UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2000 Commission File Number 000-23257 BYL BANCORP California 33-0755794 (State or other jurisdiction of (IRS Employer Incorporation or organization) Identification No.) 1875 North Tustin Street, Orange, California 92865 (Address of principal executive offices) (Zip Code) Issuer's telephone number: (714) 685-1317 Securities registered under Section 12(b) of Exchange Act: None Securities registered under Section 12(g) of Exchange Act: Common Stock, no par value -------------------------- (Title of Class) Check whether the issuer (1) filed all reports to be filed by Section 13 or 15(d) of the Securities Exchange Act during the past 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 |_| Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-K contained in this form and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. |X| There were 2,542,835 shares of Common Stock outstanding at March 23, 2001. The aggregate market value of Common Stock held by non-affiliates at March 23, 2001 was approximately $31,785,000 based upon the last known trade of $12.50 per share on March 23, 2001. Documents incorporated by reference: The proxy statement for the Annual Meeting of Shareholders of the registrant to be held in the third or fourth quarter of 2001. Certain information therein is incorporated by reference in Part III hereof. 1 BYL BANCORP Table of Contents Page Part I Item 1. Business ..................................................... 3 Item 2. Properties ................................................... 20 Item 3. Legal Proceedings ............................................ 20 Item 4. Submission of Matters to a Vote of Security Holders .......... 20 Part II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters ......................................... 21 Item 6. Selected Financial Data ..................................... 22 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation .......................... 24 Item 7A. Quantitative and Qualitative Disclosures About Market Risk... 40 Item 8. Financial Statements and Supplementary Data ................. 42 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure .................................... 79 Part III Item 10. Directors and Executive Officers of the Registrant .......... 79 Item 11. Executive Compensation ...................................... 79 Item 12. Security Ownership of Certain Beneficial Owners and Management .................................................. 79 Item 13. Certain Relationships and Related Transaction ............... 79 Part IV Item 14. Exhibits Financial Statement Schedules, and Reports on Form 8-K ................................................. 80 2 PART I ITEM 1: BUSINESS General BYL Bancorp (hereinafter the "Company") was incorporated under the laws of the State of California in 1997 and commenced operations in November 1997 as a bank holding company of BYL Bank Group (the "Bank"), which changed its name from Bank of Yorba Linda in June 1998. Other than its investment in the Bank, the Company currently conducts no other significant business activities, although it is authorized to engage in a variety of activities which are deemed closely related to the business of banking upon prior approval of the Federal Reserve's Board of Governors, the Company's primary regulator. As of December 31, 2000, the Company had total assets of approximately $286.4 million, total deposits of $254.3 million and total shareholders' equity of $29.2 million. The Bank was incorporated under the laws of the State of California in 1979 and was licensed by the California State Banking Department, now known as of the California Department of Financial Institutions ("DFI") and commenced operations as a California state chartered bank on March 3, 1980. The Bank's accounts are insured by the Federal Deposit Insurance Corporation ("FDIC"), but like most banks of its size in California, is not a member of the Federal Reserve Bank. The Bank is a California commercial bank that operates from its main office located at 1875 North Tustin Street, Orange, California, and the Bank operates seven full-service banking centers in the Bank's primary market areas of Orange and Riverside Counties, California. In addition to conducting its regular community banking activities, the Bank also originates and sells non-conforming residential real estate loans and SBA guaranteed loans. The Bank's mortgage division is located in Tustin, California. Focus and Operating Strategy The primary focus of the Bank is to provide personalized quality banking products and services to small and medium-size businesses, including professionals. The Bank originates nonconforming mortgages in California and various other states and sells such loans in the secondary market, and originates and sells SBA guaranteed loans, with the objective of building a balanced community loan and investment portfolio mix. Management believes that a local market focus accompanied by strategic placement of bank branches and personnel enables the Bank to attract and retain low-cost core deposits which provide substantially all of the Bank's funding requirements. In furtherance of its focus in operating strategy, following the receipt of all necessary regulatory approvals, the Bank completed the acquisition of the Bank of Westminster on June 14, 1996. The aggregate purchase price of the Bank of Westminster was $6.17 million. In conjunction with the acquisition of the Bank of Westminster, the Bank completed an offering of new primary stock underwritten on a firm commitment basis by Ryan, Beck & Co. Following receipt of all necessary regulatory approvals, the Company completed the acquisition of DNB Financial on May 29, 1998 in which each share of DNB Financial was converted into the right to receive 4.1162 shares of the Company's common stock, resulting in the issuance of 956,641 shares of Company common stock to the shareholders of DNB Financial. The Company or the Bank has not engaged in any material research activities relating to the development of new services or the improvement of our existing services. The Company or the Bank has no present plans regarding "a new line of business" requiring the investment of a material amount of total assets. 3 Most of the Bank's business originates from the Orange and Riverside counties, and there is no emphasis on foreign sources and application of funds. The Bank's business, based upon performance to date, does not appear to be seasonal. The Bank is not dependent upon a single customer or group of related customers for a material portion of the Bank's deposits. The Bank is unaware of any material effect upon the Bank's capital expenditures, earnings or competitive position as a result of federal, state or local environmental regulation. Proposed Merger with PBOC Holdings, Inc. On November 2, 2000, the Company and PBOC Holdings, Inc. ("PBOC"), parent company of People's Bank of California ("People's"), announced the signing of an Agreement and Plan of Reorganization (the "Agreement") dated November 1, 2000, pursuant to which PBOC will acquire the Company and the Bank. Upon consummation of the transaction, PBOC will become the surviving corporation, and People's will become the surviving bank. Consummation of the Agreement is subject to a number of conditions, including, but not limited to, the approval of the Agreement by the shareholders of the Company and the receipt of requisite regulatory approvals. Under the terms of the transaction, the holders of Company Common Stock will receive $15.00 in cash for each share of Company Common Stock owned. The cash amount may be adjusted upward or downward under certain circumstances which are set forth in the Agreement. The maximum cash price per share of Company common stock is approximately $15.34, and the minimum cash per share of Company common stock is approximately $14.50. Concurrently with the execution and delivery of the Agreement, the directors and certain executive officers of the Company entered into a form of letter agreement with PBOC pursuant to which among other things, such persons agreed to vote their shares of Company common stock in favor of approval of the Agreement. In connection with the Agreement, PBOC and the Company entered into a Stock Option Agreement dated as of November 1, 2000, pursuant to which the Company granted PBOC an option to purchase up to 505,971 shares of Company's common stock (subject to adjustment as set forth therein), which represents 19.9% of the Company's outstanding shares of common stock, at a purchase price of $10.597 per share (subject to adjustment as set forth therein). The option will become exercisable upon the occurrence of certain events, as specified in the Stock Option Agreement, none of which has occurred as of the date hereof. PBOC is a Delaware corporation and is registered as a savings and loan holding company under the Home Owners' Loan Act, as amended. PBOC operates People's, which is its wholly-owned subsidiary. At December 31, 2000, PBOC had total consolidated assets of approximately $3.3 billion, total consolidated deposits of approximately $2.0 billion, and total consolidated shareholders' equity of approximately $213.6 million. People's is a federal savings and loan association headquartered in Los Angeles California, which originally commenced operations in 1887. It currently operates 26 banking offices primarily in Los Angeles County, as well as Orange and Ventura counties in Southern California. On December 11, 2000, PBOC announced that it has executed an agreement dated December 8, 2000 in which it will be acquired by FBOP Corp., a $5.4 billion bank and savings holding company headquartered in Oak Park, Illinois. FBOP Corp. owns banks in California, Illinois and Texas. Under the terms of the agreement between FBOP Corp. and PBOC, FBOP Corp. will acquire PBOC, and California National Bank, a subsidiary of FBOP Corp., will acquire People's. 4 As required by the Agreement, on January 8, 2001, the Bank sold the R-3 certificate retained in the 1999-1 Securitization to the highest bidder in a private bidding procedure conducted by Sutro & Co. for $1,419,512, less a 5% commission and other sale-related expenses. The highest bidder was Messrs. H. Rhoads Martin, Charles Cox and Eddie Fischer, all of whom are directors of the Company and the Bank. As a result, the consideration to be received from PBOC upon consummation of the merger will be reduced by an amount equal to approximately $0.159 per share as a result of the sale of the R-3 certificate. However, since the merger was not consummated by March 6, 2001, the consideration to be received from PBOC upon consummation of the merger began increasing from March 6, 2001 on a daily basis until the closing date equal to 8% per annum on the $15.00 per share merger consideration. On March 21, 2001, at a special meeting of shareholders, the Company's shareholders approved the principal terms of the Agreement, and PBOC and the Company are waiting for approval from the Office of Thrift Supervision and completion of the 15 day waiting period before the Agreement can be consummated. The Company is unaware of any other requirements that it must fulfill in order for the Agreement to be consummated. Lower Earnings Due to Extraordinary Loss on Mortgage Loans Previously Sold On March 6, 2001, the Company announced that the Company's earnings would be substantially reduced by the recognition of certain extraordinary losses on mortgage loans previously sold. At the time of the announcement, the Company believed that earnings in the first quarter would be impacted and that it was likely that quarterly results of operations would be approximately breakeven. However, accounting rules require that contingency losses be reported at the end of the most recent accounting period to be presented. Because the Company's year-end financial statements had not been issued prior to the announcement, the Company is required to recognize the extraordinary losses as of December 31, 2000. It is currently estimated that the gross losses will be approximately $1,658,000 and the actual losses, net of reduced incentive payments, will be approximately $1,160,000 or $681,000 after tax before any future recoveries. The Company has therefore recognized in the fourth quarter of 2000 a non-recurring, extraordinary loss with respect to certain mortgage loans previously sold by both the Bank's former Diamond Bar Division and current Tustin Mortgage Division operations to third party investors. The Company's net income for the year ended December 31, 2000 has been reduced to $578,000 or $0.23 per share basic and $0.23 per share diluted. This compares with the $3,076,000 or $1.21 per share basic and diluted net income reported for the year ended December 31, 1999. The losses arise from the Bank's obligation to repurchase from the third party investors certain fraudulent mortgage loans which were originated by mortgage brokers who were not employees or affiliates of the Company or the Bank. The fraudulent loans were originated through third-party brokers and were subsequently sold as part of both of the Divisions' normal operations to certain regular investors in such loans. In the case of the Tustin Mortgage Division, these loans were originated by a professional, large-scale fraud ring operated out of Texas that is believed to have impacted over twenty different mortgage lenders other than the Bank. The fraud scheme was quite complex and is believed to have involved more than 30 persons including at least 13 businesses with various names and owners, and included developers, real estate agents, appraisers, brokers and others. In the case of the former Diamond Bar Division (which was closed by the Bank as part of its restructuring in February 2000), the fraudulent mortgage loans involve falsification of appraisals, verifications of income and earnest money deposits, forged documents, false notarizations and stolen identities of borrowers. No employee of the Company or the Bank is believed to have been in any way involved in any of the fraudulent origination activities. The Company believes that there is a substantial probability of obtaining significant future recoveries to mitigate the extraordinary losses arising from these fraudulent loans. 5 Securitizations Sale of Unguaranteed Interests in SBA Loans On December 10, 1998, the Bank entered into a Pooling and Servicing Agreement dated as of October 1, 1998 (the "SBA Pooling Agreement") between the Bank, as Servicer and Master Servicer, and Marine Midland Bank, as Trustee (the "Trustee") whereby the Bank transferred certain unguaranteed interests (the "Unguaranteed Interests") in loans (the "SBA Loans") partially guaranteed by the U.S. Small Business Administration ("SBA") to a newly-created trust (the "Trust") for the benefit of the SBA and the holders of certificates representing interests in such Trust. The Trust consists of the Unguaranteed Interests in such SBA Loans that are subject to the Pooling Agreement, and the Trust has issued three (3) classes of certificates representing certain fractional undivided ownership interests in the Trust. The Aggregate principal amount of the Unguaranteed Interests delivered to the Trust on October 31, 1998 equaled approximately $38.1 million. Pursuant to the SBA Pooling Agreement, the Trust issued $34.4 million aggregate principal amount of BYL Bank SBA Loan-Backed Adjustable Rate Certificates, Series 1998-1, Class A ("Class A Certificate"), $6.02 million aggregate principal amount of BYL Bank SBA Loan-Backed Adjustable Rate Certificates, Series 1998-1, Class M ("Class M Certificate") and $2.58 million aggregate principal amount of BYL Bank SBA Loan-Backed Adjustable Rate Certificates, Series 1998-1, Class B ("Class B Certificate"). The Class A and Class B Certificates were sold to a limited number of "Qualified Institutional Buyers" as defined in Rule 144A under the Securities Act of 1933, and institutional "Accredited Investors" as defined in Rule 501 under the Securities Act. Pursuant to the requirements of the SBA, the Class B Certificates were retained by the Bank and are subordinate to the Class A and Class M Certificates. The Class M Certificates are subordinate to the Class A Certificates. Sale of Non-SBA Commercial Loans On August 11, 1999, the Bank entered into a Pooling and Servicing Agreement dated as of June 30, 1999 (the "SBL Business Loan Pooling Agreement") among the Bank, as seller and master servicer, HSBC Bank USA, as Trustee, and Bankers Trust (Delaware) as Delaware Trustee, whereby the Bank has transferred a pool of SBL Loans to a newly-created trust (the "SBL Trust") for the benefit of the holders of certificates representing interests in such SBL Trust. The SBL Trust consists of the SBL Loans that are subject to the SBL Pooling Agreement, and the SBL Trust has issued three (3) classes of certificates representing certain fractional undivided ownership interests in the SBL Trust. The aggregate principal amount of the Business Loans delivered to the SBL Trust on August 11, 1999 equaled approximately $47.1 million. Pursuant to the SBL Pooling Agreement, the Trust issued $16 million aggregate principal amount of BYL Bank Business Loan-Backed Pass-Through Certificates, Series 1999-1, Class A-1 ("Class A-1 Certificates"), $12 million aggregate principal amount of BYL Bank Business Loan-Backed Pass Through Certificates, Series 1999-1, Class A-2 Certificates ("Class A-2 Certificates"); $27.2 million aggregate principal amount of BYL Bank Business Loan-Backed Pass-Through Certificates, Series 1999-1, Class A-3 Certificates ("Class A-3 Certificates"); $4.8 million aggregate principal amount of BYL Bank Business Loan-Backed Pass-Through Certificates, Series 1999-1, Class B Certificates ("Class B-1 Certificates"); and BYL Bank Business Loan-Backed Pass-Through Certificates, Series 1999-1, Class R Certificates ("Class R Certificates"). 6 Restructuring During the fourth quarter of 1999, the Bank evaluated various possible alternatives of increasing capital, including the issuance of various kinds of securities and the divestiture or closing of those operations which were expected to continue to provide rates of return below the Bank's targeted ROA. As a result of such evaluations, the Company determined that the maximum potential value of the Bank's commercial loan originations would be realized through the retention of these loans in the Bank's loan portfolio. This decision was based upon the current and anticipated returns obtainable from either the sale or securitization of these commercial loan originations and the proposed increased regulatory capital requirements on loan securitizations. The shift in the Bank's strategy from loan sales or securitizations to portfolio retention requires increasing levels of capital in order to maximize the value of the Bank's ability to generate commercial loans at premium yields. On February 4, 2000, the Bank completed the sale of its automobile loan portfolio of approximately $38 million and closed its indirect automobile division. On February 22, 2000, the Bank completed the sale of its Diamond Bar Mortgage Division, an originator of conforming residential mortgages. As a result of this restructuring, the Company reported a loss for the first quarter 2000 of approximately $260,000. The Company also suspended quarterly dividends effective January 1, 2000. Regulatory Actions, Prompt Corrective Action and Capital Restoration Plan During late 1999 the FDIC completed an examination (the "1999 FDIC Examination") of the books and records of the Bank. In connection with the 1999 FDIC Examination, the FDIC notified the Bank that it had incorrectly calculated the risk-weighted capital requirements of the assets retained in the Bank's 1998 and 1999 securitizations. The FDIC also challenged the assumptions and financial model used by the Bank in valuing these residual assets. Based on the assumptions deemed acceptable by the FDIC, the FDIC believed the Bank's residual assets were overstated by $2.6 million. Although the Bank disagreed with the assumptions recommended by the FDIC, it has reflected this adjustment in its quarterly call reports for regulatory capital purposes, engaged an independent third-party to review the assumptions used by the Bank as well as design a financial model to more accurately measure the value of residual assets in future reporting periods. Primarily due to these items, the Bank was classified by the FDIC as undercapitalized. As a result, the Bank filed a capital restoration plan with the FDIC, which provided that the Bank expected to be adequately capitalized by March 31, 2000. The capital restoration plan also provides for increasing levels of capital every quarter until the Bank is well capitalized in 2001. The Bank has eliminated asset securitizations from its business plan. The Bank will continue operations of all traditional retail banking activities through the Bank's existing branch system. As of December 31, 2000, the Bank's management believes the Bank is adequately capitalized, as the Bank's risk based capital ratio was 9.30%, Tier 1 leverage capital ratio was 9.42%, and total risk based capital ratio was 10.08%. In addition, as a result of the 1999 FDIC Examination, for the purpose of cooperating with the FDIC and without admitting or denying any allegations, the Bank stipulated to an administrative action with the FDIC that requires the Bank, among other items, to retain qualified management; have and maintain certain Tier 1 capital and total risk based capital ratios; eliminate from its books certain assets classified loss; revise policies concerning the Bank's asset securitization activities; obtain a model to more adequately value its retained interests related to securitized assets; and adopt and implement certain other policies relating to profitability, liquidity and funds management, sensitivity to interest rate risk; revise certain reports to the FDIC; and correct all alleged violations of law. The order became effective July 10, 2000. 