As filed with the Securities and Exchange Commission on September 5, 1997. Registration No. _________ - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------------------- FORM S-4 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 --------------------- BYL BANCORP (Exact name of registrant as specified in charter) California 6712 33-0755794 (State or other jurisdiction of (Primary Standard Industrial (IRS Employer incorporation or organization) Classification Code Number) Identification No.) Bank of Yorba Linda 18206 Imperial Highway Yorba Linda, California 92686 (714) 996-1800 (Address, including zip code, and telephone number, including area code, or registrant's principal executive offices) ---------------------------------- Mr. Robert Ucciferri President and Chief Executive Officer Bank of Yorba Linda 18206 Imperial Highway Yorba Linda, California 92686 (714) 996-1800 (Name, address, including zip code, and telephone number, including area code, of agent for service) ---------------------------------- With a copy to: Loren P. Hansen, Esq. Knecht & Hansen 1301 Dove Street, Suite 900 Newport Beach, California 92660 (714) 851-8070 ---------------------------------- Approximate date of commencement of proposed sale to public: As soon as practicable following the effective date of this Registration Statement. If the securities being registered on this form are being offered in connection with the formation of a holding company and there is compliance with General Instruction G, check the following box. /X/ CALCULATION OF REGISTRATION FEE PROPOSED PROPOSED MAXIMUM MAXIMUM TITLE OF EACH CLASS OF SECURITIES TO OFFERING PRICE AGGREGATE AMOUNT OF BE REGISTERED AMOUNT BEING REGISTERED PER SHARE (1) OFFERING PRICE(1) REGISTRATION FEE(1) - ------------------------------------ ----------------------- -------------- ----------------- ------------------- Common Stock, no par value 1,535,064 shares(2) $14.625 $22,450,311 $6,803.12 - -------------------- (1) The proposed maximum offering price and proposed maximum aggregate offering price reflect the market price and market value of the common stock of the Bank to be converted and exchanged in connection with the reorganization described in the Proxy Statement/Prospectus, calculated pursuant to Section 6(b) of the Securities Act of 1933, as amended, and Rule 457(f)(2) under the Securities Act of 1933, as amended, based on the average bid and asked price of Bank Common Stock on August 26, 1997. (2) Based on approximate number of shares to be issued in respect to the same number of outstanding shares of common stock of Bank of Yorba Linda (the "Bank"). The proposed maximum offering price and proposed maximum aggregate offering price are estimated solely in order to determine the registration fee. BYL BANCORP Cross Reference Sheet Pursuant to Rule 501(b) of Regulation S-K INFORMATION STATEMENT/PROSPECTUS ITEM AND CAPTION OF FORM S-4 CAPTION OF LOCATION ---------------------------- -------------------------------- A. INFORMATION ABOUT THE TRANSACTION 1. Forepart of Registration Statement and Outside Front Cover Page of Prospectus . . . . . . . . . . . Facing Page of Registration Statement; Cross Reference Sheet; Outside Front Cover Page of Prospectus and Proxy Statement 2. Inside Front and Outside Back Cover Page of Prospectus . . . . . . . . . . . . . . . . . . . . . Inside Front Cover Page; Available Information; Table of Contents 3. Risk Factors, Ratio of Earnings to Fixed Charges and Other Information. . . . . . . . . . . . . . . . SUMMARY OF PROXY STATEMENT/PROSPECTUS; SOLICITATION OF PROXIES; INFORMATION REGARDING THE BUSINESS AND PROPERTIES OF THE HOLDING COMPANY; BANK HOLDING COMPANY REORGANIZATION; COMPARISON OF THE RIGHTS OF HOLDERS OF HOLDING COMPANY COMMON STOCK AND BANK COMMON STOCK 4. Terms of the Transaction . . . . . . . . . . . . . . SUMMARY OF PROXY STATEMENT/PROSPECTUS; COMPARISON OF THE RIGHTS OF HOLDERS OF HOLDING COMPANY COMMON STOCK AND BANK COMMON STOCK; SOLICITATION OF PROXIES 5. Pro Forma Financial Information. . . . . . . . . . . Not Applicable 6. Material Contacts with the Company Being Acquired. . BANK HOLDING COMPANY REORGANIZATION 7. Additional Information Required for Reoffering by Persons and Parties Deemed to be Underwriters. . . . Not Applicable 8. Interests of Named Experts and Counsel . . . . . . . EXPERTS; LEGAL MATTERS 9. Disclosure of Commission Position on Indem-nification for Securities Act Liabilities. . . COMMISSION'S POSITION ON INDEMNIFICATION FOR SECURITIES ACT LIABILITIES B. INFORMATION ABOUT THE REGISTRANT 10. Information with Respect to S-3 Registrant . . . . . Not Applicable 11. Incorporation of Certain Information by Reference. . Not Applicable 12. Information with Respect to S-2 or S-3 Registrant. . Not Applicable 13. Incorporation of Certain Information by Reference. . Not Applicable 14. Information with Respect to Registrants Other Than S-3 or S-2 Registrants . . . . . . . . . . . . . . . INFORMATION CONCERNING THE BUSINESS AND PROPERTIES OF THE HOLDING COMPANY; SUPERVISION AND REGULATION OF THE HOLDING COMPANY AND THE BANK - Holding Company, Effect of Governmental Policies and Recent Legislation; RESTRICTIONS ON TRANSFERS OF FUNDS TO THE HOLDING COMPANY BY THE BANK; MARKET PRICE OF AND DIVIDENDS ON HOLDING COMPANY COMMON STOCK AND BANK COMMON STOCK C. INFORMATION ABOUT THE COMPANY BEING ACQUIRED 15. Information with Respect to S-3 Companies. . . . . . Not Applicable 16. Information with Respect to S-2 or S-3 Companies . . Not Applicable 17. Information with Respect to Companies Other Than S-2 or S-3 Companies . . . . . . . . . . . . . . . . MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF THE BANK; INFORMATION CONCERNING THE BUSINESS AND PROPERTIES OF THE BANK; SUPERVISION AND REGULATION OF THE HOLDING COMPANY AND THE BANK - Bank; Effect of Governmental Policies and Recent Legislation; RESTRICTIONS ON TRANSFERS OF FUNDS TO THE HOLDING COMPANY BY THE BANK; MARKET PRICE OF AND DIVIDENDS ON HOLDING COMPANY AND BANK COMMON STOCK; FINANCIAL STATEMENTS OF BANK 18. Information if Proxies, Consents or Authorizations are to be Solicited. . . . . . . . . . . . . . . . . Proxy Statement/Prospectus Cover Page; SUMMARY OF PROXY STATEMENT/PROSPECTUS; BANK HOLDING COMPANY REORGANIZATION - Organizational Transactions; SOLICITATION OF PROXIES - Record Date and Persons Entitled to Give Proxy; Proxy and Revocability of Proxies; Security Ownership of Certain Beneficial Owners and Management; BANK HOLDING COMPANY REORGANIZATION - Terms of the Merger Agreement; Dissenting Shareholders' Rights; INFORMATION CONCERNING THE BUSINESS AND PROPERTIES OF THE HOLDING COMPANY - Management; Employees 19. Information if Proxies, Consents or Authorizations are not to be Solicited or in an Exchange Offering. . Not Applicable 20. Indemnification of Directors and Officers. . . . . . Part II 21. Exhibits and Financial Statement Schedules . . . . . Part II 22. Undertakings . . . . . . . . . . . . . . . . . . . . Part II PROXY STATEMENT FOR APPROVAL OF PLAN OF REORGANIZATION AND MERGER AGREEMENT IN CONNECTION WITH THE FORMATION OF HOLDING COMPANY AND APPROVAL OF BYL BANCORP 1997 STOCK OPTION PLAN _____________, 1997 Dear Shareholder: You are cordially invited to attend a Special Meeting of Shareholders (the "Meeting") of Bank of Yorba Linda (the "Bank") to be held on _________, 1997 at __:p.m. at the Bank, 18206 Imperial Highway, Yorba Linda, California. Your Board of Directors looks forward to greeting personally those shareholders who attend. The enclosed Proxy Statement/Prospectus is provided by the Board of Directors of Bank of Yorba Linda in connection with the solicitation of votes of our shareholders for approval of the formation of a bank holding company for Bank of Yorba Linda. Upon approval of the Plan of Reorganization and Merger Agreement, Bank of Yorba Linda will become a subsidiary of the newly formed holding company, BYL Bancorp. Votes for approval of this action are being solicited from all shareholders of the Bank. Banking has changed dramatically over the past 17 years since the Bank was first formed. In order to take full advantage of the changes in the banking environment the Bank must continue to evolve and grow. We believe establishing a holding company will give us a broader range of options with respect to access to additional capital, possibilities for expansion of the branch system and expanded abilities in the financial services area, as well as other business activities. For these reasons, the Board of Directors has unanimously approved the proposal to form a bank holding company and recommends that you vote in favor of this proposal. The enclosed Proxy Statement/Prospectus is also provided by the Board of Directors in connection with the solicitation of votes of our shareholders as prospective shareholders of the holding company, for approval of the BYL Bancorp 1997 Stock Option Plan (the "1997 Plan"). Votes for approval of this action are also being solicited from all shareholders of the Bank as prospective shareholders of the holding company. We are asking all of the Bank's shareholders to consider and vote upon approval of the Plan of Reorganization and Merger Agreement ("Merger Agreement") entered into as of May 2, 1997, by the Bank of Yorba Linda, BYL Bancorp and BYL Merger Corporation, a California corporation. This Merger Agreement provides for the merger of BYL Merger Corporation with and into the Bank, as a result of which the bank surviving the merger, Bank of Yorba Linda, will be the wholly-owned subsidiary of BYL Bancorp. We are also asking that all of the Bank's shareholders, as prospective ________________, 1997 Page 2 shareholders of the holding company, to consider and vote upon approval of the 1997 Plan. BYL Bancorp is a newly-formed California corporation, organized at the direction of the Bank's Board of Directors for the purpose of becoming a bank holding company. In accordance with the Merger Agreement, as more fully described in the attached Proxy Statement/Prospectus, BYL Bancorp will acquire all of the outstanding shares of the Bank by issuing, subject to certain limitations, common stock in BYL Bancorp to each of the Bank's shareholders, in exchange for all of the outstanding shares of Bank of Yorba Linda's common stock. After this exchange you will have the same number of shares in BYL Bancorp as you have in the Bank. It is important to note that your stock in the Bancorp will have a value equal to the value of your stock in the Bank and therefore the exchange will take place without any recognition of gain or loss for federal income tax purposes. It is equally important to inform you that no changes in the Bank's directors, officers, or other personnel are contemplated as a result of the formation of the bank holding company. Additionally, after formation of the bank holding company, the Bank of Yorba Linda will continue its present business and operations under the name of Bank of Yorba Linda. The new 1997 Plan is intended to replace the Bank's Stock Option Plans. The 1997 Plan would reserve 460,519 shares or 30% of the unissued Common Stock of BYL Bancorp. The 1997 Plan would allow for the granting of options to directors, officers employees and consultants by attracting and retaining competent managerial personnel, and added incentive for high levels of performance and for unusual efforts to increase the earnings of BYL Bancorp and Bank of Yorba Linda. The terms and conditions of the 1997 Plan are described in the Proxy Statement/Prospectus. Section 902 and 903 of the California Corporations Code, and the Bank's Articles of Incorporation, require the approval of the Plan of Reorganization and Merger Agreement by a majority of the outstanding shares of common stock of the Bank. You are urged to read the attached documents carefully as they contain the terms of the merger, facts concerning the business, results of operations, financial condition and properties of both BYL Bancorp and Bank of Yorba Linda. It is very important that your shares be represented because the affirmative vote of a majority of the outstanding shares of Bank of Yorba Linda is required to approve the Merger Agreement and the 1997 Plan. It is therefore essential that all shareholders vote and you are urged to fill in, date, sign and mail the enclosed Proxy in the enclosed self-addressed postage prepaid envelope. ________________, 1997 Page 3 It is expected that the enclosed Proxy Statement/Prospectus and accompanying Proxy will be mailed or delivered to shareholders of the Bank on or after ___________, 1997. We hope that the Proxy Statement/Prospectus will answer any questions you may have concerning the proposed formation of the bank holding company. If you have any questions, concerning this Proxy Statement/Prospectus or the accompanying proxy, or if you need any help voting your shares, please telephone Mr. Barry J. Moore of Bank of Yorba Linda at (714) 996-1800. You interest and participation are appreciated. Sincerely, Robert Ucciferri H. Rhoads Martin President and Chief Executive Officer Chairman of the Board BANK OF YORBA LINDA 18206 Imperial Highway Yorba Linda, California 92686 NOTICE OF SPECIAL MEETING OF SHAREHOLDERS TO BE HELD ON _____________, 1997 To the Shareholders of Bank of Yorba Linda: NOTICE IS HEREBY GIVEN that, pursuant to its Bylaws and the call of the Board of Directors, the Special Meeting of Shareholders (the "Meeting") of Bank of Yorba Linda (the "Bank") will be held at 18206 Imperial Highway, Yorba Linda, California 92686 on ____________, 1997 at 5:30 p.m., California time, for the following purposes: 1. PLAN OF REORGANIZATION AND AGREEMENT OF MERGER. To consider and vote upon a proposal (the "Reorganization Proposal") to approve the Plan of Reorganization and Agreement of Merger (the "Merger Agreement"), entered into as of May 2, 1997 by and among the Bank, BYL Bancorp (the "Holding Company") and BYL Merger Corporation (the "Merger Corp."), providing for the acquisition of the Bank by the Holding Company by means of a merger (the "Merger") of the Merger Corp. with and into the Bank, as a result of which the Holding Company will issue common stock, no par value of the Holding Company ("Holding Company Common Stock"), to each of the Bank shareholders, in exchange for all of the outstanding shares of common stock, no par value of the Bank (the "Bank Common Stock"). These transactions are more fully described in the enclosed Proxy Statement/Prospectus and in the Merger Agreement attached as Appendix I to the Proxy Statement/Prospectus. 2. APPROVAL OF BYL BANCORP 1997 STOCK OPTION PLAN. To approve, as prospective shareholders of the Holding Company, the BYL Bancorp 1997 Stock Option Plan that would reserve 460,519 shares of the unissued Common Stock of the Holding Company as described in the Proxy Statement dated _________, 1997, subject to any necessary changes required by any regulatory agency. 3. ADJOURNMENT OF MEETING. To authorize the Board of Directors to adjourn the Meting to permit the further solicitation of proxies, if necessary. 4. OTHER BUSINESS. To transact such other business as may properly come before the meeting and any adjournments thereof. -1- The Board of Directors has fixed ____________, 1997 as the record date for the determination of shareholders entitled to notice of, and vote at, the Meeting. IT IS VERY IMPORTANT THAT EVERY SHAREHOLDER VOTE. YOU ARE URGED TO SIGN, DATE AND RETURN THE ENCLOSED PROXY IN THE ENCLOSED POSTAGE PAID ENVELOPE AS PROMPTLY AS POSSIBLE, WHETHER OR NOT YOU PLAN TO ATTEND THE MEETING IN PERSON. ANY SHAREHOLDER GIVING A PROXY MAY REVOKE IT PRIOR TO THE TIME IT IS VOTED BY NOTIFYING THE CORPORATE SECRETARY IN WRITING TO THAT EFFECT, BY FILING A DULY EXECUTED PROXY BEARING A LATER DATE, OR BY VOTING IN PERSON AT THE MEETING. By Order of the Board of Directors John F. Myers, Secretary Yorba Linda, California Dated: _____________, 1997 In order to facilitate the providing of adequate accommodations, please indicate on the Proxy whether or not you plan to attend the Meeting. -2- SOLICITATION OF PROXIES TO APPROVE THE PLAN OF REORGANIZATION AND MERGER AGREEMENT PROVIDING FOR THE FORMATION OF A BANK HOLDING COMPANY, AND TO APPROVE THE 1997 STOCK OPTION PLAN OF THE PROPOSED BANK HOLDING COMPANY PROSPECTUS OF BYL BANCORP PROXY STATEMENT OF BANK OF YORBA LINDA 1,535,064 SHARES OF BYL BANCORP COMMON STOCK This Proxy Statement/Prospectus is being furnished to the shareholders of BANK OF YORBA LINDA (the "Bank") in connection with the solicitation of Proxies by the Board of Directors of the Bank for the approval of the Plan of Reorganization and Merger Agreement (the "Merger Agreement") in connection with the acquisition of the Bank by BYL BANCORP (the "Holding Company") in which the Bank shall become a wholly-owned subsidiary of the Holding Company. In addition, this Proxy Statement/Prospectus is being furnished to Bank Shareholders to consider and vote upon, as prospective shareholders of the Holding Company, the Holding Company's 1997 Stock Option Plan (the "1997 Plan") that would reserve 460,519 shares of the unissued Common Stock of the Holding Company as described in this Proxy Statement/Prospectus that was approved by the Holding Company's Board of Directors, subject to the approval of the California Commissioner of Corporations and the holders of a majority of the issued and outstanding shares of the Bank as prospective shareholders of the Holding Company. This Registration Statement is not registering any shares reserved for issuance under the 1997 Plan. The Holding Company, a California corporation, has filed this Prospectus of BYL BANCORP and Proxy Statement of BANK OF YORBA LINDA (collectively the "Proxy Statement/Prospectus") with the Securities and Exchange Commission (the "Commission") as part of a Registration Statement on Form S-4 (the "Registration Statement"), pursuant to the Securities Act of 1933, as amended (the "Securities Act"), for the purpose of registering thereunder up to 1,535,064 shares of the Holding Company's common stock, no par value ("Holding Company Common Stock"), in connection with the acquisition of BANK OF YORBA LINDA, a California state-chartered banking corporation (the "Bank"), by the Holding Company through a merger (the "Merger") of BYL MERGER CORPORATION (the "Merger Corp."), a wholly-owned subsidiary of the Holding Company, with and into the Bank, as a result of which the Bank surviving the Merger, BANK OF YORBA LINDA (the "Surviving Bank"), shall become the wholly-owned subsidiary of the Holding Company, and the Bank's shareholders will receive for their Bank Common Stock, no par value ("Bank Common Stock"), an equal number of shares of Holding Company Common Stock (the "Reorganization"). This Proxy Statement/Prospectus also serves as the Prospectus of the Holding Company under the Securities Act with respect to the issuance of up to 1,535,064 shares of Holding Company Common Stock pursuant to the Merger Agreement more fully described herein whereby the Surviving Bank will become a wholly-owned subsidiary of the Holding Company. 1 As a result of the Merger, the Holding Company will (subject to certain limitations described elsewhere in this Proxy Statement/Prospectus and in the Merger Agreement), issue Holding Company Common Stock to each of the Bank Shareholders in exchange for all of the outstanding shares of Bank Common Stock. See "BANK HOLDING COMPANY REORGANIZATION," and the text of the Merger Agreement which is attached hereto as Annex I to this Proxy Statement/Pro- spectus and is hereby incorporated by reference and made a part hereof. The consummation of the proposed Reorganization is subject to the receipt of the requisite approvals of applicable regulatory agencies and the shareholders of both the Holding Company and the Bank as well as the fulfillment of certain other conditions, as more fully described in this Proxy Statement/Prospectus. See "BANK HOLDING COMPANY REORGANIZATION - Terms of the Merger Agreement; Conditions to the Merger, Termination of Merger Agreement; - Regulatory Approvals," herein. The 1997 Plan is subject to the receipt of the requisite approvals of applicable regulatory agencies and the shareholders of the Bank as prospective shareholders of the Holding Company. See "APPROVAL OF THE BYL BANCORP 1997 STOCK OPTION PLAN." This Proxy Statement/Prospectus is being first mailed or delivered to shareholders of the Bank on or about ________, 1997. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROXY STATEMENT/PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. THE DATE OF THIS PROXY STATEMENT/PROSPECTUS IS ________, 1997 2 AVAILABLE INFORMATION No person has been authorized to give any information or to make any representation not contained in or incorporated by reference in this Proxy Statement/Prospectus, and, if given or made, such information or representation not contained herein must not be relied upon as having been authorized by the Holding Company or the Bank. This Proxy Statement/Prospectus does not constitute an offer to sell, or the solicitation of an offer to purchase, any of the securities offered by this Proxy Statement/Prospectus, or the solicitation of Proxies, in any jurisdiction to or from any person to or from whom it is unlawful to make such offer or solicitation of an offer, or consent solicitation in such jurisdiction. Neither the delivery of this Proxy Statement/Prospectus nor the issuance or sale of any securities hereunder shall under any circumstances create any implication that there has been no change in the affairs of the Holding Company or the Bank since the date hereof or that the information herein is correct as of any time subsequent to the date hereof. The Holding Company is a newly formed corporation organized at the direction of the Bank's Board of Directors for the purpose of acquiring voting control of the Bank and thereby becoming a bank holding company. For further information with respect to the Reorganization, reference is made to the Merger Agreement which is incorporated by reference herewith and is attached as Annex I. As a newly formed corporation, the Holding Company has not been subject to the requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act") and there is currently no public market for its common stock. However upon consummation the Reorganization, the Holding Company will become subject to the information and reporting requirements pursuant to Section 15(d) of the Exchange Act and filings thereby required to be made with the Commission will be available for inspection and copying at the offices of the Commission set forth below. The Holding Company will become subject to the information, reporting and proxy solicitation requirements of Section 13(a) of the Exchange Act pursuant to Section 12(g) of the Exchange Act, and the Holding Company will file a registration statement under the Exchange Act prior to the effective date of this Registration Statement. The Bank is subject to the information, reporting and proxy solicitation requirements of the Exchange Act, and in accordance therewith files reports and other information with the Federal Deposit Insurance Corporation (the "FDIC"). Such reports and other information can be inspected and copied at the public reference facilities for the Registrations and Disclosure Division maintained by the FDIC at 550 17th Street, Room F-643, Washington, D.C. 20429, telephone number (202) 393-8400, and by contacting Mr. Barry J. Moore, Senior Executive Vice President of the Bank, at BANK OF YORBA LINDA, 18206 Imperial Highway, Yorba Linda, California 92886, telephone number (714) 996-1800. This Proxy Statement/Prospectus does not contain all of the information set forth in the Registration Statement. For further information with respect to the Holding Company and the securities offered hereby, reference is made to the Registration Statement, including the exhibits filed therewith. Copies of the Registration Statement, including exhibits, may be obtained from the Commission upon payment of a prescribed fee, or may be examined without charge at the public reference facilities maintained by the Commission at 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549, and at the following regional offices of the Commission: 75 Park Place, Room 1228, New York, New York 10007 and Room 3190, Kluczynski, Federal Building, 230 South, Dearborn Street, Chicago, Illinois 60604. 3 The SEC also maintains a Web Site that contains reports, proxy and information statements and other information regarding registrants that file electronically with the Commission at HTTP://www.sec.gov. 4 TABLE OF CONTENTS PAGE ---- AVAILABLE INFORMATION..........................................................3 SUMMARY OF PROXY STATEMENT/PROSPECTUS..........................................9 Bank Holding Company Reorganization.......................................9 Date, Time and Place of Meeting......................................9 Record Date..........................................................9 Parties to the Merger Agreement......................................9 Rights of Dissenting Shareholders...................................10 Vote Required.......................................................10 The Reorganization..................................................10 Reasons for the Reorganization......................................11 Restrictions on Acquisition of the Holding Company..................11 Interests of Certain Persons in the Merger..........................12 Conditions to the Reorganization and Regulatory Approvals...........12 Certain Federal Income Tax Consequences.............................13 Proxies.............................................................13 Recommendations.....................................................14 BYL Bancorp 1997 Stock Option Plan.......................................14 Summary of the 1997 Plan............................................14 Vote Required.......................................................14 SELECTED FINANCIAL DATA.......................................................15 SPECIAL MEETING OF SHAREHOLDERS...............................................17 Introduction.............................................................17 Voting of Proxies and Revocability of Proxies............................17 Record Date and Persons Entitled to Give Proxies.........................17 Cost of Solicitations of Proxies.........................................18 Security Ownership of Certain Beneficial Owners and Management...........18 BANK HOLDING COMPANY REORGANIZATION...........................................21 General..................................................................21 Reasons for Reorganization...............................................21 Organizational Transactions..............................................22 Terms of the Merger Agreement............................................23 CONVERSION..........................................................23 EFFECTIVE TIME OF THE MERGER........................................23 INTERESTS OF CERTAIN PERSONS IN THE MERGER..........................24 EMPLOYEE BENEFITS...................................................24 CONDITIONS TO THE MERGER............................................24 TERMINATION OF MERGER AGREEMENT.....................................25 Exchange of Share Certificates...........................................25 Costs of Reorganization..................................................25 Regulatory Approvals.....................................................26 Dissenting Shareholders' Rights..........................................26 Accounting Treatment.....................................................26 5 Certain Federal Income Tax Consequences..................................26 Restrictions on Affiliates...............................................28 Recommendations..........................................................28 Capitalization...........................................................28 COMPARISON OF THE RIGHTS OF HOLDERS OF HOLDING COMPANY COMMON STOCK AND BANK COMMON STOCK............................................29 Bank Common Stock........................................................29 Holding Company Common Stock.............................................30 Comparison of Bank Common Stock and Holding Company Common Stock.........32 ASSESSABILITY.......................................................32 Classification of Board of Directors.....................................33 Voting Rights............................................................33 Number of Directors......................................................33 DIVIDEND RESTRICTIONS...............................................33 DISSENTERS' RIGHTS..................................................34 RESTRICTIONS ON ACQUISITION OF THE HOLDING COMPANY............................34 California and Federal Banking Law.......................................34 Anti-Takeover Provisions in Holding Company's Articles of Incorporation..34 BOARD OF DIRECTORS..................................................35 CUMULATIVE VOTING AND SPECIAL MEETINGS..............................35 AUTHORIZED SHARES...................................................35 STOCKHOLDER VOTE REQUIRED TO APPROVE BUSINESS COMBINATION WITH PRINCIPAL STOCKHOLDERS............................................36 AMENDMENT OF ARTICLES OF INCORPORATION AND BYLAWS...................36 STOCKHOLDER NOMINATIONS AND PROPOSALS...............................36 PURPOSE AND TAKEOVER DEFENSIVE EFFECTS OF THE HOLDING COMPANY'S ARTICLES OF INCORPORATION.........................................36 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF THE BANK.........................................38 Management's Discussion..................................................38 Line of Business Results.................................................38 Financial Condition......................................................39 Results of Operations....................................................39 Distribution of Assets, Liabilities, and Shareholders' Equity............39 Net Interest Income......................................................42 Provision for Loan Losses................................................43 Non-Interest Income......................................................43 Non-Interest Expense.....................................................43 Income Taxes.............................................................44 Investment Activity......................................................44 Loans Held for Sale......................................................45 Loan Portfolio...........................................................45 Nonperforming Assets.....................................................46 Allowance for Loan Losses................................................47 Deposits.................................................................48 Liquidity and Liability Management.......................................49 Capital Resources........................................................50 6 Effects of Inflation.....................................................50 Impact of New Accounting Pronouncements..................................51 INFORMATION CONCERNING THE BUSINESS AND PROPERTIES OF THE HOLDING COMPANY.....52 Organization.............................................................52 Business.................................................................52 Management...............................................................52 Employees................................................................53 Properties...............................................................53 Legal Proceedings........................................................53 INFORMATION CONCERNING THE BUSINESS AND PROPERTIES OF THE BANK................53 General..................................................................53 Market Area..............................................................54 Operating Strategy.......................................................54 Acquisition..............................................................54 Secondary Stock Offering.................................................55 Lending Activities.......................................................55 Monetary Policy..........................................................55 Competition..............................................................56 Employees................................................................57 Premises.................................................................57 Legal Proceedings........................................................57 SUPERVISION AND REGULATION OF THE HOLDING COMPANY AND THE BANK................57 The Holding Company......................................................57 The Bank.................................................................59 Effect of Governmental Policies and Recent Legislation...................60 STANDARDS FOR SAFETY AND SOUNDNESS..................................61 PROMPT CORRECTIVE REGULATORY ACTION.................................61 OTHER ITEMS.........................................................64 CAPITAL ADEQUACY GUIDELINES.........................................65 SAFETY AND SOUNDNESS STANDARDS......................................66 PREMIUMS FOR DEPOSIT INSURANCE......................................66 INTERSTATE BANKING AND BRANCHING....................................67 COMMUNITY REINVESTMENT ACT AND FAIR LENDING DEVELOPMENTS............68 CHANGES IN ACCOUNTING PRINCIPLES....................................69 HAZARDOUS WASTE CLEAN-UP COSTS......................................72 OTHER REGULATIONS AND POLICIES......................................72 RESTRICTIONS ON TRANSFERS OF FUNDS TO THE HOLDING COMPANY BY THE BANK.........72 MARKET PRICE OF AND DIVIDENDS ON HOLDING COMPANY COMMON STOCK AND BANK COMMON STOCK.........................................................73 Market Information.......................................................73 Shareholders.............................................................75 Dividends................................................................75 DIRECTORS AND EXECUTIVE OFFICERS OF THE HOLDING COMPANY AND THE BANK..........75 The Board of Directors and Committees....................................77 7 Executive Officers.......................................................77 Director Compensation....................................................78 Executive Compensation...................................................78 Employment Agreements....................................................81 Salary Continuation Agreements...........................................81 Bank Bonus Pool..........................................................82 401(k) Plan..............................................................82 The Bank's 1990 Stock Option Plan........................................83 The Bank's 1997 Stock Option Plan........................................83 SUMMARY OF PLAN.....................................................83 AGGREGATED OPTIONS EXERCISED IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES.............................................................85 Certain Transactions.....................................................86 APPROVAL OF BYL BANCORP 1997 STOCK OPTION PLAN................................86 Introduction.............................................................86 Summary of Plan..........................................................87 Comparison to the Bank of Yorba Linda 1997 Stock Option Plan.............89 Federal Income Tax Consequences..........................................89 COMMISSION'S POSITION ON INDEMNIFICATION FOR SECURITIES ACT LIABILITIES.......90 EXPERTS.......................................................................90 LEGAL MATTERS.................................................................91 ANNUAL REPORT.................................................................91 ANNEX I: Plan of Reorganization and Merger Agreement........................92 ANNEX II: BYL Bancorp Stockholder Agreement..................................93 INDEX TO FINANCIAL STATEMENTS.................................................94 8 SUMMARY OF PROXY STATEMENT/PROSPECTUS The following is a summary of certain information contained elsewhere in this Proxy Statement/Prospectus, and is intended to assist shareholders in their review of this Proxy Statement/Prospectus. This summary does not purport to be complete and is qualified in its entirety by reference to the full text of the more detailed Proxy Statement/Prospectus, the annexes and the exhibits thereto, and the documents referred to herein and therein. Each Bank shareholder is urged to read this Proxy Statement/Prospectus and the annexes hereto in their entirety and with care. BANK HOLDING COMPANY REORGANIZATION DATE, TIME AND PLACE OF MEETING. . _____________, 1997 at 5:30 p.m. at Bank of Yorba Linda, 18206 Imperial Highway, Yorba Linda, California 92686. RECORD DATE. . . . . . . . . . . . ________________, 1997 ("Record Date"). PARTIES TO THE MERGER AGREEMENT. . The Holding Company is a California corporation, and, subject to the consummation of the Reorganization, including the approval of the Holding Company's Application to the Board of Governors of the Federal Reserve System, will acquire 100% of the outstanding shares of the Bank, and will be registered as a bank holding company under the Bank Holding Company Act of 1956, as amended. The principal executive office of the Holding Company is located at 18206 Imperial Highway, Yorba Linda, California 92886, telephone number (714) 996-1800. Upon consummation of the Reorganization, the Holding Company's business will be to act as a bank holding company for BANK OF YORBA LINDA, the bank surviving the Merger. See "BANK HOLDING COMPANY REORGANIZATION" and "INFORMATION CONCERNING THE BUSINESS AND PROPERTIES OF THE HOLDING COMPANY", herein. The Bank is a California state-chartered bank. The principal executive office of the Bank is located at 18206 Imperial Highway, Yorba Linda, California 92886, telephone number (714) 996-1800. The Bank's principal business is that of an independent commercial bank. The Bank provides a wide range of banking services to primarily small and medium sized businesses and individuals in Orange County and in the Southern California area. See "BANK HOLDING COMPANY REORGANIZATION" and "INFORMATION CONCERNING THE BUSINESS AND PROPERTIES OF THE HOLDING COMPANY." 