding company registered under the Bank
Holding Company Act of 1956, as amended (the "BHCA"), and is subject to
supervision by the Federal Reserve Board. As a bank holding company, the
Company is required to file with the Federal Reserve Board an annual report and
such other additional information as the Federal Reserve Board may require
pursuant to the BHCA. The Federal Reserve Board may also make examinations of
the Company and CNB. Under the BHCA, bank holding companies may not (subject to
certain limited exceptions) directly or indirectly acquire the ownership or
control of substantially all of the assets or more than 5% of any class of
voting shares of any company, including a bank, without the prior written
approval of the Federal Reserve Board.
In addition, subject to certain exceptions, bank holding companies are
prohibited under the BHCA from engaging in non-banking activities. One
principal exception to this prohibition is for activities found by the Federal
Reserve Board to be so closely related to banking as to be properly incident
thereto. For each application to engage in non-banking activities, the Federal
Reserve Board is required to consider whether the performance of such activities
can reasonably be expected to produce benefits to the public such as greater
convenience, increased competition, or gains in efficiency, that
6
outweigh possible adverse effects, such as undue concentration of resources,
decreased or unfair competition, conflicts of interest, or unsound banking
practices.
Subsidiary banks of a bank holding company are subject to restrictions
imposed by the Federal Reserve Act on any extensions of credit to the bank
holding company or any of its subsidiaries, on investments in the stocks or
securities thereof, and on the taking of any such stock or securities as
collateral for loans to any borrowers. Furthermore, a bank holding company and
its subsidiaries are prohibited from engaging in certain tie-in arrangements in
connection with extensions of credit, the lease or sale of any property or the
furnishing of other banking services.
The Company is also a bank holding company within the meaning of
Section 3700 of the California Financial Code. As such, the Company and its
subsidiaries are subject to examination by, and may be required to file reports
with, the Superintendent of Banks of the State of California (the
"Superintendent").
Capital Adequacy of the Company
The Federal Reserve Board has adopted risk-based capital guidelines
for bank holding companies. Under these guidelines the minimum ratio of total
capital to risk-weighted assets (including certain off-balance-sheet activities)
is 8%. At least half of the total capital is to be composed of common
stockholders' equity, minority interests in the equity accounts of consolidated
subsidiaries and a limited amount of perpetual preferred stock, less disallowed
intangibles including goodwill ("Tier 1 Capital"). The remainder of a bank's
allowable capital may include subordinated debt, other preferred stock and a
limited amount of loan loss reserves ("Tier 2 Capital").
In addition, the Federal Reserve Board has established minimum
leverage ratio guidelines for bank holding companies. These guidelines provide
for a minimum Tier 1 Capital leverage ratio (Tier 1 Capital to total assets,
less goodwill) of 3% for bank holding companies that meet certain specified
criteria, including having the highest regulatory rating. All other bank
holding companies are generally required to maintain a minimum Tier 1 Capital
leverage ratio of 3% plus an additional 100 to 200 basis points. The guidelines
also provide that bank holding companies experiencing internal growth or making
acquisitions will be expected to maintain strong capital positions substantially
above the minimum supervisory levels without significant reliance on intangible
assets (i.e. goodwill, core deposit intangibles and purchased mortgage servicing
rights). Furthermore, the guidelines indicate that the Federal Reserve Board
will continue to consider a "tangible Tier 1 Capital leverage ratio" (deducting
all intangibles) in evaluating proposals for expansion or new activities.
At December 31, 1995, the Company and CNB had total capital and
leverage capital ratios above the minimums required by the Federal Reserve
Board.
CNB
CNB, as a national banking association, is subject to the National
Bank Act and to primary supervision, examination and regulation by the
Comptroller of the Currency (the "Comptroller"). The Comptroller regulates the
number and locations of branch offices of a national bank. CNB is also a member
of the Federal Reserve System and is subject to applicable provisions of the
Federal Reserve Act and regulations issued pursuant thereto. Each depositor's
accounts with CNB are insured by the Bank Insurance Fund, which is managed by
the FDIC, to the maximum aggregate amount permitted by law, which is currently
$100,000 for all insured deposits of the depositor. For this protection, CNB
pays a semi-annual assessment and is subject to the rules and regulations of the
FDIC pertaining to deposit insurance and other matters. The Federal Reserve
Board requires banks to maintain non-interest bearing reserves against certain
of their transactional accounts (primarily deposit accounts that may be accessed
by writing checks) and non-personal time deposits.
As a creditor and a financial institution, CNB is subject to certain
regulations promulgated by the Federal Reserve Board including, without
limitation, Regulation B (Equal Credit Opportunity Act), Regulation D
(Reserves), Regulation E (Electronic Funds Transfers Act) and Regulation F
(interbank liabilities), Regulation Z (Truth in Lending
7
Act), Regulation CC (Expedited Funds Availability Act), and Regulation DD (Truth
in Savings Act). As a creditor on loans secured by real property and as an owner
of real property, CNB may be subject to potential liability under various
statutes and regulations applicable to property owners including statutes and
regulations relating to the environmental condition of the property. CNB is also
subject to applicable provisions of California law, insofar as they do not
conflict with or are not preempted by federal banking law. California law
exempts banks from the usury laws.
The supervision, regulation and examination of CNB by the bank
regulatory agencies are generally intended to protect depositors and are not
intended to protect the Company's shareholders.
Interstate Banking and Branching
On September 29, 1994, the Reigle/Neal Interstate Banking and
Branching Efficiency Act of 1994 (the "Interstate Act") was signed into law.
The Interstate Act effectively permits nationwide banking. The Interstate Act
provides that one year after enactment, adequately capitalized and adequately
managed bank holding companies may acquire banks in any state, even in those
jurisdictions that currently bar acquisitions by out-of-state institutions,
subject to deposit concentration limits. The deposit concentration limits
provide that regulatory approval by the Federal Reserve Board may not be granted
for a proposed interstate acquisition if, after the acquisition, the acquirer on
a consolidated basis would control more than 10% of the total deposits
nationwide or would control more than 30% of deposits in the state where the
acquiring institution is located. The deposit concentration state limit does
not apply for initial acquisitions in a state and in every case, may be waived
by state regulatory authority. Interstate acquisitions are subject to
compliance with the Community Reinvestment Act ("CRA"). States are permitted to
impose age requirements not to exceed five years on target banks for interstate
acquisitions. States are not allowed to opt-out of interstate banking.
