SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2000 Commission File No. 0-10232
FIRST REGIONAL BANCORP
(Exact name of registrant as specified in its charter)
California 95-3582843
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
1801 Century Park East
Los Angeles, California 90067
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (310) 552-1776
Securities registered pursuant to Section 12(b) of the Act: 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
Aggregate market value of Common Stock held by non-affiliates as of
March 22, 2001: $9,954,126
Number of shares of Common Stock outstanding at March 22, 2001:
2,755,220.
Documents incorporated by reference and parts of Form 10-K into which
incorporated:
Portions of Proxy Statement for 2001 Annual Meeting of PART III
Shareholders (to be filed within 120 days of fiscal year
end)
Annual Report on Form 10-K for the Years Ended December 31, PART IV
1982, 1987, 1988, 1991, and 1993
Registration Statement on Form 10 as Filed with the PART IV
Commission in March, 1982
Registration Statement on Form S-14 Filed with the PART IV
Commission on December 2, 1981 (File Number 2-75140)
FORM 10-K
TABLE OF CONTENTS AND
CROSS REFERENCE SHEET
Page
in Incorporation
PART I 10-K by Reference
---- ------------
ITEM 1. Business...................................... 4
ITEM 2. Properties.................................... 53
ITEM 3. Legal Proceedings............................. 55
ITEM 4. Submission of Matters to a Vote of
Securities Holders............................ 55
PART II
ITEM 5. Market for Registrant's Common Stock
and Related Stockholder Matters............... 56
ITEM 6. Selected Financial Data....................... 58
ITEM 7. Management's Discussion and Analysis
of Financial Condition and Results
Of Operations................................. 60
ITEM 8. Financial Statements and
Supplementary Data............................ 68
ITEM 9. Disagreements on Accounting and
Financial Disclosure.......................... 68
PART III
ITEM 10. Directors and Executive Officers of 2000 Proxy
the Registrant................................ 69 Statement
ITEM 11. Executive Compensation......................... 69 2000 Proxy
Statement
ITEM 12. Security Ownership of Certain 2000 Proxy
Beneficial Owners and Management.............. 69 Statement
ITEM 13. Certain Relationships and Related 2000 Proxy
Transactions.................................. 69 Statement
2
PART IV
ITEM 14. Exhibits, Financial Statement
Schedules, and Reports on Form 8-K............ 70
SIGNATURES.................................................. 71
INDEX TO FINANCIAL STATEMENTS............................... 72
INDEX TO EXHIBITS........................................... 99
3
PART I
ITEM 1. BUSINESS
BUSINESS OF FIRST REGIONAL BANCORP
First Regional Bancorp (the Company) maintains its principal executive
offices at 1801 Century Park East, Los Angeles, California 90067. The Company
was incorporated in California as Great American Bancorp on February 18, 1981
for the purpose of becoming a bank holding company and acquiring all of the
outstanding common stock of First Regional Bank (the Bank), formerly Great
American Bank, a state-chartered bank headquartered in Los Angeles (Century
City), California. The reorganization of the Bank was accomplished on March 8,
1982, under the terms of a Plan of Reorganization and Merger Agreement dated
October 15, 1981, providing for the merger of a Company subsidiary with the
Bank, with the Bank being the surviving entity in the merger. As a result of the
Bank's reorganization, the Bank's outstanding shares were exchanged on a
one-for-one basis for shares of the Company's Common Stock, and the Company
became the sole shareholder of the Bank. Prior to acquiring the Bank, the
Company did not conduct any ongoing business activities. The Company's principal
asset is the stock of the Bank and the Company's primary function is to
coordinate the general policies and activities of the Bank, as well as to
consider from time to time, other legally available investment opportunities.
Both the Company and the Bank changed their names from Great American to First
Regional in 1987 as part of an agreement with another financial institution.
Certain matters discussed in this Annual Report on Form 10-K may
constitute forward-looking statements within the meaning of the Private
Securities Reform Act of 1995 (the "Reform Act") and as such may involve risks
and uncertainties. These forward-looking statements relate to, among other
things, expectations of the business environment in which the Company and the
Bank operate, projections of future performance, perceived opportunities in the
market, and statements regarding the Company's and/or the Bank's mission and
vision. The Company's and/or the Bank's actual results, performance, or
achievements may differ significantly from the results, performance, or
achievements expressed or implied in such forward-looking statements. The
following discusses certain factors which may affect the Company's and/or the
Bank's financial results and operations and should be considered in evaluating
the Company and/or the Bank.
The Company does not anticipate that its operations will be materially
affected as a result of compliance with Federal, State and local environmental
laws and regulations.
BUSINESS OF FIRST REGIONAL BANK
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The Bank was incorporated under the laws of the State of California on
July 10, 1979, and has authorized capital of 5,000,000 shares of no par value
Common Stock. The Bank commenced operations as a California-chartered bank on
December 31, 1979. The Bank conducts a business-oriented wholesale banking
operation, with services tailored to the needs of businesses and professionals
in its service area. The Bank's main office is located in the Century City
office complex in Los Angeles, California. The Bank also has full branch
Regional Offices located in the California cities of Irvine, Glendale, Santa
Monica, Gardena and Encino. The Bank also has a Merchant Services division
located in Agoura Hills, California. The Bank's customers include professionals
working in the primary service areas as well as many business accounts located
throughout both the counties of Los Angeles and Orange. In distinction from many
other independent banks in California, the Bank's deposit business is generated
by a relatively small number of accounts, although most accounts have a very
high average balance.
The Bank offers a full range of lending services including commercial,
real estate, and real estate construction loans. The Bank has developed a
substantial portfolio of short and medium-term "mini-perm" first trust deed
loans for income properties as well as specializing in construction lending for
moderate-size commercial and residential projects. The Bank also offers
commercial loans for commercial and industrial borrowers, which includes
equipment financing as well as short-term loans. The Bank also offers standard
banking services for its customers, including telephone transfers, wire
transfers, and travelers checks. The Bank accepts all types of demand, savings,
and time certificates of deposit. The Bank's Merchant Services division offers
credit card deposit and clearing services for retailers and other businesses
that accept credit cards. The Bank does not currently offer trust services, but
it does make trust services available to its customers through a correspondent
bank. At March 22, 2001 the Bank had 101 equivalent full-time employees.
COMPETITION
The banking business in California generally, and in the Los Angeles
County area where the Bank is located, is highly competitive with respect to
both loans and deposits and is dominated by a relatively small number of major
banks which have many offices operating over wide geographic areas. The Bank
competes for deposits and loans principally with these major banks, but also
with small independent banks located in its service areas. Among the advantages
which the major banks have over the Bank are their ability to finance extensive
advertising campaigns and to allocate their investment assets to regions of
highest yield and demand. Many of the major commercial banks operating in the
Bank's service area offer certain services (such as trust and cash management
services) which are not offered directly by the Bank and, by virtue of their
greater total capitalization, such banks have
5
substantially higher lending limits than the Bank.
Moreover, banks generally, and the Bank in particular, face increasing
competition for loans and deposits from non-bank financial intermediaries such
as savings and loan associations, thrift and loan associations, credit unions,
mortgage companies, insurance companies, and other lending institutions. Money
market funds offer rates competitive with banks, and an increasingly
sophisticated financial services industry continually develops new products for
consumers that compete with banks for investment dollars. In addition, other
entities (both public and private) seeking to raise capital through the issuance
and sale of debt or equity securities compete with banks in the acquisition of
deposits.
INTERSTATE COMPETITION
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
(the "Riegle-Neal Act"), enacted on September 29, 1994, provides that interstate
branching and merging of existing banks is permitted beginning June 1, 1997,
provided that the banks are at least adequately capitalized and demonstrate good
management. Interstate mergers and branch acquisitions are permitted at an
earlier time if a state chooses to enact a law allowing such activity. The
states are also authorized to enact a law to permit interstate banks to branch
de novo.
On August 9, 1989, the Financial Institutions Reform, Recovery and
Enforcement Act of 1989 ("FIRREA") was signed into law. Among other things,
FIRREA allows the acquisition of healthy and failed savings associations by bank
holding companies, and imposes no interstate barriers on such bank holding
company acquisitions. With certain qualifications, FIRREA also allows bank
holding companies to merge acquired savings associations into their existing
commercial bank subsidiaries; however, for a period of five years from the date
of enactment, the acquired savings association must continue as a member of, and
continue to pay premiums to, the Savings Association Insurance Fund, which was
created by FIRREA to replace the Federal Savings and Loan Insurance Corporation
deposit insurance fund, which FIRREA abolished.
Recent legislation and economic developments have favored increased
competition between different types of financial institutions for both deposits
and loans, resulting in increased cost of funds to banks generally and to the
Bank in particular. In order to compete with the other financial institutions in
its service area, the Bank relies principally upon personal contacts by its
officers, directors, founders, employees and shareholders; local promotional
activity including direct mail, advertising in local newspapers and business
journals; and specialized services. The Bank's promotional activities emphasize
the advantages of dealing with a locally-owned and headquartered institution
attuned to the particular needs of the community. In the event that a customer's
loan demands exceed the
6
Bank's lending limits, the Bank attempts to arrange for such loans on a
participation basis with its correspondent banks. The Bank also assists
customers requiring services not offered by the Bank to obtain these services
from its correspondent banks.
SUPERVISION AND REGULATION
INTRODUCTION
Banking is a complex, highly regulated industry. The primary goals of
the regulatory scheme are to maintain a safe and sound banking system, protect
depositors and the Federal Deposit Insurance Corporation's insurance fund, and
facilitate the conduct of sound monetary policy. In furtherance of these goals,
Congress and the states have created several largely autonomous regulatory
agencies and enacted numerous laws that govern banks, bank holding companies and
the banking industry. Consequently, the growth and earnings performance of the
Company and the Bank can be affected not only by management decisions and
general economic conditions, but also by the requirements of applicable state
and federal statutes, regulations and the policies of various governmental
regulatory authorities, including:
o the Federal Deposit Insurance Corporation (the ("FDIC"); and
o the California Department of Financial Institutions (the "DFI")and
o the Board of Governors of the Federal Reserve System (the "FRB").
The system of supervision and regulation applicable to the Company and
the Bank establishes a comprehensive framework for their respective operations.
Federal and state laws and regulations generally applicable to financial
institutions, such as the Company and the Bank, regulate, among other things:
o the scope of business that they may conduct;
o investments that they can make;
o reserves that must be maintained against deposits;
o capital levels that must be maintained relative to the amount and
risks associated with assets;
o the nature and amount of collateral that may be taken to secure
7
loans;
o the establishment of new branches;
o mergers and consolidations with other financial institutions; and
o the amount of dividends that the Company and the Bank may pay.
The following summarizes the material elements of the regulatory
framework that applies to the Company and any subsidiaries, including the Bank.
It does not describe all of the statutes, regulations and regulatory policies
that are applicable. Also, it does not restate all of the requirements of the
statutes, regulations and regulatory policies that are described. Consequently,
the following summary is qualified in its entirety by reference to the
applicable statutes, regulations and regulatory policies. Any change in
applicable laws, regulations or regulatory policies may have a material effect
on the business of the Company and the Bank.
SUPERVISION AND REGULATION - THE COMPANY
GENERAL. The Company, as a bank holding company registered under the
Bank Holding Company Act of 1956 (the "BHCA"), is subject to regulation by the
FRB. According to FRB policy, the Company is expected to act as a source of
financial strength for the Bank and to commit resources to support them in
circumstances where the Company might not otherwise do so. Under the BHCA, the
Company and its subsidiaries are subject to periodic examination by the FRB. The
Company is also required to file periodic reports of its operations and any
additional information regarding its activities and those of its subsidiaries
with the FRB, as may be required.
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 Commissioner of the California Department of Financial Institutions
(the "Commissioner"). Regulations have not yet been proposed or adopted or steps
otherwise taken to implement the Commissioner's powers under this statute.
BANK HOLDING COMPANY LIQUIDITY. The Company is a legal entity, separate
and distinct from the Bank. Although there exists the ability to raise capital
on its own behalf or borrow from external sources, it may also obtain additional
funds through dividends paid by, and fees for services provided to, the Bank.
However, regulatory constraints may restrict or totally preclude the Bank from
paying dividends to the Company.
8
The Company is entitled to receive dividends, when and as declared by
the Bank's Board of Directors, out of funds legally available therefore, as
specified and limited by the California Financial Code. Under the California
Financial Code, funds available for cash dividend payments by a bank are
restricted to the lesser of: (i) a bank's retained earnings; or (ii) a bank's
net income for its last three fiscal years (less any distributions to
shareholders made during such period). With the prior approval of the
Commissioner, cash dividends may also be paid out of the greater of: (i) a
bank's retained earnings; (ii) net income for a bank's last preceding fiscal
year; or (iii) net income for a bank's current fiscal year. If the Commissioner
finds that the shareholders' equity of the bank is not adequate or that the
payment of a dividend would be unsafe or unsound for the bank, the Commissioner
may order the bank not to pay a dividend to the bank's shareholders.
Since the Bank is an FDIC insured institution, it is therefore
possible, depending upon its financial condition and other factors, that the
FDIC could assert that the payment of dividends or other payments might, under
some circumstances, constitute an unsafe or unsound practice and thereby
prohibit such payments.
TRANSACTIONS WITH AFFILIATES. The Company and any subsidiaries it may
purchase or organize are deemed to be affiliates of the Bank within the meaning
of Sections 23A and 23B of the Federal Reserve Act. Pursuant thereto, loans by
the Bank to affiliates, investments by the Bank in affiliates' stock, and taking
affiliates' stock by the Bank as collateral for loans to any borrower will be
limited to 10% of the Bank's capital, in the case of any one affiliate, and will
be limited to 20% of the Bank' capital in the case of all affiliates. In
addition, such transactions must be on terms and conditions that are consistent
with safe and sound banking practices; in particular, a bank and its
subsidiaries generally may not purchase from an affiliate a low-quality asset,
as defined in the Federal Reserve Act. Such restrictions also prevent a bank
holding company and its other affiliates from borrowing from a banking
subsidiary of the bank holding company unless the loans are secured by
marketable collateral of designated amounts. The Company and the Bank is also
subject to certain restrictions with respect to engaging in the underwriting,
public sale and distribution of securities. (See "Supervision and Regulation -
The Banking Subsidiaries - Recent Legislation and Regulatory Developments - 1.
Gramm-Leach-Bliley Act - Facilitating Affiliations and Expansion of Financial
Activities" herein.)
LIMITATIONS ON BUSINESSES AND INVESTMENT ACTIVITIES. Under the BHCA, a
bank holding company must obtain the FRB's approval before:
o directly or indirectly acquiring more than 5% ownership or
9
control of any voting shares of another bank or bank holding company;
o acquiring all or substantially all of the assets of another bank; or
o merging or consolidating with another bank holding company.
The FRB may allow a bank holding company to acquire banks located in
any state of the United States without regard to whether the acquisition is
prohibited by the law of the state in which the target bank is located. In
approving interstate acquisitions, however, the FRB must give effect to
applicable state laws limiting the aggregate amount of deposits that may be held
by the acquiring bank holding company and its insured depository institutions in
the state in which the target bank is located, provided that those limits do not
discriminate against out-of-state depository institutions or their holding
companies, and state laws which require that the target bank have been in
existence for a minimum period of time, not to exceed five years, before being
acquired by an out-of-state bank holding company.
In addition to owning or managing banks, bank holding companies may own
subsidiaries engaged in certain businesses that the FRB has determined to be "so
closely related to banking as to be a proper incident thereto." The Company,
therefore is permitted to engage in a variety of banking-related businesses.
Some of the activities that the FRB has determined, pursuant to its Regulation
Y, to be related to banking are:
o making or acquiring loans or other extensions of credit for its own
account or for the account of others;
o servicing loans and other extensions of credit;
o operating a trust company in the manner authorized by federal or
state law under certain circumstances;
o leasing personal and real property or acting as agent, broker, or
adviser in leasing such property in accordance with various
restrictions imposed by FRB regulations;
o providing financial, banking, or economic data processing and data
transmission services;
o owning, controlling, or operating a savings association under certain
circumstances;
o selling money orders, travelers' checks and U.S. Savings Bonds;
10
o providing securities brokerage services, related securities credit
activities pursuant to Regulation T, and other incidental activities;
and
o underwriting and dealing in obligations of the U.S., general
obligations of states and their political subdivisions, and other
obligations authorized for state member banks under federal law.
Federal law prohibits a bank holding company and any subsidiary banks from
engaging in certain tie-in arrangements in connection with the extension of
credit. Thus, for example, the Banking Subsidiaries may not extend credit, lease
or sell property, or furnish any services, or fix or vary the consideration for
any of the foregoing on the condition that:
o the customer must obtain or provide some additional credit, property
or services from or to the Banking Subsidiaries other than a loan,
discount, deposit or trust service;
o the customer must obtain or provide some additional credit, property
or service from or to the Company or any of the Banking Subsidiaries;
or
o the customer may not obtain some other credit, property or services
from competitors, except reasonable requirements to assure soundness of
credit extended.
Generally, the BHCA does not place territorial restrictions on the
domestic activities of non-bank subsidiaries of bank holding companies.
On November 12, 1999, the President signed into law the
Gramm-Leach-Bliley Act (the "GLB Act" or the "Financial Modernization Act"). The
GLB Act significantly changed the regulatory structure and oversight of the
financial services industry. The GLB Act permits banks and bank holding
companies to engage in previously prohibited activities under certain
conditions. Also, banks and bank holding companies may affiliate with other
financial service providers such as insurance companies and securities firms
under certain conditions. Consequently, a qualifying bank holding company,
called a financial holding company ("FHC"), can engage in a full range of
financial activities, including banking, insurance, and securities activities,
as well as merchant banking and additional activities that are beyond those
permitted for traditional bank holding companies. Moreover, various non-bank
financial services providers which were previously prohibited from engaging in
banking can now acquire banks while also offering services such as securities
underwriting and underwriting and brokering insurance products. The GLB Act also
expands passive investment activities by FHCs, permitting them to indirectly
invest in any type of company, financial or nonfinancial, through merchant
banking
11
activities and insurance company affiliations. (See "Supervision and Regulation
- - The Bank - Recent Legislation and Regulatory Developments - 1.
Gramm-Leach-Bliley Act" herein.)
CAPITAL ADEQUACY. Bank holding companies must maintain minimum levels
of capital under the FRB's risk based capital adequacy guidelines. If capital
falls below minimum guideline levels, a bank holding company, among other
things, may be denied approval to acquire or establish additional banks or
non-bank businesses.
The FRB's risk-based capital adequacy guidelines for bank holding
companies and state member banks, discussed in more detail below (see
"Supervision and Regulation - The Banking Subsidiaries - Recent Legislation and
Regulatory Developments - 4. Risk-Based Capital Guidelines" herein), assign
various risk percentages to different categories of assets, and capital is
measured as a percentage of risk assets. Under the terms of the guidelines, bank
holding companies are expected to meet capital adequacy guidelines based both on
total risk assets and on total assets, without regard to risk weights.
The risk-based guidelines are minimum requirements. Higher capital
levels will be required if warranted by the particular circumstances or risk
profiles of individual organizations. For example, the FRB's capital guidelines
contemplate that additional capital may be required to take adequate account of,
among other things, interest rate risk, or the risks posed by concentrations of
credit, nontraditional activities or securities trading activities. Moreover,
any banking organization experiencing or anticipating significant growth or
expansion into new activities, particularly under the expanded powers pursuant
to the GLB Act, would be expected to maintain capital ratios, including tangible
capital positions, well above the minimum levels.
LIMITATIONS ON DIVIDEND PAYMENTS. California Corporations Code Section
500 allows the Company to pay a dividend to its shareholders only to the extent
that the Company has retained earnings and, after the dividend, the Company's
assets (exclusive of goodwill and other intangible assets) would be 1.25 times
its liabilities (exclusive of deferred taxes, deferred income and other deferred
credits), and the Company's current assets would be at least equal to its
current liabilities.
Additionally, the FRB's policy regarding dividends provides that a bank
holding company should not pay cash dividends exceeding its net income or which
can only be funded in ways that weaken the bank holding company's financial
health, such as by borrowing. The FRB also possesses enforcement powers over
bank holding companies and their non-bank subsidiaries to prevent or remedy
actions that represent unsafe or unsound practices or violations of applicable
statutes and regulations.
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SUPERVISION AND REGULATION - THE BANK
GENERAL. The Bank, as a state-chartered nonmember bank, is subject to
regulation, supervision, and regular examination by the DFI and the FDIC. The
Bank's deposits are insured by the FDIC up to the maximum extent provided by
law. The regulations of these agencies govern most aspects of the Bank's
business and establish a comprehensive framework governing its operations.
California law exempts all banks from usury limitations on interest rates.
Supervision, regulation, and examination of the Bank by the regulatory agencies
are generally intended to protect depositors and are not intended to protect the
shareholders of the Company.
RECENT LEGISLATION AND REGULATORY DEVELOPMENTS. From time to time
legislation is proposed or enacted which has the effect of increasing the cost
of doing business and changing the competitive balance between banks and other
financial and non-financial institutions. Various federal laws enacted over the
past several years have provided, among other things, for the maintenance of
mandatory reserves with the FRB on deposits by depository institutions (state
reserve requirements have been eliminated); the phasing-out of the restrictions
on the amount of interest which financial institutions may pay on certain of
their customers' accounts. Federal regulators have been given increased
authority and means for providing financial assistance to insured depository
institutions and for effecting interstate and cross-industry mergers and
acquisitions of failing institutions. These laws have generally had the effect
of altering competitive relationships existing among financial institutions,
reducing the historical distinctions between the services offered by banks,
savings and loan associations and other financial service providers, and
increasing the cost of funds to banks and other depository institutions.
1. GRAMM-LEACH-BLILEY ACT
GENERAL. The Gramm-Leach-Bliley Act was signed into law on November 12,
1999. The GLB Act represents the most significant revision of the banking and
financial services industry laws since the Depression Era by revising the BHCA
and permitting full affiliations with other financial service providers. The GLB
Act permits a qualified bank holding company, called a financial holding
company, to engage in a full range of financial activities including banking,
insurance, securities activities, as well as merchant banking and other
activities that are financial in nature. The following discusses the more
significant elements of the GLB Act.
