EXHIBIT 13.1
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
The following discussion provides information about the results of operations,
financial condition, liquidity and capital resources of SC Bancorp and its
subsidiary, Southern California Bank (together, the "Company"). This
information should be read in conjunction with the audited consolidated
financial statements of the Company and the notes thereto. Reference is also
made to Item 1. of the Company's Annual Report on Form 10-K which provides
additional financial information regarding the Company. Copies of the Form 10-K
are available without charge on written request directed to Southern California
Bank, Finance Department, P.O. Box 588, La Mirada, CA 90637-0588.
RESULTS OF OPERATIONS
The Company reported net income for the years ended December 31, 1996, 1995 and
1994 of $4.5 million, $869,000 and $2.7 million, respectively. Current year net
income reflects the full realization of reductions in ongoing operating expenses
resulting from the restructuring program commenced in the third quarter of 1995
("1995 Restructuring"), and increased interest income attributable to a 23%
increase in average loan balances over the prior year. Net income for 1995
reflects approximately $1.7 million of restructuring charges and losses pretax,
and a $600,000 additional loan loss provision related to selected commercial
real estate loans. Net income for 1994 includes a $448,000 gain on the sale of
the Company's headquarters building, a $215,000 gain on the sale of loans, and a
$850,000 reversal of previously-recorded allowance for possible loan losses.
Net interest income increased to $23.2 million for the year ended December
31,1996 from $21.4 million for 1995 and $20.1 million for 1994. The increase is
primarily due to higher average loan balances. Average loan balances increased
to $321.8 million for 1996 from $261.6 million for 1995 and $203.5 million for
1994. The $58.1 million increase in average loan balances in 1995 over 1994 is
largely attributable to the purchase of $72.4 million in loans from Independence
One Bank of California, F.S.B. ("IOBC") on April 30, 1995.
The Company's net interest margin (net interest income expressed as a percentage
of average interest-earning assets) increased to 5.58% for the year ended
December 31, 1996 from 5.30% for 1995. The net interest margin for 1994 was
5.75%. The increase in the net interest margin for 1996 can be attributed to
the increase in loans as a percentage of total earning assets compared to lower
yielding investment securities. The Company's cost of funds for 1996 decreased
by approximately 12 basis points from 1995 due to the managed reduction in
higher-rate certificate of deposit balances raised prior to the IOBC
transaction. Other interest expense in 1995 included a $408,000 nonrecurring
adjustment recorded on the Company's deferred compensation plans. Despite the
reduction from the prior year, the Company's overall cost of funds for 1996
remains above 1994 levels due to increased competition for deposits in the
Company's market area. The decrease in net interest margin in 1995 compared to
1994 is largely due to the increased interest expense associated with the
certificate of deposit program that provided funding for the IOBC transaction,
and to the previously-mentioned deferred compensation interest adjustment.
Noninterest income was $5.2 million, $5.0 million and $6.7 million for the years
ended December 31, 1996, 1995 and 1994, respectively. A modest decrease in
service charge income in 1996 from the prior year was largely offset by an
increase in other deposit related fees. Noninterest income for 1995 includes a
$620,000 loss on the sale of available-for-sale investment securities and a
$407,000 benefit payment received on a corporate-owned life insurance policy.
Noninterest income decreased in 1995 compared to 1994 due to the nonrecurring
gains on asset sales discussed above, and to reductions in merchant bankcard fee
income. The Company's merchant bankcard activity decreased following the
departure of its largest bankcard customer during the third quarter of 1994.
Noninterest expense decreased to $21.2 million for the year ended December 31,
1996 from $22.3 million for the year ended December 31, 1995, excluding 1995
restructuring charges of $948,000, and $23.8 million for the year ended December
31, 1994. Occupancy expense for 1996 decreased by $815,000, net of
restructuring charges, from the prior year following the sale of two branches
and the consolidation of a third branch in conjunction with the 1995
Restructuring. FDIC insurance expense decreased by $445,000 in 1996 compared to
1995 due to reductions in the FDIC assessment rate. The reductions in 1996
noninterest expense were partially offset by a $388,000 increase in professional
and legal fees. The decrease in noninterest expense in 1995 compared to 1994
occurred primarily in occupancy, OREO, merchant bankcard and FDIC insurance
expense.
FINANCIAL CONDITION
Total assets increased to $476.0 million at December 31, 1996 from $461.8
million at December 31, 1995 and $398.6 million at December 31, 1994. Gross
loans increased 9.8% to $347.9 million from $316.8 million at December 31,1995.