Branching between states may be accomplished either by merging
separate banks located in different states into one legal entity, or by
establishing de novo branches in another state. Consolidation of banks is not
permitted until June 1, 1997, provided that the state has not passed legislation
"opting-out" of interstate branching. If a state opts-out prior to June 1,
1997, then banks located in that state may not participate in interstate
branching. A state may opt-in to interstate branching by bank consolidation or
by de novo branching by passing appropriate legislation earlier than June 1,
1997. Interstate branching is also subject to a 30% statewide deposit
concentration limit on a consolidated basis, and a 10% nationwide deposit
concentration limit. The laws of the host state regarding community
reinvestment, fair lending, consumer protection (including usury limits) and the
establishment of branches shall apply to the interstate branches.
De novo branching by an out-of-state bank is not permitted unless the
host state expressly permits de novo branching by banks from out-of-state. The
establishment of an initial de novo branch in a state is subject to the same
conditions as apply to the initial acquisition of a bank in the host state other
than deposit concentration limits.
Effective one year after enactment, the Interstate Act permits bank
subsidiaries of a bank holding company to act as agents for affiliated
depository institutions in receiving deposits, renewing time deposits, closing
loans, servicing loans and receiving payments on loans and other obligations. A
bank acting as an agent for an affiliate shall not be considered a branch of the
affiliate. Any agency relationship between affiliates must be on terms that are
consistent with safe and sound banking practices. The authority for an agency
relationship for receiving deposits includes the taking of deposits for an
existing account, but is not meant to include the opening or origination of new
deposit accounts. Subject to certain conditions, insured savings associations
which were affiliated with banks as of June 1, 1994, may act as agents for such
banks. An affiliate bank or savings association may not conduct any activity as
an agent which such institution is prohibited from conducting as a principal.
If an interstate bank decides to close a branch located in a low or
moderate income area, it must comply with additional branch closing notice
requirements. The appropriate regulatory agency is authorized to consult with
community organizations to explore options to maintain banking services in the
affected community where the branch is to be closed.
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To ensure that interstate branching does not result in taking deposits
without regard to a community's credit needs, the regulatory agencies are
directed to implement regulations prohibiting interstate branches from being
used as "deposit production offices". The regulations to implement its
provisions are due by June 1, 1997. The regulations must include a provision to
the effect that if loans made by an interstate branch are less than fifty
percent of the average of all depository institutions in the state, then the
regulator must review the loan portfolio of the branch. If the regulator
determines that the branch is not meeting the credit needs of the community, it
has the authority to close the branch and to prohibit the bank from opening new
branches in that state.
Effective January 1, 1991, California adopted legislation permitting
any out-of-state bank holding company to acquire an existing California bank if
its state of principal business provides reciprocal rights to California bank
holding companies. The Superintendent has determined that substantial
reciprocity exists between California and a variety of states including Arizona,
Oregon, Washington, and New York. Although these changes have had the impact of
increasing competition among banks and between banks and other financial service
providers, the long-term effects of this increased competition on the Bank and
on the competition which may arise as a result of the Interstate Act or other
regulatory changes, cannot be determined at this time.
Capital Adequacy of the Bank
In 1989, the Federal Reserve Board, along with the Comptroller and the
FDIC, established an interagency risk-based capital framework that establishes
uniform risk-based capital guidelines for certain banking organizations in the
United States. Under these guidelines, both assets reported on the balance
sheet and certain off-balance sheet items are assigned to certain risk
categories. Each category has an assigned risk weight. Capital ratios are then
calculated by dividing the capital by a weighted (according to risk) sum of the
assets and off-balance sheet items.
On February 28, 1991, the FDIC adopted minimum "leverage ratio"
standards for certain banking organizations. The leverage ratio is a ratio of
Tier 1 capital to quarterly average total assets. The minimum required leverage
ratio is 3.0% for banks that meet certain specified criteria, including having
the highest regulatory rating. All other banks are generally required to
maintain a leverage ratio of between 4.0% and 5.0% Tier 1 capital.
At December 31, 1995, CNB had capital ratios, both risk-adjusted and
leverage, which placed it in the "well capitalized" category. For an analysis
of the capital ratios of CNB as of December 31, 1995, see "Management's
Discussion and Analysis of Financial Conditions and Results of Operations -
Capital Resources" in the 1995 Annual Report to Shareholders, which is
incorporated herein by reference. The Company does not presently expect that
compliance with regulatory capital guidelines will have a material adverse
effect on the business of the Company or CNB. The Company anticipates that if
significant asset growth continues in the future, such growth may necessitate
the addition of capital to comply with regulatory guidelines.
Financial Institutions Reform, Recovery and Enforcement Act
The Financial Institutions Reform, Recovery and Enforcement Act of
1989 ("FIRREA") mandated changes that continue to affect the financial
institutions industry. FIRREA substantially revised the regulatory structure of
the banking, savings and financial services industries. Many of these changes
directly affect CNB and the Company. Deposits at commercial banks such as CNB
are now insured by the Bank Insurance Fund ("BIF") of the FDIC.
FIRREA requires the banking regulatory agencies to make written
evaluations after examining a depository institution for compliance with the
Community Reinvestment Act ("CRA"). The CRA evaluations now include a public
section, including the CRA rating agency assigned to CNB, and a confidential
section, which is not released to either the public or the institution, except
under limited circumstances. The regulatory guidelines now require each
institution to place the written evaluation in its CRA public file at its head
office and at one designated office in each local community. FIRREA also revised
the rating system for CRA compliance.
9
FIRREA mandated appraisals by state-certified or state-licensed
appraisers for loans made by financial institutions over certain amounts.
Effective December 31, 1992, an appraisal by a state-certified appraiser is
required for the following types of bank loans secured by real estate: (1) any
real estate loan transaction having a value of $1 million or more, or (2) any
non-residential real estate transaction or complex residential real estate
transaction in the amount of $250,000 or more. In addition, an appraisal by a
state-licensed appraiser is required for any real estate transaction having a
value of more than $100,000. The State of California has established a program
for the licenser and certification of real estate appraisers in order to meet
the requirements of FIRREA.
FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991
On December 19, 1991, the Federal Deposit Insurance Corporation
Improvement Act of 1991 ("FDICIA") was signed into law. Among other things,
FDICIA recapitalized the BIF, implemented deposit insurance reform, and imposed
new supervisory standards requiring annual examinations, independent audits,
uniform accounting and management standards and prompt corrective action for
problem institutions. As a result of FDICIA, depository institutions and their
affiliates are subject to federal standards which govern asset growth, interest
rate exposure, executive compensation, and many other areas of depository
institution operations. Only the most highly capitalized and well-managed
institutions are allowed to expand their operations and activities.