FACILITATING AFFILIATIONS AND EXPANSION OF FINANCIAL ACTIVITIES. The
GLB Act:
o eliminates many federal and state barriers to affiliations among
banks and securities firms, insurance companies, and other
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financial service providers;
o establishes a statutory framework for permitting full affiliations to
occur;
o provides financial organizations with flexibility in structuring new
financial affiliations through the FHC structure or through a bank
financial subsidiary, with certain safeguards and limitations;
o preserves the role of the FRB as the umbrella supervisory authority
for those FHCs, while incorporating a system of functional regulation
designed to utilize the strengths of various federal and state
regulatory authorities; and
o establishes a mechanism for coordination between the FRB and the
Secretary of the Treasury (the "Secretary") regarding the approval of
new financial activities for both holding companies and financial
subsidiaries of national banks.
Safety and soundness is also emphasized by requiring that banks and
holding companies be "well capitalized" and "well managed" in order to engage in
the new activities and affiliations contemplated by the GLB Act, with the
appropriate regulators given authority to address any failure to maintain safety
and soundness standards in a prompt manner.
FINANCIAL AFFILIATIONS AND ACTIVITIES. The GLB Act repeals previous
statutory prohibitions by permitting bank holding companies and FRB member banks
to engage in previously prohibited activities and affiliations. Specifically,
the GLB Act adds Section 6 to the BHCA, designating qualifying bank holding
companies engaging in the new, permissible financial activities and affiliations
as FHCs. In order for a bank holding company to qualify as an FHC, its
subsidiary depository institutions must be "well managed," "well capitalized,"
and have at least a "satisfactory" Community Reinvestment Act ("CRA") rating as
of their last examination.
On January 19, 2000, the FRB adopted interim regulations under Subpart
I of Regulation Y implementing the FHC provisions of the GLB Act. The interim
regulations, subject to revision, became effective March 11, 2000. Under the
interim regulations, a bank holding company must submit a declaration to the FRB
stating that the company elects to become an FHC and a certification that all
depository institutions controlled by the company are "well capitalized" and
"well managed." Providing that those requirements are met and that the
depository institutions have at least a "satisfactory" CRA rating, the election
to become an FHC is effective on the 31st day after the FRB receives the
election.
If any of an FHC's subsidiary depository institutions fails to retain
14
a "well managed" or "well capitalized" status, the FHC must execute an agreement
with the FRB within 45 days after notice of the deficiency, agreeing to
implement specific corrective measures to return the FHC to compliance. After
the agreement is executed, the FHC will have 180 days to correct any management
or capital deficiencies. Until the FRB has determined that the deficiencies have
been corrected, the FRB may impose any conditions or limitations on the conduct
or activities of an FHC or on any of its affiliates that the FRB deems
appropriate and consistent with the BHCA and the FHC and its affiliates may not
engage in any additional activities permitted by the GLB Act without the FRB's
prior approval.
If the FHC fails to correct the capital and management deficiencies
within 180 days, the FRB may require the FHC to divest itself of any insured
depository institutions or the FRB may require the FHC to cease engaging (both
directly and through any subsidiary that is not a depository institution or a
subsidiary of a depository institution) in all activities that are not otherwise
permissible for a traditional bank holding company under the FRB's Regulation Y.
If any one of an FHC's depository institutions falls out of compliance
with the "satisfactory" CRA rating requirement, the FHC may continue existing
activities permitted by the GLB Act. However, the FHC may not commence any
additional GLB Act activities, or acquire direct or indirect control of any
entity engaged in such activities.
The GLB Act permits FHCs to engage in non-banking activities beyond
those permitted for traditional bank holding companies. Rather than requiring
that the non-banking activities be "closely related to banking," FHCs may engage
in those activities that the FRB determines to be financial in nature,
incidental to activities that are financial in nature, or complimentary to
financial activities. The GLB Act enumerates certain permissible activities that
the FRB considers financial in nature. FHCs, however, may only engage in
complimentary financial activities if the FRB determines that the complimentary
activities do not pose a substantial risk to the safety and soundness of the
FHC's depository institutions or the financial system in general.
For those expanded financial activities that are not specifically
enumerated in the GLB Act, the FRB has the primary authority to determine which
activities are financial in nature, incidental or complimentary, and may act by
regulation or order. However, the FRB may not act unilaterally. Pursuant to the
GLB Act, a consultive process between the FRB and the Secretary is required. The
Secretary may also make similar proposals to the FRB with respect to determining
whether proposed activities are financial in nature or incidental to financial
activities regarding financial subsidiaries of national banks. Such a process is
intended to bring a balance to the determinations regarding the type of
activities that are financial and limit so-called "regulatory shopping" by
financial
15
service providers.
A qualifying FHC may engage in any new activity enumerated in the GLB
Act without receiving prior approval from the FRB. Rather, the FHC is only
required to file a notice with the FRB within 30 days after the activity is
commenced or a company is acquired. The new activities enumerated in the GLB Act
which are specifically considered financial in nature include:
o underwriting insurance or annuities, or acting as an insurance or
annuity principal, agent or broker;
o providing financial or investment advice;
o issuing or selling interests in pools of assets that a bank could
hold;
o all underwriting, dealing in or making markets in securities without
any revenue limitation;
o engaging within the United States in any activity that a bank holding
company could engage in outside of the country, if the FRB determined,
before the GLB Act, that the activity was usual in connection with
banking or other financial operations internationally;
o sponsoring and distributing all types of mutual funds;
o investment company activities;
o merchant banking equity investment activities;
o insurance company equity investments; and
o engaging in any activity that the FRB determined before the GLB Act
to be permitted for a bank holding company that is not an FHC.
The most significant of the new activities authorized by the GLB Act
are merchant banking and insurance company portfolio investment powers. Before
enactment of the GLB Act, bank holding companies had to limit their non-bank
equity investments, including controlling equity investments, to entities that
were engaged in activities that were closely related to the business of banking.
At the same time securities and insurance companies were free to make merchant
banking and insurance company portfolio investments in virtually any kind of
financial or non-financial company. Recognizing that such investments are
financial in nature, the GLB Act substantially expands the authority of an FHC
to make controlling equity investments in any kind of entity, including those
engaged in non-financial
16
activities.
MERCHANT BANKING. The GLB Act permits FHC's to make controlling equity
investments in virtually any business entity (including those that engage in
non-financial activities) by permitting the FHC to engage in merchant banking
activities. In order to engage in merchant banking activities:
o the investment must not be made by a depository institution
subsidiary of the FHC, or by a subsidiary of a depository institution;
o the FHC must own a securities affiliate;
o the investment must be made as part of a BONA FIDE underwriting or
merchant or investment banking activity, including investment
activities engaged in for the purpose of appreciation and ultimate
resale or disposition of the investment;
o the investment must be held for a period of time to enable the sale
or disposition thereof on a reasonable basis consistent with the
financial viability of the BONA FIDE underwriting or merchant or
investment banking activity; and
o the FHC must not routinely manage or operate the entity in which the
investment is made, except as may be required to obtain a reasonable
return on investment upon sale or disposition.
INSURANCE COMPANY PORTFOLIO INVESTMENTS. The GLB Act permits FHCs to
affiliate with insurance companies. The GLB Act recognizes that, as part of
their ordinary business, insurance companies frequently invest funds received
from policy holders in most or all of the shares of stock of a company that may
not be engaged in a financial activity. New Section 4(k)(4)(I) of the BHCA
permits an insurance company that is affiliated with a depository institution to
continue insurance company portfolio investment activities, provided that
certain requirements are met. Specifically, the investments held by an insurance
company affiliate of a depository institution must:
o be acquired and held by an insurance company that is predominantly
engaged in underwriting life, accident and health, or property and
casualty insurance, or in providing and issuing annuities;
o represent investments made in the ordinary course of the insurance
company's business, according to relevant state insurance laws
governing such investments; and
17
o not be routinely managed or operated by the FHC, except as may be
necessary or required to obtain a reasonable return.
To the extent that an FHC does participate in management of the portfolio,
participation would be limited to safeguarding the investments under the
applicable requirements of state insurance laws.
The GLB Act imposes other restrictions on equity investment activities
of FHCs. First, a depository institution controlled by an FHC may not cross
market the products or services of a company in which the FHC has made a
merchant banking or insurance company portfolio investment (a "portfolio
company"), and VICE VERSA. However, the GLB Act does not prevent a nonbank
affiliate of an FHC and a portfolio company from cross marketing each other's
products.
Second, a controlling investment made pursuant to the GLB Act's
merchant banking or insurance company portfolio investment authority would make
the portfolio company an "affiliate" of the FHC's depository institution for
purposes of Sections 23A and 23B of the Federal Reserve Act. Moreover, the GLB
Act establishes a presumption that an investment of 15% or more in the equity of
a portfolio company will make the portfolio company an affiliate. Thus, an
affiliated depository institution's credit and asset purchase transactions will
be subject to the "covered transaction" restrictions of Sections 23A and 23B of
the Federal Reserve Act, including quantitative limits, collateral requirements,
and the "arms'-length" transaction standard.
The Riegle-Neal Act was also amended to apply its prohibitions against
establishment of deposit production offices to interstate branches acquired or
established under the GLB Act, including all branches of a bank owned by an
out-of-state bank holding company.
PREEMPTION OF STATE LAW. The GLB Act affirms that the states are the
primary legal authority to regulate the insurance business and related
activities. However, in their regulation of insurance activities, state laws are
pre-empted to the extent that they prohibit the affiliations permitted under the
GLB Act. States may not prevent or restrict depository institutions or their
affiliates from engaging in any activity permitted under the GLB Act, such as
insurance sales, solicitations and cross-marketing. States, however are allowed
to continue regulating other insurance activities such as licensing and
requiring that insurance companies maintain certain levels of capital.
Additionally, state regulation of other activities is not pre-empted,
even if they do prevent or restrict an activity permitted under the GLB Act, so
long as they do not discriminate. Consequently, state securities regulations are
not pre-empted with respect to a state's ability to
18
investigate and enforce certain unlawful transactions or require licensing.
Similarly, state corporation and antitrust laws are not pre-empted so long as
such laws are consistent with the intent of the Financial Modernization Act
permitting affiliations.
STREAMLINING SUPERVISION OF BANK HOLDING COMPANIES. The GLB Act
authorizes the FRB to examine each holding company and its subsidiaries. The
legislation provides that the FRB may require a bank holding company or any
subsidiary to submit reports regarding: financial condition; monitoring of
financial and operating risks; transactions with depository institutions; and
compliance with the BHCA and other laws that the FRB has jurisdiction to
enforce. The FRB, however, is directed to use existing examination reports
prepared by functional regulators of the particular activity, publicly reported
information and reports filed with other agencies to the fullest extent
possible.
The FRB may only directly examine subsidiaries that are functionally
regulated by other federal or state agencies if it:
o has a reasonable basis to believe that the subsidiary is engaged in
activities that pose a material risk to an affiliated depository
institution;
o reasonably believes, after reviewing the relevant reports, that
examining the subsidiary is necessary to adequately provide information
regarding its risk monitoring systems; or
o has a reasonable basis to believe that the subsidiary is not in
compliance with the BHCA or other federal law that the FRB has specific
authority to enforce, and the FRB cannot make the determination through
an examination of an affiliated depository institution or the holding
company.
The FRB is not authorized to mandate capital requirements for any
subsidiary that is functionally regulated by another agency and which is in
compliance with the capital requirements prescribed by another federal or state
regulatory authority. Insurance and securities activities conducted in regulated
entities are subject to functional regulation by relevant state insurance
authorities and the Securities and Exchange Commission (the "SEC"),
respectively.
Also, the FRB cannot force a broker-dealer or insurance company that is
a bank holding company to contribute additional capital to a depository
institution, if the company's functional regulator determines, in writing, that
the contribution would have a material adverse effect on the broker-dealer or
insurance holding company. If a functional regulator, however, makes such a
determination, the FRB has authority to require the bank holding company to
divest its interests in the depository institution. The
19
limitations on the FRB also apply to all federal banking agencies. Thus, the
Office of the Comptroller of the Currency (the "OCC") which regulates national
banks, the Office of Thrift Supervision (the "OTS") which regulates federal
savings banks, and the FDIC will not be able to assume and duplicate the
function of being the general supervisory authority over functionally regulated
subsidiaries of banks. However, the GLB Act specifically preserves the FDIC's
authority to examine a functionally regulated affiliate of an insured depository
institution, if it is necessary to protect the deposit insurance fund.
The GLB Act also specifically limits the FRB's ability to take indirect
action against functionally regulated affiliates. Consequently, the FRB may not
promulgate rules, adopt restrictions, safeguards or any other requirement
affecting a functionally regulated affiliate unless:
o the action is necessary to address a "material risk" to the safety
and soundness of a depository institution affiliate or to the domestic
or international payments system; and
o it is not possible to guard against that material risk through
requirements imposed upon the depository institution directly.
FINANCIAL SUBSIDIARIES OF NATIONAL BANKS. In addition to the
permissible statutory subsidiaries (agricultural credit corporations, bank
service companies and community development corporations, etc.) and operating
subsidiaries (subsidiaries engaged in activities that a national bank itself can
perform), the GLB Act permits national banks to establish and operate a third
class of subsidiary known as a financial subsidiary. A financial subsidiary is a
subsidiary that performs financial activities that a national bank either cannot
otherwise perform itself, or that a national bank cannot otherwise own if not
for the enabling provisions of GLB Act.
Activities of national banks' financial subsidiaries are essentially
the same as those for FHCs. Thus, national banks, through financial
subsidiaries, are permitted to engage in the enumerated financial activities
authorized by the GLB Act. However, the following activities, although
permissible for FHCs, are prohibited for financial subsidiaries of national
banks and can only be performed in nonbank subsidiaries of FHCs. These
prohibited activities are:
o insurance or annuity underwriting, except that underwriting title
insurance is permitted for national banks in those states where
state-chartered banks may do so;
o insurance company portfolio investments;
o merchant banking; and
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o real estate investment and development activities beyond those
directly authorized by law.
The Secretary, in concert with the FRB, may jointly adopt rules lifting
the insurance underwriting, insurance company portfolio investment, and merchant
banking prohibitions beginning November 12, 2004. Additionally, the Secretary,
in conjunction with the FRB, has the authority to determine whether additional
activities are financial in nature and must follow the same evaluation criteria
that the FRB uses in determining additional financial activities for FHC
purposes.
On January 19, 2000, the OCC issued a proposal to amend Part 5 of its
regulations to provide that a national bank may establish a financial subsidiary
if:
o the national bank and its depository institution affiliates meet the
same "well capitalized," "well managed" and "satisfactory" CRA rating
standards for banking subsidiaries of FHCs;
o the aggregate consolidated financial assets of all of the national
bank's financial subsidiaries does not exceed the lesser of 45% of the
consolidated net assets of the parent bank or $50 billion; and
o a national bank that is one of the nation's 100 largest insured
banks, determined on the basis of consolidated total assets, has at
least one issue of outstanding eligible debt that is rated in one of
the three highest investment grade categories.
The proposed regulations provide for a filing and notification process.
Once expanded activities have commenced in a financial subsidiary, the proposed
regulations require a national bank to comply with certain conditions in order
to ensure that proper safeguards are implemented. These conditions include, but
are not limited to:
o requiring the national bank to deduct the total amount of its
investment in the financial subsidiary from its assets and equity for
purposes of determining regulatory capital, and presenting the
information separately in any published financial statements for the
bank;
o prohibiting the consolidation of the financial subsidiary's assets
and liabilities with those of the bank;
o requiring the national bank to establish adequate policies and
procedures to maintain the separate corporate identities of the bank
and its financial subsidiaries; and
21
o requiring adoption and implementation of policies and procedures to
identify and manage financial and operational risks associated with the
financial subsidiary.
FINANCIAL SUBSIDIARIES OF STATE-CHARTERED NONMEMBER BANKS. The GLB Act
added Section 46 to the Federal Deposit Insurance Act (the "FDI Act") which
permits state nonmember banks to hold interests in a subsidiary that are
essentially equivalent to a national bank's financial subsidiary. Additionally,
the state nonmember bank must comply with substantially all of the requirements
and conditions imposed on national banks in order to qualify and maintain their
investments in financial subsidiaries established under the GLB Act, except that
there is no requirement that the state nonmember bank be "well managed."
However, the FDI Act requires the FDIC's consent to an investment in any
financial subsidiary of a state-chartered institution. (See - 5. Expanded
Enforcement Powers - Activities of State Banks herein.)
BROKER-DEALER ACTIVITIES. The GLB Act provides for the functional
regulation of bank securities activities by the SEC. The GLB Act replaces the
broad bank exemption from broker-dealer regulation under the Securities Exchange
Act of 1934 (the "'34 Act"). The amendments include certain previously excluded
activities within the definition of "broker" and "dealer," thereby subjecting
those activities to the registration requirements and regulation of the '34 Act,
with an exception for certain activities in which banks have traditionally
engaged. These exemptions relate to:
o third-party networking arrangements;
o trustee and fiduciary activities if the bank: (i) is chiefly
compensated by means of administration and certain other fees; and (ii)
does not publicly solicit brokerage deposits; and
o identified banking products such as commercial paper, bankers'
acceptances, employee and shareholder benefit plans, sweep accounts,
affiliate transactions, private placements, safekeeping and custody
services, asset-backed securities, derivatives and other identified
banking products.
The GLB Act also amends the Investment Company Act and the Investment
Advisers Act, subjecting banks that advise mutual funds to the same regulatory
scheme as other advisers to mutual funds. It also requires banks to make
additional disclosures when a fund is sold or advised by a bank.
INSURANCE ACTIVITIES. In addition to affirming that states are the
22
functional regulators of insurance activities, the GLB Act prohibits
federally-chartered banks from engaging in any activity involving the
underwriting and sale of title insurance. National banks may, however, sell
title insurance products in any state in which state-chartered banks are
permitted to do so, so long as those activities are undertaken in the same
manner, to the same extent, and under the same restrictions that apply to
state-chartered banks.
The GLB Act requires the federal bank regulatory agencies and state
insurance regulators to coordinate efforts to supervise companies that control
both depository institutions and entities engaged in the insurance business, and
to share supervisory information including financial condition and affiliate
transactions on a confidential basis. Federal agencies are further directed to
provide notice to and consult with state regulators before taking actions which
affect any affiliates engaging in insurance activities.
UNITARY SAVINGS AND LOAN HOLDING COMPANY PROVISIONS. The GLB Act amends
the Home Owners' Loan Act (the "HOLA") to prohibit unitary savings and loan
holding companies from engaging in non-financial activities or affiliations with
non-financial organizations. The prohibition applies to applications to form
unitary savings and loan holding companies filed with the OTS after May 4, 1999.
Unitary savings and loan holding companies existing or whose applications were
pending on or before May 4, 1999, retain their authority to engage in
nonfinancial activities and affiliations.
The prohibition on non-financial affiliations, however, does not
prevent transactions that involve corporate reorganizations. Specifically, it
does not prohibit transactions that solely involve an acquisition, merger,
consolidation or other type of business combination of a savings and loan
holding company (or any savings association subsidiary) with another company,
where both are under common control.
CONSUMER PRIVACY PROTECTION. The GLB Act enhances financial privacy
laws by imposing an affirmative and continuing obligation to respect the privacy
and protect the confidentiality of nonpublic personal customer information
provided by a consumer to a financial institution, or otherwise obtained by the
financial institution. For purposes of the privacy provisions of the GLB Act, a
financial institution means any entity engaging in the financial activities that
are listed in the new Section 4(k) of the of the BHCA. Thus, the privacy
protections extend to all entities engaged in financial activities defined in
the GLB Act, whether or not they are affiliated with banks or bank holding
companies, FHCs or banks.
The GLB Act also makes it a federal crime to obtain, attempt to
23
obtain, disclose, cause to be disclosed or attempt to cause to be disclosed
customer information of a financial institution through fraudulent or deceptive
means. These include misrepresenting the identity of the person requesting the
information and misleading an institution or customer into making unwitting
disclosures of confidential information. In addition to criminal sanctions, the
legislation provides for a private right of action and enforcement by state
attorneys general.
FEDERAL HOME LOAN BANK SYSTEM MODERNIZATION. The Federal Home Loan Bank
System Modernization Act of 1999 (the "FHLBSMA") was enacted as part of the GLB
Act. The FHLBSMA reforms the Federal Home Loan Bank System (the "FHLBS") in
several ways. The more significant changes include:
o voluntary rather than mandatory membership of federal savings
associations in the FHLBS;
o permitting all community financial institutions (I.E. institutions
whose deposits are insured by the FDIC and have less than $500 million
in average total assets) to obtain advances from Federal Home Loan
Banks; and
o permitting any community financial institution greater access to
FHLBS credit facilities by expanding the types of assets that may be
pledged as collateral, including small business, agricultural, rural
development, or low-income community development loans.
In addition, a number of restrictions that had applied to FHLBS member
institutions which did not comply with the Qualified Thrift Lender ("QTL")
requirements under the HOLA were abolished, including: the Federal Home Loan
Bank stock purchase requirements; the requirement that advances only be given
for housing related purposes; the 30% limit on total advances for non-QTL
members; and certain restrictions that applied to non-QTL thrift institutions.
COMMUNITY REINVESTMENT ACT PROVISIONS. In addition to the maintenance
of at least a "satisfactory" CRA rating in order to qualify for expanded
activities, the GLB Act amends the FDIA to require full disclosure of agreements
entered into between an insured depository institution or its affiliates and
non-governmental entities or persons made under or in connection with
fulfillment of the CRA. These agreements are to be made available to the public
and federal regulatory agencies. Annually, the parties to each CRA agreement are
required to report the use of resources provided to the participating bank's
primary federal regulator.
Other provisions affecting the CRA include:
24
o reducing the frequency of CRA examinations for banks with less than
$250 million in assets to once every five years if they have
"outstanding" CRA ratings, and once every four years if they have
"satisfactory" ratings;
o requiring an FRB study of the default rates, delinquency rates and
profitability of CRA loans; and
o requiring a Treasury study of whether adequate services are being
provided under the CRA.
