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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
Commission File Number: 0-12499
First Financial Bancorp
(Exact name of registrant as specified in its charter)
California 94-28222858
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
701 South Ham Lane, Lodi, California 95242
(Address of principal executive offices) (Zip Code)
(209)-367-2000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [ X ] Yes [ ] No
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
As of January 31, 1999, there were 1,349,292 shares of Common Stock, no
par value, outstanding. The aggregate market value of the Common Stock held by
non-affiliates of the registrant was approximately $11,356,000 (based on the
$11.50 average of bid and ask prices per share on February 2, 1999.)
Part of Form 10-K into
Documents Incorporated by Reference which Incorporated
- ----------------------------------- ------------------
Proxy Statement for the Annual Meeting of
Shareholders to be held on May 18, 1999. Part III, Items 10, 11, 12, 13
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1
FIRST FINANCIAL BANCORP
1998 FORM 10-K
TABLE OF CONTENTS
PART 1
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ITEM 1. BUSINESS ..............................................................3
General ..............................................................3
The Bank .............................................................3
Bank Services ........................................................3
Sources of Business ..................................................4
Competition ..........................................................4
Employees ............................................................5
Supervision and Regulation ...........................................5
The Company .................................................5
The Bank ....................................................6
Officers ....................................................6
Recent Legislation and Regulations Affecting Banking ........7
ITEM 2. PROPERTIES ............................................................9
ITEM 3. LEGAL PROCEEDINGS ....................................................10
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ..................10
Part II
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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS ..................................................10
ITEM 6. SELECTED FINANCIAL DATA ..............................................11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS ............................................11
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ..........................33
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE ..................................33
PART III
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ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ...................33
ITEM 11 EXECUTIVE COMPENSATION ...............................................33
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT .......33
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS .......................33
PART IV
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ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K .....34
Signatures ...................................................................63
Index to Exhibits ...........................................................64
2
PART I
ITEM 1. BUSINESS
General:
First Financial Bancorp (the "Company") was incorporated under the laws of the
State of California on May 13, 1982, and operates principally as a bank holding
company for its wholly owned subsidiary, Bank of Lodi, N.A. (the "Bank"). The
Company is registered under the Bank Holding Company Act of 1956, as amended.
The Bank is the principal source of income for the Company. The Bank owns the
office building where the Bank's Lodi Branch and administrative offices are
located, and the Company owns the land upon which the Bank's Woodbridge Branch
is located. The Company receives income from the Bank under the lease associated
with the Woodbridge property. The Company also holds all of the capital stock of
Western Auxiliary Corporation (WAC), a California Corporation which functions as
trustee on deeds of trust securing mortgage loans originated by the Bank. All
references herein to the "Company" include the Bank and WAC, unless the context
otherwise requires.
The Bank:
The Bank was organized on May 13, 1982 as a national banking association. The
application to organize the Bank was accepted for filing by the Comptroller of
the Currency (the "OCC") on September 8, 1981, and preliminary approval to
organize was granted on March 27, 1982. On July 18, 1983 the Bank received from
the OCC a Certificate of Authority to Commence the Business of Banking.
Subsequently, the Bank opened branch offices in Woodbridge and Lockeford,
California. Effective February 22, 1997, the Bank acquired the Galt, Plymouth
and San Andreas offices of Wells Fargo Bank. A loan production office in Folsom,
California was opened in January, 1998, and a full-service branch was opened in
Elk Grove, California in August, 1998.
The Bank's headquarters is located at 701 South Ham Lane, Lodi, California.
There is a loan production office in Folsom, California and branch offices are
located in Woodbridge, Lockeford, Galt, Plymouth, San Andreas, and Elk Grove,
California. The Bank's primary service area, from which the Bank attracts 75% of
its business, is the city of Lodi and the surrounding area. This area is
estimated to have a population approaching 70,000 persons, with a median annual
family income of approximately $30,000. The area includes residential
developments, neighborhood shopping centers, business and professional offices
and manufacturing and agricultural concerns.
Bank Services:
The Bank offers a wide range of commercial banking services to individuals and
business concerns located in and around its primary service area. These services
include personal and business checking and savings accounts (including
interest-bearing negotiable order of withdrawal ("NOW") accounts and/or accounts
combining checking and savings accounts with automatic transfers), and time
certificates of deposit. The Bank also offers extended banking hours at its
drive-through window, night depository and bank-by-mail services, and travelers'
checks (issued by an independent entity). Each branch location has a 24 hour ATM
machine, and the Bank has 24 hour telephone banking and bill paying services.
The Bank issues MasterCard credit cards and acts as a merchant depository for
cardholder drafts under both VISA and MasterCard. In addition, it provides note
and collection services and direct deposit of social security and other
government checks.
During 1998, the Bank entered into an agreement with Investment Centers of
America to offer stocks, bonds, mutual funds, annuities and insurance products
through offices located on-site at Bank branches. The first Investment Centers
of America office was established at the Lodi branch location, and additional
offices are planned for Elk Grove and Folsom.
The Bank engages in a full complement of lending activities, including
commercial, Small Business Administration (SBA), residential mortgage,
consumer/installment, and short-term real estate loans, with particular emphasis
on short and medium-term obligations. Commercial lending activities are directed
principally toward businesses whose demand for funds falls within the Bank's
lending limit, such as small to medium-sized professional firms, retail and
wholesale outlets and manufacturing and agricultural concerns. Consumer lending
is oriented primarily to the needs of the Bank's customers, with an emphasis on
automobile financing and leasing. Consumer loans also include loans for boats,
home improvements, debt consolidation, and other personal needs. Real estate
loans include short-term "swing" loans and construction loans. Residential
mortgages are generally sold into the secondary market for these loans. SBA
loans are made available to small to medium-sized businesses.
3
Sources of Business:
Management seeks to obtain sufficient market penetration through the full range
of services described above and through the personal solicitation of the Bank's
officers, directors and shareholders. All officers are responsible for making
regular calls on potential customers to solicit business and on existing
customers to obtain referrals. Promotional efforts are directed toward
individuals and small to medium-sized businesses. The Bank's customers are able
in their dealings with the Bank to be served by bankers who have commercial loan
experience, lending authority, and the time to serve their banking needs quickly
and competently. Bankers are assigned to customers and not transferred from
office to office as in many major chain or regional banks. In order to expedite
decisions on lending transactions, the Bank's loan committee meets on a regular
basis and is available where immediate authorization is important to the
customer.
The risk of non-payment (or deferred payment) of loans is inherent in commercial
banking. Furthermore, the Bank's marketing focus on small to medium-sized
businesses may involve certain lending risks not inherent in loans to larger
companies. Smaller companies generally have shorter operating histories, less
sophisticated internal record keeping and financial planning capabilities, and
greater debt-to-equity ratios. Management of the Bank carefully evaluates all
loan applicants and attempts to minimize its credit risk through the use of
thorough loan application and approval procedures.
Consistent with the need to maintain liquidity, management of the Bank seeks to
invest the largest portion of the Bank's assets in loans of the types described
above. Loans are generally limited to less than 75% of deposits and capital
funds. The Bank's surplus funds are invested in the investment portfolio, made
up of both taxable and non-taxable debt securities of the U.S. government, U.S.
government agencies, states, and municipalities. On a day to day basis, surplus
funds are invested in federal funds and other short-term money market
instruments.
Competition:
The banking business in California generally, and in the northern portion of
central California where the Bank is located, is highly competitive with respect
to both loans and deposits and is dominated by a relatively small number of
major banks with branch office networks and other operating affiliations
throughout the State. The Bank competes for deposits and loans with these banks,
as well as with savings and loan associations, thrift and loan associations,
credit unions, mortgage companies, insurance companies and other lending
institutions. Among the advantages certain of these institutions have over the
Bank are their ability (i) to finance extensive advertising campaigns, (ii) to
allocate a substantial portion of their investment assets in securities with
higher yields (not available to the Bank if its investments are to be
diversified) and (iii) to make funds available for loans in geographic regions
with the greatest demand. In competing for deposits, the Bank is subject to the
same regulations with respect to interest rate limitations on time deposits as
other depository institutions. See "Supervision and Regulation" below.
Many of the major commercial banks operating in the Bank's service area offer
certain services, such as international banking and trust services, which are
not offered directly by the Bank, and such banks, by virtue of their greater
capitalization, have substantially higher lending limits than the Bank. In
addition, other entities, both public and private, seeking to raise capital
through the issuance and sale of debt and equity securities compete with the
Bank for the acquisition of funds for deposit.
In order to compete with other financial institutions in its primary service
area, the Bank relies principally on local promotional activities, personal
contacts by its officers, directors, employees and shareholders, extended hours
and specialized services. The Bank's promotional activities emphasize the
advantages of dealing with a locally-owned and headquartered institution
sensitive to the particular needs of the community. The Bank also assists
customers in obtaining loans in excess of the Bank's lending limit or services
not offered by the Bank by arranging such loans or services in participation
with or through its correspondent banks.
The State Bank Parity Act, effective January 1, 1996, eliminated certain
existing disparities between California state chartered banks and national
banking associations, such as the Bank, by authorizing the California
Commissioner of Financial Institutions (the "Commissioner") to address such
disparities through a streamlined rule-making process.
4
Employees:
As of December 31, 1998, the Company employed 97 full-time equivalent employees,
including four executive officers. Management believes that the Company's
relationship with its employees is good.
Supervision and Regulation
The Company
The common stock of the Company is subject to the registration requirements of
the Securities Act of 1933, as amended, and the qualification requirements of
the California Corporate Securities Law of 1968, as amended. The Company is also
subject to the periodic reporting requirements of Section 13(d) of the
Securities Exchange Act of 1934, as amended, which include, but are not limited
to, annual, quarterly and other current reports with the Securities and Exchange
Commission.
The Company is a bank holding company registered under the Bank Holding Company
Act of 1956 (the "Act") and is subject to supervision by the Board of Governors
of the Federal Reserve System (the "Board"). As a bank holding company, the
Company must file with the Board quarterly reports, annual reports, and such
other additional information as the Board may require pursuant to the Act. The
Board may also make examinations of the Company and its subsidiaries.
The Act requires prior approval of the Board for, among other things, the
acquisition by a bank holding company of direct or indirect ownership or control
of more than 5% of the voting shares, or substantially all the assets, of any
bank, or for a merger or consolidation by a bank holding company with any other
bank holding company. The Act also prohibits the acquisition by a bank holding
company or any of its subsidiaries of voting shares, or substantially all the
assets, of any bank located in a state other than the state in which the
operations of the bank holding company's banking subsidiaries are principally
conducted, unless the statutes of the state in which the bank to be acquired is
located expressly authorize such acquisition.
With certain limited exceptions, a bank holding company is prohibited from
acquiring direct or indirect ownership or control of more than 5% of the voting
shares of any company that is not a bank or bank holding company and from
engaging directly or indirectly in any activity other than banking or managing
or controlling banks or furnishing services to, or performing services for, its
authorized subsidiaries. A bank holding company may, however, engage in or
acquire an interest in a company that engages in activities that the Board has
determined to be so closely related to banking or to managing or controlling
banks as to be properly incident thereto. In making such a determination, the
Board is required to consider whether the performance of such activities
reasonably can be expected to produce benefits to the public, such as greater
convenience, increased competition, or gains in efficiency, which outweigh
possible adverse effects, such as undue concentration of resources, decreased or
unfair competition, conflicts of interest or unsound banking practices. The
Board is also empowered to differentiate between activities commenced de novo
and activities commenced by the acquisition, in whole or in part, of a going
concern.
Additional statutory provisions prohibit a bank holding company and any
subsidiary banks from engaging in certain tie-in arrangements in connection with
the extension of credit, sale or lease of property or furnishing of services.
Thus, a subsidiary bank may not extend credit, lease or sell property, or
furnish any services, or fix or vary the consideration for any of the foregoing
on the condition that: (i) the customer must obtain or provide some additional
credit, property or service from or to such bank other than a loan, discount,
deposit or trust service; or (ii) the customer must obtain or provide some
additional credit, property or service from or to the company or any other
subsidiary of the company; or (iii) the customer may not obtain some other
credit, property to service from competitors, except reasonable requirements to
assure soundness of the credit extended. These anti-tying restrictions also
apply to bank holding companies and their non-bank subsidiaries as if they were
banks.
The Company's ability to pay cash dividends is subject to restrictions set forth
in the California General Corporation Law. The Bank is a legal entity separate
and distinct from the Company, and is subject to various statutory and
regulatory restrictions on its ability to pay dividends to the Company. See Note
13(c) to the financial statements for further information regarding the payment
of cash dividends by the Company and the Bank.
The Company is a bank holding company within the meaning of Section 3700 of the
California Financial Code. As such, the Company and its subsidiaries are subject
to examination by, and may be required to file reports with, the Commissioner.
Regulations have not yet been proposed or adopted to implement the
Commissioner's powers under this statute.
5
The Bank:
The Bank, as a national banking association whose deposit accounts are insured
by the Federal Deposit Insurance Corporation (the "FDIC") up to the maximum
legal limits and the Bank is subject to regulation, supervision, and regular
examination by the OCC. The Bank is a member of the Federal Reserve System, and,
as such, is subject to certain provisions of the Federal Reserve Act and
regulations issued by the Board. The Bank is also subject to applicable
provisions of California law, insofar as they are not in conflict with, or
preempted by, federal law. The regulations of these various agencies govern most
aspects of the Bank's business, including reserves against deposits, interest
rates payable on deposits, loans, investments, mergers and acquisitions,
borrowings, dividends and location of branch offices.
Officers:
Leon Zimmerman, age 56, is President and Chief Executive Officer of the Bank and
of the Company; David M. Philipp, age 36, is Executive Vice-President, Chief
Financial Officer and Secretary of the Bank and of the Company; Lance Gallagher,
age 53, is Senior Vice President and Operations Administrator of the Bank and
the Company: and David Redman, age 54, is Senior Vice President and Chief Credit
Officer of the Bank and of the Company.
Mr. Zimmerman joined the Company in April, 1990. He was promoted from Executive
Vice President and Chief Credit Officer of Bank of Lodi to President and CEO in
August of 1994. Mr. Zimmerman became President and CEO of the Company effective
August 1995. He lives in Lodi with his wife and has resided and worked in the
San Joaquin-Sacramento Valley since 1960, serving in various banking capacities
since 1962. Mr. Zimmerman serves on many community boards and committees,
including San Joaquin County Education Foundation, Economic Development Task
Force and LEED - Sacramento Steering Committee. He is an active member of
Rotary, Chamber of Commerce and several other community groups.
Mr. Philipp joined the Company in April, 1992. Prior to joining the Company, Mr.
Philipp was the Budget Director and Financial Analyst for Merksamer Jewelers,
Inc., at that time the eighth largest jewelry retailer in the United States,
headquartered in Sacramento, California. Prior to joining Merksamer Jewelers,
Inc., Mr. Philipp was a Supervising Senior Accountant in the Sacramento office
of KPMG, LLP. While at KPMG, LLP, Mr. Philipp specialized in providing audit and
accounting services to financial institution, agribusiness, and broadcasting
clients. Mr. Philipp is a CPA and holds a Bachelor of Science in Business
Administration, Accountancy from California State University. He lives in El
Dorado Hills with his wife and two children, having been in the Greater
Sacramento area for over 25 years. On March 1, 1999 Mr. Philipp gave notice to
the Company and the Bank of his intention to resign and pursue other business
interests.
Mr. Gallagher joined the Bank in February, 1991. He was promoted from Vice
President of Compliance to Senior Vice President and Operations Administrator in
January, 1997. As a graduate of the American Bankers Associations Graduate
School of Compliance, he is responsible for the Bank's regulatory compliance
program in addition to Bank operations and item processing. Prior to joining the
Company, Mr. Gallagher was with Wells Fargo Bank for 22 years in various
customer service, operations, and human resource capacities of increasing
responsibility. He lives in San Joaquin County with his wife and has four boys
and a grandson. Mr. Gallagher is a banking instructor for The American Institute
of Banking and Delta Community College, serves as a member of the Colleges
Banking Advisory Board, a member of the Heald College Employer Advisory
Committee, and is the Initiation Coaching Program Director with U. S. Hockey
Pacific District.
Mr. Redman joined the Company in December 1997. He has over 33 years of banking
experience in central California. He was previously President and CEO of
Citizens Bank of Paso Robles, N.A. (1990 to 1995). Mr. Redman assisted in the
start up of Commerce Bank of San Luis Obispo and served as Executive Vice
President (1985 to 1990). Most recently, he was the organizing President and CEO
for Central California Bank (in organization). His banking experience includes
several years with two major California banks. Mr. Redman's education includes
Porterville Community College and the University of Washington Graduate School
of Banking. Community involvement has included the Jaycees, Lions Club, Kiwanis
Club, Rotary, Chamber of Commerce, Downtown Merchants Association and the Elks
Lodge. He lives in Valley Springs with his wife and has three grown children.
6
Recent Legislation and Regulations Affecting Banking:
From time to time, new laws are enacted which increase the cost of doing
business, limit permissible activities, or affect the competitive balance
between banks and other financial institutions. Proposals to change the laws and
regulations governing the operations and taxation of bank holding companies,
banks and other financial institutions are frequently made in Congress, in the
California legislature and before various bank holding company and bank
regulatory agencies. The likelihood of any major changes and the impact such
changes might have are impossible to predict. Certain significant recently
proposed or enacted laws and regulations are discussed below.
Interstate Banking. Since 1986, California has permitted California banks and
bank holding companies to be acquired by banking organizations based in other
states on a "reciprocal" basis (i.e., provided the other state's laws permit
California banking organizations to acquire banking organizations in that state
on substantially the same terms and conditions applicable to local banking
organizations). Since October 2, 1995, California law implementing certain
provisions of prior federal law have (1) permitted interstate merger
transactions; (2) prohibited interstate branching through the acquisition of a
branch business unit located in California without acquisition of the whole unit
of the California bank; and (3) prohibited interstate branching through de novo
establishment of California branch offices. Initial entry into California by an
out-of-state institution must be accomplished by acquisition of or merger with
an existing whole bank which has been in existence for at least five years.
Capital Requirements. Federal regulation imposes upon all FDIC-insured financial
institutions a variable system of risk-based capital guidelines designed to make
capital requirements sensitive to differences in risk profiles among banking
organizations, to take into account off-balance sheet exposures and to aid in
making the definition of bank capital uniform internationally. Under the OCC's
risk-based capital guidelines, the Bank is required to maintain capital equal to
at least 8 percent of its assets, weighted by risk. Assets and off-balance sheet
items are categorized by the guidelines according to risk, and certain assets
considered to present less risk than others permit maintenance of capital below
the 8 percent level. The guidelines established two categories of qualifying
capital: Tier 1 capital comprising core capital elements, and Tier 2 comprising
supplementary capital requirements. At least one-half of the required capital
must be maintained in the form of Tier 1 capital. For the Bank, Tier 1 capital
includes only common stockholders' equity and retained earnings, but qualifying
perpetual preferred stock would also be included without limit if the Bank were
to issue such stock. Tier 2 capital includes, among other items, limited life
(and in the case of banks, cumulative) preferred stock, mandatory convertible
securities, subordinated debt and a limited amount of the allowance for loan and
lease losses.
The guidelines also require all insured institutions to maintain a minimum
leverage ratio of 3 percent Tier 1 capital to total assets (the "leverage
ratio"). The OCC emphasizes that the leverage ratio constitutes a minimum
requirement for the most well-run banking organizations. All other banking
organizations are required to maintain a minimum leverage ratio ranging
generally from 4 to 5 percent. The Bank's required minimum leverage ratio is 4
percent.
The federal banking agencies during 1996 issued a joint agency policy statement
regarding the management of interest-rate risk exposure (interest rate risk is
the risk that changes in market interest rates might adversely affect a bank's
financial condition) with the goal of ensuring that institutions with high
levels of interest-rate risk have sufficient capital to cover their exposures.
This policy statement reflected the agencies' decision at that time not to
promulgate a standardized measure and explicit capital charge for interest rate
risk, in the expectation that industry techniques for measurement of such risk
will evolve.
However, the Federal Financial Institutions Examination Council ("FFIEC") on
December 13, 1996, approved an updated Uniform Financial Rating System
("UFIRS"). In addition to the five components traditionally included in the
so-called "CAMEL" rating system which has been used by bank examiners for a
number of years to classify and evaluate the soundness of financial institutions
(including capital adequacy, asset quality, management, earnings and liquidity),
UFIRS includes for all bank regulatory examinations conducted on or after
January 1, 1997, a new rating for a sixth category identified as sensitivity to
market risk. Ratings in this category are intended to reflect the degree to
which changes in interest rates, foreign exchange rates, commodity prices or
equity prices may adversely affect an institution's earnings and capital. The
rating system henceforth will be identified as the "CAMELS" system.