7 In order to comply with the FDIC administrative action, the Bank engaged PricewaterhouseCoopers ("PWC") to assist the Bank in determining the assumptions used in the valuation of these assets as well as design a new valuation model for ongoing measurement of the changes in valuation of these assets. The model was used for both call report and financial statement purposes for the months of August and September, and for all periods thereafter. The Bank has and will continue to use the discount rates and payment frequencies previously stipulated by the FDIC for call report purposes until the FDIC has accepted the PWC model and assumptions. The Company and the Bank now account for any adjustments generated utilizing these new assumptions as a change in estimates and adjust its financial statements in accordance with the results obtained from the model for both securitizations. As a result of the new model and assumptions the assets for the 1999-1 securitization were written down $800,000 as a permanent decline in value during the quarter ended June 30, 2000. Management believes that the Bank is in compliance with the FDIC administrative action. The Bank has now amended its call reports in order to reflect the proper computation of risk-weighted capital for residual assets and for the $2.6 million adjustment to these residual assets pursuant to the Bank's agreement with the FDIC. All call reports from December 31, 1998 through March 31, 2000 have been restated to reflect the effects of the changes, and call reports from June 30, 2000 forward continue to carry the adjustments, also pursuant to the agreement with the FDIC. As a result of a FRB examination in the first quarter of 2000, the Company executed a Memorandum of Understanding with the FRB. The FRB MOU requires that the Company, among other items, refrain from declaring dividends without the prior written approval of the FRB, refrain from certain transactions without FRB approval, develop and submit a written capital plan, submit a statement concerning the steps the Board proposes to take to improve the condition of the Bank and the consolidated organization, refrain from increasing debt or renewing existing debt without prior approval of the FRB, and submit written progress reports to the FRB. Management believes that the Company is in compliance with the FRB MOU. As described above, the Bank eliminated asset securitizations from its business plan in early 2000. Residual assets on the Bank's December 31, 2000 call report total approximately $9.98 million, or approximately 36% of the Bank's Tier 1 capital. After the sale of the remaining portions of the 1999-1 residuals in January 2001 as described below, the remaining residuals on the Bank's call reports total approximately $4.4 million or 16% of the Bank's Tier 1 capital. On March 10, 2000, the FDIC and other financial institution regulatory agencies proposed revisions to the risk-based capital treatment of recourse arrangements, direct credit substitutes and asset securitizations in FIL 15-2000. If the proposed revisions are adopted, the Bank does not believe that capital will be adversely affected. Proposed Formation of Subsidiary and Proposed Transaction As a result of the 1999 FDIC Examination, the Company had determined that it would be in the best interests of the Company and the Bank to transfer the retained assets, including the strips, residuals, servicing rights and other retained interests in the 1999 securitization, as well as most of the personnel of the SBA Department, to a proposed minority-owned subsidiary of the Company. The Company and the Bank executed a definitive agreement dated July 12, 2000 that describes the terms of a proposed joint venture for a Delaware limited liability company to be called CNL Commercial Finance, LLC. The Company and its joint venture partner, CNL Commercial Funding, LP ("CFL"), changed the corporate structure of the subsidiary to a C Corporation to be called CNL Commercial Finance, Inc. ("CCF"). The purpose of the joint venture is to originate, service and securitize commercial loans, some of which are to be guaranteed by the Small Business Administration, which are detailed below. The subsidiary, CCF, would have a total $10 million in equity capital. The Company would have 8 a 25% equity and voting interest in the subsidiary. The Company would execute a note for its $2.5 million contribution, and CFL would hold a 75% ownership interest in the subsidiary. Under the amended definitive agreement, the cash price will be at least equal to Bank's book value of the strips, residuals, servicing rights and other retained interests that are being transferred from the 1999-1 securitization, as well as other assets, but will not include one certificate that is rated investment grade Baa. On September 14, 2000, the Company and the Bank completed the first phase of the transaction with CCF, in which the Bank sold certain assets and transferred certain personnel of the SBA Division. The Bank also sold 59% of its retained interest in the 1999-1 Securitization. The Bank realized cash in the amount of $3.223 million as a result of the completion of the first phase of the CCF transaction. Following receipt of all necessary regulatory approvals, the Company and the Bank intended to complete the second phase of the transaction which would have involved the transfer of the remaining 41% of the retained interest in the 1999-1 Securitization, except for the investment rated security. At that time, the Company intended to execute the $2.5 million note as described above. At this time, because of certain issues that have arisen at the SBA, the Company will not complete the second portion of the transaction with CCF, and the CNL transaction agreements have terminated in accordance with their terms. Sale of R-3 Certificates On December 21, 2000, the Bank executed an agreement with Sutro & Co. in order to liquidate the BYL R-3 certificates. Following the termination of the CNL transaction with CCF, on January 8, 2001, the Bank sold the R-3 certificate to the highest bidder in a private bidding procedure conducted by Sutro & Co. for $1,419,512, less a 5% commission and other sale-related expenses. The highest bidder was Messrs. H. Rhoads Martin, Charles Cox and Eddie Fischer, all of whom are directors of the Company and the Bank. Supervision and Regulation The Company The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the "Bank Holding Company Act"), and is registered as such with and subject to the supervision of the Federal Reserve Board. The Company is required to file with the Federal Reserve Board quarterly and annual reports and such additional information as the Federal Reserve Board may require pursuant to the Bank Holding Company Act. The Federal Reserve Board may conduct examinations of bank holding companies and their subsidiaries. The Company will be required to obtain the approval of the Federal Reserve Board before it may acquire all or substantially all of the assets of any bank, or ownership or control of the voting shares of any bank if, after giving effect to such acquisition of shares, the Company would own or control more than 5% of the voting shares of such bank. Prior approval of the Federal Reserve Board is also required for the merger or consolidation of the Company and another bank holding company. The Company is prohibited by the Bank Holding Company Act, except in certain statutorily prescribed instances, from acquiring direct or indirect ownership or control of more than 5% of the outstanding voting shares of any company that is not a bank or bank holding company and from engaging, directly or indirectly, in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiaries. However, the Company may, subject to the prior approval of the Federal Reserve Board, engage in any, or acquire shares of companies engaged in, activities that are deemed by the Federal Reserve Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. 9 The Company, and any subsidiaries which it may acquire or organize, are deemed to be "affiliates" of the Company within the meaning of that term as defined in the Federal Reserve Act. This means, for example, that there are limitations (a) on loans by it subsidiaries to affiliates, and (b) on investments by its subsidiaries in affiliates' stock as collateral for loans to any borrower. The Company and its subsidiary are also subject to certain restrictions with respect to engaging in the underwriting, public sale and distribution of securities. The Company and its subsidiary are prohibited from engaging in certain tie-in arrangements in connection with an extension of credit, sale or lease of property or furnishing of services. Section 106(b) of the Bank Holding Company Act Amendments of 1970 generally prohibits a bank from tying a product or service to another product or service offered by its subsidiaries, or by any of its affiliates. Further, the Company and its subsidiary is required to maintain certain levels of capital. See, "Effect of Governmental Policies and Recent Legislation Capital Standards." The Federal Reserve Board may require that the Company terminate an activity or terminate control of or liquidate or divest subsidiaries or affiliates when the Federal Reserve Board determines that the activity or the control or the subsidiary or affiliates constitutes a significant risk to the financial safety, soundness or stability of any of its banking subsidiaries. The Federal Reserve Board also has the authority to regulate provisions of certain bank holding company debt, including authority to impose interest ceilings and reserve requirements on such debt. Under certain circumstances, the Company is required to file written notice and obtain approval from the Federal Reserve Board prior to purchasing or redeeming its equity securities. Under the Federal Reserve Board's regulations, a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe and unsound manner. In addition, it is the Federal Reserve Board's policy that in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company's failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve Board to be an unsafe and unsound banking practice or a violation of the Federal Reserve Board's regulations or both. The Bank The Bank is extensively regulated under both federal and state law. Set forth below is a summary description of certain laws which relate to the regulation of the Bank. The description does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations. The Bank is chartered under the laws of the State of California and its deposits are insured by the FDIC to the extent provided by law. The Bank is subject to the supervision of, and is regularly examined by, the DFI and the FDIC. Such supervision and regulation include comprehensive reviews of all major aspects of the Bank's business and condition. Various requirements and restrictions under the laws of the United States and the State of California affect the operations of the Bank. Federal and California statutes relate to many aspects of the Bank's operations, including reserves against deposits, interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowings, dividends and locations of branch offices. Further, the Bank is required to maintain certain levels of capital. 10 Effect of Governmental Policies and Recent Legislation Banking is a business that depends on rate differentials. In general, the difference between the interest rate we pay on our deposits and our other borrowings and the interest rate we receive on loans extended to our customers and securities held in our portfolio comprise the major portion of our earnings. These rates are highly sensitive to many factors that are beyond our control. Accordingly, our earnings and growth are subject to the influence of domestic and foreign economic conditions, including inflation, recession and unemployment. The commercial banking business is not only affected by general economic conditions but is also influenced by the monetary and fiscal policies of the federal government and the policies of regulatory agencies, particularly the Board of Governors of the Federal Reserve System ("FRB"). The FRB implements national monetary policies (with objectives such as curbing inflation and combating recession) by its open-market operations in U.S. Government securities, by adjusting the required level of reserves for financial institutions subject to its reserve requirements and by varying the discount rates applicable to borrowings by depository institutions. The actions of the FRB in these areas influence the growth of our loans, investments and deposits and also affects interest rates charged on loans and paid on deposits. The nature and impact of any future changes in monetary policies cannot be predicted. Capital Standards The Federal Reserve Board and FDIC have adopted risk-based minimum capital guidelines (for bank holding companies and insured non-member state banks, respectively) intended to provide a measure of capital that reflects the degree of risk associated with a banking organization's operations for both transactions reported on the balance sheet as assets and transactions, such as letters of credit and recourse arrangements, which are recorded as off balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off balance sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk, such as certain U.S. Treasury securities, to 100% for assets with relatively high credit risk, such as business loans. A banking organization's risk-based capital ratios are obtained by dividing its qualifying capital by its total risk adjusted assets. The regulators measure risk-adjusted assets, which includes off balance sheet items, against both total qualifying capital (the sum of Tier 1 capital and limited amounts of Tier 2 capital) and Tier 1 capital. Tier 1 capital consists primarily of common stock, retained earnings, noncumulative perpetual preferred stock (cumulative perpetual preferred stock for bank holding companies) and minority interests in certain subsidiaries, less most intangible assets. Tier 2 capital may consist of a limited amount of the allowance for possible loan and lease losses, cumulative preferred stock, long-term preferred stock, eligible term subordinated debt and certain other instruments with some characteristics of equity. The inclusion of elements of Tier 2 capital is subject to certain other requirements and limitations of the federal banking agencies. The federal banking agencies require a minimum ratio of qualifying total capital to risk-adjusted assets of 8% and a minimum ratio of Tier 1 capital to risk-adjusted assets of 4%. In addition to the risked-based guidelines, federal banking regulators require banking organizations to maintain a minimum amount of Tier 1 capital to total assets, referred to as the leverage ratio. For a banking organization rated in the highest of the five categories used by regulators to rate banking organizations, the minimum leverage ratio of Tier 1 capital to total assets is 3%. For all banking organizations not rated in the highest category, the minimum leverage ratio must be at least 100 to 200 basis points above the 3% minimum, or 4% to 5%. In addition to these uniform risk-based capital guidelines and leverage ratios that apply across the industry, the regulators have the discretion to set individual minimum capital requirements for specific institutions at rates significantly above the minimum guidelines and ratios. 11 In June 1996, the federal banking agencies adopted a joint agency policy statement to provide guidance on managing interest rate risk. These agencies indicated that the adequacy and effectiveness of a bank's interest rate risk management process and the level of its interest rate exposures are critical factors in the agencies' evaluation of the Bank's capital adequacy. A bank with material weaknesses in its risk management process or high levels of exposure relative to its capital will be directed by the agencies to take corrective action. Such actions will include recommendations or directions to raise additional capital, strengthen management expertise, improve management information and measurement systems, reduce levels of exposure, or some combination thereof depending upon the individual institution's circumstances. The federal banking agencies issued an interagency policy statement on the allowance for loan and lease losses which, among other things, establishes certain benchmark ratios of loan loss reserves to classified assets. The benchmark set forth by such policy statement is the sum of (a) assets classified loss; (b) 50 percent of assets classified doubtful; (c) 15 percent of assets classified substandard; and (d) estimated credit losses on other assets over the upcoming 12 months. Federally supervised banks and savings associations are currently required to report deferred tax assets in accordance with SFAS No. 109. The federal banking agencies recently issued final rules governing banks and bank holding companies, which became effective April 1, 1995, which limit the amount of deferred tax assets that are allowable in computing an institutions regulatory capital. The standard has been in effect on an interim basis since March 1993. 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. Deferred tax assets that can only be realized through future taxable earnings are limited for regulatory capital purposes to the lesser of (i) the amount that can be realized within one year of the quarter-end report date, or (ii) 10% of Tier 1 Capital. The amount of any deferred tax in excess of this limit would be excluded from Tier 1 Capital and total assets and regulatory capital calculations. Future changes in regulations or practices could further reduce the amount of capital recognized for purposes of capital adequacy. Such a change could affect the ability of the Bank to grow and could restrict the amount of profits, if any, available for the payment of dividends. Under applicable regulatory guidelines, the Bank is considered to be "adequately capitalized" at December 31, 2000. See Regulatory Actions, Prompt Corrective Action and Capital Restoration Plan. On January 1, 1998, new legislation became effective which, among other things, gave the power to the DFI to take possession of the business and properties of a bank in the event that the tangible shareholders' equity of the Bank is less than the greater of (i) 3% of the Bank's total assets or (ii) $1,000,000. Prompt Corrective Action Federal law requires each federal banking agency to take prompt corrective action to resolve the problems of insured depository institutions, including but not limited to those that fall below one or more prescribed minimum capital ratios. The law required each federal banking agency to promulgate regulations defining the following five categories in which an insured depository institution will be placed, based on the level of its capital ratios: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. 12 An insured depository institution generally will be classified in the following categories based on capital measures indicated below: "Well capitalized" "Adequately capitalized" Total risk-based capital of 10%; Total risk-based capital of 8%; Tier 1 risk-based capital of 6% and; Tier 1 risk-based capital of 4%; Leverage ratio of 5%. and Leverage ratio of 4%. "Undercapitalized" "Significantly undercapitalized" Total risk-based capital less than 8%; Total risk-based capital less than 6%; Tier 1 risk-based capital less than 4%; or Tier 1 risk-based capital less than 3%; or Leverage ratio less than 4%. Leverage ratio less than 3%. "Critically undercapitalized" Tangible equity to total assets less than 2%. An institution that, based upon its capital levels, is classified as "well capitalized," "adequately capitalized" or undercapitalized" may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment. At each successive lower capital category, an insured depository institution is subject to more restrictions. The federal banking agencies, however, may not treat an institution as "critically undercapitalized" unless its capital ratio actually warrants such treatment. The law prohibits insured depository institutions from paying management fees to any controlling persons or, with certain limited exceptions, making capital distributions if after such transaction the institution would be undercapitalized. If an insured depository institution is undercapitalized, it will be closely monitored by the appropriate federal banking agency, subject to asset growth restrictions and required to obtain prior regulatory approval for acquisitions, branching and engaging in new lines of business. Any undercapitalized depository institution must submit an acceptable capital restoration plan to the appropriate federal banking agency 45 days after becoming undercapitalized. The appropriate federal banking agency cannot accept a capital plan unless, among other things, it determines that the plan (i) specifies the steps the institution will take to become adequately capitalized, (ii) is based on realistic assumptions and (iii) is likely to succeed in restoring the depository institution's capital. In addition, each company controlling an undercapitalized depository institution must guarantee that the institution will comply with the capital plan until the depository institution has been adequately capitalized on an average basis during each of four consecutive calendar quarters and must otherwise provide adequate assurances of performance. The aggregate liability of such guarantee is limited to the lesser of (a) an amount equal to 5% of the depository institution's total assets at the time the institution became undercapitalized or (b) the amount which is necessary to bring the institution into compliance with all capital standards applicable to such institution as of the time the institution fails to comply with its capital restoration plan. Finally, the appropriate federal banking agency may impose any of the additional restrictions or sanctions that it may impose on significantly undercapitalized institutions if it determines that such action will further the purpose of the prompt correction action provisions. An insured depository institution that is significantly undercapitalized, or is undercapitalized and fails to submit, or in a material respect to implement, an acceptable capital restoration plan, is subject to additional restrictions and sanctions. These include, among other things: (i) a forced sale of voting shares to raise capital or, if grounds exist for appointment of a receiver or conservator, a forced acquisition; (ii) restrictions on transactions with affiliates; (iii) further limitations on interest rates paid on deposits; (iv) further restrictions on growth or required shrinkage; (v) modification or termination of specified activities; (vi) replacement of directors or 13 senior executive officers; (vii) prohibitions on the receipt of deposits from correspondent institutions; (viii) restrictions on capital distributions by the holding companies of such institutions; (ix) required divestiture of subsidiaries by the institution; or (x) other restrictions as determined by the appropriate federal banking agency. Although the appropriate federal banking agency has discretion to determine which of the foregoing restrictions or sanctions it will seek to impose, it is required to force a sale of voting shares or merger, impose restrictions on affiliate transactions and impose restrictions on rates paid on deposits unless it determines that such actions would not further the purpose of the prompt corrective action provisions. In addition, without the prior written approval of the appropriate federal banking agency, a significantly undercapitalized institution may not pay any bonus to its senior executive officers or provide compensation to any of them at a rate that exceeds such officer's average rate of base compensation during the 12 calendar months preceding the month in which the institution became undercapitalized. Further restrictions and sanctions are required to be imposed on insured depository institutions that are critically undercapitalized. For example, a critically undercapitalized institution generally would be prohibited from engaging in any material transaction other than in the ordinary course of business without prior regulatory approval and could not, with certain exceptions, make any payment of principal or interest on its subordinated debt beginning 60 days after becoming critically undercapitalized. Most importantly, however, except under limited circumstances, the appropriate federal banking agency, not later than 90 days after an insured depository institution becomes critically undercapitalized, is required to appoint a conservator or receiver for the institution. The board of directors of an insured depository institution would not be liable to the institution's shareholders or creditors for consenting in