OTHER PROVISIONS. Other provisions of the GLB Act include, but are not
limited to:
o requiring ATM operators who impose a fee for use of an ATM by a
non-customer to post notice on the ATM and on the screen that a fee
will be charged, the amount of the fee and that no fee will be imposed
unless such notices are made and the customer elects to proceed with
the transaction;
o requiring a General Accounting Office study of possible revisions to
the Internal Revenue Code's Subchapter S corporation rules to permit
greater access by community banks to Subchapter S tax treatment; and
o requiring a General Accounting Office study analyzing the conflict of
interest faced by the FRB between its role as a primary regulator of
the banking industry and its role as a vendor of services to the
banking and financial services industry.
CONCLUSION. The provisions of the GLB Act are numerous and become
effective at various times between the date of enactment and the middle of 2001
and beyond. Additionally, various federal regulatory authorities including the
FRB, OCC, FDIC, OTS and SEC have only started to promulgate the regulations and
interpretations required by the GLB Act. Furthermore, procedures for the
coordination of information among regulators, both state and federal, have yet
to be formulated. Management of the Company and the Bank, therefore, cannot
estimate with any degree of certainty the effect that the GLB Act, future
regulations and future regulatory information sharing will have on the financial
condition, results of operations or future prospects of the Company or the Bank.
Finally, the provisions of the GLB Act, particularly those permitting
affiliations and expansion of activities, may prompt mergers, joint ventures,
partnerships and other affiliations among providers of banking, insurance and
securities services, both domestically and internationally.
25
The extent and magnitude of these affiliations and their impact on the Company,
the Bank or on the banking industry in general cannot be predicted.
2. INTERSTATE BANKING
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
(the "Riegle-Neal Act") allows banks to open branches across state lines and
also amended the BHCA to make it possible for bank holding companies to buy
out-of-state banks in any state and convert them into interstate branches.
The amendment to the Bank Holding Company Act permits bank holding
companies to acquire banks in other states provided that the acquisition does
not result in the bank holding company controlling more than 10 percent of the
deposits in the United States, or 30 percent of the deposits in the state in
which the bank to be acquired is located. However, the Riegle-Neal Act also
provides that states have the authority to waive the state concentration limit.
Individual states may also require that the bank being acquired be in existence
for up to five years before an out-of-state bank or bank holding company may
acquire it.
The Riegle-Neal Act permits interstate branching through merging of
existing banks, provided that the banks are at least adequately capitalized and
demonstrate good management. The states were also authorized to enact laws to
permit interstate banks to branch DE NOVO. All banks, however, are prohibited
from using the interstate branching authority of the Riegle-Neal Act for the
primary purpose of deposit production or the establishment of deposit production
offices. (See "- 1. Gramm-Leach-Bliley Act - Facilitating Affiliations and
Expansion of Financial Activities" herein.)
The California Interstate Banking and Branching Act of 1995 ("CIBBA")
authorized out-of-state banks to enter California by the acquisition of or
merger with a California bank that has been in existence for at least five
years, unless the California bank is in danger of failing or in certain other
emergency situations, but limits interstate branching into California to
branching by acquisition of an existing bank. CIBBA allows a California state
bank to have agency relationships with affiliated and unaffiliated insured
depository institutions and allows a bank subsidiary of a bank holding company
to act as an agent to receive deposits, renew time deposits, service loans and
receive payments for a depository institution affiliate.
3. FEDERAL DEPOSIT INSURANCE
GENERAL. The Financial Institutions Reform, Recovery, and Enforcement
Act of 1989 ("FIRREA") has resulted in major changes in the regulation of
26
insured financial institutions, including significant changes in the authority
of government agencies to regulate insured financial institutions.
Under FIRREA, virtually all federal deposit insurance activities were
consolidated under the FDIC, including insuring deposits of federal savings
associations, state chartered savings and loans and other depository
institutions determined to be operated in substantially the same manner as a
savings association. FIRREA established two deposit insurance funds to be
administered by the FDIC. The money in these two funds is separately maintained
and not commingled. The Bank Insurance Fund (the "BIF") insures deposits of
commercial banking institutions and the Savings Association Insurance Fund (the
"SAIF") replaced the deposit insurance fund administered by the Federal Savings
and Loan Insurance Corporation. Insurance of deposits may be terminated by the
FDIC upon a finding that the institution has engaged in unsafe or unsound
practices, is in an unsafe or unsound condition to continue operations or has
violated any applicable law, regulation, rule, order or condition imposed by the
FDIC or the institution's primary regulator.
DEPOSIT INSURANCE ASSESSMENTS. Under FIRREA, the premium assessments
made on banks and savings associations for deposit insurance were initially
increased, with rates set separately for banks and savings associations, subject
to statutory restrictions.
Since 1994, the FDIC has assessed deposit insurance premiums pursuant
to a risk-based assessment system, under which an institution's premium
assessment is based on the probability that the deposit insurance fund will
incur a loss with respect to the institution, the likely amount of such loss,
and the revenue needs of the deposit insurance fund. Under the risk-based
assessment system, BIF member institutions such as the Bank are categorized into
one of three capital categories (well capitalized, adequately capitalized, and
undercapitalized) and one of three categories based on supervisory evaluations
by its primary federal regulator (in the Bank's case, the FDIC). The three
supervisory categories are: financially sound with only a few minor weaknesses
(Group A), demonstrates weaknesses that could result in significant
deterioration (Group B), and poses a substantial probability of loss (Group C).
The capital and supervisory group ratings for SAIF institutions are the same as
for BIF institutions. The capital ratios used by the FDIC to define
well-capitalized, adequately capitalized and undercapitalized are the same as in
the prompt corrective action regulations (discussed below). The BIF and SAIF
assessment rates since January 1, 1997 are summarized below; assessment figures
are expressed in terms of cents per $100 in insured deposits.
ASSESSMENT RATES EFFECTIVE JANUARY 1, 1997
SUPERVISORY GROUP
27
CAPITAL GROUP GROUP A GROUP B GROUP C
------------- ------- ------- -------
Well Capitalized................. 0 3 17
Adequately Capitalized........... 3 10 24
Undercapitalized................. 10 24 27
Commencing the first quarter of 1997, banks were required to share in the
payment of interest on the Financing Corporation Bonds (the "FICO Bonds") issued
in the 1980s to assist in the recovery of the savings and loan industry.
Previously, the FICO debt was paid solely out of the SAIF assessment base. Prior
to January 1, 2000, the FICO assessments imposed on BIF insured institutions
were assessed at a rate equal to 1/5 of the rate of the assessments imposed on
SAIF insured depository institutions. Between the first quarter of 1997 and the
fourth quarter of 1999, the quarterly FICO assessment rates for SAIF insured
institutions ranged from a high of $.0650 to a low of $.0582 per $100 in insured
deposits. The BIF assessment rate for the same period ranged from a high of
$.0130 to a low of $.01164 per $100 in insured deposits. The rates equalized
effective January 1, 2000 and the annual assessment rates for insured
institutions ranged from a high of $.0212 to a low of $.01960 per $100 in
insured deposits. Although the FICO assessment rates are annual rates, they are
subject to change quarterly. Since the FICO bonds do not mature until the year
2019, it is conceivable that banks and savings associations will continue to
share in the payment of the interest on the bonds until then.
With certain limited exceptions, FIRREA prohibits a bank from changing
its status as an insured depository institution with the BIF to the
SAIF and prohibits a savings association from changing its status as an
insured depository institution with the SAIF to the BIF, without the
prior approval of the FDIC.
FDIC RECEIVERSHIPS. Pursuant to FIRREA, the FDIC may be appointed
conservator or receiver of any insured bank or savings association. In addition,
FIRREA authorized the FDIC to appoint itself as sole conservator or receiver of
any insured state bank or savings association for any, among others, of the
following reasons:
o insolvency of such institution;
o substantial dissipation of assets or earnings due to any violation of
law or regulation or any unsafe or unsound practice;
o an unsafe or unsound condition to transact business, including
substantially insufficient capital or otherwise;
o any willful violation of a cease and desist order which has become
final;
28
o any concealment of books, papers, records or assets of the
institution;
o the likelihood that the institution will not be able to meet the
demands of its depositors or pay its obligations in the normal course
of business;
o the incurrence or likely incurrence of losses by the institution that
will deplete all or substantially all of its capital with no reasonable
prospect for the replenishment of the capital without federal
assistance; or
o any violation of any law or regulation, or an unsafe or unsound
practice or condition which is likely to cause insolvency or
substantial dissipation of assets or earnings, or is likely to weaken
the condition of the institution or otherwise seriously prejudice the
interest of its depositors.
As a receiver of any insured depository institution, the FDIC may
liquidate such institution. The liquidation must be done in an orderly manner.
The FDIC may also dispose of any matter concerning the institution that the FDIC
determines to be in the institution's, its depositors' and the FDIC's best
interests. Additionally, the FDIC, as the conservator or receiver, succeeds to
all rights, titles, powers and privileges of the insured institution.
Consequently, the FDIC may take over the assets of and operate an institution
with all the powers of its members, shareholders, directors or officers, and
conduct all business of the institution, collect all obligations and money due
to the institution, and preserve and conserve the assets and property of the
institution.
ENFORCEMENT POWERS. Some of the most significant provisions of FIRREA
were the expansion of regulatory enforcement powers. FIRREA has given the
federal regulatory agencies broader and stronger enforcement authorities
reaching a wider range of persons and entities. Some of those provisions
included those which:
o expanded the category of persons subject to enforcement under the
Federal Deposit Insurance Act;
o expanded the scope of cease and desist orders and provided for the
issuance of temporary cease and desist orders;
o provided for the suspension and removal of wrongdoers on an expanded
basis and on an industry-wide basis;
o prohibited the participation of persons suspended or removed or
convicted of a crime involving dishonesty or breach of trust from
serving in another insured institution;
29
o required the regulators to publicize all final enforcement orders;
and
o provided for extensive increases in the amounts and circumstances for
assessment of civil money penalties, civil and criminal forfeiture and
other civil and criminal fines and penalties.
CRIME CONTROL ACT OF 1990. The Crime Control Act of 1990 further
strengthened the authority of federal regulators to enforce capital
requirements, increased civil and criminal penalties for financial fraud, and
enacted provisions allowing the FDIC to regulate or prohibit certain forms of
golden parachute benefits and indemnification payments to officers and directors
of financial institutions.
4. RISK-BASED CAPITAL GUIDELINES
GENERAL. The federal banking agencies have established minimum capital
standards known as risk-based capital guidelines. The risk-based capital
guidelines include both a new definition of capital and a framework for
calculating the amount of capital that must be maintained against a bank's
assets and off balance sheet items. The amount of capital required to be
maintained is based upon the credit risks associated with a bank's types of
assets and off-balance sheet items. A bank's assets and off balance sheet items
are classified under several risk categories, with each category assigned a
particular risk weighting from 0% to 100%. A bank's risk-based capital ratio is
calculated by dividing its qualifying capital which is the numerator of the
ratio, by the combined risk weights of its assets and off balance sheet items
which is the denominator of the ratio.
QUALIFYING CAPITAL. A bank's qualifying total capital consists of two
types of capital components: "core capital elements," known as Tier 1 capital
and "supplementary capital elements," known as Tier 2 capital. The Tier 1
component of a bank's qualifying capital must represent at least 50% of
qualifying total capital and may consist of the following items that are defined
as core capital elements:
o common stockholders' equity;
o qualifying noncumulative perpetual preferred stock (including related
surplus); and
o minority interests in the equity accounts of consolidated
subsidiaries.
The Tier 2 component of a bank's qualifying total capital may consist of
30
the following items:
o a portion of allowance for loan and lease losses;
o certain types of perpetual preferred stock and related surplus;
o certain types of hybrid capital instruments and mandatory convertible
debt securities; and
o a portion of term subordinated debt and intermediate-term preferred
stock, including related surplus.
RISK WEIGHTED ASSETS AND OFF BALANCE SHEET ITEMS. Assets and credit
equivalent amounts of off-balance sheet items are assigned to one of several
broad risk classifications, according to the obligor or, if relevant, the
guarantor or the nature of collateral. The aggregate dollar value of the amount
in each risk classification is then multiplied by the risk weight associated
with that classification. The resulting weighted values from each of the risk
classification are added together. This total is the bank's total risk weighted
assets comprising the denominator of the risk-based capital ratio.
Risk weights for off-balance sheet items, such as unfunded loan
commitments, letters of credit and recourse arrangements, are determined by a
two-step process. First, the "credit equivalent amount" of the off-balance sheet
items is determined, in most cases by multiplying the off-balance sheet item by
a credit conversion factor. Second, the credit equivalent amount is treated like
any balance sheet asset and is assigned to the appropriate risk category
according to the obligor or, if relevant, the guarantor or the nature of the
collateral.
MINIMUM CAPITAL STANDARDS. The supervisory standards set forth below
specify minimum capital ratios based primarily on broad risk considerations. The
risk-based ratios do not take explicit account of the quality of individual
asset portfolios or the range of other types of risks to which banks may be
exposed, such as interest rate, liquidity, market or operational risks. For this
reason, banks are generally expected to operate with capital positions above the
minimum ratios.
All banks are required to meet a minimum ratio of qualifying total
capital to risk weighted assets of 8%. At least 4% must be in the form of Tier 1
capital, net of goodwill, and a minimum ratio of Tier 1 capital to risk weighted
assets of 4%. The maximum amount of supplementary capital elements that
qualifies as Tier 2 capital is limited to 100% of Tier 1 capital net of
goodwill. In addition, the combined maximum amount of subordinated debt and
intermediate-term preferred stock that qualifies as Tier 2 capital is limited to
50% of Tier 1 capital. The maximum amount of
31
the allowance for loan and lease losses that qualifies as Tier 2 capital is
limited to 1.25% of gross risk weighted assets. The allowance for loan and lease
losses in excess of this limit may, of course, be maintained, but would not be
included in a bank's risk-based capital calculation.
Federal banking agencies also require all banks to maintain a minimum
amount of Tier 1 capital to total assets, referred to as the leverage ratio. For
a bank rated in the highest of the five categories used by regulators to rate
banks, the minimum leverage ratio of Tier 1 capital to total assets is 3%. For
all banks not rated in the highest category, the minimum leverage ratio must be
at least 4% to 5%. These uniform risk-based capital guidelines and leverage
ratios apply across the industry. Regulators, however, have the discretion to
set minimum capital requirements for individual institutions which may be
significantly above the minimum guidelines and ratios.
OTHER FACTORS AFFECTING MINIMUM CAPITAL STANDARDS. The federal banking
agencies have established certain benchmark ratios of loan loss reserves to be
held against classified assets. The benchmark set forth by the policy statement
is the sum of:
o 100% of assets classified loss;
o 50% of assets classified doubtful;
o 15% of assets classified substandard; and
o estimated credit losses on other assets over the upcoming twelve
months.
The federal banking agencies have recently revised their risk-based
capital rules to take account of concentrations of credit and the risks of
non-traditional activities. Concentrations of credit refers to situations where
a lender has a relatively large proportion of loans involving a single borrower,
industry, geographic location, collateral or loan type. Non-traditional
activities are considered those that have not customarily been part of the
banking business, but are conducted by a bank as a result of developments in,
for example, technology, financial markets or other additional activities
permitted by law or regulation. The regulations require institutions with high
or inordinate levels of risk to operate with higher minimum capital standards.
The federal banking agencies also are authorized to review an institution's
management of concentrations of credit risk for adequacy and consistency with
safety and soundness standards regarding internal controls, credit underwriting
or other operational and managerial areas.
Further, the banking agencies recently have adopted modifications to
the risk-based capital rules to include standards for interest rate risk
32
exposure. Interest rate risk is the exposure of a bank's current and future
earnings and equity capital to adverse movements in interest rates. While
interest rate risk is inherent in a bank's role as financial intermediary, it
introduces volatility to bank earnings and to the economic value of the bank.
The banking agencies have addressed this problem by implementing changes to the
capital standards to include a bank's exposure to declines in the economic value
of its capital due to changes in interest rates as a factor that they will
consider in evaluating an institution's capital adequacy. A bank's interest rate
risk exposure is assessed by its primary federal regulator on an individualized
basis, and it may be required by the regulator to hold additional capital if it
has a significant exposure to interest rate risk or a weak interest rate risk
management process.
The federal banking agencies also limit the amount of deferred tax
assets that are allowable in computing a bank's regulatory capital. Deferred tax
assets that can be realized for taxes paid in prior carryback years and from
future reversals of existing taxable temporary differences are generally not
limited. However, deferred tax assets that can only be realized through future
taxable earnings are limited for regulatory capital purposes to the lesser of:
o the amount that can be realized within one year of the quarter-end
report date; or
o 10% of Tier 1 capital.
The amount of any deferred tax in excess of this limit would be excluded from
Tier 1 capital, total assets and regulatory capital calculations.
5. EXPANDED ENFORCEMENT POWERS
GENERAL. The Federal Deposit Insurance Corporation Improvement Act of
1991 ("FDICIA") recapitalized the FDIC's Bank Insurance Fund, granted broad
authorization to the FDIC to increase deposit insurance premium assessments and
to borrow from other sources, and continued the expansion of regulatory
enforcement powers, along with many other significant changes.
PROMPT CORRECTIVE ACTION. FDICIA established five categories of bank
capitalization: "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized," and "critically
undercapitalized" and mandated the establishment of a system of "prompt
corrective action" for institutions falling into the lower capital categories.
Under the regulations, a bank shall be deemed to be:
o "well capitalized" if it has a total risk-based capital ratio of
10.0% or more, has a Tier 1 risk-based capital ratio of 6.0%
33
or more, has a leverage capital ratio of 5.0% or more and is not
subject to specified requirements to meet and maintain a specific
capital level for any capital measure;
o "adequately capitalized" if it has a total risk-based capital ratio
of 8.0% or more, a Tier 1 risk-based capital ratio of 4.0% or more and
a leverage capital ratio of 4.0% or more (3.0% under certain
circumstances) and does not meet the definition of "well capitalized";
o "undercapitalized" if it has a total risk-based capital ratio that is
less than 8.0%, a Tier 1 risk-based capital ratio that is less than
4.0%, or a leverage capital ratio that is less than 4.0% (3.0% under
certain circumstances);
o "significantly undercapitalized" if it has a total risk-based capital
ratio that is less than 6.0%, a Tier 1 risk-based capital ratio that is
less than 3.0% or a leverage capital ratio that is less than 3.0%; and
o "critically undercapitalized" if it has a ratio of tangible equity to
total assets that is equal to or less than 2.0%.
Banks are prohibited from paying dividends or management fees to
controlling persons or entities if, after making the payment the bank would be
undercapitalized, that is, the bank fails to meet the required minimum level for
any relevant capital measure. Asset growth and branching restrictions apply to
undercapitalized banks, which are required to submit acceptable capital plans
guaranteed by its holding company, if any. Broad regulatory authority was
granted with respect to significantly undercapitalized banks, including forced
mergers, growth restrictions, ordering new elections for directors, forcing
divestiture by its holding company, if any, requiring management changes, and
prohibiting the payment of bonuses to senior management. Even more severe
restrictions are applicable to critically undercapitalized banks, those with
capital at or less than 2%, including the appointment of a receiver or
conservator after 90 days, even if the bank is still solvent. All of the federal
banking agencies have promulgated substantially similar regulations to implement
this system of prompt corrective action.
Information concerning the Bank's capital adequacy at December 31, 2000
is as follows (the Company's ratios and amounts are substantially the same):
34
AMOUNT TO BE
"WELL
MINIMUM CAPITALIZED"
AMOUNT FOR UNDER PROMPT
CAPITAL MINIMUM CORRECTIVE
ACTUAL ADEQUACY REGULATORY ACTION
AMOUNT RATIO PURPOSES RATIO PROVISIONS RATIO
THE BANK: (DOLLARS IN THOUSANDS)
Total Capital (To Risk-
Weighted Assets).............. $25,748 10.9% $18,892 8.0% $23,615 10.0%
Tier 1 Capital (To Risk-
Weighted Assets).............. 22,776 9.6 9,446 4.0 14,169 6.0
Leverage Ratio (Tier 1 Capital
To Average Assets)............ 22,776 7.4 11,290 4.0 14,112 5.0
FDICIA and the implementing regulations also provide that a federal
banking agency may, after notice and an opportunity for a hearing, reclassify a
well capitalized institution as adequately capitalized and may require an
adequately capitalized institution or an undercapitalized institution to comply
with supervisory actions as if it were in the next lower category if the
institution is in an unsafe or unsound condition or engaging in an unsafe or
unsound practice. The FDIC may not, however, reclassify a significantly
undercapitalized institution as critically undercapitalized.
OPERATIONAL STANDARDS. FDICIA also granted the regulatory agencies
authority to prescribe standards relating to internal controls, credit
underwriting, asset growth and compensation, among others, and required the
regulatory agencies to promulgate regulations prohibiting excessive compensation
or fees. Many regulations have been adopted by the regulatory agencies to
implement these provisions and subsequent legislation (see -"6. Riegle Community
Development and Regulatory Improvement Act of 1994" herein) gave the regulatory
agencies the option of prescribing the safety and soundness standards as
guidelines rather than regulations.
BROKERED DEPOSITS. Effective June 16, 1992, FDICIA placed restrictions
on the ability of banks to obtain brokered deposits or to solicit and pay
interest rates on deposits that are significantly higher than prevailing rates.
FDICIA provides that a bank may not accept, renew or roll over brokered deposits
unless: (i) it is "well capitalized"; or (ii) it is adequately capitalized and
receives a waiver from the FDIC permitting it to accept brokered deposits paying
an interest rate not in excess of 75 basis points over certain prevailing market
rates. FDIC regulations define brokered deposits to include any deposit
obtained, directly or indirectly, from any person engaged in the business of
placing deposits with, or selling interests in deposits of, an insured
depository
35
institution, as well as any deposit obtained by a depository institution that is
not "well capitalized" for regulatory purposes by offering rates significantly
higher (generally more than 75 basis points) than the prevailing interest rates
offered by depository institutions in such institution's normal market area. In
addition to these restrictions on acceptance of brokered deposits, FDICIA
provides that no pass-through deposit insurance will be provided to employee
benefit plan deposits accepted by an institution which is ineligible to accept
brokered deposits under applicable law and regulations.