Undercapitalized institutions are subject to activity limitations and other
restrictions.
BIF Recapitalization. FDICIA provides increased funding for the BIF,
primarily by increasing the authority of the FDIC to borrow from the U.S.
Treasury Department. A significant portion of any such borrowing will be repaid
by insurance premiums assessed on BIF members, including CNB, sufficient to
repay any borrowed funds within 15 years and to provide BIF reserves of $1.25
for each $100 of insured deposits. FDICIA also provides authority for special
assessments against insured deposits.
Risk Based Deposit Insurance Rates. On January 1, 1994, a permanent
risk-based deposit premium assessment system became effective under which each
depository institution is placed in one of nine assessment categories based on
certain capital and supervisory measures. The assessment rates under the system
at that time ranged from 0.25 percent to 0.31 percent of domestic deposits
depending on the assessment category into which an insured bank is placed. Once
the BIF reached reserves equal to $1.25 for each $100 of insured deposits the
assessment ratio would decline. Effective July 1995, the BIF attained its level
of required reserves and the assessment ratios under the system were adjusted to
a range of 0.0 percent (a minimum of $500 per quarter is assessed, however) to
0.27 percent.
Brokered Deposits. Under FDIC regulations governing the receipt of
brokered deposits, a bank cannot accept brokered deposits (which term is defined
to mean deposits with an interest rate which significantly exceeds prevailing
rates in its market) unless (i) it is well capitalized or (ii) it is adequately
capitalized and has received a waiver from the FDIC. Except under certain
conditions, a bank that cannot accept brokered deposits also cannot offer "pass-
through" insurance on certain employee benefit accounts. CNB is considered to
be well capitalized for purposes of this regulation and in 1994 began accepting
limited amounts of brokered deposits to help manage its liquidity position.
Prompt Corrective Regulatory Action. FDICIA categorizes banking
institutions as well-capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized and critically undercapitalized. A bank is
subject to corrective action if it is not adequately capitalized. Significantly
and critically undercapitalized banks are subject to extensive federal
regulatory control, including closure. A bank's capital tier depends upon where
its capital levels are in relation to various relevant capital measures, which
include a risk-based capital measure and a leverage capital measure, and upon
certain other factors. The federal banking authorities adopted regulations
effective December 19, 1992, which define the capital measures a bank must meet
in order to be considered well capitalized as a ratio of total capital to risk-
weighted assets of not less than 10.0%, a ratio of Tier 1 capital to risk-
weighted assets of not less than 6.0% and a leverage ratio of Tier 1 capital to
average quarterly assets of not less than 5.0%. A bank will be considered
adequately capitalized if it has a ratio of total capital to risk-weighted
assets of not less than 8.0%, a ratio of Tier 1 capital to risk-weighted assets
of not less than 4.0%, and a leverage ratio of Tier 1 capital to average
quarterly assets of not less than 4.0%. The capital levels for the
undercapitalized category are defined as any level under 8.0% for the total
risk-based
10
capital ratio, under 4.0% for the Tier 1 risk-based capital ratio, or under 4.0%
for the Tier 1 leverage ratio. A bank will be considered significantly
undercapitalized if it has a ratio of total capital to risk-weighted assets that
is less than 6.0%, a ratio of Tier 1 capital to risk-weighted assets that is
less than 3.0%, or a Tier 1 leverage ratio that is less than 3.0%. A bank will
be considered critically undercapitalized if it has a ratio of tangible equity
to total assets that is equal to or less than 2.0%. In addition to FDICIA's
capital requirements, a financial institution may be reclassified and subject to
corrective action if it receives a less than satisfactory rating in its most
recent examination for its assets, management, earnings or liquidity. The
Company and CNB were considered "well capitalized" at December 31, 1995.
FDICIA also requires an insured institution which does not meet any
one of the statutory or regulatory capital requirements applicable to it to
submit a capital restoration plan for improving its capital. In addition,
FDICIA prohibits an insured institution from making a capital distribution if it
fails to meet any capital requirements. FDICIA also contains a number of
consumer banking provisions, including disclosure requirements and substantive
contractual limitations with respect to deposit accounts, and places
restrictions on a bank's dealings with "large customers" if a principal officer
or director of the "large customer" is a member of the bank's audit committee.
Real Estate Lending. As required by FDICIA, on December 19, 1992, the
federal banking agencies adopted uniform regulations prescribing standards for
real estate lending effective March 19, 1993. The uniform rules require
depository institutions to adopt and maintain comprehensive written real estate
lending policies that are consistent with safe and sound banking practices, as
well as establish loan-to-value limitations on real estate lending by insured
depository institutions. The loan-to-value limits do not apply to loans
guaranteed by the U.S. Government or backed by the full faith and credit of a
state government; loans facilitating the sale of real estate acquired by the
lending institution in the ordinary course of collecting a debt previously
contracted; loans where real estate is taken as additional collateral solely
through an abundance of caution by the lender; loans renewed, refinanced, or
restructured by the original lender to the same borrower, without the
advancement of new funds; or loans originated prior to the effective date of the
regulation. The new regulations also allow lending institutions to make a
limited amount of loans that do not conform to the regulations' loan-to-value
limitations. CNB has amended its real estate lending policies to comply with
this legislation; such amendments are not expected to adversely affect the
Bank's operations or profitability.
Standards for Safety and Soundness. In September of 1992, the FDIC
proposed regulations to require management to establish and maintain an internal
control structure and procedures to ensure compliance with laws and regulations
concerning bank safety and soundness on matters such as loan underwriting and
documentation, asset quality, earnings, internal rate risk exposure and
compensation and other employee benefits. The proposals, among other things,
establish the maximum ratio of classified assets to total capital at 1.0 and the
minimum level of earnings sufficient to absorb losses without impairing capital.