good faith to the appointment of a receiver or conservator or to an acquisition or merger as required by the regulator. In addition to measures taken under the prompt corrective action provisions, commercial banking organizations may be subject to potential enforcement actions by the federal regulators for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. Safety and Soundness Standards Effective in 1995 the federal banking agencies adopted final guidelines establishing standards for safety and soundness, as required by the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA). These standards are designed to identify potential safety and soundness concerns and ensure that action is taken to address those concerns before they pose a risk to the deposit insurance fund. The standards relate to (i) internal controls, information systems and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) asset growth; (v) earnings; and (vi) compensation, fees and benefits. If a federal banking agency determines that an institution fails to meet any of these standards, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard. In the event the institution fails to submit an acceptable plan within the time allowed by the agency or fails in any material respect to implement an accepted plan, the agency must, by order, require this institution to correct the deficiency. Effective October 1, 1996, the federal banking agencies promulgated safety and soundness regulations and accompanying interagency compliance guidelines on asset quality and earnings standards. These new guidelines provide six standards for establishing and maintaining a system to identify problem assets and prevent those assets from deteriorating. The institution should (i) conduct periodic asset quality reviews to identify problem assets; (ii) estimate the inherent losses in those assets and establish reserves that are sufficient to absorb estimated losses; (iii) compare problem asset totals to capital; (iv) take appropriate corrective action to resolve problems assets; (v) consider the size and potential risks of material asset concentrations; and (vi) provide periodic asset reports with adequate information for management and the board of directors to assess the level of risk. These new guidelines also set forth standards for evaluating and monitoring earnings and for ensuring that earnings are sufficient for the maintenance of adequate capital and reserves. If an institution fails to comply with a safety and soundness standard, the appropriate federal banking agency may require the 14 institution to submit a compliance plan. Failure to submit a compliance plan or to implement an accepted plan may result in enforcement action. Premiums for Deposit Insurance Federal law has established several mechanisms to increase funds to protect deposits insured by Bank Insurance Fund ("BIF") administered by the FDIC. The FDIC is authorized to borrow up to $30 billion from the United States Treasury; up to 90% of the fair market value of assets of institutions acquired by the FDIC as receiver from the Federal Financing Bank; and from depository institutions that are members of the BIF. Any borrowings not repaid by asset sales are to be repaid through insurance premiums assessed to member institutions. Such premiums must be sufficient to repay any borrowed funds within 15 years and provide insurance fund reserves of $1.25 for each $100 of insured deposits. The FDIC also has authority to impose special assessments against insured deposits. The FDIC has adopted final regulations implementing a risk-based premium system required by federal law. Under the regulations, which cover the assessment periods commencing on and after January 1, 1994, insured depository institutions are required to pay insurance premiums within a range of 23 cents per $100 of deposits to 31 cents per $100 of deposits depending on their risk classification. The FDIC, effective September 15, 1995, lowered assessments from their rates of $.23 to $.31 per $100 of insured deposits to rates of $.04 to $.31, depending on the health of the Bank, as a result of the recapitalization of the BIF. On November 15, 1995, the FDIC voted to drop its premiums for well capitalized banks to zero effective January 1, 1996. Other banks will be charged risk-based premiums up to $.27 per $100 of deposits. Congress passed in 1996 and the President signed into law, provisions to strengthen the Savings and Loan Insurance Fund (SAIF") and to repay outstanding bonds that were issued to recapitalize the SAIF as a result of payments made due to the insolvency of savings and loan associations and other federally insured savings institutions in the late 1980's and early 1990's. The new law requires saving and loan associations to bear the cost of recapitalizing the SAIF and, after January 1, 1997, banks will contribute towards paying off the financing bonds, including interest. Effective January 1, 1997, SAIF-insured institutions pay 3.2 cents per $100 in domestic deposits, and BIF-insured institutions, like the Bank, pay 0.64 cents per $100 in domestic deposits. Interstate Banking and Branching On September 29, 1994, the President signed into law the Riegel Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate Act"). Under the Interstate Act, beginning one year after the date of enactment, a bank holding company that is adequately capitalized and managed may obtain approval under Bank Holding Company Act to acquire an existing bank located in another state without regard to state law. A bank holding company would not be permitted to make such an acquisition if, upon consummation, it would control (a) more than 10%4 of the total amount of deposits of insured depository institutions in the United States or (b) 30% or more of the deposits in the state in which it is located. A state may limit the percentage of total deposits that may be held in that state by any one bank or bank holding company if application of such limitation does not discriminate against out-of-state banks. An out-of-state bank holding company may not acquire a state bank in existence for less than a minimum length of time that may be prescribed by state law except that a state may not impose more than a five-year existence requirement. The Interstate Act also permits, beginning June 1, 1997, mergers of insured banks located in different states and conversion of the branches of the acquired bank into branches of the resulting bank. Each state may permit such combinations earlier than June 1, 1997, and may adopt legislation to prohibit interstate mergers after that date in that state or in other states by that state's banks. The same concentration limits discussed in the preceding paragraph apply. The Interstate Act also permits a national or state bank to 15 establish branches in a state other than its home state if permitted by the laws of that state, subject to the same requirements and conditions as for a merger transaction. In 1995, California adopted "opt in" legislation under the Interstate Act that permits out-of-state banks to acquire California banks that satisfy a five-year minimum age requirement (subject to exceptions for supervisory transactions) by means of merger or purchases of assets, although entry through acquisition of individual branches of California institutions and de novo branching into California are not permitted. The Interstate Act and the California branching statute will likely increase competition from out-of-state banks in the markets in which the Company intends to operate, although it is difficult to assess the impact that such increased competition may have on the Company's operations. The Interstate Act may increase competition in the Company's market areas especially from larger financial institutions and their holding companies. It is difficult to assess the impact each likely increased competition may have on the Company's operations. Community Reinvestment Act and Fair Lending Developments The Bank is subject to certain fair lending requirements and reporting obligations involving home mortgage lending operations and Community Reinvestment Act ("CRA") activities. The CRA generally requires the federal banking agencies to evaluate the record of a financial institution in meeting the credit needs of their local communities, including low and moderate-income neighborhoods. In addition to substantial penalties and corrective measures that may be required for a violation of certain fair lending laws, the federal banking agencies may take compliance with such laws and CRA into account when regulating and supervising other activities. In 1995 the federal banking agencies issued final regulations which change the manner in which they measure a bank's compliance with CRA obligations. The final regulations adopt a performance-based evaluation system which 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 activities or complies with other procedural requirements. In 1994 the federal Interagency Task Force on Fair Leading issued a policy statement on discrimination in lending. The policy statement describes the three methods that federal agencies will use to prove discrimination: overt evidence of discrimination, evidence of disparate treatment and evidence of disparate impact. In connection with its assessment of CRA performance, the appropriate bank regulatory agency assigns a rating of "outstanding," "satisfactory," "needs to improve" or "substantial noncompliance." The Bank has consistently been rate "satisfactory" and was examined most recently during the fourth quarter of 1998. The final report of examination has been received, and the Bank received a "satisfactory" rating. Financial Modernization Legislation On November 12, 1999, the President signed into law the Gramm-Leach-Bliley Act, or GLB Act, which significantly changed the regulatory structure and oversight of the financial services industry. The GLB Act revises the Bank Holding Company Act of 1956 and repeals the affiliation provisions of the Glass-Steagall Act of 1933, permitting a qualifying holding company, called a financial holding company, to engage in a full range of financial activities, including banking, insurance, and securities activities, as well as merchant banking and additional activities that are "financial in nature" or "complementary" to such financial activities. The GLB Act thus provides expanded financial affiliation opportunities for existing bank holding companies and permits various non-bank financial services providers to acquire banks by allowing bank holding companies to engage in activities such as securities underwriting, and underwriting and brokering of insurance products. The GLB Act also expands passive investments by financial holding companies in any type of company, financial or nonfinancial, through merchant banking 16 and insurance company investments: In order for a bank holding company to qualify as a financial holding company, its subsidiary depository institutions must be "well-capitalized" and "well-managed" and have at least a "satisfactory" Community Reinvestment Act rating. The GLB Act also reforms the regulatory framework of the financial services industry. Under the GLB Act, financial holding companies are subject to primary supervision by the FRB while current federal and state regulators of financial holding company regulated subsidiaries such as insurers, broker-dealers, investment companies and banks generally retain their jurisdiction and authority. In order to implement its underlying purposes, the GLB Act preempts state laws restricting the establishment of financial affiliations authorized or permitted under the GLB Act, subject to specified exceptions for state insurance regulators. With regard to securities laws, the GLB Act removes the current blanket exemption for banks from the broker-dealer registration requirements under the Securities Exchange Act of 1934, amends the Investment Company Act of 1940 with respect to bank common trust fund and mutual fund activities, and amends the Investment Advisers Act of 1940 to require registration of banks that act as investment advisers for mutual funds. The GLB Act also includes provisions concerning subsidiaries of banks, permitting a bank to engage in most financial activities through a financial subsidiary, provided that a bank and its depository institution affiliates are "well capitalized" and "well managed" and meet certain other qualification requirements relating to total assets, subordinated debt, capital, risk management, and affiliate transactions. With respect to subsidiaries of state banks, new activities as "principal" would be limited to those permissible for a bank financial subsidiary. The GLB Act requires a state bank with a financial subsidiary permitted under the GLB Act as well as its depository institution affiliates to be "well capitalized," and also subjects a bank to the same capital, risk management and affiliate transaction rules as applicable to banks. The provisions of the GLB Act relating to financial holding companies became effective 120 days after its enactment excluding the federal preemption provisions, which became effective on the date of enactment. The GLB Act will likely increase competition in the markets in which the Company operates, although it is difficult to assess the impact that such increased competition may have on the Company's operations. Potential Enforcement Actions Commercial banking organizations and bank holding companies, such as the Bank and the Company, may be subject to potential enforcement actions by federal and state bank regulatory officials for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. Enforcement actions may include the imposition of a conservator or receiver, the issuance of a cease and desist order that can be judicially enforced, the termination of insurance of deposits (in the case of a depository institution), the imposition of civil money penalties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the issuance of removal and prohibition orders against institution-affiliated parties and the enforcement of such actions through injunctions or restraining orders based upon a judicial determination that the agency would be harmed if such equitable relief was not granted. Hazardous Waste Clean-Up Costs Management is aware of recent legislation and cases relating to hazardous waste clean-up costs and potential liability. Based on a general survey of the loan portfolios of the Bank, conversations with local authorities and appraisers, and the type of lending currently and historically done by the Bank (the Bank has generally not made the types of loans generally associated with hazardous waste contamination problems), management is not aware of any potential liability for hazardous waste contamination. 17 Other Regulations and Policies The federal regulatory agencies have adopted regulations that implement Section 304 of FDICIA which requires federal banking agencies to adopt uniform regulations prescribing standards for real estate lending. Each insured depository institution must adopt and maintain a comprehensive written real estate lending policy, developed in conformance with prescribed guidelines, and each agency has specified loan-to-value limits in guidelines concerning various categories of real estate loans. Various requirements and restrictions under the laws of the United States and the State of California affect the operations of the Bank. Federal regulations include requirements to maintain non-interest bearing reserves against deposits, limitations on the nature and amount of loans which may be made, and restrictions on payment of dividends. The California Commissioner of Financial Institutions approves the number and locations of the branch offices of a bank. California law exempts banks from the usury laws. Business Concentrations As of December 31, 2000, the Company had approximately $286.4 million in assets and $254.3 million in deposits. No individual or single group of related accounts is considered material in relation to the Company's totals, or in relation to its overall business. Monetary Policy Banking is a business which depends on rate differentials. In general, the difference between the interest paid by the Bank on its deposits and its other borrowings and the interest rate received by the Bank on loans extended to its clients and securities held in the Bank investment portfolios will comprise a major portion of the Bank's earnings. The earnings and growth of the Bank will be affected not only by general economic conditions, both domestic and international, but also by the monetary and fiscal policies of the United States and its agencies, particularly the Federal Reserve Board. The Federal Reserve Board can and does implement national monetary policy, such as seeking to curb inflation and combat recession, by its open market operations in U.S. Government securities, limitations upon savings and time deposit interest rates, and adjustments to the discount rates applicable to borrowings by banks which are members of the Federal Reserve System. The actions of the Federal Reserve Board influence the growth of bank loans, investments and deposits and also affect interest rates charged on loans and paid on deposits. The nature and impact that future changes in fiscal or monetary policies or economic controls may have on the Bank's businesses and earnings cannot be predicted. Competition The banking business in California generally, and is the Bank's primary service areas specifically, is highly competitive with respect to both loans and deposits, and is dominated by a relatively small number of major banks with many offices and operations over a wide geographic area. Among the advantages such major banks have over the Bank are their ability to finance and wide-ranging advertising campaigns and to allocate their investment assets to regions of higher yield and demand. Such banks offer certain services such as trust services and international banking which are not offered directly by the Bank (but which can be offered indirectly by the Bank through correspondent institutions). In addition, by virtue of their greater total capitalization, such banks have substantially higher lending limits than the Bank. (Legal lending limits to an individual client are based upon a percentage of a bank's total capital accounts.) Other entities, both governmental and in private industry, seeking to raise capital through the issuance and sale of debt or equity securities also provide competition for the Bank is the acquisition of 18 deposits. Banks also compete with money market funds and other money market instruments, which are not subject to interest rate ceilings. In order to compete with other competitors in their primary service areas, the Bank attempts to use to the fullest extent the flexibility which their independent status permits. This includes an emphasis on specialized services, local promotional activity, and personal contacts by their respective officers, directors and employees. In particular, each of the banks branches offer highly personalized banking services. Employees At December 31, 2000, the Bank had a total of 211 full-time equivalent employees and 9 part-time employees. The Bank believes that its employee relations are satisfactory. 19 ITEM 2. PROPERTIES The Company currently maintains an administrative facility in Orange, California, which is utilized by the Company and the Bank. The Bank also maintains seven full service branches and two loan production offices. The Bank owns three of its branch locations and leases all of its other facilities. For additional information regarding the Bank's lease obligations, see Note E to the Consolidated Financial Statements, included in Item 8 hereof. The Company believes that all of its properties are appropriately maintained and suitable for their respective present needs and operations. ITEM 3. LEGAL PROCEEDINGS To the best of the Company's knowledge, there are no pending legal proceedings to which the Company is a party and which may have a materially adverse effect upon the Company's property or business. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of securities holders during the fourth quarter of 2000. 20 PART II ITEM 5. MARKET FOR THE BANK'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS The equity securities of BYL Bancorp consist of one class of common stock, of which there were 2,542,568 shares outstanding, held by approximately 800 shareholders of record at year-end 2000. Holders of the common stock are entitled to receive dividends, when, as and if declared by the Board of Directors out of funds legally available therefor, as specified by the California Financial Code. During 1999 the Company paid quarterly cash dividends of $0.075 per share. No dividends were paid during 2000 as the Company has suspended the payment of quarterly cash dividends. Management of the Company is aware of five (5) securities dealers who maintain an inventory and make a market in its Common Stock. The market makers are Ryan, Beck & Co., Wedbush Morgan Securities Inc., Herzog, Heine & Geduld, Sutro & Co. and Sandler, O'Neill & Partners. The information set forth in the table below summarizes, for the periods indicated, the bid and ask prices of the Company Common Stock. These quotes do not necessarily include retail markups, markdowns, or commissions and may not necessarily represent actual transactions. Additionally, there may have been transactions at prices other than those shown below. 