LENDING. New regulations were issued in the area of real estate
lending, prescribing standards for extensions of credit that are secured by real
property or made for the purpose of the construction of a building or other
improvement to real estate. In addition, the aggregate of all loans to executive
officers, directors and principal shareholders and related interests may now not
exceed 100% (200% in some circumstances) of the depository institution's
capital.
ACTIVITIES OF STATE BANKS. FDICIA imposed restrictions on the
activities of state-chartered banks which are otherwise authorized under state
law. Generally, FDICIA restricts investments and activities of state banks,
either directly or through subsidiaries, to those permissible for national
banks, unless the FDIC has determined that such activities would not pose a risk
to the insurance find of which the bank is a member and the bank is also in
compliance with applicable capital requirements. This restriction effectively
eliminated real estate investments authorized under California law.
6. RIEGLE COMMUNITY DEVELOPMENT AND REGULATORY IMPROVEMENT ACT OF 1994
The Riegle Community Development and Regulatory Improvement Act of 1994
(the "1994 Act") provides for funding for the establishment of a Community
Development Financial Institutions Fund (the "Fund"), which provides assistance
to new and existing community development lenders to help to meet the needs of
low- and moderate-income communities and groups. The 1994 Act also mandated
changes to a wide range of banking regulations. These changes included:
o less frequent regulatory examination schedules for small
institutions;
o amendments to the money laundering and currency transaction reporting
requirements of the Bank Secrecy Act; and
o amendments to the Truth in Lending Act to provide greater
36
protection for consumers by reducing discrimination against the
disadvantaged.
The "Paperwork Reduction and Regulatory Improvement Act," Title III of
the 1994 Act, required the federal banking agencies to consider the
administrative burdens that new regulations will impose before their adoption
and required a transition period in order to provide adequate time for
compliance. This Act also required the federal banking agencies to work together
to establish uniform regulations and guidelines as well as to work together to
eliminate duplicative or unnecessary requests for information in connection with
applications or notices. The Paperwork Reduction and Regulatory Improvement Act
also amended the BHCA and Securities Act of 1933 to simplify the formation of
bank holding companies.
7. SAFETY AND SOUNDNESS STANDARDS
The federal banking agencies have also adopted uniform guidelines
establishing standards for safety and soundness. The guidelines set forth
operational and managerial standards relating to internal controls, information
systems and internal audit systems, loan documentation, credit underwriting,
interest rate exposure, asset growth and compensation, fees and benefits and
asset quality and earnings. The guidelines establish the safety and soundness
standards that the agencies will use to identify and address problems at insured
depository institutions before capital becomes impaired. If an institution fails
to comply with a safety and soundness standard, the appropriate federal banking
agency may require the institution to submit a compliance plan. Failure to
submit a compliance plan or to implement an accepted plan may result in
enforcement action.
The federal banking agencies issued regulations prescribing uniform
guidelines for real estate lending. The regulations require insured depository
institutions to adopt written policies establishing standards, consistent with
such guidelines, for extensions of credit secured by real estate. The policies
must address loan portfolio management, underwriting standards and loan to value
limits that do not exceed the supervisory limits prescribed by the regulations.
Appraisals for "real estate related financial transactions" must be
conducted by either state certified or state licensed appraisers for
transactions in excess of certain amounts. State certified appraisers are
required for all transactions with a transaction value of $1,000,000 or more;
for all nonresidential transactions valued at $250,000 or more; and for
"complex" 1-4 family residential properties of $250,000 or more. A state
licensed appraiser is required for all other appraisals. However, appraisals
performed in connection with "federally related transactions" must now comply
with the agencies' appraisal standards. Federally related transactions include
the sale, lease, purchase, investment in, or exchange
37
of, real property or interests in real property, the financing or refinancing of
real property, and the use of real property or interests in real property as
security for a loan or investment, including mortgage-backed securities.
8. CONSUMER PROTECTION LAWS AND REGULATIONS
The bank regulatory agencies are focusing greater attention on
compliance with consumer protection laws and their implementing regulations.
Examination and enforcement have become more intense in nature, and insured
institutions have been advised to monitor carefully compliance with various
consumer protection laws and their implementing regulations. In addition to the
consumer privacy protections enacted pursuant to the GLB Act, banks are subject
to many other federal consumer protection laws and their regulations including,
but not limited to, the Community Reinvestment Act, the Truth in Lending Act
(the "TILA"), the Fair Housing Act (the "FH Act"), the Equal Credit Opportunity
Act (the "ECOA"), the Home Mortgage Disclosure Act ("HMDA"), and the Real Estate
Settlement Procedures Act ("RESPA").
The CRA is intended to encourage insured depository institutions, while
operating safely and soundly, to help meet the credit needs of their
communities. The CRA specifically directs the federal bank regulatory agencies,
in examining insured depository institutions, to assess their record of helping
to meet the credit needs of their entire community, including low- and
moderate-income neighborhoods, consistent with safe and sound banking practices.
The CRA further requires the agencies to take a financial institution's record
of meeting its community credit needs into account when evaluating applications
for, among other things, domestic branches, consummating mergers or
acquisitions, or holding company formations.
The federal banking agencies have adopted regulations which measure a
bank's compliance with its CRA obligations on a performance-based evaluation
system. This system bases CRA ratings on an institution's actual lending service
and investment performance rather than the extent to which the institution
conducts needs assessments, documents community outreach or complies with other
procedural requirements. The ratings range from a high of "outstanding" to a low
of "substantial noncompliance."
The ECOA prohibits discrimination in any credit transaction, whether
for consumer or business purposes, on the basis of race, color, religion,
national origin, sex, marital status, age (except in limited circumstances),
receipt of income from public assistance programs, or good faith exercise of any
rights under the Consumer Credit Protection Act. In March, 1994, the Federal
Interagency Task Force on Fair Lending issued a policy statement on
discrimination in lending. The policy statement
38
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. This means that if a creditor's
actions have had the effect of discriminating, the creditor may be held liable
- -- even when there is no intent to discriminate.
The FH Act regulates may practices, including making it unlawful for
any lender to discriminate in its housing-related lending activities against any
person because of race, color, religion, national origin, sex, handicap, or
familial status. The FH Act is broadly written and has been broadly interpreted
by the courts. A number of lending practices have been found to be, or may be
considered illegal under the FH Act, including some that are not specifically
mentioned in the FH Act itself. Among those practices that have been found to
be, or may be considered illegal under the FH Act are: declining a loan for the
purposes of racial discrimination; making excessively low appraisals of property
based on racial considerations; pressuring, discouraging, or denying
applications for credit on a prohibited basis; using excessively burdensome
qualifications standards for the purpose or with the effect of denying housing
to minority applicants; imposing on minority loan applicants more onerous
interest rates or other terms, conditions or requirements; and; racial steering,
or deliberately guiding potential purchasers to or away from certain areas
because of race.
The TILA is designed to ensure that credit terms are disclosed in a
meaningful way so that consumers may compare credit terms more readily and
knowledgeably. As a result of the TILA, all creditors must use the same credit
terminology and expressions of rates, the annual percentage rate, the finance
charge, the amount financed, the total payments and the payment schedule.
HMDA grew out of public concern over credit shortages in certain urban
neighborhoods. One purpose of HMDA is to provide public information that will
help show whether financial institutions are serving the housing credit needs of
the neighborhoods and communities in which they are located. HMDA also includes
a "fair lending" aspect that requires the collection and disclosure of data
about applicant and borrower characteristics as a way of identifying possible
discriminatory lending patterns and enforcing anti-discrimination statutes. HMDA
requires institutions to report data regarding applications for one-to-four
family loans, home improvement loans, and multifamily loans, as well as
information concerning originations and purchases of such types of loans.
Federal bank regulators rely, in part, upon data provided under HMDA to
determine whether depository institutions engage in discriminatory lending
practices.
RESPA requires lenders to provide borrowers with disclosures regarding
the nature and costs of real estate settlements. Also, RESPA prohibits
39
certain abusive practices, such as kickbacks, and places limitations on the
amount of escrow accounts.
Violations of these various consumer protection laws and regulations
can result in civil liability to the aggrieved party, regulatory enforcement
including civil money penalties, and even punitive damages.
9. RECENT CALIFORNIA DEVELOPMENTS
Effective January 1, 1998, California legislation eliminated the
provisions regarding impairment of contributed capital and the assessment of
shares when there is an impairment in capital and added as additional grounds to
close a bank, if the Commissioner finds that the bank's tangible shareholders'
equity is less than the greater of 3% of the bank's total assets or $1 million.
In addition, California law provides the Commissioner with certain
additional enforcement powers. For example, if it appears to the Commissioner
that a bank is violating its articles of incorporation or state law, or is
engaging in unsafe or unsound business practices, the Commissioner can order the
bank to comply with the law or to cease the unsafe or injurious practices or the
Commissioner can close the bank. The Commissioner also has the power to suspend
or remove the bank's officers, directors and employees who: (i) violate any law,
regulation or fiduciary duty to the bank; (ii) engage in any unsafe or unsound
practices related to the business of the bank; or (iii) are charged with or
convicted of a crime involving dishonesty or breach of trust.
10. CONCLUSION
As a result of the recent federal and California legislation, including
the GLB Act, there has been a competitive impact on commercial banking in
general and the business of the Company and the Bank in particular. There has
been a lessening of the historical distinction between the services offered by
banks, savings and loan associations, credit unions, securities dealers,
insurance companies, and other financial institutions. Banks have also
experienced increased competition for deposits and loans which may result in
increases in their cost of funds, and banks have experienced increased overall
costs. Further, the federal banking agencies have increased enforcement
authority over bank holding companies, banks and their directors and officers.
Future legislation is also likely to impact the Company's business.
Consumer legislation has been proposed in Congress which may require banks to
offer basic, low-cost, financial services to meet minimum consumer needs.
Further, the regulatory agencies have proposed and may propose a
40
wide range of regulatory changes, including the calculation of capital adequacy
and limiting business dealings with affiliates. These and other legislative and
regulatory changes may have the impact of increasing the cost of doing business
or otherwise impacting the earnings of financial institutions. However, the
degree, timing and full extent of the impact of these proposals cannot be
predicted. Management of the Company and the Bank cannot predict what other
legislation might be enacted or what other regulations might be adopted or the
effects thereof.
The foregoing summary of the relevant laws, rules and regulations
governing banks and bank holding companies do not purport to be a complete
summary of all applicable laws, rules and regulations governing banks and bank
holding companies.
IMPACT OF MONETARY POLICIES
Banking is a business which depends on rate differentials. In general,
the difference between the interest rate paid by the Bank on its deposits and
its other borrowings and the interest rate earned by the Bank on loans,
securities and other interest-earning assets will comprise the major source of
the Company's earnings. These rates are highly sensitive to many factors which
are beyond the Company's and the Bank's control and, accordingly, the earnings
and growth of the Bank are subject to the influence of economic conditions
generally, both domestic and foreign, including inflation, recession, and
unemployment; and also to the influence of monetary and fiscal policies of the
United States and its agencies, particularly the FRB. The FRB implements
national monetary policy, such as seeking to curb inflation and combat
recession, by its open-market dealings in United States government securities,
by adjusting the required level of reserves for financial institutions subject
to reserve requirements, by placing limitations upon savings and time deposit
interest rates, and through adjustments to the discount rate applicable to
borrowings by banks which are members of the Federal Reserve System. The actions
of the FRB in these areas influence the growth of bank loans, investments, and
deposits and also affect interest rates. The nature and timing of any future
changes in such policies and their impact on the Company or the Bank cannot be
predicted; however, depending on the degree to which the Bank's interest-earning
assets and interest-bearing liabilities are rate sensitive, increases in rates
would have the temporary effect of increasing their net interest margin, while
decreases in interest rates would have the opposite effect.
In addition, adverse economic conditions could make a higher provision
for loan losses more prudent and could cause higher loan charge-offs, thus
adversely affecting the Company's net income.
41
PRODUCT DEVELOPMENT RESEARCH
The Company has not engaged in any material research activities
relating to the development of new services or the improvement of existing
banking services during the last three fiscal years. The officers and employees
of the Bank are continually engaged in marketing activities, however, including
the evaluation and development of new services, to enable the Bank to retain a
competitive position in the service area.
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY
The following table shows the average balances of the Bank's assets,
liabilities, and shareholders' equity for the past two years:
For Period Ended
December 31,
2000 1999
-------- --------
(Dollars in Thousands)
Assets
Cash and Due From Banks......... $ 15,526 $ 12,354
Time Deposits with Other
Financial Institutions.......... 3,397 7,571
Investment Securities........... 21,904 68,976
Funds Sold...................... 23,706 29,579
Net Loans....................... 177,143 100,303
Other Assets.................... 7,867 4,022
-------- --------
Total...................... $249,543 $222,805
======== ========
Liabilities & Shareholders' Equity
Deposits:
Demand (non-interest
bearing)................... $ 77,461 $ 63,470
Savings.................... 1,885 1,809
42
Money Market Accounts...... 98,488 85,120
Time....................... 45,039 47,269
-------- --------
Total Deposits........ 222,873 197,668
Securities Sold Under
Agreements to Repurchase........ 888 579
Other Liabilities............... 2,877 2,356
-------- --------
Total Liabilities.......... 226,638 200,603
-------- --------
Shareholders' Equity............ 22,905 22,202
-------- --------
Total...................... $249,543 $222,805
======== ========
INTEREST RATES AND INTEREST DIFFERENTIAL
The following table sets forth the average balances outstanding for
major categories of interest earning assets and interest bearing liabilities and
the average interest rates earned and paid thereon:
For Period Ended December 31,
2000 1999
-------------------------------- ---------------------------------
Interest Average Interest Average
Average Income(2)/ Yield/ Average Income(2)/ Yield/
Balance Expense Rate % Balance Expense Rate %
------- ---------- ------- -------- ---------- -------
(Dollars in Thousands)
Interest
Earning
Assets:
Loans(1) $180,262 $19,446 10.8% $102,633 $9,910 9.7%
Investment
Securities 21,904 1,460 6.7% 68,976 3,455 5.0%
Funds Sold 23,706 1,451 6.1% 29,579 1,486 5.0%
Time Deposits
With Other
Financial
Institutions 3,397 220 6.5% 7,571 406 5.4%
-------- ------- ---- -------- ------ ---
43
2000 1999
--------------------------------- ---------------------------------
Interest Average Interest Average
Average Income(2)/ Yield/ Average Income(2)/ Yield/
Balance Expense Rate % Balance Expense Rate %
------- ---------- ------ ------- --------- ------
(Dollars in Thousands)
Total
Interest
Earning
Assets $229,269 $22,577 9.8% $208,759 $15,257 7.3%
======== ======= ======== =======
Interest
Bearing
Liabilities:
Savings
deposits $1,885 $50 2.7% $1,809 $50 2.8%
Money
Market
Accounts 98,488 2,510 2.5% 85,120 2,156 2.5%
Time 45,039 2,455 5.5% 47,269 2,238 4.7%
Securities
sold under
agreements
to repur-
chase $888 $15 1.7% $579 $17 2.9%
-------- ------ -------- ------
Total
interest
bearing
liabili-
ties $146,300 $5,030 3.4% $134,777 $4,461 3.3%
======== ======= ======== =======
- ----------
(1) This figure reflects total loans, including non-accrual loans, and is
not net of the allowance for possible losses, which had an average
balance of $3,119,000 in 2000 and $2,330,000 in 1999.
(2) Includes loan fees of $1,219,000 in 2000 and $803,000 in 1999.
The following table shows the net interest earnings and the net yield
on average interest earning assets:
2000 1999
---------- ----------
(Dollars in Thousands)
44
Total interest income (1).................. $ 22,577 $ 15,257
Total interest expense..................... 5,030 4,461
-------- --------
Net interest earnings...................... $ 17,547 $ 10,796
======== ========
Average interest earning assets............ $229,269 $208,759
Net yield on average interest earning
assets..................................... 7.7% 5.2%
- ----------
(1) Includes loan fees of $1,219,000 in 2000 and $803,000 in 1999.
The following table sets forth changes in interest income and interest
expense. The net change as shown in the column "Net Increase (Decrease)" is
segmented into the change attributable to variations in volume and the change
attributable to variations in interest rates. Non-performing loans are included
in average loans.
Increase (Decrease) Increase (Decrease)
2000 OVER 1999 1999 OVER 1998
-------------------------------- --------------------------------
Volume Rate Net Volume Rate Net
(Dollars in Thousands)
INTEREST INCOME(1)
Loans (2) ........ $8,256 $1,280 $9,536 $1,904 $(511) $1,393
Investment
securities ....... (3,871) 1,876 (1,995) 1,832 (143) 1,689
Funds sold ....... 351 (386) (35) (234) (88) (322)
Interest on time
deposits with
other financial
institutions ..... (298) 112 (186) (86) (29) (115)
------- ------- ------- ------- ------- -------
Increase (Decrease) Increase (Decrease)
2000 OVER 1999 1999 OVER 1998
-------------------------------- --------------------------------
Volume Rate Net Volume Rate Net
(Dollars in Thousands)
Total
Interest
Earning
Assets $ 4,438 $ 2,882 $7,320 $ 3,416 $ (771) $ 2,645
======= ======= ======= ======= ======= =======
45
INTEREST EXPENSE (1)
Savings $ 0 $ 0 $ 0 $ 8 $ 5 $ 13
Money market 341 13 354 474 138 612
Time (98) 315 217 525 (143) 382
Securities
sold under
agreements to
repurchase (10) 8 (2) 14 0 14
------- ------- ------ ------- ------- -------
Total interest
bearing liab-
ilities $ 232 $ 337 $ 569 $ 1,021 $ 0 $ 1,021
======= ======= ====== ======= ======= =======
- ----------
(1) The change in interest due to both rate and volume has been allocated
to the change due to volume and the change due to rate in proportion to
the relationship of the absolute dollar amounts of the change in each.
(2) Includes loan fees of $1,219,000 in 2000 and $803,000 in 1999.
INVESTMENT SECURITIES
The following table shows fair value of the investment securities
portfolio at December 31, 2000 and 1999:
December 31,
2000 1999
------ -------
(Dollars in Thousands)
U.S. Treasury Securities................... $ 1,000 $ 5,007
Obligations of U.S. Government
Agencies and Corporations.................. 1,985 3,447
Commercial Paper........................... 0 44,335
------ -------
Total................................. $2,985 $52,789
====== =======
46
The maturity schedule and weighted average yields of investment
securities at December 31, 2000 is as follows:
AVERAGE
AMOUNT YIELD
------ --------
(Dollars in Thousands)
U.S. TREASURY SECURITIES
One year or less ........................................... $1,000 6.31%
Over one year .............................................. 0 0.00%
------
Category total .................................... $1,000 6.31%
U.S. AGENCY SECURITIES
One year or less ........................................... $1,985 6.59%
Over one year ............................................. 0 0.00%
------
Category total .................................... $1,985 6.59%
COMMERCIAL PAPER
One year or less ........................................... $ 0 0.00%
Over one year .............................................. 0 0.00%
------
Category total $ 0 0.00%
TOTAL INVESTMENT PORTFOLIO
One year or less ........................................... $2,985 6.49%
Over one year through five years ........................... 0 0.00%
Over five years ............................................ 0 0.00%
------
Total $2,985 6.49%
======
LOAN PORTFOLIO
The loan portfolio consisted of the following at December 31, 2000 and
1999:
47
2000 1999
---- ----
(Dollars in Thousands)
Commercial loans ....................... $ 68,927 $ 42,789
Real estate construction loans ......... 53,352 19,267
Real estate loans ...................... 78,809 56,741
Government guaranteed loans ............ 35,047 5,084
Other loans ............................ 1,011 961
-------- --------
Total loans .................... $237,146 $124,842
Less - Allowances for loan losses ... 4,600 2,300
- Deferred loan fees ........... 989 726
-------- --------
Net loans ...................... $231,557 $116,732
======== ========
LOAN MATURITIES AND INTEREST RATES
The following table shows the amounts of total loans outstanding as of
December 31, 2000, which, based on remaining scheduled payments of principal,
are due in one year or less, more than one year but less than five years, more
than five years but less than ten years, and ten years or more. The amount due
for each interval is classified according to whether the interest rate floats in
response to changes in interest rates or is fixed.
Aggregate maturities of loan balances which are due:
In one year or less:
Interest rates are floating or
adjustable....................... $128,112
Interest rates are fixed or
predetermined.................... 1,670
After one year but within five years:
Interest rates are floating or
adjustable....................... 72,463
Interest rates are fixed or
48
predetermined.................... 733
After five years but within ten years:
Interest rates are floating or
adjustable....................... 26,310
Interest rates are fixed or
predetermined.................... 0
After ten years or more:
Interest rates are floating or
adjustable....................... 7,857
Interest rates are fixed or
predetermined.................... 0
--------
Total...................................... $237,146
========
NON-PERFORMING LOANS
The current policy is to cease accruing interest on commercial, real
estate and installment loans which are past due as to principal or interest 90
days or more, except that in certain circumstances interest accruals are
continued on loans deemed by management to be fully collectible.
The following table shows the principal amount of non-performing loans
as of December 31, 2000 and 1999:
December 31,
2000 1999
------ ------
(Dollars in Thousands)
Non-accrual loans
Commercial .................... $ 29 $ 129
Real estate loans ............. 0 0
Government guaranteed loans ... 0 0
Bankers acceptances ........... 0 0
49
Other loans ................... 0 0
------ ------
Total ................ $ 29 $ 129
====== ======
Accruing loans past due more than 90 days
Commercial .................... $1,822 $ 0
Real estate loans ............. 0 0
Government guaranteed loans ... 0 0
Bankers acceptances ........... 0 0
Other loans ................... 0 0
------ ------
Total ................ $1,822 $ 0
====== ======
Except as may have been included in the above table, at December 31,
2000, there were no loans, the terms of which had been renegotiated to provide a
reduction or deferral of interest or principal because of a deterioration of the
financial position of the borrower or which would be classified as restructured
debt in a troubled loan situation. In addition, at December 31, 2000, there were
no loans then current as to which there were serious doubts as to the ability of
the borrower to comply with the then-present loan repayment terms. For the
non-accrual loans listed in the above table, the Bank would have realized
additional gross interest income of $8,000 in 2000 had the loans been current in
accordance with their original terms.