The proposals provide that a bank's earnings are sufficient to absorb losses
without impairing capital if the bank is in compliance with minimum capital
requirements and the bank would, if its net income or loss over the last four
quarters continued over the next four quarters, remain in compliance with
minimum capital requirements. Any institution which failed to comply with these
standards would be required to submit a compliance plan. The failure to submit
a plan or to comply with an approved plan would subject the institution to
further enforcement action. Finally, independent auditors would be required to
attest to or report separately on assertions in management's report, by using
audit procedures agreed upon by the FDIC for determining the extent of
compliance with laws and regulations concerning bank safety and soundness. In
anticipation of the adoption by the FDIC of the proposed regulations, CNB has
taken steps to document and establish additional internal control structures and
procedures, as necessary, to ensure compliance with new requirements imposed by
FDICIA and the regulations thereunder concerning CNB's safety and soundness.
CNB's audit committee is composed entirely of outside directors.
11
PAYMENT OF DIVIDENDS
There are statutory and regulatory requirements applicable to the
payment of dividends by CNB to the Company and by the Company to its
shareholders.
By the Company. The Company began paying cash dividends in December
1994. The Company anticipates continuing to pay cash dividends on a semi-annual
basis to the shareholders of the Company, when and as declared by its Board of
Directors, out of funds legally available therefor, subject to the restrictions
set forth in the California General Corporation Law (the "Corporation Law").
The amount of the annual dividend is anticipated to generally range between 10%
to 25% of estimated annual earnings. 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 the following
two generally stated conditions: (i) the corporation's assets equal at least
1.25 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 interest expense for the two preceding fiscal years
was less than the average of the corporation's interest expense for such fiscal
years, the corporation's current assets must equal at least 1.25 times it
current liabilities. The primary source of funds for payment of dividends by
the Company would be obtained from dividends received from CNB.
By CNB. The board of directors of a national bank may declare the
payment of dividends from funds legally available therefore, depending upon the
earnings, financial condition and cash needs of the bank and general business
conditions. A national bank may not pay dividends from its capital. All
dividends must be paid out of net profits then on hand, after deducting losses
and bad debts. A national bank is further restricted from declaring a dividend
on its shares of common stock until its surplus fund equals the amount of
capital stock, or, if the surplus fund does not equal the amount of capital
stock, until one-tenth of the bank's net profits of the preceding half year in
the case of quarterly or semiannual dividends, or the preceding two consecutive
half-year periods in the case of an annual dividend, are transferred to the
surplus fund. Furthermore, if the total of all dividends declared by a bank in
any calendar year would exceed the total of its retained net profits of that
year combined with its net profits of the two preceding years, less any required
transfers to surplus or a fund for the retirement of any preferred stock, then
the approval of the Comptroller is required for the payment of any dividends.
Guidelines of the Comptroller set forth factors which are to be
considered by a national bank in determining the payment of dividends. A
national bank, in assessing the payment of dividends, is to evaluate the bank's
capital position, its maintenance of an adequate allowance for loan and lease
losses, and the need to revise or develop a comprehensive capital plan, complete
with financial projections, budgets and dividend guidelines. The Comptroller
has broad authority to prohibit a national bank from engaging in banking
practices which it considers to be unsafe and unsound. It is possible,
depending upon the financial condition of the national bank in question and
other factors, that the Comptroller may assert that the payment of dividends or
other payments by a bank is considered an unsafe or unsound banking practice
and, therefore, direct the bank to implement corrective action to address such a
practice. Accordingly, the future payment of cash dividends by CNB to the
Company will not only depend upon CNB's earnings during any fiscal period, but
also upon the assessment of CNB's Board of Directors of the capital requirements
of CNB and other factors, including dividend guidelines and the maintenance of
an adequate allowance for loan and lease losses.
Policy Statement on Allowance for Loan Losses
In 1993, the Federal banking agencies, through the Federal Financial
Institutions Examination Council, issued a uniform policy statement on the
adequacy of the reserves for loan and lease losses. The policy statement
establishes a benchmark equal to the sum of (a) 100% of assets classified as
uncollectible, (b) 50% of assets classified as doubtful, (c) 15% of assets
classified substandard and (d) estimated credit losses on other assets over the
upcoming 12 months. Federal bank examiners will measure the reasonableness of a
banks' methodology for computing its reserves against this benchmark which is
designed to be neither a floor nor a safe harbor.
12
Community Reinvestment Act and Fair Lending Developments
The CRA requires banks, as well as other lenders, to identify the
communities served by the bank's offices and to identify the types of credit the
bank is prepared to extend within such communities. The CRA also requires an
assessment of the performance of the bank in meeting the credit needs of its
community and to take such assessment into consideration in reviewing
applications for mergers, acquisitions, and other transactions. An
unsatisfactory CRA rating may be the basis for denying such an application. CNB
is subject to certain fair lending requirements and reporting obligations
involving home mortgage lending operations and CRA activities. In addition to
substantive penalties and corrective measures that may be required for a
violation of certain fair lending laws, the Federal banking agencies may take
compliance with such laws and CRA into account when regulating and supervising
other activities.
On March 8, 1994, the Federal Interagency Task Force on Fair Lending
issued a policy statement, which became effective April 15, 1994, on
discrimination in lending. The policy statement describes the three methods
that Federal agencies will use to prove discrimination: overt evidence of
discrimination, evidence of disparate treatment, and evidence of disparate
impact.
In connection with its assessment of CRA performance, the regulators
assign a rating of "outstanding," "satisfactory," needs to improve," or
"substantial noncompliance." The OCC conducts examinations of a bank's CRA
performance as part of its regular examination process.
PENDING LEGISLATION AND REGULATIONS
Certain legislative and regulatory proposals which could affect the
Company, CNB and the banking business in general are pending, or may be
introduced, before the U.S. Congress, the California State Legislature, and
Federal and State government agencies. The U.S. Congress is considering
numerous bills that could reform the banking laws substantially, particularly if
the current legal barriers between commercial banking and investment banking are
eliminated, as is now being proposed.
It is not known to what extent, if any, these proposals will be
enacted or what effect such legislation would have on the structure, regulation,
or competitive relationship of financial institutions. It is likely, however,
that many of these proposals would subject the Company and CNB 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. FDICIA requires the regulatory agencies
to adopt numerous rules, regulations, standards and guidelines over the next
several years. Some of these regulations have been proposed. With respect to
others, the agencies have solicited comments from the industry on the form the
regulations should take. It cannot be predicted whether or in what form any
such legislation or regulations will be enacted or the effect that such
legislation may have on the business of the Company and CNB.