9 The Merger Corp. is a California corporation organized by the Directors of the Bank as a wholly-owned subsidiary of the Holding Company. The Merger Corp.'s principal purpose is to merge with the Bank in order to facilitate the Holding Company's acquisition of the Bank. See "BANK HOLDING COMPANY REORGANIZATION - ORGANIZATIONAL TRANSACTIONS." RIGHTS OF DISSENTING SHAREHOLDERS . . . . . . . . . . Bank shareholders do not have dissenters' rights with respect to the Merger. VOTE REQUIRED. . . . . . . . . . The affirmative vote of the holders of a majority of the issued and outstanding shares of Bank Common Stock entitled to vote (the "Required Vote") is required to approve the Reorganization Proposal. A copy of the Merger Agreement is attached to this Proxy Statement/Prospectus as Annex I. See "SOLICITATION OF PROXIES - PROXY AND REVOCABILITY OF PROXIES." The affirmative vote of a majority of the outstanding shares of the Merger Corp. and the and the Holding Company entitled to vote are also required for approval of the Reorganization Proposal. See "BANK HOLDING COMPANY REORGANIZATION - TERMS OF THE MERGER AGREEMENT; CONDITIONS TO THE MERGER." THE REORGANIZATION . . . . . . . The Merger Agreement provides for the acquisition of the Bank by the Holding Company by means of the Merger. Upon consummation of the Merger, the Merger Corp. will be merged with and into the Bank under the charter of the Bank and the separate corporate existence of the Merger Corp. will cease. As a result of the Merger, the surviving entity will continue to be known as "BANK OF YORBA LINDA" and will continue the Bank's current business and operations as a California state-chartered bank in essentially the same manner as it was conducted prior to the Reorganization. Each share of Bank Common Stock outstanding immediately prior to the Merger will, on and after the consummation of the Merger, automatically represent one share of Holding Company Common Stock. Upon consummation of the Merger, all of the Surviving Bank's common stock will be owned by the Holding Company. See "BANK HOLDING COMPANY REORGANIZATION - 10 GENERAL; TERMS OF THE MERGER AGREEMENT; CONVERSION." REASONS FOR THE REORGANIZATION . . . . . . . . . In the opinion of the Bank's Board of Directors, the bank holding company structure will permit greater flexibility in responding to evolving changes in the banking and financial services industries and meeting the competition of other financial institutions. The Board of Directors of the Bank believes that the Reorganization will provide Bank Shareholders with the opportunity to own a business entity which will provide greater operating and financial flexibility and will permit expansion into a broader range of financial services and other business activities. The Holding Company anticipates that during the initial months following the consummation of the Reorganization, its principal business and activity will be to serve as the bank holding company for the Surviving Bank. See "BANK HOLDING COMPANY REORGANIZATION - REASONS FOR REORGANIZATION." RESTRICTIONS ON ACQUISITION OF THE HOLDING COMPANY. . . . . . . . . The Holding Company's Articles of Incorporation and Bylaws contain certain provisions not contained in the Articles of Incorporation or Bylaws of the Bank relating to the Board of Directors and certain business combinations, all of which may be deemed to have "anti-takeover" effects. If and when the Holding Company becomes a "listed corporation" (i.e., outstanding shares listed on an exchange or NASDAQ), which is expected to occur on or before consummation of the Reorganization, and has at least 800 holders of its equity securities, (i) the Board of Directors will be divided into 2 classes, and the members of each class shall be elected for a term of two (2) years, and (ii) cumulative voting for directors will be eliminated. The Articles of Incorporation also contain provisions indicating that (a) the affirmative vote of at least 66 2\3 of the Holding Company's outstanding shares will be required to approve certain "Business Combinations" involving a "Related Person", and (b) the affirmative vote of at least 66 2/3 of the Holding Company's outstanding shares will be required to approve or amend certain provisions of the Articles of Incorporation, including provisions limiting voting rights, approval relating to certain business 11 combinations, number and classification of directors and other items. INTERESTS OF CERTAIN PERSONS IN THE MERGER . . . . . . . . . . . The Reorganization will not have any substantive effect on the operation or management of the Surviving Bank which will continue to have the same directors, officers, management personnel, assets and operating policies as the Bank had prior to the Reorganization. Upon consummation of the Reorganization, the Holding Company will have the same directors and officers as the Holding Company had prior to consummation of the Reorganization. See "BANK HOLDING COMPANY REORGANIZATION - TERMS OF THE MERGER AGREEMENT - INTERESTS OF CERTAIN PERSONS IN THE MERGER", and "INFORMATION CONCERNING THE BUSINESS AND PROPERTIES OF THE HOLDING COMPANY - MANAGEMENT." As of the Record Date, the Bank's directors, executive officers and their affiliates beneficially owned, in the aggregate, approximately 12.24% of the Bank's outstanding shares entitled to vote for the approval of the Merger Agreement. The Holding Company has one shareholder, also a director and executive officer of the Bank, who beneficially owns 100% of the Holding Company's common stock, who intends to vote such shares in favor of approval of the Merger Agreement. Following consummation of the Reorganization, the Holding Company will repurchase such shares of the Holding Company Common Stock. See "SOLICITATION OF PROXIES - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT"; and "BANK HOLDING COMPANY REORGANIZATION - ORGANIZATIONAL TRANSACTIONS." The affirmative consent of a majority of the outstanding shares of Bank Common Stock and Holding Company Common Stock, respectively, are required to approve the Merger Agreement. See "SOLICITATION OF PROXIES"; and "BANK HOLDING COMPANY REORGANIZATION - TERMS OF THE MERGER AGREEMENT; CONDITIONS TO THE MERGER", herein. CONDITIONS TO THE REORGANIZATION AND REGULATORY APPROVALS . . . . In addition to approval of the Merger Agreement by the Board of Directors and the shareholders of the Bank, the Merger Corp. and the Holding 12 Company, consummation of the Reorganization will require the prior approval, on terms satisfactory to the Bank, the Merger Corp. and the Holding Company, of certain regulatory agencies, including the Board of Governors of the Federal Reserve System ("Federal Reserve Board"), the Federal Deposit Insurance Corporation ("FDIC"), and the California Commissioner of Financial Institutions (the "Commissioner"). Management of the Bank is not aware of any circumstances which would lead it to believe that such agencies will not approve the Merger and the Reorganization. Even if such approvals are obtained, the Board of Directors of the Bank, the Holding Company or the Merger Corp. may, under certain circumstances, terminate the Merger Agreement. See "BANK HOLDING COMPANY REORGANIZATION - REGULATORY APPROVALS." A notification for prior approval of the Holding Company to acquire the Bank was filed by the Holding Company with the Federal Reserve Board on _________, 1997. An application (the "Merger Application") for prior approval of the Merger was filed with the FDIC on _________, 1997. An application (the "State Application") for an acquisition of control of the Bank by the Holding Company was filed with the Commissioner on August 7, 1997. CERTAIN FEDERAL INCOME TAX CONSEQUENCES . . . . . . . . . . The Reorganization is conditioned upon receipt of a ruling from the Internal Revenue Service or an opinion to the effect, among other things, that no gain or loss will be recognized by Bank Shareholders upon the exchange of their common stock solely for Holding Company Common Stock. The Bank, the Holding Company or the Merger Corp. may terminate the Merger Agreement in the event a favorable ruling from the Internal Revenue Service is not received or a favorable opinion of counsel with respect to the tax effect of the reorganization is not received. See "BANK HOLDING COMPANY REORGANIZATION - CERTAIN FEDERAL INCOME TAX CONSEQUENCES." PROXIES. . . . . . . . . . . . . The enclosed Proxy is being solicited by the Board of Directors of the Bank. Each share of the Bank Common Stock represented by a properly executed Proxy will, unless such Proxy has been 13 previously revoked, be voted in accordance with the instructions indicated on such Proxy. Any Proxy may be revoked at any time prior to the time it is voted by notifying the Bank's corporate secretary in writing to that effect, by filing a duly executed proxy bearing a later date, or by voting in person at the meeting. "SOLICITATION OF PROXIES." RECOMMENDATIONS. . . . . . . . . On April 23, 1997, the Board of Directors of the Bank approved the Merger Agreement and the Reorganization and determined that the transactions contemplated by the Merger Agreement were in the best interests of the Bank and its shareholders and recommended that such shareholders approve the Merger Agreement. See "BANK HOLDING COMPANY REORGANIZATION - RECOMMENDATIONS." BYL BANCORP 1997 STOCK OPTION PLAN SUMMARY OF THE 1997 PLAN . . . . The 1997 Plan proposes to reserve 460,519 shares of Common Stock of the Holding Company for issuance pursuant to the exercise of options. The 1997 Plan is designed to replace the Bank's 1997 Stock Option Plan, with certain changes, including (i) an increase in the number of shares subject to the 1997 Plan, (ii) options may be granted to consultants, (iii) except for directors and officers, a minimum vesting at least 20% per year for full time employees, and (iv) the ability to exercise vested options under certain conditions if terminated for cause as more fully described in this Proxy Statement/Prospectus. See "APPROVAL OF BYL BANCORP 1997 STOCK OPTION PLAN." VOTE REQUIRED. . . . . . . . . . The affirmative vote of a majority of the outstanding shares of the Bank, as prospective shareholders of the Holding Company entitled to vote are also required for approval of the BYL Bancorp 1997 Stock Option Plan. See "APPROVAL OF BYL BANCORP 1997 STOCK OPTION PLAN." 14 SELECTED FINANCIAL DATA The following table presents selected financial data for the Bank as of and for each of the five years in the period ended December 31, 1996 and as of and for the six months ended June 30, 1997 and 1996. The data as of and for each of the five years in the period ended December 31, 1996 is derived from audited financial statements of the Bank and the notes thereto. The data at June 30, 1997 and for the six months ended June 30, 1997 and 1996 is derived from the unaudited financial statements of the Bank. In the opinion of management, such unaudited financial statements have been prepared on the same basis as the audited financial statements, and include all adjustments, which consist solely of normal recurring accruals, necessary for a fair statement of the results for the unaudited interim periods. Results for the six months ended June 30, 1997 should not be considered necessarily indicative of the results to be expected for the full year. The information below is qualified in its entirety by the detailed information and financial statements included elsewhere herein, and should be read in conjunction with "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS", "SUPERVISION AND REGULATION OF THE HOLDING COMPANY AND THE BANK", and the financial statements of the Bank and notes thereto included elsewhere in this Proxy Statement/Prospectus. 15 SELECTED FINANCIAL DATA The following table reflects selected financial data relating to the past five years of the Bank's operations. AT OR FOR THE SIX MONTHS ENDED JUNE 30, AT OR FOR THE YEAR ENDED DECEMBER 31, --------------------- -------------------------------------------------------- 1997 1996 1996 1995 1994 1993 1992 -------- -------- -------- ------- ------- ------- ------- SUMMARY OF OPERATIONS: Interest Income $ 6,062 $ 2,740 $ 7,498 $ 4,479 $ 4,127 $ 4,023 $ 4,516 Interest Expense 1,756 690 2,060 1,045 1,005 1,039 1,255 -------- -------- -------- ------- ------- ------- ------- Net Interest Income 4,306 2,050 5,438 3,434 3,122 2,984 3,261 Provision for Loan Losses 195 123 344 262 423 819 318 -------- -------- -------- ------- ------- ------- ------- Net Interest Income after Provision for Loan Losses 4,111 1,927 5,094 3,172 2,699 2,165 2,943 Noninterest Income 5,731 3,379 7,653 5,662 3,799 3,362 2,586 Noninterest Expense 8,282 4,545 10,661 7,095 5,687 5,336 4,691 -------- -------- -------- ------- ------- ------- ------- Income before Income Taxes 1,560 761 2,086 1,739 811 191 838 Income Taxes 667 310 884 717 335 71 336 -------- -------- -------- ------- ------- ------- ------- Net Income $ 893 $ 451 $ 1,202 $ 1,022 $ 476 $ 120 $ 502 -------- -------- -------- ------- ------- ------- ------- -------- -------- -------- ------- ------- ------- ------- PER SHARE DATA: Net Income - Primary (1) $ 0.54 $ 0.69 $ 1.05 $ 1.98 $ 0.83 $ 0.13 $ 0.91 Net Income - Fully Diluted (2) $ 0.54 $ 0.65 $ 1.04 $ 1.39 $ 0.62 $ 0.13 $ 0.65 Book Value (3) $ 8.92 $ 7.96 $ 8.43 $ 8.68 $ 6.70 $ 5.87 $ 5.73 Tangible Book Value (4) $ 7.88 $ 6.83 $ 7.35 $ 8.68 $ 6.70 $ 5.87 $ 5.73 STATEMENTS OF FINANCIAL CONDITION SUMMARY: Total Assets $152,081 $117,672 $116,467 $59,784 $53,430 $52,230 $56,204 Total Deposits 136,446 103,801 102,368 54,025 48,693 47,965 51,868 Loans Held for Sale 41,423 14,285 24,363 10,186 9,969 2,683 1,932 Total Loans, Net 68,738 61,531 63,339 30,917 27,756 37,798 38,109 Allowance for Loan Losses 1,182 1,337 1,210 580 536 413 482 Total Shareholders' Equity 13,694 12,216 12,938 5,157 4,405 4,020 3,960 SELECTED RATIOS: Return on Average Assets 1.35% 1.45% 1.35% 1.88% 0.88% 0.22% 0.94% Return on Average Equity 13.32% 17.85% 13.82% 21.37% 11.31% 3.13% 13.31% Net Interest Margin 7.71% 7.79% 7.29% 7.34% 6.83% 6.41% 6.71% Average Loans as a Percent of Average Deposits 84.72% 79.18% 79.90% 82.03% 80.76% 82.55% 83.84% Non-Performing Assets to Total Assets 1.48% 1.83% 1.49% 2.37% 1.77% 3.40% 2.88% Non-Performing Loans to Total Loans 1.94% 2.03% 1.09% 2.88% 1.00% 0.35% 3.21% Allowance for Loan Losses to Total Loans 1.70% 2.13% 1.88% 1.84% 1.90% 1.08% 1.25% Allowance for Loan Losses to Non-Performing Loans 86.98% 86.60% 172.61% 63.81% 190.07% 308.21% 38.47% Tier 1 Leverage Capital Ratio 7.97% 14.24% 9.24% 8.12% 7.54% 6.38% 6.65% Tier 1 Capital to Risk-Weighted Assets 9.99% 11.07% 11.77% 10.49% 10.71% 8.51% 8.57% Total Capital to Risk-Weighted Assets 11.06% 12.32% 13.02% 11.74% 11.96% 9.75% 9.67% - ----------------- (1) These amounts represent the net income reduced by preferred stock dividends divided by the weighted average number of common shares outstanding for the respective years. (2) These amounts represent net income dividend by the weighted average number of common shares outstanding, plus the conversion of the preferred stock and unpaid cumulative dividends. (3) As used throughout this Annual Report, the term "book value per share" is defined as total stockholders' equity less the preferred stock and unpaid cumulative dividends divided by the number of common shares outstanding at the end of the year. (4) The term "tangible book value per share" is defined as total stockholders' equity less the convertible preferred stock, unpaid cumulative dividends, and goodwill divided by the number of common shares at the end of the period. SPECIAL MEETING OF SHAREHOLDERS INTRODUCTION This Proxy Statement/Prospectus is furnished in connection with the solicitation of Proxies by the Bank Board of Directors for use at a Special Meeting of Shareholders of the Bank (the "Meeting") to be held on _____________, 1997 at 5:30 p.m. at the Bank's headquarters office, 18206 Imperial Highway, Yorba Linda, California, and at any adjournments thereof. At the Meeting, shareholders will be asked to approve the Merger Agreement providing for the merger of BYL MERGER CORPORATION (the "Merger Corp.") with and into the Bank, as a result of which the Bank will be the wholly-owned subsidiary of BYL Bancorp. In addition, this Proxy Statement/Prospectus is also furnished in connection with the solicitation of Proxies of shareholders of the Bank as prospective shareholders of the Holding Company for approval of the BYL Bancorp 1997 Stock Option Plan (the "1997 Plan"). VOTING OF PROXIES AND REVOCABILITY OF PROXIES A Proxy for use at the Meeting is enclosed. All shares of Bank Common Stock represented by properly executed Proxies received by the Bank will, unless revoked, be voted at the Meeting in accordance with the instructions on such Proxies. If no instruction is specified with regard to a mater to be considered, the shares of Bank Common stock represented by the Proxy will be voted in favor of (i) approval of the Merger Agreement, and (ii) approval of the 1997 Plan. The Proxy also confers discretionary authority to vote the shares represented thereby in accordance with the recommendations of the Bank Board of Directors on any matter that was not known at the time this Proxy Statement/Prospectus was mailed which may properly be presented for action at the Meeting and may include actions with respect to procedural matters pertaining to the conduct of the Meeting and the election of any person to any office for which a bona fide nominee is named herein if such nominee is unable to serve or for good cause will not serve. If any other business is properly presented at the Meeting, the Proxy will be voted in accordance with the recommendation of the Bank Board of Directors. Any Bank shareholder may revoke his Proxy at any item before it is voted by filing with the Bank's Corporate Secretary an instrument revoking it or a duly executed proxy bearing a later date, or by attending the Meting and advising the Chairman of his or her election to vote in person. THE BANK MUST RECEIVE PROXIES REPRESENTING A MAJORITY OF THE OUTSTANDING SHARES OF THE BANK'S COMMON STOCK FOR APPROVAL OF THE MERGER AGREEMENT AND THE 1997 Plan. RECORD DATE AND PERSONS ENTITLED TO GIVE PROXIES There were issued and outstanding 1,535,064 shares of the Bank's Common Stock at the close of business on _________ 1997, which has been set as the Record Date for the purpose of determining the shareholders entitled to vote at the Meting. The Bank has no other class of stock outstanding. Approval of the Merger Agreement and the 1997 Plan may be given by any person in whose name shares of Common Stock stand on the books of the Bank as of the Record Date, or by his or her duly authorized agent. Each holder of Bank Common Stock will be entitled to one vote for each share of Bank Common Stock standing in his or her name on the books of the Bank as of the Record Date. 17 A majority of the outstanding shares of Bank Common Stock entitled to vote shall constitute a quorum. Under the Bank's Articles of Incorporation, the Reorganization Proposal requires the affirmative vote of a majority of the outstanding shares of Bank Common Stock. In addition, approval of the 1997 Plan requires the affirmative vote of a majority of the outstanding shares of Bank Common Stock as proposed to be exchanged for Holding Company Common Stock. Accordingly, abstentions from voting will have the effect of a vote "AGAINST" the Reorganization Proposal. If you hold your Bank Common Stock in "street name" and you fail to instruct your broker or nominee as to how to vote your Bank Common Stock, you broker or nominee MAY NOT, pursuant to applicable stock exchange rules, vote your Bank Common Stock with respect to the Reorganization Proposal. COST OF SOLICITATIONS OF PROXIES This Proxy Statement/Prospectus is made on behalf of the Board of Directors of the Bank and the Holding Company, and the Bank will bear the costs of solicitation. The expense of preparing, assembling, printing and mailing this Proxy Statement/Prospectus and the materials used in this solicitation of Proxies also will be borne by the Bank. It is contemplated that Proxies will be solicited principally through the mail, but directors, officers and regular employees of the Bank may solicit Proxies personally or by telephone. Although there is no formal agreement to do so, the Bank may reimburse banks, brokerage houses and other custodians, nominees and fiduciaries for their reasonable expenses in forwarding these proxy materials to their principals. The Bank does not intend to utilize the services of other individuals or entities not employed by or affiliated with the Bank in connection with the solicitation of Proxies. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth information as of June 30, 1997 pertaining to beneficial ownership of the Bank's Common Stock by persons known to the Bank to own five percent (5%) or more of such stock, current directors and Executive Officers (1) of the Bank, and all directors and Executive Officers of the Bank as a group. The information contained herein has been obtained from the Bank's records and from information furnished directly by the individual or entity to the Bank. All shares are held with shared voting and investment power except as otherwise indicated. All addresses of Directors and Executive Officers are in care of the Bank at 18206 Imperial Highway, Yorba Linda, California. The table should be read with the understanding that more than one (l) person may be the beneficial owner or possess certain attributes of beneficial ownership with respect to the same securities. In addition, shares of Common Stock issuable pursuant to options which may be exercised within sixty (60) days of June 30, 1997 are deemed to be issued and outstanding and have been treated as outstanding in calculating the percentage ownership of those individuals possessing such interest. - ----------------- (1) As used throughout this Proxy Statement, the term "officer" or "executive officer" refers to the President and Chief Executive Officer, the Senior Executive Vice President/Chief Financial Officer, and the Executive Vice President/Credit Administrator. 18 BENEFICIAL OWNERSHIP(1) OF COMMON STOCK ON NAME TITLE JUNE 30, 1997 PERCENT ---- ----- ----------------------- ------- Basswood Partners Shareholder 152,055 9.90% Leonard O. Lindborg Director 8,533(2) .55% H. Rhoads Martin Director 19,467(3) 1.26% Barry J. Moore Sr. Executive Vice President/ 42,000(4) 2.66% Chief Operating Officer and Director Michael H. Mullarky Executive Vice President 28,332(5) 1.82% and Credit Administrator John F. Myers Director, Secretary 14,666(6) .95% - ----------------- (1) Beneficial owner of a security includes any person who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise has or shares: (a) voting power which includes the power to vote, or to direct the voting of such security; and/or the investment power, which includes the power to dispose, or to direct the disposition, of such security. Beneficial owner also includes any person who has the right to acquire beneficial ownership of such security as defined above within sixty (60) days of June 30, 1997. (2) Include 1,200 shares of Common Stock which may be acquired by Mr. Lindborg upon exercise of options pursuant to the Bank's 1990 Stock Option Plan, and 4,000 shares of Common Stock which may be acquired by Mr. Lindborg upon exercise of options pursuant to the Bank's 1997 Stock Option Plan. (3) Includes 3,467 shares of Common Stock which may be acquired by Mr. Martin upon exercise of options pursuant to the Bank's 1990 Stock Option Plan, and 4,000 shares of Common Stock which may be acquired by Mr. Martin upon exercise of options pursuant to the Bank's 1997 Stock Option Plan. (4) Includes 19,333 shares of Common Stock which may be acquired by Mr. Moore upon exercise of options pursuant to the Bank's 1990 Stock Option Plan, and 22,667 shares of Common Stock which may be acquired by Mr. Moore upon exercise of options pursuant to the Bank's 1997 Stock Option Plan. (5) Includes 4,167 shares held in the Joseph W. Mullarky Testamentary Trust dated January 5, 1987, and Mr. Michael Mullarky acts as sole trustee. Includes 17,333 shares of Common Stock which may be acquired by Mr. Mullarky upon exercise of options pursuant to the Bank's 1990 Stock Option Plan, and 2,667 shares of Common Stock which may be acquired by Mr. Mullarky upon exercise of options pursuant to the Bank's 1997 Stock Option Plan. (6) Includes 3,467 shares of Common Stock which may be acquired by Mr. Myers upon exercise of options pursuant to the Bank's 1990 Stock Option Plan, and 4,000 shares of Common Stock which may be acquired by Mr. Myers upon exercise of options pursuant to the Bank's 1997 Stock Option Plan. 19 BENEFICIAL OWNERSHIP OF COMMON STOCK ON NAME TITLE JUNE 30, 1997 PERCENT ---- ----- ------------------------ ------- Robert Ucciferri President, Chief Executive 68,745(7) 4.35% Officer and Director Brent W. Wahlberg Director 16,121(8) 1.04% All Directors and Executive 197,864(9) 12.24% Officers as a Group (7 in number) - ----------------- (7) Includes 33,333 shares of Common Stock which may be acquired by Mr. Ucciferri upon exercise of options pursuant to the Bank's 1990 Stock Option Plan, and 13,333 shares of Common Stock which may be acquired by Mr. Ucciferri upon exercise of options pursuant to the Bank's 1997 Stock Option Plan. (8) Includes 3,467 shares of Common Stock which may be acquired by Mr. Wahlberg upon exercise of options pursuant to the Bank's 1990 Stock Option Plan, and 4,000 shares of Common Stock which may be acquired by Mr. Wahlberg upon exercise of options pursuant to the Bank's 1997 Stock Option Plan. (9) Includes 81,600 shares of Common Stock which may be acquired upon exercise of options pursuant to the Bank's 1990 Stock Option Plan, and 54,667 shares of Common Stock which may be acquired upon exercise of options pursuant to the Bank's 1997 Stock Option Plan. 20 BANK HOLDING COMPANY REORGANIZATION GENERAL The Board of Directors of the Bank has unanimously approved the formation of a holding company, to be known as BYL Bancorp, for the Bank, by means of the Merger pursuant to the terms and conditions of the Merger Agreement described herein and unanimously recommends that shareholders of the Bank vote to approve the Reorganization Proposal. A copy of the Merger Agreement is attached hereto as Annex I. The following discussion of the Reorganization Proposal is a summary only and does not purport to be a complete description and is qualified in its entirety by reference to the complete Merger Agreement. At the Effective Time of the Merger (defined below), the Merger Corp. will be merged with and into the Bank, with the Bank as the Surviving Bank, as a result of which each outstanding share of Bank Common Stock shall be converted into Holding Company Common Stock on a one-for-one basis. As a result of the Merger, the current Bank Shareholders will become the sole shareholders of the Holding Company and the Holding Company will become the sole shareholder of the Surviving Bank. Upon consummation of the Reorganization, the Surviving Bank will continue the Bank's present business and operations under the name "BANK OF YORBA LINDA", as a wholly-owned subsidiary of the Holding Company and under the Articles of Incorporation and Bylaws of the Bank. The consolidated capitalization, assets, liabilities, income and financial statements of the Holding Company immediately following the Reorganization will be substantially the same as those of the Bank immediately prior to the consummation of the Reorganization. See "BANK HOLDING COMPANY REORGANIZATION - CAPITALIZATION." REASONS FOR REORGANIZATION In the opinion of the Bank's Board of Directors, the bank holding company structure will permit greater flexibility in responding to evolving changes in the banking and financial services industries and meeting the competition of other financial institutions. The Bank's Board of Directors believes that a bank holding company is an entity which can provide greater operating and financial flexibility and will permit expansion into a broader range of financial services and other business activities. Management of the Bank believes that a bank holding company will permit Bank shareholders to participate in the ownership of a more flexible entity for financing and growth within the banking and financial services industries. A bank holding company may provide more alternatives in the raising of funds required by the Bank or by the Holding Company under changing conditions in financial and monetary markets. For example, if a subsidiary bank required additional capital, the bank holding company might raise funds by relying on its own borrowing ability without having to go to the equity market. At present the Holding Company has no plans, arrangements or commitments to borrow any funds if the Merger Agreement is approved. Furthermore, upon consummation of the Reorganization and until such time at the Holding Company receives income in the form of dividends from the Surviving Bank, the Holding Company is not expected to be able to rely on its own borrowing ability to raise funds as it will not have any significant assets, other than its investment in the Surviving Bank, to support such borrowing. Flexibility in financing also will be provided by the Holding Company's authorized capitalization of 50,000,000 shares of Holding Company Common Stock, no par value, and 25,000,000 shares of Holding Company Preferred Stock, no par value. If the Reorganization Proposal is approved, up to 1,535,064 shares of Holding Company Common Stock will be issued to the shareholders of the 21 Bank, up to 460,519 shares may be issued pursuant to outstanding stock options grants and will be available for future grants issued under the Holding Company's 1997 Stock Option Plan, leaving 48,004,417 shares of authorized but unissued Holding Company Common Stock. These shares will be available for issuance from time to time to raise additional capital (such as in connection with a subsequent offering following the Reorganization, as discussed above), for acquisitions or for any other corporate purposes and, to the extent authorized by law, may be issued without further action by the Holding Company's shareholders. The Reorganization will also provide certain flexibility for acquiring or establishing other banking operations. For example, in the event an opportunity for the acquisition of another bank were to develop, it might be desirable to maintain the separate existence of the other bank after the acquisition rather than merging it into the Surviving Bank. The existence of a bank holding company would allow such an acquisition. However, except for the acquisition of the Bank described herein, at this time the Holding Company does not have any specific plans, arrangements or commitments to acquire or establish any such banking operations. The Reorganization can also allow for the distribution of certain assets of the Bank, such as the Bank's mortgage division, to a separate subsidiary of the Holding Company if certain events should occur, thereby possibly enhancing the value of the Holding Company. It is also anticipated that the new corporate structure can be used advantageously to engage in other financially oriented activities, either directly, or indirectly through newly formed subsidiaries or by acquiring companies already established in such fields. Such activities currently are limited to activities permissible under the Federal Bank Holding Company Act of 1956, as amended (the "BHC Act"). Neither the Bank nor the Holding Company is currently engaged in any specific discussions relating to acquisitions nor do they anticipate engaging in any such discussions in the immediate future. However, should the Surviving Bank or the Holding Company be presented with an acquisition opportunity within their market areas, either or both the Surviving Bank and the Holding Company expects to make a determination whether or not to and the manner in which it should pursue such opportunity, although this may require the prior approval or consent of the Federal Reserve Board and/or the Commissioner. See "SUPERVISION AND REGULATION OF THE HOLDING COMPANY AND THE BANK - THE HOLDING COMPANY." Management of the Bank believes that the Reorganization will enhance the Bank's ability to satisfy ever changing and expanding needs of present customers for banking and banking-related services and to continue to attract new customers for financial services. The recommended corporate form will better suit expansion into new areas of service than would be existing structure. The Holding Company anticipates that during the initial months following the consummation of the Reorganization, the principal business and activity of the Holding Company will be to serve as the bank holding company for the Surviving Bank. ORGANIZATIONAL TRANSACTIONS At the direction of the Board of Directors of the Bank, the Holding Company was incorporated under the laws of the State of California on April 17, 1997 for the purpose of becoming a bank holding company by acquiring all of the outstanding Bank Common Stock. Mr. Robert Ucciferri, by purchasing 150 shares of Holding Company Common Stock at $10.00 per share, provided the Holding Company's initial capitalization of $1,500. A copy of the Stockholder Agreement with Mr. 22 Ucciferri is attached hereto as Annex II. See "BANK HOLDING COMPANY REORGANIZATION - REGULATORY APPROVALS." Upon consummation of the Merger, these 150 shares of Holding Company Common Stock will be repurchased by the Holding Company for the same aggregate sum of $1,500 and cancelled. The obligation of the Holding Company to repurchase said shares and the obligation of Mr. Ucciferri to resell those shares to the Holding Company is set forth in the "BYL Bancorp Stockholder Agreement" attached to this Proxy Statement/Prospectus as Annex II. At the direction of the Board of Directors of the Bank, the Merger Corp. was incorporated under the laws of the State of California on April 17, 1997 for the purpose of merging with the Bank in order to facilitate the Holding Company's acquisition of the Bank. In order to capitalize the Merger Corp., the Merger Corp. issued 100 shares of common stock of the Merger Corp. (the "Merger Corp. Common Stock") to the Holding Company for $1,000. Prior to the Effective Time of the Merger, the Holding Company will be the sole shareholder of the Merger Corp. Upon consummation of the Merger, these 100 shares of Merger Corp. Common Stock will be converted into Surviving Bank Common Stock. TERMS OF THE MERGER AGREEMENT CONVERSION. At the Effective Time of the Merger (defined below), the shares of common stock of the Bank, Merger Corp. and Holding Company, parties to the Merger Agreement, shall be converted and exchanged as described herein. Each share of Bank Common Stock issued and outstanding immediately prior to the Effective Time of the Merger will, at the Effective Time of the Merger, automatically become and be converted into the right to receive, at the election of the shareholder, one share of Holding Company Common Stock. Each share of Merger Corp. Common Stock issued and outstanding immediately prior to the Effective Time of the Merger will, on and after the Effective Time of the Merger, be converted into one (1) share of Bank Common Stock and, as a result, at the Effective Time of the Merger, all of the common stock of the Surviving Bank will be owned by the Holding Company. Each share of Holding Company Common Stock issued and outstanding immediately prior to the Effective Time of the Merger will, at the Effective Time of the Merger, be repurchased by the Holding Company. At the Effective Time of the Merger, the Bank shareholders will be the shareholders of the Holding Company. As shareholders of the Holding Company, they will have essentially the same rights to govern the Holding Company's activities as they have with respect to the Bank; however, as shareholders of the Holding Company, they will not be entitled to vote on matters requiring the approval of Bank shareholders. Shareholders of the Holding Company will be entitled to vote with respect to matters affecting the Holding Company which will own 100% of the Surviving Bank. A discussion of those rights is contained in the section entitled "COMPARISON OF BANK COMMON STOCK AND HOLDING COMPANY COMMON STOCK." EFFECTIVE TIME OF THE MERGER. The Merger will be effective at the time the Merger Agreement is filed in the office of the Secretary of State of California (the "Effective Time of the Merger"). The Effective Time of the Merger will not occur until (i) all requisite board of directors, shareholders and 23 regulatory approvals and consents for the Merger and the Reorganization are obtained; (ii) the expiration of any applicable waiting periods under the BHC Act and the Bank Merger Act; and (iii) the satisfaction of all of the requirements of law and conditions specified in the Merger Agreement. There is no date by which the Effective Time of the Merger must occur. INTERESTS OF CERTAIN PERSONS IN THE MERGER. The Merger Agreement provides that the directors of the Bank immediately prior to the Effective Time of the Merger will be directors of the Surviving Bank. Additionally, the officers and other employees of the Bank immediately prior to the Effective Time of the Merger will all be employed in substantially the same capacities by the Surviving Bank. EMPLOYEE BENEFITS. Upon consummation of the Reorganization, the Bank's 1997 Stock Option Plan (the "Plan") will be terminated and a new Stock Option Plan of the Holding Company (the "1997 Plan") will be established. Stock options with respect to shares of Bank Common Stock granted under the Plan and outstanding prior to consummation of the Reorganization will automatically become options to purchase the same number of shares of Holding Company Common Stock upon identical terms and conditions, subject to such modifications as contained in 1997 Plan, and for an identical price. The Holding Company will assume all of the Bank's obligations with respect to such outstanding options. The 1997 Plan proposes to reserve 460,519 shares of Common Stock of the Holding Company for issuance pursuant to the exercise of options. The 1997 Plan is designed to replace the Bank's 1997 Stock Option Plan, with certain changes, including (i) an increase in the number of shares subject to the 1997 Plan, (ii) options may be granted to consultants in addition to directors, officers and employees, (iii) the exercise of options with not only cash but also a promissory note or by applying the appreciated value of the shares being surrendered to payment of the exercise price, (iv) except for directors and officers, all employees will have a minimum vesting at least 20% per year, and (v) the ability to exercise vested options under certain conditions if employee is terminated for cause as more fully described in this Proxy Statement/Prospectus. See "APPROVAL OF BYL BANCORP 1997 STOCK OPTION PLAN." All other employee benefits and benefit plans of the Bank in effect immediately prior to the Effective Time of the Merger will be unchanged by the Reorganization, except that any plan which refers to Bank Common Stock will, following consummation of the Reorganization, be deemed to refer instead to Holding Company Common Stock and will become the employee benefits and benefit plans solely of the Surviving Bank. CONDITIONS TO THE MERGER. The obligations of each of the parties to the Merger Agreement to consummate the Merger are subject to the satisfaction, on or before the Effective Time of the Merger, of the following conditions (i) approval of the terms of the Reorganization Proposal including the Merger Agreement, by the shareholders of the Bank owning at least a majority of the capital stock of the Bank; (ii) approval of the Merger Agreement by a majority of the outstanding shares of the Holding Company and the Merger Corp.; (iii) approval by a majority of the Board of Directors of both the Bank and the Merger Corp. of the Merger Agreement; (iv) approval of the Merger Agreement by the Holding Company; (v) all consents and approvals prescribed by law, including, without limitation, the approval of the Federal Reserve Board, the FDIC and the Commissioner, for the consummation of the Merger and Reorganization; and (vi) all other requirements prescribed by law which are necessary for the consummation of the Merger and Reorganization including, but not limited to, the expiration of any applicable waiting periods under the Bank Merger Act and the BHC Act. The Merger Agreement does not provide for an outside closing date for the transactions contemplated herein. 24 The directors of the Bank, the Merger Corp. and the Holding Company have unanimously approved the Reorganization Proposal. The Holding Company has filed an notification for prior approval to become a bank holding company pursuant to the BHC Act with the Federal Reserve Board and an application to acquire control of the Bank under Section 700 of the California Financial Code with the Commissioner. In addition, the Bank and the Merger Corp. have filed applications for approval of the Merger with the FDIC and the Commissioner. See "BANK HOLDING COMPANY REORGANIZATION - REGULATORY APPROVALS." TERMINATION OF MERGER AGREEMENT. The Merger Agreement may be terminated before the Effective Time of the Merger if (i) the number of shares voting against the Reorganization Proposal is such that the Board of Directors of the Bank determines that it is inadvisable to consummate the Merger or Reorganization and the Board of Directors of the Bank determines that it is inadvisable to consummate the Merger or Reorganization; (ii) any action, consent or approval, governmental or otherwise, necessary to permit the Surviving Bank to conduct all or any part of the business activities of the Bank prior to the Effective Time of the Merger, shall not have been obtained; or (iii) for any other reason the consummation of the Merger and Reorganization is inadvisable in the opinion of the Board of Directors of the Bank, the Merger Corp. or the Holding Company. Although not indicated in the Merger Agreement, the Board of Directors believes that it will give strong consideration to terminating the Merger Agreement if more than 25% of the outstanding shares of the Bank vote against the Merger. If the holders of a majority of the outstanding shares of Bank Common Stock fail to approve the Reorganization Proposal, or the transaction is otherwise terminated, as provided above, then the business of the Bank would continue to operate under the ownership of its existing shareholders. No assurances can be given as to when or if all conditions will be satisfied. EXCHANGE OF SHARE CERTIFICATES As soon as practicable after consummation of the Reorganization, the Holding Company will mail to each holder of record of Bank Common Stock immediately prior to the Effective Time of the Merger, a letter of transmittal which is to be used by each such Bank Shareholder to return to the Holding Company the stock certificates representing Bank Common Stock owned by him or her, which certificates should be duly endorsed in blank by such Bank Shareholder. As soon as practicable after receiving such certificates from a Bank Shareholder, together with the duly executed letter of transmittal and any other items specified by the letter of transmittal, the Holding Company will deliver to such Bank Shareholder new certificates evidencing the appropriate number of shares of Holding Company Common Stock. If the new certificates are to be delivered to a person other than the record holder of the certificates of Bank Common Stock surrendered in exchange therefor (i) the certificate so surrendered must be properly endorsed or accompanied by appropriate stock powers and otherwise be in proper form for transfer; (ii) the transfer must otherwise be proper; and (iii) the person requesting the transfer must pay to the Holding Company any transfer or other taxes payable by reason of the transfer or must establish to the satisfaction of the Holding Company that such taxes have been paid or are not required to be paid. COSTS OF REORGANIZATION The costs of the Reorganization are estimated at approximately $100,000. If the Reorganization is consummated, the costs of the Reorganization will be assumed and paid, to the 25 extent properly allocated, by the Holding Company, the Bank and/or the Surviving Bank. In the event the Reorganization is not consummated, such costs as have been incurred, including the cost of organizing the Holding Company and the Merger Corp., will be assumed and paid by the Bank. REGULATORY APPROVALS Federal and California law and regulations provide that certain acquisition transactions, such as the Reorganization, may not be consummated unless approved in advance by applicable regulatory authorities. The Merger Agreement provides that the Holding Company, the Bank and the Merger Corp. shall proceed expeditiously and cooperate fully in the procurement of any consents and approvals and in the taking of any other action and the satisfaction of all requirements, prescribed by law or otherwise, necessary for consummation of the Merger, including the preparation and submission of applications required to be filed with the FDIC, the Commissioner and the Federal Reserve Board. Receipt of all requisite regulatory approvals and consents is a condition precedent to the consummation of the Merger and the Reorganization. See "BANK HOLDING COMPANY REORGANIZATION - TERMS OF THE MERGER AGREEMENT - CONDITIONS TO THE MERGER." A notification for prior approval of the Holding Company to acquire the Bank was a filed with the Federal Reserve Board on __________, 1997. An application for prior approval of the Merger was filed with the FDIC on __________, 1997. An Application for prior approval of the Merger was filed with the Commissioner on August 7, 1997. There can be no assurances that the required approvals will be obtained, or as to conditions or timing of such approvals. Although neither the Holding Company nor the Bank is aware of any reason why the requisite approvals of and consents to the Merger and Reorganization would not be granted, there can be no assurance such approvals and consents will be obtained or that, if obtained, such approvals and consents will not include conditions which would be of a type that would relieve the Holding Company, the Bank or the Merger Corp. from their obligation to consummate the Merger and Reorganization. See "BANK HOLDING COMPANY REORGANIZATION - TERMS OF THE MERGER AGREEMENT - CONDITIONS TO THE MERGER" AND "- TERMINATION OF MERGER AGREEMENT." DISSENTING SHAREHOLDERS' RIGHTS Pursuant to the provisions of California law, shareholders of the Bank will not have dissenting rights in the Merger. ACCOUNTING TREATMENT Because the Merger is a reorganization with no change in ownership interests, the consolidated financial statements of the Holding Company and the financial statements of the Surviving Bank will retain the former bases of accounting of the Bank and will be presented substantially identical to the Bank's financial statements prior to the Reorganization. CERTAIN FEDERAL INCOME TAX CONSEQUENCES The following discussion, which is the opinion of Vavrinek, Trine, Day & Co., is limited to certain federal income tax consequences of the proposed Reorganization and does not discuss state, local or foreign tax consequences or all of the tax consequences that might be relevant to shareholders of the Bank entitled to special tax treatment. 