SUMMARY OF LOAN LOSS EXPERIENCE
The following table provides information concerning changes in the
allowance for possible loan losses and loans charged off and recovered for 2000
and 1999:
2000 1999
-------- --------
(Dollars in Thousands)
Amount of loans outstanding at end of
period ................................. $237,146 $124,842
======== ========
Average amount of loans outstanding
before allowance for loan losses ....... $180,262 $102,633
======== ========
50
Balance of allowance for loan losses at
beginning of period .................... $ 2,300 $ 2,500
Loans charged off:
Commercial .................... 0 0
Real estate ................... 0 46
Government guaranteed loans ... 0 0
Bankers acceptances ........... 0 0
Other ......................... 0 0
-------- -------
Total loans charged off .. 0 46
Recoveries of loans previously charged off:
2000 1999
------- -------
(Dollars in Thousands)
Commercial .................... 16 10
Real estate ................... 80 42
Government guaranteed loans ... 0 0
Bankers acceptances ........... 0 0
Other ......................... 0 0
------- -------
Total loan recoveries .... 96 52
------- -------
Net loans (recovered) charged off ...... (96) (6)
--------- ------
Provisions charged to operating expense 2,204 (206)
------- --------
Balance of allowance for possible loan
losses at end of period ................ $ 4,600 $ 2,300
======= =======
The ratio of net loans charged off to average loans outstanding was
(0.000)% and (0.006)% for the two years ended December 31, 2000 and 1999,
respectively.
The Bank has historically evaluated the adequacy of its allowance for
possible loan losses on an overall basis rather than by specific categories of
loans. In determining the adequacy of the allowance for possible loan losses,
management considers such factors as historical loan loss experience, known
problem loans, evaluations made by bank regulatory authorities, assessment of
economic conditions and other appropriate data to identify the risks in the loan
portfolio.
For the purposes of this report, the allowance for possible loan
51
losses has been allocated to the major categories of loans as set forth in the
following table. The allocations are estimates based upon historical loss
experience and management judgment. The allowance for possible loan losses
should not be interpreted as an indication that charge-offs will occur in these
amounts or proportions, or that the allocation indicates future charge-off
trends. Furthermore, the portion allocated to each loan category is not the
total amount available for future losses that might occur within such
categories, since even in this allocation is an unallocated portion, and, as
previously stated, the total allowance is applicable to the entire portfolio.
2000 1999
---- ----
ALLOWANCE RATIO OF ALLOWANCE RATIO OF
FOR LOANS TO FOR LOANS TO
POSSIBLE TOTAL POSSIBLE TOTAL
LOAN LOSSES LOANS LOAN LOSSES LOANS
----------- -------- ----------- --------
Commercial loans ... $1,404 29% $ 714 34%
Real estate loans .. 2,648 56% 1,397 61%
Gov't guaranteed ... 0 4% 0 4%
Bankers acceptances 0 0% 0 0%
Other loans ........ 3 0% 4 1%
Unallocated ........ 545 0% 185 0%
------ ---- ------ ----
Total ......... $4,600 100% $2,300 100%
====== ==== ====== ====
DEPOSITS
The average amounts of deposits for the periods indicated are
summarized below.
2000 1999
---- ----
(Dollars in Thousands)
Demand Deposits ............... $ 77,461 $ 63,470
Savings deposits, money market and
time certificates of deposit of less
than $100,000 ................. 114,556 103,645
Time certificates of deposit of
$100,000 or more .............. 30,856 30,553
-------- --------
Total ................ $222,873 $197,668
======== ========
52
The maturity schedule of time certificates of deposit of $100,000 or
more at December 31, 2000 is as follows:
DECEMBER 31, 2000
-----------------
(Dollars in Thousands)
3 months or less.......................... $35,437
Over 3 through 6 months................... 3,553
Over 6 through 12 months.................. 4,219
Over 12 months............................ 100
-------
Total............................ $43,309
=======
SELECTED FINANCIAL RATIOS
The following table sets forth the ratios of net income to average
total assets and to average shareholders' equity, and average shareholders'
equity to average total assets.
2000 1999
---- ----
Return on assets...................... 1.0% 0.8%
Return on equity...................... 10.5% 7.8%
Dividend payment ratio................ 0.0% 0.0%
Equity to assets ratio................ 9.2% 10.0%
ITEM 2. PROPERTIES
The Bank's head office is located on the ground and eighth floors of an
office building located at 1801 Century Park East, Los Angeles, California. The
Bank has leased approximately 3,735 square feet of ground
53
floor office space and approximately 8,256 square feet of eighth floor office
space under a lease which expires on February 28, 2003. The Bank has an option
to extend the term of the lease for an additional five years. The total monthly
rental for the premises is $29,400 for the period from March, 1993 through
February, 1998, and $35,280 for the period from March, 1998 through February,
2003, subject to annual adjustments for increases in property taxes and other
operating costs. At the end of 1994, the Bank elected to apply the unused tenant
improvement allowance of $224,000 against its future lease payments. Payment of
the allowance was made to the Bank over a 15-month period beginning February 1,
1995. The Bank is deferring recognition of this amount and amortizing it evenly
over the lease term.
The Bank also subleases an office on the eight floor of the same office
building consisting of approximately 4,999 square feet. The premises are
provided under a lease which expires December 31, 2003 at a monthly rental of
$10,998 plus a proportionate share of the building's operating costs.
The Bank's Merchant Services division is located at 28310 Roadside
Drive, Suite 250, Agoura Hills, California. The premises consist of
approximately 2,010 square feet which are provided under a lease which expires
on October 31, 2002. The total monthly rental is $2,754, subject to annual
adjustments of 4% and various operating costs.
The Bank also subleases an office in an executive suite facility to
house its Orange County Regional Office. The office is located at 2030 Main
Street, Irvine, California, and consists of approximately 1440 square feet. The
premises are provided under a lease which expires November 3, 2001 at a monthly
rental of $4,464 plus a proportionate share of the building's operating costs.
The Bank also leases an office located at 501 Santa Monica Boulevard,
Suite 403, Santa Monica, California to house its Santa Monica Regional Office.
The premises consisting of approximately 1,984 square feet are provided under a
lease which expires July 31, 2004 at a rental of $4,602 per month, subject to
annual adjustments and various operating costs.
The Bank's South Bay Region Office is located at 990 West 190th Street,
Suite 350, Torrance, California. The premises consist of approximately 2,209
square feet which are provided under a lease which expires on June 30, 2005. The
total monthly rental is $4,086, subject to annual adjustments and various
operating costs.
The Bank also leases an office located at 5950 La Place Court, Suite
160, Carlsbad, California to house Trust Administration Services Corp. The
premises consisting of approximately 4,294 square feet are provided under a
lease which expires January 31, 2004 at a rental of $6,870 per month,
54
subject to annual adjustments and various operating costs.
The Bank's Glendale Regional Office is located at 655 North Central
Avenue, Suite 1500, Glendale, California. The premises consist of approximately
2,812 square feet which are provided under a lease which expires on June 14,
2005. The total monthly rental is $7,030, subject to annual adjustments and
various operating costs.
The Bank also leases an office located at 16830 Ventura Blvd, Suite
202, Encino, California to house the Encino Regional Office. The premises
consisting of approximately 2,930 square feet are provided under a lease which
expires June 30, 2005 at a rental of $6,446 per month, subject to annual
adjustments and various operating costs.
ITEM 3. LEGAL PROCEEDINGS
LITIGATION
In the normal course of business, the Company and the Bank are involved
in litigation. Management does not expect the ultimate outcome of any pending
litigation to have a material effect on the Company's financial position or
results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 2000, no matters were submitted to a vote
of the Company's shareholders.
55
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
SECURITIES ACTIVITY
The common stock of First Regional Bancorp is traded on The Nasdaq Stock Market
under the trading symbol FRGB. Quotations are carried either daily or weekly by
newspapers throughout the nation including The Wall Street Journal and the Los
Angeles Times. The following table summarizes the quotations reported by Nasdaq
of First Regional Bancorp's common stock.
2000 1999
---- ----
HIGH LOW HIGH LOW
---- --- ---- ---
1st Quarter 7 1/2 6 1/2 8 3/4 7 1/2
2nd Quarter 8 1/2 6 5/8 8 3/4 6 1/8
3rd Quarter 8 3/8 6 7/8 9 1/4 7 3/8
4th Quarter 8 3/8 7 8 7
DIVIDENDS
The Company has not paid any cash dividends and it is the Company's
Board of Directors' intention that no cash dividends be declared by the Company
during this stage of the Company's development. The Board of Directors intends
to increase the Company's capital and to pay cash dividends only when it is
prudent to do so and the Company's performance justifies such action.
The Company is a legal entity separate and distinct from its
subsidiaries, and has not engaged in any activities other than acting as a
holding company. Accordingly, the Company's principal source of funds, including
funds available for payment of cash dividends to its shareholders, have and will
consist of dividends paid and other funds advanced to the Company by its
subsidiaries. As described below, statutory and regulatory requirements impose
limitations on the amounts of dividends payable by the Bank to the Company and
on extensions of credit by the Bank to the Company.
Holders of the Company's Common Stock are entitled to receive dividends
as and when declared by the Board of Directors out of funds legally available
therefore under the laws of the State of California. Under California law, the
Company would be prohibited from paying dividends unless: (1) its retained
earnings immediately prior to the dividend payment
56
equals or exceeds the amount of the dividend; or (2) immediately after giving
effect to the dividend (i) the sum of the Company's assets would be at least
equal to 125% of its liabilities, and (ii) the current assets of the Company
would be at least equal to its current liabilities, or, if the average of its
earnings before taxes on income and before interest expense for the two
preceding fiscal years was less than the average of its interest expense for the
two preceding fiscal years, at least 125% of its current liabilities.
Prior to the consummation of the reorganization of the Bank, the Bank
did not pay any cash dividends to its shareholders. It is the Bank's Board of
Directors' current intention to retain most of the Bank's earnings to increase
its capital, although the Bank may pay cash dividends to the Company as its
current sole shareholder subject to regulation and when deemed prudent. The Bank
paid dividends to the Company of $550,000, $2,00,000 and $100,000 in 2000, 1999
and 1998.
RESTRICTIONS ON TRANSFER OF FUNDS TO THE COMPANY BY THE BANK
The Company is a legal entity separate and distinct from the Bank. It
is anticipated that the Company may eventually receive sufficient income to fund
its operating expenses through the payment of management fees by its
subsidiaries. However, if the Company requires significant amounts of cash,
including funds available for the payment of dividends and extraordinary
operating expenses, such funds initially will be received as dividends paid by
the Bank. Subject to the regulatory restrictions described below, future cash
dividends by the Bank to the Company also will depend upon Management's
assessment of the Bank's future capital requirements, contractual restrictions
and other factors.
In addition, there are statutory and regulatory limitations on the
amount of dividends which may be paid to the Company by the Bank. Under
California law, funds available for cash dividend payments by a bank are
restricted to the lesser of: (i) retained earnings or (ii) the bank's net income
for its last three fiscal years (less any distributions to shareholders made
during such period). Cash dividends may also be paid out of net income for a
bank's last preceding fiscal year upon the prior approval of the California
Commissioner of Financial Institutions, without regard to retained earnings or
net income for its last three fiscal years. If the Commissioner of Financial
Institutions finds that the shareholders' equity of a bank is not adequate or
that the payment of a dividend would be unsafe or unsound for the bank, the
Commissioner may order the bank not to pay any dividend to its shareholders.
Moreover, in a policy statement adopted in November, 1985, the Federal
Reserve Board advised banks and bank holding companies that payment of cash
dividends in excess of current earnings from operations is inappropriate and may
be cause for supervisory action. As a result of this new policy, banks
57
and their holding companies may find it difficult to pay dividends out of
retained earnings from historical periods prior to the most recent fiscal year
or to take advantage of earnings generated by extraordinary items such as sales
of buildings, other large assets, or business segments in order to generate
profits to enable payment of future dividends.
Under the Financial Institutions Supervisory Act, the FDIC also has
authority to prohibit a bank from engaging in business practices which the FDIC
considers to be unsafe or unsound. It is possible, depending upon the financial
condition of the bank in question and other factors, that the FDIC could assert
that the payment of dividends or other payments might under some circumstances
be such an unsafe or unsound practice.
In addition, the Bank is subject to certain restrictions imposed by
federal law on any extensions of credit to the Company or other affiliates,
investments in stock or other securities thereof, and taking of such securities
as collateral for loans. Such restrictions prevent the Company and such other
affiliates from borrowing from the Bank unless the loans are secured by
marketable obligations of designated amounts.
ITEM 6. SELECTED FINANCIAL DATA
The balances of selected balance sheet components as of December 31 of
each of the past five years were as follows:
2000 1999 1998 1997 1996
-------- -------- -------- -------- --------
Total assets $306,079 $233,033 $193,884 $162,445 $152,449
Net loans 231,557 121,816 91,701 78,720 87,602
Investment securities 3,084 59,712 58,003 33,057 32,059
Funds sold 38,740 37,090 31,900 38,390 22,780
Total deposits 278,063 205,732 170,423 145,096 136,755
2000 1999 1998 1997 1996
-------- -------- -------- -------- --------
Shareholders' equity 22,779 20,703 20,470 15,423 14,316
Book value per share $ 8.52 $ 7.73 $ 7.22 $ 6.38 $ 5.95
outstanding
The Company's operating results are summarized as follows for the
twelve-month periods ending December 31 of each of the following years:
58
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
(Dollars in Thousands except for per share)
Interest income $22,577 $15,257 $12,612 $11,868 $11,463
Interest expense 5,030 4,461 3,440 3,285 2,974
----- ------ ------- ------- -------
Net interest income 17,547 10,796 9,172 8,583 8,489
Provision for loan losses 2,204 (206) 72 540 0
----- ------ ------- ------- -------
Net interest income after
provision for loan losses 15,343 11,002 9,100 8,043 8,489
Other income 1,740 1,935 891 695 700
Other expense 12,988 9,998 7,085 6,645 6,320
------ ------ ------- ------- -------
Income before taxes and
effects of accounting change 4,095 2,939 2,906 2,093 2,869
Provision for income taxes 1,689 1,213 1,197 885 833
----- ----- ------ ------- -------
Net income $ 2,406 $ 1,726 $ 1,709 $ 1,208 $ 2,036
Basic earnings per $ 0.89 $ 0.61 $ 0.66 $ 0.50 $ 0.85
common share outstanding
Cash dividends declared per
share $ 0.00 $ 0.00 $ 0.00 $ 0.00 $ 0.00
The number of shares outstanding (net of unearned ESOP shares) was
2,672,000 in 2000, 2,677,000 in 1999, 2,837,000 in 1998, 2,416,000 in 1997, and
2,406,000 for 1996.
The summary information presented above should be read in conjunction
with the Notes to Consolidated Financial Statements, which accompany the
Company's financial statements as described below.
59
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Summary
First Regional Bancorp (the "Company") has not conducted any
significant business activities independent of First Regional Bank (the "Bank")
since the reorganization of the Bank on March 8, 1982. Therefore, the following
discussion and analysis relates primarily to the Bank and its two reportable
business segments consisting of core bank operations and the administration
services in relation to the formation of Trust Administration Services Corp.
(TASC) during 1999. For segment reporting financial information see Note 17 of
the Consolidated Financial Statements.
CORE BANK OPERATIONS - The principal business activities of this segment
are attracting funds from the general public and originating commercial
and real estate loans for small and midsize businesses in Southern
California. This segment's primary sources of revenue are interest income
from loans and investment securities, and fees earned in connection with
loans and deposits. This segment's principal expenses consist of interest
paid on deposits, personnel, and other general and administrative
expenses.
ADMINISTRATION SERVICES - The principal business activity of this segment
is providing administrative services for self-directed retirement plans.
The primary source of revenue for this segment is fee income from
self-directed accounts. The segment's principal expenses consist of
personnel, rent, data processing, and other general and administrative
expenses.
The Company achieved continued profitability in 2000, with significant
increases in assets, deposits and loans. The Company continues to benefit from
strategic decisions made in 1995, when the Company initiated a program of
prudent, managed growth; this program resulted in higher levels of earning
assets and interest revenue in 1998, 1999 and 2000. The Company's profitability
was also in part a reflection of the continued low levels of non-performing
loans, other real estate owned, and other non-earning assets.
Average assets in 2000 were $249,543,000 compared to $222,805,000 in
1999 and $166,241,000 in 1998. As was the case in 1999 and 1998, the Company's
asset growth in 2000 was funded by an increase in deposits, as well as by the
retention of earnings for the year. The Company generated net income of
$2,406,000 in 2000 compared to a profit of $1,726,000 in 1999 and a profit of
$1,709,000 in 1998.
60
NET INTEREST INCOME
Net interest income is the excess of interest income earned on
interest-earning assets over interest expense incurred on interest-bearing
liabilities. Interest income or expense are determined by the average volume of
interest-bearing assets or liabilities, and the average rate of interest earned
or paid on those assets or liabilities. As was the case during 1999, in 2000 the
Company's continued growth efforts resulted in an increase in interest earning
assets, including loans. The Bank's core loan portfolio increased significantly
during 2000. The 2000 asset growth reflects a corresponding increase in total
deposits resulting from an increase in full service bank branches during 2000.
While the deposit growth was centered in non-interest bearing deposits and time
deposits, there was also growth in money market deposits and savings deposits.
Deposit growth interest rates increased slightly in both 2000 and 1999 from the
1998 levels, and the higher deposit levels led to significant increases in
interest expense in 2000 and 1999 after remaining relatively stable the prior
year.
OTHER OPERATING INCOME
Other operating income remained relatively constant in 2000 from the
prior year after a substantial increase in 1999 over the 1998 total. Other
operating income for 2000 was $1,740,000, versus $1,935,000 in 1999 and $891,000
for the year 1998. The Bank's Trust Administration Services Corp. (TASC), a
wholly owned subsidiary that provides administrative services to self-directed
retirement plans, had revenue that totaled $415,000 during 2000 and $618,000
during 1999; there was no such revenue in 1998. The Bank's merchant services
operation, which provides credit card deposit and clearing services to retailers
and other credit card accepting businesses, had revenue that totaled $750,000 in
2000, $513,000 in 1999 and $350,000 in 1998. The 2000 other operating income
included gains on sales of land of $68,000. The other operating income figure
included gains on sales of land of $138,000 in 1999 and $86,000 in 1998.
LOAN PORTFOLIO AND PROVISION FOR LOAN LOSSES
The loan portfolio consisted of the following at December 31, 2000 and
1999:
2000 1999
---- ----
(Dollars in Thousands)
Commercial loans........................... $ 68,927 42,789
Real estate construction loans............. 53,352 19,267
Real estate loans.......................... 78,809 56,741
61
Bankers acceptances........................ 0 0
Government Guaranteed Loans 35,047 5,084
Other loans................................ 1,011 961
------- ------
Total loans .......................$ 237,146 124,842
Less - Allowances for loan losses ...... 4,600 2,300
- Deferred loan fees 989 726
.......................................... ------- -----
Net loans ....................... $231,557 121,816
======== =======
The allowance for possible loan losses is intended to reflect the known
and unknown risks which are inherent in a loan portfolio. The adequacy of the
allowance for possible loan losses is continually evaluated in light of many
factors, including loan loss experience and current economic conditions. The
Company's emphasis on maintaining high asset quality continued in 2000, and as a
result, non-performing assets (loans past due ninety days or more excluding
government guaranteed loans, loans on nonaccrual status, and other real estate
owned) totaled $1,851,000 (less than 1% of total loans) at the end of 2000.
Although this is an increase from $129,000 on December 31, 1999, and $243,000 at
the end of 1998, management believes the allowance for possible loan losses as
of December 31, 2000 was adequate in relation to both existing and potential
risks in the loan portfolio.
The Bank has historically evaluated the adequacy of its allowance for
possible loan losses on an overall basis rather than by specific categories of
loans. In determining the adequacy of the allowance for possible loan losses,
management considers such factors as historical loan loss experience, known
problem loans, evaluations made by bank regulatory authorities, assessment of
economic conditions and other appropriate data to identify the risks in the loan
portfolio.
The allowance for possible loan losses has been allocated to the major
categories of loans as set forth in the following table. The allocations are
estimates based upon historical loss experience and management judgment. The
allowance for possible loan losses should not be interpreted as an indication
that charge-offs will occur in these amounts or proportions, or that the
allocation indicates future charge-off trends. Furthermore, the portion
allocated to each loan category is not the total amount available for future
losses that might occur within such categories, since even in this allocation is
an unallocated portion, and, as previously stated, the total allowance is
applicable to the entire portfolio.
62
2000 1999
---- ----
Allowance Ratio of Allowance Ratio of
for loans to for loans to
possible total possible total
LOAN LOSSES LOANS LOAN LOSSES LOANS
----------- -------- ----------- --------
Commercial loans... $1,404 29% $ 714 34%
Real estate loans.. 2,648 56% 1,397 61%
Gov't guaranteed... 0 4% 0 4%
Bankers acceptances 0 0% 0 0%
Other loans........ 3 0% 4 1%
Unallocated........ 545 0% 185 0%
------ ---- ------ ----
Total .... $4,600 100% $2,300 100%
====== ==== ====== ====
The allowance for possible loan losses is increased by provisions which
are charged to operating expense and is reduced by loan chargeoffs. Any
subsequent recoveries of charged off loans are added back into the allowance.
Based on its ongoing evaluation of loan risks, in 2000 provisions of $2,204,000
were made to the reserve for loan losses, $0 in loans were charged off, and
$96,000 in loans previously charged off were recovered. By way of comparison, in
1999 provisions of $(206,000) were made to the reserve for loan losses, $46,000
in loans were charged off, and $52,000 in loans previously charged off were
recovered. In 1998 provisions of $72,000 were made to the reserve for loan
losses, $19,000 in loans were charged off, and $47,000 in loans previously
charged off were recovered. These transactions brought the balance of the
allowance for possible loan losses at the end of 2000 to $4,600,000 (or 1.9% of
total loans), compared to $2,300,000 (or 1.9% of total loans) at December 31,
1999, and compared to $2,500,000 (or 2.7% of total loans) at the end of 1998.