1999 -------------- First Quarter 16.750 17.563 Second Quarter 13.375 13.625 Third Quarter 13.250 13.688 Fourth Quarter 11.750 12.000 2000 -------------- First Quarter 10.063 10.500 Second Quarter 10.500 10.938 Third Quarter 12.188 12.375 Fourth Quarter 14.188 14.500 21 ITEM 6. SELECTED FINANCIAL DATA The following is our summary consolidated financial information. The balance sheet and income statement data as of or for the five years ended December 31, 2000 are taken from our audited consolidated financial statements as of the end of and for each such year. You should read this summary consolidated financial information in conjunction with our consolidated financial statements and notes that appear in this prospectus. At or For the Year Ended December 31, ------------------------------------------------------------------------- 2000 1999 1998 1997 1996 ------------- ------------- ------------- ------------ ------------ Summary of Operations: Interest Income $ 27,953 $ 27,528 $ 24,016 $ 18,455 $ 12,642 Interest Expense 10,267 11,586 8,406 6,057 3,840 ------------- ------------- ------------- ------------ ------------ Net Interest Income 17,686 15,942 15,610 12,398 8,802 Provision for Loan Losses 600 694 755 778 364 ------------- ------------- ------------- ------------ ------------ Net Interest Income After Provision for Loan Losses 17,086 15,248 14,855 11,620 8,438 Noninterest Income 16,728 24,049 23,408 15,920 8,752 Noninterest Expense 32,791 33,891 30,870 22,717 14,045 ------------- ------------- ------------- ------------ ------------ Income Before Income Taxes 1,023 5,406 7,393 4,823 3,145 Income Taxes 445 2,330 3,277 1,968 1,229 ------------- ------------- ------------- ------------ ------------ Net Income $ 578 $ 3,076 $ 4,116 $ 2,855 $ 1,916 ============= ============= ============= ============ ============ Dividends on Common Stock $ -- $ 760 $ 467 $ 502 $ 168 Per Share Data: Net Income - Basic $ 0.23 $ 1.21 $ 1.63 $ 1.19 $ 0.98 Net Income - Diluted $ 0.23 $ 1.21 $ 1.55 $ 1.12 $ 0.96 Book Value $ 11.48 $ 11.51 $ 10.62 $ 9.01 $ 8.10 Balance Sheet Summary: Total Assets $ 286,398 $ 353,736 $ 318,013 $ 238,086 $ 183,755 Total Deposits 254,325 322,973 287,206 207,935 162,058 Loans Held for Sale 22,439 69,756 74,598 47,150 24,363 Total Loans 165,495 196,675 165,199 139,002 106,019 Allowance for Loan Losses (ALLL) 2,295 2,610 2,300 1,923 1,616 Total Shareholders' Equity 29,185 29,200 26,882 22,550 19,434 Selected Ratios: Return on Average Assets 0.18% 0.88% 1.49% 1.31% 1.23% Return on Average Equity 1.97% 11.05% 17.03% 13.80% 12.81% Net Interest Margin 6.43% 5.38% 6.40% 6.46% 6.47% Dividend Payout Ratio - Common Stock 0.00% 24.78% 11.35% 17.59% 8.82% Non-performing Loans to Total Loans 0.78% 0.84% 1.23% 0.92% 1.15% Non-performing Assets to Total Assets 0.75% 0.55% 0.94% 0.93% 1.57% ALLL to Non-performing Loans 177.63% 157.04% 113.30% 150.35% 132.68% Average Shareholder's Equity to Average Assets 9.06% 8.00% 8.75% 9.49% 9.63% 22 On June 14, 1996, the Bank acquired Bank of Westminster ("BOW"), pursuant to the terms of an Agreement and Plan of Reorganization dated January 12, 1996. The Bank acquired 100% of the outstanding common stock of BOW for $6,174,000 in cash. BOW had assets of approximately $54,923,000. At the time of such acquisition, the Bank also raised approximately $7.8 million in additional equity in a firmly underwritten offering by issuing 1,073,000 shares of the Bank's Common Stock as adjusted for the four for three stock split effective June 30, 1997. BOW's result of operations are included only since the second quarter of fiscal 1996. Due to the relatively large size of this transaction, any comparison of data as of and for the years ended December 31, 1996 and December 31, 1997 to data as of or for prior dates or periods may not be meaningful. On November 19, 1997, the Bank completed the reorganization of the Company as its bank holding company, and the Company's Common Stock began trading on that date. On May 29, 1998 pursuant to the terms of an Agreement and Plan of Reorganization dated January 29, 1998, the Company completed the acquisition of DNB Financial ("DNBF"). This transaction was structured as a pooling of interests through a tax-free exchange of 4.1162 of the Company's shares of common stock for each outstanding share of DNBF's common stock, resulting in the issuance of 956,641 shares of Company common stock to the shareholders of DNBF. The acquisition of DNBF increased the total assets of the Company and its subsidiaries to approximately $270 million and total shareholders' equity to approximately $23 million. Due to the relatively large size of this transaction, any comparison of data as of and for the years ended December 31, 1999 and December 31, 1998 to data and of or for prior date or periods may not be meaningful. 23 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following sections set forth a discussion of the significant operating changes, business trends, financial condition, earnings, capital position, and liquidity that have occurred in the two-year period ended December 31, 2000, together with an assessment, when considered appropriate, of external factors that may affect us in the future. This discussion should be read in conjunction with our consolidated financial statements and notes included herein. OVERVIEW EARNINGS SUMMARY Net income in 2000 was $.6 million, a decrease of $2.5 million or 81.2%, compared to $3.1 million in 1999. Diluted earnings per share in 2000 were $.23 compared to $1.21 in 1999. The decrease in earnings in 2000 was due to reorganization expenses, revised asset valuations, and one time fraud losses from the mortgage divisions. During the first quarter of 2000 the Company closed the Diamond Bar Mortgage Division and the Indirect Auto Division. The Company sold the indirect auto loan portfolio and incurred a $1.6 million loss on sale. During the second quarter of 2000 the company wrote down the 1999-1 securitization assets by $800,000 to record a permanent decline in fair value as a result of a new valuation model being implemented. During the third quarter of 2000 the Company closed the SBA department and sold, at carrying value, 59% or $3.0 million in residual assets from the 1999-1 securitization. In January 2001 the company sold the remaining assets of the 1999-1 securitization and incurred a $1.1 million loss on sale, which resulted in the 1999-1 securitization assets being written down by $1.1 million to reflect a permanent decline in fair value as of December 31, 2000. During the first quarter of 2001 the Company was notified that certain loans purchased by third party investors and originated by outside mortgage brokers were fraudulent and the Company is required to repurchase these loans. The Company has estimated its net loss to be $1.2 million that was recorded in our 2000 financial statements. Net income in 1999 was $3.1 million, a decrease of $1.0 million or 24.4%, compared to $4.1 million in 1998. Diluted earnings per share in 1999 were $1.21 compared to $1.55 in 1998. The decrease in earnings in 1999 was due primarily to decreased profitability of the SBA and Mortgage Loan Divisions. BALANCE SHEET SUMMARY Total assets at December 31, 2000 were $286.4 million, a $67.3 million or 19.0% decrease from $353.7 million at December 31, 1999. Average assets for 2000 were $324.3 million compared to $347.8 million for 1999. Total deposits decreased $68.7 million or 21.3% to $254.3 million at December 31, 2000. Gross loans decreased $78.5 million or 29.5% , to $187.9 million at December 31, 2000. Shareholder's equity remained the same at $29.2 million at December 31, 2000. Total assets at December 31, 1999 were $353.7 million, a $35.79 million or 11.2% increase from $318.0 million at December 31, 1998. Average assets for 1999 were $347.8 million compared to $276.4 million for 1998. The increases in shareholders' equity in 1999 and 1998 allowed us to expand our asset base. 24 The following table sets forth several key operating ratios for 2000, 1999 and 1998: For the Year Ended December 31, ---------------------------- 2000 1999 1998 ------- ------- ------- Return on Average Assets 0.18% 0.88% 1.49% Return on Average Equity 1.97% 11.05% 17.03% Average Shareholder's Equity to Average Total Assets 9.06% 8.00% 8.75% 25 DISTRIBUTION OF ASSETS, LIABILITIES, AND SHAREHOLDERS' EQUITY The following table presents, for the years indicated, the distribution of average assets, liabilities and shareholders' equity, as well as the total dollar amounts of interest income from average interest-earning assets and the resultant yields, and the dollar amounts of interest expense and average interest-bearing liabilities, expressed both in dollars and in rates. Nonaccrual loans are included in the calculation of the average balances of loans, and interest not accrued is excluded (dollar amounts in thousands). For the Year Ended December 31, ---------------------------------------------------------------------------------------------- 2000 1999 1998 ----------------------------- ------------------------------ ----------------------------- Average Average Average Interest Yield or Interest Yield or Interest Yield or Average Earned Rate Average Earned Rate Average Earned Rate Balance or Paid Paid Balance or Paid Paid Balance or Paid Paid ------- ------- ----- ------- ------- ------ -------- -------- ----- Assets Interest-Earning Assets: Investment Securities $24,001 $1,617 6.74% $21,635 $1,450 6.70% $18,564 $ 1,119 6.03% Federal Funds Sold 18,889 1,156 6.12% 20,554 976 4.75% 13,322 669 5.02% Other Earning Assets 252 8 3.17% 168 9 5.36% 2,935 171 5.83% Loans 231,704 25,172 10.86% 253,771 25,093 9.89% 209,080 22,057 10.55% ------- ------ ------- ------ ------- ------ Total Interest-Earning Assets 274,846 27,953 10.17% 296,128 27,528 9.30% 243,901 24,016 9.85% Cash and Due From Banks 20,546 24,663 15,756 Premises and Equipment 5,873 6,561 5,299 Other Real Estate Owned 670 714 1,067 Accrued Interest and Other Assets 24,943 22,294 12,641 Allowance for Loan Losses ( 2,601) ( 2,514) ( 2,281) -------- -------- -------- Total Assets $324,277 $347,846 $276,383 ======== ======== ======== Liabilities and Shareholders' Equity Interest-Bearing Liabilities: Money Market and NOW $71,903 2,335 3.25% $74,797 2,764 3.70% $53,640 1,613 3.01% Savings 60,056 2,292 3.82% 87,566 4,076 4.65% 39,308 1,622 4.13% Time Deposits under $100,000 51,258 3,095 6.04% 42,386 2,165 5.11% 51,997 2,823 5.43% Time Deposits of $100,000 or More 40,957 2,483 6.06% 39,963 2,505 6.27% 38,120 2,258 5.92% Other 1,069 62 5.80% 1,646 76 4.62% 1,623 90 5.55% ------- ------ ------- ------ ------- ------ Total Interest-Bearing Liabilities 225,243 10,267 4.56% 246,358 11,586 4.70% 184,688 8,406 4.55% ------ ------ ----- Noninterest-Bearing Liabilities: Demand Deposits 67,354 68,632 62,771 Other Liabilities 2,308 5,015 4,753 Shareholders' Equity 29,372 27,841 24,171 -------- -------- -------- Total Liabilities and Shareholders' Equity $324,277 $347,846 $276,383 ======== ======== ======== Net Interest Income $17,686 $15,942 $ 15,610 ======= ======= ======== Net Yield on Interest-Earning Assets 6.43% 5.38% 6.40% 26 EARNINGS ANALYSIS NET INTEREST INCOME A significant component of our earnings is net interest income. Net interest income is the difference between the interest we earn on our loans and investments and the interest we pay on deposits and other interest-bearing liabilities. Our net interest income is affected by changes in the amount and mix of our interest-earning assets and interest-bearing liabilities, referred to as a "volume change". It is also affected by changes in the yields we earn on interest-earning assets and rates we pay on interest-bearing deposits and other borrowed funds, referred to as a "rate change". The following table sets forth changes in interest income and interest expense for each major category of interest-earning asset and interest-bearing liability, and the amount of change attributable to volume and rate changes for the years indicated. Changes not solely attributable to rate or volume have been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the changes in each (dollar amounts in thousands). Year Ended December 31, 2000 Year Ended December 31, 1999 versus versus Year Ended December 31, 1999 Year Ended December 31, 1998 --------------------------------------------- -------------------------------------------- Increase (Decrease) Due Increase (Decrease) Due To Change in To Change in --------------------------------------------- -------------------------------------------- Volume Rate Total Volume Rate Total ------------- -------------- ------------- ------------ ------------- -------------- Interest-Earning Assets: Investment Securities $ 159 $ 8 $ 167 $ 198 $ 133 $ 331 Federal Funds Sold ( 84) 264 180 345 ( 38) 307 Other Earning Assets 4 ( 5) ( 1) ( 79) ( 83) ( 162) Loans ( 2,283) 2,362 79 4,486 (1,450) 3,036 ------------- -------------- ------------- ------------ ------------- -------------- Total Interest Income ( 2,204) 2,629 425 4,950 (1,438) 3,512 Interest-Bearing Liabilities: Money Market and NOW ( 104) ( 325) ( 429) 728 423 1,151 Savings ( 1,134) ( 650) ( 1,784) 2,222 232 2,454 Time Deposits under $100,000 497 433 930 ( 499) ( 159) ( 658) Time Deposits $100,000 or More 61 ( 83) ( 22) 112 135 247 Other ( 31) 17 ( 14) 1 ( 15) ( 14) ------------- -------------- ------------- ------------ ------------- -------------- Total Interest Expense ( 711) ( 608) ( 1,319) 2,564 616 3,180 ------------- -------------- ------------- ------------ ------------- -------------- Net Interest Income $( 1,493) $ 3,237 $1,744 $ 2,386 $(2,054) $ 332 ============= ============== ============= ============ ============= ============== 27 2000 COMPARED TO 1999 Net interest income for 2000 was $17.7 million, an increase of 10.9% compared to the $15.9 million reported in 1999. This increase was primarily due to the increase in interest rates. Prime rate increased 100 basis point in 2000. Interest income in 2000 was $27.9 million, a $.4 million or a 1.5% increase over the $27.5 million recorded in 1999. The increase in interest income was the result primarily of rate increases in prime rate offset by a decrease in average loan totals. Average loans outstanding decreased 8.7% to $231.7 million in 2000 compared to $253.8 million in 1999. The yield on interest-earning assets increased 87 basis points to 10.17% from 9.30% in 1999. The yield on the loan portfolio, the Banks largest interest-earning asset, increased 97 basis points, from 9.89% to 10.86%. Interest expense decreased in 2000 as we decreased deposits and other borrowings due to the decrease in loan totals discussed above. Interest expense was $10.2 million in 2000, compared to $11.6 million in 1999. The decrease in interest expense was primarily the result of a decrease in interest-bearing liabilities. Average interest-bearing liabilities decreased 8.6% to $225.2 million in 2000 compared to $246.4 million in 1999. A decrease in the cost of interest-bearing liabilities accounted for $608 or 46.1% of the total decrease in interest expense. Rates on interest bearing deposits decreased 14 basis points to 4.56% from 4.70% in 1999. Interest rates played a significant role in the changes in net interest income in 2000. Our yield on interest-earning assets increased 87 basis points, while the yield on interest-bearing liabilities decreased 14 basis points. The net yield on interest-earning assets in 2000 increased 105 basis points to 6.43% compared to 5.38% in 1999. 1999 COMPARED TO 1998 Net interest income for 1999 was $15.9 million, an increase of 1.9% compared to the $15.6 million reported in 1998. This increase was primarily due to the significant increase in average interest-earning assets which increased $52.2 million or 21.3% to $296.1 million in 1999 compared to $243.9 million in 1998. Interest income in 1999 was $27.5 million, a $3.5 million or a 14.6% increase over the $24.0 million recorded in 1998. The increase in interest income was the result primarily of volume increases in loan totals offset by a decreased interest rate environment. Average loans outstanding increased 21.4% to $253.8 million in 1999 compared to $209.0 million in 1998. The yield on interest-earning assets decreased 55 basis points to 9.30% from 9.85% in 1998. The yield on the loan portfolio, the Banks largest interest-earning asset, decreased 66 basis points, from 10.55% to 9.89%. Interest expense also rose significantly in 1999 as we increased deposits and other borrowings to fund the loan growth discussed above. Interest expense was $11.6 million in 1999, compared to $8.4 million in 1998. The increase in interest expense was primarily the result of an increase in interest-bearing liabilities. Average interest-bearing liabilities increased 33.4% to $246.4 million in 1999 compared to $184.7 million in 1998. An increase in the cost of interest-bearing liabilities accounted for $616 or 19.3% of the total increase in interest expense. Rates on interest bearing deposits increased 15 basis points to 4.70% from 4.55% in 1998. Interest rates played a significant role in the changes in net interest income in 1999. Our yield on interest-earning assets decreased 55 basis points, while the yield on interest-bearing liabilities increased 15 basis points. The net yield on interest-earning assets in 1999 declined 102 basis points to 5.38% compared to 6.40% in 1998. 28 NONINTEREST INCOME The Bank receive noninterest income from three primary sources: service charges and fees on accounts and banking services, fees and premiums generated by our Mortgage Loan Division, and fees, premiums, and servicing income generated by our SBA Loan Division. In 2000, noninterest income was $16.7 million, a decrease of $7.3 million or 30.4% compared to the 1999 amount of $24.0 million. The majority of the decrease is attributable to our closing the Diamond Bar Mortgage Division and SBA Division and the $800,000 write-down and $1.1 million loss from sale of the assets retained in the 1999-1 securitization. Loans sold declined from $695 million in 1999 to $415 million in 2000. In 1999, noninterest income was $24.0 million, an increase of $.6 million or 2.6% compared to the 1998 amount of $23.4 million. The majority of the increase was generated by our SBA and Mortgage Loan Divisions who continued to expand their operations in 1999. The majority of the increase was from the increase in Net Servicing and Interest-Only Strip Income, which increased to $1.8 million or 157.1%, compared to $0.7 million in 1998. NONINTEREST EXPENSE Noninterest expense reflects our costs of products and services related to systems, facilities and personnel. The major components of noninterest expense stated as a percentage of average assets are as follows: 2000 1999 1998 ------- ------- ------- Salaries and Employee Benefits 5.32% 5.72% 7.11% Occupancy Expenses .63 .65 .60 Furniture and Equipment .61 .80 .74 Professional Fees and Outside Services .71 .56 .65 OREO Expenses .06 .06 .10 Commission and Loan Expenses .82 .47 .38 Office Expenses .49 .58 .55 Other 1.47 .90 1.04 ------- ------- ------- 10.11% 9.74% 11.17% ======= ======= ======= Noninterest expense was $32.8 million in 2000, a decrease of $1.1 million or 3.2% over the $33.9 million reported in 1999. The majority of this decrease is attributable to our closing of the Diamond Bar Mortgage Division and SBA Division. Professional fees and outside services have increased due to increased regulatory oversight and commission and loan expenses increased primarily due to the $1.6 million loss on sale of our indirect auto loan portfolio during the first quarter of 2000. Noninterest expense was $33.9 million in 1999, an increase of $3.0 million or 9.7% over the $30.9 reported in 1998. The majority of this increase, $1.9 million, was from the expansion of facilities and equipment for our SBA and Mortgage Loan Divisions. Other expense categories increased in total amount but declined as a percentage of total assets. INCOME TAXES Income tax expense was $.4, $2.3, and $3.3 million for the years ended December 31, 2000, December 31, 1999, and December 31, 1998, respectively. These expenses resulted in an effective tax rate of 43.5% in 2000, 43.1% in 1999, and 44.3% in 1998. The increase in effective rate in 2000 and 1998 was due primarily to non-deductible merger expenses. 29 BALANCE SHEET ANALYSIS INVESTMENT PORTFOLIO The following table summarizes the amounts and distribution of our investment securities held as of the dates indicated, and the weighted average yields as of December 31, 2000 (dollar amounts in thousands): December 31, ------------------------------------------------------------------------------------------ 2000 1999 1998 -------------------------------------- ------------------------- ------------------------- Weighted Book Market Average Book Market Book Market Value Value Yield Value Value Value Value ----------- ------------ ----------- ----------- ------------ ------------ ----------- Available-for-Sale Securities U.S. Government and Agency Securities: Within One Year $ -- $ -- $ -- $ -- $ -- $ -- One to Five Years -- -- -- -- -- -- After Ten Years -- -- -- -- -- -- -------- -------- -------- -------- -------- -------- Total U.S. Government and Agency Securities -- -- -- -- -- -- Municipal Securities - Five to Ten Years -- -- -- -- -- -- Mutual Funds -- -- -- -- 3,000 3,000 Mortgage Backed Securities 5,768 5,768 9.90% 6,597 6,868 2,305 2,570 -------- -------- -------- -------- -------- -------- Total Available-for-Sale Securities $ 5,768 $ 5,768 9.90% $ 6,597 $ 6,868 $ 5,305 $ 5,570 ======== ======== ======== ======== ======== ======== Held-to-Maturity Securities U.S. Treasuries: Within One Year $ -- $ -- $ 500 $ 501 $ 2,001 $ 2,015 One to Five Years -- -- -- -- 498 511 -------- -------- -------- -------- -------- -------- Total U.S. Treasuries Securities -- -- 500 501 2,499 2,526 U.S. Government and Agency Securities: Within One Year 998 999 6.24% 3,013 2,987 994 1,001 One to Five Years 10,000 9,962 5.60% 10,995 10,755 7,035 7,029 Five to Ten Years -- -- -- -- -- -- After Ten Years -- -- -- -- -- -- -------- -------- -------- -------- -------- -------- Total U.S. Government and Agency Securities 10,998 10,961 5.66% 14,008 13,742 8,029 8,030 Municipal Securities: One to Five Years -- -- -- -- -- -- Five to Ten Years -- -- -- -- -- -- -------- -------- -------- -------- -------- -------- Total Municipal Securities -- -- -- -- -- -- Mortgage Backed Securities 165 165 6.83% 204 202 316 318 -------- -------- -------- -------- -------- -------- Total Held-to-Maturity Securities $ 11,163 $ 11,126 5.67% $ 14,712 $ 14,445 $ 10,844 $ 10,874 ======== ======== ======== ======== ======== ======== 30 Securities may be pledged to meet security requirements imposed as a condition to receipt of deposits of public funds and other purposes. At December 31, 2000 and 1999, the carrying values of securities pledged to secure public deposits and other purposes were $11.2 million and $14.7 million, respectively. LOANS HELD FOR SALE We originate mortgage loans and SBA loans for sale to institutional investors. Loans held for sale decreased from $74.6 million at December 31, 1998, to $69.8 million at December 31, 1999 and to $22.4 million at December 31, 2000. Historically, we sold these loans within sixty (60) days of origination, but during 1998 the Bank began to warehouse and accumulate pools of loans to take advantage of short-term fluctuations in the market. At December 31, 2000 and 1999, we were servicing approximately $242.8 million and $220.1 million, respectively, in SBA and other loans previously sold. In connection with a portion of these loans, the Company has capitalized approximately $2.9 million and $2.8 million in servicing assets at December 31, 2000 and 1999, respectively. Servicing assets are amortized over the estimated life of the serviced loan using a method that approximates the interest method. We evaluate the carrying value of the excess servicing receivables by estimating the excess future servicing income, based on our best estimate of the remaining loan lives. We have also recorded interest-only strips receivable in connection with our loan sales and securitizations. These totaled $8.5 million in 2000 and $12.9 million at December 31, 1999. See also Note C in the Consolidated Financial Statements for additional information on loans held for sale and key assumptions used to value retained interest in securitizations. LOAN PORTFOLIO The following table sets forth the components of total net loans outstanding in each category at the date indicated (dollar amounts in thousands): December 31, -------------------------------------------------------------------- 2000 1999 1998 1997 1996 --------- --------- --------- --------- -------- Loans Commercial $ 28,893 $ 52,695 $ 56,244 $ 36,359 $24,512 Real Estate - Construction 11,995 5,524 4,411 2,867 4,149 Real Estate - Other 120,535 98,010 82,235 84,792 71,799 Consumer 4,072 40,446 22,309 14,984 5,559 --------- --------- --------- --------- -------- Total Loans 165,495 196,675 165,199 139,002 106,019 Net Deferred Loan Costs (Fees) 74 2,209 1,255 471 173 Allowance for Loan Losses ( 2,295) ( 2,610) ( 2,300) ( 1,923) ( 1,616) --------- --------- --------- --------- -------- Net Loans $ 163,274 $ 196,274 $ 164,154 $ 137,550 $104,576 ========= ========= ========= ========= ======== Commitments Standby Letters of Credit $ 1,236 $ 839 $ 360 $ 371 $ 203 Undisbursed Loans and Commitments to Grant Loans 22,612 28,060 21,627 18,521 14,843 --------- --------- --------- --------- -------- Total Commitments $ 23,848 $ 28,899 $ 21,987 $ 18,892 $15,046 ========= ========= ========= ========= ======== 31 RISK ELEMENTS We assess and manage credit risk on an ongoing basis through our lending policies. We strive to continue our historically low level of credit losses by continuing our emphasis on credit quality in the loan approval process, active credit administration and regular monitoring. In extending credit and commitments to borrowers, we generally require collateral and/or guarantees as security. The repayment of such loans is expected to come from cash flow or from proceeds from the sale of selected assets of the borrower. Our requirement for collateral and/or guarantees is determined on a case-by-case basis in connection with our evaluation of the credit worthiness of the borrower. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, income-producing properties, residences and other real property. We secure our collateral by perfecting our interest in business assets, obtaining deeds of trust, or outright possession among other means. We believe that our lending policies and underwriting standards will tend to minimize losses in an economic downturn, however, there is no assurance that losses will not occur under such circumstances. The following table shows the maturity distribution of the fixed rate portion of the loan portfolio and the repricing distribution of the variable rate portion of the loan portfolio, including loans held for sale, at December 31, 2000: Over 3 Months Due after 3 Months through one year to Due after or Less 12 months five years five years Total ----------- ---------- ----------- ----------- ----------- $ 133,261 $ 8,352 $ 19,216 $ 25,887 $ 186,716 =========== ========== =========== =========== Loans on Non-Accrual 1,292 ----------- Total Loans, including Loans Held for Sale $ 188,008 =========== 32 NONPERFORMING ASSETS The following table provides information with respect to the components of our nonperforming assets at the dates indicated (dollar amounts in thousands): For the Year Ended December 31, ---------------------------------------------------------- 2000 1999 1998 1997 1996 ------- ------- ------- ------- ------- Loans 90 Days Past Due and Still Accruing $ -- $ 120 $ 223 $ -- $ 122 Nonaccrual Loans 1,292 1,542 1,807 1,279 1,096 ------- ------- ------- ------- ------- Total Nonperforming Loans 1,292 1,662 2,030 1,279 1,218 Other Real Estate Owned 858 277 971 924 1,661 ------- ------- ------- ------- ------- Total Nonperforming Assets $ 2,150 $ 1,939 $ 3,001 $ 2,203 $ 2,879 ======= ======= ======= ======= ======= Nonperforming Loans as a Percentage of Total Loans 0.78% 0.84% 1.22% 1.88% 1.79% Allowance for Loan Loss as a Percentage of Nonperforming Loans 177.63% 157.04% 113.30% 81.86% 78.82% Nonperforming Assets as a Percentage of Total Assets 0.75% 0.55% 0.94% 1.75% 2.45% Nonaccrual loans are generally past due 90 days or are loans that we believe the interest on which may not be collectible. Loans past due 90 days will continue to accrue interest only when we believe the loan is both well-secured and in the process of collection. Other real estate owned is acquired through foreclosure or other means. These properties are recorded on an individual asset basis at the estimated fair value less selling expenses. We believe these properties can be liquidated at or near their current fair value. 33 PROVISION AND ALLOWANCE FOR LOAN LOSSES The allowance for loan losses is maintained at a level that is considered adequate to provide for the loan losses inherent in our loans. The provision for loan losses was $600,000 in 2000 compared to $694,000 in 1999 and $775,000 in 1998. The following table summarizes, for the years indicated, changes in the allowances for loan losses arising from loans charged-off, recoveries on loans previously charged-off, and additions to the allowance which have been charged to operating expenses and certain ratios relating to the allowance for loan losses (dollar amounts in thousands): For the Year Ended December 31, ---------------------------------------------------------------- 2000 1999 1998 1997 1996 -------- -------- -------- -------- -------- Outstanding Loans: Average for the Year $231,704 $253,771 $209,080 $155,588 $102,145 End of the Year $165,495 $196,675 $165,199 $139,002 $106,019 Allowance For Loan Losses: Balance at Beginning of Year $ 2,610 $ 2,300 $ 1,923 $ 1,616 $ 1,047 Actual Charge-Offs: Commercial 85 102 175 486 318 Consumer 117 118 252 29 21 Real Estate 829 298 101 20 192 -------- -------- -------- -------- -------- Total Charge-Offs 1,031 518 528 535 531 Less Recoveries: Commercial 21 123 140 33 19 Consumer 18 10 7 7 11 Real Estate 77 1 3 24 6 -------- -------- -------- -------- -------- Total Recoveries 116 134 150 64 36 -------- -------- -------- -------- -------- Net Loans Charged-Off 915 384 378 471 495 Provision for Loan Losses 600 694 755 778 364 Allowance on Loans Acquired from BOW -- -- -- 700 -------- -------- -------- -------- -------- Balance at End of Year $ 2,295 $ 2,610 $ 2,300 $ 1,923 $ 1,616 ======== ======== ======== ======== ======== Ratios: Net Loans Charged-Off to Average Loans 0.39% 0.15% 0.18% 0.30% 0.48% Allowance for Loan Losses to Total Loans 1.39% 1.33% 1.39% 1.38% 1.87% Net Loans Charged-Off to Beginning Allowance for Loan Losses 35.06% 16.70% 19.66% 29.15% 47.28% Net Loans Charged-Off to Provision for Loan Losses 152.50% 55.33% 50.07% 60.54% 135.99% Allowance for Loan Losses to Nonperforming Loans 177.63% 157.04% 113.30% 150.35% 132.68% 34 We believe that the allowance for loan losses is adequate. Quarterly detailed reviews are performed to identify the risks inherent in the loan portfolio, assess the overall quality of the loan portfolio and to determine the adequacy of the allowance for loan losses and the related provision for loan losses to be charged to expense. These systematic reviews follow the methodology set forth by the FDIC in its 1993 policy statement on the allowance for loan losses. A key element of our methodology is the credit classification process. Loans identified as less than "acceptable" are reviewed individually to estimate the amount of probable losses that need to be included in the allowance. These reviews include analysis of financial information as well as evaluation of collateral securing the credit. Additionally, we consider the inherent risk present in the "acceptable" portion of the loan portfolio taking into consideration historical losses on pools of similar loans, adjusted for trends, conditions and other relevant factors that may affect repayment of the loans in these pools. The following table summarizes the allocation of the allowance for loan losses by loan type for the years indicated and the percent of loans in each category to total loans (dollar amounts in thousands): December 31, 2000 December 31, 1999 December 31, 1998 December 31, 1997 December 31, 1996 ----------------- ----------------- ----------------- ----------------- ----------------- Loan Loan Loan Loan Loan Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- Commercial $ 829 17.5% $ 960 26.8% $ 854 34.1% $ 657 26.2% $ 806 22.5% Construction 241 7.2% 134 2.8% 100 2.7% 33 2.1% 65 6.9% Real Estate 774 72.8% 1,034 49.8% 1,049 49.8% 873 61.0% 569 64.8% Consumer 109 2.5% 267 20.6% 55 13.5% 139 10.8% 50 5.8% Unallocated 342 n/a 215 n/a 242 n/a 221 n/a 126 n/a ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ $2,295 100.0% $2,610 100.0% $2,300 100.0% $1,923 100.0% $1,616 100.0% ====== ====== ====== ====== ====== ====== ====== ====== ====== ====== FUNDING Deposits are our primary source of funds. At December 31, 2000, we had a deposit mix of 49.8% in time and savings deposits, 23.8% in money market and NOW deposits, and 26.4% in noninterest-bearing demand deposits. Our net interest income is enhanced by our percentage of noninterest-bearing deposits. The following table summarizes the distribution of average deposits and the average rates paid for the years indicated (dollar amounts in thousands): December 31, -------------------------------------------------------------------- 2000 1999 1998 ------------------- -------------------- ------------------- Average Average Average Average Average Average Balance Rate Balance Rate Balance Rate -------- ------- -------- ------- -------- ------- Money Market and NOW Accounts $ 71,903 3.25% $ 74,797 3.70% $ 53,640 3.01% Savings Deposits 60,056 3.82% 87,566 4.65% 39,308 4.13% TCD Less than $100,000 51,258 6.04% 42,386 5.11% 51,997 5.43% TCD $100,000 or More 40,957 6.06% 39,963 6.27% 38,120 5.92% -------- -------- -------- Total Interest-Bearing Deposits 224,174 4.55% 244,712 4.70% 183,065 4.54% Noninterest-Bearing Demand Deposits 67,354 n/a 68,632 n/a 62,771 n/a -------- -------- -------- Total Average Deposits $291,528 3.50% $313,344 3.67% $245,836 3.38% ======== ======== ======== 35 The scheduled maturity distribution of the Bank's time deposits of $100,000 or greater, as of December 31, 2000, were as follows (dollar amounts in thousands): Three Months or Less $ 14,197 Over Three Months to One Year 22,645 Over One Year to Three Years 1,932 -------- $ 38,774 ======== LIQUIDITY AND INTEREST RATE SENSITIVITY The objective of the Bank's asset/liability strategy is to manage liquidity and interest rate risks to ensure the safety and soundness of the Bank and its capital base, while maintaining adequate net interest margins and spreads to provide an appropriate return to the our shareholders. We manage the Bank's interest rate risk exposure by limiting the amount of long-term fixed rate loans we hold for investment, by originating mortgage and SBA loans for sale to the secondary market, increasing emphasis on shorter-term, higher yield loans for portfolio, increasing or decreasing the relative amounts of long-term and short-term borrowings and deposits and/or purchasing commitments to sell loans. The table below sets forth the interest rate sensitivity of our interest-earning assets and interest-bearing liabilities as of December 31, 2000, using the interest rate sensitivity gap ratio. For purposes of the following table, an asset or liability is considered rate-sensitive within a specified period when it can be repriced or matures within its contractual terms, except for loans held for sale which we classifies as highly liquid based on historical sale patterns (dollar amounts in thousands): After After One Within Three Months Year But Three But Within Within After Months One Year Five Years Five Years Total -------- ----------- ----------- ---------- -------- Interest-Earning Assets: Interest Bearing Deposits $ 111 $ -- $ -- $ -- $ 111 Federal Funds Sold 26,100 -- -- -- 26,100 Investment Securities and FHLB Stock 2,293 998 10,000 4,269 17,560 Gross Loans 133,261 8,352 19,216 25,887 186,716 -------- -------- -------- -------- -------- $161,765 $ 9,350 $ 29,216 $ 30,156 $230,487 ======== ======== ======== ======== ======== Interest-Bearing Liabilities: Money Market and NOW Deposits $ 60,523 $ -- $ -- $ -- $ 60,523 Savings 44,795 -- 44,795 Time Deposits 32,408 43,562 5,885 81,855 -------- -------- -------- -------- -------- $137,726 $ 43,562 $ 5,885 $ -- $187,173 ======== ======== ======== ======== ======== Interest Rate Sensitivity Gap $ 24,039 $(34,212) $ 23,331 $ 30,156 $ 43,314 Cumulative Interest Rate Sensitivity Gap $ 24,039 $(10,173) $ 13,158 $ 43,314 $ 86,628 Ratios Based on Total Assets: Interest Rate Sensitivity Gap 6.80% (9.67%) 6.60% 8.53% 12.24% Cumulative Interest Rate Sensitivity Gap 6.80% (2.88%) 3.72% 12.24% 36 Liquidity refers to our ability to maintain a cash flow adequate to fund both on-balance sheet and off-balance sheet requirements on a timely and cost-effective basis. Potentially significant liquidity requirements include funding of commitments to loan clients and withdrawals from deposit accounts. CAPITAL RESOURCES Shareholders' equity at December 31, 2000 and 1999 was $29.2 million. Average shareholders' equity for 2000 was $29.4 million compared to $27.8 million in 1999. Shareholders' equity activity is primarily from net income of $578 in 2000 less a decline in other comprehensive income totaling $620. Shareholders' equity at December 31, 1999 was $29.2 million, an increase of $2.3 million or 8.6% over $26.9 million at December 31, 1998. Average shareholders' equity for 1999 was $27.8 million compared to $24.2 million in 1998. In 1990, the banking industry began to phase in new regulatory capital adequacy requirements based on risk-adjusted assets. These requirements take into consideration the risk inherent in investments, loans, and other assets for both on-balance sheet and off-balance sheet items. Under these requirements, the regulatory agencies have set minimum thresholds for Tier 1 capital, total capital and leverage ratios. At December 31, 1999, the Bank's capital exceeded the Tier 1 Capital and Leverage Ratio's minimum regulatory requirement and was below the minimum regulatory requirement for Total Capital. The Bank was considered to be under-capitalized at December 31, 1999, as defined in the regulations issued by the FDIC. The Bank's risk-based capital ratios, shown below as of December 31, 2000, have been computed in accordance with regulatory accounting policies (Our capital ratios are comparable to the Bank's). Minimum Requirements Bank ---------------- ----------- Tier 1 Capital 4.00% 9.30% Total Capital 8.00% 10.08% Leverage Ratio 4.00% 9.42% On March 8, 2000 the Bank was notified by the FDIC that the Bank is under-capitalized for purposes of Prompt Corrective Action. Accordingly, the Bank is prohibited, among other things, from renewing broker deposits, paying dividends and is subject to enforcement actions. Subsequent to the notification by the FDIC, the Bank has filed a capital restoration plan with the FDIC. The plan provides that the Bank will have Total Capital in excess of 8% by March 31, 2000 and in excess of 10% by the third quarter of 2001. See also Note O in the Consolidated Financial Statements for additional information on our regulatory capital requirements and computations. EFFECTS OF INFLATION The financial statements and related financial information presented herein have been prepared in accordance with GAAP, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution's performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or same magnitude as the price of goods and services. 37 IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities"(as amended in 2000 by SFAS No. 138). This Statement establishes accounting and reporting standards for derivative instruments and for hedging activities. This new standard was originally effective for 2000. In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133". This Statement establishes the effective date of SFAS No. 133 for 2001. SFAS No. 133 is not expected to have a material impact on the Company's financial statements. YEAR 2000 ISSUES The Year 2000 issue is the result of computer programs being written using two digits rather than four to define the applicable year. As a result, date-sensitive software and/or hardware may recognize a date using "00" as the year 1900 rather than year 2000, causing systems to fail to function or generate erroneous data. The Company expended approximately $113,000 through the periods ended December 31, 1999 in connection with its year 2000 compliance program. The Company experienced no significant problems related to its information technology systems upon arrival of the Year 2000, nor was there any interruption in service to its customers. 38 SUMMARY OF QUARTERLY RESULTS The following table summarizes quarterly operating results for 2000 and 1999. 2000 Earnings by Quarter --------------------------------------------------- First Second Third Fourth Total -------- -------- -------- -------- -------- Interest Income $ 7,547 $ 7,102 $ 6,885 $ 6,419 $ 27,953 Interest Expense 2,990 2,624 2,445 2,208 10,267 -------- -------- -------- -------- -------- Net Interest Income 4,557 4,478 4,440 4,211 17,686 Provision for Loan Losses 50 150 200 200 600 -------- -------- -------- -------- -------- Net Interest Income After Provision for Loan Losses 4,507 4,328 4,240 4,011 17,086 Noninterest Income 5,122 4,289 4,906 2,411 16,728 Noninterest Expense 10,018 7,841 7,383 7,549 32,791 -------- -------- -------- -------- -------- Income Before Income Taxes (389) 776 1,763 (1,127) 1,023 Income Taxes (129) 349 749 (524) 445 -------- -------- -------- -------- -------- Net Income $ (260) $ 427 $ 1,014 $ (603) $ 578 ======== ======== ======== ======== ======== Net Income Per Share- Basic $ (0.10) $ 0.17 $ 0.40 $ (0.24) $ 0.23 ======== ======== ======== ======== ======== Net Income Per Share- Diluted $ (0.10) $ 0.17 $ 0.40 $ (0.24) $ 0.23 ======== ======== ======== ======== ======== 1999 Earnings by Quarter --------------------------------------------------- First Second Third Fourth Total -------- -------- -------- -------- -------- Interest Income $ 6,492 $ 6,446 $ 7,192 $ 7,398 $ 27,528 Interest Expense 2,798 2,568 3,053 3,167 11,586 -------- -------- -------- -------- -------- Net Interest Income 3,694 3,878 4,139 4,231 15,942 Provision for Loan Losses 180 51 130 333 694 -------- -------- -------- -------- -------- Net Interest Income After Provision for Loan Losses 3,514 3,827 4,009 3,898 15,248 Noninterest Income 5,968 5,213 6,867 6,001 24,049 Noninterest Expense 8,683 7,788 9,058 8,362 33,891 -------- -------- -------- -------- -------- Income Before Income Taxes 799 1,252 1,818 1,537 5,406 Income Taxes 340 570 775 645 2,330 -------- -------- -------- -------- -------- Net Income $ 459 $ 682 $ 1,043 $ 892 $ 3,076 ======== ======== ======== ======== ======== Net Income Per Share- Basic $ 0.18 $ 0.27 $ 0.41 $ 0.35 $ 1.21 ======== ======== ======== ======== ======== Net Income Per Share- Diluted $ 0.18 $ 0.27 $ 0.41 $ 0.35 $ 1.21 ======== ======== ======== ======== ======== 39 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK Net Interest Margin. As previously discussed, net interest income is the difference between the interest income and fees earned on loans and investments and the interest expense paid on deposits and other liabilities. The amount by which interest income exceed interest expense depends on two factors: the volume of earnings assets compared to the volume of interest-bearing deposits and liabilities, and the interest rat earned on those interest earning assets compared with the interest paid on those interest-bearing deposits and liabilities. Net interest margin is the net interest income expressed as a percentage of earning assets. To maintain its net interest margin, the Company must manage the relationship between interest earned and paid, and the relationship is subject to the following types of risks that are related to changes in interest rates. Market Risk. The market values of assets or liabilities on which the interest rate is fixed will increase or decrease with changes in market interest rates. If the Company invests funds in a fixed rate long-term security and then interest rates rise, the security is worth less than a comparable security just issued because the older security pays less interest than the newly issued security. If the older security had to be sold, the Company would have to recognize a loss. Correspondingly, if interest rates decline after a fixed rate security is purchased, its value increases. Therefore, while the value changes regardless of which direction interest rates move, the adverse exposure to "market risk" is primarily due to rising interest rates. This exposure is lessened by managing the amount of fixed rate assets and by keeping maturities relatively short. However, this strategy must be balanced against the need for adequate interest income because variable rate and shorter fixed rate securities generally earn less interest than longer term fixed rate securities. There is market risk relating to the Company's fixed rate or term liabilities as well as its assets. For liabilities, the adverse exposure to market risk is to lower rates because the Company must continue to pay the higher rate until the end of the term. However, because the amount of fixed rate liabilities is significantly less that the fixed rate assets, and because the average maturity is substantially less for liabilities than for the assets, the market risk is not as great. Net interest margin was 6.43% in 2000 compared to 5.38% in 1999 and 6.40% in 1998. The following is a summary of the carrying amounts and estimated fair values of selected Company financial assets and liabilities at December 31, 2000 (amounts in thousands): Carrying Estimated Amount Fair Value -------- ---------- Financial Assets: Securities $ 16,931 $ 16,894 Loans, Net of Allowance for Credit Losses $163,274 $162,780 Financial Liabilities: Deposits $254,325 $254,384 Other than a relatively small difference due to credit quality issues pertaining to loans, the difference between the carrying amount and the fair value is a measure of how much more or less valuable the Company's financial instruments are to it than when acquired. The net difference for interest-bearing financial assets is $0.6 million. The amount is not deemed to be significant compared to the outstanding balances taken as a whole. 40 Mismatch Risk. Another interest-related risk arises from the fact that when interest rate change, the changes do not occur equally in the rates of interest earned and paid because of difference in the contractual terms of the assets and liabilities held. The Company has a large portion of its loan portfolio tied to the prime interest rate. If the prime rate is lowered because of general market conditions, e.g., other banks are lowering their lending rates; these loans will be repriced. If the Company were at the same time to have a large proportion of its deposits in long-term fixed rate certificates, net interest income would decrease immediately. Interest earned on loans would decline while interest expense would remain at higher levels for a period of time because of the higher rate still being paid on deposits. A decrease in net interest income could also occur with rising interest rates if the Company had a large portfolio of fixed rate loans and securities funded by deposit accounts on which the rate is steadily rising. This exposure to "mismatch risk" is managed by matching the maturities and repricing opportunities of assets and liabilities. This is done by varying the terms and conditions of the products that are offered to depositors and borrowers. For example, if many depositors want longer-term certificates while most borrowers are requesting loans with floating interest rates, the Company will adjust the interest rates on the certificates and loans to try to match up demand. The company can then partially fill in mismatches by purchasing securities with the appropriate maturity or repricing characteristics. One of the means of monitoring this matching process is the use of a "gap" report table. This table show the extent to which the maturities or repricing opportunities of the major categories of assets and liabilities are matched based upon specific interest rate shifts of up to +/- 300 basis points. The following table shows the estimated impact to net interest income for an instantaneous shift in various interest rates as of December 31, 2000 (the dollar change in net interest income represents the estimated change for the next 12 months): Change in Net Change in Interest Rates Interest Income -------------------------- ---------------- +300 basis points $ 2,179 +200 basis points 1,525 +100 basis points 738 -100 basis points (841) -200 basis points (1,748) -300 basis points (2,329) The Company has adequate capital to absorb any potential losses as a result of a decrease in interest rates. Periods of more than one year is not estimated because steps can be taken to mitigate the adverse effects of any interest rate changes. Basis Risk. A third interest-related risk arises from the fact that interest rates rarely change in a parallel or equal manner. The interest rates associated with the various assets and liabilities differ in how often they change, the extent to which they change, and whether they change sooner or later than other interest rates. For example, while the repricing of a specific asset and a specific liability may fall in the same period of a gap report the interest rate on the asset may rise 100 basis points, while market conditions dictate that the liability increases only 50 basis points. While evenly matched in the gap report, the Company would experience an increase in net interest income. This exposure to "basis risk" is the type of interest risk least able to be managed, but is also the least dramatic. Avoiding concentration in only a few types of assets or liabilities is the best insurance that the average interest received and paid will move in tandem, because the wider diversification means that many different rates, each with their own volatility characteristics, will come into play. The Company has made an effort to minimize concentrations in certain types of assets and liabilities. 