26 In the opinion of Vavrinek, Trine, Day & Co., the Bank's certified public accountants, the proposed Merger will qualify for federal income tax purposes as a reorganization within the meaning of Section 368 of the Internal Revenue Code of 1986, as amended (the "Code"). This opinion is conditioned upon the accuracy of various representations made to counsel and certain assumptions made by counsel. The assumptions include, among others, the assumption that there is no, and through the Effective Time of the Merger there will be no, plan or intention on the part of shareholders of the Bank who own one percent (1%) or more of Bank Common Stock and, to the best knowledge of the management of the Bank, the Merger Corp. and the Holding Company, there is no, and through the Effective Time of the Merger there will be no, plan or intention on the part of the remaining shareholders of the Bank to sell or otherwise dispose of the Holding Company Common Stock to be received in the Merger. The opinion is based on current law and assumes that the Merger is consummated as described herein. Neither this summary nor the opinion of Vavrinek, Trine, Day & Co. is binding on the IRS and no ruling from the IRS has been sought or will be sought with respect to such tax consequences. Based upon the qualification of the Merger as a reorganization within the meaning of Section 368 of the Code: (a) No gain or loss will be recognized by the Bank, the Merger Corp. or the Holding Company as a result of the Merger; (b) No gain or loss will be recognized by the shareholders of the Bank upon receipt of the Holding Company Common Stock in exchange for their shares of Bank Common Stock pursuant to the Merger; (c) The basis of the Holding Company Common Stock received by the shareholders of the Bank pursuant to the Merger will be the same as the basis of the shares of Bank Common Stock surrendered in exchange therefor; (d) The holding period of the Holding Company Common Stock received by shareholders of the Bank pursuant to the Merger will include the holding period of the Bank Common Stock surrendered in exchange therefor, provided that such Bank Common Stock is held as a capital asset on the date of consummation of the Merger; (e) A holder of an outstanding option granted under the Bank's Stock Option Plans will not recognize income, gain or loss solely as a result of the assumption of the Bank's Stock Option Plans by the Holding Company. (f) The assumption by the Holding Company of outstanding incentive stock options granted under the Bank's Stock Option Plans will not be deemed a modification of the option under Section 424(h) of the Code. THE BANK'S SHAREHOLDERS ARE URGED TO CONSULT THEIR OWN TAX ADVISORS AS TO SPECIFIC TAX CONSEQUENCES TO THEM OF THE MERGER INCLUDING TAX RETURN REPORTING REQUIREMENTS AND THE APPLICABILITY AND EFFECT OF FEDERAL, STATE, LOCAL, FOREIGN AND OTHER APPLICABLE TAX LAWS. 27 RESTRICTIONS ON AFFILIATES The obligation of the Bank and the Holding Company to consummate the Reorganization is subject to the condition that each person who is an "affiliate" of the Bank for purposes of Rule 145 promulgated under the Securities Act, execute and deliver a letter to the effect that, among other things; (i) such person will not dispose of any shares of Holding Company Common Stock to be received by him pursuant to the Merger Agreement (a) in violation of the Securities Act or the rules and regulations of the SEC promulgated thereunder (and, accordingly, that any public offering or sale of such shares will require either registration under the Securities Act or compliance with the resale provision of Rule 145 or the availability of another exemption from the registration requirements of the Securities Act), or (b) prior to such time as financial results covering at least 30 days of postmerger combined operations have been published; and (ii) such person consents to the placing of a legend on the certificate evidencing such shares referring to the issuance of such shares in a transaction to which Rule 145 is applicable and to the giving of stop-transfer instructions to the Holding Company's transfer agent with respect to such certificates. For purposes of Rule 145, affiliates include the Bank's directors and executive officers. According to Rule 145, the affiliates will be restricted in their ability to resell their stock. These restrictions include the limitation, subject to certain exceptions, that not more than one percent (1%) of the total number of Holding Company shares outstanding be sold for the account of any affiliate in any three month period. RECOMMENDATIONS The Bank's Board of Directors has carefully reviewed the Reorganization Proposal and believes that, for the reasons set forth in this Proxy Statement/Prospectus, the proposed Reorganization, is fair to and in the best interests of the Bank and the Bank's shareholders. On April 23, 1997, the Bank's Board of Directors unanimously approved the Merger Agreement and the Reorganization and unanimously recommended that the Bank's shareholders consent to the Merger Agreement. CAPITALIZATION The following table sets forth the actual capitalization of the Bank at June 30, 1997, the proposed capitalization of the Merger Corp. and the Holding Company immediately prior to consummation of the Reorganization, and the pro forma capitalization of the Surviving Bank and the Holding Company on a consolidated basis to reflect the consummation of the Reorganization. 28 BANK OF BYL MERGER BYL BANCORP AND YORBA LINDA CORP(1) BYL BANCORP(2) BANK OF YORBA LINDA ----------------------------------------------------------------- Shareholders' Equity Common Stock. . . . . $10,298,000 $1,000 $1,500 $10,298,000 Undivided Profits . . 3,396,000 0 0 3,396,000 ----------- --------- ---------- ----------- Total . . . . . . . $13,694,000 $1,000 $1,500 $13,694,000 ----------- --------- ---------- ----------- ----------- --------- ---------- ----------- Share Data: Common Stock Authorized. . . . . 5,000,000 1,000,000 50,000,000 50,000,000 Outstanding . . . . 1,535,064 100 150 1,535,064 Par Value . . . . . No Par No Par No Par No Par Preferred Stock Authorized . . . . 1,000,000 None 25,000,000 25,000,000 Outstanding . . . . None N/A None None COMPARISON OF THE RIGHTS OF HOLDERS OF HOLDING COMPANY COMMON STOCK AND BANK COMMON STOCK The Bank is a California banking corporation organized under the laws of the State of California, and the rights of Bank Shareholders are governed by the California Financial Code, the California Corporations Code (the "Corporations Code"), the Articles of Incorporation of the Bank (the "Bank Articles"), and the bylaws of the Bank, as amended (the "Bank Bylaws"). Upon consummation of the Reorganization, the Bank Shareholders will become shareholders of the Holding Company ("Holding Company Shareholders"). As shareholders of the Holding Company, the rights of the then former Bank Shareholders will be governed by Division 1, Chapters 1 - 23 of the Corporations Code, other applicable California statutes, the Articles of Incorporation of the Holding Company (the "Holding Company Articles"), and the bylaws of the Holding Company (the "Holding Company Bylaws"). BANK COMMON STOCK The Bank is authorized by its Articles of Incorporation, as amended, to issue 5,000,000 shares of Bank Common Stock, without par value, and 1,000,000 shares of Bank Preferred Stock At June 30, 1997, 1,535,064 shares of Bank Common Stock, and no shares of Preferred Stock, were issued and outstanding. Holders of Bank Common Stock are entitled to one vote, in person or by proxy, for each share of Bank Common Stock held of record in the shareholder's name on the books of the Bank as of the record date on any matter submitted to the vote of the shareholders. Each share of Bank Common Stock has the same rights, privileges and preferences as every other share and will share equally in the Bank's net assets upon liquidation or dissolution. The Bank Common Stock has no - ----------------- (1) Funds to capitalize the Merger Corp. will be obtained by issuing 100 shares of common stock to the Holding Company for $1,000. Upon consummation of the Merger, these 100 shares of Merger Corp. Common Stock will be converted into Surviving Bank Common Stock. (2) Funds to capitalize the Holding Company have been obtained by issuing 150 shares of common stock to Mr. Robert Ucciferri for $1,500. Upon consummation of the Reorganization, and pursuant to a written agreement, these will be repurchased for $1,500 and cancelled by the Holding Company. See "ANNEX II." 29 preemptive, conversion or redemption rights or sinking fund provisions and all the shares offered hereby will, when issued, be fully paid. Shares of Bank Common Stock are subject to assessment by the Bank upon order of the Commissioner for the purpose of correcting an impairment of contributed capital in the manner and to the extent provided in Division 1 of the California Financial Code. See "COMPARISON OF THE RIGHTS OF HOLDERS OF HOLDING COMPANY COMMON STOCK AND BANK COMMON STOCK - ASSESSABILITY." California law prohibits a California state-chartered bank from lending on the security of its own stock. Shareholders are entitled to dividends when, as and if declared by the Bank's Board of Directors out of funds legally available therefor (and after satisfaction of the prior rights of holders of outstanding preferred stock, if any) subject to certain restrictions on payment of dividends imposed by the California Financial Code and other applicable regulatory limitations. See "COMPARISON OF THE RIGHTS OF HOLDERS OF HOLDING COMPANY COMMON STOCK AND BANK COMMON STOCK - DIVIDEND RESTRICTIONS." The transfer agent and registrar for the Bank Common Stock is U.S. Stock Transfer Corporation. HOLDING COMPANY COMMON STOCK The Holding Company is authorized by its Articles of Incorporation to issue 50,000,000 shares of Holding Company Common Stock, without par value, and 25,000,000 shares of Holding Company Preferred Stock, without par value. As of the date hereof, 150 shares of Holding Company Common Stock were issued and outstanding. Holders of Holding Company Common Stock will be entitled to one vote, in person or by proxy, for each share of Holding Company Common Stock held of record in the shareholder's name on the books of the Holding Company as of the record date on any matter submitted to the vote of the shareholders, except that in connection with the election of directors, and until the Holding Company is considered to be a "listed corporation" as provided in Corporations Code Section 310.5, which is intended to occur upon the completion of the Reorganization, the shares may be voted cumulatively. However, the Holding Company's Articles of Incorporation provide there will be no cumulative voting for the election of directors if and when the Holding Company becomes a "listed corporation" (i.e., outstanding shares listed on the New York or American Stock Exchange or outstanding securities designated as qualified for trading as a national market security on the National Association of Securities Dealers Automatic Quotation System and has at least 800 holders of its equity securities; the Bank currently has approximately 800 holders of its securities). The Holding Company intends to become a "listed corporation" at the time the Reorganization is consummated. The Holding Company's Articles of Incorporation provide that the Board of Directors will be divided into two classes, with any class having a term of two years, if and when the Holding Company becomes a "listed corporation" (as defined in the previous paragraph). Upon the Holding Company becoming a "listed corporation," the Board of Directors of the Holding Company will be divided into two classes, each of which shall contain approximately one-half of the whole number of the members of the Board. The members of each class shall be elected for a term of two years, with the terms of office of all members of one class expiring each year so that approximately one-half of the total number of directors are elected each year. The Holding Company's Articles of Incorporation also provide that any vacancy occurring in the Board, including a vacancy created by an increase in the number of directors, shall be filled by a vote of two-thirds of the directors then in office and any 30 director so chosen shall hold office for a term expiring at the annual meeting of stockholders at which the term of the class to which the director has been chosen expires. The classified Board is intended to provide for continuity of the Board of Directors and to make it more difficult and time consuming for a stockholder group to fully use its voting power to gain control of the Board of Directors without consent of the incumbent Board of Directors of the Holding Company. The Articles of Incorporation of the Holding Company also require the approval of the holders of at least 66-2/3% of the Holding Company's outstanding shares of voting stock to approve certain "Business Combinations" (as defined therein) involving a "Related Person" (as defined therein) except in cases where the proposed transaction has been approved in advance by a majority of those members of the Holding Company's Board of Directors who are unaffiliated with the Related Person and were directors prior to the time when the Related Person became a Related Person. The term "Related Person" is defined to include any individual, corporation, partnership or other entity (other than the Bank or its subsidiary) which owns beneficially or controls, directly or indirectly, 10% or more of the outstanding shares of voting stock of the Holding Company or an affiliate of such person or entity. This proposed provision of the Articles of Incorporation applies to any "Business Combination," which is defined to include: (i) any merger or consolidation of the Holding Company with or into any Related Person; (ii) any sale, lease, exchange, mortgage, transfer, or other disposition of 25% or more of the assets of the Holding Company or combined assets of the Holding Company and its subsidiaries to a Related Person; (iii) any merger or consolidation of a Related Person with or into the Holding Company or a subsidiary of the Holding Company; (iv) any sale, lease, exchange, transfer, or other disposition of 25% or more of the assets of a Related Person to the Holding Company or a subsidiary of the Holding Company; (v) the issuance of any securities of the Holding Company or a subsidiary of the Holding Company to a Related Person; (vi) the acquisition by the Holding Company or a subsidiary of the Holding Company of any securities of a Related Person; (vii) any reclassification of common stock of the Holding Company or any recapitalization involving the common stock of the Holding Company; or (viii) any agreement or other arrangement providing for any of the foregoing. Under California law, absent this proposed provision, business combinations, including mergers, consolidations and sales of substantially all of the assets of a corporation must, subject to certain exceptions, be approved by the vote of the holders of a majority of the outstanding shares of common stock of the Holding Company and any other affected class of stock. The increased stockholder vote required to approve a business combination may have the effect of foreclosing mergers and other business combinations which a majority of stockholders deem desirable and place the power to prevent such a merger or combination in the hands of a minority of stockholders. Each share of Holding Company Stock has the same rights, privileges and preferences as every other share and will share equally in the Holding Company's net assets upon liquidation of dissolution. Holding Company Common Stock will have no preemptive, conversion or redemption rights or sinking fund provisions and all of the issued and outstanding shares of Holding Company Common Stock, when issued, will be fully paid and nonassessable. The Holding Company's Articles of Incorporation also provide that amendments to the Holding Company's Articles of Incorporation must be approved by a majority vote of its Board of Directors and also by a majority of the outstanding shares of its voting stock, provided, however, that an affirmative vote of at least 66-2/3% of the outstanding voting stock entitled to vote (after giving effect to the provision limiting voting rights) is required to amend or repeal certain provisions of the Articles of Incorporation, including the provision limiting voting rights, the provisions relating to approval of certain business combinations, the number and classification of directors, director and officer indemnification by the Holding Company and amendment of the Holding Company's Bylaws and Articles of Incorporation. The Holding Company's 31 Bylaws may be amended by its Board of Directors, or by a vote of 66-2/3% of the total votes eligible to be voted at a duly constituted meeting of stockholders. See "COMPARISON OF THE RIGHTS OF HOLDERS OF HOLDING COMPANY COMMON STOCK AND BANK COMMON STOCK - ASSESSABILITY." Shareholders are entitled to dividends when, as and if declared by the Holding Company's Board of Directors out of funds legally available therefor (and after satisfaction of the prior rights of holders of outstanding preferred stock, if any (subject to certain restrictions on payment of dividends imposed by the General Corporation Law of California. See "COMPARISON OF THE RIGHTS OF HOLDERS OF HOLDING COMPANY COMMON STOCK AND BANK COMMON STOCK - DIVIDEND RESTRICTIONS." Following consummation of the Reorganization, the transfer agent and registrar for the Holding Company Common Stock will be U.S. Stock Transfer Corporation. COMPARISON OF BANK COMMON STOCK AND HOLDING COMPANY COMMON STOCK ASSESSABILITY. As a California state-chartered bank, the Bank's Common Stock is subject to assessment pursuant to the provisions of Division 1 of the California Financial Code. Section 662 of Division 1 of the California Financial Code provides that when a bank's contributed capital is "impaired" (when the retained earnings deficit is in excess of 40% of contributed capital), the Commissioner shall order the bank to restore its capital impairment within 60 days of the issuance of such an order. If the contributed capital is not restored by other means, the bank's board is required to levy and collect an assessment on its outstanding common shares pursuant to Section 423 of the California Corporations Code. The date the bank levies the assessment must be within 60 days after the Commissioner's order and the resolutions levying the assessment of the common stock must fix a date not more than 60 days after the date of the adoption of the assessment resolution on which the assessment is payable (the "Payable Date"); fix a date not less than 30 nor more than 60 days from the Payable Date on which such assessment becomes delinquent if not paid (the "Delinquency Date"); fix a date not less than 15 nor more than 60 days from the Delinquency Date for the sale of the delinquent shares (the "Sale Date"); and fix the hour and place of sale. If an assessment is levied, the shareholders of the bank are required to pay the assessment on a pro rata basis determined by the number of shares held by each shareholder. If a shareholder has not paid the amount of the assessment by the Delinquency Date, the shareholder may, prior to the Sale Date, redeem his shares by paying the amount of the assessment together with a penalty of 5% of the amount of the assessment on such shares. If a particular shareholder fails or refuses to pay such shareholder's pro rata portion of the assessment, the assessed shares may be sold by the bank in satisfaction of the assessment and penalties thereon. The shareholders are not subject to personal liability for payment of such an assessment. The bank's only remedy for the collection of any such assessment is the sale of the shares as described above or, in the event no such sale can be consummated, forfeiture of such shares. Holding Company Common Stock is not assessable. Under applicable regulatory policies, however, holding companies of federally insured financial institutions such as the Bank are required to serve as a "source of strength" for their insured subsidiaries. As a practical matter, this may result in the Holding Company being required by regulatory order or directive to contribute additional capital to the Bank, to guarantee certain Bank obligations or to take other actions requiring the investment of Holding Company capital or resources for the Bank's benefit. 32 CLASSIFICATION OF BOARD OF DIRECTORS The Bank's Articles of Incorporation requires the Bank's Board of Directors to be divided into two (2) classes, with each class having a term of office of two (2) years. Each director of the Bank must be elected every two (2) years. The Holding Company's Articles of Incorporation and Bylaws provide for its Board of Directors to be divided into two (2) classes with each class having a term of two years, if and when the Holding Company becomes a "listed corporation", which is intended to occur upon consummation of the Reorganization. VOTING RIGHTS In addition to the description of voting rights contained in "COMPARISON OF THE RIGHTS OF HOLDERS OF HOLDING COMPANY COMMON STOCK AND BANK COMMON STOCK -BANK COMMON STOCK" and "- HOLDING COMPANY COMMON STOCK", the Bank may amend its Articles of Incorporation or Bylaws to eliminate cumulative voting if and when the Bank becomes a "listed corporation" (as defined above). NUMBER OF DIRECTORS Although the Corporations Code does not require the Holding Company or the Bank to maintain any specific range of number of directors, the number of directors of the Holding Company and the Bank may not be less than a stated minimum nor more than a stated maximum (which in no case shall be greater than two times the stated minimum minus one) with the exact number of directors to be fixed, within the limits specified. The Bank Bylaws currently provide that the number of directors on the Bank Board of Directors may not be fewer than five nor more than nine, and the current number of members on the Bank's Board of Directors has been fixed at seven. The Holding Company Bylaws currently provide that the number of directors on the Holding Company Board of Directors may not be fewer than six nor more than eleven, and the current number of members on the Holding Company's Board of Directors has been fixed at seven. DIVIDEND RESTRICTIONS. Since the Bank is a state-charted bank, its ability to pay dividends or make distributions to its shareholders is subject to restrictions set forth in the California Financial Code. The California Financial Code provides that neither a bank nor any majority-owned subsidiary of a bank may make a distribution to its shareholders in an amount which exceeds the lesser of (i) the bank's retained earnings; or (ii) the bank's net income for its last three fiscal years, less the amount of any distributions made by the bank or by any majority-owned subsidiary of a bank may, with the prior approval of the Commissioner, make a distribution to the shareholders of the bank in an amount not exceeding the greatest of (i) its retained earnings; (ii) its net income for its last fiscal year; or (iii) stockholders' equity of a bank is inadequate or that the making of a distribution by a bank would be unsafe our unsound, the Commissioner may order the bank to refrain from making a proposed distribution. The ability of the Holding Company to pay cash dividends is limited by the provisions of Section 500 of the California Corporations Code, which prohibits the payment of dividends unless (i) the retained earnings of the corporation immediately prior to the distribution exceeds the amount of the distribution; (ii) the assets of the corporation exceed 1 1/4 times its liabilities; or (iii) the current assets of the corporation exceed its current liabilities, but if the average pre-tax earnings of the corporation before interest expense for the two years preceding the distribution was less than the average interest expense of the corporation for those years, the current assets of the corporation must exceed 1 1/4 times its current liabilities. 33 DISSENTERS' RIGHTS. Pursuant to the General Corporation Law of California, holders of Holding Company Common Stock would be entitled, subject to the provisions of Chapter 13, to dissenters' rights in connection with any transaction which constitutes a reorganization (as defined in Section 181 of the California Corporations Code). However, pursuant to the California Financial Code, shareholders of Bank Common Stock are not entitled to dissenters' rights in connection with any transactions between two banking institutions which constitutes a reorganization (as defined in Section 181 of the California Corporations Code) where the Bank is the corporation surviving such transaction, even if dissenters' rights were otherwise available pursuant to Chapter 13. Therefore, no dissenters' rights will apply to the Reorganization. RESTRICTIONS ON ACQUISITION OF THE HOLDING COMPANY The following discussion is a summary of certain provisions of California and Federal law and regulations and California corporate law, as well as the Articles of Incorporation and Bylaws of the Holding Company, relating to stock ownership and transfers, the Board of Directors and business combinations, all of which may be deemed to have "anti-takeover" effects. The description of these provisions is necessarily general and reference should be made to the actual law and regulations and to the Articles of Incorporation and Bylaws of the Holding Company. See "ADDITIONAL INFORMATION" as to how to obtain a copy of these documents. CALIFORNIA AND FEDERAL BANKING LAW The Federal Change in Bank Control Act of 1978 prohibits a person or group of persons "acting in concert" from acquiring "control" of a bank holding company unless the Federal Reserve Bank (the "FRB") has been given 60 days' prior written notice of such proposed acquisition and within that time period the FRB has not issued a notice disapproving the proposed acquisition or extending for up to another 30 days the period during which such a disapproval may be issued. An acquisition may be made prior to the expiration of the disapproval period if the FRB issues written notice of its intent not to disapprove the action. Under a rebuttable presumption established by the FRB, the acquisition of more than 10% of a class of voting stock of a bank with a class of securities registered under Section 12 of the Securities Exchange Act of 1934, as amended (such as the Common Stock), would, under the circumstances set forth in the presumption, constitute the acquisition of control. Under the California Financial Code, no person shall, directly or indirectly, acquire control of a California licensed bank or a bank holding company unless the Commissioner has approved such acquisition of control. A person would be deemed to have acquired control of the Holding Company under this state law if such person, directly or indirectly, has the power (i) to vote 25% or more of the voting power of the Holding Company or (ii) to direct or cause the direction of the management and policies of the Holding Company. For purposes of this law, a person who directly or indirectly owns or controls 10% or more of the Common Stock would be presumed to control the Holding Company. In addition, any "company" would be required to obtain the approval of the FRB under the Holding Company Holding Company Act of 1956, as amended (the "BHC Act"), before acquiring 25% (5% in the case of an acquiror that is, or is deemed to be, a bank holding company) or more of the outstanding Common Stock of, or such lesser number of shares as constitute control over, the Holding Company. ANTI-TAKEOVER PROVISIONS IN HOLDING COMPANY'S ARTICLES OF INCORPORATION The Holding Company's Articles of Incorporation contain certain provisions that deal with matters of corporate governance and certain rights of shareholders. The following discussion is a 34 general summary of the Holding Company's Articles of Incorporation and regulatory provisions relating to stock ownership and transfer, the Board of Directors and business combinations, which might be deemed to have a potential "anti-takeover" effect. These proposed provisions may have the effect of discouraging a future takeover attempt which is not approved by the Board of Directors but which individual Holding Company stockholders may deem to be in their best interest or in which stockholders may receive a substantial premium for their shares over then current market prices. As a result, shareholders who might desire to participate in such a transaction may not have an opportunity to do so. Such provisions will also render the removal of incumbent Board of Directors or management of the Holding Company more difficult. Any provision requiring more than a majority vote by the Holding Company's stockholders may only be effective for a two year period from its effective date, unless renewed by the Board of Directors and the stockholders. The following description of certain of the amendments to the Articles of Incorporation of the Holding Company is necessarily general, and reference should be made in each case to such Articles of Incorporation, which is contained as an exhibit to the Holding Company's registration statement. See "ADDITIONAL INFORMATION" as to how to obtain a copy of these documents. BOARD OF DIRECTORS. When the Holding Company becomes a "listed corporation", as defined in "COMPARISON OF THE RIGHTS OF HOLDERS OF HOLDING COMPANY COMMON STOCK AND BANK COMMON STOCK - HOLDING COMPANY COMMON STOCK," the Board of Directors of the Holding Company will be divided into two classes, each of which shall contain approximately one-half of the whole number of the members of the Board. The members of each class shall be elected for a term of two years, with the terms of office of all members of one class expiring each year so that approximately one-half of the total number of directors are elected each year. The effect of a vacancy on the Board of Directors is also described in "COMPARISON OF THE RIGHTS OF HOLDERS OF HOLDING COMPANY COMMON STOCK AND BANK COMMON STOCK - HOLDING COMPANY COMMON STOCK." The classified Board is intended to provide for continuity of the Board of Directors and to make it more difficult and time consuming for a stockholder group to fully use its voting power to gain control of the Board of Directors without consent of the incumbent Board of Directors of the Holding Company. CUMULATIVE VOTING AND SPECIAL MEETINGS. if the Holding Company becomes a "listed corporation," the Articles of Incorporation do not provide for cumulative voting for any purpose, as described in "COMPARISON OF THE RIGHTS OF HOLDERS OF HOLDING COMPANY COMMON STOCK AND BANK COMMON STOCK - HOLDING COMPANY COMMON STOCK." AUTHORIZED SHARES. The Articles of Incorporation authorize the issuance of 50,000,000 shares of Common Stock and 25,000,000 shares of preferred stock. The shares of Common Stock and preferred stock were authorized in an amount greater than that to be issued in the Reorganization to provide the Holding Company's Board of Directors with as much flexibility as possible to effect, among other transactions, financings, acquisitions, stock dividends, stock splits and the exercise of employee stock options. However, these additional authorized shares may also be used by the Board of Directors consistent with its fiduciary duty to deter future attempts to gain control of the Holding Company. The Board of Directors also has sole authority to determine the terms of any one or more series of preferred stock, including voting rights, conversion rates, and liquidation preferences. As a result of the ability to fix voting rights for a series of preferred stock, the Board has the power, to the extent consistent with its fiduciary duties to issue a series of preferred stock to persons friendly to management in order to attempt to block a tender offer, merger or other transaction by which a third party seeks control of the Holding Company, and thereby assist members of management to retain their positions. The Holding Company's Board has no present plans for the issuance of additional shares, other than the issuance of shares of Common Stock upon exercise of stock options. 35 STOCKHOLDER VOTE REQUIRED TO APPROVE BUSINESS COMBINATION WITH PRINCIPAL STOCKHOLDERS. The Articles of Incorporation require the approval of the holders of at least 66-2/3% of the Holding Company's outstanding shares of voting stock to approve certain "Business Combinations" (as defined in therein) involving a "Related Person" (as defined therein) except in cases where the proposed transaction has been approved in advance by a majority of those members of the Holding Company's Board of Directors who are unaffiliated with the Related Person and were directors prior to the time when the Related Person became a Related Person, as described more fully in "COMPARISON OF THE RIGHTS OF HOLDERS OF HOLDING COMPANY COMMON STOCK AND BANK COMMON STOCK - HOLDING COMPANY COMMON STOCK." Under California law, absent this proposed provision, business combinations, including mergers, consolidations and sales of substantially all of the assets of a corporation must, subject to certain exceptions, be approved by the vote of the holders of a majority of the outstanding shares of common stock of the Holding Company and any other affected class of stock. The increased stockholder vote required to approve a business combination may have the effect of foreclosing mergers and other business combinations which a majority of stockholders deem desirable and place the power to prevent such a merger or combination in the hands of a minority of stockholders. AMENDMENT OF ARTICLES OF INCORPORATION AND BYLAWS. The Holding Company's Articles of Incorporation must be approved by a majority vote of its Board of Directors and also by a majority of the outstanding shares of its voting stock, provided, however, that an affirmative vote of at least 66-2/3% of the outstanding voting stock entitled to vote (after giving effect to the provision limiting voting rights) is required to amend or repeal certain provisions of the Articles of Incorporation, including the provision limiting voting rights, the provisions relating to approval of certain business combinations, the number and classification of directors, director and officer indemnification by the Holding Company and amendment of the Holding Company's Bylaws and Articles of Incorporation, as described in "COMPARISON OF THE RIGHTS OF HOLDERS OF HOLDING COMPANY COMMON STOCK AND BANK COMMON STOCK - HOLDING COMPANY COMMON STOCK." The Holding Company's Bylaws may be amended by its Board of Directors, or by a vote of 66-2/3% of the total votes eligible to be voted at a duly constituted meeting of stockholders. STOCKHOLDER NOMINATIONS AND PROPOSALS. The Bylaws of the Holding Company require a stockholder who intends to nominate a candidate for election to the Board of Directors to give not less than 10 days' advance notice to the Secretary of the Holding Company. The Articles of Incorporation provide that a stockholder who desires to raise new business to provide certain information to the Holding Company concerning the nature of the new business, the stockholder and the stockholder's interest in the business matter. Similarly, a stockholder wishing to nominate any person for election as a director must provide the Holding Company with certain information concerning the nominee and the proposing stockholder. PURPOSE AND TAKEOVER DEFENSIVE EFFECTS OF THE HOLDING COMPANY'S ARTICLES OF INCORPORATION. The Board of Directors of the Holding Company believes that the provisions described above are prudent and will reduce the Holding Company's vulnerability to takeover attempts and certain other transactions which have not been negotiated with and approved by its Board of Directors. The Board of Directors believes these provisions are in the best interest of the Holding Company and its stockholders. In the judgment of the Board of Directors, the Holding Company's Board will be in the best position to determine the true value of the Holding Company and to negotiate more effectively for what may be in the best interest of its stockholders. Accordingly, the Board of Directors believes that it is in the best interest of the Holding Company and its stockholders to encourage potential acquirors to negotiate directly with the Board of Directors of the Holding Company and that these provisions will encourage such negotiations and discourage hostile takeover attempts. It is also the view of the Board of Directors that these provisions should not discourage persons from proposing 36 a merger or other transaction at a price reflective of the true value of the Holding Company and which is in the best interest of all stockholders. Attempts to acquire control of financial institutions have recently become increasingly common. Takeover attempts which have not been negotiated with and approved by the Board of Directors present to stockholders the risks of a takeover on terms which may be less favorable than might otherwise be available. A transaction which is negotiated and approved by the Board of Directors, on the other hand, can be carefully planned and undertaken at an opportune time in order to obtain maximum value of the Holding Company and its stockholders, with due consideration given to matters such as the management and business of the acquiring corporation and maximum strategic development of the Holding Company's assets. An unsolicited takeover proposal can seriously disrupt the business and management of a corporation and cause it to incur great expense. Although a tender offer or other takeover attempt may be made at a price substantially above the current market prices, such offers are sometimes made for less than all of the outstanding shares of a target company. As a result, stockholders may be presented with the alternative of partially liquidating their investment at a time that may be disadvantageous, or retaining their investment in an enterprise which is under different management and whose objectives may not be similar to those of the remaining stockholders. The concentration of control, which could result from a tender offer or other takeover attempt, could also deprive the Holding Company's remaining stockholders of benefits of certain protective provisions of the Exchange Act, if the number of beneficial owners became less than the 300 thereby allowing for Exchange Act deregistration. Despite the belief of the Holding Company as to the benefits to stockholders of these provisions of the Holding Company's Articles of Incorporation, these provisions may also have the effect of discouraging a future takeover attempt which would not be approved by the Holding Company's Board, but pursuant to which stockholders may receive a substantial premium for their shares over then current market prices. As a result, stockholders who might desire to participate in such a transaction may not have any opportunity to do so. Such provisions will also render the removal of the Holding Company's Board of Directors and of management more difficult. The Board of Directors of the Holding Company, however, has concluded that the potential benefits outweigh the possible disadvantages. Pursuant to applicable law, at any annual or special meeting of its stockholders, the Holding Company may adopt additional charter provisions regarding the acquisition of its equity securities that would be permitted for a California business corporation. The Holding Company does not presently intend to propose the adoption of further restrictions on the acquisition of the Holding Company's equity securities. The cumulative effect of the restriction on acquisition of the Holding Company contained in the Articles of Incorporation and Bylaws, federal law and California law may be to discourage potential takeover attempts and perpetuate incumbent management, even though certain stockholders of the Holding Company may deem a potential acquisition to be in their best interest, or deem existing management not to be acting in their best interests. 37 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MANAGEMENT'S DISCUSSION Management's discussion, which incorporates an analysis of financial condition and results of operations, is designed to provide a more comprehensive understanding of the significant changes and trends related to the Bank's financial condition, results of operations, liquidity, and capital resources. The discussion should be read in conjunction with the Financial Statements of the Bank and Notes thereto. 38 FINANCIAL CONDITION As of June 30, 1997, the Bank's total assets were $152.1 million, an increase of $35.6 million or 30.6% from the December 31, 1996 total assets of $116.5 million. The increase in capital during 1996 allowed the Bank to expand its SBA and Mortgage Loan Division resulting in a $17.1 million increase in loans held for sale and a $5.3 million increase in total loans. Federal funds sold also increased $11.6 million during this period. During 1996, the Bank's total assets increased $56.7 million from $59.8 million at December 31, 1995 to $116.5 million at December 31, 1996. This increase resulted primarily from the acquisition of Bank of Westminster on June 13, 1996. Bank of Westminster (BOW) had total assets of $54.9 million when acquired by the Bank. To fund this acquisition, the Bank raised $7.8 million of additional capital in an underwritten offering of common stock. (See also Note O in the accompanying financial statements.) The Bank's total assets increased by $6.4 million from $53.4 million at December 31, 1994 to $59.8 million at December 31, 1995. This increase was funded primarily by an increase in deposits of $5.3 million and an increase in shareholders' equity of $800,000. RESULTS OF OPERATIONS Net income for the six months ended June 30, 1997 was $893,000 or $0.54 per share compared to $451,000 or $0.69 per share for the same period in 1996. Earnings per share comparisons for the first six months of 1997 versus the comparable 1996 period are negatively impacted by the increase in the weighted average number of common shares outstanding for the 1997 periods due to the public offering of 805,000 Shares (1,073,333 adjusted for the stock split) of the Bank's Common Stock in conjunction with the simultaneous acquisition of the Bank of Westminster in June of 1996. In 1996, net income was $1.2 million or $1.39 per share compared to $1.0 million or $2.64 per share in 1995. The Bank's 1996 net income increased by $179,000 compared to the 1995 net income. This increase was attributable primarily to the acquisition of BOW and continuing profitability of its SBA and Mortgage Loan Divisions. Net income for 1995 was $1.0 million or $2.64 per share ($1.85 fully diluted) compared to $476,000 or $1.11 per share ($0.82 fully diluted) in 1994 and $120,000 or $0.17 per share ($0.17 fully diluted) in 1993. FOR THE SIX FOR THE YEAR ENDED MONTHS ENDED DECEMBER 31, JUNE 30, -------------------- 1997 1996 1995 ------------- ------- ------ Return on Average Assets 1.35% 1.35% 1.88% Return on Average Equity 13.32% 13.82% 21.37% Average Shareholder's Equity to Average Total Assets (Including Preferred Stock) 10.15% 9.78% 8.12% DISTRIBUTION OF ASSETS, LIABILITIES, AND SHAREHOLDERS' EQUITY The following table presents, for the periods 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). 