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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended December 31, 1995.
OR
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ____________ to ____________.
Commission file number 0-11008
CU BANCORP
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(Exact name of registrant as specified in its charter)
California 95-3657044
(State or other jurisdiction) (I.R.S. Employer
of incorporation or organization) Identification Number)
16030 Ventura Boulevard
Encino, California 91436
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (818) 907-9122
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Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, NO PAR VALUE
(title of class)
Indicate by check mark whether the registrant has (1) filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 month (or for shorter periods that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes x No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (Section 220.405 of this chapter) is not contained herein,
and will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K [ x ]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of February 28, 1996: $53,134,221
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Common Stock, no par value -
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The number of shares outstanding of the issuer's classes of common stock as of
February 28, 1996:
Common Stock, no par value 5,285,333 shares
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DOCUMENTS INCORPORATED BY REFERENCE
Part III is hereby incorporated by reference from sections of the Registrant's
Definitive Proxy Statement which will be filed within 120 days of fiscal year
ended December 31, 1995.
This document contains 60 pages.
Exhibit Page begins on Page 61
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TABLE OF CONTENTS
Item
Part Number Item Page
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I 1. Business 4
I 2. Properties 21
I 3. Legal Proceedings 22
I 4. Submission of Matters to a Vote 22
of Security Holders
I 4.A. Executive Officers of the Registrant 22
II 5. Market for the Company's Common Stock 25
and Related Stockholder Matters
II 6. Selected Financial Data 25
II 7. Management's Discussion and Analysis
of Financial Condition and Results
of Operations 26
II 8. Financial Statements and Supplementary
Data 38
II 9. Changes in and Disagreements with *
Accountants on Accounting and
Financial Disclosure
III 10. Directors and Executive Officers of **
the Company
III 11. Executive Compensation **
III 12. Security Ownership of Certain **
Beneficial Owners and Management
III 13. Certain Relationships and Related **
Transaction
IV 14. Exhibits, Financial Statement
Schedules and Reports on Form 8-K 58
* This item is omitted because it is either inapplicable or the answer
thereto is in the negative.
** Incorporated by reference from the Company's proxy statement which
will be filed within 120 days of fiscal year ended December 31, 1995.
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PART I
Item 1. BUSINESS
General Development of Business
CU Bancorp, (the "Company") was incorporated under the laws of
the State of California on September 3, 1981. It is the parent of California
United Bank, a National Banking Association (the "Bank") which is a wholly
owned subsidiary of the Company and the sole subsidiary of the Company.
DESCRIPTION OF BUSINESS
Commercial Banking Business
CU Bancorp is a California corporation incorporated in 1981 and is
registered as a bank holding company under the Bank Holding Company Act of
1956, as amended. The Company does not conduct any activities other than in
connection with its ownership of the Bank which is CU Bancorp's sole
subsidiary. The company functions primarily as the sole stockholder of the
Bank and establishes general policies and activities for the Bank. The Bank
was founded in April 1982 and provides an extensive range of commercial banking
services.
The Bank is a commercial bank which delivers a mix of banking products
and services to middle market businesses, the entertainment industry and high
net worth individuals. The Bank offers lending, deposit, accounts receivable
financing, letters of credit, cash management, SBA and international trade
services from seven full -service offices. The Bank's primary focus is to
engage in middle market lending to businesses, professionals, the entertainment
industry, and high net-worth individuals. While the Bank does not actively
solicit retail or consumer banking business, it offers these services primarily
to owners, officers, and employees of its business customers, and customers of
accounting and business management firms with which the Bank regularly does
business.
The Entertainment Division specializes in meeting the banking needs of
Southern California's entertainment industry, including motion picture and
television financing, record labels, talent agencies, business managers,
commercial houses and a variety of other related business activities. This
division offers certain specialty products aimed at the entertainment industry
and related individuals.
The SBA division offers financing alternatives to businesses in the
Bank's market through the use of government guaranteed loans. This division
offers both term and shorter term credit products.
The International Trade Services Group offers a broad range of
services to support the import/export activities of customers. The division
has direct correspondent relationships with major overseas banks, providing
business customers with a broad international reach. The division facilitates
a wide variety of international banking transactions, including letters of
credit, short term trade related financing, domestic and foreign collections,
wire transfers, standby commitments and government assisted programs.
The Bank attracts customers and deposits by offering a personalized
approach and a high degree of service. The key to the Bank's deposit
generation is personal contacts and services rather than rate competition. A
significant portion of its business is with business customers who conduct
substantially all of their banking business with the Bank.