7
As of December 31, 1998, the Bank's total risk-based capital ratio was
approximately 11.17 percent and its leverage ratio was approximately 7.35
percent. The Bank does not presently expect that compliance with the risk-based
capital guidelines or minimum leverage requirements will have a materially
adverse effect on its business in the reasonably foreseeable future. Nor does
the Bank expect that its sensitivity to market risk will adversely affect its
overall CAMELS rating as compared with its previous CAMEL ratings by bank
examiners.
Deposit Insurance Assessments. In 1995, the FDIC, pursuant to Congressional
mandate, reduced bank deposit insurance assessment rates to a range from $0 to
$.27 per $100 of deposits, dependent upon a bank's risk. The FDIC has continued
these reduced assessment rates through 1998. Based upon the above risk-based
assessment rate schedule, the Bank's current capital ratios, the Bank's current
level of deposits, and assuming no further change in the assessment rate
applicable to the Bank during 1999, the Bank estimates that its annual
noninterest expense attributed to the regular assessment schedule will not
increase during 1999.
Prompt Corrective Action. Prompt Corrective Action Regulations (the "PCA
Regulations") of the federal bank regulatory agencies established five capital
categories in descending order (well capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized and critically
undercapitalized), assignment to which depends upon the institution's total
risk-based capital ratio, Tier 1 risk-based capital ratio, and leverage ratio.
Institutions classified in one of the three undercapitalized categories are
subject to certain mandatory and discretionary supervisory actions, which
include increased monitoring and review, implementation of capital restoration
plans, asset growth restrictions, limitations upon expansion and new business
activities, requirements to augment capital, restrictions upon deposit gathering
and interest rates, replacement of senior executive officers and directors, and
requiring divestiture or sale of the institution. The Bank has been classified
as a well-capitalized bank since adoption of the PCA Regulations.
Community Reinvestment Act. Community Reinvestment Act ("CRA") regulations
effective as of July 1, 1995 evaluate banks' lending to low and moderate income
individuals and businesses across a four-point scale from "outstanding" to
"substantial noncompliance," and are a factor in regulatory review of
applications to merge, establish new branches or form bank holding companies. In
addition, any bank rated in "substantial noncompliance" with the CRA regulations
may be subject to enforcement proceedings. The Bank has a current rating of
"satisfactory" CRA compliance.
Year 2000 Compliance. The Federal Financial Institutions Examination Council has
issued an interagency statement to the chief executive officers of all federally
supervised financial institutions, including the Bank, regarding Year 2000
project management awareness. Unless financial institutions address the
technology issues associated with Year 2000, the Council anticipates there could
occur major disruptions in the operations of financial institutions. The
interagency statement provides guidance to financial institutions, to providers
of data services, and all examining personnel of the federal banking agencies
regarding Year 2000 issues. The federal banking agencies intend to conduct Year
2000 compliance examinations, and the failure to implement a Year 2000 program
may constitute an unsafe and unsound banking practice. See the discussion of
this subject at the heading "Year 2000 Preparedness" under Item 7 herein,
Management's Discussion and Analysis of Financial Condition and Results of
Operations, and at footnote 23 to the Company's Consolidated Financial
Statements.
Safety and Soundness Standards. Federal bank regulatory agency safety and
soundness standards for insured financial institutions establish standards for
(1) internal controls, information systems and internal audit systems; (2) loan
documentation; (3) credit underwriting; (4) interest rate exposure; (5) asset
growth; and (6) compensation, fees and benefits. In addition, the standards
prohibit the payment of compensation which is excessive or which could lead to
material financial loss. If an agency determines that an institution fails to
meet any standard established by the guidelines, the agency may require the
financial institution to submit to the agency an acceptable plan to achieve
compliance with the standard. Agencies may elect to initiate enforcement action
in certain cases where failure to meet one or more of the standards could
threaten the safe and sound operation of the institution. The Bank has not been
and does not expect to be required to submit a safety and soundness compliance
plan because of a failure to meet any of the safety and soundness standards.
Permitted Activities. In recent years, the Federal banking agencies, especially
the OCC and the Board, have taken steps to increase the types of activities in
which national banks and bank holding companies can engage, and to make it
easier to engage in such activities. On November 20, 1996, the OCC issued final
regulations permitting national banks to engage in a wider range of activities
through subsidiaries. "Eligible institutions" (those national banks that are
well capitalized, have a
8
high overall rating and a satisfactory CRA rating, and are not subject to an
enforcement order) may engage in activities related to banking through operating
subsidiaries after going through a new expedited application process. In
addition, the new regulations include a provision whereby a national bank may
apply to the OCC to engage in an activity through a subsidiary in which the bank
itself may not engage. Although the Bank in not currently intending to enter
into any new type of business, this OCC regulation could be advantageous to the
Bank if the Bank determines to expand its operations in the future, depending on
the extent to which the OCC permits national banks to engage in new lines of
business and whether the Bank qualifies as an "eligible institution" at the time
of making application.
Monetary Policies. Banking is a business in which profitability depends on rate
differentials. In general, the differences between the interest rate received by
a bank on loans extended to its customers and securities held in that bank's
investment portfolio and the interest rate paid on its deposits and its other
borrowings constitute the major portion of the bank's earnings. To the extent
that a bank is not able to compensate for increases in the cost of deposits and
other borrowings with greater income from loans, securities and fees, the net
earnings of that bank will be reduced. The interest rates paid and received by
any bank are highly sensitive to many factors which are beyond the control of
that bank, including the influence of domestic and foreign economic conditions.
See Item 7 herein, Management's Discussion and Analysis of Financial Condition
and Results of Operations.
The earnings and growth of a bank are also affected by the monetary and fiscal
policy of the United States Government and its agencies, particularly the Board.
These agencies can and do implement national monetary policy, which is used in
part to curb inflation and combat recession. Among the instruments of monetary
policy used by these agencies are open market transactions in United States
Government securities, changes in the discount rates of member bank borrowings,
and changes in reserve requirements. The actions of the Board have had a
significant effect on banks' lending, investments and deposits, and such actions
are expected to continue to have a substantial effect in the future. However,
the nature and timing of any further changes in such policies and their impact
on banks cannot be predicted.
Proposed Legislation and Regulation. Certain legislative and regulatory
proposals that could affect the Bank and the banking business in general are
pending or may be introduced before the United States Congress, the California
State Legislature and Federal and state government agencies. The United States
Congress is considering numerous bills that could reform banking laws
substantially. For example, proposed bank modernization legislation under
consideration would, among other matters, include a repeal of the Glass-Steagall
Act restrictions on banks that now prohibit the combination of commercial and
investment banks.
It is not known whether any of these current legislative proposals will be
enacted and what effect such legislation would have on the structure, regulation
and competitive relationships of financial institutions. It is likely, however,
that many of these proposals would subject the Bank to increased regulation,
disclosure and reporting requirements and would increase competition to the Bank
and its cost of doing business.
In addition to pending legislative changes, the various banking regulatory
agencies frequently propose rules and regulations to implement and enforce
already existing legislation. It cannot be predicted whether or in what form any
such rules or regulations will be enacted or the effect that such rules and
regulations may have on the Bank's business.
The above description of the business of the Bank should be read in conjunction
with Item 7 herein, Management's Discussion and Analysis of Financial Condition
and Results of Operations.
ITEM 2. PROPERTIES
The Bank owns a 0.861 acre lot located at the corner of Ham Lane and Tokay
Street, Lodi, California. A 34,000 square foot, tri-level commercial building
for the main branch and administrative offices of the Company and the Bank was
constructed on the lot. The Company and the Bank use approximately 75% of the
leasable space in the building and the remaining area is either leased or
available for lease as office space to other tenants. The construction of this
building in 1991 has enabled the Bank to better serve its customers with more
teller windows, four drive-through lanes and expanded safe deposit box capacity.
9
The Company owns a 10,000 square foot lot located on Lower Sacramento Road in
the unincorporated San Joaquin County community of Woodbridge, California. The
entire parcel has been leased to the Bank on a long term basis at market rates.
The Bank has constructed, furnished and equipped a 1,437 square foot branch
office on the parcel and commenced operations of the Woodbridge Branch on
December 15, 1986.
The Bank assumed a long-term ground lease on 1.7 acres of land at 19000 North
Highway 88, Lockeford, California. The building previously occupying the Lodi
site at 701 South Ham Lane was moved to Lockeford, California, and has become
the permanent branch office of the Bank at that location. A temporary 1,000
square foot office had been used by the Bank at the Lockeford location. The
permanent office was opened on April 1, 1991. The temporary office, along with a
portion of the permanent building, are leased by the Bank to two tenants.
On February 22, 1997, the Bank acquired the Galt, Plymouth and San Andreas
branches of Wells Fargo Bank. The transaction included the assumption of the
6,000 square foot branch building lease in Galt with a remaining term of two
years, and the purchase of the branch building and land for the Plymouth and San
Andreas offices. The Plymouth and San Andreas offices are approximately 1,200
and 5,500 square feet, respectively. In November, 1998, upon expiration of the
Galt lease, the Galt branch was relocated to a new 3,000 square foot leased
facility one block west of the old location. The new Galt location is leased
under a five year lease with three successive five-year renewal options.
In January, 1998, the Bank opened a 1,220 square foot loan production office in
Folsom, California. The office was leased for one year with a one year renewal
option which has been exercised by the Bank. In August, 1998, the Bank opened a
4,830 square foot full service branch in Elk Grove, California. The office is
leased under a three year lease with two successive three-year renewal options.
ITEM 3. LEGAL PROCEEDINGS
Not Applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
There is no established public trading market for the common stock of the
Company. The Company's common stock is traded in the over-the-counter market and
is not presently listed on a national exchange or reported by the NASDAQ Stock
Market. Trading of the stock has been limited and has been principally contained
within the Company's general service area. As of March 1, 1999, there were 1,037
shareholders of record of the Company's common stock. Set forth below is the
range of high and low bid prices for the common stock during 1997 and 1998.
1998 1997
Bid Price of Common Shares High Low High Low
First Quarter $ 13.25 13.00 $ 10.25 9.50
Second Quarter 14.50 13.63 10.25 9.63
Third Quarter 14.63 13.25 12.75 9.81
Fourth Quarter 13.38 12.00 13.00 12.13
The foregoing prices are based on trades of which Company is aware and reflect
inter-dealer prices, without retail mark-up, mark-down or commissions, and may
not necessarily represent actual transactions.
10
ITEM 6. SELECTED FINANCIAL DATA
(in thousands except per share amounts)
Consolidated Statement of Income 1998 1997 1996 1995 1994
- ------------------------------------------------------------------------------------------------------
Interest Income $ 11,508 10,592 8,045 8,089 7,462
Interest Expense 4,028 3,785 3,254 3,138 2,767
Net Interest Income 7,480 6,807 4,791 4,951 4,695
Provision for Loan Losses 250 (60) 310 115 323
Noninterest Income 1,878 1,423 1,067 940 1,050
Noninterest Expense 7,712 6,796 4,654 4,534 5,137
Net Income $ 1,052 1,015 640 843 338
Per Share Data
- ------------------------------------------------------------------------------------------------------
Basic Earnings $ .78 .77 .49 .65 .26
Diluted Earnings .74 .73 .48 .64 .26
Cash Dividends Declared $ .20 .20 .20 .15 --
Consolidated Balance Sheet Data
- ------------------------------------------------------------------------------------------------------
Federal Funds Sold $ 4,800 4,900 1,100 3,300 2,000
Investment Securities 45,647 61,917 36,913 36,945 33,100
Loans, net of loss reserve and
deferred fees 91,078 62,228 52,672 50,524 55,812
Total Assets 164,400 147,850 104,913 103,972 105,167
Total Deposits 149,544 133,891 92,207 89,216 89,979
Note Payable -- -- -- 2,585 2,618
Total Stockholders' Equity $ 13,857 12,861 11,889 11,564 10,610
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Certain statements in this Annual Report on Form 10-K include forward-looking
information within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and
are subject to the "safe harbor" created by those sections. These
forward-looking statements involve certain risks and uncertainties that could
cause actual results to differ materially from those in the forward-looking
statements. Such risks and uncertainties include, but are not limited to, the
following factors: competitive pressure in the banking industry; changes in the
interest rate environment; general economic conditions, either nationally or
regionally becoming less favorable than expected and resulting in, among other
things, a deterioration in credit quality and an increase in the provision for
possible loan losses; changes in the regulatory environment; changes in business
conditions; volatility of rate sensitive deposits; operational risks, including
data processing system failures or fraud; asset/liability matching risks and
liquidity risks; and changes in the securities markets.
The following discussion addresses information pertaining to the financial
condition and results of operations of the Company that may not be otherwise
apparent from a review of the consolidated financial statements and related
footnotes. It should be read in conjunction with those statements and notes
found on pages 36 through 63, as well as other information presented throughout
this report.
11
Summary of Earnings Performance
- ----------------------------------------------------------------------------------------------------------------------------
For the Year Ended December 31:
----------------------------------------------------------------------
1998 1997 1996
Earnings (in thousands) $ 1,052 1,015 640
- ----------------------------------------------------- ---------------------- ----------------------- -----------------------
Basic earnings per share $ .78 .77 .49
Diluted earnings per share $ .74 .73 .48
Return on average assets 0.68% 0.75% 0.60%
Return on average equity 7.90% 8.18% 5.44%
Dividend payout ratio 25.57% 26.11% 42.55%
- ----------------------------------------------------- ---------------------- ----------------------- -----------------------
"Cash" earnings (in thousands) (1) $ 1,268 1,293 640
Diluted "cash" earnings per share $ .89 .93 .48
"Cash" return on average assets 0.82% 0.96% 0.60%
"Cash" return on average equity 9.52% 10.42% 5.44%
- ----------------------------------------------------- ---------------------- ----------------------- -----------------------
Operating "Cash" earnings (in thousands) (2) $ 1,375 1,293 640
Diluted operating "cash" earnings per share $ .97 .93 .48
Operating "Cash" return on average assets 0.89% 0.96% 0.60%
Operating "Cash" return on average equity 10.32% 10.42% 5.44%
- ----------------------------------------------------- ---------------------- ----------------------- -----------------------
Average equity to average assets 8.64% 9.12% 11.12%
- ----------------------------------------------------- ---------------------- ----------------------- -----------------------
<FN>
(1) "Cash" earnings represent earnings based upon generally accepted accounting
principles plus the after-tax, non-cash effect on earnings of the
amortization of intangible assets. Following the 1997 acquisition of three
branches from Wells Fargo Bank, the "cash" earnings, return on assets, and
return on equity are the most comparable to prior year numbers. They are
also the more relevant performance measures for shareholders because they
measure the Company's ability to support growth and pay dividends.
(2) Operating "Cash" net income is computed by excluding the after-tax impact
of significant elements of revenue or costs that obscure the operating
results of core operations. Adjustments for the twelve months ended
December 31, 1998 have been made to exclude from net income the preliminary
costs of a strategic growth initiative for which the company ceased further
pursuit in May, 1998.
</FN>
During 1998, the Company aggressively pursued a number of strategic growth
opportunities. One such opportunity significantly impacted expenses and the
amount of expenses related thereto has been added back to "cash" earnings to
determine operating "cash" earnings. Operating "cash" earnings per share
increased by 4% in 1998 compared to 1997. If significant loan loss recoveries
were excluded from the computation of operating "cash" earnings in 1997,
operating "cash" earnings in 1998 would be approximately 50% greater than 1997.
The increase is attributable to loan and deposit growth of 45% and 12%,
respectively, as well as record levels of mortgage loan origination and sales
volumes. As a result of the earnings in 1998, the Company continued the practice
of paying a quarterly dividend of $.05 per share that began in the first quarter
of 1995.
Diluted earnings per share for 1998 increased by 1.4% over 1997, while 1998
"cash" earnings per share declined by 4% compared to 1997. Diluted and cash
earnings per share for 1997 were 52% and 94%, respectively, above the comparable
levels for 1996. "Cash" return on equity for 1998 decreased by 9% compared to
1997, while "cash" return on equity in 1997 was 92% above 1996. Financial
leverage improved as a result of deposit growth in both 1998 and 1997. Average
equity to average assets was reduced by 48 and 200 basis points in 1998 and
1997, respectively. As a result each dollar of equity supported $12 and $11 in
assets in 1998 and 1997, respectively, compared to $11 and $9 in 1997 and 1996,
respectively. Deposits grew in connection with business development efforts in
both 1998 and 1997 as well as the acquisition of three branches from Wells Fargo
Bank on February 22, 1997. The acquisition increased deposits by $34 million as
of the closing date of the transaction.
12
Earnings per share increased in 1997 versus 1996 as a result of a 30% increase
in net interest income, a 120% reduction in the provision for loan losses and a
31% increase in noninterest income. The foregoing improvements were partially
offset by a 45% increase in noninterest expenses. While net interest income
increased in part because of significant loan loss recoveries, the growth in net
interest income was also the result of both increases in the volume of earning
assets and deposits and an increase in net interest margin. Noninterest income
in 1997 increased due in part to record volumes in both SBA and mortgage lending
of the Bank. Service charges and noninterest expenses increased principally as a
result of the acquisition of three branches from Wells Fargo Bank on February
22, 1997.
Branch Expansion and Acquisitions
In August, 1998, the Bank opened a full-service branch in the Elk Grove,
California market. The Elk Grove office is approximately 30 miles North of the
Bank's corporate headquarters in Lodi, California and it effectively expands the
Bank's trade area into South Sacramento County.
In January, 1998, the Bank opened a loan production office in the growing market
of Folsom, California. The Folsom office is approximately 45 miles Northeast of
the Bank's corporate headquarter's in Lodi, California and effectively expanded
the Bank's trade area into the greater Sacramento area.
On February 22, 1997, the Bank completed the acquisition of the Galt, Plymouth,
and San Andreas, California, branches of Wells Fargo Bank. The Bank purchased
the premises and equipment of the Plymouth and San Andreas branches and assumed
the building lease for the Galt branch. The Bank also purchased the furniture
and equipment of all three branches and paid a premium for the deposits of each
branch. The total cost of acquiring the branches, including payments to Wells
Fargo Bank as well as other direct costs associated with the purchase, was $2.86
million. The transaction was accounted for using the purchase method of
accounting. Accordingly, the purchase price was allocated first to identifiable
tangible assets based upon those assets' fair value and then to identifiable
intangible assets based upon the assets' fair value. The excess of the purchase
price over identifiable tangible and intangible assets was allocated to
goodwill. Allocations to identifiable tangible assets, identifiable intangible
assets, and goodwill were $856 thousand, $1.98 million, and $24 thousand,
respectively. Deposits totaling $34 million were acquired in the transaction.
13
Net Interest Income
The following table provides a detailed analysis of net interest spread and net
interest margin for the years ended December 31, 1998, 1997, and 1996,
respectively:
- ------------------------- ------------------------------- -------------------------------- ---------------------------------
For the Year Ended For the Year Ended For the Year Ended
December 31, 1998 December 31, 1997 December 31, 1996
(in thousands) (in thousands) (in thousands)
------------------------------- -------------------------------- ---------------------------------
Average Income/ Average Income/ Average Income/
Balance Expenses Yield Balance Expenses Yield Balance Expense Yield
Earning Assets:
Investment securities(1) $ 53,370 3,431 6.43% 53,580 3,519 6.57% 34,700 2,233 6.44%
Federal funds sold 6,780 348 5.13% 8,400 461 5.49% 3,790 199 5.25%
Loans (2) 73,720 7,729 10.48% 58,600 6,612 11.28% 54,520 5,613 10.30%
-------- ------ ------ ------- ------ ------ ------ ----- ------
133,870 11,508 8.60% 120,580 10,592 8.78% 93,010 8,045 8.65%
======== ====== ====== ======= ====== ====== ====== ===== =====
Liabilities:
Noninterest bearing $ 17,080 -- -- 13,470 -- -- 8,280 -- --
deposits
Savings, money market, 76,600 1,652 2.16% 67,520 1,660 2.46% 47,820 1,193 2.49%
& NOW deposits
Time deposits 46,800 2,376 5.08% 41,550 2,125 5.11% 34,320 1,799 5.24%
Note payable -- -- -- -- -- -- 2,440 262 10.74%
-------- ------ ----- ------- ------ ------ ------ ----- ------
Total Liabilities $140,480 4,028 2.87% 122,540 3,785 3.09% 92,860 3,254 3.50%
======== ====== ===== ======= ====== ====== ====== ===== ======
Net Spread 5.73% 5.69% 5.15%
===== ====== ======
- ------------------------- ---------- ----------- -------- ---------- ---------- ---------- ----------- ----------- ---------
Earning Income Earning Income Earning Income
Assets (Expense) Yield Assets (Expense) Yield Assets (Expense) Yield
Yield on average earining
assets 133,870 11,508 8.60% 120,580 10,592 8.78% 93,010 8,045 8.65%
-------- ------ ----- ------- ------ ------ ------ ----- ------
Cost of funds for average
earning assets 133,870 (4,028) 3.01% 120,580 (3,785) (3.13%) 93,010 (3,254) (3.50)%
-------- ------ ----- ------- ------ ------ ------ ----- ------
Net Interest Margin $ 133,870 7,480 5.59% 120,580 6,807 5.65% 93,010 4,791 5.15%
======== ====== ===== ======= ====== ====== ====== ===== =====
- ------------------------- ---------- ----------- -------- ---------- ---------- ---------- ----------- ----------- ---------
<FN>
(1) Income on tax-exempt securities has not been adjusted to a tax equivalent basis.