39 FOR THE SIX MONTHS ENDED JUNE 30, ------------------------------------------------------------------------- 1997 1996 ------------------------------------ ----------------------------------- AVERAGE AVERAGE INTEREST YIELD OR INTEREST YIELD OR AVERAGE EARNED RATE AVERAGE EARNED RATE BALANCE OR PAID PAID BALANCE OR PAID PAID --------- ---------- --------- --------- --------- ---------- ASSETS Interest-Earning Assets: Investment Securities $ 6,500 $ 194 5.97% $ 4,151 $ 103 4.96% Federal Funds Sold 6,320 162 5.13% 3,647 97 5.32% Other Earning Assets - - - - - - Loans 98,841 5,706 11.55% 44,823 2,540 11.33% -------- -------- -------- -------- Total Interest-Earning Assets 111,661 6,062 10.86% 52,621 2,740 10.41% Cash and Due From Banks 9,650 5,825 Premises and Equipment 3,771 1,010 Other Real Estate Owned 1,086 725 Accrued Interest and Other Assets 7,107 2,647 Allowance for Loan Losses ( 1,073) ( 672) -------- -------- Total Assets $132,202 $ 62,156 -------- -------- -------- -------- LIABILITIES AND SHAREHOLDERS' EQUITY Interest-Bearing Liabilities: Money Market and NOW $ 26,036 $ 327 2.51% $ 17,489 $ 237 2.71% Savings 17,564 342 3.89% 9,094 143 3.14% Time Deposits under $100,000 17,355 530 6.11% 6,286 171 5.44% Time Deposits of $100,000 or More 21,421 557 5.20% 4,839 139 5.74% --------- -------- -------- ------- Total Interest-Bearing Liabilities 82,376 1,756 4.26% 37,708 690 3.66% -------- ------- Noninterest-Bearing Liabilities: Demand Deposits 34,295 18,899 Other Liabilities 2,118 810 Shareholders' Equity 13,413 4,739 --------- -------- Total Liabilities and Shareholders' Equity $132,202 $ 62,156 --------- -------- --------- -------- Net Interest Income $ 4,306 $ 2,050 -------- -------- -------- -------- Net Yield on Interest-Earning Assets 7.71% 7.79% 41 FOR THE YEAR ENDED DECEMBER 31,, ------------------------------------------------------------------------- 1996 1995 ------------------------------------ ----------------------------------- AVERAGE AVERAGE INTEREST YIELD OR INTEREST YIELD OR AVERAGE EARNED RATE AVERAGE EARNED RATE BALANCE OR PAID PAID BALANCE OR PAID PAID --------- --------- --------- ---------- --------- ---------- ASSETS Interest-Earning Assets: Investment Securities $ 6,229 $ 356 5.72% $ 4,163 $ 219 5.26% Federal Funds Sold 4,240 222 5.24% 2,402 138 5.75% Other Earning Assets - - 23 2 8.70% Loans 64,155 6,920 10.79% 40,215 4,120 10.24% ------ -------- -------- --------- Total Interest-Earning Assets 74,624 7,498 10.05% 46,803 4,479 9.57% Cash and Due From Banks 7,839 5,689 Premises and Equipment 2,363 665 Other Real Estate Owned 776 549 Accrued Interest and Other Assets 4,314 1,357 Allowance for Loan Losses ( 985) ( 583) ------- ------- Total Assets $88,931 $54,480 ------- ------- ------- ------- LIABILITIES AND SHAREHOLDERS' EQUITY Interest-Bearing Liabilities: Money Market and NOW $21,574 $ 576 2.67% $16,732 $ 453 2.71% Savings 14,329 512 3.57% 9,008 278 3.09% Time Deposits under $100,000 9,233 496 5.37% 3,702 182 4.92% Time Deposits of $100,000 or More 8,526 476 5.58% 2,418 132 5.46% ------- -------- ------- -------- Total Interest-Bearing Liabilities 53,662 2,060 3.84% 31,860 1,045 3.28% -------- -------- Noninterest-Bearing Liabilities: Demand Deposits 25,400 17,163 Other Liabilities 1,169 675 Shareholders' Equity 8,700 4,782 ------- ------- Total Liabilities and Shareholders' Equity $88,931 $54,480 ------- ------- ------- ------- Net Interest Income $ 5,438 $ 3,434 -------- -------- -------- -------- Net Yield on Interest-Earning Assets 7.29% 7.34% 42 NET INTEREST INCOME Net interest income for the six months ended June 30, 1997 was $4.3 million compared to $2.1 million for the same period in 1996. This increase was primarily attributed to increases in earning assets as the net interest margin was 7.71% in 1997 compared to 7.79% in 1996. Average interest-earning assets increased to $111.7 million during the first six months of 1997 compared to $52.6 million in 1996. Net interest income in 1996 was $5.4 million, an increase of $2 million or 58% from $3.4 million in 1995. This increase was primarily attributable to the substantial increase in total interest-earning assets which increased from $46.8 million in 1995 to $74.6 million in 1996. (Changing interest rates had a very minor impact as the net yield on interest-earning assets decreased only 5 basis points from 7.34% in 1995 to 7.29% in 1996.) The increase in total interest-earning assets was a result of the acquisition of BOW. Total interest income in 1996 was $7.5 million compared to $4.5 million in 1995. Increased loan volume, from the acquisition of BOW and the SBA and Mortgage Loan Divisions, was accountable for 85% of the increase in total interest income. The total yield on interest-earning assets also increased 48 basis points contributing $234,000 to the increase in interest income. Total interest expense also increased dramatically in 1996, rising to $2.1 million from $1.0 million in 1995. Again this increase was primarily attributable to increased volume in deposits (primarily acquired from BOW) which accounted for $951,000 of the total increase. The average rate paid on deposits also increased 56 basis points increasing interest expense by $64,000. For 1995, net interest income was $3.4 million, an increase of $312,000 or 10.0% from $3.1 million in 1994. This increase was primarily attributable to increases in the net yield on interest-earning assets as the volume of total interest-earning assets remained fairly stable in 1995. Total interest income increased $352,000 in 1995 primarily as the result of a 55 basis point increase in yields on interest-earning assets to 9.57% from 9.02% in 1994. This increase was comparable to the national trend that saw the prime rate increase from 7.75% at November of 1994 to 8.75% at December of 1995. Rates paid on deposits also increased in 1995, but only 28 basis points, to 3.28% from 3.00% in 1994, as total interest expense increased $40,000 in 1995. The Bank also benefited from a slight drop in interest-bearing deposits offset partially by an increase in noninterest-bearing demand deposits. The combination of these factors in 1995 increased the net yield on interest-earning assets 51 basis points from 6.83% in 1994 to 7.34% in 1995. 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). 6 MONTHS ENDED JUNE 30, 1997 YEAR ENDED DECEMBER 31, 1996 YEAR ENDED DECEMBER 31, 1995 VERSUS VERSUS VERSUS 6 MONTHS ENDED JUNE 30, 1996 YEAR ENDED DECEMBER 31, 1995 YEAR ENDED DECEMBER 31, 1994 ------------------------------ ------------------------------ ------------------------------ INCREASE (DECREASE) DUE INCREASE (DECREASE) DUE INCREASE (DECREASE) DUE TO CHANGE IN TO CHANGE IN TO CHANGE IN ------------------------------ ------------------------------ ------------------------------ VOLUME RATE TOTAL VOLUME RATE TOTAL VOLUME RATE TOTAL --------- ------- -------- ---------- ------- --------- --------- ------- -------- INTEREST-EARNING ASSETS: Investment Securities $ 67 $ 24 $ 91 $ 117 $ 20 $ 137 $( 7) $ 36 $ 29 Federal Funds Sold 75 ( 10) 65 97 ( 15) 82 54 35 89 Other Earning Assets - - - - - - ( 3) 2 ( 1) Loans 3,116 50 3,166 2,571 229 2,800 16 219 235 ------- ------- ------- ------- ------ ------- -------- ------- ------- Total Interest Income 3,258 64 3,322 2,785 234 3,019 60 292 352 INTEREST-BEARING LIABILITIES: Money Market and NOW 139 ( 49) 90 129 ( 6) 123 ( 50) ( 16) ( 66) Savings 158 41 199 185 49 234 ( 18) ( 1) ( 19) Time Deposits under $100,000 336 23 359 296 18 314 2 50 52 Time Deposits $100,000 or More 458 ( 40) 418 341 3 344 33 40 73 ------- ------- ------- ------- ------ ------- -------- ------- ------- Total Interest Expense 1,091 ( 25) 1,066 951 64 1,015 ( 33) 73 40 ------- ------- ------- ------- ------ ------- -------- ------- ------- Net Interest Income $ 2,167 $ 89 $ 2,256 $ 1,834 $ 170 $ 2,004 $ 93 $ 219 $ 312 ------- ------- ------- ------- ------ ------- -------- ------- ------- ------- ------- ------- ------- ------ ------- -------- ------- ------- 43 PROVISION FOR LOAN LOSSES During 1996, the provision for loan losses was $344,500 an increase of $82,500 from the $262,000 provision in 1995. This increase was primarily due to increased net charge-offs which totaled $414,000 in 1996 compared to $218,000 in 1995. Charge-offs in 1996 increased primarily due to the increased volume in loans related to the acquisition of BOW. At December 31, 1996, the allowance for loan losses was 1.88% of loans, a slight increase over the 1.84% at December 31, 1995. The provision for loan losses decreased $161,000 to $262,000 in 1995 compared to the $423,000 provision in 1994. This decrease was primarily due to a decrease in net loan charge-offs. During the same period, the allowance for loan losses to total loans decreased slightly to 1.84% at December 31, 1995 compared to 1.90% at December 31, 1994. NONINTEREST INCOME The Bank receives noninterest income from three primary sources: service charges and fees on accounts and banking services, fees and premiums generated by the Mortgage Loan Division, and fees, premiums, and servicing income generated by the SBA Loan Division. For the six-months ended June 30, 1997, noninterest income was $5.7 million compared to $3.4 million for the same period in 1996. The majority of this increase ($2.0 million) was generated by the Bank's SBA and Mortgage Loan Divisions who were able to expand their operations in 1997. The acquisition of BOW also increased service charge income by $300,000. During 1996, noninterest income increased $2 million to $7.7 million compared to $5.7 million in 1995. The majority of this increase ($1.7 million) was generated by the Bank's SBA and Mortgage Loan Divisions. During 1996, the Mortgage Loan Division's noninterest income was $4.5 million (representing 58% of the Bank's total noninterest income), an increase of $1.2 million or 36% more than the 1995 total of $3.3 million. The SBA Loan Division also experienced a significant increase in 1996 as total noninterest income from that division reached $2.4 million, a 26% increase over the 1995 total of $1.9 million. Service charges, fees and other income also increased in 1996 due to the acquisition of BOW. During 1995, total noninterest income was $5.7 million, an increase of 50% over $3.8 million in 1994. This increase was also generated primarily by increases in the Mortgage and SBA Loan Divisions. NONINTEREST EXPENSE Noninterest expense for the first six months of 1997 was $8.3 million compared to $4.6 million for the same period of 1996. The acquisition of BOW in June of 1996 generated the majority of this increase. Noninterest expenses in 1996 totaled $10.7 million, or approximately a 50% increase over the 1995 amount of $7.1 million. The majority of this increase ($1.8 million) was created by increased salaries and employee benefits generated by the acquisition of BOW and the Mortgage and the SBA Loan Divisions. Compensation in these divisions are primarily incentive-based, therefore, significant increases in the volume of loan originations results in significant increases in salaries and incentive payments (see "General" and "Noninterest Income"). Increases in occupancy expenses and furniture and equipment were primarily related to the acquisition of BOW. Other expenses increased $1.4 million, primarily due to the acquisition of BOW, increases in OREO expenses and contracted costs of loan packaging and processing related to the volume increases in the SBA and Mortgage Loan Divisions. Noninterest expenses in 1995 totaled $7.1 million, or approximately a 25% increase over the 1994 amount of $5.7 million. The majority of this increase was created by increased salaries and employees benefits, especially in the Mortgage and the SBA Loan Divisions. 44 INCOME TAXES Income tax expense was $884,000, $717,000, and $335,000 for the years ended December 31, 1996, December 31, 1995, and December 31, 1994, respectively. These expenses resulted in an effective tax rate of 42% in 1996 and 41% for 1995 and 1994. INVESTMENT ACTIVITY The following table summarizes the amounts and distribution of the Bank's investment securities held as of the dates indicated, and the weighted average yields as of June 30, 1997 (dollar amounts in thousands): JUNE 30, 1997 DECEMBER 31, ------------------------------ --------------------------------------- 1996 1995 WEIGHTED ------------------ ------------------- BOOK MARKET AVERAGE BOOK MARKET BOOK MARKET VALUE VALUE YIELD VALUE VALUE VALUE VALUE -------- -------- ----------- -------- -------- -------- --------- AVAILABLE-FOR-SALE SECURITIES: OTHER SECURITIES Within One Year $1,350 $1,350 5.47% $3,000 $3,000 ------ ------ ------ ------ Total Other Securities 1,350 1,350 5.47% 3,000 3,000 ------ ------ ------ ------ Total Available-for-Sale Securities $1,350 $1,350 5.47% $ - $ - $3,000 $3,000 ------ ------ ------- ------- ------ ------ ------ ------ ------- ------- ------ ------ HELD-TO-MATURITY SECURITIES: U.S. TREASURIES: Within One Year $ 500 $ 500 6.23% $ 500 $ 504 One to Five Years 798 802 6.28% 799 802 ------ ------ ------- ------- Total U.S. Treasuries Securities 1,298 1,302 6.26% 1,299 1,306 U.S. GOVERNMENT AND AGENCY SECURITIES: Within One Year 999 995 4.10% 999 987 951 979 One to Five Years 2,950 2,973 6.24% 2,935 2,957 298 306 ------ ------ ------- ------- ------ ------ Total U.S. Government and Agency Securities 3,949 3,968 5.70% 3,934 3,944 1,249 1,285 MUNICIPAL SECURITIES One to Five Years 541 536 3.40% 541 533 543 529 ------ ------ ------- ------- ------ ------ Total Municipal Securities 541 536 3.40% 541 533 543 529 ------ ------ ------- ------- ------ ------ Total Held-to-Maturity Securities $5,788 $5,806 5.54% $ 5,774 $ 5,783 $1,792 $1,814 ------ ------ ------- ------- ------ ------ ------ ------ ------- ------- ------ ------ Securities may be pledged to meet security requirements imposed as a condition to receipt of deposits of public funds and other purposes. At June 30, 1997, December 31, 1996 and 1995, the carrying values of securities pledged to secure public deposits and other purposes were $6,138,000, $3,321,000 and $1,792,000, respectively. --------------------------- (4) Other securities consist of a Cash Fund that invests in U.S. Government Securities. (5) The only tax exempt securities held by the Bank are those issued by municipalities. The weighted average yields for those investments are not presented on a tax equivalent basis. 45 LOANS HELD FOR SALE The Bank originates mortgage loans and SBA loans for sale to institutional investors. Loans held for sale have increased from $10.0 million at December 31, 1994, to $10.2 million at December 31, 1995, to $24.4 million at December 31, 1996 to $41.4 million at June 30, 1997. Generally, the Bank sells these loans within thirty (30) days of origination, but may hold these loans for longer periods depending on market conditions. At December 31, 1996 and 1995, the Bank was servicing approximately $44,194,000 and $23,929,000, respectively, in SBA loans previously sold. In connection with a portion of these loans, the Bank has capitalized approximately $1,249,000 and $632,000 in excess servicing receivables at December 31, 1996 and 1995, respectively. Excess servicing receivables are amortized over the estimated life of the serviced loan using a method that approximates the interest method. The Bank evaluates the carrying value of the excess servicing receivables by estimating the excess future servicing income, based on management's best estimate of the remaining loan lives. When the Bank sells the guaranteed portion of SBA loans, the cost allocated to the portion of the loan retained is based on the relative fair value of all components of the loan, including excess servicing receivables. The Bank has recorded discounts of approximately $1,063,000 and $312,000 at December 31, 1996 and 1995, respectively in connection with these loans. These discounts are amortized over the estimated life of each loan using the interest method. 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, JUNE 30, ------------------------ 1997 1996 1995 ---------- -------- --------- LOANS Commercial $17,978 $13,577 $ 5,686 Real Estate - Construction 3,254 3,101 17 Real Estate - Other 42,629 44,218 24,129 Consumer 5,659 3,348 1,636 ------- ------- -------- Total Loans 69,520 64,244 31,468 Net Deferred Loan Costs 400 305 29 Allowance for Loan Losses (1,182) (1,210) (580) ------- ------- -------- Net Loans $68,738 $63,339 $ 30,917 ------- ------- -------- ------- ------- -------- COMMITMENTS Standby Letters of Credit $ 557 $ 96 $ 143 Undisbursed Loans and Commitments to Grant Loans 12,225 11,356 6,016 ------- ------- -------- Total Commitments $12,782 $11,452 $ 6,159 ------- ------- -------- ------- ------- -------- The increase in loans during 1996 was primarily attributable to the acquisition of BOW. 46 LOAN PORTFOLIO - CONTINUED The majority of the loans have floating rates tied to the Bank's base rate or other market rate indicator. This serves to lessen the risk to the Bank from movement in interest rates, particularly rate increases. The following table shows the maturity of fixed rate loans and the repricing frequency of floating rate loans outstanding as of June 30, 1997 (dollar amounts in thousands - includes loans held for sale): TOTAL MATURITY/REPRICING FREQUENCY LOANS PERCENT - --------------------------------- --------- ---------- Three Months or Less $21,859 31.4% Over Three Months through 12 Months 6,087 8.8 Over One Year through Five Years 36,648 52.7 Over Five Years 4,926 7.1 --------- ---------- $69,520 100.0% --------- ---------- --------- ---------- NONPERFORMING ASSETS The following table provides information with respect to the components of the Bank's nonperforming assets at the dates indicated (dollar amounts in thousands): FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED DECEMBER 31, JUNE 30, ----------------------- 1997 1996 1995 -------- ------- -------- Loans 90 Days Past Due and Still Accruing $ 730 $ 122 $ 149 Nonaccrual Loans 629 579 760 ------ ------ ------ Total Nonperforming Loans 1,359 701 909 Other Real Estate Owned 893 1,030 507 ------ ------ ------ Total Nonperforming Assets $2,252 $1,731 $1,416 ------ ------ ------ ------ ------ ------ Nonperforming Loans as a Percentage of Total Loans 1.94% 1.09% 2.88% Allowance for Loan Loss as a Percentage of Nonperforming Loans 86.98% 172.61% 63.81% Nonperforming Assets as a Percentage of Total Assets 1.48% 1.49% 2.37% Nonaccrual loans are generally past due 90 days or are loans that management believes the interest on which may not be collectible. Loans past due 90 days will continue to accrue interest only when management believes 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. Management believes these properties can be liquidated at or near their current fair value. 47 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 Bank's loans. The provision for loan losses was $344,500 in 1996 compared to $262,000 in 1995 and $423,000 in 1994. 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 SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED ------------------------------------- JUNE 30, 1997 1996 1995 1994 -------------- ------- ------- ------- OUTSTANDING LOANS(6): Average for the Period $70,480 $49,017 $31,492 $35,571 End of the Period $69,520 $64,244 $31,468 $28,267 ALLOWANCE FOR LOAN LOSSES: Balance at Beginning of Year $ 1,210 $ 580 $ 536 $ 413 Actual Charge-Offs: Commercial 240 280 133 331 Consumer 4 16 23 7 Real Estate - 144 77 49 ------- ------- ------- ------- Total Charge-Offs 244 440 233 387 Less Recoveries: Commercial 10 15 10 80 Consumer 5 6 2 6 Real Estate 6 5 3 1 ------- ------- ------- ------- Total Recoveries 21 26 15 87 ------- ------- ------- ------- Net Loans Charged-Off 223 414 218 300 Provision for Loan Losses 195 344 262 423 Allowance on Loans Acquired from BOW - 700 - - ------- ------- ------- ------- Balance at End of Period $ 1,182 $ 1,210 $ 580 $ 536 ------- ------- ------- ------- ------- ------- ------- ------- RATIOS:(7) Net Loans Charged-Off to Average Loans 0.63% 0.84% 0.69% 0.84% Allowance for Loan Losses to Total Loans 1.70% 1.88% 1.84% 1.90% Net Loans Charged-Off to Beginning Allowance for Loan Losses 36.86% 71.38% 40.67% 72.64% Net Loans Charged-Off to Provision for Loan Losses 114.36% 120.35% 83.21% 70.92% Allowance for Loan Losses to Nonperforming Loans 86.98% 172.61% 63.81% 190.07% - ---------------------------------- (6) Excludes loans held for sale. (7) Analyzed for June 30, 1997. 48 ALLOWANCE FOR LOAN LOSSES - CONTINUED Management believes that the allowance for loan losses is adequate. While management uses available information to recognize losses on loans and leases, future additions to the allowance may be necessary based on changes in economic conditions. In addition, both Federal and state regulators, as an integral part of their examination process, periodically review the Bank's allowance for loan losses and may recommend additions based upon their evaluation of the portfolio at the time of their examination. 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): JUNE 30, 1997 DECEMBER 31, 1996 DECEMBER 31, 1995 --------------------------- --------------------------- --------------------------- PERCENT OF PERCENT OF PERCENT OF LOANS IN EACH LOANS IN EACH LOANS IN EACH ALLOWANCE CATEGORY TO ALLOWANCE CATEGORY TO ALLOWANCE CATEGORY TO AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS ---------- -------------- ---------- -------------- ---------- -------------- Commercial $ 577 26% $ 659 21% $ 256 18% Real Estate - Construction 22 5% 56 5% 15 1% Real Estate 372 61% 378 69% 205 76% Consumer 72 8% 45 5% 27 5% Unallocated 139 N/A 72 N/A 77 N/A ------- ---- ------- ---- ------- ---- $ 1,182 100% $ 1,210 100% $ 580 100% ------- ---- ------- ---- ------- ---- ------- ---- ------- ---- ------- ---- DEPOSITS Deposits are the Bank's primary source of funds. At December 31, 1996, the Bank had a deposit mix of 44% in time and savings deposits, 25% in money market and NOW deposits, and 31% in noninterest-bearing demand deposits. The Bank's net interest income is enhanced by its 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, ------------------------------------------------------- JUNE 30, 1997 1996 1995 ------------------------ ------------------------ ----------------------- AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE BALANCE RATE BALANCE RATE BALANCE RATE ---------- -------- ---------- -------- -------- -------- NOW Accounts $ 11,972 2.16% $ 11,679 1.95% $ 6,583 2.07% Savings Deposits 17,564 3.89% 14,329 3.57% 9,008 3.09% Money Market Accounts 14,064 2.82% 9,895 3.52% 10,149 3.12% TCD Less than $100,000 17,355 6.11% 9,233 5.37% 3,702 4.92% TCD $100,000 or More 21,421 5.20% 8,526 5.58% 2,418 5.46% ---------- --------- -------- Total Interest-Bearing Deposits 82,376 4.26% 53,662 3.84% 31,860 3.28% Noninterest-Bearing Demand Deposits 34,295 N/A 25,400 N/A 17,163 N/A ---------- --------- -------- Total Average Deposits $ 116,671 3.01% $ 79,062 2.61% $ 49,023 2.13% ---------- ----- --------- ----- -------- ----- ---------- ----- --------- ----- -------- ----- 49 DEPOSITS - CONTINUED The scheduled maturity distribution of the Bank's time deposits of $100,000 or greater, as of June 30, 1997, were as follows (dollar amounts in thousands): Three Months or Less $ 9,290 Over Three Months to One Year 10,745 Over One Year to Five Years 1,332 ------- $21,367 ------- ------- LIQUIDITY AND LIABILITY MANAGEMENT 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 Bank's shareholders. The Bank manages its interest rate risk exposure by limiting the amount of long-term fixed rate loans it holds 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 the Bank's interest-earning assets and interest-bearing liabilities as of December 31, 1996, 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 (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: Federal Funds Sold $ 500 $ - $ - $ - $ 500 Investment Securities 992 799 3,983 - 5,774 Gross Loans 52,701 4,287 10,772 20,848 88,608 -------- -------- --------- --------- -------- Total 54,193 5,086 14,755 20,848 94,882 INTEREST-BEARING LIABILITIES: Money Market and NOW Deposits $ 25,831 $ - $ - $ - $ 25,831 Savings 18,324 - - - 18,324 Time Deposits 11,764 11,898 2,585 - 26,247 -------- -------- --------- --------- -------- Total 55,919 11,898 2,585 - 70,402 -------- -------- --------- --------- -------- Interest Rate Sensitivity Gap $( 1,726) $( 6,812) $ 12,170 $ 20,848 $ 24,480 -------- -------- --------- --------- -------- -------- -------- --------- --------- -------- Cumulative Interest Rate Sensitivity Gap $( 1,726) $( 8,538) $ 3,632 $ 24,480 $ 24,480 Ratio Based on Total Assets ( 1.48%) ( 7.33%) 3.12% 21.02% 21.02% - ---------------------- (8) Includes loans held for sale. 50 LIQUIDITY AND LIABILITY MANAGEMENT - CONTINUED Liquidity refers to the Bank's 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 customers and withdrawals from deposit accounts. The Bank's liquidity ratio is defined as: the sum of cash and due from banks net of reserve requirements, federal funds sold, interest-bearing deposits with other financial institutions and investments securities, less amounts pledged to secure deposits and for other purposes, divided by the sum of total deposits, less deposits secured by marketable securities and short-term borrowings. Using this definition at December 31, 1996, the Bank's liquidity ratio was 14.8%, compared to 24.0% at December 31, 1995. At December 31, 1996, the loan-to-deposit ratio (including loans held for sale) was 85.7%, as compared to 76.1% at December 31, 1995. CAPITAL RESOURCES Shareholders' equity averaged $8.7 million in 1996, an increase of $3.9 million or 82% compared to 1995. At December 31, 1996, shareholders' equity amounted to $12.9 million, an increase of $7.7 million or 68% over the prior year. During 1996, the Bank increased shareholders equity by $7.8 million in a secondary stock offering and redeemed its outstanding preferred stock for $1.0 million. 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, 1996, the Bank's capital exceeded all minimum regulatory requirements and the Bank was considered to be "well capitalized" as defined in the regulations issued by the FDIC. The Bank's risk-based capital ratios, shown below as of December 31, 1996 and June 30, 1997, have been computed in accordance with regulatory accounting policies. MINIMUM REQUIREMENTS JUNE 30, 1997 DECEMBER 31, 1996 ------------ ------------- ----------------- Tier 1 Leverage Capital Ratio 4% 8.0% 9.2% Tier 1 Risk Based Capital Ratio 8% 10.0% 11.8% Total Risk Based Capital Ratio 4% 11.1% 13.0% 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. 51 INFORMATION CONCERNING THE BUSINESS AND PROPERTIES OF THE HOLDING COMPANY ORGANIZATION The Holding Company was organized under the laws of California on April 17, 1997 at the direction of the Board of Directors of the Bank for the purpose of becoming a bank holding company by acquiring all of the outstanding Bank Common Stock. Mr. Robert Ucciferri has provided the Holding Company's initial capitalization of $1,500 by purchasing 150 shares of Holding Company Common Stock at $10.00 per share. Upon consummation of the Reorganization, these 150 shares will be repurchased, for the same aggregate sum of $1,500, and cancelled by the Holding Company, in accordance with the terms of the "BYL Bancorp Stockholder Agreement" attached hereto as Annex II. Prior to the Effective Time of the Merger, the Holding Company will purchase, for $1,000, and will own 100% of the common stock of the Merger Corp., a California corporation organized for the sole purpose of facilitating the Reorganization. At the Effective Time of the Merger, the outstanding shares of Merger Corp. Common Stock will be cancelled and will cease to be outstanding. See "BANK HOLDING COMPANY REORGANIZATION - ORGANIZATIONAL TRANSACTIONS." BUSINESS The Holding Company has not yet engaged in any substantial business activity. The Holding Company has filed with the Federal Reserve Board its notification for prior approval to become a bank holding company through the acquisition of 100% of the voting shares of the Bank pursuant to the BHC Act. Furthermore, the Holding Company and the Merger Corp. have filed applications with the FDIC and the Department of Financial Institutions, providing for the merger of the Merger Corp. with and into the Bank, and for the acquisition of the Bank by the Holding Company. See "BANK HOLDING COMPANY REORGANIZATION - REGULATORY APPROVALS." Upon consummation of the Reorganization, the Holding Company will own all of the common stock of the Surviving Bank, the Surviving Bank will be the Holding Company's wholly-owned bank subsidiary and the Holding Company will be registered as a bank holding company. There can be no assurances that the required approvals will be obtained, or as to conditions or timing of such approvals. Subject to constraints under the BHC Act, the Holding Company may acquire other financial institutions in the future. See "BANK HOLDING COMPANY REORGANIZATION - REASONS FOR THE REORGANIZATION." During the initial months following the consummation of the Reorganization, the principal business activity of the Holding Company will be to serve as the bank holding company for the Surviving Bank. At the present time, the Holding Company has no specific plans to engage in any activities other than acting as a bank holding company for the Surviving Bank. The Holding Company may, however, seek to raise additional equity capital through a sale of Holding Company securities shortly following the Reorganization, although no specific proposals have been made at this time. MANAGEMENT The Board of Directors of the Holding Company consists of Leonard O. Lindborg, H. Rhoads Martin, Jr., Barry J. Moore, John F. Myers, Robert Ucciferri and Brent W. Wahlberg, all of whom are presently directors of the Bank and who will continue to serve as directors of the Holding Company until either the 1998 or 1999 annual meeting of shareholders of the Holding Company, depending when such director's class is to be elected and until their successors are elected and qualified, and 52 depending upon the Holding Company becoming a "listed corporation,' which is intended to occur upon the consummation of the Reorganization. It is anticipated that, initially, directors of the Holding Company will receive no fees for their attendance at Holding Company Board of Directors meetings. For additional information regarding the directors, see "SOLICITATION OF PROXIES - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT." The officers of the Holding Company are, and upon consummation of the Reorganization will continue to be, Mr. Ucciferri, who will serve as President and Chief Executive Officer, Mr. Moore, who will serve as Executive Vice President and Chief Financial Officer, and Mr. Myers, who will serve as Secretary. It is expected that until the officers of the Holding Company begin to devote significant time to the separate management of the Holding Company's business, which is not expected to occur until such time as the Holding Company becomes actively involved in additional businesses, the officers will only receive compensation for services as directors, officers and employees of the Bank, and no separate compensation will be paid for their services to the Holding Company. At the present time, the Holding Company does not intend to employ any persons other than its officers. If the Holding Company establishes or acquires other businesses, it may add additional employees at that time. EMPLOYEES Currently, the Holding Company has no full-time or part-time employees. It is anticipated that the Holding Company will utilize the employees of the Surviving Bank without payment therefor until it becomes actively engaged in business. Thereafter, the Holding Company will pay the Surviving Bank for a fair and reasonable amount for all services furnished to it. PROPERTIES Currently, the Holding Company does not own or lease any property. It is anticipated that the Holding Company will utilize the premises of the Surviving Bank without payment therefor until it becomes actively engaged in business. Thereafter, the Holding Company will pay the Surviving Bank for a fair and reasonable amount for all services furnished to it. LEGAL PROCEEDINGS The Holding Company is not a party to any pending legal proceeding and is unaware of any proceeding being contemplated against it by any governmental entity. INFORMATION CONCERNING THE BUSINESS AND PROPERTIES OF THE BANK GENERAL The Bank is a commercial bank organized under the laws of the State of California and commenced operations on March 3, 1980. The Bank is not a member of the Federal Reserve System, and its deposits are insured by the FDIC to the maximum amount permitted under the Federal Deposit Insurance Act. As of June 30, 1997, the Bank had total assets of $152.1 million, total deposits of $136.4 million, and total shareholders' equity of $13.7 million. 53 MARKET AREA The Bank engages in the general business of banking throughout its primary market area of Yorba Linda, California and the surrounding area of Orange County by offering a wide range of banking products and services, including (i) originating and selling of Nonconforming Mortgages and SBA guaranteed loans; (ii) providing many types of business and personal savings, money market and demand accounts, and other consumer banking services; and (iii) originating several other types of loans, including secured and unsecured commercial and consumer loans, commercial real estate loans, and commercial and residential construction loans. The Bank maintains its main office in Yorba Linda, and presently operates three (3) full service branches in Costa Mesa, California, Westminster, California, and Huntington Beach, California, and a limited service branch office in Laguna Hills, California. Each banking office concentrates on servicing the local community in which it is located. The Bank also maintains a mortgage banking office in Tustin, California and a SBA loan office in Mission Viejo, California. The Bank's target market is small-to-medium size businesses, professionals, general retail customers and the local community. The Bank relies almost entirely on a foundation of locally generated core deposits. Core deposits are defined as deposits held by the Bank on the basis of a direct and ongoing relationship between the Bank and depositor, and not solely on the basis of competitive price considerations. Core deposits include the following types of deposit accounts: noninterest bearing demand deposits, money market and NOW, and savings accounts. OPERATING STRATEGY The Bank's operating strategy emphasizes (i) expanding its programs for originating and selling N/C Mortgages and SBA guaranteed loans; (ii) continued focus on providing personalized, quality banking products to small- and medium-size businesses, professionals, general retail customers and to the local community; and (iii) continued expansion of the Bank, primarily in Orange County, California, through internal growth and through selective acquisitions of financial institutions or the selective acquisition of branches of such institutions (the Bank has no written or oral agreements for such acquisitions at this time). ACQUISITION Following the receipt of all necessary regulatory approvals, the Bank completed the acquisition of Bank of Westminster ("BOW") on June 14, 1996 pursuant to the terms of the Agreement and Plan of Reorganization dated January 12, 1996 in which the Bank organized and established a wholly-owned subsidiary of the Bank for the sole purpose of facilitating the merger of BOW with the Bank. The subsidiary was consolidated with BOW under the name and charter of BOW (the "Consolidation"), and , immediately thereafter, the consolidated corporation was merged with and into the Bank (the "Merger"). The Bank acquired 100% of the outstanding common stock of BOW for $6.17 million in cash. BOW had total assets of $54.92 million. The acquisition was accounted for using the purchase method of accounting in accordance with Accounting Principles Board Opinion No. 16. "Business Combinations." Under this method of accounting, the purchase price was allocated to the assets acquired and deposits and liabilities assumed based on their fair values as of the acquisition date. The financial statements include the operations of BOW from the date of the acquisition. Goodwill arising from the transaction totaled approximately $1.717 million is being amortized over fifteen years on a straight-line basis. 54 The Bank may consider acquiring other banks and/or additional branches as permitted by California law. However, the Bank has no other written or oral agreements regarding any such activities. There can be no assurance, however, that appropriate acquisition candidates will be located, that the Bank will have sufficient capital resources to effect the acquisitions, that necessary regulatory approvals could be obtained, or that the acquisitions, if made, would be profitable for the Bank. SECONDARY STOCK OFFERING During 1996, the Bank completed a secondary stock offering underwritten on a firm commitment basis by Ryan, Beck & Co. In connection with this offering, the Bank issued 805,000 shares of common stock generating $7.8 million in additional capital, net of underwriting discounts and transaction costs of $1.1 million. Proceeds from this offering were used, in part, to fund the acquisition of BOW. LENDING ACTIVITIES Under applicable regulations, the Bank originates, purchases and sells loans, or participating interests in loans. See "Supervision and Regulation" for a description of applicable regulations which limit lending in relation to assets or net worth. The Bank originates, purchases and participates in loans for its own portfolio and for sale in the secondary market. Lending activities include the origination and purchase of long-term adjustable-rate and to a lesser extent fixed-rate conforming and nonconforming residential mortgage loans, construction loans, commercial business, commercial real estate loans, SBA loans, and consumer loans. Approximately 80% of the Bank's mortgage loans are secured by property located in California with the remaining 20% secured by properties throughout the continental United States. 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 received by the Bank on loans extended to its customers and securities held in the Bank investment portfolios will comprise the 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 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. 55 COMPETITION The Bank faces substantial competition for deposits and loans throughout its market area. Competition for loans comes from other commercial banks, saving institutions, mortgage banking firms, credit unions, thrift and loans and other financial intermediaries. Many of the financial intermediaries operating in the Bank's market areas offer certain services, such as trust and international banking services, which the Bank does not offer directly. Additionally, banks with larger capitalization and financial intermediaries not subject to bank regulatory restrictions have larger lending limits and are thereby able to serve the credit needs of larger customers. In order to compete, the Bank relies upon personal contacts by the officers, directors and employees of the Bank to establish and maintain relationships with Bank customers. The Bank focuses its efforts on the needs of professionals, construction businesses and small and medium-sized businesses. In the event there are customers whose loan demands exceed the Bank's lending limit, the Bank seeks to arrange for such loans on a participation basis with other financial institutions and intermediaries. The Bank also assists those customers requiring other services not offered by the Bank to obtain such services from its correspondent banks. Management of the Bank believes that a portion of its customer base is from customers who were dissatisfied with the level of service provided at larger financial institutions. While some of such customers have followed officers of those institutions who were hired by the Bank, others were attracted to the Bank by referrals from other customers. These personal relationships, providing a high level of customer service, and referrals from satisfied customers form the basis of the Bank's competitive approach. The Bank also utilizes advertising, rate competition and the development of proprietary banking products, services or programs. In the past, the principal competition for deposits and loans have been banks (particularly major banks), savings and loan associations and credit unions. To a lesser extent thrift and loan companies, mortgage brokerage companies and insurance companies also have provided competition. Recent federal and state legislation increased competition by expanding the authority of savings and loan associations to make consumer and commercial loans. Legislation has eliminated all interest rate differentials between banks and savings and loans, further increasing the ability of savings and loan to compete with commercial banks and thrift and loan companies. In the past several years, other financial intermediaries have begun to offer financial services traditionally offered by banks. Institutions, such as brokerage houses and even retail establishments also offer new investment vehicles such as money-market funds. Other entities, both public and private, seeking to raise capital through the issuance and sale of debt or equity securities are also competitors with banks and savings and loan associations in the acquisition of deposits. In 1982, federal legislation authorized certain financial institutions to pay money-market interest rates on certain types of accounts. This has led to increased competition between financial institutions and money-market funds and has increased the Bank's relative cost of funds. Within the financial institution industry, the trend has been towards offering more varied services, such as discount brokerage services, often through affiliate relationships. The direction of Federal legislation seems to favor competition between different types of financial institutions and to foster new entries into the financial services market. 