SUBORDINATED DEBENTURE
In 1995, the Company consummated a private offering of $3.0 million in
11.5% subordinated notes. The notes, which will mature on September 15, 2005,
were offered to the Board of Directors, bank officers and other accredited
investors within the meaning of Rule 501 under the Securities Act of 1933, as
amended. The debentures are redeemable by the Company after September 30, 1998
at a premium ranging from 0% to 5% of the premium redeemed. In an identical
transaction, CNB issued subordinated debt to the Company in an equal amount.
The notes qualify as Tier 2 capital of CNB.
13
COMPETITORS
Commercial banks, in general, have historically been less restricted
in the types of loans they may lawfully make than have been non-bank financial
institutions. However, the Depository Institutions Deregulation and Monetary
Control Act, enacted in 1980, has increased the ability of non-banking
institutions to compete with banks in lending activities. Federally chartered
savings and loan associations may now invest up to 10% of their assets in
commercial corporate, business or agricultural loans, and may offer credit card
services. Federal credit unions have previously been authorized by law to offer
certain types of consumer loans. Additionally, since December 31, 1980, banks
and other financial institutions, nationwide, have been permitted to offer
check-like services, such as negotiable order of withdrawal (NOW) accounts, on
which interest or dividends may be paid under certain circumstances.
SELECTED STATISTICAL INFORMATION
The following tables present selected financial information regarding
the Bank's loans and deposits. This information should be read in conjunction
with the company's Consolidated Financial Statements and the notes thereto and
Management's Discussion and Analysis of Financial condition and Results of
Operations included in the Company's 1995 Annual Report to Shareholders, which
has been incorporated herein by reference.
TABLE I - LOAN MATURITIES - The following table details the maturity structure
of the Bank's Commercial, SBA, Venture Lending and Real Estate Construction and
Land loan portfolio at December 31, 1995.
(Dollars in Thousands) Commercial, Real estate
SBA and construction and
Loan due in: Venture Lending Land
- -------------------------------------------------------------------------------
One year or less:
Floating Rate $54,151 $23,480
Fixed Rate 1,435 409
One to five years:
Floating Rate 27,293 --
Fixed Rate 5,172 --
After five years:
Floating Rate -- --
Fixed Rate 501 --
------- -------
Total $88,552 $23,889
======= =======
TABLE II - COMPOSITION OF LOANS - The following table details the composition of
CNB's gross loan portfolio at:
December 31
-----------------------------------------------------------------------------------------------
1995 1994 1993 1992 1991
-----------------------------------------------------------------------------------------------
(Dollars in millions) $ % $ % $ % $ % $ %
-----------------------------------------------------------------------------------------------
Commercial 88.6 54.0 81.7 58.6 77.7 57.7 73.5 56.9 60.6 57.8
Real estate construction
and Land 23.9 14.5 18.1 13.0 19.1 14.2 23.0 17.8 17.0 16.3
Real estate term 23.0 14.0 13.1 9.4 12.1 9.0 11.2 8.7 9.6 9.2
Consumer 28.7 17.5 21.1 15.1 18.2 13.5 16.6 12.8 17.5 16.7
-----------------------------------------------------------------------------------------------
Total 164.2 100.0 134.0 96.1 127.1 94.4 124.3 96.2 104.7 100.0
-----------------------------------------------------------------------------------------------
Loans Held For Sale -- -- 5.4 3.9 7.6 5.6 4.9 3.8 -- --
-----------------------------------------------------------------------------------------------
Total Loans $164.2 100.0 $139.4 100.0 $134.7 100.0 $129.2 100.0 $104.7 100.0
===============================================================================================
14
TABLE III - NON-PERFORMING LOANS -The following table details CNB's
non-performing loan portfolio for the last five years.
December 31
-------------------------------------------------------
(Dollars in thousands) 1995 1994 1993 1992 1991
------------------------------------------------------
Non-accrual $2,513 $3,244 $ 997 $513 $738
Accruing loans past due 830 1,371 1,903 -- 55
90 days or more
Restructured loans -- -- -- -- --
------------------------------------------------------
Total $3,343 $4,615 $2,900 $513 $793
Percent of total loans 2.0% 3.3% 2.2% .4% .8%
------------------------------------------------------
TABLE IV - ALLOCATION OF ALLOWANCE FOR LOAN LOSSES - CNB's allocation of its
allowance for loan losses for the past five years is detailed as follows:
December 31
----------------------------------------------------------------------------------------------------------
(Dollars in thousands) 1995 1994 1993 1992 1991
----------------------------------------------------------------------------------------------------------
$ Percent to $ Percent to $ Percent to $ Percent to $ Percent to
total loans total loans total loans total loans total loans
----------------------------------------------------------------------------------------------------------
Amount of allowance
allocated to:
Commercial $1,057 0.65 $1,834 1.32 $1,496 1.11 $1,216 0.94 $1,018 0.97
Real estate
construction
and land 153 0.09 180 0.13 308 0.23 263 0.20 184 0.18
Real estate term 696 0.43 132 0.09 391 0.29 56 0.05 48 0.04
Consumer 273 0.17 273 0.19 10 0.01 190 0.14 217 0.20
Loans held for sale -- -- 14 0.01 27 0.02 23 0.02 -- --
Unallocated 504 0.30 485 0.35 15 0.01 -- -- 3 .01
----------------------------------------------------------------------------------------------------------
Total $2,683 1.64 $2,918 2.09 $2,247 1.67 $1,748 1.35 $1,470 1.40
==========================================================================================================
TABLE V - The following table summarizes the activity in CNB's allowance for
loan losses for the past five years:
December 31
-------------------------------------------------------
(Dollars in thousands) 1995 1994 1993 1992 1991
-------------------------------------------------------
Allowance for loan losses:
Balance at the beginning
of period $ 2,918 $ 2,247 $ 1,748 $1,470 $1,301
Charge Offs:
Commercial (973) (748) (1,069) (520) (23)
Real estate construction -- (123) -- (62) (188)
Real estate term -- -- -- -- --
Consumer installment (101) (141) (159) (145) (2)
-------------------------------------------------------
Total (1,074) (1,012) (1,228) (727) (213)
Recoveries:
Commercial 156 57 -- 4 --
Real estate construction -- -- -- 95 --
Real state term -- -- -- -- --
Consumer installment 2 6 48 4 --
-------------------------------------------------------
Total 158 63 48 103 --
Net charge-offs (916) (949) (1,180) (624) (213)
-------------------------------------------------------
Provision charged to income 681 1,620 1,679 902 382
-------------------------------------------------------
Balance at the end of period $ 2,683 $ 2,918 $ 2,247 $1,748 $1,470
=======================================================
15
Table VI - IMPAIRED LOANS
The following table details the carrying value of CNB's impaired loans, in
accordance with FASB 114, by type of loan as of December 31, 1995:
Net
Recorded Valuation Carrying
(Dollars in thousands) Amount Allowance Value
-----------------------------------
Commercial $ 851 $260 $ 591
Real Estate - Construction
and Land -- -- --
Real Estate - Term 1,662 249 1,413
-----------------------------------
Total $2,513 $509 $2,004
===================================
All the above impaired loans were measured based on the fair value of the
loan's collateral. The allowance for loan losses for all other loans, including
consumer loans which are considered to be small homogenous loans as defined by
FAS 114, is determined based on the methodology discussed in the Company's
Annual Report.