(2) Nonaccrual loans are included in the loan totals for each year.
</FN>
Net interest income increased by 10% in 1998 after increasing by 42% in 1997.
The increase in 1998 was the result of both growth in earning assets and
deposits as well as decreased deposit costs. The increase in 1997 was also the
result of both growth in earning assets and deposits as well as increased
earning asset yields and decreased deposit costs. The increase in 1997 also
included $445 thousand in interest received in connection with significant loan
loss recoveries. Excluding these recoveries from 1997, net interest income would
have increased by 18% in 1998.
Average earning assets increased by 11% in 1998 compared to 1997 and 30% in 1997
compared to 1996. The increase in average earning assets was driven by growth in
average deposits during both years. Average deposits increased by 15% in 1998
compared to 1997 and 36% in 1997 compared to 1996.
The mix of earning assets in 1998 changed as a result of year-over-year loan
growth of 45% compared to 18% in 1997. Average loans in 1998 increased 26%
compared to 1997. The increase absorbed the liquidity created by the growth in
deposits during 1998 and offset the impact of falling interest rates in all
asset categories. The loan growth also increased the average
14
loan-to-deposit ratio to 52% in 1998 compared to 48% in 1997. The
loan-to-deposit ratio declined to 48% in 1997 from 60% in 1996 as a result of
the deposits acquired in branch purchases. Average investments were nearly
unchanged in 1998 compared to 1997. The investment portfolio, into which the
proceeds from the 1997 branch acquisition were initially invested, increased on
average by 54% in 1997.
Net interest margin declined by 6 basis points in 1998 after increasing by 50
basis points in 1997. Excluding the impact of interest from the recovery of loan
losses in 1997, net interest margin would have increased by 31 basis points in
1998. This adjusted increase in 1998 was the result of several key items:
o The impact on average earning asset yields of declining interest rates
was overcome by the growth in loans that had higher yields than
investments and federal funds sold. While the yields on federal funds
and investments declined by 36 and 14 basis points, respectively,
earning asset yields decreased by 18 basis points.
o The general decline in interest rates helped to bring down the cost of
average NOW, savings and certificates of deposit by 32, 26, and 3
basis points, respectively.
o The mix of noninterest bearing deposits increased to 12% of average
deposits in 1998 from 11% in 1997.
Net interest margin increased by 50 basis points in 1997 after declining by 37
basis points in 1996. The increase in 1997 was the result of several key items:
o The general level of short-term interest rates as indicated by the
comparative yields on federal funds sold increased by approximately 24
basis points.
o Approximately $445 thousand in loan interest income was recognized
during 1997 as a result of nonaccrual loan payoffs. The recovery of
nonaccrual interest increased loan yields and net interest margin for
the year by 76 basis points and 37 basis points respectively.
o The general decline in interest rates helped to bring down the cost of
average certificates of deposit by 13 basis points, while a new tiered
rate pricing structure for savings, money market, and NOW accounts
reduced the cost of those funds by 3 basis points.
o In addition to changes in the pricing structure of deposits, the mix
of noninterest bearing and lower cost transaction accounts increased
for 1997, while the mix of higher cost certificates of deposit
declined.
o The mortgage note payable, which carried a yield of 10.45%, was paid
off during November 1996.
15
The following table presents the monetary impact of the aforementioned changes
in earning asset and deposit volumes, yields and mix for the three years ended
December 31, 1998, 1997, and 1996
- ---------------------------------------------------------------------------------------------------------------------------------
1998 compared to 1997 1997 compared to 1996 1996 compared to 1995
(in thousands) (in thousands) (in thousands)
Change due to: Change due to: Change due to:
Interest Income: Volume Rate Mix Total Volume Rate Mix Total Volume Rate Mix Total
------ ---- --- ----- ------ ---- --- ----- ------ ---- --- -----
--------------------------------------------------------------------------------------------------------
Investment securities $ 391 (79) (398) (86) 661 46 578 1,285 67 135 255 457
Federal funds sold 51 (30) (134) (113) 59 9 194 262 7 (17) 8 (2)
Loans 735 (470) 850 1,115 1,664 539 (1,203) 1,000 229 (300) (428) (499)
------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total interest income $ 1,177 (579) 318 916 2,384 594 (431) 2,547 303 (182) (165) (44)
======= ======= ======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Interest Expense:
Noninterest-bearing
deposits -- -- -- -- -- -- -- -- -- -- -- --
Savings, money market, $ 243 (206) (45) (8) 382 (16) 103 469 56 (27) (22) 7
& NOW accounts
Time deposits 311 (15) (45) 251 573 (44) (205) 324 79 35 13 127
Note payable -- -- -- -- 84 (262) (84) (262) 13 -- (30) (17)
------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total interest expense $ 554 (221) (90) 243 1,039 (322) (186) 531 148 8 (39) 117
======= ======= ======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Net interest income $ 623 (358) 408 673 1,345 916 (245) 2,016 155 (190) (126) (161)
======= ======= ======= ======= ======= ======= ======= ======= ======= ======= ======= =======
- ---------------------------------------------------------------------------------------------------------------------------------
The volume, rate, and mix variances for net interest income in 1998 compared to
1997 indicate that a negative rate variance driven by falling interest rates was
offset by a positive mix variance driven by a 26% increase in average loans.
That left the net increase in net interest income approximately equal to the
positive volume variance from the 11% growth in average earning assets. The net
interest income rate variance is significantly impacted by $445 thousand in 1997
interest income recognized in connection with loan loss recoveries. Excluding
the recovered interest from 1997, the rate variance would have been a positive
$87 thousand despite falling earning asset yields. The benefit from declining
deposit rates more than offsets declines in interest income that resulted from
falling earning asset yields.
The increase in net interest income for 1997 attributable to volume is
illustrative of the principal impact of acquiring the new branches. Interest
income increased by $2.4 million as a result of volume, while interest expense
increased by $1.0 million. Approximately 49% of the positive rate variance of
$916 thousand for 1997 compared to 1996 is the result of the nonaccrual interest
recoveries realized during the year. The remainder of the variance is
principally the result of paying off the mortgage note payable and yield
increases for loans and investments. The negative impact of earning asset mix
variances with respect to loans was minimized for 1997 relative to 1996 due to
favorable mix changes in the deposit base. Noninterest bearing demand deposits
increased to 11% of average deposits for 1997 compared to 9% for 1996. NOW
accounts increased to 37% of average deposits compared to 34% in 1996.
16
Allowance for Loan Losses
The following table reconciles the beginning and ending allowance for loan
losses for the previous five years. Reconciling activity is broken down into the
three principal items that impact the reserve: (1) reductions from charge-offs;
(2) increases from recoveries; and (3) increases or decreases from positive or
negative provisions for loan losses.
- --------------------------------------------------------------------------------------------
(in thousands) 1998 1997 1996 1995 1994
Balance at beginning of period $ 1,313 1,207 959 1,127 924
Charge-offs:
Commercial 67 249 237 357 98
Real estate 25 -- -- 30 --
Consumer 40 41 97 95 77
------- ------- ------- ------- -------
Total Charge-offs $ 132 290 334 482 175
Recoveries:
Commercial 112 434 260 174 37
Real estate -- -- -- -- --
Consumer 21 22 12 25 18
------- ------- ------- ------- -------
Total Recoveries 133 456 272 199 55
------- ------- ------- ------- -------
Net charge-offs $ (1) (166) 62 283 120
Additions charged to operations 250 (60) 310 115 323
------- ------- ------- ------- -------
Balance at end of period $ 1,564 1,313 1,207 959 1,127
======= ======= ======= ======= =======
Ratio of net charge-offs to average
loans outstanding (.001%) (.28%) 0.11% 0.50% 0.20%
======= ======= ======= ======= =======
- --------------------------------------------------------------------------------------------
<FN>
Footnote 1(g) to the consolidated financial statement discusses the factors used
in determining the provision for loan losses and the adequacy of the allowance
for loan losses.
</FN>
Charge-off activity declined by 54% in 1998 compared to 1997, while recoveries
declined by 71% for the same period. The decline in charge-offs is consistent
with the asset quality statistics discussed below in the Asset Quality section.
The Bank has not modified or significantly excepted its underwriting standards
despite growing competition within the industry. The decline in recoveries is a
function of the significant recoveries that were realized in 1997.
Charge-off activity declined by 31% and 13%, respectively, in 1996 and 1997,
while recoveries increased by 37% and 68%, respectively, for the same periods.
These trends are consistent with the improvements discussed below in the Asset
Quality section. The principal reason for the increases in recoveries was
improvement in the repayment capacity of certain credits that had previously
been charged off combined with the Bank's continued efforts subsequent to
charge-off to work diligently toward collection.
17
The loan loss provision for 1998 increased significantly relative to 1997. The
reason for the increase was twofold. With year-over-year increase in the loan
portfolio of 45%, a larger provision was necessitated by the significant growth
in lending volume and the losses inherent in that volume. In addition, the 1997
provision was negative as a result of the significant recoveries that
effectively amplified the year-to-year change in the provision with respect to
both 1998 and 1996. The declining charge-offs and larger recoveries during 1997
increased the loan loss reserve by more than management believed was necessary
to provide for loss potential in the loan portfolio. Accordingly, a negative
provision resulted from the reversal of a portion of the reserve. The loan loss
provision for 1996 exceeded the provision for 1995 by 170%. Although net
charge-offs declined from 1995 to 1996, management determined that the loan loss
provision of $310 thousand was necessary to provide for the loss potential with
respect to a specific group of loan relationships that exhibited increased
credit risk at that time.
Noninterest Income
Noninterest income increased by 32% and 33% in 1998 and 1997, respectively. SBA
revenue for 1998 was even with 1997. The increases in 1998 came from growth in
the other major components of noninterest income: service charges, mortgage
income, and other noninterest income. The following table summarizes the
significant elements of service charge, SBA, mortgage and Farmer Mac revenue for
the three years ending 1998, 1997, and 1996:
-------------------------------------------------------------------------------------------------------------
(in thousands) 1998 1997 1996
-------------------------------------------------------------------------------------------------------------
Periodic deposit account charges $ 352 307 192
Returned item charges 344 332 259
Ancillary services charges 82 70 33
Other service charges 68 57 75
-------------------------------------------------
Total service charge revenue 846 766 559
=================================================
Gain on sale of SBA loans 191 217 163
SBA loan servicing revenue 226 199 183
-------------------------------------------------
Total SBA revenue 417 416 346
Gain on sale of mortgage loans 243 77 44
Mortgage loan servicing revenue 92 53 41
-------------------------------------------------
Total mortgage revenue 335 130 85
Farmer Mac origination, sale and servicing 32 29 20
-------------------------------------------------
Total loan origination, sale and servicing revenue $ 784 575 451
-------------------------------------------------------------------------------------------------------------
Service charge revenue increased by 10% in 1998 compared to 1997 and 37% in 1997
compared to 1996. The growth in service charge income for 1998 was driven by
deposit growth. Average deposits grew 15% in 1998. The growth in service charge
revenue for 1997 resulted primarily from the acquisition of three branches as
discussed above in "Branch Acquisition." The acquisition increased deposits by
approximately 37%. In addition to deposit growth, the Bank's service charge
schedule was reviewed during 1997, and certain rates were increased in areas
where the Bank's rates were more than competitive.
Revenue from SBA loan sales was nearly comparable to the record level set in
1997, when SBA loan sales revenue increased by 33% over 1996. While SBA loan
originations increased in 1998 relative to 1997, the production cycle for many
of these loans extended relative to 1997, and fewer loans were sold. Partially
disbursed SBA loans at December 31, 1998 were $6.4 million compared to $1.1
million at December 31, 1997. The 33% increase in 1997 was the result of both
increases in the volume of loans originated and sold as well as a general
increase in the loan sale premiums realized in the secondary market for SBA loan
sales. During 1996, a new incentive compensation program was put into place. The
program was designed to provide incentives for increasing levels of production.
As production increased, the SBA servicing portfolio increased and resulted in
the 13% and 9% increases in SBA servicing revenue for 1998 and 1997,
respectively.
18
Revenue from mortgage loan sales reached a new record in 1998, surpassing the
previous record by 216%. Mortgage revenue for 1997 increased by 75% over 1996.
Mortgage operations were reorganized in 1994, and part of the annual increases
since that time are the result of the relationships that have been developed
with builders, realtors, and title companies. In addition to reorganized
operations, housing activity in the Bank's trade area continued to improve in
1998, building on the improvements in 1997. The Bank continues to package home
construction and mortgage take-out loans in a competitive manner and has
successfully marketed this product in the new trade areas that were opened as a
result of the acquisition of branches from Wells Fargo Bank in early 1997 (see
"Branch Acquisition" above). Finally, declining mortgage rates during 1998 and
1997 had a favorable impact on mortgage loan refinance volumes.
The Bank began to participate in the Federal Agricultural Mortgage Corporation
("Farmer Mac") lending program in late 1994, whereby qualifying mortgage loans
on agricultural property are originated and sold.
Noninterest Expenses
Noninterest expenses increased by 13% in 1998 compared to 1997 and 46% in 1997
compared to 1996. Growth in the Bank's branch network in 1998 and 1997 had a
significant impact on year-to-year comparability as did certain strategic
expenses incurred in 1998. Noninterest expenses for 1998 included 12 months of
expenses for the three new branches purchased in 1997 compared to ten months for
those branches in 1997. In addition, a loan production office in Folsom,
California was opened in January, 1998, and a full service branch in Elk Grove,
California was opened in August, 1998. Excluding the above factors, noninterest
expense increased by 5.5% in 1998 compared to 1997.
The single biggest factor behind the increase in 1997 compared to 1996 was the
acquisition of three branches from Wells Fargo Bank on February 22, 1997 as
discussed above in "Branch Acquisition." Excluding the expenses associated with
the three new branches in 1997 noninterest expenses increased by 17% in 1997
compared to 1996.
Noninterest expense is broken down into four primary categories each of which is
discussed in this section.
Salaries and Employee Benefits
The following table provides the detail for each major segment of salaries and
employee benefits together with relevant statistical data:
---------------------------------------------------------------------------------------------------------------
(in thousands except full time equivalents) 1998 1997 1996
----------------------------------------------------------------------------------------------------------------
Regular payroll, contract labor, and overtime $ 2,641 2,298 1,699
Incentive compensation and profit sharing 339 335 125
Payroll taxes and employment benefits 576 459 381
--------------------------------------------------
Total Salaries and Employee Benefits $ 3,556 3,092 2,205
==================================================
Number of full-time equivalent employees 95.00 82.00 62.25
--------------------------------------------------
Regular payroll per full-time equivalent employee 27.80 28.02 27.29
--------------------------------------------------
Incentive compensation to regular payroll 12.8% 14.6% 7.4%
--------------------------------------------------
Payroll taxes and benefits per full-time equivalent employee 6.06 5.60 6.12
---------------------------------------------------------------------------------------------------------------
Total salaries and benefits expense increased by 15% in 1998 and 40% in 1997.
Excluding the timing of expenses from new branches, the increases were 10% and
4% respectively. The adjusted rate of change for 1998 includes both wage
adjustments, additional positions added in the mortgage and SBA departments to
support growth and supplemental compensation accruals made pursuant to the
agreements summarized in Footnote 9 to the 1998 Consolidated Financial
Statements. The adjusted rate of change for 1997 reflects wage adjustments and
higher incentive compensation accruals related to increased profitability.
Regular payroll increased by 35% in 1997 compared to 1996 due primarily to the
increase in personnel from the three branches purchased from Wells Fargo Bank
(see "Branch Acquisition above"). At the closing date of the transaction, the
branch acquisition added 20 full-time equivalents. Regular payroll per full-time
equivalent declined by less than 1% in 1998 after increasing by 2.7% in 1997.
19
Incentive compensation includes bonus awards under the Incentive Compensation
Plan, contributions to the Employee Stock Ownership Plan and matching
contributions to the 401(k) Stock Ownership Plan. The Incentive Compensation
Plan pays bonuses to officers based upon the actual results of departmental and
Bank-wide performance in comparison to predetermined targets. Contributions to
the Employee Stock Ownership Plan are made at the discretion of the board of
directors based upon profitability. Matching contributions to the 401(k) Stock
Ownership Plan are made at the rate of 50% of the first 4% of compensation
contributed by employees. The rate of incentive compensation for 1997 was nearly
double the rate in 1996 based upon increased profitability.
Payroll taxes and employee benefits per full-time equivalent increased in 1998
compared to 1997 and declined in 1997 compared to 1996. The increase in 1998 is
related primarily to supplemental compensation accruals made pursuant to the
agreements summarized in Footnote 9 to the 1998 Consolidated Financial
Statements. The decline in 1997 was because certain benefit expenses did not
increase proportionately with the increase in full-time equivalents. Despite an
increase of 20 full-time equivalents, workers compensation insurance declined
slightly in 1997, and medical insurance per full-time equivalent declined by
$377.
Occupancy Expense
The following table provides the detail for each major segment of occupancy
expense:
-------------------------------------------------------------------------------------------------
(in thousands except square footage and cost per sq. ft.) 1998 1997 1996
-------------------------------------------------------------------------------------------------
Depreciation $289 265 251
Property taxes, insurance, and utilities 220 204 168
Property maintenance 144 154 109
Net rental expense (income) 62 (30) (45)
---------------------------
Total Occupancy $715 593 483
===========================
Square footage of occupied and unoccupied space 42,945 40,725 28,312
---------------------------
Occupancy cost per square foot $16.65 14.56 17.06
---------------------------
Locations 8 6 3
-------------------------------------------------------------------------------------------------
Occupancy expenses increased by 21% in 1998 compared to 1997 and 23% in 1997
compared to 1996.
The primary reason for the increase in 1998 is the increase in net rental
expense. The increase is related to the January opening of a loan production
office in Folsom, California and the August opening of a full service branch in
Elk Grove, California. In addition, the Galt branch was relocated in November,
1998. While the new rental expense in Galt is lower than it would have been
absent a relocation, it is higher per month than it was in 1997. With respect to
the three branches acquired from Wells Fargo Bank in 1997, 1998 includes two
additional months of occupancy expenses compared to 1997.
The increase in 1997 is attributable to the acquisition of three branches from
Wells Fargo Bank (see "Branch Acquisition"). Approximately 13,500 square feet of
space was added by the branch acquisition. Two of the locations were purchased
and the third, representing 6,000 square feet, was leased. The occupancy cost
per square foot declined by 15% as the acquired locations had a lower cost per
square foot than existing locations.
Equipment Expense
The following table provides the detail for each major segment of equipment
expense:
-------------------------------------------------------------------
(in thousands) 1998 1997 1996
-------------------------------------------------------------------
Depreciation $ 406 318 232
Maintenance 104 136 109
Rental expense 26 1 26
---------------------------------------
Total Equipment $ 536 455 367
-------------------------------------------------------------------
Equipment expense increased by 18% in 1998 compared to 1997 and increased by 24%
in 1997 compared to 1996.