The Company adopted Statement of Financial Accounting Standards (SFAS)
No. 114, "Accounting by Creditors for Impairment of a Loan," effective January
1, 1995. This Statement defines an impaired loan as one for which it is likely
that an institution will be unable to collect all amounts due (that is, all
principal and interest) according to the contractual terms of the loan. The
Statement generally requires impaired loans to be measured at the present value
of expected future cash flows discounted at the effective interest rate of the
loan, or, as an expedient, at the loan's observable market price, or the fair
value of the collateral if the loan is collateral dependent. In 2000, the
Company identified loans having an aggregate average balance of $1,420,000 which
it concluded were impaired under SFAS No. 114. During 1999, the Company
identified loans having an aggregate average balance of $243,000 which it
concluded were impaired under SFAS No. 114. In contrast during 1998, the Company
had identified loans having an aggregate average balance of $370,000 which it
concluded were impaired. The Company's policy is generally to discontinue the
accrual of interest income on impaired loans, and to recognize income on such
loans only after the loan principal has been repaid in full, and to establish a
general loss reserve
63
for each of the loans.
OPERATING EXPENSES
Total operating expenses rose in 2000, to $12,988,000 from $9,998,000
in 1999 and $7,085,000 in 1998. While the total expense figures increased
primarily due to increases in overall bank growth, most components continue to
be moderated by the effects of an ongoing program of expense control.
Salaries and related benefits expense increased again in 2000, rising
to $7,662,000 from a 1999 total of $5,344,000 and from $3,555,000 in 1998. The
increase in this expense category principally reflects the increases in staffing
which took place due to the addition of the TASC operation as well as staffing
in the new regional offices as part of the Company's growth initiative.
Occupancy expense rose in 2000, to $937,000 from $694,000 in 1999 and a 1998
total of $410,000; the increases reflect the rent paid on the various facilities
which house the Bank's new regional offices and the TASC operation. Custodial
and other services to customers declined to $0 in 2000 as they declined in both
1999 and 1998 standing at $168,000 for 1999 versus $553,000 in 1998. This
category typically fluctuates in conjunction with the deposit balances
maintained by customers, and this factor accounts for the changes in this area
over the past three years. Other expenses rose again in 2000 as they did in 1999
and 1998. Other expenses totaled $4,389,000 in 2000 compared to $3,792,000 in
1999, which was increased from $2,567,000 in 1998. Other expenses in 2000
include professional services of $385,000 a decrease from the prior year when
professional services were $607,000 for 1999, a significant increase after
totaling $330,000 in 1998. Data processing fees rose in 2000 to $708,000
compared to $545,000 in 1999 and $365,000 in 1998. A positive factor was the
continued low level of premiums for FDIC insurance, reflecting the banking
industry's achievement of full capitalization of the Bank Insurance Fund as
defined by applicable statute. General insurance increased to $295,000 during
2000 from $212,000 during 1999 and $120,000 for 1998. Equipment expense
increased to $498,000 during 2000 from $375,000 during 1999 and $254,000 for
1998. Most of the remaining categories of other expense generally remained
stable: directors fees were $71,000 in 2000, $73,000 in 1999, and 72,000 in
1998; and other expenses, which rose to $1,983,000 in 2000 from $1,573,000 in
1999 and $1,192,000 in 1998 principally due to higher costs of services provided
to customers.
TAXES
The combined effects of the activity described above resulted in Income
Before Taxes of $4,095,000 in 2000, up from $2,939,000 in 1999, and $2,906,000
in 1998. In 2000, the Company recorded tax provisions of $1,689,000. During
1999, the Company recorded tax provisions of $1,213,000 and during 1998, the
company recorded tax provisions of $1,197,000. As a result, the Company
generated Net Income of $2,406,000 in 2000, compared to
64
$1,726,000 in 1999, and versus Net Income of $1,709,000 in 1998.
LIQUIDITY, SOURCES OF FUNDS, AND CAPITAL RESOURCES
The Bank continues to enjoy a liquid financial position. Total liquid
assets (cash and due from banks, investment securities, and federal funds sold)
totaled $62,643,000 and $106,876,000 (or 22.5% and 51.9% of total deposits) at
December 31, 2000 and 1999, respectively. In addition, at December 31, 2000,
some $35 million of the banks total loans consisted of government guaranteed
loans which represent a significant source of liquidity due to the active
secondary markets which exist for these assets. The ratio of net loans
(including government guaranteed loans) to deposits was 83.3% and 59.2% at the
end of 2000 and 1999, respectively.
In January 1999, the Bank established TASC, a wholly owned subsidiary
that provides administrative services to self-directed retirement plans.
Deposits held for TASC clients by the bank represent approximately 11% and 16%
of the Bank's total deposits as of December 31, 2000 and 1999.
Prior to the commencement of the TASC operations, the bank had a
long-term relationship with Transcorp Pension Services, Inc. (Transcorp). The
Bank's deposit and service relationships with Transcorp ended in 1999. Deposits
of custodial clients of retirement plans administered by Transcorp Pension
Services, a corporate customer of the Bank, represented approximately 0% of the
Bank's total deposits as of December 31, 1999.
The Bank's investment portfolio continues to be composed of high
quality, low risk securities, principally U.S. Agency securities. Losses of
$24,000 were recorded on securities sales during 2000. No gains or losses were
recorded on securities sales during 1999 or 1998. As of December 31, 2000 the
Bank's investment portfolio contained gross unrealized gains of $2,000 and no
gross unrealized losses, for net unrealized gains of $1,000; as of December 31,
1999 the Bank's investment portfolio contained no gross unrealized gains and
gross unrealized losses of $2,000, for net unrealized losses of $1,000. The
Company adopted SFAS No. 115 in 1994, with the result that the net unrealized
gains and losses gave rise to a $1,000 (net of taxes) increase in shareholders'
equity as of December 31, 2000, and a $1,000 decrease (net of taxes) in the
Company's shareholders' equity as of December 31, 1999. Because the Company's
holdings of securities are intended to serve as a source of liquidity should
conditions warrant, the securities have been classified by the Company as
"available for sale," and thus the unrealized gains and losses had no effect on
the Company's income statement.
The Bank's management has attempted to match the rates and maturities
of its interest-bearing assets and liabilities as part of its liquidity and
asset/liability management policy. The objective of this policy is to
65
moderate the fluctuations of net interest revenue which result from changes in
the level of interest rates. The table which follows indicates the repricing or
maturity characteristics of the major categories of the Bank's assets and
liabilities, and thus the relative sensitivity of the Bank's net interest income
to changes in the overall level of interest rates. A positive "gap" for a period
indicates that an upward or downward movement in the level of interest rates
would have a corresponding change in net interest income, while a negative "gap"
implies that an interest rate movement would result in an inverse change in net
interest income.
ONE MONTH SIX MONTHS ONE YEAR NON-
BUT LESS BUT LESS BUT LESS FIVE INTEREST
FLOATING LESS THAN THAN THAN THAN YEARS EARNING
CATEGORY RATE ONE MONTH SIX MONTHS ONE YEAR FIVE YEARS OR MORE OR BEARING TOTAL
======================================== ======== ========= ========== ========== ========== ======= ========== ========
FED FUNDS SOLD 38,740 0 0 0 0 0 0 38,740
TIME DEPOSITS WITH OTHER BANKS 0 0 99 0 0 0 0 99
INVESTMENT SECURITIES 0 0 2,985 0 0 0 0 2,985
-------- -------- -------- -------- -------- -------- -------- --------
SUBTOTAL 38,740 0 3,084 0 0 0 0 41,824
LOANS 229,154 425 483 762 733 0 0 231,557
-------- -------- -------- -------- -------- -------- -------- --------
TOTAL EARNING ASSETS 267,894 425 3,567 762 733 0 0 273,381
CASH AND DUE FROM BANKS 0 0 0 0 0 0 20,819 20,819
PREMISES AND EQUIPMENT 0 0 0 0 0 0 1,392 1,392
OTHER REAL ESTATE OWNED 0 0 0 0 0 0 0 0
OTHER ASSETS 0 0 0 0 0 0 10,487 10,487
-------- -------- -------- -------- -------- -------- -------- --------
TOTAL NON-EARNING ASSETS 0 0 0 0 0 0 32,698 32,698
-------- -------- -------- -------- -------- -------- -------- --------
TOTAL ASSETS 267,894 425 3,567 762 733 0 32,698 306,079
FUNDS PURCHASED 1,457 0 0 0 0 0 0 1,457
REPURCHASE AGREEMENTS 0 0 0 0 0 0 0 0
-------- -------- -------- -------- -------- -------- -------- --------
SUBTOTAL 1,457 0 0 0 0 0 0 1,457
SAVINGS DEPOSITS 13,394 0 0 0 0 0 0 13,394
MONEY MARKET DEPOSITS 99,626 0 0 0 0 0 0 99,626
TIME DEPOSITS 0 38,926 20,230 6,028 227 0 0 65,411
-------- -------- -------- -------- -------- -------- -------- --------
TOTAL BEARING LIABILITIES 114,477 38,926 20,230 6,028 227 0 0 179,888
DEMAND DEPOSITS 0 0 0 0 0 0 99,632 99,632
OTHER LIABILITIES 0 0 0 0 0 0 3,780 3,780
EQUITY CAPITAL 0 0 0 0 0 0 22,779 22,779
-------- -------- -------- -------- -------- -------- -------- --------
TOTAL NON-BEARING LIABILITIES 0 0 0 0 0 0 126,191 126,191
-------- -------- -------- -------- -------- -------- -------- --------
TOTAL LIABILITIES 114,477 38,926 20,230 6,028 227 0 126,191 306,079
GAP 153,417 (38,501) (16,663) (5,266) 506 0 (93,493) 0
CUMULATIVE GAP 153,417 114,916 98,253 92,987 93,493 93,493 0 0
As the table indicates, the vast majority of the Company's assets are
66
either floating rate or, if fixed rate, have short maturities. Since the yields
on these assets quickly adjust to reflect changes in the overall level of
interest rates, there are no significant unrealized gains or losses with respect
to the Company's assets, nor is there much likelihood of large realized or
unrealized gains or losses developing in the future. For this reason, realized
or unrealized gains or losses are not expected to have any significant impact on
the Company's future operating results or liquidity.
The Company continues to maintain a strong and prudent capital
position. Total shareholders' equity was $22,779,000 and $20,703,000 as of
December 31, 2000 and 1999, respectively. The Company's capital ratios for those
dates in comparison with regulatory capital requirements were as follows:
12-31-00 12-31-99
-------- --------
Leverage Ratio (Tier I Capital
to Assets:
First Regional Bancorp 7.40% 8.90%
Regulatory requirement 4.00% 4.00%
The "regulatory requirement" listed represents the level of capital
required for Adequately Capitalized status.
In addition, bank regulators have risk-adjusted capital guidelines
which assign risk weighting to assets and off-balance sheet items and place
increased emphasis on common equity. The Company's risk adjusted capital ratios
for the dates listed in comparison with the risk adjusted capital requirements
were as follows:
12-31-00 12-31-99
-------- --------
Tier I Capital to Assets:
First Regional Bancorp 9.60% 10.50%
Regulatory requirement 4.00% 4.00%
Tier I + Tier II Capital to Assets:
First Regional Bancorp 10.90% 11.70%
Regulatory requirement 8.00% 8.00%
The Company is well capitalized under regulation guidelines and
believes that it will continue to meet all applicable capital standards.
During 1998, the company established an Employee Stock Ownership Plan
consisting of 150,000 shares of First Regional common stock acquired in market
transactions or directly from First Regional Bancorp at an average price of
$9.48 per share. This new Plan will build the capital base of First Regional
Bank and provide its employees with a powerful incentive to achieve further
improvements in First Regional's operating performance.
67
During 1999, the company repurchased 275,800 shares of its outstanding
common stock at a total cost of $2,059,000 and during 2000, the company
repurchased 94,000 shares of its outstanding common stock at a total cost of
$685,000. As the average price paid for these repurchased shares was less than
the book value per share outstanding, these purchases resulted in an increase in
book value per share of the remaining outstanding shares, thus benefiting
existing shareholders.
INFLATION
The impact of inflation on the Company differs significantly from other
industries, since virtually all of its assets and liabilities are monetary.
During periods of inflation, companies with net monetary assets will always
experience a reduction in purchasing power. Inflation continues to have an
impact on salary, supply, and occupancy expenses, but the rate of inflation in
general and its impact on these expenses in particular has remained moderate in
recent years.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See "Item 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K" below for financial statements filed as part of this report.
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
The Company has not reported a disagreement with its existing or
previous accountants on any matter of accounting principle or practice on
financial statement disclosure.
68
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
The information pertaining to directors which is required by this item
will be included in the definitive proxy statement to be filed by the Company
within 120 days of fiscal year end pursuant to Section 14 of the Act. Such
information is hereby incorporated by reference in accordance with Rule G of the
General Instructions to the Annual Report on Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item will be included in the
definitive proxy statement to be filed by the Company within 120 days of fiscal
year end pursuant to Section 14 of the Act. Such information is hereby
incorporated by reference in accordance with Rule G of the General Instructions
to the Annual Report on Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item will be included in the
definitive proxy statement to be filed by the Company within 120 days of fiscal
year end pursuant to Section 14 of the Act. Such information is hereby
incorporated by reference in accordance with Rule G of the General Instructions
to the Annual Report on Form 10-K.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item will be included in the
definitive proxy statement to be filed by the Company within 120 days of fiscal
year end pursuant to Section 14 of the Act. Such information is hereby
incorporated by reference in accordance with Rule G of the General Instructions
to the Annual Report on Form 10-K.
69
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K
List of Documents filed as a part of this report:
(a) Financial Statements and Financial Statement Schedules
See Index to Financial Statements which is part of this Form 10-K.
(b) Exhibits
See Index to Exhibits which is part of this Form 10-K
(Exhibits are listed by numbers corresponding to the Exhibit Table in
Item 601 of Regulation S-K)
(c) Reports on Form 8-K
No reports on Form 8K were filed in the fourth quarter of 2000.
70
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.
First Regional Bancorp
By:/S/ JACK A. SWEENEY
------------------------------------
Jack A. Sweeney, Chairman of the Board
Chief Executive Officer
Date: March 29, 2001
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed by the following persons on behalf of the registrant
and in the capacities and on the dates indicated.
Signature Title Date
/S/ JACK A. SWEENEY Director, Chairman March 29, 2001
- ----------------------- of the Board and Chief
Jack A. Sweeney Executive Officer
/S/ LAWRENCE J. SHERMAN Director, Vice Chairman March 29, 2001
- ------------------------ of the Board
Lawrence J. Sherman
/S/ H. ANTHONY GARTSHORE Director and President March 29, 2001
- ------------------------
H. Anthony Gartshore
/S/ THOMAS MCCULLOUGH Director, Chief March 29, 2001
- ------------------------ Financial Officer and
Thomas E. McCullough Chief Accounting
Officer
/S/ GARY HORGAN Director March 29, 2001
- ---------------------
Gary Horgan
/S/ FRED M. EDWARDS Director March 29, 2001
- ------------------------
Fred M. Edwards
/S/ MARILYN J. SWEENEY Director March 29, 2001
- ------------------------
Marilyn J. Sweeney
71
INDEX TO FINANCIAL STATEMENTS
FINANCIAL STATEMENTS PAGE IN FORM 10-K
First Regional Bancorp and Subsidiary:
Report of Independent Auditors .......................... 74
Consolidated Balance Sheets as of
December 31, 2000 and 1999 .............................. 75
Consolidated Statements of Earnings for
the years ended December 31, 2000, 1999,
1998 .................................................... 76
Consolidated Statements of Shareholders'
Equity for the years ended December 31, 2000,
1999, and 1998 .......................................... 78
Consolidated Statements of Cash Flows for
the years ended December 31, 2000, 1999,
and 1998 ................................................ 79
Notes to Consolidated Financial Statements .............. 81
First Regional Bancorp (Parent Company):
Note 16 to Consolidated Financial
Statements .............................................. 97
All other financial statement schedules are omitted because they are
not applicable, not material or because the information is included in the
financial statements or the notes.
72
FIRST REGIONAL BANCORP AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2000 AND 1999 AND FOR EACH
OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 2000 AND INDEPENDENT
AUDITORS' REPORT
73
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
First Regional Bancorp and Subsidiary
Century City, California:
We have audited the accompanying consolidated balance sheets of First Regional
Bancorp and subsidiary (the "Company") as of December 31, 2000 and 1999, and the
related consolidated statements of earnings, changes in shareholders' equity,
and cash flows for each of the three years in the period ended December 31,
2000. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of First Regional Bancorp and its
subsidiary as of December 31, 2000 and 1999, and the results of their earnings
and their cash flows for each of the three years in the period ended December
31, 2000, in conformity with accounting principles generally accepted in the
United States of America.
/s/ DELOITTE & TOUCHE LLP
Deloitte & Touche LLP
Los Angeles, California
January 26, 2001
74
FIRST REGIONAL BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2000 AND 1999
- -------------------------------------------------------------------------------
ASSETS 2000 1999
Cash and due from banks (Note 6) $ 20,819,000 $ 10,074,000
Federal funds sold 38,740,000 37,090,000
------------- -------------
Cash and cash equivalents 59,559,000 47,164,000
Investment securities available for sale, amortized cost of $2,983,000
and $52,791,000 (Note 2) 2,985,000 52,789,000
Interest-bearing deposits in financial institutions 99,000 6,923,000
Loans, net (Note 3) 231,557,000 121,816,000
Premises and equipment, net (Note 4) 1,392,000 1,172,000
Accrued interest receivable and other assets (Notes 14 and 15) 8,769,000 2,468,000
Income tax assets (Note 5) 1,718,000 701,000
------------- -------------
TOTAL $ 306,079,000 $ 233,033,000
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Deposits (Notes 12, 14, and 15):
Noninterest bearing $ 99,632,000 $ 65,405,000
Interest bearing:
Time deposits 65,411,000 44,052,000
Money market deposits 99,626,000 87,670,000
Other 13,394,000 8,605,000
------------- -------------
Total deposits 278,063,000 205,732,000
Fed funds purchased 1,457,000 3,195,000
Note payable (Note 10) 1,163,000 1,313,000
Accrued interest payable and other liabilities 2,617,000 2,090,000
------------- -------------
Total liabilities 283,300,000 212,330,000
------------- -------------
COMMITMENTS AND CONTINGENCIES (Notes 4 and 6)
SHAREHOLDERS' EQUITY (Notes 7, 8, 9, and 10):
Common stock, no par value; authorized, 50,000,000 shares;
outstanding, 2,795,000 (2000) and 2,809,000 (1999) shares 14,074,000 14,410,000
Unearned ESOP shares; 123,000 in 2000 and 132,000 in 1999 (1,102,000) (1,244,000)
------------- -------------
Total common stock, no par value; outstanding
2,672,000 (2000) and 2,677,000 (1999) shares 12,972,000 13,166,000
Retained earnings 9,806,000 7,538,000
Accumulated other comprehensive income (loss) 1,000 (1,000)
------------- -------------
Total shareholders' equity 22,779,000 20,703,000
------------- -------------
TOTAL $ 306,079,000 $ 233,033,000
============= =============
See notes to consolidated financial statements.
75
FIRST REGIONAL BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF EARNINGS
YEARS ENDED DECEMBER 31, 2000, 1999, AND 1998
- -------------------------------------------------------------------------------
2000 1999 1998
INTEREST INCOME:
Interest on loans $ 19,446,000 $ 9,910,000 $ 8,517,000
Interest on deposits in financial institutions 220,000 406,000 521,000
Interest on federal funds sold 1,451,000 1,486,000 1,808,000
Interest on investment securities 1,460,000 3,455,000 1,766,000
---------- ---------- ----------
Total interest income 22,577,000 15,257,000 12,612,000
---------- ---------- ----------
INTEREST EXPENSE:
Interest on deposits (Notes 12 and 14) 5,015,000 4,444,000 3,437,000
Interest on other borrowings 15,000 17,000 3,000
---------- ---------- ----------
Total interest expense 5,030,000 4,461,000 3,440,000
---------- ---------- ----------
NET INTEREST INCOME 17,547,000 10,796,000 9,172,000
PROVISION (REVERSAL) FOR LOAN
LOSSES (Note 3) 2,204,000 (206,000) 72,000
---------- ---------- ----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 15,343,000 11,002,000 9,100,000
---------- ---------- ----------
OTHER OPERATING INCOME:
Customer service fees (Note 14) 1,573,000 1,468,000 680,000
Other, net 167,000 467,000 211,000
---------- ---------- ----------
Total other operating income 1,740,000 1,935,000 891,000
---------- ---------- ----------
OTHER OPERATING EXPENSES:
Salaries and related benefits (Notes 6 and 10) 7,662,000 5,344,000 3,555,000
Occupancy expenses (Note 4) 937,000 694,000 410,000
Custodial and other service (Note 14) 168,000 553,000
Other expenses (Notes 13 and 14) 4,389,000 3,792,000 2,567,000
---------- ---------- ----------
Total other operating expenses 12,988,000 9,998,000 7,085,000
---------- ---------- ----------
See notes to consolidated financial statements.