Either alone or in concert with correspondent banks, the Bank offers a
wide variety of credit and deposit services to its customers. Management
believes that its current and prospective customers favorably respond to the
individualized tailored banking services that the Bank provides. Deposit
services,
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which the Bank offers, include personal and business checking accounts and
savings accounts, insured money market deposit accounts, interest-bearing
negotiable orders of withdrawal ("NOW") accounts, and time certificates of
deposit, along with IRA and Keogh accounts. The Bank offers sophisticated on
line banking capabilities to customers through its electronic banking programs.
The Bank has not requested and does not have regulatory approval to offer trust
services; nor does it have any present intention to seek such approval. The
Bank has made arrangements with a number of trust companies to refer
prospective customers, in connection with which the Bank may receive a referral
fee.
Continued development of a diversified commercial oriented deposit and
lending base is the Bank's highest priority. Loans and time and demand
deposits are actively solicited by the directors, officers, and employees of
the Bank. The executive and senior officers of the Bank have had substantial
experience in soliciting bank deposits and in serving the comprehensive banking
needs of small and mid-size businesses.
During 1995, the Bank serviced the commercial banking business from
five offices including: its head office at 16030 Ventura Boulevard, in Encino,
California 91436, a suburb of Los Angeles; an office in West Los Angeles,
located at 10880 Wilshire Boulevard, Los Angeles California 90024, in the
Westwood commercial and retail district, with close freeway access; a Ventura
County (Camarillo) Regional Office; a South Bay Regional office in Gardena,
California; and a San Gabriel Valley Regional Office, located in City of
Industry, which serves the San Gabriel Valley and northern Orange County. In
January 1996, the Bank added branches in Santa Ana and Anaheim in Orange
County as a result of its merger with Corporate Bank.
In January 1996, the Company completed the acquisition of Corporate
Bank of Santa Ana California which was merged into the Bank. Corporate Bank
served both small and mid market business entities, as well as offering certain
consumer based products such as home equity lines of credit and auto loans and
leases. It is contemplated that upon full integration of the Corporate Bank
business that the business of these offices will mirror those of the Bank as a
whole.
On January 10, 1996, the Bank announced an agreement to merge with
Home Interstate Bancorp, parent of Home Bank, based in the South Bay.
The merger with Home Bank is expected to be completed in mid - 1996, and
will create a Bank with 22 branches and over $800 million in assets.
Historical Regulatory Matters
In 1992, the Bank and Bancorp both consented to agreements with their
primary regulators, a Formal Agreement with the OCC and a Memorandum of
Understanding with the Federal Reserve Bank of San Francisco. In June of 1992,
a new management team replaced substantially all of prior management. In
November of 1993, following the first OCC examination subsequent to new
management's implementation of internal controls and other new management
techniques, the OCC released The Bank from the Formal Agreement and later that
same month the Federal Reserve Bank of San Francisco determined that Bancorp
had met all the requirements of the Memorandum of Understanding and terminated
that document. The Bank's capital ratios, as of December 31, 1995, are in
excess of all minimums imposed by law and regulation and qualify to rate the
Bank as a "well capitalized" bank. For further information see Note 16 to the
Financial Statements.
The Formal Agreement required the implementation of certain policies
and procedures for the operation of the Bank to improve lending operations and
management of the loan portfolio. The Formal Agreement required the Bank to
maintain a Tier 1 risk weighted capital ratio of 10.5% and a 6% Tier 1 capital
ratio based on adjusted total assets. The Formal Agreement mandated the
adoption of a written program to essentially reduce criticized assets, maintain
adequate loan loss reserves and improve bank administration, real estate
appraisal, asset review management and liquidity policies, and restricted the
payment of dividends.
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The agreement specifically required the Bank to: 1) create a
compliance committee; 2) have a competent chief executive officer and senior
loan officer, satisfactory to the OCC, at all times; 3) develop a plan for
supervision of management; 4) create and implement policies and procedures for
loan administration; 5) create a written loan policy; 6) develop and implement
an asset review program; 7) develop and implement a written program for the
maintenance of an adequate Allowance for Loan and Lease Losses, and review the
adequacy of the Allowance; 8) eliminate criticized assets; 9) develop and
implement a written real estate appraisal policy; 10) obtain and improve
procedures regarding credit and collateral documentation; 11) develop a
strategic plan; 12) develop a capital program to maintain adequate capital
(this provision also restricts the payment of dividends by the Bank unless :(a)
the Bank is in compliance with its capital program; (b) the Bank is in
compliance with 12 U.S.C. Sections 55 and 60; and (c) with the prior written
approval of the OCC Regional Administrator; 13) develop and implement a written
liquidity, asset and liability management policy; 14) document and support the
reasonableness of any management and other fees to any director or other party;
15) correct violations of law; and 16) provide reports to the OCC regarding
compliance.