41 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Index to Financial Statements Page Independent Auditors' Report 43 Consolidated Balance Sheets at December 31, 2000 and 1999 44 and 45 Consolidated Statements of Income for each of the Years in the Three-Year Period Ended December 31, 2000 46 Consolidated Statements of Shareholders' Equity for each of the Years in the Three-Year Period Ended December 31, 2000 47 Consolidated Statements of Cash Flows for each of the Years in the Three-Year Period Ended December 31, 2000 48 Notes to Financial Statements 49 through 78 All supplemental schedules are omitted as inapplicable or because the required information is included in the financial statements or notes hereto. 42 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders of BYL Bancorp and Subsidiary We have audited the accompanying consolidated balance sheets of BYL Bancorp and Subsidiary as of December 31, 2000 and 1999, and the related consolidated statements of income, 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 financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial 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, the financial statements referred to above present fairly, in all material respects, the financial position of BYL Bancorp and Subsidiary as of December 31, 2000 and 1999, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2000, in conformity with generally accepted accounting principles. VAVRINEK, TRINE, DAY & CO., LLP Laguna Hills, California March 8, 2001 43 BYL BANCORP AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS December 31, 2000 and 1999 (Dollar Amounts in Thousands) 2000 1999 --------- --------- ASSETS Cash and Due from Banks $ 30,370 $ 34,119 Federal Funds Sold 26,100 -- --------- --------- TOTAL CASH AND CASH EQUIVALENTS 56,470 34,119 Interest-Bearing Deposits 111 100 Investment Securities Available for Sale 5,768 6,868 Held to Maturity 11,163 14,712 --------- --------- TOTAL INVESTMENT SECURITIES 16,931 21,580 Federal Home Loan Bank Stock, at Cost 629 1,113 Loans Held for Sale 22,439 69,756 Loans Commercial 28,893 52,695 Real Estate - Construction 11,995 5,524 Real Estate - Other 120,535 98,010 Consumer 4,072 40,446 --------- --------- TOTAL LOANS 165,495 196,675 Net Deferred Loan Costs 74 2,209 Allowance for Loan Losses (2,295) (2,610) --------- --------- NET LOANS 163,274 196,274 Premises and Equipment 5,770 6,447 Other Real Estate Owned 858 277 Cash Surrender Value of Life Insurance 2,290 2,196 Deferred Tax Assets 3,180 1,804 Goodwill 1,204 1,324 Interest-Only Strips Receivable and Servicing Assets 11,340 15,659 Accrued Interest and Other Assets 1,902 3,087 --------- --------- $ 286,398 $ 353,736 ========= ========= The accompanying notes are an integral part of these consolidated financial statements. 44 BYL BANCORP AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS December 31, 2000 and 1999 (Dollar Amounts in Thousands) 2000 1999 --------- --------- LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Noninterest-Bearing Demand $ 67,152 $ 66,619 Money Market and NOW 60,523 73,193 Savings 44,795 79,983 Time Deposits Under $100,000 43,081 56,750 Time Deposits $100,000 and Over 38,774 46,428 --------- --------- TOTAL DEPOSITS 254,325 322,973 Accrued Interest and Other Liabilities 2,888 1,563 --------- --------- TOTAL LIABILITIES 257,213 324,536 Commitments and Contingencies - Note E and K Shareholders' Equity Preferred Shares - Authorized 25,000,000 Shares; None Outstanding Common Shares - Authorized 50,000,000 Shares; Issued and Outstanding 2,542,568 in 2000 and 2,537,102 Shares in 1999 12,815 12,788 Retained Earnings 16,496 15,918 Accumulated Other Comprehensive Income (126) 494 --------- --------- TOTAL SHAREHOLDERS' EQUITY 29,185 29,200 --------- --------- $ 286,398 $ 353,736 ========= ========= The accompanying notes are an integral part of these consolidated financial statements. 45 BYL BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands, Except Per Share Data) 2000 1999 1998 ------- ------- ------- INTEREST INCOME Interest and Fees on Loans $25,172 $25,093 $22,057 Interest on Investment Securities 1,512 1,310 1,119 Other Interest Income 1,269 1,125 840 ------- ------- ------- TOTAL INTEREST INCOME 27,953 27,528 24,016 INTEREST EXPENSE Interest on Money Market and NOW 2,335 2,764 1,613 Interest on Savings Deposits 2,292 4,076 1,622 Interest on Time Deposits 5,578 4,670 5,081 Interest on Other Borrowings 62 76 90 ------- ------- ------- TOTAL INTEREST EXPENSE 10,267 11,586 8,406 ------- ------- ------- NET INTEREST INCOME 17,686 15,942 15,610 Provision for Credit Losses 600 694 755 ------- ------- ------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 17,086 15,248 14,855 NONINTEREST INCOME Net Servicing and Interest-Only Strip Income 1,985 1,817 662 Net Gain on Sale and Securitization of Loans 12,116 19,563 19,724 Service Charges, Fees, and Other Income 2,627 2,669 3,022 ------- ------- ------- 16,728 24,049 23,408 ------- ------- ------- 33,814 39,297 38,263 NONINTEREST EXPENSE Salaries and Employee Benefits 17,262 19,906 19,662 Occupancy Expenses 2,033 2,287 1,645 Furniture and Equipment 1,966 2,798 2,032 Other Expenses 11,530 8,900 7,531 ------- ------- ------- 32,791 33,891 30,870 ------- ------- ------- INCOME BEFORE INCOME TAXES 1,023 5,406 7,393 Income Taxes 445 2,330 3,277 ------- ------- ------- NET INCOME $ 578 $ 3,076 $ 4,116 ======= ======= ======= Per Share Data Net Income - Basic $ 0.23 $ 1.21 $ 1.63 Net Income - Diluted $ 0.23 $ 1.21 $ 1.55 The accompanying notes are an integral part of these consolidated financial statements. BYL BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY Years Ended December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands, Except Per Share Data) Common Shares Accumulated ----------------------- Other Number of Comprehensive Retained Comprehensive Shares Amount Income Earnings Income ----------- ---------- ------------- ------------- --------------- Balance at January 1, 1998 2,503,171 $12,622 $ 9,955 $ (27) Comprehensive Income: Net Income $ 4,116 4,116 Other Comprehensive Income - Unrealized Gain on Available-for-Sale Securities, Net of Taxes of $116 183 183 Unrealized Gain on Interest-Only Strips Net of Taxes of $256 364 364 ---------- Total Comprehensive Income $ 4,663 ========== Cash in Lieu of Fractional Shares from Merger with DNB (2) Dividends on Common (467) Exercise of Stock Options 28,131 138 --------- ------- --------- ------- Balance at December 31, 1998 2,531,302 12,760 13,602 520 Comprehensive Income: Net Income $ 3,076 3,076 Other Comprehensive Income - Unrealized Gain on Available-for-Sale Securities, Net of Taxes of $2 3 3 Unrealized Loss on Interest-Only Strips Net of Taxes of $21 (29) (29) ---------- Total Comprehensive Income $ 3,050 ========== Dividends on Common (760) Exercise of Stock Options 5,800 28 --------- ------- --------- ------- Balance at December 31, 1999 2,537,102 12,788 15,918 494 Comprehensive Income: Net Income $ 578 578 Other Comprehensive Income - Unrealized Loss on Available-for-Sale Securities, Net of Taxes of $308 (441) (441) Add Reclassification Adjustment for Loss Included in Net Income, net of Taxes of $196 282 282 Unrealized Loss on Interest-Only Strips Net of Taxes of $902 (1,277) (1,277) Add Reclassification Adjustment for Loss Included in Net Income, net of Taxes of $576 816 816 --------- Total Comprehensive Loss $ (42) ========= Exercise of Stock Options 5,466 27 --------- ------- --------- ------- Balance at December 31, 2000 2,542,568 $12,815 $ 16,496 $ (126) ========= ======= ========= ======== The accompanying notes are an integral part of these consolidated financial statements. 47 BYL BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands) OPERATING ACTIVITIES 2000 1999 1998 --------- --------- --------- Net Income $ 578 $ 3,076 $ 4,116 Adjustments to Reconcile Net Income to Net Cash Provided (Used) by Operating Activities: Depreciation and Amortization 4,238 3,622 1,920 Deferred Income Taxes (939) 57 (496) Loans Originated for Sale (367,581) (690,108) (336,685) Proceeds from Loan Sales 425,430 701,551 319,630 Gain on Sale of Loans (12,116) (19,563) (19,724) Provision for Loan Losses 600 694 755 Write Down of Available-for-Sale Securities 478 -- -- Write Down of Interest-Only Strips Receivable 1,392 -- -- Other Real Estate Owned Losses 75 72 220 Other Items - Net 1,180 1,995 (5,784) --------- --------- --------- NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES 53,335 1,396 (36,048) INVESTING ACTIVITIES Net Change in Interest-Bearing Deposits (11) (100) 3,419 Purchases of Available-for-Sale Securities -- (236) (1,894) Purchases of Held-to-Maturity Securities (20,006) (10,994) (10,551) Proceeds from Maturities and Sale of Available-for-Sale Securities 899 3,452 18,683 Proceeds from Maturities of Held-to-Maturity Securities 23,538 7,108 2,663 Proceeds from Sale of Interest-Only Strips 3,003 -- -- Net Change in Loans 30,411 (33,022) (28,838) Proceeds from Sales of Other Real Estate Owned 824 830 1,212 Purchases of Premises and Equipment (1,386) (2,294) (2,184) Proceeds from Sale of Premises and Equipment 365 30 82 --------- --------- --------- NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES 37,637 (35,226) (17,408) FINANCING ACTIVITIES Net Change in Demand Deposits and Savings Accounts (47,325) 20,624 67,451 Net Change in Time Deposits (21,323) 15,143 11,820 Net Change Short-Term Borrowings -- -- (4,000) Reductions in Long-Term Debt -- -- (465) Proceeds from Exercise of Stock Options 27 28 138 Dividends Paid -- (760) (467) --------- --------- --------- NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES (68,621) 35,035 74,477 --------- --------- --------- INCREASE IN CASH AND CASH EQUIVALENTS 22,351 1,205 21,021 Cash and Cash Equivalents at Beginning of Year 34,119 32,914 11,893 --------- --------- --------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 56,470 $ 34,119 $ 32,914 ========= ========= ========= Supplemental Disclosures of Cash Flow Information: Interest Paid $ 10,381 $ 11,495 $ 8,338 Income Taxes Paid $ 742 $ 2,470 $ 4,237 The accompanying notes are an integral part of these consolidated financial statements. 48 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands) NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation The financial statements include the accounts of BYL Bancorp and its subsidiary, BYL Bank Group ("the Bank"), collectively referred to herein as the "Company". Nature of Operations The Bank operates seven retail branches in Orange and Riverside County, California. It also operates a Small Business Administration ("SBA") loan department and a mortgage loan department. The Bank's primary source of revenue is providing loans to customers for both retention in the Bank's loan portfolio as well as sales to other institutional investors. Use of Estimates in the Preparation of Financial Statements The preparation of financial statements in conformity with generally accepted accounting principles 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 financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents For purposes of reporting cash flows, cash and cash equivalents include cash, due from banks and federal funds sold. Generally, federal funds are sold for one day periods. Cash and Due From Banks Banking regulations require that all banks maintain a percentage of their deposits as reserves in cash or on deposit with the federal reserve bank. The Bank complied with the reserve requirements as of December 31, 2000. The Bank maintains amounts due from banks which exceed federally insured limits. The Bank has not experienced any losses in such accounts. Investment Securities Bonds, notes, and debentures for which the Bank has the positive intent and ability to hold to maturity are reported at cost, adjusted for premiums and discounts that are recognized in interest income using the interest method over the period to maturity. 49 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands) NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued Investment Securities - Continued Investments not classified as trading securities nor as held to maturity securities are classified as available-for-sale securities and recorded at fair value. Unrealized gains or losses on available-for-sale securities are excluded from net income and reported as an amount net of taxes as a separate component of other comprehensive income included in shareholders' equity. Premiums or discounts on held-to-maturity and available-for-sale securities are amortized or accreted into income using the interest method. Realized gains or losses on sales of held-to-maturity or available-for-sale securities are recorded using the specific identification method. Loans Held for Sale Mortgage, SBA loans and other loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated market value in the aggregate. Net unrealized losses are recognized through a valuation allowance by charges to income. Loans Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding unpaid principal balances reduced by any charge-offs or specific valuation accounts and net of any deferred fees or costs on originated loans, or unamortized premiums or discounts on purchased loans. Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield of the related loan. The accrual of interest on impaired loans is discontinued when, in management's opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received. For impairment recognized in accordance with Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 114, "Accounting by Creditors for Impairment of a Loan", as amended by SFAS No. 118, the entire change in the present value of expected cash flows is reported as either provision for loan losses in the same manner in which impairment initially was recognized, or as a reduction in the amount of provision for loan losses that otherwise would be reported. 50 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands) NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued Securitizations and Loan Sales The Company sells the guaranteed portion of SBA loans and securitizes certain unguaranteed commercial loans and the unguaranteed portion of SBA loans. To calculate the gain (loss) on sale of loans, the Company's investment in the loan is allocated among the retained portion of the loan, subordinated certificates, the servicing retained, the interest-only strip, and the sold portion of the loan, based on the relative fair value of each portion. The gain (loss) on the sold portion of the loan is recognized at the time of sale based on the difference between the sale proceeds and the allocated investment. To obtain fair values, quoted market prices are used if available. If fair value quotes are unavailable, the Company estimates fair value based on the present value of future expected cash flows estimated using management's best estimates of the key assumptions - credit loss, prepayment speed and discount rates commensurate with the risks involved. As a result of the relative fair value allocation, the carrying value of the retained portion is discounted, with the discount accreted to interest income over the life of the loan. That portion of the excess servicing fees that represent contractually specified servicing fees (contractual servicing) are reflected as a servicing asset which is amortized over an estimated life using a method approximating the level yield method; in the event future prepayments exceed Management's estimates and future expected cash flows are inadequate to cover the unamortized servicing asset, additional amortization would be recognized. The portion of excess servicing fees in excess of the contractual servicing fees is reflected as interest-only (I/O) strips receivable which are classified as interest-only strips receivable available for sale and are carried at fair value. Actual prepayment rates may be affected by a variety of economic and other factors, including prevailing interest rates and the availability of alternative financing. The effect of these factors varies depending on the types of loans. Estimated prepayment rates are based on management's expectations of future prepayments, and, while management believes that the term of amortization and market interest rate on the variable rate loans somewhat reduce the prepayment risk, there can be no assurance that management's prepayment estimates are accurate. If the actual prepayment rate or actual losses for loans sold is higher than projected at the time such loans were sold, the carrying value of the servicing asset and or I/O strip may be considered impaired and be reduced by a charge to earnings if an impairment is considered "other than temporary". If the actual prepayment rate for loans sold is lower than estimated, the carrying value of the servicing asset is not increased, although the total future cash flow income would exceed previously estimated amounts. Allowance for Loan Losses The allowance for loan losses is increased by charges to income and decreased by charge-offs (net of recoveries). The Company performs quarterly detailed reviews to identify the risks inherent in the loan portfolio, assess the overall quality of the loan portfolio and to determine the adequacy of the allowance for loan losses and the related provision for loan losses to be charged to expense. This systematic reviews follow the methodology set forth by the FDIC in its 1993 policy statement on the allowance for loan losses. 51 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands) NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued Allowance for Loan Losses - Continued Loans identified as less than "acceptable" are reviewed individually to estimate the amount of probable losses that need to be included in the allowance. These reviews include analysis of financial information as well as evaluation of collateral securing the credit. Additionally, management considers the inherent risk present in the "acceptable" portion of the loan portfolio taking into consideration historical losses on pools of similar loans, adjusted for trends, conditions and other relevant factors that may affect repayment of the loans in these pools. Mortgage Banking Activities The Company originates and sells residential mortgage loans to a variety of secondary market investors, including the Federal Home Loan Mortgage Corporation (FHLMC), the Federal National Mortgage Association (FNMA) and others. Gains and losses on the sale of mortgage loans are recognized upon delivery based on the difference between the selling price and the carrying value of the related mortgage loans sold. Deferred origination fees and expenses are recognized at the time of sale in the determination of the gain or loss. The Company sells the servicing for such loans to the purchaser of the loans. The Company recognizes the gain or loss on servicing sold when all risks and rewards of ownership have transferred. Mortgage loans held for sale are stated at the lower of cost or market as determined by the outstanding commitments from investors or current investor yield requirements calculated on an aggregate loan basis. Valuation adjustments are charged against noninterest income. Forward commitments to sell, and put options on mortgage-backed securities are used to reduce interest rate risk on a portion of loans held for sale and anticipated loan fundings. The resulting gains and losses on forward commitments are deferred and included in the carrying values of loans held for sale. Premiums on put options are capitalized and amortized over the option period. Gains and losses on forward commitments and put options deferred against loans held for sale approximately offset equivalent amounts of unrecognized gains and losses on the related loans. Forward commitments to sell and put options on mortgage-backed securities that hedge anticipated loan funding are not reflected in the consolidated statement of financial condition. Gains and losses on these instruments are not recognized until the actual sale of the loans held for sale. Loans generally fund in 10 to 30 days from the date of commitment. The Company no longer utilizes these activities to reduce interest rate risk. 52 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands) NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued Premises and Equipment Land is carried at cost. 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, which ranges from three to ten years for furniture and fixtures and forty years for buildings. Leasehold improvements are amortized using the straight-line method over the estimated useful lives of the improvements or the remaining lease term, whichever is shorter. Expenditures for betterment or major repairs are capitalized and those for ordinary repairs and maintenance are charged to operations as incurred. Other Real Estate Owned Real estate properties acquired through, or in lieu of, loan foreclosure are initially recorded at fair value at the date of foreclosure establishing a new cost basis. After foreclosure, valuations are periodically performed by management and the real estate is carried at the lower of cost or fair value minus estimated costs to sell. Revenue and expenses from operations and changes in the valuation allowance are included in other expenses. Goodwill and Other Intangibles Goodwill represents the excess of the purchase price over the estimated fair value of net assets associated with acquisition transactions of the Company accounted for as purchases and is amortized over fifteen years. Core deposit intangibles represent the intangible value of depositor relationships resulting from deposit liabilities assumed in acquisitions and are amortized over seven years. Goodwill and other intangibles are evaluated periodically for other than temporary impairment. Should such an assessment indicate that the undiscounted value of an intangible may be impaired, the net book value of the intangible would be written down to net estimated recoverable value. Income Taxes Deferred income taxes are computed using the asset and liability method, which recognizes a liability or asset representing the tax effects, based on current tax law, of future deductible or taxable amounts attributable to events that have been recognized in the consolidated financial statements. A valuation allowance is established to reduce the deferred tax asset to the level at which it is "more likely than not" that the tax asset or benefits will be realized. Realization of tax benefits of deductible temporary differences and operating loss carryforwards depends on having sufficient taxable income of an appropriate character within the carryforward periods. 