20
The increase in 1998 was driven by two additional months of costs in 1998 for
the three branches acquired from Wells Fargo Bank in 1997 and the loan
production office and full service branch opened in the communities of Folsom
and Elk Grove California, respectively, in January and August of 1998,
respectively. The Galt branch was also relocated in November, 1998, and some
equipment was replaced.
The increase in 1997 was a function of the equipment acquired in, or purchased
as a result of, the acquisition of three branches from Wells Fargo Bank (see
"Branch Acquisition"). The increase in 1997 was also due in part to the
depreciation expense taken on when a new banking information system, the Phoenix
Banking System, was put into place in June of 1996. 1997 was the first full year
of depreciation and followed six months of depreciation in 1996. The old system
was no longer operationally or technologically current. As such, it was subject
to significant maintenance and repair expenses. Those costs declined by 24% in
1996 as a result of the new system. Concurrent with conversion to the Phoenix
Banking System, the bank also contracted with an outside vendor to process
customer checks and statements. These functions had previously been done
internally with rented equipment. As a result of this change, rental expenses
for equipment were nearly eliminated in 1997 compared to 1996.
Other Noninterest Expense
The following table provides the detail for each major segment of other
noninterest expense:
------------------------------------------------------------------------------------------------------
(in thousands) 1998 1997 1996
------------------------------------------------------------------------------------------------------
Third party data processing $ 719 642 371
Intangible amortization 372 479 ---
Professional fees 423 401 372
Telephone and postage 217 182 132
Director fees and retirement 223 150 124
Office supplies 176 142 113
Marketing 213 120 121
Printing 145 117 86
Other real estate owned losses and holding costs (12) 94 49
Business development 57 55 43
Regulatory assessments 51 53 40
Other 320 220 148
------------------------------------------------
Total Other Noninterest Expense $ 2,905 2,656 1,599
------------------------------------------------------------------------------------------------------
Other noninterest expenses increased by 10% in 1998 compared to 1997 and 66% in
1997 compared to 1996.
Approximately 3% out of the 10% increase in 1998 compared to 1997 is the result
of the new branches in 1998 and the inclusion of the three branches acquired in
1997 for twelve months in 1998 compared to 10 months for 1997. The remainder of
the increase is driven primarily by volume related costs. Average loans and
deposit volumes increased by 26% and 15%, respectively.
The most significant items behind the increase for 1997 were the acquisition of
three branches from Wells Fargo Bank (see Branch Acquisition), the outsourcing
of more functions to third party processors and increased losses and holding
costs on other real estate owned.
The acquisition of new branches in 1997 affected noninterest expenses in varying
degrees depending upon the fixed or variable nature of expenses. The most
definitive impact was the amortization of the core deposit and goodwill
intangible assets purchased in the acquisition. Amortization for 1997 amounted
to 24% of the purchase price of the related assets and represented 45% of the
increase in other noninterest expense for 1997 compared to 1996. The Bank is
using an accelerated method of amortization for these assets over an eight year
period. Excluding intangible amortization, the increase in other noninterest
expenses in 1997 was 36%.
21
As discussed under "Equipment Expense" above, the Bank outsourced the processing
of customer checks and statements to a third party in June of 1996. As a result
of this change in mid 1996, third party data processing costs increased in both
1996 and 1997. The acquisition of new branches approximately doubled the Bank's
customer base and added to the increase in third party data processing volumes
for 1997 compared to 1996.
Losses and holding costs for other real estate owned nearly doubled in 1997
compared to 1996. The Bank moved aggressively in 1997 to reduce other real
estate owned. In connection with that effort, carrying values and asking prices
were reduced to facilitate the sale of properties. In addition, new properties
were brought in during 1997 and increased holding costs, such as taxes and
bonds, compared to 1996.
Income Taxes
The provision for income taxes as a percentage of pretax income for 1998, 1997,
and 1996 was 25%, 32%, and 28%, respectively. The effective rate is lower than
the combined marginal rate for state and federal taxes due primarily to the
level of tax exempt income relative to total pre-tax income. Tax exempt income
increased in 1998 compared to 1997 due to an investment of $4.2 million in the
cash surrender value of life insurance as discussed below under Balance Sheet
Review. Tax exempt income declined during 1997 and 1996 in order to recoup
alternative minimum taxes paid in previous periods. As of December 31, 1998,
substantially all of these credits have been recovered, and the Company is in a
position to benefit from tax exempt income on a current basis. Footnote 12 to
the Consolidated Financial Statements contains a detailed presentation of the
income tax provision and the related current and deferred tax assets and
liabilities.
Balance Sheet Review
The following table presents average balance sheets for the years ended December
31, 1998, 1997 and 1996.
- ----------------------------------------------------------------------------------------------------------------------------
For the Year Ended For the Year Ended For the Year Ended
December 31, 1998 December 31, 1997 December 31, 1996
(in thousands) (in thousands) (in thousands)
-----------------------------------------------------------------------------
Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ -------
- ----------------------------------------------------------------------------------------------------------------------------
Assets:
Cash & Due from banks $ 6,701 4.32% 5,362 3.94% 4,020 3.80%
Federal funds sold 6,780 4.37% 8,400 6.17% 3,790 3.58%
Investment securities 53,370 34.42% 53,580 39.36% 34,700 32.82%
Loans (net of allowance for loan losses and 71,752 46.29% 56,744 41.68% 53,213 50.33%
deferred income)
Premises and equipment, net 7,188 4.64% 7,227 5.31% 7,044 6.66%
Other assets 9,220 5.96% 4,830 3.54% 2,966 2.81%
-------- ------ ------- ------ ------- ------
Total Assets $155,011 100.00% 136,143 100.00% 105,733 100.00%
======== ====== ======= ====== ======= ======
Liabilities & Stockholders' Equity:
Deposits $140,480 90.63% 122,540 90.00% 90,420 85.52%
Note payable -- -- -- -- 2,440 2.31%
Other liabilities 1,215 .78% 1,193 .88% 1,113 1.05%
Stockholders' equity 13,316 8.59% 12,410 9.12% 11,760 11.12%
-------- ------ ------- ------ ------- ------
Total Liabilities & Stockholders' Equity $155,011 100.00% 136,143 100.00% 105,733 100.00%
======== ====== ======= ====== ======= ======
- ----------------------------------------------------------------------------------------------------------------------------
22
Average total assets increased by 14% in 1998 compared to 1997 and 29% in 1997
compared to 1996. Year-end asset totals at December 31, 1998 reached $164.4
million and represented an increase of 11% over December 31, 1997. The increase
in 1998 is a function of deposit growth throughout the Bank's branch network, as
average deposits increased by 15% in 1998. The increase in 1997 is largely
attributable to $34 million in deposits acquired in connection with the
acquisition of three branches from Wells Fargo Bank (see "Branch Acquisition").
Deposits at December 31, 1997 increased by 45%, or $41.6 million, compared to
December 31, 1996. Average deposits for 1997 exceeded 1996 by 36%. The increase
in deposits reduced the ratio of average equity to average assets by 200 basis
points in 1997 to 9.12% and provided for a more efficient use of capital.
The liquidity generated by the growth in deposits funded growth in the loans
during 1998 and both loans and investment securities in 1997. Average loans
increased by 26% and 7% in 1998 and 1997, respectively, while loans at December
31, 1998 and 1997 were 45% and 18%, respectively, above the comparable prior
year-end totals. The average investment portfolio for 1997 was 54% larger than
in 1996.
23
Investment Securities
The following table presents the investment portfolio at December 31, 1998, 1997
and 1996 by security type, maturity, and yield:
- --------------------------------------------------------------------------------------------------------------------------------
Book Value at December 31 (in thousands):
1998 1997 1996
---- ---- ----
Amount Yield(a) Amount Yield(a) Amount Yield(a)
- -----------------------------------------------------------------------------------------------------------------------------
U.S. Treasury Securities:
Within 1 year $ 1,000 5.87% 2,995 5.94% 600 8.09%
Ater 1 year, within 5 years -- -- 1,000 5.87% 3,972 5.93%
After 5 years, within 10 years -- -- -- -- -- --
After 10 years -- -- -- -- -- --
---------------------------------------------------------------
Total U.S. Treasury $ 1,000 5.87% 3,995 5.92% 4,572 6.21%
U.S. Agency Securities:
Within 1 year 1,512 5.68% 2,101 7.06% 4,023 5.94%
After 1 year, within 5 years 13,482 6.50% 13,997 6.46% 8,537 6.71%
After 5 years, within 10 years 3,000 6.93% 9,986 7.07% 5,038 7.04%
After 10 years 1,500 6.85% 4,993 7.63% 483 8.30%
--------------------------------------------------------------
Total U.S. Agency $19,494 6.53% 31,077 6.88% 18,081 6.67%
Collateralized Mortgage Obligations:
Within 1 year -- -- -- -- -- --
After 1 year, within 5 years -- -- 225 6.08% 329 5.65%
After 5 years, within 10 years 153 5.51% 277 6.27% 376 5.84%
After 10 years 304 8.34% 534 6.57% 534 6.40%
--------------------------------------------------------------
Total Collateralized Mortgage Obligations $ 457 7.39% 1,036 6.38% 1,239 6.03%
Municipal Securities:
Within 1 year 1,196 6.20% 688 6.67% 250 6.33%
After 1 year, within 5 years 2,439 7.08% 3,118 6.94% 3,455 6.88%
After 5 years, within 10 years -- -- 530 7.60% 886 6.14%
After 10 years -- -- -- -- -- --
--------------------------------------------------------------
Total Municipals $ 3,635 6.79% 4,336 6.98% 4,591 6.71%
Other Debt Securities:
Within 1 year 93 8.50% 22 7.86% 27 8.57%
After 1 year, within 5 years 113 6.83% 2,748 7.41% 492 8.25%
After 5 years, within 10 years 2,509 7.28% 7 9.73% 1,097 7.33%
After 10 years -- -- 972 7.67% 33 8.15%
--------------------------------------------------------------
Total Other Debt Securities $ 2,813 7.36% 3,749 7.48% 1,649 7.64%
Money Market Mutual Fund 17,602 4.83% 17,200 6.12% 6,482 5.28%
Federal Agency Stock 126 6.00% 126 6.00% 83 6.00%
Unrealized Holding Gain/(Loss) 520 -- 398 -- 216 --
--------------------------------------------------------------
Total $45,647 5.93% 61,917 6.59% 36,913 6.39%
- -----------------------------------------------------------------------------------------------------------------------------
<FN>
(a) The yields on tax-exempt obligations have not been computed on a tax-equivalent basis.
</FN>
24
The investment portfolio at December 31, 1998 was 26% below the prior year total
after increasing by 68% in 1997 compared to 1996. The decline in the portfolio
during 1998 funded increases in loan volume. The growth in the portfolio during
1997 resulted from the investment of the deposit liquidity that was received
when the Bank purchased three branches from Wells Fargo Bank (see "Branch
Acquisition").
With the exception of the sale of money market mutual fund shares, the decline
in the portfolio during 1998 came solely from maturities and calls. The general
decline in interest rates during 1998 led to the call of several agency
securities that were purchased in 1997. Maturities and calls during 1998 were
approximately $20.9 million. At December 31, 1998, the portfolio included $9.0
million in callable agency securities with an average maturity, months-to-call,
and yield of 8.33%, 7.0%, and 6.9%, respectively.
The growth in the portfolio during 1997 was focused primarily in the U.S. Agency
segment and more specifically callable U.S. Agency bonds. The callable bonds
provide attractive yields relative to noncallable securities for the same
contractual maturity. In a rising rate scenario, the call option to the issuer
loses economic advantage. As a result, the securities estimated life extends but
the yield in excess of non-callable yields at the purchase date provides some
compensation for the extended life. In a falling rate scenario, the call option
to the issuer gains economic advantage. As a result, the likelihood of the bond
being called increases. While the proceeds from the call would need to be
reinvested at lower rates, the higher coupon on the callable bond compensates
for the risk of the bond being called. The callable U.S Agency securities
purchases were diversified. Final maturities ranged from three to fifteen years
with call protection from three months to two years. At December 31, 1997, the
Bank's callable U.S. Agency portfolio totaled $21 million and had an average
final maturity of nine years with average call protection of ten months.
A portion of the investment portfolio contains structured notes. Structured
notes generally carry terms that reference some index or predefined schedule as
a means of determining the coupon rate of interest to be paid on the security,
and there may also be interest rate caps or floors that limit the extent to
which the coupon rate can adjust in any given period and/or for the life of the
security. Depending upon the referenced index or predefined schedule as well as
the interest rate cap or floor, the coupon rate of a structured note can lead,
lag, move in tandem with, or move in the opposite direction of market interest
rates. As a result, the market value of the note can be favorably or adversely
impacted depending upon the direction and magnitude of change in market interest
rates. Structured notes may also contain provisions that give the issuer the
right to call the security away from the owner at a predetermined price;
therefore, the contractual, expected, and actual final maturity of the notes may
differ. Both the collateralized mortgage obligations and the structured agency
bonds are considered to be derivative securities under the broadest definitions
of derivatives, however, derivative investments in the Bank's portfolio are
structured such that they fall on the conservative end of the derivative risk
spectrum.
The amortized cost of the Bank's structured note portfolio at December 31, 1998
and 1997 was $.50 million and $1.0 million, respectively, and represented
approximately 1.1% and 1.6%, respectively, of the investment portfolio. The
market value of the structured note portfolio at December 31, 1998 and 1997 was
$.50 million and $1.0 million, respectively. All of the structured notes were
issued by Federal Agencies and therefore carry the implied AAA credit rating of
the Federal Government. The structured note portfolio at December 31, 1998 and
1997 carries only floating rate coupons that generally lag overall movements in
market interest rates.
25
Loans
The following table summarizes gross loans and the components thereof as of
December 31 for each of the last five years:
- ----------------------------------------------------------------------------------------------------------------------------
Outstanding at December 31 (in thousands):
-----------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
- ----------------------------------------------------------------------------------------------------------------------------
Commercial $77,956 53,684 45,322 41,538 44,847
Real estate construction 11,743 6,900 5,802 7,549 9,809
Installment and other 3,463 3,525 3,155 2,757 2,656
------- ------ ------ ------ ------
$93,162 64,109 54,279 51,844 57,312
======= ====== ====== ====== ======
- ----------------------------------------------------------------------------------------------------------------------------
Gross loans outstanding as of December 31, 1998 and 1997 exceeded the comparable
prior year-end totals by 45% and 18%, respectively. Improving economic
conditions and business development efforts were the foundation for the growth
in both years. A significant amount of effort was put forth by management during
1994 to improve the credit quality of the loan portfolio and alter the labor
intensiveness of certain segments of the portfolio. The portfolio dollars
declined in 1995 as a result of these efforts. During 1995 and thereafter,
management's focus expanded to business development and the approach to business
development was refined. The growth in 1996 through 1998 is attributable to
diligent application of those business development disciplines.
The most significant segment of the loan portfolio is commercial loans, which
represented 84% of the total portfolio at December 31, 1998 and 1997. Commercial
loans include agricultural loans, working capital loans to businesses in a
number of industries, and loans to finance commercial real estate. Agricultural
loans represented approximately 14% and 21% of the commercial loan portfolio at
December 31, 1998 and 1997, respectively. Agricultural loans are diversified
throughout a number of agricultural business segments, including dairy,
orchards, row crops, vineyards, cattle and contract harvesting. Agricultural
lending risks are generally related to the potential for volatility of
agricultural commodity prices. Commodity prices are affected by government
programs to subsidize certain commodities, weather, and overall supply and
demand in wholesale and consumer markets. Excluding agricultural loans, the
remaining portfolio is principally dependent upon the health of the local
economy and related to the real estate market.
The maturity and repricing characteristics of the loan portfolio at December 31,
1998 are as follows:
- ---------------------------------------------------------------------------------------------------------------
Due: (1) Fixed Rate Floating Rate Total
---------- ------------- -----
In 1 year or less $ 13,039 18,294 31,333
After 1 year through 5 years 20,867 15,916 36,783
After 5 years 9,705 15,341 25,046
-------- ------ ------
Total Loans $ 43,611 49,551 93,162
======== ====== ======
- ---------------------------------------------------------------------------------------------------------------
<FN>
(1) Scheduled repayments are reported in the maturity category in which the payment is due.
</FN>
Approximately 47% of the loan portfolio carries a fixed rate of interest as of
December 31, 1998, while approximately 73% of the portfolio matures within five
years.
26
Deposits
The following table summarizes average deposit balances and rates for the years
ended December 31, 1998, 1997, and 1996:
- ----------------------------------------------------------------------------------------------------------------------------
(in thousands) For the Year Ended For the Year Ended For the Year Ended
December 31, 1998 December 31, 1997 December 31, 1996
Type Average Average Average Average Average Average
Amount Rate Amount Rate Amount Rate
- ----------------------------------------------------------------------------------------------------------------------------
Demand - non-interest bearing $ 17,080 N/A 13,470 N/A 8,280 N/A
NOW accounts 34,311 1.31% 27,520 1.68% 19,561 1.89%
Money market accounts 16,829 3.13% 17,870 3.09% 12,469 2.95%
Savings 25,460 2.66% 22,130 2.92% 15,790 2.89%
Time deposits 46,800 5.08% 41,550 5.11% 34,320 5.24%
-------- ----- ------- ----- ------ -----
Total Deposits $140,480 2.87% 122,540 3.09% 90,420 3.31%
======== ===== ======= ===== ====== =====
- ----------------------------------------------------------------------------------------------------------------------------
Average deposits increased by approximately 15% and 36% in 1998 and 1997,
respectively, while the average rate declined by 22 basis points in each year.
The deposit growth in 1998 came from account growth at all branches throughout
the Bank's network. The growth was the result of business development efforts in
the lending area as well as a continued influx of "large" bank customers that
have grown tired of merger activity among large institutions. The majority of
the deposit growth in 1997 came from the acquisition of three branches with $34
million in deposits from Wells Fargo Bank on February 22, 1997 (see "Branch
Acquisition"). Deposits also grew as a result of internal growth that resulted
from the focused business development efforts of Bank officers and staff.
The reduced rates on the deposit portfolio in 1998 and 1997 are a function of
changes in mix, pricing, and the general level of interest rates. The mix of
deposits has become more cost efficient over the past three years. The mix of
noninterest bearing deposits was 12%, 11%, and 9% for 1998, 1997, and 1996,
respectively. The mix of certificates of deposit declined significantly from
1996 to 1997 in favor of NOW, money market and savings accounts. The savings,
money market, and NOW accounts were repriced in early 1997. The basis used to
pay interest on these accounts was changed from a flat rate of interest
regardless of balance to a tiered rate of interest with increasingly higher
rates paid on incrementally higher balances. The base rates in the pricing
mechanism for these accounts have been reduced in conjunction with the overall
decline in market interest rates.
Certificates of deposit contain regular and individual retirement account
balances. There are no brokered certificates of deposit in the portfolio.
Certificates of $100,000 or more represent approximately 32% of the certificate
of deposit portfolio at December 31, 1998, and the maturities of those
certificates are as follows:
- ------------------------------------------------------------------------------
(in thousands) 1998
----
Three months or less $ 9,054
Four months to six months 2,609
Seven months to twelve months 2,694
Over twelve months 608
Total time deposits of $100,000 or more $14,965
=======
- ------------------------------------------------------------------------------
27
Asset Quality
The following table contains asset quality information with respect to the loan
portfolio and other real estate owned:
- ----------------------------------------------------------------------------------------------------------------------------
Asset Quality Statistics at December 31
(in thousands except multiples and percentages) 1998 1997 1996 1995 1994
- ----------------------------------------------------------------------------------------------------------------------------
Nonaccrual loans $ 248 340 898 987 765
Accruing loans past due more than 90 days 191 65 52 118 40
------ ----- ----- ----- -----
Total nonperforming loans $ 439 405 950 1,105 805
====== ===== ===== ===== =====
Allowance for loan losses 1,564 1,313 1,207 959 1,127
Allowance for loan losses to nonperforming loans 356% 324% 127% 87% 140%
Total loan portfolio delinquency 1.40% 1.09% 2.14% 2.57% 2.71%
Allowance for loan losses to total gross loans 1.69% 2.05% 2.22% 1.85% 1.97%
Other real estate owned $ 129 159 400 357 175
- ----------------------------------------------------------------------------------------------------------------------------
The Company's nonaccrual policy is discussed in note 1(c) to the consolidated
financial statements. Interest income recorded on these nonaccrual loans was
approximately $2,000, $8,000, $7,000, $13,000 and $14,000 in 1998, 1997, 1996,
1995 and 1994, respectively. Interest income foregone or reversed on these loans
was approximately $43,000, $45,000, $149,000, $161,000 and $74,000 in 1998,
1997, 1996, 1995 and 1994, respectively. At December 31, 1998, there were no
individually material or a material amount of loans in the aggregate for which
management had serious doubts as to the borrower's ability to comply with
present loan repayment terms and which may result in the subsequent reporting of
such loans as nonaccrual.