CNB considers a loan impaired when, based on current information and
events, it is probable that CNB will be unable to collect all amounts due
according to the contractual terms of the loan agreement. This policy is
generally consistent with CNB's nonaccrual policy. Loans which are over 90 days
contractually delinquent and loans which have developed inherent problems prior
to being 90 days delinquent are considered impaired. An insignificant delay or
shortfall in the amount of payments is not considered an event that, when
considered in isolation, would automatically cause a loan to be considered
impaired for purposes of FAS 114. Examples for insignificant delays or
shortfalls may include, depending on the specific facts and circumstances, those
that are associated with temporary stoppage in operations due to equipment
failure or a natural disaster, or due to tight cash flows during the off-peak
season of a business loan customer. CNB did not recognize interest on impaired
loans during the year ended December 31, 1995.
Table VII - MATURITIES OF CERTIFICATES OF DEPOSIT
The following table presents the maturities of CNB's certificates of deposit
over $100,000 as of December 31, 1995.
(Dollars in thousands)
- ----------------------
Three months or less $21,256
Three to six months 4,489
Six to twelve months 1,210
Over twelve months 149
-------
Total $27,104
=======
For information regarding certain required disclosures of the maturities of
investments, refer to Note 2 in the Company's 1995 Annual Report to Shareholders
which is incorporated herein by reference.
16
EMPLOYEES
The Company has no salaried employees, since all officers of the
Company are employees of CNB. At December 31, 1995, CNB had 109 full time
equivalent employees. Management believes that its employee relations are good
and that the benefits provided by CNB to its employees are competitive.
FORWARD-LOOKING STATEMENTS
Except for the historical information contained in this Annual Report
on Form 10-K, certain items herein constitute forward-looking statements,
including without limitation, certain matters discussed under Part I, Item 1,
"Business," under the headings "Market Area and Client Base," "Trust
Department," "Supervision and Regulation--Capital Adequacy of the Bank" and "--
Federal Deposit Insurance Corporation Improvement Act of 1991 --Risk Based
Deposit Insurance Rates," Part I, Item 3, "Legal Proceedings," and Part II, Item
7, "Management's Discussion and Analysis of Financial Condition and Results of
Operation" (incorporated herein by reference). The matters referred to in such
statements involve risks and uncertainties including, but not limited to, the
impact of economic conditions (both generally and more specifically in the
markets the Bank operates), the impact of competition for the Bank's Clients
from other providers of financial services, the impact of government legislation
and regulation (which changes from time to time and over which the Bank has no
control), and other risks detailed in this Report and in the Company's other
filings with the Securities and Exchange Commission.
ITEM 2. PROPERTIES
The Company leases, from an unaffiliated party, approximately 19,000
square feet of office space, consisting of a portion of the first and second
floors of a two-story building at the intersection of Stevens Creek Boulevard
and Torre Avenue in Cupertino, California. The lease commenced on October 1,
1992, and has a term of ten years, with two consecutive five-year renewal
options. The current minimum monthly rental payments are approximately $42,000,
and are subject to annual adjustments depending on the percentage increase in
the consumer price index over the prior period. The rent is further subject to
adjustment upon exercise of each renewal option, to an amount equal to the then
current market rental rate for similar properties. At December 31, 1994, the
Company subleased all 19,000 square feet of the leased premises to CNB for an
amount equivalent to the Company's expense related to such premises.
CNB has entered into a lease for 3,900 square feet of office space on
the ground floor of Sixty South Market Street, San Jose, CA, effective August 1,
1993. The lease has a term of five years, with an option to extend for an
additional five years. The monthly rent is approximately $5,200 and is subject
to annual adjustments. The rent is subject to adjustment upon exercise of the
renewal option to an amount equal to the then current market rental rate for
similar space.
Effective March 28, 1994, CNB extended its lease for 5,300 square feet
of office space at 3 Palo Alto Square in Palo Alto, CA, which currently
accommodates its Palo Alto regional banking office, and its Emerging Growth
Industries division. The term is for eight years, with a base rent of $11,125
per month, with scheduled annual increases. The Company has an option to extend
the lease for two additional five-year periods.
On July 13, 1995, CNB entered into an agreement to lease, upon
completion, approximately 6,000 square feet of a new building currently under
construction. The leased space is located at 400 Emerson Street, Palo Alto, CA.
This space will accommodate a new branch office, as well as, the new
headquarters for CNB's Trust Division. The twelve year lease will have a base
rent of $16,500 per month with a rental adjustment schedule which increases the
base rent every two years. The adjustment will be based on a consumer price
index but shall not be less than four percent over the two year period and not
greater than ten percent over the two year period. CNB anticipates occupancy
in late Spring, 1996.
The Company believes that its facilities are well maintained and
adequate to meet its current requirements.
17
ITEM 3. LEGAL PROCEEDINGS
On January 25, 1994, Sumitomo Bank ("Sumitomo") as trustee for the
California Dental Guild Real Estate Mortgage Fund II ("Fund II"), filed suit
against CNB in the Superior Court of the State of California, Santa Clara
County, alleging negligence by CNB and, by amendment of the complaint, one of
its officers, in connection with the administration of a trust account.
Sumitomo brought suit in its capacity as successor trustee for Fund II for
monetary damages of approximately $2.2 million.
In July 1995, CNB entered into an agreement with Sumitomo to settle
the litigation for approximately $1.8 million. The Company believes, based on
advice from counsel, that it is highly probable that insurance coverage for a
significant portion of this settlement is available under its director and
officer liability insurance policy and its professional liability insurance
policy, as well as the errors and omissions policy of the insurance agent which
sold the Company these policies. The Company's insurance company has denied the
Company's claim for coverage under these policies and the Company has initiated
litigation against the insurance company as well as the agent from whom the
Company obtained such policies. However due to the uncertainty associated with
such recovery, the Company has reflected the $1.8 million cost of the legal
settlement in its 1995 earnings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The information required by this Item is incorporated by reference to
the section entitled "Stock Activity" on page 22 of the Company's 1995 Annual
Report to Shareholders.