Total deposits at December 31, 1996 were $415.3 million, a $8.5 million increase
from $406.8 million at year-end 1995, despite the sale or consolidation of three
branches in the first quarter of 1996. The increase in loan balances at
December 31, 1995 compared to December 31, 1994 is largely due to the purchase
of loans from IOBC, and to SBA loan purchases completed during the fourth
quarter of 1995. The increase in deposit balances for the same period reflects
the acquisition of deposits from IOBC and the deposits raised through a
promotional certificate of deposit program run during the first quarter of 1995.
The following table provides a summary comparison of assets and liabilities in
the Company's consolidated balance sheets and the percentage distribution of
these items for the dates indicated:
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December 31, 1996 1995 1994
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(DOLLARS IN THOUSANDS) Balance % Balance % Balance %
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ASSETS
Cash and cash equivalents $ 33,768 7.1% $ 29,088 6.3% $ 31,118 7.8%
Investment securities 76,590 16.1% 94,030 20.4% 131,881 33.1%
Loans, net 342,228 71.9% 310,576 67.3% 202,0725 0.6%
Premises and equipment, net 7,740 1.6% 9,734 2.1% 10,254 2.6%
Other real estate owned, net 536 0.1% 2,073 0.4% 5,837 1.5%
Accrued interest receivable 3,931 0.8% 4,297 0.9% 4,330 1.1%
Other assets 11,220 2.4% 11,981 2.6% 13,063 3.3%
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TOTAL ASSETS $ 476,013 100.0% $ 461,779 100.0% $ 398,555 100.0%
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LIABILITIES and SHAREHOLDERS' EQUITY
Deposits
Noninterest-bearing deposits $ 125,903 26.4% $ 130,378 28.2% $ 118,020 29.6%
Interest-bearing demand & savings deposits 144,190 30.3% 130,301 28.2% 147,552 37.0%
Time certificates of deposit 145,233 30.5% 146,132 31.7% 74,367 18.7%
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Total deposits 415,326 87.2% 406,811 88.1% 339,939 85.3%
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Borrowed funds and other
interest-bearing liabilities 8,096 1.7% 6,407 1.4% 13,77 13.5%
Accrued interest payable and other liabilities 2,672 0.6% 3,049 0.6% 3,001 0.7%
Total Shareholders' Equity 49,919 10.5% 45,512 9.9% 41,844 10.5%
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TOTAL LIABILITIES
and SHAREHOLDERS' EQUITY $ 476,013 100.0% $ 461,779 100.0% $ 398,555 100.0%
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Nonaccrual loans increased to $2.8 million, or .082%, of total loans at December
31, 1996 from $1.4 million, or 0.44%, of total loans at December 31, 1995. The
increase in nonaccrual loans in 1996 is primarily due to one real estate loan.
Nonaccrual loans were $1.6 million, or 0.78%, of total loans at December 31,
1994. Net loan charge-offs were $317,000, or 0.10%, of average outstanding
loans for 1996, a decrease from $1.7 million, or 0.67%, of average loans for
1995, and $4.6 million, or 2.28%, of average loans for 1994. The decrease in
net charge-offs reflects the continued improvement in the quality of the
Company's loan portfolio.
LIQUIDITY
Liquidity management involves the Company's ability to meet the cash flow
requirements of its customers who may be depositors wanting to withdraw funds or
borrowers needing assurance that sufficient funds will be available to meet
their credit needs. The
Company's liquid assets consist of cash and cash equivalents and investment
securities, excluding those pledged as collateral. The Company has
established policy guidelines to support the sound management of its
liquidity position based on regulatory guidance and industry practice. It is
the Company's policy to maintain a liquidity ratio (liquid assets to liquid
liabilities) of between 20% and 40%, and to limit gross loans to no more than
85% of deposits. At December 31,1996, the Company's ratios were within these
guidelines: the liquidity ratio was 21.64% and the loan to deposit ratio was
83.59%.
The Company maintains short-term sources of funds to meet periodic planned and
unplanned increases in loan demand and deposit withdrawals and maturities. The
initial source of liquidity is the excess funds sold daily to other banks in the
form of Federal funds. Besides cash and cash equivalents, the Company holds
investment securities classified as available-for-sale. Available-for-sale
securities can be sold in response to liquidity needs or used as collateral
under reverse repurchase agreements. While the Company currently has no plans
to liquidate securities in the portfolio, it has sold securities in previous
years. The likelihood that securities would be sold in the future and the
potential for losses to be realized remains uncertain. In the event that
securities held as available-for-sale were sold at a loss, any loss would be
reflected in the results of operations on an after-tax basis. However, there
would be no expected impact on the Company's financial condition, given that the
securities are carried at their estimated fair value, net of any unrealized
loss. The unrealized loss on available-for-sale securities increased to $1.5
million at December 31, 1996 from $1.3 million at December 31, 1995.