56 EMPLOYEES At June 30, 1997, the Bank employed 146 full-time equivalent persons. The Bank believes that its employee relations are satisfactory. There is no collective bargaining agreement in place with any of the Bank's employees. PREMISES The Bank's principal office is located in a free standing two story building in the City of Yorba Linda. The building was constructed for the Bank on 55,000 square feet of land in a shopping center leased in 1981. The lease runs through 2002, with six five-year options to extend. The Bank also entered into a lease in May 1993 for approximately 4,742 square feet of space to house its Costa Mesa office. These premises were already improved to house a financial institution branch office. The lease has a term of five years with two five-year options to extend. The Bank owns its branch facility in Westminster, which is a free standing, two story building of approximately 24,653 square feet constructed in 1979 on 53,317 square feet of land. The Bank owns its branch facility in Huntington Beach, which is a free standing building of approximately 8,962 square feet constructed in 1986 on 37,956 square feet of land. The Bank has also entered into a lease dated March 18, 1997 for approximately 1869 square feet in Laguna Hills for a limited service branch. The lease has a term of three years. The Bank has also entered into a lease dated December 22, 1995 for approximately 3,330 square feet of space in Mission Viejo to house its SBA Lending Division. The lease has a term of three years with a three-year option to extend. The Bank has also entered into a lease dated June 28, 1996 for approximately 7,330 square feet in Tustin to house its Mortgage Loan Division. The lease has a term of six years with two six-year options to extend. LEGAL PROCEEDINGS There are no material pending legal proceedings, other than ordinary, routine litigation incidental to the Bank's business, to which the Bank is a party or of which any of its property is subject. SUPERVISION AND REGULATION OF THE HOLDING COMPANY AND THE BANK THE HOLDING COMPANY If the Reorganization is consummated, the Holding Company, as a registered bank holding company, will be subject to regulation under the BHC Act. The Holding Company will be required to file with the Federal Reserve Board quarterly and annual reports and such additional information s the Federal Reserve Board may require pursuant to the BHC Act. The Federal Reserve Board may conduct examinations of the Holding Company and its subsidiaries. 57 The Federal Reserve Board may require that the Holding Company terminate an activity or terminate control of or liquidate or divest certain subsidiaries or affiliates when the Federal Reserve Board believes the activity or the control or the subsidiary or affiliate 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 Holding Company would be required to file written notice and obtain approval from the Federal Reserve Board prior to purchasing or redeeming its equity securities. Under the BHC Act and regulations adopted by the Federal Reserve Board, a bank holding company and its nonbanking subsidiaries are prohibited from requiring certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. Further, the Holding Company is required by the Federal Reserve Board to maintain certain levels of capital. See "SUPERVISION AND REGULATION OF THE HOLDING COMPANY AND THE BANK - EFFECT OF GOVERNMENTAL POLICIES AND RECENT LEGISLATION - CAPITAL ADEQUACY GUIDELINES." The Holding Company will be required to obtain the prior approval of the Federal Reserve Board for the acquisition of more than 5% of the outstanding shares of any class of voting securities or substantially all of the assets of any bank or bank holding company. Prior approval of the Federal Reserve Board will also be required for the merger or consolidation of the Holding Company and another bank holding company. The Holding Company will be prohibited by the BHC 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 Holding Company would be able, subject to the prior approval of the Federal Reserve Board, to 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. In making any such determination, the Federal Reserve Board is required to consider whether the performance of such activities by the Holding Company or an affiliate can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition or gains in efficiency, that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. The Federal Reserve Board is also empowered to differentiate between activities commenced DE NOVO and activities commenced by acquisition, in whole or in part, of a going concern and is generally prohibited from approving an application by a bank holding company to acquire voting shares of any commercial bank in another state unless such acquisition is specifically authorized by the laws of such other state. 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 or 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. 58 The Holding Company will also be a bank holding company within the meaning of Section 3700 of the California Financial Code. As such, the Holding Company and its subsidiaries would be subject to examination by, and may be required to file reports with, the Commissioner. Finally, the Holding Company will be subject to the periodic reporting requirements of the Securities Exchange Act of 1934, as amended, including but not limited to, filing annual, quarterly and other current reports with the Securities and Exchange Commission. THE BANK The Bank, as a California state-chartered bank, is subject to primary supervision, periodic examination and regulation by the Commissioner. The Bank is also subject to certain regulations of the Federal Deposit Insurance Corporation if the FDIC should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity or other aspects of the Bank's operations are unsatisfactory or that the Bank or its management is violating or has violated any law or regulation, various remedies are available to the FDIC. Such remedies include the power to enjoin "unsafe or unsound" practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict the growth of the Bank, to assess civil monetary penalties, to remove officers and directors and ultimately to terminate the Bank's deposit insurance, which for a California state-chartered bank, would result in revocation of the Bank's charter. The Commissioner has many of the same remedial powers. The Bank is insured by the FDIC, which currently insured deposits of each member bank to a maximum of $100,000 per depositor. For this protection, the bank, as is the case with all insured banks, pays a semi-annual statutory assessment and is subject to the rules and regulations of the FDIC. See "SUPERVISION AND REGULATION OF HOLDING COMPANY AND BANK - EFFECT OF GOVERNMENTAL POLICIES AND RECENT LEGISLATION." Various requirements and restrictions under the laws of California and the United States affect the operations of the Bank. State and federal statutes and regulations 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. See "SUPERVISION AND REGULATION OF THE HOLDING COMPANY AND THE BANK - EFFECT OF GOVERNMENTAL POLICIES AND RECENT LEGISLATION - CAPITAL ADEQUACY GUIDELINES." There are statutory and regulatory limitations on the amount of dividends by state chartered banks to the lesser of retained earnings or the bank's net income for its last three fiscal years (less any distributions to shareholders made during such period). In the event a bank has not retained earnings or net income for its last three fiscal years, cash dividends may be paid in an amount not exceeding the net income for such bank's last preceding fiscal year only after obtaining the prior approval of the Commissioner. Furthermore, the FDIC also has authority to prohibit the Bank from engaging in what, in the FDIC's opinion, constitutes an unsafe or unsound practice in conducting its business. It is possible, depending upon the financial condition of the bank in questions and other factors, that the FDIC could assert that the payment of dividends or other payments might, under some circumstances, be such an unsafe or unsound practice. Further, the FDIC and the Federal Reserve Board have established guidelines with respect to the maintenance of appropriate levels of capital by banks or bank holding 59 companies under their jurisdiction. Compliance with the standards set forth in such guidelines and the restrictions that are or may be imposed under the prompt corrective action provisions of the FDIC Improvement Act could limit the amount of dividends which the Bank may pay. See "SUPERVISION AND REGULATION OF THE HOLDING COMPANY AND THE BANK - FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991 - PROMPT CORRECTIVE REGULATORY ACTION" AND "- CAPITAL ADEQUACY GUIDELINES" for a discussion of these additional restrictions on capital distributions. The Bank is subject to certain restrictions imposed by federal law on any extensions of credit to, or the issuance of a guarantee or letter of credit on behalf of its affiliates, the purchase of or investments in stock or other securities thereof, the taking of such securities as collateral for loans and the purchase of assets of its affiliates. Such restrictions prevent its affiliates from borrowing from the Bank unless the loans are secured by marketable obligations of designated amounts. Further, such secured loans and investments by the Bank in any other affiliate is limited to 10% of the Bank's capital and surplus (as defined by federal regulations) and such secured loans and investments are limited, in the aggregate, to 20% of the Bank's capital and surplus (as defined by federal regulations). California law also imposes certain restrictions with respect to transactions involving controlling persons of the Bank. Additional restrictions on transactions with affiliates may be imposed on the Bank under the prompt corrective action provisions of the FDIC Improvement Act. See "SUPERVISION AND REGULATION OF THE HOLDING COMPANY AND THE BANK - EFFECT OF GOVERNMENTAL POLICIES AND RECENT LEGISLATION - FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991 - PROMPT CORRECTIVE REGULATORY ACTION." The Bank is also subject to the periodic reporting requirements of the Securities Exchange Act of 1934, as amended, including, but not limited to, filing annual, quarterly, and other current reports with the FDIC. EFFECT OF GOVERNMENTAL POLICIES AND RECENT LEGISLATION 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 Federal Reserve Board. The Federal Reserve Board implements national monetary policies (with objectives such as curbing inflation and combating recession) by its open-market operations in United States Government securities, by adjusting the required level of reserves for financial intermediaries subject to its reserve requirements and by varying the discount rates applicable to borrowings by depository institutions. The actions of the Federal Reserve Board in these areas 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 of any future changes in monetary policies cannot be predicted. From time to time, legislation is enacted which has the effect of increasing the cost of doing business, limiting or expanding permissible activities or affecting the competitive balance between banks and other financial intermediaries. Proposals to change the laws and regulations governing the operations and taxation of banks, bank holding companies and other financial intermediaries are frequently made in Congress, in the California legislature and before various bank regulatory and other professional agencies. The likelihood of any major changes and the impact such changes might have on the Bank are impossible to predict. Certain of the potentially significant changes which have been enacted and proposals which have been made recently are discussed below. Federal Deposit Insurance Corporation Improvement Act of 1991. On December 19, 1991, the FDIC Improvement Act was enacted into law. Set forth below is a brief discussion of certain 60 portions of this law and implementing regulations that have been adopted or proposed by the Federal Reserve Board, the Comptroller of the Currency ("Comptroller"), the Office of Thrift Supervision ("OTS") and the FDIC (collectively, the "federal banking agencies"). STANDARDS FOR SAFETY AND SOUNDNESS. The FDIC Improvement Act requires the federal banking agencies to prescribe, by regulation, standards for all insured depository institutions and depository institution holding companies relating to internal controls, loan documentation, credit underwriting, interest rate exposure and asset growth. Standards must also be prescribed for classified loans, earnings and the ratio of market value to book value for publicly traded shares. The FDIC Improvement Act also requires the federal banking agencies to issue uniform regulations prescribing standards for real estate lending that are to consider such factors as the risk to the deposit insurance fund, the need for safe and sound operation of insured depository institutions and the availability of credit. Further, the FDIC Improvement Act requires the federal banking agencies to establish standards prohibiting compensation, fees and benefit arrangements that are excessive or could lead to financial loss. In July 1992, the federal banking agencies issued a joint advance notice of proposed rule making requesting public comment on the safety and soundness standards required to be prescribed by the FDIC Improvement Act. The purpose of the notice is to assist the federal banking agencies in the development of proposed regulations. In accordance with the FDIC Improvement Act, final regulations must become effective no later than December 1, 1993. In December 1992, the federal banking agencies issued final regulations prescribing uniform guidelines for real estate lending. The regulations, which became effective March 19, 1993, require insured depository institutions to adopt written policies establishing standards, consistent with such guidelines, for extensions of credit secured by real estate. The policies must address loan portfolio management, underwriting standards and loan-to-value limits that do not exceed the supervisory limits prescribed by the regulations. PROMPT CORRECTIVE REGULATORY ACTION. The FDIC Improvement Act requires each federal banking agency to take prompt corrective action to resolve the problems of insured depository institutions that fall below one or more prescribed minimum capital ratios. The purpose of this law is to resolve the problems of insured depository institutions at the least possible long-term cost to the appropriate deposit insurance fund. 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 (significantly exceeding the required minimum capital requirements), adequately capitalized (meeting the required capital requirements), undercapitalized (failing to meet any one of the capital requirements), significantly undercapitalized (significantly below any one capital requirement) and critically undercapitalized (failing to meet all capital requirements). In September 1992, the federal banking agencies issued uniform final regulations implementing the prompt corrective action provisions of the FDIC Improvement Act. Under the regulations, an insured depository institution will be deemed to be: - "well capitalized" if it (i) has total risk-based capital of 10% or greater, Tier 1 risk-based capital of 6% or greater and a leverage capital ratio of 5% or greater and (ii) is not subject to an order, written agreement, capital directive or prompt corrective action directive to meet and maintain a specific capital level for any capital measure; 61 - "adequately capitalized" if it has total risk-based capital of 8% or greater, Tier 1 risk-based capital of 4% or greater and a leverage capital ratio of 4% or greater (or a leverage capital ratio of 3% or greater if the institution is rated composite 1 under the applicable regulatory rating system in its most recent report of examination); - "undercapitalized" if it has total risk-based capital that is less than 8%, Tier 1 risk-based capital that is less than 4% or a leverage capital ratio that is less than 4% (or a leverage capital ratio that is less than 3% if the institution is rated composite 1 under the applicable regulatory rating system in its most recent report of examination); - "significantly undercapitalized" if it has total risk-based capital that is less than 6%, Tier 1 risk-based capital that is less than 3% or a leverage capital ratio that is less than 3%; and - "critically undercapitalized" if it has a ratio of tangible equity to total assets that is equal to or less than 2%. An institution that, based upon its capital levels, is classified as well capitalized, adequately capitalized or undercapitalized may be reclassified to the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, (i) determines that the institution is an unsafe or unsound condition or (ii) deems the institution to be engaging in an unsafe or unsound practice and not to have corrected the deficiency. At each successive lower capital category, an insured depository institution is subject to more restrictions and federal banking agencies are given less flexibility in deciding how to deal with it. 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 62 of voting shares to raise capital or, if grounds exist for appointment of a receiver or conservator, a forced merger; (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 senior executive officers, subject to certain grandfather provisions for those elected prior to enactment of the FDIC Improvement Act; (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. The FDIC has adopted risk-based minimum capital guidelines 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. In addition to the risk-based guidelines, the FDIC requires banks to maintain a minimum amount of Tier 1 capital to total assets, referred to as the leverage ratio. For a bank rated in the highest of the five categories used by the FDIC to rate banks, the minimum leverage ratio of Tier 1 capital to total assets is 3%. For all banks not rated in the highest category, the minimum leverage ratio must be at least 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 FDIC has the discretion to set individual minimum capital requirements for specific institutions at rates significantly above the minimum guidelines and ratios. In August 1995, the federal banking agencies adopted final regulations specifying that the agencies will include, in their evaluations of a bank's capital adequacy, an assessment of the 63 exposure to declines in the economic value of the bank's capital due to changes in interest rates. The final regulations, however, do not include a measurement framework for assessing the level of a bank's exposure to interest rate risk, which is the subject of a proposed policy statement issued by the federal banking agencies concurrently with the final regulations. The proposal would measure interest rate risk in relation to the effect of a 200 basis point change in market interest rates on the economic value of a bank. Banks with high levels of measured exposure or weak management systems generally will be required to hold additional capital for interest rate risk. The specific amount of capital that may be needed would be determined on a case-by-case basis by the examiner and the appropriate federal banking agency. Because this proposal has only recently been issued, the Bank currently is unable to predict the impact of the proposal on the Bank if the policy statement is adopted as proposed. In January 1995, the federal banking agencies issued a final rule relating to capital standards and the risks arising from the concentration of credit and nontraditional activities. Institutions which have significant amounts of their assets concentrated in high risk loans or nontraditional banking activities and who fail to adequately manage these risks, will be required to set aside capital in excess of the regulatory minimums. The federal banking agencies have not imposed any quantitative assessment for determining when these risks are significant, but have identified these issues as important factors they will review in assessing an individual bank's capital adequacy. In December 1993, 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. As of September 30, 1996, the Bank had a total risk-based capital ratio of 15.90%, a Tier 1 risk-based capital ratio of 14.65% and a leverage capital ratio of 9.49%. The Bank is considered to be well capitalized as of September 30, 1996. A subsequent reduction in the Bank's capital could cause it to fall within a lower capital category and subject it to the mandatory and discretionary sanctions applicable to that category. Further, as noted above, an institution that, based upon its capital levels, is well capitalized, adequately capitalized or undercapitalized can, under certain circumstances, be reclassified to the next lower capital category. OTHER ITEMS. The FDIC Improvement Act also, among other things, (i) limits the percentage of interest paid on brokered deposits and limits the unrestricted use of such deposits to only those institutions that are well capitalized; (ii) requires the FDIC to charge insurance premiums based on the risk profile of each institution; (iii) eliminates "pass through" deposit insurance for certain employee benefit accounts unless the depository institution is well capitalized or, under certain circumstances, adequately capitalized; (iv) prohibits insured state chartered banks from engaging as principal in any type of activity that is not permissible for a national bank unless the FDIC permits such activity and the bank meets all of its regulatory capital requirements; (v) directs the appropriate federal banking agency to determine the amount of readily marketable purchased mortgage servicing rights that may be included in calculating such institution's tangible, core and risk-based capital; and (vi) provides that, subject to certain limitations, any federal savings association may acquire or be acquired by any insured depository institution. In addition, the FDIC has issued final and proposed regulations implementing provisions of the FDIC Improvement Act relating to powers of insured state banks. Final regulations issued in October 64 1992 prohibit insured state banks from making equity investments of a type, or in an amount, that are not permissible for national banks. In general, equity investments include equity securities, partnership interests and equity interests in real estate. Under the final regulations, non-permissible investments must be divested by no later than December 19, 1996. The Bank has no such non-permissible investments. Regulations issued in December 1993 prohibit insured state banks from engaging as principal in any activity not permissible for a national bank, without FDIC approval. The proposal also provides that subsidiaries of insured state banks may not engage as principal in any activity that is not permissible for a subsidiary of a national bank, without FDIC approval. The impact of the FDIC Improvement Act on the Bank is uncertain, especially since many of the regulations promulgated thereunder have only been recently adopted and certain of the law's provisions still need to be defined through future regulatory action. Certain provisions, such as the recently adopted real estate lending standards and the limitations on investments and powers of state banks and the rules to be adopted governing compensation, fees and other operating policies, may affect the way in which the Bank conducts its business, and other provisions, such as those relating to the establishment of the risk-based premium system, may adversely affect the Bank's results of operations. Furthermore, the actual and potential restrictions and sanctions that apply to or may be imposed on undercapitalized institutions under the prompt corrective action and other provisions of the FDIC Improvement Act may significantly adversely affect the operations and liquidity of the Bank, the value of its Common Stock and its ability to raise funds in the financial markets. CAPITAL ADEQUACY GUIDELINES. The FDIC has issued guidelines to implement the risk-based capital requirements. The guidelines are intended to establish a systematic analytical framework that makes regulatory capital requirements more sensitive to differences in risk profiles among banking organizations, takes off-balance sheet items into account in assessing capital adequacy and minimizes disincentives to holding liquid, low-risk assets. Under these guidelines, assets and credit equivalent amounts of off-balance sheet items, such as letters of credit and outstanding loan commitments, are assigned to one of several risk categories, which range from 0% for risk-free assets, such as cash and certain U.S. Government securities, to 100% for relatively high-risk assets, such as loans and investments in fixed assets, premises and other real estate owned. The aggregated dollar amount of each category is then multiplied by the risk-weight associated with that category. The resulting weighted values from each of the risk categories are then added together to determine the total risk-weighted assets. A banking organization's qualifying total capital consists of two components: Tier 1 capital (core capital) and Tier 2 capital (supplementary capital). Tier 1 capital consists primarily of common stock, related surplus and retained earnings, qualifying noncumulative perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries. Intangibles, such as goodwill, are generally deducted from Tier 1 capital; however, purchased mortgage servicing rights and purchase credit card relationships may be included, subject to certain limitations. At least 50% of the banking organization's total regulatory capital must consist of Tier 1 capital. Tier 2 capital may consist of (i) the allowance for possible loan and lease losses in an amount up to 1.25% of risk- weighted assets; (ii) perpetual preferred stock, cumulative perpetual preferred stock and long-term preferred stock and related surplus; (iii) hybrid capital instruments (instruments with characteristics of both debt and equity), perpetual debt and mandatory convertible debt securities; and (iv) eligible term subordinated debt and intermediate-term preferred stock with an original maturity of five years or more, including related surplus, in an amount up to 50% of Tier 1 65 capital. The inclusion of the foregoing elements of Tier 2 capital are subject to certain requirements and limitations of the federal banking agencies. The FDIC has also adopted a minimum leverage capital ratio of Tier 1 capital to average total assets of 3% for the highest rated banks. This leverage capital ratio is only a minimum. Institutions experiencing or anticipating significant growth or those with other than minimum risk profiles are expected to maintain capital well above the minimum level. Furthermore, higher leverage capital ratios are required to be considered well capitalized or adequately capitalized under the prompt corrective action provisions of the FDIC Improvement Act. SAFETY AND SOUNDNESS STANDARDS. In February 1995, the federal banking agencies adopted final guidelines establishing standards for safety and soundness, as required by FDICIA. The guidelines set forth operational and managerial standards relating to internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation, fees and benefits. Guidelines for asset quality and earnings standards will be adopted in the future. The guidelines establish the safety and soundness standards that the agencies will use to identify and address problems at insured depository institutions before capital becomes impaired. If an institution fails to comply with a safety and soundness standard, the appropriate federal banking agency may require the institution to submit a compliance plan. Failure to submit a compliance plan or to implement an accepted plan may result in enforcement action. In December 1992, the federal banking agency issued final regulations prescribing uniform guidelines for real estate lending. The regulations require insured depository institutions to adopt written policies establishing standards, consistent with such guidelines, for extensions of credit secured by real estate. The policies must address loan portfolio management, underwriting standards and loan to value limits that do not exceed the supervisory limits prescribed by the regulations. Appraisals for "real estate related financial transactions" must be conducted by either state-certified or state-licensed appraisers for transactions in excess of certain amounts. State-certified appraisers are required for all transactions with a transaction value of $1,000,000 or more; for all nonresidential transactions valued at $250,000 or more; and for "complex" 1-4 family residential properties of $250,000 or more. A state-licensed appraiser is required for all other appraisals. However, appraisals performed in connection with "federally related transactions" must now comply with the agencies' appraisal standards. Federally related transactions include the sale, lease, purchase, investment in, or exchange of, real property or interests in real property, the financing of real property, and the use of real property or interests in real property as security for a loan or investment, including mortgage backed securities. PREMIUMS FOR DEPOSIT INSURANCE. Federal law has established several mechanisms to increase funds to protect deposits insured by the 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 implemented a final risk-based assessment system, as required by FDICIA, effective January 1, 1994, under which an institution's premium assessment is based on the probability that 66 the deposit insurance fund will incur a loss with respect to the institution, the likely amount of any such loss, and the revenue needs of the deposit insurance fund. As long as BIF's reserve ratio is less than a specified "designated reserve ratio," 1.25%, the total amount raised from BIF members by the risk-based assessment system may not be less than the amount that would be raised if the assessment rate for all BIF members were .023% of deposits. 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 condition 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. Assembly Bill 3351 (the "Banking Consolidation Bill") became effective July 1, 1997, which creates the California Department of Financial Institutions ("DFI") to be headed by a Commissioner of Financial Institutions out of the existing California State Banking Department which regulates state chartered commercial banks and trust companies in California. The Banking Consolidation Bill, among other provisions, also (i) transfers regulatory jurisdiction over state chartered savings and loan associations from the Department of Savings and Loans ("DSL") to the newly created DFI and abolishes the DSL; (ii) transfers regulatory jurisdiction over state chartered industrial loan companies and credit unions from the Department of Corporations to the newly-created DFI; and (iii) establishes within the DFI separate divisions for credit unions, commercial banks, industrial loan companies and savings and loans. As the Banking Consolidation Bill has only recently been enacted, it is impossible to predict with any degree of certainty what impact it will have on the banking industry in general and the Bank in particular. Congress has recently passed, and the President has signed into law provisions to strengthen the Savings Association Insurance Fund (the "SAIF") and to repay outstanding bonds that were issued to recapitalize the SAIF's successor as result of payments made due to insolvency of savings and loan associations and other federally insured savings institutions in the late 1980's and early 1990's. The new law will require savings 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. In 2000, the banking industry will assume the bulk of the payments. The new law also aims to merge the Bank Insurance Fund and SAIF by 1999 but not until the bank and savings and loan charters are combined. The Treasury Department has until March 31, 1997 to deliver to Congress on combining the charters. Additionally, the new provides "regulatory relief" for the banking industry by effecting approximately 30 laws and regulations. The costs and benefits of the new law to the Bank can not currently be accurately predicted. INTERSTATE BANKING AND BRANCHING. On September 29, 1994, the President signed in law the Riegle-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 regulatory approval 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% 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 the bank 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 67 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 establish branches in a state other than its home state if permitted by the laws of that state, subject to the same requirement and conditions as for a merger transaction. Effective October 2, 1995, California adopted legislation which "opts California into" the Interstate Act. However, the California Legislation restricts out of state banks from purchasing branches or starting a de novo branch to enter the California banking market. Such banks may proceed only by way of purchases of whole banks. The Interstate Act is likely to increase competition in the Bank's market areas especially from larger financial institutions and their holding companies. It is difficult to asses the impact such likely increased competition will have on the Bank' operations. In 1986, California adopted an interstate banking law. The law allows California banks and bank holding companies to be acquired by banking organizations in other states on a "reciprocal" basis (i.e., provided the other state's law permit California banking organizations to acquire banking organizations in that state on substantially the same terms and conditions applicable to banking organizations solely within that state). The law took effect in two states. The first state allowed acquisitions on a "reciprocal" basis within a region consisting of 11 western states. The second stage, which became effective January 1, 1991, allows interstate acquisitions on a national "reciprocal" basis. California has also adopted similar legislation applicable to savings associations and their holding companies. On September 28, 1995, Governor Wilson signed Assembly Bill No. 1482, the Caldera, Weggeland, and Killea California Interstate Banking and Branching Act of 1995 (the "1995 Act"). The 1995 Act, which was filed with the Secretary of State as Chapter 480 of the Statutes of 1995, became operative on October 2, 1995. The 1995 Acts opts in early for interstate branching, allowing out-of-state banks to enter California by merging or purchasing a California bank or industrial loan company which is at least five years old. Also, the 1995 Act repeals the California Interstate (National) Banking Act of 1986, which regulated the acquisition of California banks by out-of-state bank holding companies. In addition, the 1995 Act permits California state banks, with the approval of the Commissioner of Financial Institutions, to establish agency relationships with FDIC-insured banks and savings associations. Finally, the 1995 Act provides for regulatory relief, including (i) authorization for the Commissioner to exempt banks from the requirement of obtaining approval before establishing or relocating a branch office or place of business, (ii) repeal of the requirement of directors' oaths (Financial Code Section 682), and (iii) repeal of the aggregate limit on real estate loans (Financial Code Section 1230). 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 financial institutions in meeting the credit needs of their local community, including low and moderate income neighborhoods. In addition to substantial penalties 68 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 May 1995, the federal banking agencies issued final regulations which change the manner in which they measure a bank's compliance with its CRA obligations. The final regulations adopt a performance-based evaluation system which bases CRA ratings on an institutions' actual lending service and investment performance rather than the extent to which the institution conducts needs assessments, documents community outreach or complies with other procedural requirements. In March 1994, the Federal Interagency Tax Force on Fair lending 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 February 1995, the federal banking agencies adopted final safety and soundness standards for all insured depository institutions. The standards, which were issued in the form of guidelines rather than regulations, relate to internal controls, information systems, internal audit systems, loan underwriting and documentation, compensation and interest rate exposure. In general, the standards are designed to assist the federal banking agencies in identifying and addressing problems at insured depository institutions before capital becomes impaired. If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to submit a compliance plan. Failure to submit a compliance plan may result in enforcement proceedings. Additional standards on earnings and classified assets are expected to be issued in the near future. CHANGES IN ACCOUNTING PRINCIPLES. In March of 1995, the FASB issued SFAS No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF. SFAS No. 121 establishes accounting standards for the impairment of long-lived assets, certain identifiable intangibles, and goodwill related to those assets to be held and used and for long-lived assets and certain identifiable intangibles to be disposed of. The statement does not apply to financial instruments long-term customer relationships of a financial institution (core deposits), mortgage and other servicing rights, and tax deferred assets. SFAS 121 requires the review of long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances include, for example, a significant decrease in market value of an assets, a significant change in use of an asset, or an adverse change in a legal factor that could affect the value of an asset. If such an event occurs and it is determined that the carrying value of the asset may not be recoverable, an impairment loss should be recognized a measured by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Fair value can be determined by a current transaction, quoted market prices, or present value of estimated expected future cash flows discounted at the appropriate rate. The statement is effective for fiscal years beginning after December 15, 1995. The implementation of SFAS No. 121 did not have a material impact on its results of operations or financial position. In May of 1995, the FASB issued SFAS 122, ACCOUNTING FOR MORTGAGE SERVICING RIGHTS. SFAS No. 122 eliminates distinctions between servicing rights that were purchased and those that were retained upon the sale of loans. The statement requires mortgage servicers to recognize as separate assets rights to service loans, no matter how the rights were acquired. Institutions who sell loans and retain the servicing rights will be required to allocate the total cost of the loans to servicing rights and loans based on their relative fair values if the value can be estimated. SFAS No. 122 is effective for fiscal years beginning after December 15, 1995. Further, SFAS No. 122 requires that all capitalized mortgage servicing rights be periodically evaluated for impairment based upon the current 69 fair value of these rights. This Statement, which is superseded by SFAS No.125, ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENT OF LIABILITIES, did not have a material effect on the Bank's financial condition and results of operations. In October of 1995, the FASB issued SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, establishing financial accounting and reporting standards for stock-based employee compensation plans. This statement encourages all entities to adopt a new method of accounting to measure compensation cost of all employee stock compensation pans based on the estimated fair value of the award at the date it is granted. Companies are, however, allowed to continue to measure compensation cost for those plans using the intrinsic value based method of accounting, which generally does not result in compensation expense recognition for most plans. Companies that elect to remain with the existing accounting are required to disclose in a footnote to the financial statements pro forma net income and, if presented, earnings per share, as if this statement had been adopted. The accounting requirements of this statement are effective for transactions entered into in fiscal years that begin after December 15, 1995; however, companies are required to disclose information for awards granted in their first fiscal year beginning after December 15, 1994. The Bank has elected the proforma disclosure requirements as noted in the note to the Financial Statements. In June of 1996, the FASB issued SFAS No. 125, ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF LIABILITIES, and in December, 1996 issued SFAS No. 127, DEFERRAL OF THE EFFECTIVE DATE OF CERTAIN PROVISIONS OF FASB STATEMENT NO. 125 (AN AMENDMENT OF FASB STATEMENT NO. 125) establishing accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities based on consistent application of the financial-components approach. This approach requires the recognition of financial assets and servicing assets that are controlled by the reporting entity, the derecognition of financial assets when control is surrendered, and the derecognition of liabilities when they are extinguished. Specific criteria are established for determining when control has been surrendered in the transfer of financial assets. Liabilities and derivatives incurred or obtained by transferors in conjunction with the transfer of financial assets are required to be measured at fair value, if practicable. Servicing assets and other retained interests in transferred assets are required to be measured by allocating the previous carrying amount between the assets sold, if any, and the interest that is retained, if any, based on the relative fair values of the assets on the date of the transfer. Servicing assets retained are subsequently subject to amortization and assessment for impairment. Management believes the implementation of this statement will not have a material effect on the Bank's financial condition or results of operations. In March 1997, the FASB issued Statement of Financial Accounting Standards No. 128 (SFAS No. 128), "EARNINGS PER SHARE." SFAS No. 128 supersedes APB Opinion No. 15, EARNINGS PER SHARE, and is substantially the same as the International Accounting Standard 33, EARNINGS PER SHARE, recently issued by the International Standards Committee. SFAS No. 128 establishes standards for computing earnings per share (EPS) previously found in APB Opinion No. 15 and makes them comparable to international EPS standards. It replaces the presentation of primary EPS with a presentation of basic EPS. Under basic EPS, dilution is excluded and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. It also requires dual presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures. 