(Continued)
76
FIRST REGIONAL BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF EARNINGS
YEARS ENDED DECEMBER 31, 2000, 1999, AND 1998
- -------------------------------------------------------------------------------
2000 1999 1998
INCOME BEFORE PROVISION FOR
INCOME TAXES $4,095,000 $2,939,000 $2,906,000
PROVISION FOR INCOME TAXES (Note 5) 1,689,000 1,213,000 1,197,000
---------- ---------- ----------
NET INCOME $2,406,000 $1,726,000 $1,709,000
========== ========== ==========
BASIC EARNINGS PER COMMON SHARE
(Note 8) $ 0.89 $ 0.61 $ 0.66
========== ========== ==========
DILUTED EARNINGS PER COMMON SHARE
(Note 8) $ 0.89 $ 0.59 $ 0.59
========== ========== ==========
See notes to consolidated financial statements. (Concluded)
77
FIRST REGIONAL BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2000, 1999, AND 1998
- -------------------------------------------------------------------------------
COMMON STOCK ACCUMULATED
----------------------------- OTHER
SHARES RETAINED COMPREHENSIVE COMPREHENSIVE
OUTSTANDING AMOUNT EARNINGS INCOME (LOSS) INCOME
BALANCE, JANUARY 1, 1998 2,416,000 $ 11,286,000 $ 4,128,000 $ 9,000
Common stock repurchased and retired (4,000) (20,000) (16,000)
Common stock issued in private
placement and for ESOP 503,000 4,574,000
Unearned ESOP shares (146,000) (1,386,000)
Options exercised, including tax benefit 68,000 194,000
Comprehensive income:
Net income 1,709,000 $ 1,709,000
Other comprehensive income -
Net change in unrealized loss on
securities available for sale, net of tax (8,000) (8,000)
-------------
Comprehensive income $ 1,701,000
------------ ------------ --------- -------- ============
BALANCE, DECEMBER 31, 1998 2,837,000 14,648,000 5,821,000 1,000
Common stock repurchased and retired (276,000) (2,050,000) (9,000)
Common stock issued in private
placement 23,000 205,000
Earned ESOP shares 15,000 142,000
Options exercised, including tax benefit 78,000 221,000
Comprehensive income:
Net income 1,726,000 $ 1,726,000
Other comprehensive income -
Net change in unrealized loss on
securities available for sale, net of tax (2,000) (2,000)
-------------
Comprehensive income $ 1,724,000
------------ ------------ --------- -------- ============
BALANCE, DECEMBER 31, 1999 2,677,000 13,166,000 7,538,000 (1,000)
Common stock repurchased and retired (94,000) (547,000) (138,000)
Earned ESOP shares 9,000 142,000
Options exercised, including tax benefit 80,000 211,000
Comprehensive income:
Net income 2,406,000 $ 2,406,000
Other comprehensive income -
Net change in unrealized gain on
securities available for sale, net of tax 2,000 2,000
-------------
Comprehensive income $ 2,408,000
------------ ------------ --------- -------- ============
BALANCE, DECEMBER 31, 2000 2,672,000 $ 12,972,000 $ 9,806,000 $ 1,000
============ ============ ========= ========
See notes to consolidated financial statements
78
FIRST REGIONAL BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2000, 1999, AND 1998
- --------------------------------------------------------------------------------
2000 1999 1998
OPERATING ACTIVITIES:
Net income $ 2,406,000 $ 1,726,000 $ 1,709,000
Adjustments to reconcile net income to net
cash (used in) provided by operating activities:
Provision (reversal) for losses on loans 2,204,000 (206,000) 72,000
Provision for depreciation 261,000 193,000 136,000
Gain on sale of real estate (68,000) (138,000) (86,000)
Amortization of investment securities
premiums and discounts, net (126,000) (228,000) (287,000)
Gain on sale of loans (9,000)
(Gain) loss on sale of premises and equipment (1,000) 4,000
Amortization of loan premiums and discounts,
net 647,000 (308,000) (464,000)
Increase in interest receivable and other assets (6,301,000) (1,181,000) (181,000)
Increase (decrease) in interest payable and
other liabilities 672,000 563,000 (393,000)
Deferred income tax (benefit) provision (1,163,000) 86,000 (212,000)
Deferred compensation expense 142,000 142,000
------------- ------------- -------------
Net cash (used in) provided by
operating activities (1,326,000) 648,000 289,000
------------- ------------- -------------
INVESTING ACTIVITIES:
Net decrease (increase) in interest-bearing
deposits in financial institutions 6,824,000 3,220,000 (3,517,000)
Net increase in loans (112,592,000) (29,378,000) (13,017,000)
Proceeds from sale of loans 452,000
Purchases of investment securities (2,960,000) (199,162,000) (88,500,000)
Proceeds from maturities of investment
securities 52,893,000 194,287,000 67,346,000
Purchases of premises and equipment (481,000) (574,000) (352,000)
Proceeds from sale of premises and equipment 120,000
Proceeds from sale of real estate 68,000 138,000 86,000
------------- ------------- -------------
Net cash used in investing activities (56,248,000) (31,469,000) (37,382,000)
------------- ------------- -------------
See notes to consolidated financial statements.
(Continued)
79
FIRST REGIONAL BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2000, 1999, AND 1998
- --------------------------------------------------------------------------------
2000 1999 1998
FINANCING ACTIVITIES:
Net increase (decrease) in time deposits $ 21,359,000 $ (7,102,000) $ 19,785,000
Net increase in noninterest-bearing deposits
and other interest-bearing deposits 50,972,000 42,411,000 5,542,000
Net (decrease) increase in Fed funds
purchased (1,738,000) 3,194,000 (5,000)
Decrease in note payable (150,000) (150,000) (37,000)
Sales of common stock 205,000 4,688,000
Stock options exercised 211,000 309,000 96,000
Common stock repurchased and retired (685,000) (2,059,000) (36,000)
------------ ------------ ------------
Net cash provided by
financing activities 69,969,000 36,808,000 30,033,000
------------ ------------ ------------
INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS 12,395,000 5,987,000 (7,060,000)
CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR 47,164,000 41,177,000 48,237,000
------------ ------------ ------------
CASH AND CASH EQUIVALENTS,
END OF YEAR $ 59,559,000 $ 47,164,000 $ 41,177,000
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF
NONCASH INVESTING AND FINANCING
ACTIVITIES -
Issuance of debt for ESOP shares $ 1,500,000
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Interest paid $ 4,854,000 $ 4,002,000 $ 3,354,000
Income taxes paid $ 1,941,000 $ 853,000 $ 1,397,000
See notes to consolidated financial statements.
(Concluded)
80
FIRST REGIONAL BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2000, 1999, AND 1998
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
First Regional Bancorp, a bank holding company (the "Company"), and its
subsidiary, First Regional Bank, a California state-chartered bank (the
"Bank"), primarily serve Southern California through their branches. The
Company's primary source of revenue is providing loans to customers, which
are predominantly small and midsize businesses. The Company has two
operating segments as discussed in Note 17. The accounting and reporting
policies of the Company conform to accounting principles generally
accepted in the United States of America and general practices within the
banking industry. The following are descriptions of the more significant
of these policies.
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements
include the accounts of the Company and the Bank. All significant
intercompany transactions and accounts have been eliminated.
USE OF ESTIMATES IN THE PREPARATION OF THE FINANCIAL STATEMENTS - The
preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the consolidated financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
INVESTMENT SECURITIES - Investment securities available for sale are
reported in the accompanying consolidated balance sheets at fair value,
and the net unrealized gain or loss on such securities (unless other than
temporary) is reported as a separate component of shareholders' equity.
Premiums and discounts on debt securities are amortized or accreted as
adjustments to interest income using the level-yield method. Realized
gains and losses on sales of securities are determined on a
specific-identification basis and reported in earnings.
LOANS - Loans are carried at face amount less payments collected, deferred
fees, and allowances for loan losses. Interest on loans is accrued monthly
on a simple-interest basis. Loan origination fees and commitment fees, net
of related costs, are deferred and recognized over the contractual lives
of the loans as a yield adjustment. Premiums on purchases of loans are
amortized on a level-yield method over the estimated lives of the loans,
considering estimated prepayments.
The allowance for loan losses is maintained at a level considered adequate
by management to provide for losses that might be reasonably anticipated.
The allowance is increased by provisions charged to earnings and reduced
by charge-offs, net of recoveries. Management's periodic estimates of the
allowance for loan losses are inherently uncertain and depend on the
outcome of future events. Such estimates are based on previous loan loss
experience; current economic conditions; volume, growth, and composition
of the loan portfolio; the value of collateral; and other relevant
factors.
81
Loans are considered to be impaired when it is not probable that they will
be collected in accordance with their original terms. Impaired loans are
carried at the lower of their contractual balances or estimated fair
values. Specific reserves necessary to reduce their carrying amounts to
fair value are included in the allowance for loan losses.
All loans on nonaccrual are considered to be impaired; however, not all
impaired loans are on nonaccrual status. Impaired loans on accrual status
must be such that the loan underwriting supports the debt service
requirements. Factors that contribute to a performing loan being
classified as impaired include: a below-market interest rate, delinquent
taxes, and debts to other lenders that cannot be serviced out of existing
cash flow.
Nonaccrual loans are those which are past due 90 days as to either
principal or interest, or earlier when payment in full of principal or
interest is not expected. When a loan is placed on nonaccrual status,
interest accrued but not received is reversed against interest income.
Thereafter, interest income is no longer recognized, and the full amount
of all payments received, whether principal or interest, is applied to the
principal balance of the loan. A nonaccrual loan may be restored to an
accrual basis when principal and interest payments are current, and full
payment of principal and interest is expected.
OTHER REAL ESTATE OWNED - Other real estate owned is recognized when a
property collateralizing a loan is foreclosed upon or otherwise acquired
by the Bank in satisfaction of the loan. Upon foreclosure, other real
estate owned is recorded at estimated fair value. Reductions in value at
the time of foreclosure are charged against the allowance for loan losses.
Allowances are recorded to provide for estimated declines in fair value
and costs to sell subsequent to the date of acquisition. The Bank has no
other real estate owned as of December 31, 2000.
PREMISES AND EQUIPMENT - Premises and equipment are carried at cost less
accumulated depreciation and amortization. Depreciation is computed using
the straight-line method over the estimated useful lives of the assets,
which range from 5 to 15 years. Amortization is computed using the
straight-line method over the estimated useful lives of the leasehold
improvements or the term of the lease, whichever is shorter.
INCOME TAXES - Deferred income taxes are recognized for the tax
consequences in future years of differences between the tax bases of
assets and liabilities and their financial reporting amounts at each
year-end based on enacted tax laws and statutory tax rates applicable to
the periods in which the differences are expected to affect taxable
income. A deferred tax asset is recorded to the extent that management
believes it is more likely than not to be realized. A valuation allowance
is recognized for the remaining portion of the deferred tax asset.
FED FUNDS PURCHASED - Fed funds purchased generally mature within one to
four days from the transaction date. Fed funds purchased are reflected at
the amount of cash received in connection with the transaction.
CASH AND CASH EQUIVALENTS - Cash and cash equivalents include cash and due
from banks and federal funds sold. Generally, federal funds are sold for
one-to-four day periods.
EARNINGS PER COMMON SHARE - Basic earnings per share ("EPS") are computed
by dividing income available to common shareholders by the
weighted-average number of common shares outstanding during each year. The
computation of diluted EPS also considers the number of shares issuable
upon the assumed exercise of outstanding common stock options. All
earnings per common share amounts presented have been restated in
accordance with the provisions of this statement. A reconciliation of the
numerator and the denominator used in the computation of basic and diluted
earnings per common share is included in Note 8.
ADMINISTRATIVE AND CUSTODIAL SERVICES - Trust Administrative Services
Corp. ("TASC"), a wholly owned
82
subsidiary of the Bank, maintains investments and assets as a custodian
for customers. The amount of these investments and assets and the related
liability have not been recorded in the accompanying consolidated balance
sheets, because they are not assets or liabilities of the Bank or the
Company, with the exception of any funds held on deposit with the Bank.
Administrative and custodial fees are recorded on an accrual basis.
STOCK COMPENSATION PLANS - The Company policy is to account for
stock-based compensation using the intrinsic value method. Accordingly,
compensation cost of stock options, not subject to variable accounting
treatment, is measured as the excess, if any, of the quoted market price
of the Bank's stock at the date of the grant over the amount an employee
must pay to acquire the stock. For stock options that have been repriced
compensation expense is determined in accordance with variable accounting
treatment.
EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST - The debt of the Employee Stock
Ownership Plan and Trust ("ESOP") is recorded as debt of the Company, and
the shares pledged as collateral are reported as unearned ESOP shares in
the balance sheet. As shares are released from collateral, the Company
reports compensation expense equal to the current market price of the
shares, and the shares become outstanding for EPS computations.
RECENT ACCOUNTING PRONOUNCEMENTS - Statement of Financial Accounting
Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and
Hedging Activities," as amended, is effective for financial statements for
periods beginning after June 15, 2000. This statement establishes
accounting and reporting standards for derivative instruments, including
certain derivative instruments embedded in other contracts (collectively
referred to as derivatives), and for hedging activities. The Company has
determined that the adoption of SFAS No. 133 will not have a material
impact on the Company's financial statements, and as such no transition
adjustment amounts have been disclosed in the December 31, 2000 financial
statements.
83
2. INVESTMENT SECURITIES
The amortized cost and estimated fair values of securities available for
sale as of December 31, 2000 and 1999 were as follows:
GROSS
UNREALIZED
AMORTIZED GAINS FAIR
2000 COST (LOSSES) VALUE
U.S. Treasury securities $ 1,000,000 $ 1,000,000
U.S. agency securities 1,983,000 2,000 1,985,000
------------ ------------ ------------
$ 2,983,000 $ 2,000 $ 2,985,000
============ ============ ============
1999
U.S. Treasury securities $ 5,009,000 $ (2,000) $ 5,007,000
U.S. agency securities 3,447,000 3,447,000
Commercial paper 44,335,000 44,335,000
------------ ------------ ------------
$ 52,791,000 $ (2,000) $ 52,789,000
============ ============ ============
All securities held at December 31, 2000 are scheduled to mature in 2001.
The Bank's investments in commercial paper are subject to credit risk. The
Bank's policy is to purchase commercial paper rated "A1" by Moody's or
"P1" by Standard & Poor's. All purchases are reviewed and approved by the
Investment Committee.
Securities carried at $1,998,000 and $8,000,000 were pledged as of
December 31, 2000 and 1999, respectively, to secure current or future
public deposits and for other purposes required or permitted by law.
3. LOANS
The loan portfolio consisted of the following at December 31, 2000 and
1999:
2000 1999
Real estate loans $ 78,809,000 $ 56,741,000
Commercial loans 68,927,000 42,789,000
Real estate construction loans 53,352,000 19,267,000
Government guaranteed loans 35,047,000 5,084,000
Other loans 1,011,000 961,000
------------- -------------
237,146,000 124,842,000
Allowance for loan losses (4,600,000) (2,300,000)
Deferred loan fees, net (989,000) (726,000)
------------- -------------
Loans, net $ 231,557,000 $ 121,816,000
============= =============
Government guaranteed loans represent loans for which the repayment of
principal and interest is guaranteed by the U.S. government. The loans
bear contractual interest at various rates above national prime lending
rates and were generally purchased at premiums. Premiums on purchases of
government guaranteed loans are amortized on
84
a level-yield method over the estimated lives of the loans, considering
estimated prepayments.
The Bank's lending is concentrated in real estate and businesses in
Southern California. From time to time, this area has experienced adverse
economic conditions. Future declines in the local economy or in real
estate values may result in increased losses that cannot reasonably be
predicted at this date. No industry constitutes a concentration in the
Bank's portfolio, except the real estate construction industry.
An analysis of the activity in the allowance for loan losses for the years
ended December 31, 2000, 1999, and 1998 is as follows:
2000 1999 1998
Balance, beginning of year $ 2,300,000 $ 2,500,000 $ 2,400,000
Provision for loan losses (reversal) 2,204,000 (206,000) 72,000
Loans charged off (46,000) (19,000)
Recoveries on loans previously charged off 96,000 52,000 47,000
----------- ----------- -----------
Balance, end of year $ 4,600,000 $ 2,300,000 $ 2,500,000
=========== =========== ===========
Management believes the allowance for loan losses as of December 31, 2000
is adequate to absorb losses inherent in the loan portfolio. Management's
estimates of the allowance are subject to potential adjustment by the
Federal Deposit Insurance Corporation ("FDIC") and the California
Department of Financial Institutions upon examination of the Bank by such
authorities.
At December 31, 2000 and 1999, the recorded investment in loans for which
impairment had been recognized was $1,851,000 and $129,000, with specific
reserves of $370,000 and $65,000, respectively. The average recorded
investment in impaired loans during 2000, 1999, and 1998 was $1,420,000,
$243,000, and $370,000, respectively. Interest income on impaired loans of
$0, $0, and $43,000 was recognized for cash payments received in 2000,
1999, and 1998, respectively.
In the ordinary course of business, the Bank may grant loans to its
directors and executive officers. The Bank had no loans outstanding to
directors and executive officers at December 31, 2000, 1999, or 1998.
4. PREMISES AND EQUIPMENT
Premises and equipment consisted of the following as of December 31, 2000
and 1999:
2000 1999
Furniture, fixtures, and equipment $ 3,001,000 $ 2,559,000
Leasehold improvements 629,000 591,000
----------- -----------
3,630,000 3,150,000
Accumulated depreciation and amortization (2,238,000) (1,978,000)
----------- -----------
Premises and equipment, net $ 1,392,000 $ 1,172,000
=========== ===========
Rental expense for premises included in occupancy expenses for 2000, 1999,
and 1998 was approximately $889,000, $664,000, and $385,000, respectively.
The future minimum rental commitments, primarily representing
noncancelable operating leases for premises, were
85
as follows at December 31, 2000, excluding the effect of future
cost-of-living increases provided for in the leases, and net of sublease
income:
MINIMUM
YEAR ENDED RENTAL
DECEMBER 31, COMMITMENTS
2001 $ 985,000
2002 943,000
2003 571,000
2004 264,000
2005 114,000
---------------
Total $ 2,877,000
==============
5. INCOME TAXES
Income tax expense (benefit) for the years ended December 31, 2000, 1999,
and 1998 consists of the following:
2000 1999 1998
Current provision:
Federal $ 2,163,000 $ 771,000 $ 1,068,000
State 689,000 356,000 341,000
----------- ----------- -----------
2,852,000 1,127,000 1,409,000
----------- ----------- -----------
Deferred (benefit) provision:
Federal (925,000) 119,000 (190,000)
State (238,000) (33,000) (22,000)
----------- ----------- -----------
(1,163,000) 86,000 (212,000)
----------- ----------- -----------
Total $ 1,689,000 $ 1,213,000 $ 1,197,000
=========== =========== ===========
86
Income tax (liabilities) assets consisted of the following at December 31,
2000 and 1999:
2000 1999
Income taxes currently (payable) receivable:
Federal $ (198,000) $ (68,000)
State 2,000 18,000
----------- -----------
(196,000) (50,000)
----------- -----------
Deferred income tax assets:
Federal 1,422,000 497,000
State 492,000 254,000
----------- -----------
1,914,000 751,000
----------- -----------
Net $ 1,718,000 $ 701,000
=========== ===========
The components of the net deferred income tax assets at December 31 are
summarized as follows:
FEDERAL 2000 1999
Deferred tax liabilities:
Prepaid expenses $ (80,000) $ (118,000)
State taxes (168,000) (86,000)
Depreciation (180,000) (119,000)
----------- -----------
Gross liabilities (428,000) (323,000)
=========== ===========
Deferred tax assets:
Loan and real estate loss allowances 977,000 227,000
Deferred compensation 575,000 446,000
State franchise tax 235,000 97,000
Goodwill 46,000 23,000
Contribution charge-off 3,000
Other 17,000 24,000
----------- -----------
Gross assets 1,850,000 820,000
=========== ===========
Net deferred tax assets - federal $ 1,422,000 $ 497,000
=========== ===========
87
STATE 2000 1999
Deferred tax liabilities:
Prepaid expenses $ (25,000) $ (37,000)
Depreciation (50,000) (35,000)
----------- -----------
Gross liabilities (75,000) (72,000)
----------- -----------
Deferred tax assets:
Loan and real estate loss allowances 364,000 169,000
Deferred compensation 183,000 142,000
Goodwill 15,000 7,000
Other 5,000 8,000
----------- -----------
Gross assets 567,000 326,000
----------- -----------
Net deferred tax assets - state 492,000 254,000
----------- -----------
Net deferred tax assets $ 1,914,000 $ 751,000
=========== ===========
The income tax provision (benefit) for the years ended December 31, 2000,
1999, and 1998 varied from the federal statutory tax rate for the
following reasons:
2000 1999 1998
--------------------- --------------------- ----------------------
AMOUNT RATE AMOUNT RATE AMOUNT RATE
Tax expense at
statutory rate $ 1,433,000 35.0% $ 1,029,000 35.0% $ 1,017,000 35.0%
State franchise taxes,
net of federal
income tax benefit 297,000 7.3 213,000 7.3 211,000 7.3
Other, net (41,000) (1.0) (29,000) (1.0) (31,000) (1.1)
----------- ---- ----------- ---- ----------- ----
Total $ 1,689,000 41.3% $ 1,213,000 41.3% $ 1,197,000 41.2%
=========== ==== =========== ==== =========== ====
6. COMMITMENTS AND CONTINGENCIES
As of December 31, 2000, the Company had the following commitments and
contingent liabilities:
Undisbursed loans $81,210,000
Standby letters of credit $ 1,336,000
The Bank uses the same standards of credit underwriting in entering into
these commitments to extend credit as it does for making loans and,
therefore, does not anticipate any losses as a result of these
transactions. Also, commitments may expire unused, and consequently, the
above amounts do not necessarily represent future cash requirements. The
majority of the commitments above carry variable interest rates.
The Company sponsors a defined contribution 401(k) plan benefiting
substantially all employees. At the discretion of the Board of Directors,
the Company matches employee contributions. Currently, the Company
provides 50 percent matching up to the first 6 percent of wages
contributed by an employee. Company contributions are used to
88
buy the Company's common stock on the open market for allocation to the
employees' accounts in the plan. The Company contributed approximately
$88,000, $70,000, and $47,000 for the years ended December 31, 2000, 1999,
and 1998, respectively.
As of December 31, 2000, the Bank had unused lines of credit with other
depository institutions of $11,500,000.
The Bank processes merchant credit card transactions for a fee. The Bank
is subject to off-balance-sheet credit risk in relation to these
transactions. To help mitigate this risk, the Bank requires participating
merchants to have deposits on hand at the Bank. At December 31, 2000 and
1999, there were $20,737,000 and $13,718,000 of merchant credit card
deposit balances on hand.