Nonperforming loans increased by 8%, or $34 thousand, after having declined in
1997 and 1996. Portfolio delinquency also declined in 1997 and 1996, while the
1998 level increased to 1.4% The allowance for loan losses increased for each of
the last three years after declining by 15% in 1995 compared to 1994. As a
result, the allowance coverage ratio for nonperforming loans increased in 1996,
1997, and 1998, reaching 3.56 times at December 31, 1998. Notwithstanding the
stable asset quality statistics in 1998 and 1997, the allowance for loan losses
was increased in order to provide for the inherent loss potential in the new
loan portfolio growth. The following table summarizes the allocation of the
allowance for loan losses at December 31 for each of the last five years:
- ----------------------------------------------------------------------------------------------------------------------------
(in thousands) December 31, 1998 December 31, 1997 December 31, 1996 December 31, 1995 December 31, 1994
----------------- ----------------- ----------------- ----------------- -----------------
except percentages
Loan Category Amount % Amount % Amount % Amount % Amount %
------ ------ ------ ------ ------
Loans Loans Loans Loans Loans
----- ----- ----- ----- -----
Commercial $ 240 63.16% 309 60.95% 490 91.42% 295 84.29% 376 78.25%
Real estate 129 33.95% 192 37.87% 45 8.40% 38 10.86% 121 17.12%
Consumer 11 2.89% 6 1.18% 1 0.19% 17 4.86% 4 4.63%
Unallocated 1,184 N/A 806 N/A 671 N/A 609 N/A 629 N/A
----- ------- ----- ------- ----- ------- --- ------- ----- -------
$1,564 100.00% 1,313 100.00% 1,207 100.00% 959 100.00% 1,127 100.00%
===== ======= ===== ======= ===== ======= === ======= ===== =======
- ----------------------------------------------------------------------------------------------------------------------------
Please also see "Allowance for Loan Losses".
28
Market Risk
While there are several varieties of market risk, the market risk material to
the Company and the Bank is interest rate risk. Within the context of interest
rate risk, market risk is the risk of loss due to changes in market interest
rates that have an adverse effect on net interest income, earnings, capital or
the fair value of financial instruments. Exposure to this type of risk is a
regular part of a financial institution's operations. The fundamental activities
of making loans, purchasing investment securities, and accepting deposits
inherently involve exposure to interest rate risk. As described in "Asset
Liability Management," the Company monitors the repricing differences between
assets and liabilities on a regular basis and estimates exposure to net interest
income, net income, and capital based upon assumed changes in the market yield
curve. The following table summarizes the expected maturity, principal repayment
and fair value of the financial instruments that are sensitive to changes in
interest rates as of December 31, 1998.
- --------------------------------------------------------------------------------------------------------------------------------
Expected Maturity / Principal Repayment Total Fair
In Thousands 1999 2000 2001 2002 2003 after 03 Balance Value
- --------------------------------------------------------------------------------------------------------------------------------
Interest-Sensitive Assets:
Federal funds sold $ 4,800 -- -- -- -- -- 4,800 4,800
Fixed rate investments (1) 3,346 1,982 4,554 5,233 1,585 9,315 26,015 26,015
Floating rate investments (1) 18,102 -- -- 91 -- 1,439 19,632 19,632
Fixed rate loans (2) 13,039 3,333 5,066 6,628 5,840 9,705 43,611 44,481
Floating rate loans (2) 18,294 4,862 1,633 3,700 5,721 15,341 49,551 49,551
Interest-Sensitive Liabilities:
NOW account deposits (3) -- -- -- -- -- 36,181 36,181 36,181
Money market deposits (3) -- -- -- -- -- 19,482 19,482 19,482
Savings deposits (3) -- -- -- -- -- 25,987 25,987 25,987
Certificates of deposit 45,799 2,234 371 615 340 -- 49,359 49,447
Interest-Sensitive Off-Balance
Sheet Items:
Loans serviced for others -- -- -- -- -- -- 66,903 670
Commitments to lend -- -- -- -- -- -- 21,290 213
Standby letters of credit -- -- -- -- -- -- 156 2
- --------------------------------------------------------------------------------------------------------------------------------
<FN>
(1) Expected maturities for investment securities are based upon anticipated
prepayments as evidenced by historical prepayment patterns.
(2) Expected maturities for loans are based upon contractual maturity dates.
(3) NOW, money market and savings deposits do not carry contractual maturity
dates; therefore, they have been shown in the "after 03" category. The
actual maturities of NOW, money market, and savings deposits could vary
substantially if future prepayments differ from the Company's historical
experience.
</FN>
29
Asset Liability Management
The primary goal of the Company's asset and liability management system is to
maximize net interest margin within reasonable risk parameters with respect to
the maturity and pricing structure of assets and liabilities. The Company
monitors the repricing differences between assets and liabilities on a regular
basis and estimates exposure to net interest income, net income, and capital
based upon assumed changes in the market yield curve. The following table
summarizes the repricing intervals for the balance sheet at December 31, 1998:
- ----------------------------------------------------------------------------------------------------------------------------
By Repricing Interval
- ----------------------------------------------------------------------------------------------------------------------------
(in thousands) Within After three After six After one After five Noninterest Total
three months, months, year, years bearing funds
months within six within one within five
months year years
- ----------------------------------------------------------------------------------------------------------------------------
Assets
Federal funds sold $ 4,800 -- -- -- -- -- 4,800
Investment securities 19,225 148 4,126 16,473 5,675 -- 45,647
Loans 51,324 3,881 3,369 22,285 12,303 -- 93,162
Noninterest earning assets
and allowance for loan
losses -- -- -- -- -- 20,791 20,791
-------------------------------------------------------------------------------------------------
Total Assets $ 75,349 4,029 7,495 38,758 17,978 20,791 164,400
=================================================================================================
Liabilities and
Stockholders' Equity
Savings, money market &
NOW deposits $ 81,650 -- -- -- -- -- 81,650
Time deposits 25,573 10,097 10,129 3,560 -- -- 49,359
Other liabilities and
stockholders' equity -- -- -- -- -- 33,391 33,391
-------------------------------------------------------------------------------------------------
Total Liabilities and $ 107,223 10,097 10,129 3,560 -- 33,391 164,400
Stockholders' Equity
=================================================================================================
Interest Rate $ (31,874) (6,068) (2,634) 35,198 17,978 (12,600) --
Sensitivity Gap
=================================================================================================
Cumulative Interest Rate $ (31,874) (37,942) (40,576) (5,378) (12,600) -- --
Sensitivity Gap
- ---------------------------=================================================================================================
The interest rate gaps reported in the table arise when assets are funded with
liabilities having different repricing intervals. Since these gaps are actively
managed and change daily as adjustments are made in interest rate forecasts and
market outlook, positions at the end of any period may not be reflective of the
Company's interest rate sensitivity in subsequent periods. Active management
dictates that longer-term economic views are balanced against prospects for
short-term interest rate changes in all repricing intervals. For purposes of the
above analysis, repricing of fixed-rate instruments is based upon the
contractual maturity of the applicable instruments. In addition, repricing of
assets and liabilities is assumed in the first available repricing period.
Actual payment patterns may differ from contractual payment patterns, and it has
been management's experience that repricing does not always correlate directly
with market changes in the yield curve.
30
Fluctuations in interest rates can also impact the market value of assets and
liabilities either favorably or adversely depending upon the nature of the rate
fluctuations as well as the maturity and repricing structure of the underlying
financial instruments. To the extent that financial instruments are held to
contractual maturity, market value fluctuations related to interest rate changes
are realized only to the extent that future net interest margin is either higher
or lower than comparable market rates for the period. To the extent that
liquidity management dictates the need to liquidate certain assets prior to
contractual maturity, changes in market value from fluctuating interest rates
will be realized in income to the extent of any gain or loss incurred upon the
liquidation of the related assets.
Liquidity
Liquidity is managed on a daily basis by maintaining cash, federal funds sold,
and short-term investments at levels commensurate with the estimated
requirements for loan demand and fluctuations in deposits. Loan demand and
deposit fluctuations are affected by a number of factors, including economic
conditions, seasonality of the borrowing and deposit bases, and the general
level of interest rates. The Bank maintains two lines of credit with
correspondent banks as a supplemental source of short-term liquidity in the
event that saleable investment securities and loans or available new deposits
are not adequate to meet liquidity needs. The Bank may also borrow on a
short-term basis from the Federal Reserve in the event that other liquidity
sources are not adequate.
At December 31, 1998, liquidity was considered adequate, and funds available in
the local deposit market and scheduled maturities of investments are considered
sufficient to meet long-term liquidity needs. Compared to 1997, liquidity
declined in 1998 as a result of the growth in loans. The growth was adequately
funded by investment portfolio maturities and deposit portfolio growth.
Capital Resources
Consolidated capital increased by $1 million, or 8%, during 1998. The increase
was due primarily to net income of $1.05 million. The increase in the net
unrealized gain on available for sale securities of $84 thousand together with
capital paid in upon exercise of stock options of $129 thousand offset $269
thousand in capital used to pay dividends. The consolidated capital to assets
ratio declined by 27 basis points, to 8.43% from 8.70%, due to the growth in
assets related to the growth in deposits.
The Bank's total risk-based and leverage capital ratios at December 31, 1998
were 11.17% and 7.35%, respectively, at December 31, 1998 compared to 12.9% and
7.1%, respectively, at December 31, 1997. The decline in the total risk-based
ratio reflects the additional leverage created by the growth in deposits as well
as increased lending which moves assets from lower risk-weight categories to the
higher risk-weight categories of loans. The total risk-based and leverage
capital ratios at December 31, 1998, are in excess of the required regulatory
minimums of 10% and 5%, respectively, for well-capitalized institutions.
Year 2000 Preparedness
Preparedness for the year 2000 date change with respect to computer systems is
recognized as a serious issue throughout the banking industry. Both the Company
and the Bank have a detailed year 2000 compliance plan that has been approved by
their respective boards of directors. The potential impact of the Year 2000
compliance issue on the financial services industry could be material, as
virtually every aspect of the industry and processing of transactions will be
affected. Due to the size of the task facing the financial services industry and
the interdependent nature of its transactions, the Company may be adversely
affected by this problem, depending on whether it and the entities with which it
does business address this issue successfully. The impact of Year 2000 issues on
the Company will depend not only on corrective actions that the Company takes,
but also on the way in which Year 2000 issues are addressed by governmental
agencies, businesses and other third parties that provide services or data to,
or receive services or data from, the Company, or whose financial condition or
operational capability is important to the Company.
31
The Company's State of Readiness
The Company engages the services of third-party software vendors and service
providers for substantially all of its electronic data processing. Thus, the
focus of the Company is to monitor the progress of its primary software
providers toward Year 2000 compliance and prepare to test future-data sensitive
data of the Company in simulated processing.
The Company's Year 2000 compliance program has been divided into phases, all of
them common to all sections of the process: (1) inventorying date-sensitive
information technology and other business systems; (2) assigning priorities to
identified items and assessing the efforts required for Year 2000 compliance of
those determined to be material to the Company; (3) upgrading or replacing
material items that are determined not to be Year 2000 compliant and testing
material items; (4) assessing the status of third party risks; and (5) designing
and implementing contingency and business continuation plans.
As part of the on-going supervision of the banking industry, bank regulatory
agencies are continuously surveying the Company's progression and results of
each one of these phases.
In the first phase, the Company conducted a thorough evaluation of current
information technology systems, software and embedded technologies, resulting in
the identification of 21 Mission Critical Systems that could be affected by Year
2000 issues. Non-information technology systems such as climate control systems,
elevators and vault security equipment, were also surveyed. This stage of the
Year 2000 process is complete.
In phase two of the process, results from the inventory were assessed to
determine the Year 2000 impact and what actions were required to obtain Year
2000 compliance. For the Company's mission-critical systems, actions needed
consist principally of upgrades to application versions that vendors have tested
for Year 2000 compliance. The Bank's core information system is The Phoenix
Banking System (PBS) from Phoenix International Ltd., which was developed in the
early 1990's. The Bank converted to PBS in 1996. PBS was developed with a
four-digit year field. Phoenix International Ltd. has completed year 2000
testing on version 2.01 of PBS. No code changes to PBS were necessary to
complete those tests.
The third phase includes the upgrading, replacement and/or retirement of
systems, and testing. This stage of the Year 2000 process was substantially
completed for mission critical systems by February 28, 1999. The Company and the
Bank upgraded to version 2.01 of PBS during the fourth quarter of 1998 and
completed on-site testing by January 31, 1999. Each of the upgrades, to the
extent economically feasible, is run through a test environment before it is
implemented. It is also tested to see how well it integrates with the Company's
overall data processing environment. Final "future-date" testing of system
upgrades and replacements is scheduled to be completed by March 31, 1999.
The fourth phase, assessing third party risks, includes the process of
identifying and prioritizing critical suppliers and customers at the direct
interface level, as well as other material relationship with third parties,
including various exchanges, clearing houses, other banks, telecommunication
companies and public utilities. This evaluation includes communicating with the
third parties about their plans and progress in addressing Year 2000 issues.
Detailed evaluations of the most critical third parties have been initiated.
These evaluations will be followed with contingency plans, which are ongoing and
scheduled to be completed in the second quarter of 1999, with follow up reviews
scheduled through the remainder of 1999.
Contingency Plan
The final phase of the Company's Year 2000 compliance program relates to
contingency plans. The Company maintains contingency plans in the normal course
of business designed to be deployed in the event of various potential business
interruptions. These plans have been expanded to address Year 2000-specific
interruptions such as power and telecommunication infrastructure failures, and
will continue to be supplemented if and when the results of systems integration
testing identify additional business functions at risk. The Company is defining
core business processes that are dependent upon mission-critical systems and
reviewing the business impact on those processes from the failure of mission
critical systems in order to develop specific business resumption contingency
plans.
32
Costs
As the Company relies upon third-party software vendors and service providers
for substantially all of its electronic data processing, the primary cost of the
Year 2000 Project has been and will continue to be the reallocation of internal
resources and, therefore, does not represent incremental expense to the Company.
Management estimates that the incremental cost of mitigating Year 2000 risk
exclusive of management time that has been redirected to focus on this matter
will be approximately $50 thousand.
Risks
Failure to correct a material Year 2000 problem could result in an interruption
in, or a failure of, certain normal business activities or operations. The
Company believes that, with the implementation of upgraded business systems and
completion of the Year 2000 Project as scheduled, the possibility of significant
interruptions of normal operations due to the failure of those systems will be
reduced. However, the Company is also dependent upon the power and
telecommunications infrastructure within the United States, and processes large
volumes of transactions through various clearing houses and correspondent banks.
The most reasonably likely worst case scenario would be that the Company may
experience disruption in its operations if any of these third-party suppliers
reported a system failure. Although the Company's Year 2000 Project will reduce
the level of uncertainty about the compliance and readiness of its material
third-party providers, due to the general uncertainty over Year 2000 readiness
of these third-party suppliers, the Company is unable to determine at this time
whether the consequences of Year 2000 failures will have a material impact.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Item 14(a) herein.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
Not Applicable
PART III
ITEMS 10, 11, 12 and 13.
The information required by these items is contained in the Company's definitive
Proxy Statement for the Annual Meeting of Shareholders to be held on May 18,
1999, and is incorporated herein by reference. The definitive Proxy Statement
will be filed with the Commission within 120 days after the close of the
Company's fiscal year pursuant to Regulation 14A of the Securities Exchange Act
of 1934.
33
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) Financial Statements and Schedules Page Reference
Independent Auditors' Report 37
Consolidated Balance Sheets as of
December 31, 1998 and 1997. 38
Consolidated Statements of Changes in Equity
Years Ended 1998, 1997, and 1996 39
Consolidated Statements of Income
Years Ended 1998, 1997, and 1996 40
Consolidated Statements of Cash Flows
Years Ended 1998, 1997, and 1996 41
Notes to Consolidated Financial Statements 42
(b) Reports on Form 8-K
On October 30, 1998 the Company filed a Current Report on Form
8-K regarding its press release of the same date, reporting the
Company's results of operations for the quarter ended September
30, 1998 and the declaration of a cash dividend of $.05 per
share, payable November 27, 1998 to shareholders of record on
November 13, 1998.
On January 29, 1999 the Company filed a Current Report on Form
8-K regarding its press release of the same date, reporting the
Company's results of operations for the year ended December 31,
1998 and the declaration of a cash dividend of $.05 per share,
payable February 26, 1999 to shareholders of record on February
12, 1999.
(c) Exhibits
Exhibit No. Description
----------- -----------
3(a) Articles of Incorporation, as amended, filed as
Exhibit 3.1 to the Company's General Form for
Registration of Securities on Form 10, filed on
September 21, 1983, is hereby incorporated by
reference.
3(b) Bylaws, as amended.
4 Specimen Common Stock Certificate, filed as
Exhibit 4.1 to the Company's General Form for
Registration of Securities on Form 10, filed on
September 21, 1983, is hereby incorporated by
reference.
10(a) First Financial Bancorp 1991 Director Stock
Option Plan and form of Nonstatutory Stock
Option Agreement, filed as Exhibit 4.1 to the
Company's Form S-8 Registration Statement
(Registration No. 33-40954), filed on May 31,
1991, is hereby incorporated by reference.
34
10(b) Amendment to First Financial Bancorp 1991
Director Stock Option Plan, filed as Exhibit 4.3
to the Company's Post-Effective Amendment No. 1
to Form S-8 Registration Statement (Registration
No. 33-40954), filed as Exhibit 10 to the
Company's Quarterly Report on Form 10-Q for the
period ended March 31, 1995, is hereby
incorporated by reference.
10(c) First Financial Bancorp 1991 Employee Stock
Option Plan and forms of Incentive Stock Option
Agreement and Nonstatutory Stock Option
Agreement, filed as Exhibit 4.2 to the Company's
Form S-8 Registration Statement (Registration
No. 33-40954), filed on May 31, 1991, is hereby
incorporated by reference.
10(d) Bank of Lodi Employee Stock Ownership Plan,
filed as Exhibit 10 to the Company's Annual
Report on Form 10-K for the year ended December
31, 1992, is hereby incorporated by reference.
10(e) First Financial Bancorp 1997 Stock Option Plan,
filed as Exhibit 10 to the Company's Quarterly
Report on Form 10-Q for the period ended
September 30, 1997, is hereby incorporated by
reference.
10(f) Bank of Lodi Incentive Compensation Plan, filed
as Exhibit 10(f) to the Company's Annual Report
on Form 10-K for the year ended December 31,
1997, is hereby incorporated by reference.
10(g) First Financial Bancorp 401(k) Profit Sharing
Plan, filed as Exhibit 10(g) to the Company's
Annual Report on Form 10-K for the year ended
December 31, 1997, is hereby incorporated by
reference.
10(h) Employment Agreement dated as of September 30,
1998, between First Financial Bancorp and Leon
J. Zimmerman., filed as Exhibit 10(h) to the
Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1998, is hereby
incorporated by reference.
10(i) Employment Agreement dated as of September 30,
1998, between First Financial Bancorp and David
M. Philipp, filed as Exhibit 10(i) to the
Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1998, is hereby
incorporated by reference.
10(j) Executive Supplemental Compensation Agreement
effective as of April 3, 1998, between Bank of
Lodi, N.A. and Leon J. Zimmerman, filed as
Exhibit 10(j) to the Company's Quarterly Report
on Form 10-Q for the quarter ended September 30,
1998, is hereby incorporated by reference.
10(k) Executive Supplemental Compensation Agreement
effective as of April 3, 1998, between Bank of
Lodi, N.A. and David M. Philipp, filed as
Exhibit 10(k) to the Company's Quarterly Report
on Form 10-Q for the quarter ended September 30,
1998, is hereby incorporated by reference.
10(l) Life Insurance Endorsement Method Split Dollar
Plan Agreement effective as of April 3, 1998,
between Bank of Lodi, N.A. and Leon J.
Zimmerman, filed as Exhibit 10(l) to the
Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1998, is hereby
incorporated by reference.