53 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands) NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued Disclosure About Fair Value of Financial Instruments SFAS No. 107 specifies the disclosure of the estimated fair value of financial instruments. The Bank's estimated fair value amounts have been determined by the Bank using available market information and appropriate valuation methodologies. Considerable judgment is required to develop the estimates of fair value. Accordingly, the estimates are not necessarily indicative of the amounts the Company could have realized 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. 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 the balance sheet date and, therefore, current estimates of fair value may differ significantly from the amounts presented in the accompanying Notes. Earnings Per Shares (EPS) Basic EPS excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Stock-Based Compensation SFAS No. 123, "Accounting for Stock-Based Compensation," encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at fair value. The Company has chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's stock at the date of the grant over the amount an employee must pay to acquire the stock. The pro forma effects of adoption are disclosed in Note M. Current Accounting Pronouncements In June 1998, FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities"(as amended in 2000 by SFAS No. 138). This Statement establishes accounting and reporting standards for derivative instruments and for hedging activities. This new standard was originally effective for 2000. In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133". This Statement establishes the effective date of SFAS No. 133 for 2001. SFAS No. 133 is not expected to have a material impact on the Company's financial statements. 54 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands) NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued Reclassifications Certain reclassifications were made to prior years' presentations to conform to the current year. These classifications are of a normal recurring nature. NOTE B - INVESTMENT SECURITIES Debt and equity securities have been classified in the consolidated balance sheets according to management's intent. The carrying amount of securities and their approximate fair values at December 31 were as follows: Gross Gross Amortized Unrealized Unrealized Cost Gains (Losses) Fair Value -------- -------- -------- ---------- Available-for-Sale Securities: December 31, 2000: Mortgage-Backed Securities $ 5,768 $ -- $ -- $ 5,768 ======== ======== ======== ======== December 31, 1999: Mortgage-Backed Securities $ 6,597 $ 271 $ -- $ 6,868 ======== ======== ======== ======== Held-to-Maturity Securities: December 31, 2000: U.S. Government and Agency Securities $ 10,998 $ 1 $ (38) $ 10,961 Mortgage-Backed Securities 165 -- -- 165 -------- -------- -------- -------- $ 11,163 $ 1 $ (38) $ 11,126 ======== ======== ======== ======== December 31, 1999: U.S. Treasury $ 500 $ 1 $ -- $ 501 U.S. Government and Agency Securities 14,008 -- (266) 13,742 Mortgage-Backed Securities 204 -- (2) 202 -------- -------- -------- -------- $ 14,712 $ 1 $ (268) $ 14,445 ======== ======== ======== ======== 55 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands) NOTE B - INVESTMENT SECURITIES - Continued The gross unrealized gain of $271 on available-for-sale securities is included in accumulated other comprehensive income at December 31, 1999, net of taxes of $111. During 2000, the Company wrote down the available-for-sale mortgage-back securities and recorded a loss of $478. The write down reflected the permanent decline in value resulting from a sale that closed on January 17, 2001. During 1998, the Company received $1,504 in proceeds and recorded a loss of $39 from the sale of investment securities. The Company did not sell any investment securities for the years ended December 31, 2000 and 1999. Investment securities carried at $11,163 and $14,712 at December 31, 2000 and 1999, respectively, were pledged to secure public deposits and other purposes as required by law. The scheduled maturities of securities available for sale and securities held to maturity at December 31, 2000, were as follows: Available-for-Sale Held-to-Maturity -------------------- --------------------- Amortized Fair Amortized Fair Cost Value Cost Value ------- ------- ------- ------- Due In One Year or Less $ -- $ -- $ 998 $ 999 Due from One to Five Years -- -- 10,000 9,962 Mortgage-Backed Securities 5,768 5,768 165 165 ------- ------- ------- ------- $ 5,768 $ 5,768 $11,163 $11,126 ======= ======= ======= ======= NOTE C - LOANS HELD FOR SALE The Bank originates mortgage and SBA loans for sale to institutional investors. A substantial portion of the Bank's revenues are from origination of loans guaranteed by the Small Business Administration under its Section 7 program and sale of the guaranteed portions of those loans. Funding for the Section 7 program depends on annual appropriations by the U.S. Congress. At December 31, 2000 and 1999, the Bank was servicing approximately $242,843 and $220,120, respectively, in loans previously sold. 56 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands) NOTE C - LOANS HELD FOR SALE - Continued A summary of the changes in the servicing assets and interest-only strips receivable is as follows: Servicing Assets -------------------------------------- 2000 1999 1998 -------- -------- -------- Balance at Beginning of Year $ 2,803 $ 2,479 $ 1,920 Increase from Loan Sales 948 1,045 968 Amortization and Prepayments Charged to Income (466) (721) (409) Increase in Valuation Allowance (401) -- -- -------- -------- -------- Balance at End of Year $ 2,884 $ 2,803 $ 2,479 ======== ======== ======== Interest-Only Strips Receivable -------------------------------------- 2000 1999 1998 -------- -------- -------- Balance at Beginning of Year $ 12,286 $ 5,926 $ 644 Increase from Loan Sales 2,305 7,224 5,437 Amortization and Prepayments Charged to Income (1,524) (864) (155) Writedown of Interest-Only Strips Receivable (1,392) -- -- Sale of Interest-Only Strips Receivable (3,003) -- -- -------- -------- -------- Balance at End of Year $ 8,672 $ 12,286 $ 5,926 ======== ======== ======== Unrecognized Gain (Loss) at End of Year $ (216) $ 570 $ 620 The unrecognized gain (loss) on interest-only strips receivable of $(216) and $570 is included in accumulated other comprehensive income, net of taxes of $90 and $236 at December 31, 2000 and 1999, respectively. The estimated fair value of the servicing assets was approximately $2,884 at December 31, 2000. Fair value is estimated by discounting estimated future cash flows from the servicing assets using discount rates that approximate current market rates over the expected lives of the loans being serviced. For purposes of measuring impairment, the Bank has identified each servicing asset with the underlying loan being serviced. A direct write down is recorded where the fair value is below the carrying amount of a specific servicing asset. 57 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands) NOTE C - LOANS HELD FOR SALE - Continued Included in the above Interest-Only Strips Receivable are retained interest in securitized assets ("RISA"), which has been capitalized upon the securitization of $43,000 of the unguaranteed portion of SBA loans in 1998 ("1998-1") and $60,000 of commercial real estate loans in 1999 ("1999-1"). The RISA represents the present value of the estimated future earnings to be received by the company from the excess spread created in securitization transactions. Excess spread is calculated by taking the difference between the coupon rate of the loans sold and the certificate rate paid to the investors less contractually specified servicing and costs and projected credit losses, after giving effect to estimated prepayments. The Company utilized prepayment rates for the 1998 securitization of 12% in 1998 and 15.3% in 1999. The prepayment rate for the 1999 securitization is 5% for the first sixty months and 15% thereafter. Annual net credit loss assumptions utilized for the 1998 and 1999 securitization transactions ranged from .25% to .50%. The Company used a discount rate during 1998 and 1999 of 125 to 525 basis points over the certificate rates paid to investors at the time of securitization in discounting future earnings. RISA is classified in a manner similar to available for sale securities and as such is marked to market each quarter. The Company is not aware of an active market for the purchase or sale of the RISA, and accordingly, the company determines the estimated fair value of the RISA by discounting the expected cash flows released from the trust (the "Cash-Out Method") using a discount rate which the Company believes is commensurate with the risks involved. Any changes in the market value of RISA is reported as a separate component of shareholders' equity as an unrealized gain or loss, net of deferred taxes. In initially valuing the RISA, the Company establishes an off balance sheet allowance for expected future credit losses. The allowance is based upon historical experience and management's estimate of future performance regarding credit losses. The amount is reviewed periodically and adjustments are made if actual experience or other factors indicate that future performance may differ from management's prior estimates. During the second quarter of 2000 the Company increased the discount rate used to fair value the RISA by approximately 300 basis points and recorded a $800 permanent decline in value on its 1999-1 RISA. During the third quarter the Company sold 59% of its 1999-1 RISA for $3,003. On January 8, 2001, in an arms length transaction, the Company sold the remaining balance of the 1999-1 RISA to a group of directors for $1,339 and wrote down the RISA by $592 in 2000 to reflect the permanent decline in value resulting from sale. As of December 31, 2000 the 1999-1 RISA was carried at net realizable value. During 2000 the Company received cash flows from the RISA's trusts of $1,885 on the interest only strip receivable and $363 in servicing income. Static pool losses are calculated by summing the actual and projected future credit losses and dividing them by the original balance of each pool of assets. No losses have occurred from securitized loans. The static losses for the unguaranteed portion of SBA loans securitized are 1.63%, 1.39% and 3.15% at December 31, 2000, 1999, and 1998, respectively. 58 BY BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands) NOTE C - LOANS HELD FOR SALE - Continued At December 31, 2000, key economic assumptions used to fair value the RISA for the 1998-1 unguaranteed portion of SBA loans securitized, along with the decline in the RISA due to an immediate 10 percent and 20 percent adverse changes in those assumptions are as follows: SBA Loans 1998-1 ---------- Carrying Value of Retained Interest - Fair Value $ 3,733 Weighted-Average Life (in years) 10.7 Prepayment Speed Assumption (annual rate) 14.44% Decline in Fair Value from a 10% Adverse Change 80 Decline in Fair Value from a 20% Adverse Change 158 Expected Credit Losses (annual rate) 0.40% Decline in Fair Value from a 10% Adverse Change 40 Decline in Fair Value from a 20% Adverse Change 81 Discount Rate (annual rate) 13.28% Decline in Fair Value from a 10% Adverse Change 167 Decline in Fair Value from a 20% Adverse Change 319 The decline in fair value due to changes in the assumptions are hypothetical and should be used with caution. As the figures indicate, changes in fair value based on a 10 percent variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in the table, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumption; in reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments and increase credit losses), which might magnify or counteract the sensitivities. 59 BY BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands) NOTE C - LOANS HELD FOR SALE - Continued The following table presents the estimated future undiscounted retained interest earnings to be received from securitizations as of December 31, 2000. Estimated future undiscounted RISA earnings are calculated by taking the difference between the coupon rate of the contracts sold and the rates paid to the investors, less the contractually specified servicing fee of .40% and costs, after giving effect to estimated prepayments and assuming no losses. To arrive at the RISA, this amount is reduced by the off balance sheet allowance established for potential future losses and by discounting to present value. 2000 1999 -------- -------- Estimated Net Undiscounted RISA Earnings $ 7,716 $ 19,475 Off Balance Sheet Allowance for Losses (700) (1,864) Discount to Present Value (3,283) (6,966) -------- -------- Retained Interest in Securitized Assets $ 3,733 $ 10,645 ======== ======== Outstanding Balance of Loans Sold Through Securitizations $ 29,440 $ 94,297 ======== ======== The following table presents the total loans being serviced for the unguaranteed portion of SBA loans sold through the 1998-1 securitization along with the guaranteed portion being serviced and related past due loans as of December 31, 2000 and credit losses for the year ended December 31, 2000. 2000 -------- Loans Sold through Securitization Serviced by the Company $ 29,440 Guaranteed portion Sold on Secondary Market and Serviced by the Company 62,434 Loans Remaining on Balance Sheet 322 -------- Total Loans Related to Securitization being Managed by the Company $ 92,196 ======== Loans Past Due over 60 Days $ 1,624 Net Losses on Above Loans for the Year $ -- 60 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands) NOTE D - LOANS The Bank's loan portfolio consists primarily of loans to borrowers within Orange and Riverside County in Southern California. Although the Bank seeks to avoid concentrations of loans to a single industry or based upon a single class of collateral, real estate and real estate associated businesses are among the principal industries in the Bank's market area and, as a result, the Bank's loan and collateral portfolios are, to some degree, concentrated in those industries. A summary of the changes in the allowance for loan losses as of December 31 follows: 2000 1999 1998 ------- ------- ------- Balance at Beginning of Year $ 2,610 $ 2,300 $ 1,923 Additions to the Allowance Charged to Expense 600 694 755 Recoveries on Loans Charged Off 116 134 150 ------- ------- ------- 3,326 3,128 2,828 Less Loans Charged Off (1,031) (518) (528) ------- ------- ------- $ 2,295 $ 2,610 $ 2,300 ======= ======= ======= The following is a summary of the investment in impaired loans, the related allowance for credit losses, and income recognized thereon as of December 31: 2000 1999 1998 ------- ------- ------- Recorded Investment in Impaired Loans $ 1,292 $ 1,542 $ 1,806 Related Allowance for Impaired Losses $ 180 $ 243 $ 289 Average Recorded Investment in Impaired Loans $ 2,074 $ 2,349 $ 2,102 Interest Income Recognized from Cash Payments $ -- $ -- $ -- Loans having carrying values of $1,479, $725, and $1,479 were transferred to other real estate owned in 2000, 1999 and 1998, respectively. During 1999 loans totaling $517 were made to facilitate the sale of other real estate owned. 61 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands) NOTE E - PREMISES AND EQUIPMENT A summary of premises and equipment follows: 2000 1999 -------- -------- Land $ 943 $ 943 Buildings 2,107 2,091 Leasehold Improvements 1,585 1,685 Furniture, Fixtures, and Equipment 8,005 7,584 -------- -------- 12,640 12,303 Less Accumulated Depreciation and Amortization (6,870) (5,856) -------- -------- $ 5,770 $ 6,447 ======== ======== The Bank has entered into various operating lease agreements, primarily covering its branch locations. These agreements expire at various times through the year 2005. The approximate future minimum annual payments for these leases by year are as follows: 2001 $ 1,107 2002 856 2003 650 2004 152 2005 76 ------- $ 2,841 ======= The minimum rental payments shown above represent the existing lease obligations, are not a forecast of future rental expense, and do not include sublease income. Total rental expense included in occupancy expense and furniture and equipment expense was approximately $955 in 2000, $1,526 in 1999, and $987 in 1998. 62 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands) NOTE F - DEPOSITS At December 31, 2000, the scheduled maturities of time deposits are as follows: 2001 $ 75,970 2002 4,445 2003 1,362 2004 through 2005 78 -------- $ 81,855 ======== NOTE G - OTHER EXPENSES A summary of other expenses for the years ended December 31 is as follows: 2000 1999 1998 -------- ------ ------- Regulatory Assessments $ 544 $ 61 $ 58 Other Real Estate Owned 202 226 288 Professional Fees and Outside Services 2,299 1,965 1,792 Loan Expenses 2,674 1,649 1,047 Office Expenses 1,586 2,016 1,527 Write Down of Available for Sale Securities 478 -- -- Other 3,747 2,983 2,819 -------- ------ ------- $ 11,530 $8,900 $ 7,531 ======== ====== ======= 63 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands) NOTE H - INCOME TAXES The provisions for income taxes included in the statements of income consist of the following: 2000 1999 1998 -------- ------ ------- Current: Federal $ 1,005 $1,704 $ 2,723 State 379 569 1,050 -------- ------ ------- 1,384 2,273 3,773 Deferred (939) 57 (496) -------- ------ ------- $ 445 $2,330 $ 3,277 ======== ====== ======= Deferred taxes are a result of differences between income tax accounting and generally accepted accounting principles with respect to income and expense recognition. The Company's principal differences are from loan loss provision accounting, loan sales, and depreciation differences. The following is a summary of the components of the deferred tax asset account recognized in the accompanying consolidated balance sheets: 2000 1999 ------- ------- Deferred Tax Assets: Allowance for Loan Losses $ 724 $ 763 Other Real Estate Writedowns 49 91 Gain on Sale of Loans 385 1,098 California Franchise Tax 108 196 Unrealized Losses on Securities and Other Assets 90 -- Other Assets/Liabilities 1,848 160 ------- ------- 3,204 2,308 Deferred Tax Liabilities: Unrealized Gains on Securities and Other Assets -- (347) Premises and Equipment (24) (157) ------- ------- (24) (504) ------- ------- Net Deferred Tax Assets $ 3,180 $ 1,804 ======= ======= 64 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands, Except Per Share Data) NOTE H - INCOME TAXES - Continued A comparison of the federal statutory income tax rates to the Company's effective income tax rates for the years ended December 31 follows: 2000 1999 1998 ------------------- --------------------- --------------------- Amount Rate Amount Rate Amount Rate ------- ------- ------- ------- ------- ------- Federal Tax Rate $ 348 34.0% $ 1,838 34.0% $ 2,514 34.0% California Franchise Taxes, Net of Federal Tax Benefit 74 7.2 387 7.1 536 7.3 Tax Savings from Exempt Interest (43) (4.2) (42) (0.8) (44) (0.6) Merger Expenses 136 13.3 -- -- 222 3.0 Other Items - Net (70) (6.8) 147 2.8 49 0.6 ------- ------- ------- ------- ------- ------- Bank's Effective Rate $ 445 43.5% $ 2,330 43.1% $ 3,277 44.3% ======= ======= ======= ======= ======= ======= NOTE I - EARNINGS PER SHARE (EPS) The following is a reconciliation of net income and shares outstanding to the income and number of share used to compute EPS: 2000 1999 1998 ---------------------- ---------------------- ---------------------- Income Shares Income Shares Income Shares ------- --------- -------- --------- -------- --------- Net Income as Reported $ 578 $ 3,076 $ 4,116 Weighted Average Shares Outstanding During the Year 2,538,624 2,534,053 2,520,828 ------- --------- -------- --------- -------- --------- Used in Basic EPS 578 2,538,624 3,076 2,534,053 4,116 2,520,828 Dilutive Effect of Outstanding Stock Options 2,464 17,556 135,410 ------- --------- -------- --------- -------- --------- Used in Dilutive EPS $ 578 2,541,088 $ 3,076 2,551,609 $ 4,116 2,656,238 ======= ========= ======== ========= ======== ========= 65 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands) NOTE J - EMPLOYEE BENEFITS The Bank has a salary deferral 401(k) Plan that covers substantially all employees. The Bank contributed matching funds at its option, which amounted to $359, $381, and $302 in 2000, 1999 and 1998, respectively. The Bank has entered into retirement benefit agreements with certain officers providing for future benefits aggregating approximately $2,496, payable in equal annual installments for ten years from the death or retirement dates of each participating officer. The obligations for these agreements are funded by single premium life insurance policies, with cash surrender values aggregating approximately $2,290 and $2,196 at December 31, 2000 and 1999, respectively. As of December 31, 2000, 1999, and 1998, approximately $292, $216, and $152, respectively, has been accrued in conjunction with these agreements. NOTE K - COMMITMENTS AND CONTINGENCIES The Company is involved in various litigation which has arisen in the ordinary course of its business. In the opinion of management, based upon representation of legal counsel, the disposition of such pending litigation will not have a material effect on the Bank's financial statements. In the ordinary course of business, the Bank enters into financial commitments to meet the financing needs of its customers. These financial commitments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk not recognized in the statement of financial position. The Bank's exposure to loan loss in the event of nonperformance on commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments as it does for loans reflected in the financial statements. As of December 31, 2000, the Bank had the following outstanding financial commitments whose contractual amount represents credit risk: Commitments to Extend Credit $22,612 Standby Letter of Credit 1,236 ------- $23,848 ======= 66 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands) NOTE K - COMMITMENTS AND CONTINGENCIES - Continued Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Standby letters of credit are conditional commitments to guarantee the performance of a Bank customer to a third party. Since many of the commitments and standby letters of credit are expected to expire without being drawn upon, the total amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank, is based on management's credit evaluation of the customer. The majority of the Bank's commitments to extend credit and standby letters of credit are secured by real estate. NOTE L - RELATED PARTY TRANSACTIONS In the ordinary course of business, the Bank has granted loans to certain officers and directors and the companies with which they are associated. In the Bank's opinion, all loans and loan commitments to such parties are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons The following is an analysis of the activity of all such loans: 2000 1999 ------- ------- Beginning Balance $ 2,781 $ 2,241 Credits Granted, Including Renewals -- 1,033 Repayments (972) (493) ------- ------- Ending Balance $ 1,809 $ 2,781 ======= ======= The Bank leases its main Riverside facility from a partnership comprised of two of its directors. The initial term of the lease started in 1982 and expires in 2002, with two successive ten year options. Monthly rental expense, currently at $15, is adjusted for cost of living increases every three years. The Bank also pays its pro-rata share of taxes and common operating expenses. As described in Note C, a group of directors, in an arms length transaction, purchased the remaining interest in the 1999 RISA for $1,339. 