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. Diluted EPS is computed similarly to fully diluted EPS pursuant to APB Opinion No. 15. SFAS No. 128 will be effective for financial statements issued for periods ending after December 15, 70 1997, including interim periods; earlier application is not permitted. However, disclosure of pro forma EPS amounts computed using SFAS No. 128 in the notes to the financial statements in periods prior to required adoption are permitted. It is not anticipated that the financial impact of this statement will have a material effect on the Bank. In February 1997, the FASB issued Statement of Financial Accounting Standards No. 129 (SFAS No. 129), "DISCLOSURE OF INFORMATION ABOUT CAPITAL STRUCTURE." SFAS No. 129 continues the previous requirements to disclose certain information about an entity's capital structure found in APB Opinion No. 10, OMNIBUS OPINION-1966, APB Opinion No. 15, EARNINGS PER SHARE, and SFAS No. 47, DISCLOSER OF LONG-TERM OBLIGATIONS, for entities that were subject to the requirements of those standards. SFAS No. 129 eliminates the exemption of non-public entities from certain disclosure requirements of APB Opinion No. 15 as provided by SFAS No. 21, SUSPENSION OF THE REPORTING OF EARNINGS PER SHARE AND SEGMENT INFORMATION BY NON-PUBLIC ENTERPRISES. SFAS No. 129 will be effective for financial statements issued for periods ending after December 15, 1997. It is not anticipated that the financial impact of this statement will have a material effect on the Bank. In July 1997, the FASB issued Statement of Financial Accounting Standards No. 130 (SFAS No. 130), "Reporting Comprehensive Income," requiring businesses to disclose comprehensive income and its components in their general-purpose financial statements. FASB Concepts Statement 6 defines comprehensive income as "the change in equity (net assets) of a business enterprise during a period from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners." Accounting principles generally require all recognized revenues, expenses, gains, and losses be included in net income. Various FASB statements, however, require companies to report certain changes in assets or liabilities as a separate component of the equity section of the balance sheet including foreign currency translation adjustments, unrealized holding gains and losses on available-for-sale securities, changes in the market value of a futures contract that qualifies as a hedge of an asset reported at fair value, and minimum pension liability adjustments. Such items, along with net income, are components of comprehensive income. All items of comprehensive income are to be reported in a "financial statement that is displayed with the same prominence as other financial statements." SFAS 130 does not require a specific format for this financial statement, but does mandate the display of an amount representing total comprehensive income for the period (companies are not required to use the terms "comprehensive income" or "total comprehensive income" in their financial statements). An appendix to SFAS 130 includes example reporting formats. Additionally, the statement requires the classification of items comprising other comprehensive income by their nature, and the accumulated balance of other comprehensive income must be displayed separately from retained earnings and additional paid-in capital in the equity section of the balance sheet. The new rules will be effective for the fiscal years beginning after December 15, 1997, with reclassification of comparative (earlier period) financial statements. The standard is not applicable to not-for-profit organizations. It is not anticipated that the financial impact of this statement will have a material effect on the Bank. In July 1997, the FASB issued Statement of Financial Accounting Standards No. 131 (SFAS No. 131), "Disclosures About Segments of an Enterprise and Related Information," which calls for new segment information in public companies' annual financial statements issued to shareholders. The new statement supersedes SFAS 14, "Financial Reporting for Segments of a Business Enterprise," but retains the disclosure requirements regarding major customers. SFAS No. 131 does not apply to nonpublic companies or not-for-profit organizations. Public companies will report financial and descriptive information about their reportable operating segments-"components of an 71 enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance." Disclosure of information not prepared for internal use generally is not required if reporting the information would be impracticable. SFAS No. 131 mandates disclosure of (1) a measure of segment profit/loss, (2) certain revenue and expense items, and (3) segment assets. The standard calls for reconciliations of total segment revenues, total segment profit/loss, total segment assets, and other amounts disclosed for segments, to corresponding amounts in the company's general-purpose financial statements. Additionally, public companies will be required to report information regarding: (i) the entity's products/services (or groups of similar products/services); (ii) countries in which the company earns revenues and holds assets; and (iii) major customers (regardless of whether this information is used in making operating decisions). SFAS No. 131 also calls for descriptive information about (1) the way the operating segments were determined, (2) products/services provided by the operating segments, (3) differences between the measurements used in reporting segment information and those used in the company's general-purpose financial statements, and (4) changes in the measurement of segment amounts from period to period. SFAS 131 is effective for financial statements for periods beginning after December 15, 1997. In the initial year of application, comparative information for earlier years must be restated. SFAS No. 131 need not be applied to interim statements in the initial year of application; however, comparative information (i.e., first-year data) will be required in interim statements for the second year. It is not anticipated that the financial impact of this statement will have a material effect on the Board. 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 portfolio 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. 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. RESTRICTIONS ON TRANSFERS OF FUNDS TO THE HOLDING COMPANY BY THE BANK The Holding Company is a legal entity separate and distinct from the Bank. There are statutory and regulatory limitations on the amount of dividends which may be paid to the Holding Company by the Bank. Under California law, no distribution of dividends is permitted unless: (i) such distribution would not exceed a bank's retained earnings; or (ii) in the alternative, 72 after giving effect to the distribution, (y) the sum of a bank's assets (net of goodwill, capitalized research and development expenses and deferred charges) would be not less than 125% of its liabilities (net of deferred taxes, income and other credits), or (z) current assets would not be less than current liabilities (except that if a bank's average earnings before taxes for the last two years had been less than average interest expenses, current assets must not be less than 125% of current liabilities). The FDIC also has authority to prohibit the Bank from engaging in what, in the FDIC's opinion, constitutes an unsafe or unsound practice in conducting its business. It is possible, depending upon the financial condition of the bank in question and other factors, that the FDIC could assert that the payment of dividends or other payments might, under some circumstances, be such an unsafe or unsound practice. Further, the FDIC has established guidelines with respect to the maintenance of appropriate levels of capital by bank under their jurisdiction. Compliance with the standards set forth in such guidelines and the restrictions that are or may be imposed under the prompt corrective action provisions of the FDIC Improvement Act could limit the amount of dividends which the Bank may pay to the Holding Company. See "SUPERVISION AND REGULATION OF THE HOLDING COMPANY AND THE BANK - FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991 - PROMPT CORRECTIVE REGULATORY ACTION" AND "- CAPITAL ADEQUACY GUIDELINES" for a discussion of these additional restrictions on capital distributions. Following the Reorganization, the Bank would be subject to certain restrictions imposed by federal law on any extensions of credit to, or the issuance of a guarantee or letter of credit on behalf of, the Holding Company or other affiliates, the purchase of or investments in stock or other securities thereof, the taking of such securities as collateral for loans and the purchase of assets of the Holding Company or other affiliates. Such Restrictions would prevent the Holding Company and such other affiliates from borrowing from the bank unless the loans are secured by marketable obligations of designated amounts. Further, such secured loans and investments by the Bank to or in the Holding Company or to in any other affiliate would be limited to 10% of the Bank's capital and surplus (as defined by federal regulations) and such secured loans and investments would be limited, in the aggregate, to 20% of the Bank's capital and surplus (as defined by federal regulations). In addition, following the Reorganization any transaction with an affiliate of the Bank must be on terms and under circumstances that are substantially the same as a comparable transaction with a non-affiliate. Additional restrictions on transactions with affiliates may be imposed on the Bank under the prompt corrective action provisions of the FDIC Improvement Act. See "SUPERVISION AND REGULATION OF THE HOLDING COMPANY AND THE BANK - EFFECT OF GOVERNMENTAL POLICIES AND RECENT LEGISLATION - FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991 - PROMPT CORRECTIVE REGULATORY ACTION." MARKET PRICE OF AND DIVIDENDS ON HOLDING COMPANY COMMON STOCK AND BANK COMMON STOCK MARKET INFORMATION There is no trading in the Holding Company Common Stock. After consummation of the Holding Company Reorganization, it is anticipated that the Holding Company Common Stock will be traded in the over-the-counter market and most probably will be, in the near term, listed on any exchange or on NASDAQ. 73 Management of the Bank is aware of four (4) securities dealers who maintain an inventory and make a market in Bank Common Stock. The market makers are Ryan, Beck & Co. and Wedbush Morgan Securities Inc. The information set forth in the table below summarizes, for the periods indicated, the bid and ask prices of Bank Common Stock based upon information provided by Ryan, Beck & Co., which became the Bank's market maker in the second quarter of 1996 when the Bank's Common Stock became listed on Nasdaq National Market. 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. 1996 High Low Trading Volume ---- ---- --- -------------- Second Quarter 11 3/4 11 399,733 Third Quarter 11 1/2 9 3/4 926,028 Fourth Quarter 14 3/4 10 1/4 3,413,338 1997 ---- First Quarter 18 1/8 13 7/8 820,026 Second Quarter 21 1/4 16 1/2 1,758,273 Prior to the Bank's Common Stock listing on Nasdaq National Market, there had been a limited market for the Bank's Common Stock, which was not listed on any exchange or Nasdaq prior to its list on the Nasdaq National Market. Management believes that approximately 3,000 shares of Common Stock of the Bank were traded in 1994, approximately 8,000 shares were traded in 1995, and no shares were traded n the first three months of 1996. The price at which these shares were traded is not known to Bank's management, and management may not be aware of all of the trades that occurred because management did not receive notification of trades held in nominee name. Although management cannot confirm the accuracy of this information, it was reported on the financial data reporting service widely used in the financial community that approximately 48,000 shares of common stock were traded during the year ended December 31, 1994 at prices per share which ranged from 4-1/4 to 5-5/16. Near the year ended December 31, 1995, approximately 3,000 shares of Common Stock were traded at prices per share which ranged from 4-1/4 to 5-1/4. During the first five months of 1996, 800 shares traded at 4-3/8. Stock price data reflects inter-dealer prices, without retail mark-up, mark-down or commission. Upon consummation of the Reorganization, the Holding Company will assume the Bank's rights and obligations under the Bank's Stock Option Plan and under each of the outstanding options previously granted under the Plan by which assumption the optionee shall have the right to purchase one share of Holding Company Common Stock for each share of Bank Common Stock the optionee was entitled to purchase prior the Holding Company Reorganization. Upon consummation of the Reorganization, up to 1% of the outstanding shares of Holding Company Common Stock could be sold pursuant to Rule 144 under the Securities Act for the account of an affiliate of the Holding Company during a three month period. For purposes of Rule 144, affiliates including the Holding Company's directors and executive officers and the Bank's directors and executive officers. 74 SHAREHOLDERS As of the Record Date, there were approximately 800 holders of record of Bank Common Stock. As of the Record Date, there was 1 shareholder of Holding Company Common Stock. DIVIDENDS The Holding Company has never paid a dividend. In January 1997 and April 1997, the Board of Directors of the Bank declared a $.05 per share cash dividend, and the Bank intends to continue quarterly payments of cash dividends until the completion of the Reorganization. Following the completion of the Reorganization, the Holding Company intends to continue the pattern of paying quarterly dividends on its common stock. However, no assurance can be given that the pattern of dividends described herein will continue at the Bank, or if the Reorganization is consummated, at the Holding Company, or if any cash dividends will be paid in the future either by the Bank, or if the Reorganization Proposal is approved, by the Holding Company. On June 30, 1997, the Bank completed a four (4) for three (3) stock split of the issued and outstanding shares of the Bank. Upon consummation of the Reorganization, as a bank holding company without significant assets other than its equity interest in the Surviving Bank, the Holding Company's ability to pay cash dividends will depend upon the dividends it receives from the Surviving Bank which, in turn, are subject to certain limitations. In addition, the Holding Company's and the Bank's ability to pay dividends are, and the Surviving Bank's ability to pay cash dividends will be, limited by California law. The Bank's Board of Directors intends to retain earnings, if any, in order to increase capital, and to pay cash dividends only when it is prudent to do so and the Bank's performance justifies such action. See "SUPERVISION AND REGULATION OF THE HOLDING COMPANY AND THE BANK - THE BANK - POTENTIAL AND EXISTING ENFORCEMENT ACTIONS." Since the Bank is a state-chartered bank, its ability to pay dividends or make distributions to its shareholders is subject to restrictions set forth in the California Financial Code. The California Financial Code provides that a bank may not make a distribution to its shareholders in an amount which exceeds the less of (i) the bank's retained earnings; or (ii) the bank's net income for its last three fiscal years, less the amount of any distributions made by the bank to the shareholders of the bank during such period. However, a bank may, with the prior approval of the Commissioner make a distribution to the shareholders of the bank in an amount not exceeding the greatest of (i) its retained earnings; (ii) its net income for its last fiscal year; or (iii) its net income for its current fiscal year. In the event that the Commissioner determines that the stockholders' equity of a bank is inadequate or that the making of a distribution by a bank would be unsafe or unsound, the Commissioner may order the bank to refrain from making a proposed distribution. Under the FDIC Improvement Act, additional limitations can be imposed on the Bank with regard to making capital distributions if after such transaction the Bank would be undercapitalized. See "SUPERVISION AND REGULATION OF THE HOLDING COMPANY AND THE BANK - EFFECT OF GOVERNMENTAL POLICIES AND RECENT LEGISLATION - FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991." DIRECTORS AND EXECUTIVE OFFICERS OF THE HOLDING COMPANY AND THE BANK The following table provides certain information as of the Record Date with respect to each Director of the Bank and the Holding Company. Reference is made to the section entitled 75 "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT" for information pertaining to stock ownership of the nominees. YEAR FIRST NAME OF DIRECTOR APPOINTED AND OFFICES HELD BUSINESS EXPERIENCE OR ELECTED (OTHER THAN DIRECTOR) AGE (1) DURING PAST 5 YEARS DIRECTOR - --------------------- --- ------------------- ---------- Leonard O. Lindborg 61 Retired, manages investments 1996 H. Rhoads Martin, Jr. 50 President, Martin Companies, a real 1990 Chairman of the Board estate investment and property management firm John F. Myers, 60 Retired Pharmacist, former owner, 1990 Secretary B&B Pharmacy Barry J. Moore, 48 Banker (2) 1996 Executive Vice President Robert C. Ucciferri, 60 Banker (3) 1990 President Brent W. Wahlberg 75 Retired (formerly Vice President of 1979 Eadington Fruit Company) There are no family relationships between any of the directors or executive officers of the Bank. On June 25, 1997, Mr. John C. Coelho, founding director and Chairman of the Board, retired from the Bank. Mr. H. Rhoads Martin was thereafter appointed Chairman of the Board of the Bank and the Holding Company. In connection with Mr. Coelho's retirement, Mr. Coelho's options of approximately 10,667 shares, of which 9,689 shares are vested, at an average exercise price of approximately $5.87 per share, under the 1990 Plan, and 5,333 shares, of which 1,779 shares are vested at an average exercise price of $12.75 per share, under the 1997 Plan as adjusted for the four-for-three stock split, will expire, unless exercised or extended, during the latter part of September, 1997. The Board of Directors may provide additional benefits to Mr. Coelho in connection with his retirement. - ---------------------------------- (1) Ages are as of March 31, 1997. (2) Mr. Moore was first employed by the Bank in 1980 as Vice President Branch Manager/Commercial Lender. He left shortly thereafter to relocate to San Diego (Torrey Pines Bank). He returned to the Bank in 1986 as Executive Vice President/Credit Administrator. After the departure of the previous Chief Executive Officer, Mr. Moore served as Acting Chief Executive Officer and Director until the arrival of Mr. Ucciferri six months later. Mr. Moore was appointed Chief Financial Officer in 1991 and has served as a Director since January 1996. (3) Prior to joining the Bank, Mr. Ucciferri served in various positions with Citizens Bank of Costa Mesa and El Camino Bank, both owned by the same holding company. His positions included President of both banks (at different times) and Executive Vice President of Citizens Bank. 76 THE BOARD OF DIRECTORS AND COMMITTEES During 1996, the Board of Directors of the Bank held twelve (12) regular meetings and seven (7) special meetings. In addition to meeting as a group to review the Bank's business, certain members of the Board of Directors of the Bank also devoted their time and talents to the following standing committees: The Bank's Audit Committee, currently composed of Directors Martin (Chairman), Myers and Wahlberg, met six (6) times in 1996. The purpose of this Committee is to direct the audits and credit review activities and to make certain that these functions are performed with the necessary freedom and independence to insure the examination of all records, and to recommend to the Board of Directors the appointment of an outside accounting firm and to meet with and review the reports of the accounting firm. The Bank's Compensation Committee, currently composed of Directors Wahlberg (Chairman), Martin, Myers and Ucciferri, met six (6) times in 1996. This Committee makes recommendations to the Board of Directors regarding compensation matters, some of which may be delegated to this Committee. The Bank does not have a standing Nominating Committee, but the full Board of Directors acts as a Nominating Committee. None of the incumbent Directors attended less than seventy-five percent (75%) of all Board and committee meetings held during the period for which he has been a Director. EXECUTIVE OFFICERS The following table sets forth as to each of the persons who currently serves as an executive officer of the Bank, such person's age, principal, occupation, current position with the Bank, and the period during which the person has served in such position. BUSINESS EXPERIENCE EXECUTIVE NAME AND POSITION AGE DURING PAST FIVE YEARS OFFICER SINCE - ----------------- --- ---------------------- ------------- Robert Ucciferri 60 President and Chief Executive Officer 1990 Barry J. Moore 48 Senior Executive Vice President, Chief Operating Officer and Chief 1986 Financial Officer Michael H. Mullarky (1) 50 Executive Vice President and Credit 1990 Administrator - ------------------------------- (1) Executive Vice President and Credit Administrator Michael Mullarky joined the Bank in 1991. Mr. Mullarky has a total of 27 years of banking experience, primarily in lending and credit administration. He served at Citizens Bank of Costa Mesa for 9 years as part of senior management and was the S.V.P./Loan Administrator at the time he left to join the Bank. 77 DIRECTOR COMPENSATION During 1996, the Bank paid fees of $800 per month for each director minus the amount of medical insurance premium payments paid on behalf of each director if a director elects to be covered under the Bank's medical insurance plan. Effective January 1, 1997, the Board of Directors changed the amount of compensation to $2,000 per month for each director minus the amount of medical insurance premium payments paid on behalf of each director if a director elects to be covered under the Bank's medical insurance plan, except that Messrs. Ucciferri and Moore receive $500.00 per month. EXECUTIVE COMPENSATION The following summary compensation table sets forth, for the last three (3) completed fiscal years, the cash and certain other compensation paid by the Bank to the Bank's President and Chief Executive Officer and the other Executive Officers of the Bank whose total annual salary and bonus for the fiscal year ended December 31, 1996 exceeded $100,000. 78 LONG-TERM ALL OTHER ANNUAL COMPENSATION COMPENSATION COMPENSATION ------------------------------------------------------- ---------------------------- (A) (B) (C) (D) (E) AWARDS STOCK OTHER ANNUAL OPTIONS NAME AND PRINCIPAL POSITION FISCAL YEAR SALARY($) BONUS($) COMPENSATION (#) ($) - --------------------------- ----------- --------- -------- ------------ ------- ------- Robert Ucciferri 1996 $ 128,000 $ 95,785 $ -0- -0- $42,469(15) President and CEO 1995 $ 120,000 $201,016 $ -0- -0- $ 2,832(16) 1994 $ 115,700 $ 10,000 $ -0- -0- $ 2,832(17) - -------------------------------- (C) Total base salary paid for fiscal years 1996, 1995 and 1994 for the Bank. (D) The initial portion of Mr. Ucciferri's 1995 bonus ($76,160) was accrued and paid in 1995, and the remainder of Mr. Ucciferri's 1995 bonus ($124,856) was accrued in 1995 and paid in 1996. The initial portion of Mr. Moore's 1995 bonus ($38,060) was accrued and paid in 1995, and the remainder of Mr. Moore's 1995 bonus ($67,448) was accrued in 1995 and paid in 1996. The initial portion of Mr. Mullarky's 1995 bonus ($38,060) was accrued and paid in 1995, and the remainder of Mr. Mullarky's 1995 bonus ($67,448) was accrued in 1995 and paid in 1996. The chart also reflects the following bonuses earned in 1996 and paid in 1997: Mr. Ucciferri ($95,785), Mr. Moore ($43,825) and Mr. Mullarky ($40,715). (E) Represents the dollar value of other annual compensation not properly categorized as salary or bonus; including (i) perquisites and other personal benefits, securities or property unless the aggregate amount of such compensation is the lesser of either $50,000 or 10% of the total annual salary and bonus reported for the named executive officer in columns (C) and (D); (ii) above-market or preferential earnings on restricted stock, options, stock appreciation rights ("SARs") or deferred compensation paid during the fiscal year or payable during that period but deferred at the election of the named executive officer; (iii) earnings on long-term incentive plan ("LTIP") compensation paid during the fiscal year or payable during that period but deferred at the election of the named executive officer; (iv) amounts reimbursed during the fiscal year for the payment of taxes; and (v) the dollar value of the difference between the price paid by a named executive officer for any security of the Bank purchased from the Bank (through deferral of salary or bonus, or otherwise), and the fair market value of such security at the date of purchase, unless that discount is available generally, either to all security holders or to all salaried employees of the registrant. None of the named officers had other annual compensation in excess of 10% of the total annual salary and bonus reported for any of the last three fiscal years. (15) Includes $2400 received from the Bank as directors' fees, $39,661 Salary Continuation Agreement accruals, and $408 as a supplemental life insurance premium. (16) Includes $2400 received from the Bank as director's fees and $432 as a supplemental life insurance premium. (17) Includes $2400 received from the Bank as Director's fees and $432 as a supplemental life insurance premium. LONG-TERM ALL OTHER ANNUAL COMPENSATION COMPENSATION COMPENSATION ------------------------------------------------------- ---------------------------- (A) (B) (C) (D) (E) AWARDS STOCK OTHER ANNUAL OPTIONS NAME AND PRINCIPAL POSITION FISCAL YEAR SALARY($) BONUS($) COMPENSATION (#) ($) - --------------------------- ----------- --------- -------- ------------ ------- -------- Barry J. Moore 1996 $ 97,000 $ 43,825 $-0- -0- $11,200(18) Senior EVP and CFO 1995 $ 85,000 $105,508 $-0- -0- $ 132(19) 1994 $ 81,200 $ 5,000 $-0- -0- $ 132(20) Michael H. Mullarky 1996 $ 85,000 $ 40,715 $-0- -0- $ 255(21) EVP and Credit Administrator 1995 $ 85,000 $105,508 $-0- -0- $ 269(22) 1994 $81,200 $ 5,000 $-0- -0- $ 264(23) - ---------------------------- (18) Includes $2400 received from the Bank as Directors' fees, $8,668 Salary Continuation Agreement accruals, and $132 as a supplmental life insurance premium. (19) Includes $132 as a supplmental life insurance premium. (20) Includes $132 as a supplmental life insurance premium. (21) Includes $255 as a supplemental life insurance premium. (22) Includes $269 as a supplemental life insurance premium. (23) Includes $264 as a supplemental life insurance premium. EMPLOYMENT AGREEMENTS On November 28, 1995, the Bank and Mr. Ucciferri executed a five (5) year employment agreement commencing January 1, 1996 at a base salary of $120,000 per annum, which will be reviewed annually by the Board. Mr. Ucciferri's base salary for 1997 is $149,000. Mr. Ucciferri is also entitled to the use of a car, and Mr. Ucciferri may also participate in any bonus, pension or profit sharing plan or other employee benefit plan that is or may be adopted by the Bank. Mr. Ucciferri is also entitled to five (5) weeks vacation per year and appropriate medical and dental insurance. If Mr. Ucciferri is terminated without cause, he will be entitled to twelve (12) months severance pay, and if Mr. Ucciferri is terminated within nine (9) months of a merger, or change of control of more than 25% of the issued and outstanding stock of the Bank, Mr. Ucciferri will be entitled to twenty-four (24) months severance pay. The Agreement also contains provisions regarding disability and dispute resolution procedures. On November 28, 1995, the Bank and Mr. Moore executed a five (5) year employment agreement commencing January 1, 1996 at a base salary of $85,000 per annum, which will be reviewed annually by the Board. Mr. Moore's base salary for 1997 is $110,000. Mr. Moore is also entitled to the use of a car, and Mr. Moore may also participate in any bonus, pension or profit sharing plan or other employee benefit plan that is or may be adopted by the Bank. Mr. Moore is also entitled to five (5) weeks vacation per year and appropriate medical and dental insurance. If Mr. Moore is terminated without cause, he will be entitled to twelve (12) months severance pay, and if Mr. Moore is terminated within nine (9) months of a merger, or change of control of more than 25% of the issued and outstanding stock of the Bank, Mr. Moore will be entitled to twenty-four (24) months severance pay. The Agreement also contains provisions regarding disability and dispute resolution procedures. On November 28, 1995, the Bank and Mr. Mullarky executed a five (5) year employment agreement commencing January 1, 1996 at a base salary of $85,000 per annum, which will be reviewed annually by the Board. Mr. Mullarky's base salary for 1997 is $85,000. Mr. Mullarky is also entitled to the use of a car, and Mr. Mullarky may also participate in any bonus, pension or profit sharing plan or other employee benefit plan that is or may be adopted by the Bank. Mr. Mullarky is also entitled to five (5) weeks vacation per year and appropriate medical and dental insurance. If Mr. Mullarky is terminated without cause, he will be entitled to twelve (12) months severance pay, and if Mr. Mullarky is terminated within nine (9) months of a merger, or change of control of more than 25% of the issued and outstanding stock of the Bank, Mr. Mullarky will be entitled to twenty-four (24) months severance pay. The Agreement also contains provisions regarding disability and dispute resolution procedures. SALARY CONTINUATION AGREEMENTS On November 28, 1995, the Bank approved a Salary Continuation Agreement for Mr. Ucciferri effective January 1, 1996 that would provide an annual sum of $64,700 in equal monthly installments over a ten (10) year period upon his retirement at age 67. The Bank has purchased single premium life insurance to cover the retirement benefits. The Bank must accrue increasing amounts every year in order to fund various provisions of the Agreement, including provisions regarding death after retirement, death prior to retirement, and disability prior to retirement provisions. In 1996, the Bank accrued $39,661 for Mr. Ucciferri's benefit, and the Bank has accrued a total of $39,661 through December 31, 1996 for Mr. Ucciferri's benefit. If Mr. Ucciferri voluntarily terminates his employment, he will receive the accrued amount under the Agreement within two (2) years of the termination. If Mr. Ucciferri is terminated without cause, Mr. Ucciferri will begin 81 receiving the amount accrued in the year of termination at age sixty-seven (67) in equal monthly installments spread over ten (10) years. Mr. Ucciferri will receive no benefits under the Agreement if Mr. Ucciferri's employment is terminated for cause. On November 28, 1995, the Bank approved a Salary Continuation Agreement for Mr. Moore effective January 1, 1996 that would provide an annual sum of $64,800 in equal monthly installments over a ten (10) year period upon his retirement at age sixty-five (65). The Bank has purchased single premium life insurance to cover the retirement benefits. The Bank must accrue increasing amounts every year in order to fund various provisions of the Agreement, including provisions regarding death after retirement, death prior to retirement, and disability prior to retirement provisions. In 1996, the Bank accrued $8,668 for Mr. Moore's benefit, and the Bank has accrued a total of $8,668 through December 31, 1996 for Mr. Moore's benefit. If Mr. Moore voluntarily terminates his employment, he will receive the accrued amount under the Agreement within two (2) years of the termination. If Mr. Moore is terminated without cause, Mr. Moore will begin receiving the amount accrued in the year of termination at age sixty-five (65) in equal monthly installments spread over ten (10) years. Mr. Moore will receive no benefits under the Agreement if Mr. Moore's employment is terminated for cause. The Bank is considering and may extend similar salary continuation benefits to Mr. Mullarky. BANK BONUS POOL In December 1991, the Board of Directors established a Bank Bonus Pool which takes effect only if certain threshold tests are met. The Bonus Pool is calculated based on the Bank's return on equity, loan losses and income after taxes. In 1994, the 1991 Bonus Pool called for payment of $170,982 although actual payment was only $28,020 of which $20,000 was paid to the three Executive Officers and $8,020 was distributed among 42 staff members. The $142,962 difference between the calculated and actual bonus was not accepted by executive management in order to maintain an adequate Tier 1 capital ratio. In 1995, the 1991 Bonus Pool accrued a total of $448,092; $177,370 was paid in 1995 and the balance of $270,722 was paid in February 1996. Of the $448,092 total, $412,032 was paid to the three Executive Officers and $36,090 was distributed among 42 employees. In April 1996, the Board of Directors adopted the 1996 Executive Incentive Plan for the top three executive officers of the Bank. The performance criteria includes return on average shareholders equity, average loan loss and the short-term objective of limiting depository runoff following the acquisition of Bank of Westminster, which was completed on June 14, 1996. In order to be eligible for incentive payout, the Bank must be satisfactorily rated by its regulatory agencies. In 1996, the 1996 Executive Incentive Plan accrued a total of $200,510. The sum of $180,325 was paid in January, 1997. 401(k) PLAN Effective February 1, 1992, the Bank adopted a 401(k) Plan that allows eligible employees to contribute, as deferred compensation, between one percent (1%) and fifteen percent (15%) of their salary to a trust established pursuant to the 401(k) Plan. The Bank may match contributions up to a given percentage of each participant's compensation. In addition, the Bank may make additional contributions on a discretionary basis as a profit sharing contribution. Contributions by the Bank would vest over a five-year period. The Bank did not make any contributions for 1996. 82 THE BANK'S 1990 STOCK OPTION PLAN In 1990, the Bank's Board of Directors adopted the 1990 Stock Option Plan (the "1990 Plan"), which was approved by the shareholders of the Bank at the 1991 Annual Meeting of Shareholders. The purpose of the 1990 Plan was to secure for the Bank and its shareholders benefits of the incentives inherent in the ownership of Common Stock by those directors and key full-time officers and employees of the Bank who will share responsibility with the management of the Bank for its future growth and success. The 1990 Plan authorized the granting of (i) options which qualify as "incentive stock options" under the Code, and (ii) nonstatutory stock options. The 1990 Plan provided that incentive stock options and nonstatutory stock options representing a total of up to 103,926 shares of Common Stock, will be available for grant to directors and full-time salaried officers and employees of the Bank. During 1991, stock options to purchase a total of 102,300 shares were granted under the 1990 Plan. During 1992, the Board of Directors voted to cancel the existing stock options and grant new options at $6.50 per share. There are currently 138,568 option shares that are outstanding under the 1990 Stock Option Plan, and no stock options were granted in 1996 to the named executive officers. With the adoption of the Bank's 1997 Stock Option Plan by the Board of Directors and approved by shareholders, the 1990 Plan was cancelled on May 21, 1997. THE BANK'S 1997 STOCK OPTION PLAN At the Bank's 1997 Annual Meeting of Shareholders on May 21, 1997, shareholders of the Bank approved the Bank of Yorba Linda 1997 Stock Option Plan (the "Bank's 1997 Plan"), which was adopted by the Board of Directors of Bank on February 19, 1997, subject to the approval of the holders of a majority of the issued and outstanding shares of the Bank. The purpose of the Bank's 1997 Plan is to strengthen the Bank by providing an additional means of attracting and retaining competent managerial personnel and by providing to participating officers, key employees and directors, added incentive for high levels of performance and for unusual efforts to increase the earnings of the Bank. The Bank's 1997 Plan seeks to accomplish these purposes and achieve these results by providing a means whereby such officers, key employees and directors, purchase shares of the Bank's Common Stock pursuant to options granted in accordance with the Bank's 1997 Plan. The Board of Directors intended to grant approximately 60% of the options available for grant under the Bank's 1997 Plan to the management personnel in the Bank's Mortgage and SBA Departments, with the remaining options to be granted to the Bank's directors and executive officers, and the Board of Directors has granted under the Bank's 1997 Plan a total of 125,000 stock options. The Board of Directors intends to establish a stock option plan at the holding company, and the stock option allocations to directors, executive officers and other bank officers will be absorbed under the holding company stock option plan. SUMMARY OF PLAN The purpose of the Bank's 1997 Plan is to strengthen the Bank by providing an additional means of attracting and retaining competent managerial personnel. The Bank's 1997 Plan provides to participants added incentive for high levels of performance and for unusual efforts to increase the earnings of the Bank. It is intended that the Bank's 1997 Plan was intended to assist in 83 accomplishing these objectives and facilitate in achieving these results by providing a means whereby directors, officers and key employees of the Bank may purchase shares of the Common Stock of the Bank pursuant to options granted in accordance with the 1997 Plan. 460,519 unissued shares of the Bank, including the 138,568 option shares outstanding under the 1990 Stock Option Plan, approximately 30% of the issued and outstanding shares of the Bank, will be reserved for issuance to directors, officers and employees of the Bank ("Eligible Participants"). Options granted pursuant to the 1997 Plan may be non-qualified options or incentive stock options within the meaning of Section 422A of the Internal Revenue Code. The Bank's 1997 Plan is intended to be administered by the Board of Directors of the Bank or by a committee appointed from time to time by the Board. The Board of Directors or the committee will determine with respect to the Eligible Participants in the Bank's 1997 Plan and the extent of their participation. The purchase price of stock subject to each option shall be not less than one hundred (100%) of the fair market value of such stock at the time such option is granted. An Eligible Participant owning more than ten percent (10%) of the total combined voting power of all classes of stock of the Bank may only be granted an option with an exercise price at least 110% of the fair value of Bank stock at the date of grant. The purchase price of any shares exercised shall be paid in full in cash or, with the prior written approval of the committee, in shares of the Bank or on a deferred basis evidenced by a promissory note. In addition, the optionee shall have the right upon exercise of an option to surrender for cancellation a portion of the option for the number of shares exercised. Options may be granted pursuant to the Bank's 1997 Plan for a term of up to ten (10) years. Each option shall be exercisable according to the determination of the Board or committee. Options granted under the Bank's 1997 Plan shall not be transferable by the optionee during the optionee's lifetime. In the event of termination of employment as a result of the optionee's disability or in the event of an employee's death during the exercise period, to the extent the option is exercisable on the date employment terminates or the date the employee dies, the option shall remain exercisable for up to one (1) year (but not beyond the end of the original option term) by the disabled optionee or, in the event of death of the optionee, a non-qualified option shall be exercisable by the person or persons to whom rights under the option shall have passed by will or the laws of descent and distribution. If an optionee's employment is terminated, unless termination was by reason of disability or death, the optionee shall have the right, for a 3-month period after termination, to exercise that portion of the option which was exercisable immediately prior to such termination. If an optionee's employment is terminated for cause, the optionee shall have the right for a 30 day period after termination, to exercise that portion of the option which was exercisable immediately prior to such termination. In no event may the option be exercised after the end of the original option term. If an option expires or is otherwise cancelled without being exercised, the number of option shares subject to such option will again become available for grant under the 1997 Plan. In the event of certain changes in the outstanding Common Stock of the Bank without receipt of consideration by the Bank, such as stock dividends, stock splits, recapitalization, reclassification, reorganization, merger, stock consolidation, or otherwise, appropriate and proportionate adjustments shall be made in the number, kind and exercise price of shares covered by any unexercised or partially unexercised options which were already granted. Optionees will receive prior notice of any pending dissolution or liquidation of the Bank, or reorganization, merger or dissolution or liquidations of the Bank, or reorganization, merger or consolidation where the Bank is not the surviving corporation or 84 sale of substantially all the assets of the Bank or other form of corporate reorganization in which the Bank is not a surviving entity, or the acquisition of stock representing more than 50% of the voting power of the stock of the Bank then outstanding ("Terminating Event"). Optionees have thirty (30) days from the date of mailing of such notices to exercise any option, whether or not fully exercisable, in full. After such thirty (30) days, any option not exercised shall terminate and upon the occurrence of the Terminating Event, the Bank's 1997 Plan shall terminate, unless some other provision is made in connection with the Terminating Event. The Board reserves the right to suspend, amend, or terminate the Bank's 1997 Plan, and, with the consent of the optionee, make such modifications, of the terms and conditions of his or her option as it deems advisable, such as changing the number of shares or the period such shares are vested, except that the Board may not, without further approval of a majority of the shares, increase the maximum number of shares covered by the Bank's 1997 Plan, change the minimum option price, increase the maximum term of options under the Bank's 1997 Plan or permit options to be granted to any one other than an officer, employee or director of the Bank. Unless previously terminated by the Board of Directors, the Bank's 1997 Plan shall terminate ten years from the date the Bank's 1997 Plan was adopted by the Board of Directors of the Bank, or February 19, 2007. If, and when, the formation of the Bank's Holding Company is completed and the Holding Company's 1997 Stock Option Plan is established, the Bank's 1997 Plan will be terminated. AGGREGATED OPTIONS EXERCISED IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES VALUE OF NUMBER OF UNEXERCISED UNEXERCISED IN-THE-MONEY OPTIONS/SARS OPTIONS/SARS AT FY-END (#) AT FY-END (#) SHARES ACQUIRED VALUE EXERCISABLE/ EXERCISABLE/ NAME ON EXERCISE (#) REALIZED ($) UNEXERCISABLE (1) UNEXERCISABLE (2) - ---- --------------- ------------ ----------------- ----------------- Robert Ucciferri -0- N/A 25,000/0 $190,625/0 Barry J. Moore -0- N/A 12,500/0 $ 95,313/0 Michael H. Mullarky -0- N/A 12,500/0 $ 95,313/0 As of December 31, 1996, there were options outstanding to purchase a total of 94,400 shares (not adjusted for the four-for-three stock split effective June 30, 1997) of the Bank's Common Stock, and no options under the 1990 Plan were exercised in 1996, and no options were granted to any of the persons specified in the chart above in 1996. On February 19, 1997, the Board of Directors granted additional options under the 1990 Stock Option Plan and approved the 1997 Stock Option Plan that was designed to replace the 1990 Stock Option Plan. On February 19, 1997, Mr. Moore was granted an additional stock option for 2,000 shares, and Mr. Mullarky was granted an - -------------------------- (1) Shares not adjusted for four-for-three stock split effective June 30, 1997. (2) As a result of trades on December 31, 1996 at $14.1252 per share. 