At December 31, 1995, there were approximately 402 holders of record of
the Company's Common Stock.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this Item is incorporated herein by
reference to the table entitled "Financial Highlights" on page 1 of the
Company's 1995 Annual Report to Shareholders.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The information required by this Item is incorporated herein by
reference to the section entitled "Management's Discussion and Analysis of
Financial Condition and Results of Operations" on pages 9 through 22 of the
Company's 1995 Annual Report to Shareholders.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item is incorporated herein by
reference to the Company's Consolidated Financial Statements and the notes
thereto, and the Independent Auditor's Report thereon, set forth on pages 23
through 41 of the Company's 1995 Annual Report to Shareholders.
18
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
The information required to be reported on this item has been
previously reported in a Form 8-K filed on October 20, 1994, which is
incorporated herein by reference.
PART III
Certain information required by Part III is omitted from this Report
in that the Company intends to file its definitive proxy statement pursuant to
Regulation 14A (the "Proxy Statement") not later than 120 days after the end of
the fiscal year covered by this Report, and certain information therein is
incorporated herein by reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item is incorporated herein by
reference to the information relating to the directors of the Company set forth
under the captions "Election of Directors" and "Compliance with Section 16(a) of
the Securities Exchange Act of 1934" in the Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated herein by
reference to the information relating to executive compensation set forth under
captions "Executive Compensation and Other Matters" in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated herein by
reference related to ownership of equity securities as set forth under the
caption "General Information - Stock Ownership of Certain Beneficial Owners and
Management" in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated herein by
reference to the information relating to certain relationships and related
transactions set forth under the caption "Compensation Committee Interlocks and
Insider Participation" in the Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this Report:
(1) Financial Statements.
The following Consolidated Financial Statements of Cupertino
National Bancorp and Subsidiary and Independent Accountants'
Report are contained in and incorporated by reference herein to
the Company's 1995 Annual Report to Shareholders:
Consolidated Balance Sheets - At December 31, 1995 and 1994
19
Consolidated Statements of Income - For the years ended December
31, 1995, 1994 and 1993.
Consolidated Statements of Shareholders' Equity -For the years
ended December 31, 1995, 1994 and 1993.
Consolidated Statements of Cash Flows - For the years ended
December 31, 1995, 1994 and 1993.
Notes to Consolidated Financial Statements.
Independent Accountants' Reports.
With the exception of the information incorporated by reference
to the Company's 1995 Annual Report to Shareholders in Parts I,
II and IV of this Form 10-K, the Company's 1995 Annual Report to
Shareholders is not to be deemed filed as part of this Report.
(2) Financial Statement Schedules.
All financial statement schedules are omitted because they are
not applicable or not required, or because the required
information is included in Management's Discussion and Analysis
of Financial Condition and Results of Operations or in the
Consolidated Financial Statements and Notes thereto contained in
the Company's 1995 Annual Report to Shareholders, which are
incorporated herein by reference.
(3) Exhibits.
The exhibits listed on the accompanying Exhibit Index are filed
as part of, or are incorporated by reference into, this Report.
Exhibit Nos. 10.2, 10.5, 10.7, 10.8, 10.9, 10.10, 101.11, 10.15,
10.13, 10.14 are management contracts or are compensatory plans
or arrangements covering executive officers or directors of the
Company.
(b) Reports on Form 8-K.
The Company filed the following reports on Form 8-K during the
fourth quarter of fiscal 1995:
Date of Report Items Reported
-------------- --------------
October 10, 1995 Pursuant to Item 5, the Company reported
entering into a form of Debenture Agreement
with certain of its Officers, Directors and
other accredited investors with the meaning
of Rule 501 under the Securities Act of
1933, as amended, dated September 27, 1995.
20
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.
CUPERTINO NATIONAL BANCORP
By: /s/ C. Donald Allen
--------------------------------
C. Donald Allen, Director and
Chief Executive Officer
Dated: March 29, 1996
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints C. Donald Allen and Steven C. Smith or
either of them, his or her true and lawful attorneys-in-fact and agents, with
full power of substitution and resubstitution, for him or her, and in his or her
name, place and stead, in any and all capacities to sign any and all amendments
to this Report on Form 10-K, and to file the same, with all exhibits thereto and
other documents in connection therewith, with the Securities and Exchanges
Commission, granting unto said attorneys-in-fact and agents, and each of them,
full power and authority to do and perform each and every act and thing
requisite and necessary to be done in connection therewith, as fully to all
intents and purposes as he or she might or could do in person, hereby ratifying
and confirming all that said attorneys-in-fact and agents, or either of them, or
their or his substitutes or substitute, may lawfully do or cause to be done by
virtue of hereof.
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 in the capacities and on the dates indicated.
Signature Title Date
- --------- ----- ----
/s/ C. Donald Allen Director and March 29, 1996
- ------------------------- Chief Executive Officer
C. Donald Allen (Principal Executive Officer)
/s/ Steven C. Smith Executive Vice President, March 29, 1996
- ------------------------- Chief Operating Officer
Steven C. Smith
/s/ Heidi Wulfe Senior Vice President March 29, 1996
- ------------------------- Chief Financial Officer
Heidi Wulfe (Principal Financial and
Accounting Officer)
/s/ David K. Chui Director March 29, 1996
- -------------------------
David K. Chui
/s/ Carl E. Cookson Director March 29, 1996
- -------------------------
Carl E. Cookson
21
Signature Title Date
- --------- ----- ----
/s/ Jerry R. Crowley Director March 29, 1996
- -------------------------
Jerry R. Crowley
/s/ Janet M. DeCarli Director March 29, 1996
- -------------------------
Janet M. DeCarli
/s/ John M. Gatto Director March 29, 1996
- ------------------------- Chairman of the Board
John M. Gatto
/s/ William H. Guengerich Director March 29, 1996
- -------------------------
William H. Guengerich
/s/ James E. Jackson Director March 29, 1996
- -------------------------
James E. Jackson
/s/ Rex D. Lindsay Director and March 29, 1996
- ------------------------- Vice Chairman of the Board
Rex D. Lindsay
/s/ Glen McLaughlin Director and March 29, 1996
- -------------------------
Glen McLaughlin
/s/ Norman Meltzer Director March 29, 1996
- -------------------------
Norman Meltzer
/s/ Dick J. Randall Director March 29, 1996
- -------------------------
Dick J. Randall
/s/ Dennis S. Whittaker Director March 29, 1996
- -------------------------
Dennis S. Whittaker
22
INDEX TO EXHIBITS
Sequentially
Number Exhibit Numbered Page
- ------ ------- -------------
3.1 Amended Articles of Incorporation of Cupertino
National Bancorp - filed as Exhibit 4.1 of
Registrant's Exhibits to Form S-8 Registration
Statement (No. 33-36057), as filed with the
Securities and Exchange Commission (the "Commission")
on July 25, 1990 and incorporated herein by
reference.