The Company's liquid assets were $89.3 million at December 31,1996 compared to
$101.2 million at December 31, 1995. Liquid assets have decreased due to the
use of proceeds received from the sale and maturity of investment securities to
fund loan growth.
Secondary sources of liquidity include reverse repurchase arrangements to borrow
cash for short to intermediate periods of time using the Company's available-
for-sale securities as collateral, Federal funds lines of credit that allow the
Company to temporarily borrow an aggregate of up to $30.0 million from three
commercial banks, and a $6.5 million line of credit with the Federal Home Loan
Bank ("FHLB") collateralized by mortgage loans. At December 31,1996, the
Company had unpledged securities with a fair value of approximately $53.6
million that could be used for reverse repurchases. Federal funds arrangements
with correspondent banks are subject to the terms of the individual arrangements
and may be terminated at the discretion of the correspondent bank. The largest
amount borrowed during 1996 through reverse repurchase arrangements, Federal
funds lines, and FHLB lines was $20.5 million, $8.8 million and $1.0 million,
respectively.
CAPITAL RESOURCES
The Company and its bank subsidiary are subject to risk-based capital
regulations adopted by the federal banking regulators in January 1990. These
guidelines are used to evaluate capital adequacy, and are based on an
institution's asset risk profile and off balance sheet exposures, such as unused
loan commitments and standby letters of credit. The regulations require that a
portion of total capital be core, or Tier 1, capital consisting of common
shareholders' equity and perpetual preferred stock, less goodwill and certain
other deductions, with the remaining, or Tier 2, capital consisting of other
elements, primarily subordinated debt, mandatory convertible debt, and
grandfathered senior debt, plus the allowance for loan losses, subject to
certain limitations. As of December 1992, the risk-based capital rules were
further supplemented by a leverage ratio, defined as Tier 1 capital divided by
quarterly average assets after certain adjustments. The minimum leverage ratio
is 3 percent for banking organizations that do not anticipate significant growth
and have well-diversified risk (including no undue interest rate exposure),
excellent asset quality, high liquidity, and good earnings. Other banking
organizations not in this category are expected to have ratios of at least 4 to
5 percent, depending on their particular condition and growth plans. Higher
capital ratios can be mandated by the regulators if warranted by the particular
circumstances or risk profile of a banking organization. In the current
regulatory environment, banking companies must stay well-capitalized, as defined
in the banking regulations, in order to receive favorable regulatory treatment
on acquisitions and favorable risk-based deposit insurance assessments.
Management seeks to maintain capital ratios in excess of the regulatory
minimums. As of December 31,1996, the capital ratios of the Company and the
Bank exceeded the well-capitalized thresholds prescribed in the rules.
The following table sets forth the risk-based and leverage capital ratios for
the Company and the Bank at December 31, 1996:
Company Bank
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(DOLLARS IN THOUSANDS) Amount % Amount %
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Leverage ratio $ 47,166 9.97% $ 44,970 9.51%
Regulatory minimum 18,917 4.00% 18,908 4.00%
Excess 28,249 5.97% 26,062 5.51%
Risk-based ratios
Tier 1 capital $ 47,166 (a) 11.20% (b) $ 44,970 (a) 10.68% (c)
Tier 1 minimum 16,850 4.00% (d) 16,838 4.00% (d)
Excess 30,316 7.20% 28,132 6.68%
Total capital $ 52,113 (e) 12.37% (b) $ 49,917 (e) 11.86% (c)
Total capital minimum 33,700 8.00% 33,676 8.00%
Excess 18,413 4.37% 16,241 3.86%
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(a) Includes common shareholders' equity (excluding unrealized losses on
available-for-sale securities) less goodwill. The Tier 1 capital ratio is
adjusted for the disallowed portion of deferred tax assets, if applicable.
(b) Risk-weighted assets of $421.2 million were used to compute these
percentages.
(c) Risk-weighted assets of $420.9 million were used to compute these
percentages.
(d) Insured institutions, such as the Bank, must maintain a leverage ratio of
4% or 5%, a Tier 1 capital ratio of at least 4% or 6%, and a Total capital
ratio of at least 8% or 10% in order to be categorized adequately
capitalized or well-capitalized, respectively.
(e) Tier 1 capital plus the allowance for loan losses, limited to 1.25% of
total risk-weighted assets.