Regulations of the Federal Reserve Board require depository institutions
to maintain a portion of their deposits in the form of either cash or
deposits with the Federal Reserve Bank that are noninterest bearing and
are not available for investment purposes. The average Federal Reserve
balances required to be maintained to meet these requirements were
approximately $5,950,000 and $3,643,000 at December 31, 2000 and 1999,
respectively.
In the normal course of business, the Company and the Bank are involved in
litigation. Management does not expect the ultimate outcome of any pending
litigation to have a material effect on the Company's financial position
or results of operations.
7. REGULATORY CAPITAL
The Bank is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory--and possibly
additional discretionary-actions by the regulators that, if undertaken,
could have a direct, material effect on the Company's consolidated
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's
assets, liabilities, and certain off-balance-sheet items as calculated
under regulatory accounting practices. The Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the
table below) of total and Tier I capital (as defined in the regulations)
to risk-weighted assets (as defined), and of Tier I capital (as defined)
to average assets (as defined). Management believes, as of December 31,
2000 and 1999, that the Bank meets all capital adequacy requirements to
which it is subject.
As of December 31, 2000 and 1999, the most recent notifications from the
FDIC 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, and Tier I leverage ratios as set forth in the table. There
are no conditions or events since the most recent notification that
management believes have changed the Bank's category.
89
Following is a table showing the minimum capital ratios required for the
Bank and the Bank's actual capital ratios and actual capital amounts at
December 31, 2000 and 1999 (the Company's ratios and amounts are
substantially the same):
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
---------------------------------------------------------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
(000'S) (000'S) (000'S)
As of December 31, 2000:
Total capital
(to risk-weighted assets) $ 25,748 10.9% $ 18,892 > 8.0% $ 23,615 >10.0%
Tier I capital
(to risk-weighted assets) $ 22,776 9.6% $ 9,446 > 4.0% $ 14,169 >6.0%
Tier I capital
(to average assets) $ 22,776 7.4% $ 11,290 > 4.0% $ 14,112 > 5.0%
As of December 31, 1999:
Total capital
(to risk-weighted assets) $ 23,013 11.7% $ 15,748 > 8.0% $19,684 > 10.0%
Tier I capital
(to risk-weighted assets) $ 20,713 10.5% $ 7,874 > 4.0% $ 11,811 > 6.0%
Tier I capital
(to average assets) $ 20,713 8.9% $ 9,356 > 4.0% $ 11,695 > 5.0%
8. EARNINGS PER SHARE RECONCILIATION
DECEMBER 31, 2000
-----------------------------------------------
WEIGHTED-
AVERAGE
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
BASIC EPS
Income available to common shareholders $ 2,406,000 2,691,000 $ 0.89
EFFECT OF DILUTIVE SECURITIES
Incremental shares from assumed exercise
of outstanding options 19,000
------------ --------- --------
DILUTED EPS
Income available to common shareholders $ 2,406,000 2,710,000 $ 0.89
============ ========= ========
90
DECEMBER 31, 1999
-----------------------------------------------
WEIGHTED-
AVERAGE
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
BASIC EPS
Income available to common shareholders $ 1,726,000 2,832,000 $ 0.61
EFFECT OF DILUTIVE SECURITIES
Incremental shares from assumed exercise
of outstanding options 94,000 (0.02)
DILUTED EPS
------------ --------- --------
Income available to common shareholders $ 1,726,000 2,926,000 $ 0.59
============ ========= ========
DECEMBER 31, 1998
-----------------------------------------------
WEIGHTED-
AVERAGE
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
BASIC EPS
Income available to common shareholders $ 1,709,000 2,595,000 $ 0.66
EFFECT OF DILUTIVE SECURITIES
Incremental shares from assumed exercise
of outstanding options 169,000 (0.04)
DILUTED EPS
------------ --------- ------
Income available to common shareholders $ 1,709,000 2,764,000 $ 0.62
============ ========= ======
9. STOCK COMPENSATION PLANS
No options were granted in 1998. In 1999, the Company adopted a new
nonqualified employee stock option plan that authorizes the issuance of up
to 600,000 shares of its common stock and expires in 2009, and granted
335,000 options at an exercise price of $7.75 per share. These options
were canceled in 2000. In 2000, 335,000 options were granted under the new
plan at an exercise price of $7.25, and an additional 15,000 options were
granted at $8.00 per share. All options granted during 2000, vest over a
seven-year period, expiring in 2009. As a result of repricing the 335,000
options during 2000, these options are subject to variable accounting
treatment in accordance with Financial Accounting Standards Board
Interpretation No. 44 ("FIN"), "Accounting for Certain Transactions
Involving Stock Compensation," and FIN 28, "Accounting for Stock
Appreciation Rights and Other Variable Stock Option or Award Plans." As a
result of applying FIN 44 and 28 to the repriced options, the Company
realized $24,000 of accrued compensation expense at December 31, 2000.
The Company also has a nonqualified employee stock option plan that
authorizes the issuance of up to 350,000 shares of its common stock and
expires in April 2001. In 2000, 10,000 shares were granted under this plan
at an exercise price or $7.25, vesting over a five-year period and
expiring in 2005. Under both plans, options may be granted at a price not
less than the fair market value of the stock at the date of grant.
91
At December 31, 2000, 1999, and 1998, the Company had options outstanding
granted under the plans as follows:
2000 1999 1998
----------------------------- --------------------------- ---------------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
Outstanding at
beginning of year 441,000 $ 6.52 206,000 $ 2.36 280,000 $ 2.29
Granted 360,000 7.30 335,000 7.75
Exercised (100,000) 2.45 (90,000) 2.08 (74,000) 2.10
Terminated (335,000) 7.75 (10,000) 2.00
------- ------- -------
Outstanding at
end of year 366,000 7.27 441,000 6.52 206,000 2.36
======= ======= =======
Options exercis-
able at year-end 2,000 5.75 96,000 2.41 64,000 2.38
======= ======= =======
Information pertaining to options outstanding at December 31, 2000 is as
follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------- --------------------------
WEIGHTED- WEIGHTED-
AVERAGE AVERAGE WEIGHTED-
RANGE OF NUMBER REMAINING EXERCISE AVERAGE
EXERCISE PRICES OUTSTANDING LIFE PRICE NUMBER PRICE
$5.75 6,000 1 year $ 5.75 2,000 $ 5.75
$7.25-$8.00 360,000 8.5 years $ 7.28
The estimated fair value of options granted during 2000 was $1.60 per
share. No compensation cost has been recognized for the stock option plan.
Had compensation cost for the Company's stock option plan been determined
based on the fair value at the grant dates for awards under the plan
consistent with the method of SFAS No. 123, the Company's net income and
basic EPS for the years ended December 31, 2000, 1999, and 1998 would have
been reduced to the pro forma amounts indicated below:
2000 1999 1998
Net income to common shareholders:
As reported $ 2,406,000 $ 1,726,000 $ 1,709,000
Pro forma $ 2,352,000 $ 1,669,000 $ 1,672,000
Basic earnings per share:
As reported $ 0.89 $ 0.61 $ 0.66
Pro forma $ 0.88 $ 0.59 $ 0.64
92
The fair values of options granted under the Company's stock option plan
during 2000 were estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted-average assumptions where
used: no dividend yield, expected volatility of 53 percent, risk-free
interest rate of 5.5 percent, and expected lives of seven years.
10. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST
During 1998, the Company established an ESOP for eligible employees.
Full-time and part-time employees of the Bank who have been credited with
at least 1,000 hours during a 12-month period and who have attained age 21
are eligible to participate.
On September 30, 1998, the ESOP borrowed $1,500,000 from an unrelated bank
in order to fund the purchase of 150,000 shares of the Company's common
stock. This loan is scheduled to be repaid monthly on a straight-line
basis over five years, with the funds for repayment from the Company's
contributions to the ESOP. The ESOP shares were pledged as collateral for
its debt. The interest rate on this loan is variable, prime plus .5
percent, with interest of 10 percent at December 31, 2000. The outstanding
principal balance of the ESOP loan at December 31, 2000 and 1999 was
$1,163,000 and $1,313,000, respectively.
Shares purchased by the ESOP are held in a trust account for allocation
among participants as the loan is repaid. The number of shares allocated
each plan year is dependent upon the ratio of that year's total loan
payment to the aggregate payments scheduled to occur throughout the term
of the loan. The annual allocation of shares is apportioned among
participants on the basis of compensation in the year of allocation.
Unallocated ESOP shares are excluded from EPS computations. ESOP benefits
generally become 100 percent vested after an employee completes seven
years of credited service. Benefits are payable upon death, retirement, or
disability. The number of shares of common stock allocated to employee
accounts was 9,000 and 15,000 shares at December 31, 2000 and 1999.
Periodic compensation expense associated with the ESOP is recognized based
upon both the number of shares pro rata allocated and the periodic fair
market value of the common stock. The expense related to the ESOP for the
years ended December 31, 2000, 1999, and 1998 was $274,000, $269,000, and
$68,000, respectively.
At December 31, 2000 and 1999, unearned compensation related to the ESOP
approximated $1,102,000 and $1,244,000, respectively, and is shown as a
reduction of shareholders' equity in the accompanying consolidated balance
sheets. Based upon the market price of the Company's stock at December 31,
2000, the unearned shares of the ESOP have a cumulative fair value of
$892,000.
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11. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
The following estimated fair value amounts have been determined by the
Company using available market information and appropriate valuation
methodologies. However, considerable judgment is required to interpret
market data to develop the estimates of fair value. Accordingly, the
estimates presented herein are not necessarily indicative of the amounts
the Company could realize in a current market exchange. The use of
different market assumptions and/or estimation methodologies may have a
material effect on the estimated fair value amounts.
DECEMBER 31, 2000 DECEMBER 31, 1999
------------------------------- -------------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
(000'S) (000'S)
Assets:
Cash and due from banks $ 20,819 $ 20,819 $ 10,074 $ 10,074
Federal funds sold 38,740 38,740 37,090 37,090
Interest-bearing deposits in
financial institutions 99 99 6,923 6,923
Investment securities available
for sale 2,985 2,985 52,789 52,789
Loans 231,557 234,233 121,816 124,298
Accrued interest receivable 1,943 1,943 858 858
Liabilities:
Deposits:
Noninterest bearing 99,632 99,632 65,405 65,405
Interest bearing:
Time deposits 65,411 65,432 44,052 43,996
Money market and other deposits 113,020 113,020 96,275 96,275
Note payable 1,163 1,163 1,313 1,313
Federal funds purchased 1,457 1,457 3,195 3,195
Accrued interest payable 417 417 241 241
Fair values of commitments to extend credit and standby letters of credit
are immaterial as of December 31, 2000 and 1999.
The fair values of cash and due from banks, federal funds sold,
interest-bearing deposits in financial institutions, noninterest-bearing
deposits, money market and other deposits, and Fed funds purchased
approximate their carrying value.
The fair value of investment securities available for sale is based on
quoted market prices, dealer quotes, and prices obtained from independent
pricing services. The fair value of loans and interest-bearing deposits is
estimated based on present values using applicable risk-adjusted spreads
to the U.S. Treasury curve to approximate current entry-value interest
rates applicable to each category of such financial instruments.
No adjustment was made to the entry-value interest rates for changes in
credit of performing loans for which there are no known credit concerns.
Management segregates loans in appropriate risk categories. Management
believes that the risk factor embedded in the entry-value interest rates,
along with the general reserves applicable to the performing loan
portfolio for which there are no known credit concerns, results in a fair
valuation of such loans on an entry-value basis. The fair value of
nonperforming loans with a recorded book value of $29,000 and $129,000 in
2000 and 1999 was not estimated because it is not practicable to
reasonably assess the credit adjustment that would
94
be applied in the marketplace for such loans.
The fair value estimates presented herein are based on pertinent
information available to management as of December 31, 2000 and 1999.
Although management is not aware of any factors that would significantly
affect the estimated fair value amounts, such amounts have not been
comprehensively revalued for purposes of these financial statements since
that date, and therefore, current estimates of fair value may differ
significantly from the amounts presented herein.
12. DEPOSITS AND INTEREST EXPENSE
A summary of interest expense on deposits for the years ended December 31,
2000, 1999, and 1998 is as follows:
2000 1999 1998
Money market savings / NOW account deposits $2,510,000 $2,156,000 $1,544,000
Time deposits under $100,000 712,000 1,464,000 1,026,000
Time deposits of $100,000 or more 1,743,000 774,000 830,000
Savings deposits 50,000 50,000 37,000
---------- ---------- ----------
$5,015,000 $4,444,000 $3,437,000
========== ========== ==========
The maturities of time deposits as of December 31, 2000 are as follows:
2001 $65,184,000
2002 3,000
2003 113,000
2004 111,000
-----------
$65,411,000
===========
The aggregate amount of time deposits in denominations of $100,000 or more
outstanding as of December 31, 2000 and 1999 was approximately $43,309,000
and $32,297,000, respectively. The aggregate amount of deposits from
escrow-related accounts was approximately $10,643,000 and $13,879,000 as
of December 31, 2000 and 1999, respectively. Additionally, the aggregate
amount of deposits from bankruptcy-related accounts was approximately
$12,122,000 and $12,218,000 as of December 31, 2000 and 1999,
respectively. The Company has two surety bonds totaling $17 million in
place of collateral for the bankruptcy-related deposits.
95
13. OTHER OPERATING EXPENSES
Included in other operating expenses for the years ended December 31,
2000, 1999, and 1998 are the following items:
2000 1999 1998
Professional services $ 385,000 $ 607,000 $ 330,000
Data processing fees 708,000 545,000 365,000
Equipment expense 498,000 375,000 254,000
General insurance 295,000 212,000 120,000
Stationery and supplies 222,000 208,000 132,000
Customer courier service 298,000 272,000 174,000
Other 1,983,000 1,573,000 1,192,000
------------- ------------- -------------
Total $ 4,389,000 $ 3,792,000 $ 2,567,000
============= ============= =============
14. ADMINISTRATION OF SELF-DIRECTED RETIREMENT ACCOUNTS
In January 1999, the Bank established TASC, a wholly owned subsidiary that
provides administrative services to self-directed retirement plans. In
conjunction with the formation of TASC, the Bank acquired the retirement
plan division of another institution at a cost of approximately $900,000,
which was recorded as goodwill in the accompanying consolidated 1999
balance sheet (included in other assets) and is being amortized over the
expected recoverable period of seven years on a straight-line basis. As of
December 31, 2000, the Bank was the custodian of approximately
$321,394,000 in retirement assets.
Deposits held for TASC clients by the Bank represent approximately 11
percent of the Bank's total deposits as of December 31, 2000. The Bank
paid interest of $643,000 and $672,000 on deposits of TASC clients and
received fees of $410,000 and $587,000 from TASC clients during 2000 and
1999, respectively. Goodwill of $128,000 and $128,000 was amortized into
operating expenses during 2000 and 1999, respectively.
Prior to the commencement of TASC operations, the Bank had a long-term
relationship with Transcorp Pension Services, Inc. ("Transcorp"), an
administrator of self-directed individual retirement accounts and
simplified employee pension retirement plans, pursuant to which the Bank
provided custodial and other services to IRA and pension plans for which
Transcorp served as administrator. The Bank's deposit and service
relationships with Transcorp ended in 1999. There were no deposits of
custodial clients of the plans Transcorp administers as of December 31,
1999. For the years ended December 31, 1999 and 1998, the Bank paid
interest of $122,000 and $782,000, respectively, on deposits of Transcorp
custodial clients, and paid $168,000 and $553,000, respectively, in
administrative fees to Transcorp on behalf of its custodial clients.
15. RELATED-PARTY TRANSACTIONS
As of December 31, 2000 and 1999, deposits from directors, officers, and
their affiliates amounted to $830,000 and $1,078,000, respectively.
During 2000, the Company purchased a split dollar life insurance policy on
behalf of one of the Company's executive officers. The policy was fully
funded at purchase. The Company and officer's estate are co-beneficiaries,
with each receiving a certain amount upon death of the officer.
96
16. FINANCIAL INFORMATION REGARDING FIRST REGIONAL BANCORP
As of December 31, 2000 and 1999, the Company's investment in the Bank was
recorded on the equity method at $23,366,000 and $21,429,000,
respectively. The Company's cash balance held in the Bank was $78,000 and
$185,000 as of December 31, 2000 and 1999, respectively. The only other
significant asset or liability recorded on the Company's balance sheets in
2000 and 1999 is a tax benefit of $455,000 and $334,000, respectively,
pertaining to the exercise of stock options. The Company's significant
operations consist solely of the recognition of its equity in the income
or loss of the Bank. The Bank paid dividends of $550,000, $2,000,000, and
$100,000 to the Company in 2000, 1999, and 1998, respectively.
Federal law restricts the Bank from extending credit to the Company; any
such extensions of credit are subject to strict collateral requirements.
17. SEGMENT REPORTING
Management has evaluated the Company's overall operation, and determined
that its business consists of two reportable business segments as of
December 31, 2000 and 1999, core banking operations, and the
administrative services in relation to TASC. The following describes these
two business segments:
CORE BANK OPERATIONS - The principal business activities of this segment
are attracting funds from the general public and originating commercial
and real estate loans for small and midsize businesses in Southern
California. This segment's primary sources of revenue are interest income
from loans and investment securities, and fees earned in connection with
loans and deposits. This segment's principal expenses consist of interest
paid on deposits, personnel, and other general and administrative
expenses.
ADMINISTRATIVE SERVICES - The principal business activity of this segment
is providing administrative services for self-directed retirement plans.
The primary source of revenue for this segment is fee income from
self-directed accounts. The segment's principal expenses consist of
personnel, rent, data processing, and other general and administrative
expenses.
Total assets of TASC at December 31, 2000 and 1999 were $894,000 and
$1,617,000, respectively. The remaining assets reflected on the balance
sheets of the Company are associated with the core banking operations.
The following table shows the net income (loss) for the core banking
operations and the administration and custodial services for the years
ended December 31, 2000 and 1999.
CORE BANKING ADMINISTRATIVE YEAR ENDED
OPERATIONS SERVICES DECEMBER 31, 2000
Net interest income $ 17,547,000 $ 17,547,000
Provision for loan losses 2,204,000 2,204,000
Other operating income 1,325,000 $ 415,000 1,740,000
Other operating expenses 12,029,000 959,000 12,988,000
Provision for income taxes 1,689,000 1,689,000
------------ ------------ ------------
Net income $ 2,950,000 $ (544,000) $ 2,406,000
============ ============ ============
97
CORE BANKING ADMINISTRATIVE YEAR ENDED
OPERATIONS SERVICES DECEMBER 31, 1999
Net interest income $ 10,796,000 $ 10,796,000
Reversal of loan losses (206,000) (206,000)
Other operating income 1,317,000 $ 618,000 1,935,000
Other operating expenses 9,005,000 993,000 9,998,000
Provision for income taxes 1,213,000 1,213 000
------------ --------- -----------
Net income $ 2,101,000 $(375,000) $ 1,726,000
============ ========= ===========
The operations of the administrative services positively affect the
results of core banking operations by providing a low-cost source of
deposits.
18. QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized quarterly financial data follows:
THREE MONTHS ENDED
--------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
2000 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Net interest income $ 3,546 $ 4,278 $ 4,639 $ 5,084
Provision for loan losses $ 150 $ 564 $ 710 $ 780
Net income $ 513 $ 550 $ 611 $ 732
Basic earnings per common share $ 0.19 $ 0.20 $ 0.23 $ 0.27
Diluted earnings per common share $ 0.19 $ 0.20 $ 0.23 $ 0.27
1999
Net interest income $ 2,436 $ 2,587 $ 2,779 $ 2,994
Provision for loan losses $ (220) $ 25 $ 0 $ (11)
Net income $ 409 $ 333 $ 396 $ 588
Basic earnings per common share $ 0.14 $ 0.11 $ 0.14 $ 0.22
Diluted earnings per common share $ 0.14 $ 0.11 $ 0.13 $ 0.21
98
INDEX TO EXHIBITS
EXHIBIT NO.
3.1 Articles of Incorporation, as amended (filed as Exhibit 3.1 to the
Company's Registration Statement on Form S-14, File No. 2-75140 filed December
2, 1981 and incorporated herein). Certificate of Chairman and Chief Executive
Officer and Assistant Secretary evidencing amendment of Articles of
Incorporation by written consent of shareholders on November 24, 1987 and filed
with the Secretary of State of the State of California on December 7, 1987
(filed as Exhibit 3.1 to the Company's Annual Statement on Form 10-K for the
year ended December 31, 1987 and incorporated herein). Certificate of Chairman
and Chief Executive Officer and Assistant Secretary evidencing amendment of
Articles of Incorporation adopted at Annual Shareholders Meeting on May 19, 1988
and filed with the Secretary of State of the State of California (filed as
Exhibit 3.1 to the Company's Annual Statement on Form 10-K for the year ended
December 31, 1988 and incorporated herein).
3.2 Bylaws, as amended (filed as Exhibit 3(b) to the Company's Registration
Statement on Form 10, File No. 0-10232 filed in March, 1982 and incorporated
herein). Certificate of Assistant Secretary evidencing amendment adopted at
Annual Shareholders Meeting on May 16, 1985 (filed as Exhibit 3.2 to the
Company's Annual Statement on Form 10-K for the year ended December 31, 1985 and
incorporated herein).
10.1 1982 Stock Option Plan and Agreement, as amended (filed as Exhibit 10.1
to Company's Annual Statement on Form 10-K for the year ended December 31, 1982
and incorporated herein).
10.2 1991 Stock Option Plan and Agreement (filed as Exhibit 10.4 to
Company's Annual Statement on Form 10-K for the year ended December 31, 1991 and
incorporated herein).
10.3 Lease for ground and eighth floor premises at 1801 Century Park East,
Los Angeles, California (filed as Exhibit 10.3 to Company's Annual Statement on
Form 10-K for the year ended December 31, 1993 and incorporated herein). Lease
for office at 28310 Roadside Drive, Suite 152, Agoura Hills, California.
11 Statement regarding computation of per share earnings (see Note 1 of
the Notes to Consolidated Financial Statements at page 87 of this report on Form
10-K)
21 Subsidiary of Registrant
99