10(m) Life Insurance Endorsement Method Split Dollar
Plan Agreement effective as of April 3, 1998,
between Bank of Lodi, N.A. and David M. Philipp,
filed as Exhibit 10(m) to the Company's
Quarterly Report on Form 10-Q for the quarter
ended September 30, 1998, is hereby incorporated
by reference.
35
10(n) Form of Director Supplemental Compensation
Agreement, effective as of April 3, 1998, as
executed between Bank of Lodi, N.A. and each of
Benjamin R. Goehring, Michael D. Ramsey, Weldon
D. Schumacher and Dennis R. Swanson, filed as
Exhibit 10(n) to the Company's Quarterly Report
on Form 10-Q for the quarter ended September 30,
1998, is hereby incorporated by reference.
10(o) Form of Life Insurance Endorsement Method Split
Dollar Plan Agreement, effective as of April 3,
1998, as executed between Bank of Lodi, N.A. and
each of Benjamin R. Goehring, Michael D. Ramsey,
Weldon D. Schumacher and Dennis R. Swanson,
filed as Exhibit 10(o) to the Company's
Quarterly Report on Form 10-Q for the quarter
ended September 30, 1998, is hereby incorporated
by reference.
10(p) Form of Director Supplemental Compensation
Agreement, effective as of April 3, 1998, as
executed between Bank of Lodi, N.A. and each of
Angelo J. Anagnos, Raymond H. Coldani, Bozant
Katzakian and Frank M. Sasaki, filed as Exhibit
10(p) to the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 1998,
is hereby incorporated by reference.
10(q) Form of Life Insurance Endorsement Method Split
Dollar Plan Agreement, effective as of April 3,
1998, as executed between Bank of Lodi, N.A. and
each of Angelo J. Anagnos, Raymond H. Coldani,
Bozant Katzakian and Frank M. Sasaki, filed as
Exhibit 10(q) to the Company's Quarterly Report
on Form 10-Q for the quarter ended September 30,
1998, is hereby incorporated by reference.
11 Statement re computation of earnings per share
is incorporated herein by reference to Footnotes
1(k) and 13 to the consolidated financial
statements included in this report.
21 Subsidiaries of the Company: The Company owns
100 percent of the capital stock of Bank of
Lodi, National Association, a national banking
association, and 100 percent of the capital
stock of Western Auxiliary Corporation.
23 Consent of KPMG LLP, independent auditors.
27 Financial Data Schedule.
(d) Financial Statement Schedules
No financial statement schedules are included in this report on
the basis that they are either inapplicable or the information
required to be set forth therein is contained in the financial
statements included in this report.
36
Independent Auditors' Report
The Board of Directors
First Financial Bancorp:
We have audited the accompanying consolidated balance sheets of First Financial
Bancorp and subsidiaries as of December 31, 1998 and 1997, and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the years in the three-year period ended December 31, 1998. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of First Financial
Bancorp and subsidiaries as of December 31, 1998 and 1997, and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 1998, in conformity with generally accepted accounting
principles.
/s/ KPMG LLP
Sacramento, California
February 19, 1999
37
FIRST FINANCIAL BANCORP AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands)
December 31, 1998 and 1997
Assets 1998 1997
- ------------------------------------------------------------------------------------------
Cash and due from banks (note 2) $ 7,329 7,183
Federal funds sold 4,800 4,900
Investment Securities: (note 3)
Held-to-maturity securities (at amortized cost, market
value of $1,785 in 1997) -- 1,716
Available-for-sale securities at fair value 45,647 60,201
- ------------------------------------------------------------------------------------------
Total investments 45,647 61,917
Loans, net of deferred loan fees and allowance for loan losses of
$2,084 and $1,881 in 1998 and 1997, respectively (notes 4 & 14) 91,078 62,228
Premises and equipment, net (note 5) 7,261 7,233
Accrued interest receivable 1,353 1,473
Other Assets (note 6) 6,932 2,916
- ------------------------------------------------------------------------------------------
$164,400 147,850
==========================================================================================
Liabilities and Stockholders' Equity
- ------------------------------------------------------------------------------------------
Liabilities:
Deposits (notes 7 & 14):
Noninterest bearing $ 18,535 14,928
Interest bearing 131,009 118,963
- ------------------------------------------------------------------------------------------
Total deposits 149,544 133,891
Accrued interest payable 389 429
Other liabilities 610 669
- ------------------------------------------------------------------------------------------
Total liabilities 150,543 134,989
Stockholders' equity (notes 13 & 17):
Common stock - no par value; authorized 9,000,000 shares, issued and
outstanding in 1998, 1,349,292 shares; in 1997, 1,332,842 shares 7,584 7,455
Retained earnings 5,971 5,188
Accumulated other comprehensive income 302 218
- ------------------------------------------------------------------------------------------
Total stockholders' equity 13,857 12,861
- ------------------------------------------------------------------------------------------
Commitments and contingencies (notes 8, 9, 10 & 19)
$164,400 147,850
==========================================================================================
<FN>
See accompanying notes to consolidated financial statements.
</FN>
FIRST FINANCIAL BANCORP AND SUBSIDIARIES
Statements of Stockholders' Equity
(in thousands except share amounts)
Years Ended December 31, 1998, 1997 and 1996
Accumulated
Common Common Other
Stock Stock Comprehensive Retained Comprehensive
Description Shares Amounts Income Earnings Income Total
- ------------------------------------- ------------ ------------ --------------- -------- ---------------- ------------
Balance at December 31, 1995 1,306,996 $ 7,314 4,059 191 11,564
Comprehensive income:
Net income $ 640 640 640
---------------
Other comprehensive loss:
Unrealized holding losses arising
during the current period, net of tax
effect of $48 (64)
---------------
Total other comprehensive loss (64) (64) (64)
---------------
Comprehensive income $ 576
===============
Options exercised (Note 13) 1,954 10 10
Cash dividend declared (Note 13) (261) (261)
------------------------- --------------------------------------
Balance at December 31, 1996 1,308,950 7,324 4,438 127 11,889
Comprehensive income:
Net income $ 1,015 1,015 1,015
---------------
Other comprehensive income:
Unrealized holding gains arising
during the current period, net of tax
effect of $92 91
---------------
Total other comprehensive income 91 91 91
===============
Comprehensive income $ 1,106
===============
Options exercised (Note 13) 23,892 131 131
Cash dividend declared (Note 13) (265) (265)
--------------------------------------------------------------------------------
Balance at December 31, 1997 1,332,842 7,455 5,188 218 12,861
Comprehensive income:
Net income $ 1,052 1,052 1,052
---------------
Other comprehensive income:
Unrealized holding gains arising
during the current period, net of tax
effect of $39 84
---------------
Total other comprehensive income 84 84 84
---------------
Comprehensive income $ 1,136
===============
Options exercised (Note 13) 16,450 129 129
Cash dividend declared (Note 13) (269) (269)
------------------------- --------------------------------------
Balance at December 31, 1998 1,349,292 $ 7,584 5,971 302 13,857
========================= ======================================
<FN>
See accompanying notes to consolidated financial statements.
</FN>
39
FIRST FINANCIAL BANCORP AND SUBSIDIARIES
Consolidated Statements of Income
(in thousands except per share amounts)
Years Ended December 31, 1998, 1997 and 1996
1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------
Interest income:
Loans, including fees $ 7,729 6,612 5,613
Interest on investment securities
availablefor sale:
Taxable 3,191 3,252 1,918
Exempt from Federal taxes 240 150 202
Interest on investment securities held
to maturity:
Exempt from Federal taxes -- 117 113
Federal funds sold 348 461 199
- --------------------------------------------------------------------------------------------------------------------
Total interest income 11,508 10,592 8,045
Interest expense:
Deposit accounts 4,028 3,785 2,992
Other -- -- 262
- --------------------------------------------------------------------------------------------------------------------
Total interest expense 4,028 3,785 3,254
- --------------------------------------------------------------------------------------------------------------------
Net interest income 7,480 6,807 4,791
- --------------------------------------------------------------------------------------------------------------------
Provision for loan losses (note 4) 250 (60) 310
Net interest income after provision
for loan losses 7,230 6,867 4,481
Noninterest income:
Service charges 846 766 559
Premiums and fees from SBA and
mortgage operations 784 575 451
Other 248 82 57
- --------------------------------------------------------------------------------------------------------------------
Total noninterest income 1,878 1,423 1,067
Noninterest expense:
Salaries and employee benefits 3,556 3,092 2,205
Occupancy 715 593 483
Equipment 536 455 367
Other (Note 11) 2,905 2,656 1,599
- --------------------------------------------------------------------------------------------------------------------
Total noninterest expense 7,712 6,796 4,654
- --------------------------------------------------------------------------------------------------------------------
Income before provision for income
taxes 1,396 1,494 894
Provision for income taxes (note 12) 344 479 254
- --------------------------------------------------------------------------------------------------------------------
Net income $ 1,052 1,015 640
====================================================================================================================
Earnings per share:
- --------------------------------------------------------------------------------------------------------------------
Basic (Note 13) $ .78 .77 .49
====================================================================================================================
Diluted (Note 13) $ .74 .73 .48
====================================================================================================================
<FN>
See accompanying notes to consolidated financial statements.
</FN>
40
FIRST FINANCIAL BANCORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
Years Ended December 31, 1998, 1997, and 1996
1998 1997 1996
- ---------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
- ---------------------------------------------------------------------------------------------------------
Net income $ 1,052 1,015 640
Adjustments to reconcile net income to net cash flows
provided by operating activities:
Increase in loans held for resale (811) (1,318) (166)
(Decrease) increase in deferred loan income (49) 168 40
Provision for other real estate owned losses (16) 60 35
Depreciation and amortization 1,071 1,066 481
Provision for loan losses 250 (60) 310
Provision for deferred taxes (52) (28) (98)
Decrease (increase) in accrued interest receivable 120 (413) 79
(Decrease) increase in accrued interest payable (40) 105 (84)
Increase in cash surrender value of life insurance (149) -- --
Increase in other assets (145) (492) (79)
(Decrease) increase in other liabilities (59) 176 294
- ---------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 1,172 279 1,610
Cash flows from investing activities:
Proceeds from maturity of held-to-maturity securities 540 70 249
Proceeds from maturity of available-for-sale securities 20,317 19,230 30,780
Proceeds from sale of available-for-sale securities 8,500 28,077 --
Purchases of available-for-sale securities 12,964) (72,201) (31,107)
Increase in loans made to customers (28,240) (7,928) (2,629)
Proceeds from the sale of other real estate 45 285 209
Purchases of bank premises, equipment and intangible assets (712) (3,127) (1,207)
Purchase of cash surrender value life insurance (4,125) -- --
- ---------------------------------------------------------------------------------------------------------
Net cash used in investing activities (16,639) (35,594) (3,705)
Cash flows from financing activities:
Net increase in deposits 15,653 41,684 2,991
Payments on notes payable -- -- 2,585)
Proceeds received upon exercise of stock options 129 131 10
Dividends paid (269) (265) (261)
- ---------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 15,513 41,550 155
- ---------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 46 6,235 (1,940)
Cash and cash equivalents at beginning of year 12,083 5,848 7,788
- ---------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 12,129 12,083 5,848
=========================================================================================================
Supplemental Disclosures of Cash Flow Information:
Cash paid during the year for:
Interest $ 4,068 3,680 3,338
Income taxes 677 476 242
<FN>
See accompanying notes to consolidated financial statements.
</FN>
41
FIRST FINANCIAL BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(1) Summary of Significant Accounting Policies
The accounting and reporting policies of First Financial Bancorp (the
Company) and its subsidiaries, Bank of Lodi, N.A., (the Bank) and
Western Auxiliary Corporation (WAC) conform with generally accepted
accounting principles and prevailing practices within the banking
industry. In preparing the consolidated financial statements,
management is required to make estimates and assumptions that affect
the reported amounts of assets and liabilities as of the date of the
balance sheet and revenue and expense for the period. Actual results
could differ from those estimates applied in the preparation of the
consolidated financial statements. The following are descriptions of
the significant accounting and reporting policies:
(a) Principles of Consolidation
The consolidated financial statements include the accounts of the
Company and its subsidiaries for all periods presented. All material
intercompany accounts and transactions have been eliminated in
consolidation.
(b) Investment Securities
The Company designates a security as held-to-maturity or
available-for-sale when a security is purchased. The selected
designation is based upon investment objectives, operational needs,
intent and ability to hold. The Company does not engage in trading
activity.
Held-to-maturity securities are carried at cost, adjusted for accretion
of discounts and amortization of premiums, which are recognized as
adjustments to interest income using the interest method.
Available-for-sale securities are recorded at fair value with
unrealized holding gains and losses, net of the related tax effect
reported as a separate component of stockholders' equity until
realized. Effective October 1, 1998, all held-to-maturity securities
with an amortized cost of $1,174,000, were transferred to the
available-for-sale category when Statement of Financial Accounting
Standards (SFAS) No. 133, Accounting for Derivative Instruments and
Hedging Activities was adopted. For the year ended December 31, 1997,
there were no transfers between classifications.
To the extent that the fair value of a security is below cost and the
decline is other than temporary, a new cost basis is established using
the current market value, and the resulting loss is charged to
earnings.
Gains and losses realized upon disposition of securities are recorded
as a component of noninterest income on the trade date, based upon the
net proceeds and the adjusted carrying value of the securities using
the specific identification method.
42
(c) Loans
Loans are stated at principal balances outstanding, net of deferred
origination fees, costs and loan sale premiums. A loan is considered
impaired when based on current information and events, it is probable
that the Company will be unable to collect all amounts due according to
the "contractual terms" of the loan agreement, including scheduled
interest payments. For a loan that has been restructured, the
contractual terms of the loan agreement refer to the contractual terms
specified by the original loan agreement, not the contractual terms
specified by the restructuring agreement. An impaired loan is measured
based upon the present value of future cash flows discounted at the
loan's effective rate, the loan's observable market price, or the fair
value of collateral if the loan is collateral dependent. Interest on
impaired loans is recognized on a cash basis. Large groups of small
balance, homogenous loans are collectively evaluated for impairment. If
the measurement of the impaired loan is less than the recorded
investment in the loan, an impairment is recognized by increasing the
allowance for loan losses. Loans held for sale are carried at the lower
of aggregate cost or market.
Interest on loans is accrued daily. Nonaccrual loans are loans on which
the accrual of interest ceases when the collection of principal or
interest is determined to be doubtful by management. It is the general
policy of the Bank to discontinue the accrual of interest when
principal or interest payments are delinquent 90 days or more unless
the loan is well secured and in the process of collection. When a loan
is placed on non-accrual status, accrued and unpaid interest is
reversed against current period interest income. Interest accruals are
resumed when such loans are brought fully current with respect to
interest and principal and when, in the judgment of management, the
loans are estimated to be fully collectible as to both principal and
interest.
(d) Loan Origination Fees and Costs
Loan origination fees, net of certain direct origination costs, are
deferred and amortized as a yield adjustment over the life of the
related loans using the interest method, which results in a constant
rate of return. Loan commitment fees are also deferred. Commitment fees
are recognized over the life of the resulting loans if the commitments
are funded or at the expiration of the commitments if the commitments
expire unexercised. Origination fees and costs related to loans held
for sale are deferred and recognized as a component of gain or loss
when the related loans are sold.
(e) Gain or Loss on Sale of Loans and Servicing Rights
Transfers and servicing of financial assets and extinguishments of
liabilities are accounted for and reported based on consistent
application of a financial-components approach that focuses on control.
Transfers of financial assets that are sales are distinguished from
transfers that are secured borrowings. Servicing assets and other
retained interests in transferred assets are measured by allocating the
previous carrying amount of the transferred assets between the assets
sold, if any and retained interests, if any, based on their relative
fair value at the date of transfer. Liabilities and derivatives
incurred or obtained by transferors as part of a transfer of financial
assets are to be initially measured at fair value. Servicing assets and
liabilities are to be subsequently amortized in proportion to and over
the period of estimated net servicing income or loss and assessed for
asset impairment or increased obligation based on fair value.
The Bank recognizes a gain and a related asset for the fair value of
the rights to service loans for others when loans are sold. The fair
value of the servicing assets is estimated based upon the present value
of the estimated expected future cash flows. The Bank measures the
impairment of the servicing asset based on the difference between the
carrying amount of the servicing asset and its current fair value. As
of December 31, 1998 and 1997, there was no impairment in mortgage
servicing asset.
A gain or loss is recognized to the extent that the sales proceeds and
the fair value of the servicing asset exceed or are less than the book
value of the loan. Additionally, a normal cost for servicing the loan
is considered in the determination of the gain or loss.
When servicing rights are sold, a gain or loss is recognized at the
closing date to the extent that the sales proceeds, less costs to
complete the sale, exceed or are less than the carrying value of the
servicing rights held.
43
(g) Allowance for Loan Losses
The allowance for loan losses is established through a provision
charged to expense. Loans are charged off against the allowance for
loan losses when management believes that the collectibility of the
principal is unlikely. Recoveries of amounts previously charged off are
added back to the allowance. The allowance is an amount that management
believes will be adequate to absorb losses inherent in existing loans,
standby letters of credit, overdrafts and commitments to extend credit
based on evaluations of collectibility and prior loss experience. The
evaluations take into consideration such factors as changes in the
nature and volume of the portfolio, overall portfolio quality, loan
concentrations, specific problem loans, commitments, and current and
anticipated economic conditions that may affect the borrowers' ability
to pay. While management uses these evaluations to recognize the
provision for loan losses, future provisions may be necessary based on
changes in the factors used in the evaluations. The allowance for loan
losses is also subject to review by the Comptroller of the Currency,
the Bank's principal regulator.
(h) Premises and Equipment
Premises and equipment are carried at cost less accumulated
depreciation. Depreciation is calculated using the straight-line method
over the estimated useful lives of the related assets. Estimated useful
lives are as follows:
Building 35 years
Improvements, furniture, and equipment 3 to 10 years
Expenditures for repairs and maintenance are charged to operations as
incurred; significant betterments are capitalized. Interest expense
attributable to construction-in-progress is capitalized.
(i) Intangible Assets
Goodwill, representing the excess of purchase price over the fair value
of net assets acquired, results from branch acquisitions made by the
Bank. Goodwill is being amortized on an accelerated basis over eight
years. Core deposit intangibles are amortized on an accelerated basis
over eight years. Intangible assets are reviewed on a periodic basis
for other than temporary impairment. If such impairment is indicated,
recoverability of the asset is assessed based upon expected
undiscounted net cash flows.
(j) Other Real Estate Owned
Other real estate owned (OREO) consists of property acquired through
foreclosure and is recorded at the time of foreclosure at its fair
market value. Thereafter, it is carried at the lower of cost or fair
market value less estimated completion and selling costs. If at
foreclosure, the loan balance is greater than the fair market value of
the property acquired, the excess is charged against the allowance for
loan losses. Subsequent operating expenses or income, changes in
carrying value, and gains or losses on disposition of OREO are
reflected in other noninterest expense. Fair market value is generally
determined based upon independent appraisals.
Revenue recognition on the disposition of OREO is dependent upon the
transaction meeting certain criteria relating to the nature of the
property sold and the terms of the sale. Under certain circumstances,
revenue recognition may be deferred until these criteria are met.
(k) Earnings Per Share
Basic earnings per share (EPS) includes no dilution and is computed by
dividing income available to common stockholders by the
weighted-average number of common shares outstanding for the period.
Diluted EPS reflects the potential dilution of securities that could
share in the earnings of an entity.
44
(l) Income Taxes
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases and operating loss and tax credit carryforwards.
Deferred tax assets and liabilities are measured using enacted tax
rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates
is recognized in income in the period that includes the enactment date.
Income tax expense is allocated to each entity of the Company based
upon analyses of the tax consequences of each company on a stand alone
basis.
(m) Comprehensive Income
In June 1997, the Financial Accounting Standards Board (FASB) issued
SFAS No. 130, Reporting Comprehensive Income. SFAS No. 130 established
standards for reporting and display of comprehensive income and its
components in a full set of general purpose financial statements. The
Company adopted SFAS No. 130 as of January 1, 1998 and discloses
comprehensive income in the consolidated statements of stockholders'
equity.
(n) Statements of Cash Flows
For purposes of the statements of cash flows, cash, non-interest
bearing deposits in other banks and federal funds sold, which generally
have maturities of one day, are considered to be cash equivalents.