3.2 Bylaws of Cupertino National Bancorp--filed as Exhibit
of Registrant's Exhibits to Form S-8 Registration
Statement (No. 33-36057), as filed with the Commission
on July 25, 1990 and incorporated herein by reference.
4.1 Specimen Stock Certificate filed as Exhibit 4.1 of
Registrant's Exhibits to Form S-2 Registration Statement
(No. 33-30297), as filed with the Commission on August 2,
1989 and incorporated herein by reference.
4.2 Form of Subordinated Debentures filed as Exhibit 1 of
Registrant's Exhibits to Form 8-K as filed with the
Commission on October 25, 1995 and incorporated by
reference.
10.1 Lease - Banking Facility--filed as Exhibit 10.1 of
Registrant's Exhibits to Amendment No. 1 to Form S-18
Registration Statement (No. 2-94390), as filed with the
Commission on December 11, 1984 and incorporated herein
by reference.
10.2** 1985 Stock Option Plan, filed as Exhibit 10.2 of
Registrant's Exhibits to Form 10-K for the fiscal year
ended December 31, 1993, as filed with the Commission on
March 25, 1994 and incorporated herein by reference.
10.3 Form of incentive stock option agreement for use with 1985
Stock Option Plan filed--as Exhibit 4.4 of Registrant's
Exhibits to Form S-8 Registration Statement (No. 33-36057),
as filed with the Commission on July 25, 1990 and
incorporated herein by reference.
10.4 Form of non-statutory stock option agreement or use with
1985 Stock Option Plan--incorporated herein by reference
and filed as Exhibit 4.5 of Registrant's Exhibits to
Form S-8 Registration Statement (No. 33-36057), as filed
with the Commission on July 25, 1990.
10.5** 1986 Non-Qualified Stock Option Plan--filed as Exhibit 10.3
of Registrant's Exhibits to Form 10-K for the fiscal year
ended December 31, 1986, as filed with the Commission on
March 31, 1987 and incorporated herein by reference.
10.6 Form of non-qualified stock option agreement for use with
1986 Non-Qualified Stock Option Plan--filed as Exhibit 10.7
23
Sequentially
Number Exhibit Numbered Page
- ------ ------- -------------
Form 10-K for the fiscal year ended December 31, 1986,
as filed with the Commission on March 31, 1987 and
incorporated herein by reference.
10.7** 1989 Non-Qualified Stock Option Plan--filed as Exhibit
10.11 of Registrant's Form S-2 registration statement
(No. 33-30297), filed with the Commission on August 2,
1989 and incorporated herein by reference.
10.8** Employment Agreement with C. Donald Allen dated July 1,
1990--filed as Exhibit 10.9 of Registrant's Exhibits to
Form 10-K for the fiscal year ended December 31, 1990,
as filed with the Commission on March 30, 1991 and
incorporated herein by reference.
10.9** Cupertino National Bancorp Stock Purchase Plan--filed as
Exhibit 10.10 of Registrant's Exhibits to Form 10-K for
the fiscal year ended December 31, 1990, as filed with
the Commission on March 30, 1991, and incorporated herein
by reference.
10.10** Salary Continuation Agreement with C. Donald Allen dated
August 1, 1993, filed as Exhibit 10.10 of Registrant's
Exhibits to Form 10-K for the fiscal year ended December
31, 1993, as filed with the Commission on March 25, 1994,
and incorporated herein by reference.
10.11** Salary Continuation Agreement with Scott Montgomery dated
August 1, 1993, filed as Exhibit 10.11 of Registrants
Exhibits to Form 10-K for the fiscal year ended December
31, 1993, as filed with the Commission on September 7,
1994, and incorporated herein by reference.
10.12 Litigation Settlement filed as Exhibit 10.12 of
Registrant's Exhibits to Form 10-Q as filed with the
Commission for quarter end September 30, 1995, and
incorporated herein by reference.
10.13 Emerson Lease filed as Exhibit 10.13 of Registrant's
Exhibits to Form 10-Q as filed with the Commission for
quarter end September 30, 1995, and incorporated herein
by reference.
10.14 1995 Stock Option Plan as Exhibit 10.14 of Registrant's
Form S-8 registration statement filed with the Commission
on September 7, 1995 and incorporated herein by reference.
10.15** Cupertino National Bancorp 401(k) Profit Sharing Plan as
Exhibit 10.15 of Registrant's Form S-8 registration
statement filed with the Commission on September 7, 1995
and incorporated herein by reference.
10.16** Cupertino National Bancorp Employee Stock Purchase Plan as
Exhibit 10.16 of Registrant's Form S-8 registration
statement filed with the Commission on September 7, 1995
and incorporated herein by reference.
24
Sequentially
Number Exhibit Numbered Page
- ------ ------- -------------
10.17** Form of Salary Continuation Agreement with certain
executive officers.
13.1 1995 Annual Report to Shareholders (to be deemed filed
only to the extent required by the instructions to
exhibits for Reports on Form 10-K).
22.1 Subsidiaries of the Registrant--filed as Exhibit 22.1
of Registrant's Exhibits to Form 10-K for the fiscal
year ended December 31, 1985, as filed with the
Commission on March 31, 1986 and incorporated herein
by reference.
23.1 Independent Accountants' Consent - Coopers & Lybrand, L.L.P.
23.2 Independent Auditors' Consent - Deloitte & Touche, LLP
25.1 Power of Attorney. Reference is made to page 21 of this report.
27.0 Financial Data Schedule
* Previously filed.
** A management contract or compensatory plan or arrangement required to be
filed pursuant to Item 14(c).
25