67 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands, Except Per Share Data) NOTE M - STOCK OPTION PLAN At December 31, 1999, the Company has an option plan which is described below. The Company applies APB Opinion No. 25 and related interpretations in accounting for its plan. Accordingly, no compensation cost has been recognized for its fixed stock option plan. In 1997, the Company adopted an incentive stock option plan under which up to 460,519 shares of the Company's common shares may be issued to directors, officers, and key employees at not less than 100% of the fair market value at the date the options are granted. The fair value of each option granted was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions; risk-free rates of 4.5% in 1998, volatility of 28% in 1998 and expected lives of five years. The weighted-average fair value of options granted during 1998 was $5.22. A summary of the status of the Company's fixed stock option plan as of December 31, 2000, 1999, and 1998, and changes during the years ending on those dates is presented below: 2000 1999 1998 ----------------------- ----------------------- ------------------------ Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ----------- ---------- ----------- ---------- ----------- ----------- Outstanding at Beginning of Year 404,102 $ 12.88 413,102 $ 12.80 288,700 $ 9.56 Options Granted -- -- -- -- 152,533 17.47 Options Exercised (5,466) 4.88 (5,800) 4.88 (28,131) 4.88 Options Forfeited (86,950) 15.31 (3,200) 17.38 -- -- ----------- ----------- ----------- Outstanding at End of Year 311,686 12.34 404,102 12.88 413,102 12.80 =========== =========== =========== Options Exercisable at Year-End 250,646 11.08 284,636 10.95 203,052 9.31 Weighted-Average Fair Value of Options Granted During the Year $ -- $ -- $ 5.22 68 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands, Except Per Share Data) NOTE M - STOCK OPTION PLAN - Continued The following table summarizes information about fixed options outstanding at December 31, 2000: Options Outstanding Options Exercisable ------------------------------------------------------- ------------------------------- Weighted- Weighted Weighted- Average Average Average Exercise Number Remaining Exercise Number Exercise Price Outstanding Contractual Life Price Exercisable Price - ------------------------ ---------------- -------------------- -------------- ---------------- ------------- $4.88 76,735 1.8 years $ 4.88 76,735 $ 4.88 $12 to $13 133,218 5.9 years $ 12.70 133,218 $ 12.70 $17 to $21 101,733 7.2 years $ 17.48 40,693 $ 17.48 ---------------- ---------------- 311,686 5.3 years 250,646 ================ ================ Had the Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, the Company's net income would have been reduced to the following pro forma amount: 2000 1999 1998 -------------- ------------- ------------- Net Income: As Reported $ 578 $ 3,076 $ 4,116 Pro Forma $ 409 $ 2,703 $ 3,888 Per Share Data: Net Income - Basic As Reported $ .23 $ 1.21 $ 1.63 Pro Forma $ .16 $ 1.07 $ 1.54 Net Income - Diluted As Reported $ .23 $ 1.21 $ 1.55 Pro Forma $ .16 $ 1.06 $ 1.46 69 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands) NOTE N - FAIR VALUE OF FINANCIAL INSTRUMENTS The fair value of a financial instrument is the amount at which the asset or obligation could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the entire holdings of a particular financial instrument. Because no market value exists for a significant portion of the financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature, involve uncertainties and matters of judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Fair value estimates are based on financial instruments both on and off the balance sheet without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Additionally, tax consequences related to the realization of the unrealized gains and losses can have a potential effect on fair value estimates and have not been considered in many of the estimates. The following methods and assumptions were used to estimate the fair value of significant financial instruments: Financial Assets The carrying amounts of cash, short term investments, due from customers on acceptances, and Bank acceptances outstanding are considered to approximate fair value. Short term investments include federal funds sold, securities purchased under agreements to resell, and interest bearing deposits with Banks. The fair values of investment securities, including available-for-sale, are generally based on quoted market prices. The fair value of loans are estimated using a combination of techniques, including discounting estimated future cash flows and quoted market prices of similar instruments where available. Financial Liabilities The carrying amounts of deposit liabilities payable on demand, commercial paper, and other borrowed funds are considered to approximate fair value. For fixed maturity deposits, fair value is estimated by discounting estimated future cash flows using currently offered rates for deposits of similar remaining maturities. The fair value of long term debt is based on rates currently available to the Bank for debt with similar terms and remaining maturities. Off-Balance Sheet Financial Instruments The fair value of commitments to extend credit and standby letters of credit is estimated using the fees currently charged to enter into similar agreements. The fair value of these financial instruments is not material. 70 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands) NOTE N - FAIR VALUE OF FINANCIAL INSTRUMENTS - Continued The estimated fair value of financial instruments at December 31, 2000 and 1999 is summarized as follows: December 31, ------------------------------------------------------------ 2000 1999 ---------------------------- ---------------------------- Carrying Fair Carrying Fair Value Value Value Value ------------- ------------- ------------- ------------- Financial Assets: Cash and Due From Banks $ 30,370 $ 30,370 $ 34,119 $ 34,119 Federal Funds Sold 26,100 26,100 -- -- Interest-Bearing Deposits 111 111 100 100 Investment Securities 16,931 16,894 21,580 21,313 Federal Home Loan Bank Stock, at Cost 629 629 1,113 1,113 Loans Held for Sale 22,439 23,337 69,756 71,849 Loans, net 163,274 162,780 196,274 196,136 I/O Strips Receivable and Servicing Assets 11,340 11,340 15,659 15,659 Cash Surrender Value - Life Insurance 2,290 2,290 2,196 2,196 Financial Liabilities: Deposits 254,325 254,384 322,973 323,010 NOTE O - REGULATORY MATTERS 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 regulators that, if undertaken, could have a direct material effect on the Bank's 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 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). 71 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands) NOTE O - REGULATORY MATTERS - Continued As of December 31, 2000, the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as adequately-capitalized under the regulatory framework for prompt corrective action (there are no conditions or events since that notification that management believes have changed the Bank's category). To be categorized as well-capitalized, the Bank must maintain minimum ratios as set forth in the table below and be released from the administrative action described below. Required Capital -------------------------------------------- To Be Well- Capitalized For Capital Under Prompt Adequacy Corrective Actual Purposes Provisions --------------------- --------------------- --------------------- Amount Ratio Amount Ratio Amount Ratio ---------- -------- ---------- --------- ---------- -------- As of December 31, 2000: Total Capital (to Risk-Weighted Assets) $29,346 10.08% $ 23,281 8.00% $29,102 10.00% Tier 1 Capital (to Risk-Weighted Assets) $27,051 9.30% $ 11,641 4.00% $17,461 6.00% Tier 1 Capital (to Average Assets) $27,051 9.42% $ 11,484 4.00% $14,355 5.00% As of December 31, 1999: Total Capital (to Risk-Weighted Assets) $29,539 7.99% $ 29,542 8.00% $36,928 10.00% Tier 1 Capital (to Risk-Weighted Assets) $26,930 7.28% $ 14,771 4.00% $22,157 6.00% Tier 1 Capital (to Average Assets) $26,930 7.40% $ 14,550 4.00% $18,187 5.00% Effective July 10, 2000, the Bank stipulated to an administrative action with the FDIC that requires the Bank, among other items, to retain qualified management; have and maintain certain Tier 1 capital ratio of 8.00% as of December 31, 2000 and total risk based capital ratio of 9.50% as of December 31, 2000 and 11.00% as of December 31, 2001; eliminate from its books certain assets classified loss; revise policies concerning the Bank's asset securitization activities; obtain a model to more adequately value its retained interest related to securitized assets; and adopt and implement certain other policies relating to profitability, liquidity and funds management, sensitivity to interest rate risk; revise certain reports to the FDIC; not pay dividends; and correct all alleged violations of law. As of December 31, 2000 the Bank believes it is substantially in compliance with the administrative order. 72 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands, Except Per Share Data) NOTE P - MERGERS AND ACQUISITIONS On November 1, 2000 the Company signed an Agreement and Plan of Reorganization to be acquired by PBOC Holdings, Inc. Under the terms of the transaction, the holders of the Company Common Stock will receive $15.00 in cash for each share of Company Common Stock owned. The cash amount may be adjusted upward or downward under certain circumstances, which are set forth in the agreement. At the close of business on May 29, 1998, the Company consummated a merger with DNB Financial and its wholly-owned subsidiary, De Anza National Bank. This merger was accounted for by the pooling of interest method, whereby the Company's Financial Statements have been restated as if the two companies were historically one unit. A total of 956,641 common shares were issued to the shareholders of DNB Financial in connection with this merger. NOTE Q - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY ONLY BYL Bancorp operates BYL Bank Group. BYL Bancorp commenced operations during 1997. The earnings of the subsidiary are recognized on the equity method of accounting. Condensed financial statements of the parent company only are presented below: December 31, -------------------- 2000 1999 ------- ------- ASSETS: Cash $ 96 $ 134 Investment in Subsidiary 29,089 29,029 Other Assets -- 37 ------- ------- $29,185 $29,200 ======= ======= LIABILITIES: Long-Term Debt $ -- $ -- Other Liabilities -- -- ------- ------- TOTAL LIABILITIES -- -- SHAREHOLDER'S EQUITY 29,185 29,200 ------- ------- $29,185 $29,200 ======= ======= 73 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands) NOTE Q - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY ONLY - Continued CONDENSED STATEMENTS OF INCOME Year Ended December 31, ----------------------- 2000 1999 ----- ------ INCOME: Cash Dividends from Subsidiary $ -- $ 760 Interest Income -- -- ----- ------ TOTAL INCOME -- 760 EXPENSES: Merger Related Expenses -- -- Other 102 50 ----- ------ TOTAL EXPENSES 102 50 ----- ------ INCOME BEFORE EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARY (102) 710 EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARY 680 2,366 ----- ------ NET INCOME $ 578 $3,076 ===== ====== 74 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands) NOTE Q - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY ONLY - Continued CONDENSED STATEMENTS OF CASH FLOWS Year Ended December 31, ----------------------- 2000 1999 ----- ------- CASH FLOWS FROM OPERATING ACTIVITIES: Net Income $ 578 $ 3,076 Noncash Items Included in Net Income: Equity in Income of Subsidiary (680) (3,126) Change in Other Assets and Liabilities 37 (37) ----- ------- NET CASH USED IN OPERATING ACTIVITIES (65) (87) CASH FLOWS FROM INVESTING ACTIVITIES: Dividends Received from Subsidiary -- 760 ----- ------- NET CASH PROVIDED BY INVESTING ACTIVITIES -- 760 CASH FLOWS FROM FINANCING ACTIVITIES: Repayments of Long-Term Debt -- Options Exercised and Shares Retired 27 28 Dividends Paid (760) ----- ------- NET CASH USED (PROVIDED) BY FINANCING ACTIVITIES 27 (732) ----- ------- NET DECREASE IN CASH AND CASH EQUIVALENTS (38) (59) CASH AND CASH EQUIVALENTS, AT BEGINNING OF YEAR 134 193 ----- ------- CASH AND CASH EQUIVALENTS AT ENDING OF YEAR $ 96 $ 134 ===== ======= 75 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands) NOTE R - SEGMENT INFORMATION The Company has two primary reportable segments; its wholesale lending operations and its retail banking operations. The wholesale lending segment originates loans for resale to institutional investors. The Company's SBA Loan Division and its Mortgage Loan Division are included in this segment. The retail banking segment accepts deposits, originates loans and provides other banking services to the communities in which its seven branch offices are located. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates performance based on profit or loss from operations before allocation of the provision for loan losses, administrative costs, amortization of goodwill and income taxes. The retail segment charges the wholesale segments for use of excess funds based on the estimated cost of outside financing. The following tables summarize segment operations and asset allocations for the last three years: 2000 ------------------------------------------------------------ Wholesale Segments -------------------------- Retail Total Mortgage SBA Segment Company --------- --------- --------- --------- Condensed Income Statement Net Interest Income $ 2,281 $ 5,106 $ 10,299 $ 17,686 Noninterest Income 11,914 2,900 1,914 16,728 Operating Expense (12,777) (4,551) (8,111) (25,439) --------- --------- --------- --------- Operational Profit 1,418 3,455 4,102 8,975 Provision for Loan Losses (600) Administrative Costs (7,231) Goodwill Amortization (121) Income Taxes (445) --------- Net Income $ 578 ========= Total Assets at December 31, 2000 $ 24,025 $ 112,543 $ 149,830 $ 286,398 Loans Originated for Sale during 2000 $ 279,000 $ 89,000 Loans Sold during 2000 $ 315,000 $ 100,000 76 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands) NOTE R - SEGMENT INFORMATION - Continued 1999 ----------------------------------------------------------- Wholesale Segments -------------------------- Retail Total Mortgage SBA Segment Company --------- --------- --------- --------- Condensed Income Statement Net Interest Income $ 2,933 $ 3,398 $ 9,611 $ 15,942 Noninterest Income 16,582 5,641 1,826 24,049 Operating Expense (16,011) (4,031) (7,604) (27,646) --------- --------- --------- --------- Operational Profit 3,504 5,008 3,833 12,345 Provision for Loan Losses (694) Administrative Costs (6,124) Goodwill Amortization (121) Income Taxes (2,330) --------- Net Income $ 3,076 ========= Total Assets at December 31, 1999 $ 44,103 $ 139,488 $ 170,145 $ 353,736 Loans Originated for Sale during 1999 $ 567,000 $ 123,000 Loans Sold during 1999 $ 587,000 $ 108,000 1998 ----------------------------------------------------------- Wholesale Segments -------------------------- Retail Total Mortgage SBA Segment Company --------- --------- --------- --------- Condensed Income Statement Net Interest Income $ 2,772 $ 3,382 $ 9,456 $ 15,610 Noninterest Income 13,487 6,899 3,022 23,408 Operating Expense (11,225) (4,405) (10,433) (26,063) --------- --------- --------- --------- Operational Profit 5,034 5,876 2,045 12,955 Provision for Loan Losses (755) Administrative Costs (4,686) Goodwill Amortization (121) Income Taxes (3,277) --------- Net Income $ 4,116 ========= Total Assets at December 31, 1998 $ 37,365 $ 74,720 $ 205,928 $ 318,013 Loans Originated for Sale during 1998 $ 245,000 $ 89,000 Loans Sold during 1998 $ 222,000 $ 94,000 77 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999, and 1998 (Dollar Amounts in Thousands) NOTE S - SUBSEQUENT EVENTS During the first quarter of 2001 the Company was notified that certain loans purchased by third party investors and originated by outside mortgage brokers were fraudulent and the Company is required to repurchase these loans. The Company has estimated that the gross losses will be approximately $1,658 and the actual losses, net of reduced incentive payments, will be approximately $1,160. Accordingly, the Company recorded a $1,160 loss contingency as of December 31, 2000. 78 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS The information required by this Item is incorporated by reference from the Company's Proxy Statement for the Annual Meeting of Shareholders to be held in the third or fourth quarter, 2001. ITEM 11. EXECUTIVE COMPENSATION The information required by this Item is incorporated by reference from the Company's Proxy Statement for the Annual Meeting of Shareholders to be held in the third or fourth quarter, 2001. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item is incorporated by reference from of the Company's Proxy Statement for the Annual Meeting of Shareholders to be held in the third or fourth quarter, 2001. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item is incorporated by reference from of the Company's Proxy Statement for the Annual Meeting of Shareholders to be held in the third or fourth quarter, 2001. 79 PART IV ITEM 14. EXHIBITS AND REPORTS ON FORM 8-K a) Exhibits EXHIBIT NO. 2.1 Plan of Reorganization and Merger Agreement - Annex I of Proxy Statement/Prospectus incorporated by reference (A) 2.2 Agreement and Plan of Reorganization and ancillary documents, among BYL Bancorp, BYL Bank Group, PBOC Holdings, Inc. and People's Bank of California dated November 1, 2000 (J) 3.1 Articles of Incorporation of the Registrant (A) 3.2 Amendment to Articles of Incorporation of Registrant (A) 3.3 Bylaws of the Registrant (A) 4.1 Specimen Certificate evidencing shares of Registrant's Common Stock (A) 4.2 Stockholder Agreement Covering Issuance and Compulsory Repurchase of Organizing Shares of Registrant - Annex II of Proxy Statement/Prospectus incorporated by reference (A) 10.1 Form of Indemnification Agreement (A) 10.2 BYL Bancorp 1997 Stock Option Plan, as amended in 1998 (C) 10.3 Form of Proxy, Proxy Statement and Notice of Annual Shareholders' Meeting for 1999 Annual Meeting (E) 10.4 Employment Agreement - Mr. Robert Ucciferri (A) 10.5 Employment Agreement - Mr. Barry J. Moore (A) 10.6 Employment Agreement - Mr. Michael Mullarky (A) 10.7 Employment Agreement - Ms. Gloria Van Kampen (D) 10.8 Employment Agreement - Mr. Gary Strachn (G) 10.9 Salary Continuation Agreement - Mr. Robert Ucciferri (A) 10.10 Salary Continuation Agreement - Mr. Barry J. Moore (A) 10.11 Salary Continuation Agreement - Mr. Michael Mullarky (F) 10.12 Salary Continuation Agreement - Ms. Gloria Van Kampen (F) 10.13 Agreement and Plan of Reorganization with DNB Financial (B) 10.14 Agreements, as amended, for formation of CNL Financial Services, Inc. (H) 10.15 Agreement by and among BYL Bancorp, BYL Bank Group, JAM Partners, L.P., Sy Jacobs, Everest Partners Limited Partnership, Everest Managers, L.L.C., David M. W. Harvey and Nick Becker Dated September 7, 2000 (I) 10.16 Form of Proxy, Proxy Statement and Notice of Annual Shareholders' Meeting for 2000 Annual Meeting (K) 10.17 Form of Proxy, Proxy Statement and Notice of Special Meeting for March 21, 2001 Special Shareholder Meeting (L) 21.1 Subsidiary of BYL Bancorp (A) 23.1 Consent of Vavrinek, Trine, Day & Co., LLP 80 b) Reports on Form 8-K (a) Form 8-K filed on November 3, 2000 regarding Agreement and Plan of Reorganization and related documents, among BYL Bancorp, BYL Bank Group, PBOC Holdings, Inc. and People's Bank of California dated November 1, 2000. (b) Form 8-K filed on March 7, 2001 regarding extraordinary losses on mortgage loans sold. - --------------------------------- (A) Filed as an Exhibit to the Registrant's Registration Statement (File No. 333-34995) filed on September 5, 1997, which exhibit is incorporated herein by this reference. (B) Filed as an Exhibit to Form 8-K filed on January 29, 1998, which exhibit is incorporated herein by this reference. (C) Filed as an Exhibit to the Registration Statement on Form S-8 filed on May 15, 1998. (D) Filed as an Exhibit to the Annual Report on Form 10-K as of December 31, 1998. (E) Filed as an exhibit to the Annual Report on Form 10-K as of December 31, 1998, incorporating Schedule 14-A information pursuant to Section 14(a) of the Securities Exchange Act of 1934, filed on May 18, 1999. (F) Filed as an Exhibit to Form 10-Q filed on November 15, 1999, which Exhibit is incorporated herein by this reference. (G) Filed on an Exhibit to the Annual Report on Form 10-K as of December 31, 1999. (H) Filed as an Exhibit to Form 10-Q on August 17, 2000. (I) Filed as and Exhibit to Form 8-K filed on September 8, 2000. (J) Filed as Exhibits to Form 8-K filed on November 3, 2000. (K) Filed as an exhibit to the Annual Report on Form 10-K as of December 31, 1999, incorporating Schedule 14A information pursuant to Section 14(a) of the Securities Exchange Act of 1934, filed on August 22, 2000. (L) Final Schedule 14A information pursuant to Section 14(a) of the Securities Exchange Act of 1934, filed on January 23, 2001. 81 SIGNATURES In accordance with 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. BYL BANCORP By: /s/ Robert Ucciferri ------------------------------------- Robert Ucciferri President and Chief Executive Officer In accordance with the Securities Exchange Act, this report has been signed by the following persons on behalf of the registrant and in the capacities on the dates indicated: Signature Title Date - --------- ----- ---- /s/ Barry J. Moore Senior Executive Vice President March 30, 2001 - ------------------------------ and Chief Financial Officer Barry J. Moore /s/ Henry C. Cox II Director March 30, 2001 - ------------------------------ Henry C. Cox II /s/ Eddie R. Fischer Director March 30, 2001 - ------------------------------ Eddie R. Fischer /s/ Neil Hatcher Director March 30, 2001 - ------------------------------ Neil Hatcher /s/ Leonard O. Lindborg Director March 30, 2001 - ------------------------------ Leonard O. Lindborg /s/ H. Rhoads Martin, Jr. Chairman of the Board, Director March 30, 2001 - ------------------------------ H. Rhoads Martin, Jr. /s/ John F. Myers Director March 30, 2001 - ------------------------------ John F. Myers /s/ Brent W. Wahlberg Director March 30, 2001 - ------------------------------ Brent W. Wahlberg /s/ Sy Jacobs Director March 30, 2001 - ------------------------------ Sy Jacobs 82