(o) Impairment of Long-Lived Assets and Long-Lived Assets to
Be Disposed Of
Long-lived assets and certain identifiable intangibles are reviewed for
impairment whenever events or changes in circumstances indicate that
the carrying amount of an asset may not be recoverable. Recoverability
of assets to be held and used is measured by a comparison of the
carrying amount of an asset to future net cash flows expected to be
generated by the asset. If such assets are considered to be impaired,
the impairment to be recognized is measured by the amount by which the
carrying amount of the assets exceed the fair value of the assets.
Assets to be disposed of are reported at the lower of the carrying
amount or fair value less costs to sell.
(p) Stock Based Compensation
The Company accounts for its stock option plan using the intrinsic
value method. Compensation expense is recorded on the date of grant
only if the current market price of the underlying stock exceeds the
exercise price.
(q) Segment Reporting
The Company adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information." SFAS No. 131 establishes standards
for the way public business enterprises are to report information about
operating segments in annual financial statements and requires those
enterprises to report selected information about operating segments in
interim financial reports issued to shareholders. It also establishes
standards for related disclosures about products and services,
geographic areas, and major customers. SFAS No. 131 supersedes SFAS No.
14, "Financial Reporting for Segments of a Business Enterprise" but
retains the requirements to report information about major customers.
As of December 31, 1998 and 1997, the Company did not have any
reportable segments under the provisions of SFAS No. 131.
(2) Restricted Cash Balances
The Bank is required to maintain certain daily reserve balances in
accordance with Federal Reserve Board requirements. Aggregate reserves
of $1,855,000 and $1,053,000 were maintained to satisfy these
requirements at December 31, 1998 and 1997, respectively.
45
(3) Investment Securities
Investment securities at December 31, 1998 and 1997 consisted of the
following:
December 31, 1998
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
- --------------------------------------------------------------------------------------------------------------------------
Available for Sale
------------------
U.S. Treasury securities $ 1,000,000 3,000 -- 1,003,000
U.S. Agency securities 19,494,000 311,000 7,000 19,798,000
Municipal securities 3,635,000 175,000 -- 3,810,000
Collateralized mortgage obligations 457,000 5,000 4,000 458,000
Other debt securities 2,813,000 37,000 -- 2,850,000
Money market mutual fund 17,602,000 -- -- 17,602,000
Investment in Federal Agency stock 126,000 -- -- 126,000
- --------------------------------------------------------------------------------------------------------------------------
Total $ 45,127,000 531,000 11,000 45,647,000
==========================================================================================================================
December 31, 1997
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
- --------------------------------------------------------------------------------------------------------------------------
Held to Maturity
----------------
Municipal Securities $ 1,716,000 69,000 -- 1,785,000
- --------------------------------------------------------------------------------------------------------------------------
Available for Sale
------------------
U.S. Treasury securities 3,995,000 5,000 -- 4,000,000
U.S. Agency securities 31,077,000 208,000 14,000 31,271,000
Municipal securities 2,620,000 155,000 -- 2,775,000
Collateralized mortgage obligations 1,036,000 5,000 17,000 1,024,000
Other debt securities 3,749,000 58,000 2,000 3,805,000
Money market mutual fund 17,200,000 -- -- 17,200,000
Investment in Federal Agency stock 126,000 -- -- 126,000
- -------------------------------------------------------------------------------------------------------------------------
59,803,000 431,000 33,000 60,201,000
- -------------------------------------------------------------------------------------------------------------------------
Total $ 61,519,000 500,000 33,000 61,986,000
=========================================================================================================================
Investment securities totaling $4,559,000 and $4,631,000 were pledged
as collateral to secure Local Agency Deposits as well as treasury, tax
and loan accounts with the Federal Reserve at December 31, 1998 and
1997, respectively.
Proceeds from the sale of Available for Sale securities during 1998 and
1997 were $8,500,000 and $28,077,000, respectively, and represented the
sale of money market mutual fund shares at book value. Accordingly, no
gain or loss was realized. There were no sales of Available for Sale
securities during 1996.
Federal Agency stock dividends paid to the Company were $7,000, $7,000,
and $5,000 in 1998, 1997 and 1996, respectively.
The amortized cost and estimated fair value of debt securities at
December 31, 1998, by contractual maturity, or expected maturity where
applicable, are shown below. Expected maturities will differ from
contractual maturities because certain securities provide the issuer
with the right to call or prepay obligations with or without call or
prepayment penalties.
46
December 31, 1998
Amortized Market
Cost Value
- ------------------------------------------------------------------------------------------------
Due in one year or less $ 3,801,000 3,846,000
Due after one year through five years 16,034,000 16,449,000
Due after five years through 10 years 3,251,000 3,277,000
Due after 10 years 4,313,000 4,347,000
=-----------------------------------------------------------------------------------------------
$ 27,399,000 27,919,000
================================================================================================
(4) Loans
The Bank grants commercial, installment, real estate construction and
other real estate loans to customers primarily in the trade areas
served by its branches. Generally, the loans are secured by real estate
or other assets. Although the Bank has a diversified loan portfolio, a
significant portion of its debtors' ability to honor their contract is
dependent upon the condition of the local real estate markets in which
the loans are made.
Outstanding loans consisted of the following at December 31:
1998 1997
- ------------------------------------------------------------------------------------------------
Commercial $73,195,000 50,155,000
Real estate construction 11,743,000 6,900,000
Other real estate 4,761,000 3,529,000
Installment and other 3,463,000 3,525,000
- ------------------------------------------------------------------------------------------------
93,162,000 64,109,000
Deferred loan fees and loan sale premiums (520,000) (568,000)
Allowance for loan losses (1,564,000) (1,313,000)
- ------------------------------------------------------------------------------------------------
$91,078,000 62,228,000
================================================================================================
Included in total loans are loans held for sale of $2,619,000 and
$1,807,000 for 1998 and 1997, respectively. SBA and mortgage loans
serviced by the Bank totaled $66,903,000 and $45,939,000, and
$41,319,000 in 1998, 1997, and 1996, respectively.
Changes in the allowance for loan losses were as follows:
1998 1997 1996
- ------------------------------------------------------------------------------------------------
Balance, beginning of year $ 1,313,000 1,207,000 959,000
Loans charged off (132,000) (290,000) (334,000)
Recoveries 133,000 456,000 272,000
Provision charged to operations 250,000 (60,000) 310,000
- ------------------------------------------------------------------------------------------------
Balance, end of year $ 1,564,000 1,313,000 1,207,000
================================================================================================
Nonaccrual loans totaled $248,000, $340,000, and $898,000 at December
31, 1998, 1997 and 1996, respectively. Interest income which would have
been recorded on nonaccrual loans was $43,000, $45,000 and $149,000, in
1998, 1997, and 1996, respectively.
Impaired loans are loans for which it is probable that the Bank will
not be able to collect all amounts due. At December 31, 1998 and 1997,
the Bank had outstanding balances of $248,000 and $821,000 in impaired
loans which had valuation allowances of $32,000 in 1998 and $100,000 in
1997. The average outstanding balances of impaired loans for the years
ended December 31, 1998, 1997 and 1996 were $535,000, $1,150,000 and
$1,116,000 respectively, on which $40,000, $47,000 and $45,000,
respectively, was recognized as interest income.
At December 31, 1998 and 1997, the collateral value method was used to
measure impairment for all loans classified as impaired. Impaired loans
at December 31, 1998 and 1997 consisted solely of commercial loans.
47
(5) Premises and Equipment
Premises and equipment consisted of the following at December 31:
1998 1997
- ------------------------------------------------------------------------------------------------
Land $ 874,000 874,000
Building 5,705,000 5,705,000
Leasehold improvements 1,477,000 1,258,000
Furniture and equipment 3,069,000 2,616,000
- ------------------------------------------------------------------------------------------------
11,125,000 10,453,000
- ------------------------------------------------------------------------------------------------
Accumulated depreciation and amortization (3,864,000) (3,220,000)
- ------------------------------------------------------------------------------------------------
$ 7,261,000 7,233,000
================================================================================================
The Bank leases a portion of its building to unrelated parties under
operating leases which expire in various years.
The minimum future rentals to be received on noncancelable leases as of
December 31, 1998 are summarized as follows:
Year Ending December 31,
- --------------------------------------------------------------------------------
1999 $ 63,000
2000 48,000
2001 1,000
- --------------------------------------------------------------------------------
Total minimum future rentals $ 102,000
================================================================================
(6) Other Assets
Other assets includes the cash surrender value of life insurance of
$4,274,000 at December 31, 1998. The cash surrender value of life
insurance consists primarily of the Bank's contractual rights under
single-premium life insurance policies written on the lives of certain
officers and the directors of the Company and the Bank. The policies
were purchased in order to indirectly offset anticipated costs of
certain benefits payable upon the retirement, and the death or
disability of the directors and officers pursuant to deferred
compensation agreements. The cash surrender value accumulates tax-free
based upon each policy's crediting rate which is adjusted by the
insurance company on an annual basis.
Other real estate owned is also included in other assets and was
$129,000 and $159,000 at December 31, 1998 and 1997, respectively.
During 1998, 1997, and 1996, other real estate owned of $0, $170,000
and $297,000, respectively, was acquired through foreclosure as
settlement for loans. These amounts represent noncash transactions, and
accordingly, have been excluded from the Consolidated Statements of
Cash Flows.
48
(7) Deposits
The following is a summary of deposits at December 31:
1998 1997
- --------------------------------------------------------------------------------
Demand $ 18,535,000 14,928,000
NOW and Super NOW Accounts 36,181,000 29,734,000
Money Market 19,482,000 20,456,000
Savings 25,987,000 24,802,000
Time,$100,000 and over 14,965,000 13,484,000
Other Time 34,394,000 30,487,000
- --------------------------------------------------------------------------------
$ 149,544,000 133,891,000
================================================================================
Interest paid on time deposits in denominations of $100,000 or more was
$737,000, $620,000 and $607,000 in 1998, 1997 and 1996, respectively.
At December 31, 1998, the aggregate maturities for time deposits is as
follows:
- --------------------------------------------------------------------------------
1999 $45,799,000
2000 2,234,000
2001 371,000
2002 615,000
2003 340,000
- --------------------------------------------------------------------------------
Total $49,359,000
================================================================================
(8) Operating Leases
The Bank has noncancelable operating leases with unrelated parties for
office space and equipment. The lease payments for future years are as
follows:
Year Ending December 31, Lease Payments
- --------------------------------------------------------------------------------
1999 $ 127,000
2000 108,000
2001 67,000
2002 52,000
2003 52,000
Thereafter 44,000
- --------------------------------------------------------------------------------
$ 450,000
================================================================================
Total rental expense for operating leases was $114,000, $32,000 and
$35,000 in 1998, 1997 and 1996 respectively.
(9) Supplemental Compensation Agreements
Effective April 3, 1998 the Company and the Bank entered into
nonqualified supplemental compensation agreements with all of the
directors and certain executive officers for the provision of death,
disability and post-employment/retirement benefits. The agreement with
directors includes elective provisions for service as a director
emeritus following termination of service as a member of the Bank's
Board of Directors. Directors who elect to serve as a director emeritus
receive certain benefits during such period of service in addition to
benefits applicable to all directors which commence upon expiration of
the three year emeritus period. The Company will accrue for the
compensation based on anticipated years of service and the vesting
schedule provided in the agreements. The executive officer agreements
are defined contribution agreements whereby the benefit accruals under
the plan are
49
the amount by which, if any, the increase in cash surrender value of
the related insurance policies exceeds a predetermined profitability
index. At December 31, 1998, accrued compensation under both plans was
$72,000. The Company adopted SFAS No. 132, "Employers' Disclosures
about Pensions and Other Post Retirement Benefits." SFAS No. 132 does
not change the measurement or recognition of expenses under the
supplemental compensation agreements.
(10) Financial Instruments with Off-Balance Sheet Risk
In the normal course of business, the Company is a party to financial
instruments with off-balance sheet risk. These financial instruments
include commitments to extend credit and standby letters of credit.
The Company's exposure to credit loss in the event of nonperformance by
the other party to the financial instrument for commitments to extend
credit and standby letters of credit is represented by the contractual
notional amount of those instruments. The Company uses the same credit
policies in making commitments and conditional obligations as it does
for on-balance sheet instruments.
At December 31, 1998 and 1997, financial instruments whose contract
amounts represent credit risk are as follows:
1998 1997
- --------------------------------------------------------------------------------
Commitments to extend credit $ 21,290,000 17,950,000
================================================================================
Standby letters of credit $ 156,000 50,000
================================================================================
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. Commitments generally have fixed expiration dates, other
termination clauses and may require payment of a fee. Many of the
commitments are expected to expire without being drawn upon and
accordingly, the total commitment amounts do not necessarily represent
future cash requirements. The Company evaluates each customer's
creditworthiness on a case-by-case basis. Upon extension of credit, the
amount of collateral obtained, if any, is based on management's credit
evaluation of the counter-party. Collateral varies but may include
accounts receivable, inventory, property, plant and equipment, and
income-producing or other real estate.
Standby letters of credit are conditional commitments issued by the
Company to guarantee the performance of a customer to a third party.
These guarantees are primarily issued to support private borrowing
arrangements. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to
customers. Collateral obtained, if any, is varied.
(11) Other Noninterest Expense
Other noninterest expense for the years 1998, 1997 and 1996 included
the following significant items:
1998 1997 1996
- -----------------------------------------------------------------------------------------------------------
Intangible amortization $ 372,000 479,000 --
Ancillary data processing expense 385,000 326,000 105,000
Directors' fees 199,000 150,000 124,000
Legal fees 197,000 166,000 207,000
Provision for other real estate owned losses (16,000) 60,000 35,000
50
(12) Income Taxes
The provision for income taxes for the years 1998, 1997 and 1996
consisted of the following:
1998 Federal State Total
- -----------------------------------------------------------------------------------------------------------
Current $ 252,000 144,000 396,000
Deferred, net (12,000) (40,000) (52,000)
- -----------------------------------------------------------------------------------------------------------
Income tax expense $ 240,000 104,000 344,000
===========================================================================================================
1997
- -----------------------------------------------------------------------------------------------------------
Current $ 312,000 195,000 507,000
Deferred, net 16,000 (44,000) (28,000)
- -----------------------------------------------------------------------------------------------------------
Income tax expense $ 328,000 151,000 479,000
===========================================================================================================
1996
- -----------------------------------------------------------------------------------------------------------
Current $ 212,000 140,000 352,000
Deferred, net (66,000) (32,000) (98,000)
- -----------------------------------------------------------------------------------------------------------
Income tax expense $ 146,000 108,000 254,000
===========================================================================================================
Income taxes receivable of $117,000 are included in other assets at
December 31, 1998. Income taxes payable of $164,000 are included in
other liabilities at December 31, 1997.
51
The provision for income taxes differs from amounts computed by
applying the statutory Federal income tax rate to operating income
before income taxes. The reasons for these differences are as follows:
1998 1997 1996
Amount Rate Amount Rate Amount Rate
- -------------------------------------------------------------------------------------------------------------------
Federal income tax expense, at statutory
income tax rates $ 475,000 34% 508,000 34% 304,000 34%
State franchise tax expense, net of federal
income tax benefits 100,000 7% 107,000 7% 63,000 7%
Tax-free interest income (136,000) (10%) (83,000) (6%) (97,000) (11%)
Change in the beginning of the year deferred
tax asset valuation allowance (45,000) (3%) 32,000 2%
Other (50,000) (3%) (85,000) (5%) (16,000) (2%)
- -------------------------------------------------------------------------------------------------------------------
$ 344,000 25% 479,000 32% 254,000 28%
===================================================================================================================
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31, 1998 and 1997 are presented below.
Deferred tax assets: 1998 1997
- --------------------------------------------------------------------------------------------------------------------
Allowance for loan losses $ 553,000 419,000
Allowance for losses on other real estate owned 14,000 60,000
Deferred loan income 145,000 157,000
Accumulated Amortization 260,000 154,000
Deferred compensation 74,000 53,000
Alternative minimum tax credit carryforwards 2,000 60,000
Other 86,000 93,000
- --------------------------------------------------------------------------------------------------------------------
Total gross deferred tax assets 1,134,000 996,000
Less valuation allowance (120,000) (165,000)
- --------------------------------------------------------------------------------------------------------------------
Deferred tax assets, net of allowance 1,014,000 831,000
- --------------------------------------------------------------------------------------------------------------------
Deferred tax liabilities:
Accumulated depreciation (103,000) (61,000)
Deferred loan origination costs (173,000) (108,000)
Unrealized gain on available-for-sale securities, net (219,000) (180,000)
Other (100,000) (76,000)
- --------------------------------------------------------------------------------------------------------------------
Total gross deferred tax liabilities (595,000) (425,000)
- --------------------------------------------------------------------------------------------------------------------
Net deferred tax asset $ 419,000 406,000
====================================================================================================================
The valuation allowance for deferred tax assets decreased by $45,000
for the year ended December 31, 1998. In assessing the realizability of
deferred tax assets, management considers whether it is more likely
than not that some portion or all of the deferred tax assets will not
be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the
periods in which those temporary differences become deductible.
Management considers the scheduled reversal of deferred tax
liabilities, projected future taxable income, and tax planning
strategies in making this assessment. Based upon the level of
historical taxable income and projections for future taxable income
over the periods which the deferred tax assets are deductible,
management believes it is more likely than not the Company will realize
the benefits of these deductible differences, net of the existing
valuation allowances at December 31, 1998 and 1997.
52
(13) Stockholders' Equity
(a) Stock Options
In December 1982, the Board of Directors adopted the First Financial
Bancorp 1982 Stock Incentive Plan. A total of 250,000 shares of the
Company's common stock were reserved for issuance under the Plan.
Options were granted at an exercise price not less than the fair market
value of the stock at the date of grant and became exercisable over
varying periods of time and expired 10 years from such date.
In February 1991, the Board of Directors adopted the First Financial
Bancorp 1991 Employee Stock Option Plan and Director Stock Option Plan.
The maximum number of shares issuable under the Employee Stock Option
Plan is 178,500. The maximum number of shares issuable under the
Director Stock Option Plan was 55,000. Options are granted at an
exercise price of at least 100% and 85% of the fair market value of the
stock on the date of grant for the Employee Stock Option Plan and the
Director Stock Option Plan, respectively. The 1991 Plans replaced the
1982 Plan; however, this does not adversely affect any stock options
outstanding under the 1982 Plan.
In February 1997, the Board of Directors adopted the First Financial
Bancorp 1997 Stock Option Plan. The maximum number of shares issuable
under the Plan is 393,207 less any shares reserved for issuance
pursuant to the 1991 Plans. Options are granted at an exercise price of
at least 100% and 85% of the fair market value of the stock on the date
of grant for employee stock options and director stock options,
respectively. The 1997 Plan replaces the 1991 Plans; however, this does
not adversely affect any stock options outstanding under the 1991
Plans.
Stock option plan activities are summarized as follows:
Options Outstanding
Exercise Price
Options Per Share
- --------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1995 209,724 $ 5.74 - 10.43
====================================================================================================================
Options exercised (3,675) $ 5.78 - 8.57
====================================================================================================================
Options expired (10,374) $ 5.74 - 10.43
====================================================================================================================
Balance, December 31, 1996 195,675 $ 5.74 - 8.57
====================================================================================================================
Options granted 76,500 $10.00 - 12.50
====================================================================================================================
Options exercised (27,600) $ 5.74 - 8.57
====================================================================================================================
Options expired (28,000) $ 6.80 - 10.00
====================================================================================================================
Balance, December 31, 1997 216,575 $ 5.74 - 12.50
====================================================================================================================
Options exercised (16,450) $ 5.74 - 6.80
====================================================================================================================
Options expired (17,525) $ 6.75 - 12.50
====================================================================================================================
Balance, December 31, 1998 182,600 $ 5.74 - 12.50
====================================================================================================================
53
At December 31, 1998, the weighted-average remaining contractual life
of all outstanding options was 5.16 years, respectively. At December
31, 1998, the number of options exercisable was 142,700 and the
weighted-average exercise price of those options was $7.20.
There were no stock options granted during 1998 or 1996. The per share
weighted-average fair value of stock options granted during 1997 was
$3.03. The fair value of each option grant is estimated on the date of
grant using the Black-Sholes option-pricing model with the following
weighted-average assumptions used for grants: dividend yield of 2.18%;
expected volatility of 18.4%; risk-free interest rate of 6.2%; and an
expected life of five years.