85 additional stock option for 500 shares. Please see The Bank's 1997 Stock Option Plan for a description of the Bank's 1997 Stock Option Plan. When the Bank's 1997 Plan was approved by shareholders, the 1990 Stock Option Plan was cancelled and no further options were granted under the 1990 Stock Option Plan. Please see Proposal 2 for a description of the Holding Company's 1997 Stock Option Plan. When the Holding Company's 1997 Stock Option Plan is approved by shareholders of the Bank as prospective shareholders of the Holding Company, the Bank's 1997 Stock Option Plan is intended to be cancelled and no further options are intended to be granted under the Bank's 1997 Stock Option Plan. CERTAIN TRANSACTIONS During the previous three (3) years, the Bank has had, and expects to have in the future, banking transactions in the ordinary course of its business with directors, officers and their associates. These transactions have been (and those in the future are intended to be) on substantially the same terms, including interest rates, collateral and repayment terms on extensions of credit, as those prevailing at the same time for comparable transactions with others and did not involve more than the normal risk of collectability or present other unfavorable features. During the period from January 1, 1996 through December 31, 1996, the maximum aggregate extensions of credit to directors, executive officers and persons with which they are financially or otherwise closely associated was approximately $1,367,134 or 10.5%% essential of the Bank's equity capital. Loans to directors, officers and employees or their related interests are permitted, but must be made in compliance with all applicable laws and regulations including Regulation O, Section 215.4(b) of the Financial Institutions Regulatory and Interest Rate Control Act of 1978, and Section 3372 of the California Financial Code. These laws require that all director and director related loan requests are granted with interest rates and terms based on the same criteria as comparable credit risks within the Bank. All loans to executive officers and directors must be approved by the Senior Loan Committee prior to submission to the Board of Directors. All loans made to any member of the Board of Directors or the Executive Officers of the Bank on behalf of himself or any related entity, or immediate family member requires prior approval of the majority of the full Board of Directors. At December 31, 1996, the Bank had $1,367,134 in loan commitments to directors and executive officers with an aggregate outstanding balance of $1,359,984. On July 15, 1986, 10,000 units of the Bank were sold for an aggregate of $1 million to certain members of the Board of Directors of the Bank. Each unit was composed of one (1) share of the Bank's Cumulative Non-Voting Convertible Series A Preferred Stock and a five (5)-year warrant that would allow the holder to purchase the same number of shares of Common Stock of the Bank as the holder would acquire upon conversion of the Preferred Stock. The warrants expired in 1991. Based on shareholder approval and the necessary regulatory approvals obtained subsequently, the terms and conditions of the issued and outstanding Preferred Stock were amended in 1992 to provide for noncumulative dividends. On December 31, 1995, the Bank paid $162,000 of the unpaid cumulative dividends. On February 29, 1996, following necessary regulatory approvals, the Bank redeemed the Preferred Stock and paid $150,111 in remaining unpaid accrued dividends. APPROVAL OF BYL BANCORP 1997 STOCK OPTION PLAN INTRODUCTION Shareholders of the Bank, as prospective shareholders of the Holding Company, are being asked to approve the proposed BYL Bancorp 1997 Stock Option Plan (the "1997 Plan"), which was 86 adopted by the Board of Directors of Holding Company on April 23, 1996, subject to the approval of the California Commissioner of Corporations and the holders of a majority of the issued and outstanding shares of the Bank as prospective shareholders of the Holding Company. The purpose of the 1997 Plan is to strengthen the Holding Company and its prospective wholly-owned subsidiary bank, BANK OF YORBA LINDA (the "Bank"), by providing an additional means of attracting and retaining competent managerial personnel and by providing to participating officers, key employees, directors and consultants added incentive for high levels of performance and for unusual efforts to increase the earnings of the Company and the Bank. The 1997 Plan seeks to accomplish these purposes and achieve these results by providing a means whereby such officers, key employees, directors and consultants may purchase shares of the Company's Common Stock pursuant to options granted in accordance with the 1997 Plan. The Board of Directors believes the 1997 Plan is beneficial to the Holding Company, the Bank and the Holding Company's shareholder and prospective shareholders. The 1997 Plan is subject to approval of the California Commissioner of Corporations and the holders of a majority of the issued and outstanding shares of the Bank as prospective shareholders of the Holding Company, subject to any required changes of any regulatory agency. SUMMARY OF PLAN The purpose of the 1997 Plan is to strengthen the Holding Company and the Bank by providing an additional means of attracting and retaining competent managerial personnel. The 1997 Plan provides to participants added incentive for high levels of performance and for unusual efforts to increase the earnings of the Holding Company and the Bank. It is intended that the 1997 Plan will assist in accomplishing these objectives and facilitate in achieving these results by providing a means whereby directors, officers, key employees and consultants may purchase shares of the Common Stock of the Holding Company pursuant to options granted in accordance with the 1997 Plan. 460,519 unissued shares of the Holding Company, or approximately 30% of the issued and outstanding shares of the Holding Company, will be reserved for issuance to directors, officers and employees ("Eligible Participants"). Options granted pursuant to the 1997 Plan may be non-qualified options or incentive stock options within the meaning of Section 422A of the Internal Revenue Code. The 1997 Plan will be administered by the Board of Directors of the Holding Company or by a committee appointed from time to time by the Board. The Board of Directors or the committee will determine with respect to the Eligible Participants in the 1997 Plan and the extent of their participation. The purchase price of stock subject to each option shall be not less than one hundred (100%) of the fair market value of such stock at the time such option is granted. An Eligible Participant owning more than ten percent (10%) of the total combined voting power of all classes of stock of the Holding Company may only be granted an option with an exercise price at least 110% of the fair value of Holding Company stock at the date of grant. The purchase price of any shares exercised shall be paid in full in cash or, with the prior written approval of the committee, in shares of the Holding Company or on a deferred basis evidenced by a promissory note. In addition, the optionee shall have the right upon exercise of an option to surrender for cancellation a portion of the option for the number os shares exercised. Options may be granted pursuant to the 1997 Plan for a term of up to ten (10) years. Each option shall be exercisable according to the determination of the Board or committee, except that options granted to employees that are not directors or officers shall be exercisable at a minimum of 20% per year over a five year period. 87 Options granted under the 1997 Plan shall not be transferable by the optionee during the optionee's lifetime. Except for options granted to consultants, in the event of termination of employment as a result of the optionee's disability or in the event of an employee's death during the exercise period, to the extent the option is exercisable on the date employment terminates or the date the employee dies, the option shall remain exercisable for up to one (1) year (but not beyond the end of the original option term) by the disabled optionee or, in the event of death of the optionee, a non-qualified option shall be exercisable by the person or persons to whom rights under the option shall have passed by will or the laws of descent and distribution. Except for options granted to consultants, if an optionee's employment is terminated, unless termination was by reason of disability or death, the optionee shall have the right, for a 3-month period after termination, to exercise that portion of the option which was exercisable immediately prior to such termination. If an optionee's employment is terminated for cause, except for options granted to consultants and business advisors, the optionee shall have the right for a 30 day period after termination, to exercise that portion of the option which was exercisable immediately prior to such termination. In no event may the option be exercised after the end of the original option term. However, such termination provisions shall not apply for options granted to consultants. In the event of certain changes in the outstanding Common Stock of the Holding Company without receipt of consideration by the Holding Company, such as stock dividends, stock splits, recapitalization, reclassification, reorganization, merger, stock consolidation, or otherwise, appropriate and proportionate adjustments shall be made in the number, kind and exercise price of shares covered by any unexercised or partially unexercised options which were already granted. Optionees will receive prior notice of any pending dissolution or liquidation of the Holding Company, or reorganization, merger or dissolution or liquidations of the Holding Company, or reorganization, merger or consolidation where the Holding Company is not the surviving corporation or sale of substantially all the assets of the Holding Company or other form of corporate reorganization in which the Holding Company is not a surviving entity, or the acquisition of stock representing more than 50% of the voting power of the stock of the Holding Company then outstanding ("Terminating Event"). Optionees have thirty (30) days from the date of mailing of such notices to exercise any option in full. After such thirty (30) days, any option not exercised shall terminate and upon the occurrence of the Terminating Event, the 1997 Plan shall terminate, unless some other provision is made in connection with the Terminating Event. The Board reserves the right to suspend, amend, or terminate the 1997 Plan, and, with the consent of the optionee, make such modifications, of the terms and conditions of his or her option as it deems advisable, such as changing the number of shares or the period such shares are vested, except that the Board may not, without further approval of a majority of the shares, increase the maximum number of shares covered by the 1997 Plan, change the minimum option price, increase the maximum term of options under the 1997 Plan or permit options to be granted to any one other than an officer, employee, director, or consultant of the Holding Company. Unless previously terminated by the Board of Directors, the 1997 Plan shall terminate ten years from the date the 1997 Plan was adopted by the Board of Directors of the Holding Company, or April 23, 2007. Shares of the Holding Company's Common Stock to be issued upon exercise of stock options need not be registered with the SEC. However, the Holding Company has applied for a permit from the California Commissioner of Corporations and the Holding Company intends to register the 88 Common Stock reserved for issuance under the 1988 Plan with the SEC prior to issuing any of its Common Stock upon exercise thereof. COMPARISON TO THE BANK OF YORBA LINDA 1997 STOCK OPTION PLAN The Holding Company's 1997 Plan differs from the Bank's 1997 Stock Option Plan (the "Bank's 1997 Plan"), which will terminate in February 1997, and will be terminated by the Bank upon the assumption of the Bank's Stock Options by the Holding Company under the 1997 Plan, in several important respects. The 1997 Plan reserves up to 460,519 shares or approximately 30% of the currently issued and outstanding shares of the Holding Company. By comparison, the Bank's 1997 Plan reserves 322,000 shares of the Bank's Common Stock, and an additional 138,568 shares were previously outstanding under the Bank's 1990 Stock Option Plan. The Bank's 1997 Plan will expire in February, 2007, and the establishment of the 1997 Plan is designed to replace the Bank's 1997 Plan. Currently, there are 125,000 shares outstanding under the Bank's 1997 Plan, and there are 138,568 shares outstanding under the Bank's 1990 Plan. The total number of shares under the 1997 Plan will be equal to 30% of the issued and outstanding shares of the Holding Company, which is within the administrative standards of the California Commissioner of Corporations. The 1997 Plan allows for options to be exercised with cash, a promissory note, or the surrender of a portion of the option being exercised by applying the appreciated value of the shares being surrendered to payment of the exercise price. The Bank's 1997 Plan also allows options to be exercised with cash, a promissory note, or the surrender of a portion of the option being exercised by applying the appreciated value of the shares being surrendered to payment of the exercise price. The 1997 Plan also allows for the granting of options to consultants, and options granted to such consultants may not be terminated before the expiration of such option. The Bank's Plan currently allows options to be granted to directors, officers and key employees only. Except for optionees that are directors and officers of the Holding Company and any of its subsidiaries, the 1997 Plan requires full-time employees to receive a minimum exercise period of a stock option of at least 20% per year over five years from the date the option is granted. In comparison, the Bank's 1997 Plan allows the Bank and the optionee complete discretion in the vesting of such options. Except for optionees that are consultants, the 1997 Plan and the Bank's 1997 Plan both provide that options will terminate subject to possible reinstatement by the Stock Option Committee if an optionee is terminated for cause. FEDERAL INCOME TAX CONSEQUENCES To the extent that options granted under the 1997 Plan qualify as incentive stock options and (i) the optionee does not sell the stock acquired upon exercise of the options within two (2) years of the date of grant and one (1) year from the date of exercise and (ii) the optionee was employed by the Holding Company or a subsidiary for the entire period beginning on the date of grant of option and ending three (3) months prior to the exercise of the option, then the optionee will not recognize compensation income to the extent of any "bargain element" determined as of the time of grant or exercise, and the Holding Company will not be entitled to a corresponding tax deduction. However, the bargain element is a time of tax preference for the purpose of determining the employee's alternative minimum tax. 89 If the optionee disposes of the stock acquired through the exercise of the incentive stock option prior to satisfaction of the holding period or fails to satisfy the employment requirement, the optionee will recognize compensation income and the Holding Company will be entitled to a corresponding tax deduction to the extent of the lesser of (i) the excess of the fair market value of the stock at the date of exercise over the exercise price or (ii) the amount realized in excess of the tax basis of the stock if disposed in a taxable transaction. If the options granted under the 1997 Plan are nonqualified, the optionee will not recognize taxable income, and the Holding Company will not be entitled to a corresponding tax deduction, at the time of grant or exchange. Upon the exercise of a non-qualified stock option, however, the optionee will recognize taxable income equal to the "bargain element" or the "spread", the difference between the fair market value determined as of the time of exercise of the Holding Company's Common Stock acquired by the optionee and the option price paid for the stock. The Holding Company will be entitled to a corresponding tax deduction equal to the income recognized by the optionee provided that the income tax withholding attributable to the optionee's recognized income is collected from the optionee. Shares of the Holding Company's Common Stock to be issued upon exercise of stock options need not be registered with the Securities and Exchange Commission. However, the Holding Company has applied for a permit from the California Commissioner of Corporations and the Holding Company intends to register the Common Stock reserved for issuance under the 1997 Plan with the SEC prior to issuing any of its Common Stock upon exercise thereof. Approval of the 1997 Plan requires the affirmative vote of a majority of the issued and outstanding shares of the Bank as prospective shareholders of the Holding Company, and the 1997 Plan is subject to the approval of the California Commissioner of Corporations. The description herein is intended to highlight and summarize the principle terms of the 1997 Plan. For further information, shareholders are referred to a copy of the 1997 Plan which is available for inspection at the Holding Company. THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE APPROVAL OF THE HOLDING COMPANY'S 1997 STOCK OPTION PLAN COMMISSION'S POSITION ON INDEMNIFICATION FOR SECURITIES ACT LIABILITIES Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the Holding Company, the Holding Company has been advised that in the opinion of the Commission, such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. EXPERTS The financial statements of the Bank, as of December 31, 1996 and 1995, and for the years then ended included in this Proxy Statement/Prospectus have been so included in reliance upon the report of Vavrinek, Trine Day and Co., independent certified accountants, for 1996, and Dayton & Associates, independent certified accountants, for 1995, to the extent set forth in their report included herein, given on the authority of those firms as an expert in auditing and accounting. Dayton & Associates was merged into Vavrinek, Trine, Day and Co. in 1996. 90 LEGAL MATTERS The validity of the Holding Company Common Stock being registered with the Commission will be passed upon for the Holding Company and the Bank by Knecht & Hansen, Newport Beach, California. The opinion given under "Certain Federal Income Tax Consequences" has been rendered by Vavrinek, Trine, Day & Co. ANNUAL REPORT UPON WRITTEN REQUEST OF ANY PERSON ENTITLED TO VOTE AT THE MEETING, ADDRESSED TO BANK OF YORBA LINDA, 18206 IMPERIAL HIGHWAY, YORBA LINDA, CALIFORNIA 92686, ATTENTION: MR. BARRY J. MOORE, FIRST EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER, THE BANK WILL PROVIDE, WITHOUT CHARGE, A COPY OF ITS 1996 ANNUAL REPORT TO SHAREHOLDERS. 91 ANNEX I: PLAN OF REORGANIZATION AND MERGER AGREEMENT A copy of the Plan of Reorganization and Merger Agreement entered into as of May 2, 1997 by the Bank, Holding Company and the Merger Company is attached hereto. PLAN OF REORGANIZATION AND MERGER AGREEMENT This Plan of Reorganization and Merger Agreement is entered into as of May 2, 1997, by and between Bank of Yorba Linda ("Bank"), BYL Merger Corporation ("Subsidiary"), and BYL Bancorp ("Holding Company"). RECITALS AND UNDERTAKINGS A. Bank is a California banking corporation with its principal office in the City of Yorba Linda, County of Orange, California. Subsidiary and Holding Company are each corporations duly organized and existing under the laws of the State of California with their principal offices in the City of Yorba Linda, County of Orange, California. B. As of March 31, 1997, Bank had 5,000,000 shares of no par value Common Stock authorized and 1,151,420 shares outstanding, and 1,000,000 shares of Preferred Stock authorized and 0 shares outstanding. C. As of the date hereof, Subsidiary has an authorized maximum number of shares of capital stock of 1,000,000 shares of no par value Common Stock, and at the time of the merger referred to herein 100 of such shares of Common Stock will be outstanding, all of which outstanding shares will be owned by Holding Company. D. As of the date hereof, Holding Company has an authorized maximum number of shares of capital consisting of 50,000,000 shares of no par value Common Stock, and 25,000,000 shares of no par value Preferred Stock, of which 150 shares of Common Stock will be outstanding and no shares of Preferred Stock will be outstanding at the time of the merger referred to herein. E. The Boards of Directors of Bank and Subsidiary have, respectively, approved this Agreement and authorized its execution; and the Board of Directors of Holding Company has approved this Agreement and has authorized the Holding Company to join in and be bound by this Agreement, and authorized the undertakings and representations made herein by Holding Company. NOW, THEREFORE, in consideration of the promises and the mutual covenants, agreements and undertakings of the parties herein set forth and for the purpose of prescribing the terms and conditions of the merger, the parties hereto agree as follows: SECTION 1. GENERAL 1.1 THE MERGER. On the Effective Date, Subsidiary shall be merged into Bank, which shall be the Surviving Corporation (the "Surviving Corporation") and a subsidiary of Holding Company, and its name shall continue to be "Bank of Yorba Linda." -1- 1.2 EFFECTIVE DATE. The merger described herein shall become effective, and actions to consummate such merger shall commence, at the close of business on the date (the "Effective Date") upon which an executed counterpart of this Agreement (as amended, if necessary, to conform to any requirements of law or governmental authority or agency, which requirements are not materially in contravention of any of the substantive terms hereof) shall have been filed with the Office of the Secretary of State of the State of California, in accordance with Section 1103 of the California Corporations Code. 1.3 ARTICLES OF INCORPORATION, BYLAWS AND CERTIFICATE OF AUTHORITY. At the close of business on the Effective Date, the Articles of Incorporation of Bank, as in effect immediately prior to such time on the Effective Date, shall be and remain the Articles of Incorporation of the Surviving Corporation, the Bylaws of Bank shall be and remain the Bylaws of the Surviving Corporation until altered, amended or repealed; the Certificate of Authority of Bank issued by the Superintendent of Banks of the State of California shall be and remain the Certificate of Authority of the Surviving Corporation; and Bank insurance of deposits coverage by the Federal Deposit Insurance Corporation shall be and remain the deposit insurance of the Surviving Corporation. 1.4 DIRECTORS AND OFFICERS OF THE SURVIVING CORPORATION. At the close of business on the Effective Date, the directors and officers of Bank immediately prior to such time on the Effective Date shall be and remain the directors and officers of the Surviving Corporation. Directors of the Surviving Corporation shall serve until the next Annual Meeting of Shareholders of the Surviving Corporation or until such time as their successors are elected and have qualified. 1.5 EFFECT OF THE MERGER. (a) ASSETS AND RIGHTS. At the close of business on the Effective Date and thereafter, all rights, privileges, franchises and property of Subsidiary, and all debts and liabilities due or to become due to Subsidiary, including things in action and every interest or asset of conceivable value or benefit, shall be deemed fully and finally and without any right of reversion transferred to and vested in the Surviving Corporation without further act or deed, and the Surviving Corporation shall have and hold the same in its own right as fully as the same was possessed and held by Subsidiary. (b) LIABILITIES. At the close of business on the Effective Date and thereafter, all debts, liabilities, and obligations due or to become due of, and all claims and demands for any cause existing against, Subsidiary shall be and become the debts, liabilities or obligations of, or the claims and demands against, the Surviving Corporation in the same manner as if the Surviving Corporation had itself incurred or become liable for them. (c) CREDITORS' RIGHTS AND LIENS. At the close of business on the Effective Date and thereafter, all rights of creditors of Subsidiary, and all liens upon the property of Subsidiary, shall be preserved unimpaired, and shall be limited to the property affected by such liens immediately prior to the Effective Date. -2- (d) PENDING ACTIONS. At the close of business on the Effective Date and thereafter, any action or proceeding pending by or against Subsidiary shall not be deemed to have abated or been discontinued, but may be pursued to judgment with the full right to appeal or review. Any such action or proceeding may be pursued as if the merger described herein had not occurred, or with the Surviving Corporation substituted in place of Subsidiary, as the case may be. 1.6 FURTHER ASSURANCES. Bank and Subsidiary each agree that at any time, or from time to time, as and when requested by the Surviving Corporation, or by its successors and assigns, it will execute and deliver, or cause to be executed and delivered, in its name by its last acting officers, or by the corresponding officers of the Surviving Corporation, all such conveyances, assignments, transfers, deeds or other instruments, and will take or cause to be taken such further or other action as the Surviving Corporation, its successors or assigns may deem necessary or desirable in order to evidence the transfer, vesting or devolution of any property right, privilege or franchise or to vest or perfect in or confirm to the Surviving Corporation, its successors and assigns, title to and possession of all the property rights, privileges, powers, immunities, franchises and interests referred to in this Section 1, or otherwise to carry out the intent and purposes of this Agreement. SECTION 2. CAPITAL STOCK OF THE SURVIVING CORPORATION 2.1 STOCK OF SUBSIDIARY. At the close of business on the Effective Date, each share of Common Stock of Subsidiary issued and outstanding immediately prior thereto shall, by virtue of the merger described herein, be deemed to be exchanged for and converted into one fully paid share, assessable in accordance with Section 662 of the California Financial Code, of Common Stock of Bank as the Surviving Corporation. 2.2 STOCK OF BANK. At the close of business on the Effective Date, each share of Common Stock of Bank issued and outstanding immediately prior thereto shall, by virtue of the merger described herein, and without any action on the part of the holder thereof, be exchanged for and converted into one share of fully paid nonassessable Common Stock of Holding Company, in accordance with the provisions of Paragraph 2.3. 2.3 EXCHANGE OF STOCK BY BANK SHAREHOLDERS. The conversion of the shares of Bank provided in Paragraph 2.2 above shall occur automatically at the close of business on the Effective Date without action by the holders thereof. Each share certificate evidencing ownership of shares of Bank Common Stock thereupon shall be deemed to evidence one share of Common Stock of the Holding Company. Each holder of shares of Bank Common Stock may but is not required to surrender his share certificate or certificates to the Holding Company, or an Exchange Agent appointed by the Holding Company, and shall be entitled to receive in exchange therefor a certificate or certificates representing the number of shares into which his shares theretofore represented by a certificate or certificates so surrendered shall have been converted. -3- 2.4 EMPLOYEE STOCK OPTIONS. At the close of business on the Effective Date, the Holding Company will assume Bank's rights and obligations under Bank's Stock Option Plan (the "Plan") and under each of the outstanding options previously granted under the Plan (each such option existing immediately prior to the Effective Date being an "existing option" and each such option so assumed by the Holding Company being called an "assumed option"), by which assumption the optionee shall have the right to purchase one share of Holding Company Common Stock for each share of Common Stock of Bank he was entitled to purchase under such existing option, except that no option shall survive to purchase fractional shares. Each assumed option, subject to such modification as may be required, shall constitute a continuation of the existing option substituting the Holding Company for Bank and employment by the Holding Company or any of its subsidiaries for employment by the Bank. The price per share of Holding Company Common Stock at which the assumed option (or any installment) may be exercised shall be the price as was applicable to the purchase of the Bank Common Stock pursuant to the existing option, and all other terms and conditions applicable to the assumed options shall, except as herein provided, be unchanged. Each option granted under the Plan after the close of business on the Effective Date shall evidence the right to purchase shares of Common Stock of the Holding Company rather than shares of Common Stock of the Bank and the Plan shall be modified to so provide. 2.5 OTHER RIGHTS TO STOCK. From time to time, as and when required by the provisions of any agreement to which Bank or Holding Company shall become a party after the date hereof providing for the issuance of shares of Common Stock or other equity securities of Bank or Holding Company in connection with a merger into Bank of any other banking institution or other corporation, or the acquisition by the Bank of the assets or stock of any other banking institution or corporation, Holding Company shall issue in accordance with the terms of any such agreement, its Common Stock or other equity securities as required by such agreement, or in substitution of the shares of Common Stock or other equity securities of Bank required to be issued by such agreement, as the case may be, which the shareholders of any other such banking institution or other corporation shall be entitled to receive by virtue of any such agreement. SECTION 3. OBLIGATIONS OF THE PARTIES PENDING THE EFFECTIVE DATE OF MERGER 3.1 STOCKHOLDER APPROVALS. As soon as practicable, this Agreement shall be duly submitted to stockholders of Bank, Subsidiary and the Holding Company for the purpose of considering and acting upon this Agreement in the manner required by law. Each of the parties shall use its best efforts to obtain the requisite approval of its stockholders to this Agreement and the transactions contemplated herein. 3.2 REGULATORY APPROVALS. Each of the parties hereto shall execute and file with the appropriate regulatory authorities all necessary documents and instruments and shall take every reasonable and necessary step and action to comply with and to secure such regulatory approval of this Agreement and the transactions contemplated herein as may be required by all applicable statutes, rules and regulations, including -4- without limitation the consents and approvals referred to in Paragraphs 4.1(b), 4.1(c) and 4.1(d). SECTION 4. CONDITIONS PRECEDENT, TERMINATION AND PAYMENT OF EXPENSES 4.1 CONDITIONS PRECEDENT TO THE MERGER. Consummation of the merger described herein is subject to satisfaction of the following conditions: (a) Ratification and confirmation of this Agreement by the respective stockholders of Bank, the Subsidiary and the Holding Company, in accordance with the applicable provisions of law; (b) Obtaining all other consents and approvals, on terms and conditions satisfactory to each of the parties hereto, and satisfying all other requirements, prescribed by law or otherwise, which are necessary for the merger described herein to be consummated, including without limitation: approvals from the Federal Deposit Insurance Corporation, the Superintendent of Banks of the State of California, and the Board of Governors of the Federal Reserve System under the Bank Holding Company Act of 1956, approval from the California Commissioner of Corporations under the California Corporate Securities Law of 1968 and authorizations, to the extent necessary under applicable blue sky laws with respect to the securities of the Holding Company issued upon consummation of the merger, and the declaration as effective by the Securities and Exchange Commission of a registration statement under the Securities Act of 1933 with respect to the securities of the Holding Company issuable upon consummation of the merger, (c) Issuance (unless waived by each of the parties hereto) of a favorable ruling by the Internal Revenue Service of the United States Department of the Treasury, in form and substance satisfactory to each of the parties hereto and their counsel, with respect to the tax consequences to the parties and their stockholders of the merger described herein; (d) Procuring all other consents or approvals, governmental or otherwise, which in the opinion of counsel for Bank are or may be necessary to permit or to enable the Surviving Corporation to conduct, upon and after the merger described herein, all or any part of the business and other activities in which Bank will be engaged up to the time of such merger, in the same manner and to the same extent Bank engages in such businesses and other activities immediately prior to such merger; and (e) Performance by each of the parties hereto of all obligations under this Agreement which are to be performed prior to the consummation of the merger described herein. 4.2 TERMINATION OF THE MERGER. If any condition specified in Paragraph 4.1 has not been fulfilled, or prior to the Effective Date a majority of the members of the Board of Directors of any of the parties hereto has determined that: -5- (a) The number of shares of Common Stock of Bank voting against the merger makes consummation of the merger inadvisable; or (b) Any action, suit, proceeding or claim relating to the merger described herein has been instituted, made or threatened which makes consummation of the merger inadvisable; or (c) For any other reason consummation of the merger is inadvisable; then this Agreement may be terminated at any time before the merger becomes effective. Upon termination, this Agreement shall be void and of no further effect, and there shall be no liability by reason of this Agreement or the termination thereof on the part of the parties or their respective directors, officers, employees, agents or shareholders. 4.3 EXPENSES OF THE MERGER. All expenses of the merger, described herein, including, without limitation, filing fees, printing costs, mailing costs, accountant's fees and legal fees, shall be borne jointly by the Surviving Corporation and the Holding Company; provided, however, that if the merger is abandoned for any reason, then all of such expenses, including but not limited to, the Holding Company's obligation to repurchase the shares issued to its initial shareholders, shall be paid by Bank. SECTION 5. MISCELLANEOUS 5.1 ENTIRE AGREEMENT. This Agreement embodies the entire agreement among the parties and there have been and are no agreements, representations or warranties among the parties with respect to the subject matter of this Agreement other than those set forth herein or those provided for herein. 5.2 GOVERNING LAW. This Agreement has been executed in the State of California and the laws of such State shall govern the validity and the interpretation hereof and the performance by the parties hereto. 5.3 COUNTERPARTS. To facilitate the filing of this Agreement, any number of counterparts hereof maybe executed and each such counterpart shall be deemed to be an original instrument, but all such counterparts together shall constitute but one instrument. -6- IN WITNESS WHEREOF, the parties hereto have caused this Plan of Reorganization and Merger Agreement to be executed by their duly authorized officers as of the day and year first above written. BANK OF YORBA LINDA By: /s/ Robert Ucciferri --------------------------------------- Robert Ucciferri, President and Chief Executive Officer By: /s/ John F. Myers --------------------------------------- John F. Myers, Secretary BYL MERGER CORPORATION By: /s/ Robert Ucciferri --------------------------------------- Robert Ucciferri, President and Chief Executive Officer By: /s/ Barry J. Moore --------------------------------------- Barry J. Moore, Secretary BYL BANCORP By: /s/ Robert Ucciferri --------------------------------------- Robert Ucciferri, President and Chief Executive Officer By: /s/ John F. Myers --------------------------------------- John F. Myers, Secretary -7- ANNEX II: BYL BANCORP STOCKHOLDER AGREEMENT A copy of the BYL Bancorp Stockholder Agreement entered into as of April 23, 1997 by the Holding Company and Mr. Robert Ucciferri is attached hereto. STOCKHOLDER AGREEMENT THIS AGREEMENT is entered into this 23rd day of April, 1997 by and between Robert Ucciferri ("Shareholder") and BYL Bancorp ("Corporation"), a California corporation with its principal executive office in Yorba Linda, California 92686. A. WHEREAS, the Articles of Incorporation of the Corporation currently authorize the issuance of up to 50,000,000 of its no par value Common Stock ("Common Stock") and 25,000,000 of its no par value Preferred Stock. B. WHEREAS, the Board of Directors of the Corporation have authorized the sale and issuance of 150 shares of the Corporation's Common Stock at the purchase price of $10.00 per share to Shareholder pursuant to the terms of Corporation Code Section 25102(f); C. WHEREAS, Shareholder desires to purchase 150 shares of the Corporation's Common Stock for the purchase price of $10.00 per share pursuant to the terms and conditions herein set forth; IT IS MUTUALLY AGREED by and between the parties hereto as follows: 1. PURCHASE. The Corporation agrees to sell and Shareholder agrees to for each purchase 150 shares of the Corporation's Common Stock at the price of $10.00 per share for an aggregate purchase price of $1500.00 2. TRANSFER OF SHARES. The Shareholder agrees not to sell, assign, transfer, encumber, hypothecate, or make any other disposition of any of the shares of the Common Stock to be purchased except with the prior written consent of the Corporation and except in accordance with the terms of this Stockholder Agreement. This Stockholder Agreement shall be binding upon and shall operate for the benefit of the Corporation and the Shareholder and the respective executors or administrators and any transferees or assignees of the Shareholder, whether such transfers or assignments are in accordance with or in violation of the provisions of this Stockholder Agreement. 3. THE PURCHASE BY THE CORPORATION. Upon consummation of the merger between the Corporation's wholly-owned subsidiary, BYL Merger Corporation, and pursuant to which this Corporation will issue shares of its Common Stock to the shareholders of Bank of Yorba Linda ("the Merger"), the Corporation shall be obligated to repurchase for cash and the Shareholder shall be obligated to resell to the Corporation the above-mentioned shares at the repurchase price of $10.00 per share, for a total repurchase price of $1,500. The repurchase and repayment therefor shall -1- occur simultaneously with the consummation of the Merger, at which time Shareholder's share certificates shall be returned and cancelled. 4. TERMINATION. This Stockholder Agreement shall terminate upon the occurrence of any of the following events: (a) The bankruptcy, receivership, or dissolution of the Corporation; (b) Mutual agreement of the Corporation and Shareholder; or (c) The failure of the consummation of the Merger for any reason whatsoever. 