No compensation cost has been recognized for its stock options in the
accompanying consolidated financial statements. Had the Company
determined compensation cost based on the fair value at the grant date
for its stock options, the Company's net income would have been reduced
to the pro forma amounts indicated below for the period ended December
31:
1998 1997 1996
- ------------------------------------------------------------------------------------------------
Net Income
As reported $1,052,000 $1,015,000 $640,000
Pro forma 1,022,000 985,000 630,000
Basic Net Income Per Share
As reported $ .78 $ .77 $ .49
Pro forma .76 .75 .48
Diluted Net Income Per Share
As reported $ .74 $ .73 $ .48
Pro forma .72 .71 .47
Pro forma net income reflects only options granted after 1994.
Therefore, the full impact of calculating compensation cost for stock
options using the fair value method is not reflected in the pro forma
net income amounts presented above because compensation cost is
reflected over the options' vesting period of five years and
compensation cost for options granted prior to January 1, 1995 is not
considered.
(b) Employee Stock Ownership Plan
Effective January 1, 1992, the Bank established the Bank of Lodi
Employee Stock Ownership Plan. The plan covers all employees, age 21 or
older, beginning with the first plan year in which the employee
completes at least 1,000 hours of service. The Bank's annual
contributions to the plan are made in cash and are at the discretion of
the Board of Directors based upon a review of the Bank's profitability.
Contributions for 1998, 1997 and 1996 totaled approximately $116,000,
$98,000, and $37,000, respectively.
Contributions to the plan are invested primarily in the Common Stock of
First Financial Bancorp and are allocated to participants on the basis
of salary in the year of allocation. Benefits become 20% vested after
the third year of credited service, with an additional 20% vesting each
year thereafter until 100% vested after seven years. As of December 31,
1998, the plan owned 34,714 shares of Company Common Stock.
(c) Dividends and Dividend Restrictions
On January 28, 1999, the Company's Board of Directors declared a cash
dividend of five cents per share payable on February 26, 1999, to
shareholders of record on February 12, 1999.
54
The Company's principal source of funds for dividend payments is
dividends received from the Bank. Under applicable Federal laws,
permission to pay a dividend must be granted to a bank by the
Comptroller of the Currency if the total dividend payment of any
national banking association in any calendar year exceeds the net
profits of that year, as defined, combined with net profits for the two
preceding years. At December 31, 1998, there were Bank retained
earnings of $2,420,000 free of this condition.
(d) Weighted Average Shares Outstanding
Basic and diluted earnings per share for the years ended December 31,
1998, 1997, and 1996 were computed as follows:
Income Shares Per-Share
1998 (numerator) (denominator) Amount
-----------------------------------------------------------------------------------------------
Basic earnings per share $ 1,052,000 1,341,192 $ .78
Effect of dilutive securities -- 84,234 --
--------------------------------------
Diluted earnings per share $ 1,052,000 1,425,426 $ .74
======================================
Income Shares Per-Share
1997 (numerator) (denominator) Amount
-----------------------------------------------------------------------------------------------
Basic earnings per share $ 1,015,000 1,323,398 $ .77
Effect of dilutive securities -- 68,678 --
--------------------------------------
Diluted earnings per share $ 1,015,000 1,392,076 $ .73
======================================
Income Shares Per-Share
1996 (numerator) (denominator) Amount
-----------------------------------------------------------------------------------------------
Basic earnings per share $ 640,000 1,307,364 $ .49
Effect of dilutive securities -- 32,547 --
--------------------------------------
Diluted earnings per share $ 640,000 1,339,911 $ .48
======================================
(14) Related Party Transactions
During the normal course of business, the Bank enters into transactions
with related parties, including directors, officers, and affiliates.
These transactions include borrowings from the Bank with substantially
the same terms, including rates and collateral, as loans to unrelated
parties. At December 31, 1998 and 1997, respectively, such borrowings
totaled $1,018,000 and $922,000, respectively. Deposits of related
parties held by the Bank totaled $671,000 and $1,000,000 at December
31, 1998 and 1997, respectively.
55
The following is an analysis of activity with respect to the aggregate
dollar amount of loans made by the Bank to directors, officers and
affiliates for the years ended December 31:
1998 1997
- --------------------------------------------------------------------------------------------------------------------
Balance, beginning of year $ 922,000 1,176,000
Loans funded 738,000 524,000
Principal repayments (642,000) (778,000)
- --------------------------------------------------------------------------------------------------------------------
Balance, end of year $1,018,000 922,000
====================================================================================================================
(15) Parent Company Financial Information
This information should be read in conjunction with the other notes to
the consolidated financial statements. The following presents summary
balance sheets as of December 31, 1998 and 1997, and statements of
income, and cash flows information for the years ended December 31,
1998, 1997, and 1996.
Balance Sheets:
- --------------------------------------------------------------------------------------------------------------------
Assets 1998 1997
- --------------------------------------------------------------------------------------------------------------------
Cash in bank $ 121,000 139,000
Investment securities available-for-sale, at fair value 5,000 5,000
Premises and equipment, net 64,000 66,000
Investment in wholly-owned subsidiaries 13,521,000 12,548,000
Other assets 146,000 107,000
- --------------------------------------------------------------------------------------------------------------------
$ 13,857,000 12,865,000
====================================================================================================================
Liabilities and Stockholders' Equity
- --------------------------------------------------------------------------------------------------------------------
Accounts payable and other liabilities $ -- 4,000
- --------------------------------------------------------------------------------------------------------------------
Common stock 7,584,000 7,455,000
Retained earnings 5,971,000 5,188,000
Accumulated other comprehensive income 302,000 218,000
- --------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 13,857,000 12,861,000
- --------------------------------------------------------------------------------------------------------------------
$ 13,857,000 12,865,000
====================================================================================================================
Statements of Income: 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------
Rent from subsidiary $ 5,000 6,000 356,000
Interest from unrelated parties -- 2,000 9,000
Other expenses (316,000) (215,000) (626,000)
Equity in income of subsidiaries 1,154,000 1,100,000 832,000
Income tax benefit 209,000 122,000 69,000
- --------------------------------------------------------------------------------------------------------------------
Net income $ 1,052,000 1,015,000 640,000
====================================================================================================================
56
Statements of Cash Flows: 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------
Net Income $1,052,000 1,015,000 640,000
Adjustments to reconcile net income to net cash
flows provided by (used in) operating activities:
Depreciation and amortization 2,000 2,000 125,000
Provision for deferred taxes 27,000 (36,000) 7,000
(Decrease) increase in other liabilities (4,000) (23,000) 27,000
(Increase) decrease in other assets (66,000) (15,000) 3,000
Increase in equity of subsidiaries (879,000) (774,000) (832,000)
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities 132,000 169,000 (30,000)
Proceeds from sale of available-for-sale securities -- 75,000 302,000
Investment in subsidiary (10,000) -- --
Capital expenditures -- -- (4,000)
- --------------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by investing activities (10,000) 75,000 298,000
Payments on notes payable -- -- (33,000)
Proceeds received upon exercise of stock options 129,000 131,000 10,000
Dividends paid (269,000) (265,000) (261,000)
- --------------------------------------------------------------------------------------------------------------------
Net cash used by financing activities (140,000) (134,000) (284,000)
- --------------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash (18,000) 110,000 (16,000)
- --------------------------------------------------------------------------------------------------------------------
Cash at beginning of year 139,000 29,000 45,000
- --------------------------------------------------------------------------------------------------------------------
Cash at end of year $ 121,000 139,000 29,000
====================================================================================================================
(16) Lines of Credit
The Bank has two lines of credit with correspondent banks totaling
$5,000,000. As of December 31, 1998 and 1997, no amounts were
outstanding under these lines of credit.
(17) 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 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 measure 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).
First, a bank must meet a minimum Total Risk-Based Capital to
risk-weighted assets ratio of 8%. Risk-based capital and asset
guidelines vary from Tier I capital guidelines by redefining the
components of capital, categorizing assets into different classes, and
including certain off-balance sheet items in the calculation of the
capital ratio. The effect of the risk-based capital guidelines is that
banks with high exposure will be required to raise additional capital
while institutions with low risk exposure could, with the concurrency
of regulatory authorities, be permitted to operate with lower capital
ratios. In addition, a bank must meet minimum Tier I Capital to average
assets ratio.
57
Management believes, as of December 31, 1998, that the Bank meets all
capital adequacy requirements to which it is subject. As of December
31, 1998, the most recent notification, the Federal Deposit Insurance
Corporation (FDIC) categorized the Bank as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as
adequately capitalized, the Bank must meet the minimum ratios as set
forth below. There are no conditions or events since that notification
that management believes have changed the Bank's category.
The Bank's actual capital amounts and ratios as of December 31, 1998
are as follows:
To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
Amount Ratio Amount Ratio Amount Ratio
- -------------------------------------------------------------------------------------------------------------------------------
Total Risk-based capital less than less than less than less than
(to Risk weighted assets) $13,084,000 11.17% $9,371,000 8.0% $11,714,000 10.0%
less than less than less than less than
Tier I Capital (to Risk Weighted assets) $11,620,000 9.92% $4,685,000 4.0% $ 7,028,000 6.0%
less than less than less than less than
Tier I Capital (to Average Assets) $11,620,000 7.35% $6,324,000 4.0% $ 7,905,000 5.0%
The Bank's actual capital amounts and ratios as of December 31, 1997
are as follows:
To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
Amount Ratio Amount Ratio Amount Ratio
- -------------------------------------------------------------------------------------------------------------------------------
Total Risk-based capital less than less than less than less than
(to Risk weighted assets) $11,459,000 12.95% $7,081,000 8.0% $8,851,000 10.0%
less than less than less than less than
Tier I Capital (to Risk Weighted assets) $10,352,000 11.70% $3,541,000 4.0% $5,310,000 6.0%
less than less than less than less than
Tier I Capital (to Average Assets) $10,352,000 7.11% $5,828,000 4.0% $7,285,000 5.0%
(18) Fair Values of Financial Instruments
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amounts reported in the balance
sheet for cash and due from banks and federal funds sold are a
reasonable estimate of fair value.
Investment securities: Fair values for investment securities are based
on quoted market prices, where available. If quoted market prices are
not available, fair values are based on quoted market prices of
comparable instruments. (See note 3).
Loans: For variable-rate loans that reprice frequently and with no
significant change in credit risk, fair values are based on carrying
values. The fair values for fixed-rate loans are estimated using
discounted cash flow analyses, using interest rates currently being
offered for loans with similar terms to borrowers of similar credit
quality.
58
Commitments to extend credit and standby letters of credit: The fair
value of commitments is estimated using the fees currently charged to
enter into similar agreements, taking into account the remaining terms
of the agreement and the present creditworthiness of the counter
parties. For fixed-rate loan commitments, fair value also considers the
difference between current levels of interest rates and the committed
rates. The fair value of letters of credit is based upon fees currently
charged for similar agreements or on the estimated cost to terminate
them or otherwise settle the obligation with the counter parties at the
reporting date.
Deposit liabilities: The fair values disclosed for demand deposits
(e.g., interest and non-interest checking, savings, and money market
accounts) are, by definition, equal to the amount payable on demand at
the reporting date (i.e., their carrying amounts). The fair values for
fixed-rate time deposits are estimated using a discounted cash flow
calculation that applies interest rates currently being offered on time
deposits to a schedule of aggregated expected monthly maturities on
time deposits.
Limitations: 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
Company's entire holdings of a particular financial instrument. Because
no market exists for a significant portion of the Company's 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 and involve uncertainties and
matters of significant judgment and therefore cannot be determined with
precision. Changes in assumptions could significantly affect the
estimates.
Fair value estimates are based on existing on and off balance sheet
financial instruments without attempting to estimate the value of
anticipated future business and the value of assets and liabilities
that are not considered financial instruments. Other significant assets
and liabilities that are not considered financial assets or liabilities
include deferred tax assets, premises, and equipment. In addition, the
tax ramifications related to the realization of the unrealized gains
and losses can have a significant effect on fair value estimates and
have not been considered in many of the estimates.
The estimated fair values of the Company's financial instruments are
approximately as follows:
1998
Carrying Fair
Amount Value
- -----------------------------------------------------------------------------------------------------------
Financial assets:
Cash and due from banks and federal funds sold $ 12,129,000 12,129,000
Investment securities 45,647,000 45,647,000
Loans:
Gross Loans 93,162,000 94,032,000
Allowance for loan losses (1,564,000) (1,564,000)
Deferred loan fees and loan sale premiums (520,000) (520,000)
------------------------------------------------------------------------------------
Net loans $ 91,078,000 91,948,000
Financial liabilities:
Deposits:
Demand $ 18,535,000 18,535,000
Now and Super Now accounts 36,181,000 36,181,000
Money Market 19,482,000 19,482,000
Savings 25,987,000 25,987,000
Time 49,359,000 49,447,000
----------------------------------------------------------------------------------
Total deposits $ 149,544,000 149,632,000
59
Contract Carrying Fair
Amount Amount Value
- --------------------------------------------------------------------------------------------------------------------
Unrecognized financial instruments:
Commitments to extend credit $ 21,290,000 -- 213,000
Standby letters of credit 156,000 -- 2,000
1997
Carrying Fair
Amount Value
- --------------------------------------------------------------------------------------------------------------------
Financial assets:
Cash and due from banks and federal funds sold $ 12,083,000 12,083,000
Investment securities 61,917,000 61,986,000
Loans:
Gross Loans 64,109,000 64,556,000
Allowance for loan losses (1,313,000) (1,313,000)
Deferred loan fees and loan sale premiums (568,000) (568,000)
-----------------------------------------------------------------------------------
Net loans $ 62,228,000 62,675,000
Financial liabilities:
Deposits:
Demand $ 14,928,000 14,928,000
Now and Super Now accounts 29,734,000 29,734,000
Money Market 20,456,000 20,456,000
Savings 24,802,000 24,802,000
Time 43,971,000 43,911,000
----------------------------------------------------------------------------------
Total deposits $ 133,891,000 133,831,000
Contract Carrying Fair
Amount Amount Value
- --------------------------------------------------------------------------------------------------------
Unrecognized financial instruments:
Commitments to extend credit $ 17,950,000 -- 180,000
Standby letters of credit 50,000 -- 1,000
(19) Legal Proceedings
The bank is involved in various legal actions arising in the ordinary
course of business. In the opinion of management, after consulting with
legal counsel, the ultimate disposition of these matters will not have
a material effect on the Bank's financial condition, results of
operations, or liquidity.
(20) Derivative Financial Instruments
As of December 31, 1998 and 1997, the Company has no off-balance sheet
derivatives. The Company held $457,000 and 1,036,000 in collateralized
mortgage obligations and $500,000 and $1,000,00 in structured notes as
of December 31, 1998 and 1997 respectively. These investments are held
in the available for sale portfolio.
60
(21) Acquisition of Branches
On February 22, 1997, the the Bank, completed the acquisition of the
Galt, Plymouth, and San Andreas, California, branches of Wells Fargo
Bank. The Bank purchased the premises and equipment of the Plymouth and
San Andreas branches and assumed the building lease for the Galt
branch. The Bank also purchased the furniture and equipment of all
three branches and paid a premium for the deposits of each branch. The
total cost of acquiring the branches, including payments to Wells Fargo
Bank as well as other direct costs associated with the purchase, was
$2.86 million. The transaction was accounted for using the purchase
method of accounting. Accordingly, the purchase price was allocated
first to identifiable tangible assets based upon those assets' fair
value and then to identifiable intangible assets based upon the assets'
fair value. The excess of the purchase price over identifiable tangible
and intangible assets was allocated to goodwill. Allocations to
identifiable tangible assets, identifiable intangible assets, and
goodwill were $856 thousand, $1.98 million, and $24 thousand,
respectively. Deposits totaling $34 million were acquired in the
transaction.
(22) Western Auxiliary Corporation
On June 9, 1998 the Company incorporated Western Auxiliary Corporation
(WAC). The Company capitalized WAC as a wholly-owned subsidiary during
the quarter ended September 30, 1998 with an initial capitalization of
$10,000. WAC earns fee income by acting as trustee on the Bank's trust
deed transactions and receives the necessary operational resources
under an intercompany services agreement between WAC and the Bank.
(23) Year 2000
Both the Company and the Bank have a detailed year 2000 compliance plan
that has been approved by their respective board of directors. The
Bank's core banking system, The Phoenix Banking System, uses a
four-digit date field; therefore, it is expected to be year 2000
compliant. Testing to confirm this status was completed by the Bank in
early 1999. With respect to external systems, the Company and the Bank
are in contact with vendors and customers in order to monitor the
progress with year 2000 compliance efforts and assess the need for
contingency plans, if applicable. To date vendors and customers have
provided confirmations that they are either compliant or are making
progress toward planned compliance prior to the end of 1999. The cost
of year 2000 compliance efforts are not expected to be material to the
financial position, the results of operations, or liquidity of the
Company.
(24) Prospective Accounting Pronouncements
Accounting for Mortgage-Backed Securities Retained after the
Securitization of Mortgage Loans Held for Sale by a Mortgage Banking
Enterprise
In October 1998, the FASB issued SFAS No. 134, Accounting for
Mortgage-Backed Securities Retained after the Securitization of
Mortgage Loans Held for Sale by a Mortgage Banking Enterprise. SFAS No.
134 requires that after the securitization of mortgage loans held for
sale, an entity engaged in mortgage banking activities classify the
resulting mortgage-backed securities or other retained interests based
on its ability and intent to sell or hold those investments. SFAS No.
134 is effective for the first fiscal quarter beginning after December
15, 1998. The Company will adopt the statement beginning January 1,
1999. Management does not expect that adoption of SFAS No. 134 will
have a material impact on the Company's consolidated financial
statements.
61
Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use
In March 1998, the American Society of Certified Public Accountants
(AICPA) issued Statement of Position (SOP) 98-1, Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use. SOP
98-1 provides guidance on accounting for the costs of computer software
developed or obtained for internal use. It specifies that computer
software meeting certain characteristics be designated as internal-use
software and sets forth criteria for expensing, capitalizing, and
amortizing certain costs related to the development or acquisition of
internal-use software. SOP 98-1 is effective for fiscal years beginning
after December 15, 1998. The Company will adopt the statement beginning
January 1, 1999. Management does not expect that adoption of SOP 98-1
will have a material impact on the Company's consolidated financial
statements.
Reporting on the Costs of Start-Up Activities
In April 1998, the AICPA issued SOP 98-5, Reporting on the Costs of
Start-Up Activities. SOP 98-5 provides guidance on the financial
reporting of start-up costs and organization costs. It requires costs
of start-up activities and organization costs to be expensed as
incurred. SOP 98-5 is effective for fiscal years beginning after
December 15, 1998. The Company will adopt the statement beginning
January 1, 1999. Management does not expect that adoption of SOP 98-5
will have a material impact on the Company's consolidated financial
statements.
62
SIGNATURES
Pursuant to the requirements of Section 13 of 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, on the 26th day of March,
1999.
FIRST FINANCIAL BANCORP
/s/ LEON J. ZIMMERMAN
-------------------------------
Leon J. Zimmerman
President and Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
report has been signed by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Capacity Date
-------- ----
/s/ BENJAMIN R. GOEHRING Director and Chairman of the Board March 26, 1999
- --------------------------------------------
Benjamin R. Goehring
/s/ WELDON D. SCHUMACHER Director and Vice Chairman of the Board March 26, 1999
- --------------------------------------------
Weldon D. Schumacher
/s/ BOZANT KATZAKIAN Director March 26, 1999
- --------------------------------------------
Bozant Katzakian
/s/ ANGELO J. ANAGNOS Director March 26, 1999
- --------------------------------------------
Angelo J. Anagnos
/s/ RAYMOND H. COLDANI Director March 26, 1999
- --------------------------------------------
Raymond H. Coldani
Director March 26, 1999
- --------------------------------------------
Michael D. Ramsey
Director March 26, 1999
- --------------------------------------------
Dennis Swanson
/s/ LEON J. ZIMMERMAN Director, President and March 26, 1999
- -------------------------------------------- Chief Executive Officer
Leon J. Zimmerman (Principal Executive Officer)
/s/ DAVID M. PHILIPP Executive Vice President, March 26, 1999
- -------------------------------------------- Chief Financial Officer and Secretary
David M. Philipp (Principal Financial and Accounting Officer)
63
INDEX TO EXHIBITS
Exhibit Page
------- ----
3(b) Bylaws, as amended 65
23 Consent of Expert 80
27 Financial Data Schedule (electronic submission only)
64