5. LEGEND. Upon execution of this Stockholder Agreement, the certificate representing the number of shares of Stock to be issued shall be endorsed as follows: "It is unlawful to consummate a sale or transfer of this security, or any interest therein, or to receive any consideration therefor, without the prior written consent of the Commissioner of Corporations of the State of California, except as permitted by the Commissioner's rules. Additionally, this certificate is transferable only upon compliance with provisions of a Stockholder Agreement dated April 23, 1997." 6. GOVERNING LAW. This Stockholder Agreement shall be construed and governed by the laws of the State of California. The offer and sale of this stock will not be accompanied by the publication of any advertisement, that no selling expenses will be given, paid or incurred in connection therewith, that no promotional considerations will be given, paid or incurred in connection therewith, that a notice in the form prescribed by the rules of Commissioner of Corporations ("Commissioner") shall be filed with the Commissioner, and that a copy of Section 260.141.11 of the Corporate Securities Rules is attached hereto and is hereby acknowledged as received by shareholder. 7. ENTIRE AGREEMENT. This Stockholder Agreement constitutes the sole and only agreement of the parties hereto respecting the sale and purchase of the shares of the Corporation and the resale and repurchase of the shares of the Corporation's Common Stock and correctly sets forth the rights, duties, and obligations of each party to the other in relation thereto as of this date. Any prior agreements, promises, negotiations or representations concerning the subject matter of this Stockholder Agreement not expressly set forth in this Stockholder Agreement are of no force or effect. -2- IN WITNESS WHEREOF, the parties hereto have executed this Stockholder Agreement in Yorba Linda, California on the date first above written. BYL BANCORP By /s/ John C. Coelho --------------------------------------- John C. Coelho Chairman of the Board By /s/ Barry J. Moore --------------------------------------- Barry J. Moore Chief Financial Officer By /s/ Robert Ucciferri --------------------------------------- Robert Ucciferri "Shareholder" -3- INDEX TO FINANCIAL STATEMENTS Independent Auditors' Report Financial Statements of BANK OF YORBA LINDA Statements of Financial Condition as of December 31, 1996 and 1995 and June 30, 1997 (unaudited) Statements of Income for the Years Ended December 31, 1996, 1995 and 1994 and Six Months Ended June 30, 1997 and 1996 (unaudited) Statements of Changes in Shareholders' Equity for the Years Ended December 31, 1996, 1995 and 1994 and Six Months Ended June 30, 1997 (unaudited) Statements of Cash Flows for the Years Ended December 31, 1996, 1995 and 1994 and Six Months Ended June 30, 1997 and 1996 (unaudited) Notes to Financial Statements Financial Statements of the Holding Company are not presented herein because BYL Bancorp has no assets and liabilities and has not conducted any business other than of an organizational nature. All schedules are omitted because the required information is not applicable or is included in the Financial Statements of BANK OF YORBA LINDA and the related notes. To the Board of Directors and Shareholders of Bank of Yorba Linda INDEPENDENT AUDITORS' REPORT We have audited the accompanying statement of condition of Bank of Yorba Linda as of December 31, 1996 and the related statements of income, changes in shareholders' equity, and cash flows of the year then ended. These financial statements are the responsibility of the Bank's management. Our responsibility is to express an opinion on these financial statements based on our audit. The financial statements as of December 31, 1995 and 1994, were audited by Dayton & Associates, who merged with Vavrinek, Trine, Day & Co. as of September 1, 1996, and whose report dated January 4, 1996 expressed an unqualified opinion on those statements. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the 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 audit provides 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 Bank of Yorba Linda as of December 31, 1996, and the results of its operations and its cash flows for the year then ended, in conformity with generally accepted accounting principles. VAVRINEK, TRINE, DAY & CO. February 5, 1997, except for Note P as to which the date is June 30, 1997. Laguna Hills, California F-1 BANK OF YORBA LINDA STATEMENTS OF FINANCIAL CONDITION DECEMBER 31, 1996 AND 1995 AND JUNE 30, 1997 (UNAUDITED) June 30, 1997 1996 1995 ------------ ------------ ------------ (Unaudited) ASSETS Cash and Due from Banks $ 11,490,000 $ 11,760,461 $ 6,400,869 Investment Securities - Note B: Available for Sale 1,350,000 - 3,000,000 Held to Maturity 5,788,000 5,773,634 1,791,593 ------------ ------------ ------------ TOTAL INVESTMENT SECURITIES 7,138,000 5,773,634 4,791,593 Federal Funds Sold 12,100,000 500,000 3,400,000 Loans Held for Sale 41,423,000 24,363,386 10,186,064 Loans - Note C: Commercial 17,978,000 13,577,349 5,685,792 Real Estate 45,883,000 47,318,946 24,146,266 Consumer 5,659,000 3,347,850 1,635,735 ------------ ------------ ------------ TOTAL LOANS 69,520,000 64,244,145 31,467,793 Net Deferred Loan Costs 400,000 305,320 29,435 Allowance for Credit Losses (1,182,000) (1,210,000) (580,000) ------------ ------------ ------------ NET LOANS 68,738,000 63,339,465 30,917,228 Premises and Equipment - Note D 4,520,000 3,706,933 672,292 Other Real Estate Owned 893,000 1,029,861 506,800 Cash Surrender Value of Life Insurance 883,000 861,956 818,300 Goodwill - Note O 1,603,000 1,659,868 - Accrued Interest and Other Assets 3,293,000 3,471,448 2,090,622 ------------ ------------ ------------ $152,081,000 $116,467,012 $ 59,783,768 ------------ ------------ ------------ ------------ ------------ ------------ The accompanying notes are an integral part of these financial statements. F-2 BANK OF YORBA LINDA STATEMENTS OF FINANCIAL CONDITION DECEMBER 31, 1996 AND 1995 AND JUNE 30, 1997 (UNAUDITED) June 30, 1997 1996 1995 (Unaudited) ------------ ------------ ------------ LIABILITIES AND SHAREHOLDERS' EQUITY Deposits - Note E: Noninterest-Bearing Demand $ 40,059,000 $ 31,964,976 $ 19,271,848 Money Market and NOW 28,411,000 25,831,214 18,123,129 Savings 17,438,000 18,324,403 7,527,460 Time Deposits Under $100,000 29,171,000 11,912,358 5,276,354 Time Deposits $100,000 and Over 21,367,000 14,335,005 3,826,599 ------------ ------------ ------------ TOTAL DEPOSITS 136,446,000 102,367,956 54,025,390 Accrued Interest and Other Liabilities 1,941,000 1,160,672 601,115 ------------ ------------ ------------ TOTAL LIABILITIES 138,387,000 103,528,628 54,626,505 Commitments and Contingencies - Note H Shareholders' Equity - Notes J, K, and L: Serial Preferred Stock, No Par Value - Authorized 1,000,000 Shares, Series A; Issued and Outstanding 10,000 Shares in 1995 - - 1,000,000 Common Shares - Authorized 5,000,000 Shares; Issued and Outstanding 1,535,064 Shares in 1997 and 1996 and 461,731 Shares in 1995 10,298,000 10,298,485 2,539,630 Undivided Profits, Including Transfer of $735,006 from Common Shares on December 31, 1988 3,396,000 2,639,899 1,617,633 ------------ ------------ ------------ TOTAL SHAREHOLDERS' EQUITY 13,694,000 12,938,384 5,157,263 ------------ ------------ ------------ $152,081,000 $116,467,012 $ 59,783,768 ------------ ------------ ------------ ------------ ------------ ------------ The accompanying notes are an integral part of these financial statements. F-3 BANK OF YORBA LINDA STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994 AND SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) Six Months Ended June 30, Year Ended December ----------------------- ------------------------------------ 1997 1996 1996 1995 1994 ---------- ---------- ---------- ---------- ---------- (Unaudited) INTEREST INCOME Interest and Fees on Loans $5,706,000 $2,540,000 $6,919,824 $4,120,407 $3,885,254 Interest on Investment Securities 194,000 103,000 355,932 219,103 189,991 Other Interest Income 162,000 97,000 222,184 139,874 51,540 ---------- ---------- ---------- ---------- ---------- TOTAL INTEREST INCOME 6,062,000 2,740,000 7,497,940 4,479,384 4,126,785 INTEREST EXPENSE Interest on Money Market and NOW 327,000 237,000 576,264 453,625 518,219 Interest on Savings Deposits 342,000 143,000 511,854 278,445 297,635 Interest on Time Deposits 1,087,000 310,000 971,653 312,838 188,772 ---------- ---------- ---------- ---------- ---------- TOTAL INTEREST EXPENSE 1,756,000 690,000 2,059,771 1,044,908 1,004,626 ---------- ---------- ---------- ---------- ---------- NET INTEREST INCOME 4,306,000 2,050,000 5,438,169 3,434,476 3,122,159 Provision for Credit Losses 195,000 123,000 344,500 262,000 423,000 ---------- ---------- ---------- ---------- ---------- NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 4,111,000 1,927,000 5,093,669 3,172,476 2,699,159 NONINTEREST INCOME Gains, Fees, and Servicing Income on Loans Sold 5,049,000 3,006,000 6,859,948 5,157,436 3,377,074 Service Charges, Fees, and Other Income 682,000 373,000 793,183 504,431 421,969 ---------- ---------- ---------- ---------- ---------- 5,731,000 3,379,000 7,653,131 5,661,867 3,799,043 ---------- ---------- ---------- ---------- ---------- 9,842,000 5,306,000 12,746,800 8,834,343 6,498,202 NONINTEREST EXPENSE Salaries and Employee Benefits 5,144,000 2,675,000 6,158,400 4,399,141 3,140,798 Occupancy Expenses 419,000 277,000 717,025 537,553 499,836 Furniture and Equipment 647,000 271,000 666,995 434,597 424,508 Other Expenses - Note F 2,072,000 1,322,000 3,118,798 1,723,725 1,622,133 ---------- ---------- ---------- ---------- ---------- 8,282,000 4,545,000 10,661,218 7,095,016 5,687,275 ---------- ---------- ---------- ---------- ---------- INCOME BEFORE INCOME TAXES 1,560,000 761,000 2,085,582 1,739,327 810,927 Income Taxes - Note G 667,000 310,000 884,000 717,000 335,000 ---------- ---------- ---------- ---------- ---------- NET INCOME $ 893,000 $ 451,000 $1,201,582 $1,022,327 $ 475,927 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Net Income Per Share: Primary $ 0.54 $ 0.69 $ 1.05 $ 1.98 $ 0.83 Fully Diluted $ 0.54 $ 0.65 $ 1.04 $ 1.39 $ 0.62 Shares Used in Computation: Primary 1,647,485 609,048 1,120,147 461,731 461,731 Fully Diluted 1,647,485 693,846 1,160,880 737,129 770,359 The accompanying notes are an integral part of these financial statements. F-4 BANK OF YORBA LINDA STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994 AND SIX MONTHS ENDED JUNE 30, 1997 (UNAUDITED) Serial Common Shares Preferred Number of Undivided Stock Shares Amount Profits Total ----------- ----------- ----------- ----------- ------------ BALANCE AT JANUARY 1, 1994 $ 1,000,000 461,731 $ 2,539,630 $ 480,666 $ 4,020,296 Net Income 475,927 475,927 Preferred Dividends (91,006) (91,006) ----------- ----------- ----------- ----------- ------------ BALANCE AT DECEMBER 31, 1994 1,000,000 461,731 2,539,630 865,587 4,405,217 Net Income 1,022,327 1,022,327 Preferred Dividends (270,281) (270,281) ----------- ----------- ----------- ----------- ------------ BALANCE AT DECEMBER 31, 1995 1,000,000 461,731 2,539,630 1,617,633 5,157,263 Net Income 1,201,582 1,201,582 Preferred Dividends (159,316) (159,316) Redemption of Preferred Stock (1,000,000) (20,000) (1,020,000) Issuance of Common Shares, Net of Expenses of $1,096,145 1,073,333 7,758,855 7,758,855 ----------- ----------- ----------- ----------- ------------ BALANCE AT DECEMBER 31, 1996 - 1,535,064 10,298,485 2,639,899 12,938,384 Net Income 893,094 893,094 Dividends (134,324) (134,324) Payment for Fractional Shares Related to Stock Split (3,256) (3,256) ----------- ----------- ----------- ----------- ------------ BALANCE AT JUNE 30, 1997 $ - 1,535,064 $10,298,485 $ 3,395,413 $13,693,898 (UNAUDITED) ----------- ----------- ----------- ----------- ------------ ----------- ----------- ----------- ----------- ------------ The accompanying notes are an integral part of these financial statements. F-5 BANK OF YORBA LINDA STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994 AND SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) Six Months Ended June 30, Year Ended December ---------------------------- ------------------------------------------- 1997 1996 1996 1995 1994 -------------- ------------ -------------- ------------- ------------ (Unaudited) OPERATING ACTIVITIES Net Income $ 893,000 $ 451,000 $ 1,201,582 $ 1,022,327 $ 475,927 Adjustments to Reconcile Net Income to Net Cash Provided (Used) by Operating Activities: Depreciation and Amortization 425,000 131,000 405,351 256,637 250,352 Deferred Income Taxes (294,000) (86,000) (234,000) (224,000) (305,000) Loans Originated for Sale (102,190,000) (52,115,000) (111,080,174) (87,344,000) (7,285,890) Proceeds from Loan Sales 85,130,000 48,016,000 96,902,852 87,127,177 59,934,110 Provision for Credit Losses 195,000 123,000 344,500 262,000 423,000 Other Real Estate Owned Losses 33,000 - 207,425 53,289 165,318 Other Items - Net 1,218,000 585,000 (638,325) (700,136) 38,247 ------------- ------------ -------------- ------------- ------------ NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES (14,590,000) (2,895,000) (12,890,789) 453,294 (6,238,046) INVESTING ACTIVITIES Net Change in Interest-Bearing Deposits - - - 99,000 (99,000) Proceeds from Sales of Other Real Estate Owned 381,000 - 264,465 120,911 187,163 Purchases of Available-for-Sale Securities (1,350,000) (7,000,000) (7,000,000) (5,000,000) (1,975,586) Purchases of Held-to-Maturity Securities - (994,000) (994,283) (950,741) (5,508,691) Proceeds from Maturities of Available-for-Sale Securities - 6,000,000 10,000,000 3,995,333 - Proceeds from Maturities of Held-to-Maturity Securities - 1,000,000 3,250,000 1,250,000 5,300,000 Net Change in Loans (5,871,000) 3,422,000 546,721 (3,440,986) 10,243,873 Net Cash Received from Purchase of Bank of Westminster - 4,618,000 4,617,819 - - Purchases of Premises and Equipment (1,181,000) (242,000) (570,511) (357,622) (92,801) Purchase of Life Insurance - - - (818,300) - Proceeds from Sale of Premises and Equipment - - 34,563 69,900 - ------------- ------------ -------------- ------------- ------------ NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES (8,021,000) 6,804,000 10,148,774 (5,032,505) 8,054,958 FINANCING ACTIVITIES Net Change in Demand Deposits and Savings Accounts 9,788,000 549,000 (2,189,127) 176,192 3,241,668 Net Change in Time Deposits 24,290,000 (493,000) 811,195 5,155,957 (2,513,640) Proceeds from Stock Offering - 7,787,000 7,758,855 - - Redemption of Preferred Stock - (1,020,000) (1,020,000) - - Dividends Paid (137,000) (159,000) (159,316) (270,281) (91,006) ------------- ------------ -------------- ------------- ------------ NET CASH PROVIDED BY FINANCING ACTIVITIES 33,941,000 6,664,000 5,201,607 5,061,868 637,022 ------------- ------------ -------------- ------------- ------------ INCREASE IN CASH AND CASH EQUIVALENTS 11,330,000 10,573,000 2,459,592 482,657 2,453,934 Cash and Cash Equivalents at Beginning of Year 12,260,000 9,801,000 9,800,869 9,318,212 6,864,278 ------------- ------------ -------------- ------------- ------------ CASH AND CASH EQUIVALENTS AT END OF YEAR $ 23,590,000 $ 20,374,000 $ 12,260,461 $ 9,800,869 $ 9,318,212 ------------- ------------ -------------- ------------- ------------ ------------- ------------ -------------- ------------- ------------ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash Used During the Year for Interest $ 1,018,000 $ 656,000 $ 1,962,523 $ 979,102 $ 1,009,540 Cash Used During the Year for Income Taxes $ 1,688,000 $ 399,000 $ 1,109,000 $ 976,000 $ 498,000 The accompanying notes are an integral part of these financial statements. F-6 BANK OF YORBA LINDA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1996, 1995, AND 1994 NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS The Bank operates four retail branches in Orange 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 EQUIVALENTS For the purpose of presentation in the statements of cash flows, cash and cash equivalents are defined as those amounts included in the statements of financial condition captions "Cash and Due from Banks" and "Federal Funds Sold". SECURITIES HELD TO MATURITY 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. SECURITIES AVAILABLE FOR SALE Available-for-sale securities consist of bonds, notes, debentures, and certain equity securities not classified as trading securities nor as held-to-maturity securities. Unrealized holding gains and losses, net of tax, on available-for-sale securities are reported as a net amount in a separate component of shareholders' equity until realized. Gains and losses on the sale of available-for-sale securities are determined using the specific-identification method. Premiums and discounts are recognized in interest income using the interest method over the period to maturity. F-7 BANK OF YORBA LINDA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1996, 1995, AND 1994 NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED LOANS HELD FOR SALE Mortgage and SBA 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 No. 114, ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN (SFAS No. 114), 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. ALLOWANCE FOR CREDIT LOSSES The allowance for credit losses is increased by charges to income and decreased by charge-offs (net of recoveries). Management's periodic evaluation of the adequacy of the allowance is based on the Bank's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, and current economic conditions. 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. F-8 BANK OF YORBA LINDA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1996, 1995, AND 1994 NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED PREMISES AND EQUIPMENT Land is carried at cost. Bank premises, furniture and equipment, and leasehold improvements are carried at cost less accumulated depreciation and amortization. INCOME TAXES Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. FINANCIAL INSTRUMENTS In the ordinary course of business, the Bank has entered into off-balance sheet financial instruments consisting of commitments to extend credit, commitments under credit card arrangements, commercial letters of credit, and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded or related fees are incurred or received. NET INCOME PER SHARE Net income per share of common stock has been computed on the basis of the weighted average number of shares of common stock outstanding plus shares issuable upon the assumed exercise of outstanding stock options. CURRENT ACCOUNTING PRONOUNCEMENTS In June of 1996, the FASB issued SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities", as amended by SFAS No. 127 "Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125, establishing accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities based on consistent application of the financial-components approach. This approach requires the recognition of financial assets when control is surrendered, and the derecognition of liabilities when they are extinguished. Specific criteria are established for determining when control has been surrendered in the transfer of financial assets. Liabilities and derivatives incurred or obtained by transferors in conjunction with the transfer of financial assets are required to be measured at fair value, if practicable. Servicing assets and other retained interests in transferred assets are required to be measured by allocating the previous carrying amount between the assets sold, if any, and the interest that is retained, if any, based on the relative fair values of the assets on the date of the transfer. Servicing assets retained are subsequently subject to amortization and assessment for impairment. Management has not determined the potential impact this statement will have, however, management believes that there will be no material effect on the Bank's financial condition or results of operations. SFAS No. 125 is effective for transactions occurring after December 31, 1996. F-9 BANK OF YORBA LINDA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1996, 1995, AND 1994 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 statements of financial condition according to management's intent. The carrying amount of securities and their approximate fair values at December 31 were as follows: Gross Unrealized Amortized Gains Fair Cost (Losses) Value ---------- --------- ---------- AVAILABLE-FOR-SALE SECURITIES: DECEMBER 31, 1995: Other $3,000,000 $ - $3,000,000 ---------- --------- ---------- ---------- --------- ---------- HELD-TO-MATURITY SECURITIES: DECEMBER 31, 1996: U.S. Treasuries $1,298,644 $ 7,356 $1,306,000 U.S. Government and Agency Securities 3,933,500 10,500 3,944,000 Municipal Securities 541,490 (8,490) 533,000 ---------- --------- ---------- $5,773,634 $ 9,366 $5,783,000 ---------- --------- ---------- ---------- --------- ---------- DECEMBER 31, 1995: U.S. Government and Agency Securities $1,248,986 $ 36,014 $1,285,000 Municipal Securities 542,607 (13,607) 529,000 ---------- --------- ---------- $1,791,593 $ 22,407 $1,814,000 ---------- --------- ---------- ---------- --------- ---------- The Bank did not sell any investment securities for the years ended December 31, 1996, 1995, and 1994. Investment securities carried at approximately $3,321,000 and $1,792,000, at December 31, 1996 and 1995, respectively, were pledged to secure public deposits and other purposes as required by law. F-10 BANK OF YORBA LINDA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1996, 1995, AND 1994 NOTE B - INVESTMENT SECURITIES - CONTINUED The scheduled maturities of securities held to maturity and securities available for sale at December 31, 1996, were as follows: HELD-TO-MATURITY SECURITIES --------------------------- Amortized Fair Cost Value ------------ ----------- Due in One Year or Less $1,785,842 $1,790,000 Due from One Year to Five Years 3,987,792 3,993,000 ------------ ----------- $5,773,634 $5,783,000 ------------ ----------- ------------ ----------- NOTE C - LOANS The Bank's loan portfolio consists primarily of loans to borrowers within Orange 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. The Bank also originated 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, 1996 and 1995, the Bank was servicing approximately $44,194,000 and $23,929,000, respectively, in SBA loans previously sold. In connection with a portion of these loans, the Bank has capitalized approximately $1,249,000 and $632,000 in excess servicing receivables at December 31, 1996 and 1995, respectively. Excess servicing receivables are amortized over the estimated life of the serviced loan using a method that approximates the interest method. The Bank evaluates the carrying value of the excess servicing receivables by estimating the excess future servicing income, based on management's best estimate of the remaining loan lives. F-11 BANK OF YORBA LINDA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1996, 1995, AND 1994 NOTE C - LOANS - CONTINUED When the Bank sells the guaranteed portion of SBA loans, the cost allocated to the portion of the loan retained is based on the relative fair value of all components of the loan, including excess servicing receivables. The Bank has recorded discounts of approximately $1,063,000 and $312,000 at December 31, 1996 and 1995, respectively in connection with these loans. These discounts are amortized over the estimated life of each loan using the interest method. A summary of the changes in the allowance for credit losses as of December 31 follows: 1996 1995 1994 ---------- ---------- ---------- Balance at Beginning of Year $ 580,000 $ 536,000 $ 413,000 Additions to the Allowance Charged to Expense 344,500 262,000 423,000 Recoveries on Loans Charged Off 25,500 15,000 87,000 Allowance on Loans Acquired from Bank of Westminster 700,000 - - ---------- ---------- ---------- 1,650,000 813,000 923,000 Less Loans Charged Off (440,000) (233,000) (387,000) ---------- ---------- ---------- $1,210,000 $ 580,000 $ 536,000 ---------- ---------- ---------- ---------- ---------- ---------- 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: 1996 1995 ---------- --------- Recorded Investment in Impaired Loans $1,991,000 $ 760,000 Related Allowance for Impaired Losses $ 415,000 $ 163,000 Average Recorded Investment in Impaired Loans $1,591,000 $ 847,000 Interest Income Recognized for Cash Payments $ 19,000 $ None Loans having carrying values of $994,951, $18,000 and $50,237 were transferred to other real estate owned in 1996, 1995 and 1994, respectively. F-12 BANK OF YORBA LINDA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1996, 1995, AND 1994 NOTE D - PREMISES AND EQUIPMENT A summary of premises and equipment follows: 1996 1995 ---------- ----------- Land $ 821,188 $ - Buildings 1,826,737 - Furniture, Fixtures, and Equipment 2,918,103 2,207,710 Leasehold Improvements 678,812 615,476 ---------- ----------- 6,244,840 2,823,186 Less Accumulated Depreciation and Amortization (2,537,907) (2,150,894) ---------- ----------- $3,706,933 $ 672,292 ---------- ----------- ---------- ----------- NOTE E - DEPOSITS At December 31, 1996, the scheduled maturities of time deposits are as follows: 1997 $23,661,908 1998 through 2000 2,585,455 ----------- $26,247,363 ----------- ----------- NOTE F - OTHER EXPENSES A summary of other expenses for the years ended December 31 is as follows: 1996 1995 1994 ------------ ------------ ----------- Regulatory Assessments $ 29,082 $ 81,854 $ 148,064 Other Real Estate Owned 323,528 122,280 240,360 Commissions 199,585 124,280 135,236 Professional Fees and Outside Services 687,325 271,718 159,046 Loan Expenses 246,916 139,498 146,586 Office Expenses 748,199 533,278 554,227 Other 884,163 450,817 238,614 ------------ ------------ ----------- $ 3,118,798 $ 1,723,725 $ 1,622,133 ------------ ------------ ----------- ------------ ------------ ----------- F-13 BANK OF YORBA LINDA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1996, 1995, AND 1994 NOTE G - INCOME TAXES The provisions for income taxes included in the statements of income consist of the following: 1996 1995 1994 ----------- ----------- ----------- Current: Federal $ 806,000 $ 686,000 $ 471,000 State 312,000 255,000 169,000 ----------- ----------- ----------- 1,118,000 941,000 640,000 Deferred (234,000) (224,000) (305,000) ----------- ----------- ----------- $ 884,000 $ 717,000 $ 335,000 ----------- ----------- ----------- ----------- ----------- ----------- Deferred taxes are a result of differences between income tax accounting and generally accepted accounting principles with respect to income and expense recognition. The Bank'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 statements of financial condition: 1996 1995 ----------- ---------- Deferred Tax Assets: Allowance for Loan Losses $ 260,000 $ 99,000 Premises and Equipment - 33,000 Gain on Sale of Loans 649,000 383,000 California Franchise Tax 106,000 87,000 Other Assets/Liabilities 183,000 4,000 ----------- ---------- 1,198,000 606,000 Deferred Tax Liabilities: Premises and Equipment (478,000) - ----------- ---------- $ 720,000 $ 606,000 ----------- ---------- ----------- ---------- A comparison of the federal statutory income tax rates to the Bank's effective income tax rates for the years ended December 31 follows: 1996 1995 1994 ---------------------- ----------------------- ---------------------- Amount Rate Amount Rate Amount Rate -------- ----- -------- ----- -------- ----- Federal Tax Rate 709,000 34.0% 591,000 34.0% $276,000 34.0% California Franchise Taxes, Net of Federal Tax Benefit 159,000 7.6 132,000 7.6 63,000 7.8 Tax Savings from Exempt Interest (5,000) (0.2) (15,000) (0.9) (11,000) (1.3) Other Items - Net 21,000 1.0 9,000 0.5 7,000 0.8 -------- ----- -------- ----- -------- ----- Bank's Effective Rate $884,000 42.4% $717,000 41.2% $335,000 41.3% -------- ----- -------- ----- -------- ----- -------- ----- -------- ----- -------- ----- F-14 BANK OF YORBA LINDA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1996, 1995, AND 1994 NOTE H - COMMITMENTS AND CONTINGENCIES The Bank has entered into various operating lease agreements, primarily covering its branch locations. These agreements expire at various times through the year 2003. The approximate future minimum annual payments for these leases by year are as follows: 1997 $ 476,000 1998 461,000 1999 416,000 2000 416,000 2001 433,000 Thereafter 194,000 ---------- $2,396,000 ---------- ---------- The minimum rental payments shown above are given for the existing lease obligations and are not a forecast of future rental expense. Total rental expense included in occupancy expense and furniture and equipment expense was approximately $445,000 in 1996, $378,000 in 1995, and $352,000 in 1994. The Bank 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, 1996, the Bank had the following outstanding financial commitments whose contractual amount represents credit risk: Commitments to Extend Credit $11,356,000 Standby Letters of Credit 96,000 ----------- $11,452,000 ----------- ----------- F-15 BANK OF YORBA LINDA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1996, 1995, AND 1994 NOTE H - 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 I - 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 balance of these loans outstanding at December 31, 1996 was approximately $1,367,000 and approximately $460,000 at December 31, 1995. NOTE J - PREFERRED STOCK The Bank is authorized to issue 1,000,000 shares of its preferred stock in series. The rights, preferences, privileges and restrictions of each series of preferred stock are determined upon issuance. On July 16, 1986, the Bank issued 10,000 shares of its Series A preferred stock at a price of $100 per share for a total consideration of $1,000,000 to members of the Board of Directors. During 1996 the Bank redeemed all outstanding preferred stock for $1,020,000. NOTE K - STOCK OPTION PLAN At December 31, 1996, the Bank has an option plan which is described below. The Bank applies APB Opinion 25 and related interpretations in accounting for its plan. Accordingly, no compensation cost has been recognized for its fixed stock option plan. Had compensation costs for this plan been determined based on the fair value at the grant dates consistent with the method of SFAS 123, the impact would not have materially affected net income. In 1990, the Bank adopted an incentive stock option plan under which up to 138,568 shares of the Bank'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. F-16 BANK OF YORBA LINDA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1996, 1995, AND 1994 NOTE K - STOCK OPTION PLAN - CONTINUED A summary of the status of the Bank's fixed stock option plan as of December 31, 1996, 1995, and 1994, and changes during the years ending on those dates is presented below: 1996 1995 1994 ----------------------- ---------------------- ---------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ------- --------- ------- --------- ------- --------- Outstanding at beginning of Year 130,400 $4.88 130,400 $4.88 133,067 $4.88 Forfeited (4,533) 4.88 (2,667) 4.88 ------- ------- ------- Outstanding at end of year 125,867 4.88 130,400 4.88 130,400 4.88 ------- ------- --------- --------- ------- ------- --------- --------- Options exercisable at year-end 125,867 4.88 129,867 4.88 124,507 4.88 As of December 31, 1996, all outstanding options had a weighted-average remaining contractual life of 5.8 years. NOTE L - QUASI REORGANIZATION On December 31, 1988 the Bank effected a quasi reorganization whereby $735,006 was transferred from common shares to undivided profits to eliminate the accumulated deficit. Subsequent to that date the Bank has transferred from undivided profits to common shares $195,000 of benefits from net operating losses and investment tax credits. NOTE M - 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. F-17 BANK OF YORBA LINDA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1996, 1995, AND 1994 NOTE M - FAIR VALUE OF FINANCIAL INSTRUMENTS - CONTINUED 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. F-18 BANK OF YORBA LINDA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1996, 1995, AND 1994 NOTE M - FAIR VALUE OF FINANCIAL INSTRUMENTS - CONTINUED The estimated fair value of financial instruments at December 31, 1996 is summarized as follows (dollar amounts in thousands): Carrying Value Fair Value -------------- ------------ FINANCIAL ASSETS: Cash and Due From Banks $ 11,760 $ 11,760 Federal Funds Sold $ 500 $ 500 Investment Securities $ 5,774 $ 5,783 Loans Held for Sale $ 24,363 $ 25,410 Loans $ 63,339 $ 62,858 Cash Surrender Value - Life Insurance $ 862 $ 862 FINANCIAL LIABILITIES: Deposits $102,368 $102,343 NOTE N - 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). Management believes, as of December 31, 1996, that the Bank meets all capital adequacy requirements to which it is subject. F-19 BANK OF YORBA LINDA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1996, 1995, AND 1994 NOTE N - REGULATORY MATTERS - CONTINUED As of December 31, 1996, the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well-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. 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, 1996: Total Capital (to Risk-Weighted Assets) $11,882 13.0% $7,303 8.0% $9,128 10.0% Tier 1 Capital (to Risk-Weighted Assets) $10,741 11.8% $3,651 4.0% $5,477 6.0% Tier 1 Capital (to Average Assets) $10,741 9.2% $4,648 4.0% $5,810 5.0% AS OF DECEMBER 31, 1995: Total Capital (to Risk-Weighted Assets) $ 5,286 11.8% $3,602 8.0% $4,502 10.0% Tier 1 Capital (to Risk-Weighted Assets) $ 4,723 10.5% $1,801 4.0% $2,701 6.0% Tier 1 Capital (to Average Assets) $ 4,723 8.1% $2,327 4.0% $2,909 5.0% At December 31, 1996, Tier 1 Capital was comprised of stockholders equity less goodwill of $1,660,000 and other regulatory adjustments of $538,000. Tier 1 Capital at December 31, 1995 was stockholders equity less regulatory adjustments of $434,000. The California Financial Code provides that a bank may not make a cash distribution to its shareholders in excess of the lesser of the Bank's undivided profits or the Bank's net income for its last three fiscal years less the amount of any distribution made by the Bank to shareholders during the same period. Banking regulations require that all banks maintain a percentage of their deposits as reserves in cash or on deposit at the Federal Reserve Bank. At December 31, 1996, required reserves were approximately $860,000. F-20 BANK OF YORBA LINDA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1996, 1995, AND 1994 NOTE O - MERGER WITH BANK OF WESTMINSTER On June 13, 1996, the Bank acquired 100% of the outstanding common stock of Bank of Westminster (BOW) for $6,174,000 in cash. BOW had total assets of approximately $54,923,000. The acquisition was accounted for using the purchase method of accounting in accordance with Accounting Principles Board Opinion No. 16. "Business Combinations". Under this method of accounting, the purchase price was allocated to the assets acquired and deposits and liabilities assumed based on their fair values as of the acquisition date. The financial statements include the operations of BOW from the date of the acquisition. Goodwill arising from the transaction totaled approximately $1,717,000 and is being amortized over fifteen years on a straight-line basis. The following table sets forth selected unaudited pro forma combined financial information of the Bank and BOW for the years ended December 31, 1996 and 1995. The pro forma operating data reflects the effect of the acquisition of BOW as if it was consummated at the beginning of each year presented. The pro forma results are not necessarily indicative of the results that would have occurred had the acquisition been in effect for the full years presented, nor are they necessarily indicative of the results of future operations (amounts in thousands, except per share data). Year Ended -------------------------------------- December 31, 1996 December 31, 1995 ----------------- ----------------- Interest and Noninterest Income $17,560 $15,761 Net Income $ 1,068 $ 1,160 Net Income per Share: Primary $ 0.97 $ 1.10 Fully Divided $ 0.97 $ 0.88 These proforma disclosures include adjustment to interest income from the payment of the purchase price in cash, goodwill amortization and adjustments to net income per share to reflect the issuance of common stock to affect the purchase. No adjustments have been reflected in these amounts for the expected cost savings to be derived from this merger. NOTE P - STOCK SPLIT On June 30, 1997, the Bank's Common Shares were split, four shares for three shares. The per share data in the statements of income and the information in Note K have been adjusted to give retroactive affect to this transaction. F-21 PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS Article V of the Registrant's Articles of Incorporation provides that the liability of the directors of the corporation for monetary damages shall be eliminated to the fullest extent permissible under California law. Article VI of the Registrant's Articles of Incorporation provides that the corporation is authorized to provide for the indemnification of agents (as defined in Section 317 of the California General Corporation Law) of the corporation in excess of that expressly permitted by such Section 317 for breach of duty to the corporation and its shareholders to the fullest extent permissible under California law. Article III of the Registrant's Bylaws provides, in pertinent part, that each person who is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another foreign or domestic corporation or other entity, shall be indemnified by the Registrant to the full extent permitted by the General Corporation Law of the State of California or any other applicable laws. Article III also authorizes the registrant to enter into one or more agreements with any person which provides for indemnification greater or different than that provided for in that Article. Both the Registrant and its proposed wholly-owned subsidiary, Bank of Yorba Linda, have entered into indemnification agreements with their respective officers and directors in the forms incorporated by reference as Exhibit 10.1 to this Registration Statement. Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted pursuant to the foregoing provisions to directors, officers or persons controlling the Registrant, the Registrant has been informed that, in the opinion of the Securities and Exchange Commission, such indemnification is against public policy as expressed in said Act and is therefore unenforceable. ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) Exhibits. EXHIBIT NO. EXHIBIT ----------- ------- 2.1 Plan of Reorganization and Merger Agreement - Annex I of Proxy Statement/Prospectus incorporated by reference 3.1 Articles of Incorporation of the Registrant. 3.2 Amendment to Articles of Incorporation of Registrant 3.3 Bylaws of the Registrant II-1 EXHIBIT NO. EXHIBIT ----------- ------- 4.1 Specimen Certificate evidencing shares of Registrant's Common Stock 4.2 Stockholder Agreement Covering Issuance and Compulsory Repurchase of Organizing Shares of Registrant - Annex II of Proxy Statement/Prospectus incorporated by reference 5.1 Opinion of Knecht & Hansen 8.1 Tax Opinion of Vavrinek, Trine, Day & Co. 10.1 Form of Indemnification Agreement 10.2 BYL Bancorp 1997 Stock Option Plan and form of Stock Option Agreement 10.3 Form of Proxy 10.4 Employment Agreement - Mr. Robert Ucciferri 10.5 Employment Agreement - Mr. Barry J. Moore 10.6 Employment Agreement - Mr. Michael Mullarky 10.7 Salary Continuation Agreement - Mr. Robert Ucciferri 10.8 Salary Continuation Agreement - Mr. Barry J. Moore 21.1 Subsidiary of BYL Bancorp 23.1 Consent of Vavrinek, Trine, Day & Co. 23.2 Consent of Knecht & Hansen (included in Exhibit 5.1) _________________________________________ (b) Financial Statement Schedules All schedules are omitted because the required information is not applicable or is included in the Financial Statements of the Bank and the related notes. (c) Not applicable. II-2 ITEM 22. UNDERTAKINGS (a) The undersigned Registrant hereby undertakes to file, during any period in which offers or sales are being made, a post-effective amendment to this Registration Statement: (i) To include any prospectus required by Section 10(a)(3) of the Securities Act; (ii) To reflect in the prospectus any facts or events arising after the effective date of the Registration Statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the Registration Statement; (iii) To include any material information with respect to the plan of distribution not previously disclosed in the Registration Statement or any material change to such information in the Registration Statement. (b) Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officer and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Company has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. (c) The undersigned Registrant hereby undertakes to respond to requests for information that is incorporated by reference into the Proxy Statement/Prospectus pursuant to Item 4 of this form, within one business day of receipt of such request, and to send the incorporated documents by first class mail or other equally prompt means. This includes information contained in documents filed subsequent to the effective date of the Registration Statement through the date of responding to the request. (d) The undersigned Registrant hereby undertakes to supply by mans of a post-effective amendment all information concerning a transaction, and the company being acquired involved therein, that was not the subject of and included in the Registration Statement when it became effective. II-3 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Yorba Linda, State of California, on August 20, 1997. BYL BANCORP a California corporation By /s/ Robert Ucciferri -------------------------------------- Robert Ucciferri, President and Chief Executive Officer Pursuant to the requirements of the Securities Act of 1933, this registration statement has been signed by the following persons in the capacities and on the dates indicated. SIGNATURE TITLE DATE /s/ Robert Ucciferri President and Chief Executive August 20, 1997 - --------------------------- Officer (Principal Executive Robert Ucciferri Officer and Director) /s/ Barry J. Moore Executive Vice President and August 20, 1997 - --------------------------- Chief Financial Officer (Principal Barry J. Moore Financial Officer and Accounting Officer) /s/ Leonard O. Lindborg Director August 20, 1997 - --------------------------- Leonard O. Lindborg /s/ H. Rhoads Martin, Jr. Chairman of the Board, Director August 20, 1997 - --------------------------- H. Rhoads Martin, Jr. /s/ John F. Myers Director August 20, 1997 - --------------------------- John F. Myers /s/ Brent W. Walhberg Director August 20, 1997 - --------------------------- Brent W. Wahlberg II-4