The Company's Memorandum of Understanding ("MOU") with the Federal
Reserve required: 1) a plan to improve the financial condition of CU Bancorp
and the Bank; 2) development of a formal policy regarding the relationship of
CU Bancorp and the Bank, with regard to dividends, intercompany transactions,
tax allocation and management or service fees; 3) a plan to assure that CU
Bancorp has sufficient cash to pay its expenses; 4) ensure that regulatory
reporting is accurate and submitted on a timely basis; 5) prior approval of the
Federal Reserve Bank prior to the payment of dividends; 6) prior approval of
the Federal Reserve Bank prior to CU Bancorp incurring any debt and 7)
quarterly reporting regarding the condition of the Company and steps taken
regarding the Memorandum of Understanding.
The release of both agreements indicates that the Company has
complied with the Formal Agreement and the Memorandum of Understanding,
including improvement of asset and management quality, the development and
implementation of policies and procedures as well as reporting methodologies
and the maintenance of the required capital ratios.
The Company
Bancorp is a legal entity separate and distinct from the Bank. There
are various legal limitations on the ability of the Bank to finance or
otherwise supply funds to Bancorp. In particular, under federal banking law, a
national bank, such as the Bank, may not declare a dividend that exceeds
undivided profits, and the approval of the OCC is required if the total of all
dividends declared in any calendar year exceeds such bank's net profits, as
defined, for that year combined with its retained net profits for the preceding
two years. In addition, federal law significantly limits the extent to which
the Bank may supply funds to Bancorp, whether through direct extensions of
credit or through purchases of securities or assets, issuance of guarantees or
the like. Generally, any loan made by the Bank to Bancorp must be secured by
certain kinds and amounts of collateral and is limited to 10% of the Bank's
capital and surplus (as defined), and all loans by the Bank to Bancorp are
limited to 20% of the Bank's capital and surplus. The Bank may extend credit
to Bancorp without regard to these restrictions to the extent such extensions
of credit are secured by specific kinds of collateral such as obligations of or
guaranteed by the U.S. Government or its agencies and certain bank deposits.
Mortgage Banking
Until November 1993, the Bank operated in two distinct segments,
commercial banking and mortgage banking. The Bank sold the origination portion
of its mortgage banking division in November 1993 to Republic Bancorp of Ann
Arbor Michigan. This division had been established in February of 1988. The
purpose of this division was to underwrite residential mortgages and
subsequently sell them into the secondary market. Mortgages were originated on
both a servicing retained and servicing released basis.
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Substantially all the loans originated by this division were presold to
institutional investors or government agencies and are only originated subject
to this forward commitment.
The Bank retained the mortgage servicing portfolio after the sale of
the division, although it retained the former division to service the loans.
At December 31, 1995 substantially all of the mortgage loan servicing portfolio
had been sold. See Management's Discussion and Analysis for further
amplification on operating contributions of this division and the effect of the
sale.
Entertainment Division
The Bank's entertainment division, based in its West Los Angeles
Regional Office, is designed specifically to serve the needs of accountants and
business managers serving artists and other entertainment industry related
companies and individuals, while providing a more diverse source of deposits
for the Bank as a whole.
Customers and Business Concentration
The Bank believes that there is no single customer whose loss would
have a material adverse effect on the Bank. At year end 1995, the Bank
obtained approximately 7.2% of its deposits from companies associated with the
real estate business, primarily title and escrow companies. While this
appears to be a significant deposit concentration, because these deposits are
attributable to a large number of companies in a diverse market (from small
single family homes to larger projects), the Bank does not believe there is a
problematical concentration in any one industry. To account for seasonal and
economic variations in this industry, the Bank has taken a number of steps to
insure liquidity. Regarding business concentrations in both lending and
deposit activities, see Management's Discussion and Analysis.
Competition
The Company does not conduct any business unrelated to the business of
the Bank and thus is affected by competition only in the Banking industry.
The Bank's primary commercial banking market area consists of the area
encompassed in an approximately sixty mile radius from the downtown Los Angeles
area, including much of Ventura County, the San Fernando Valley, Beverly Hills,
West Los Angeles, the San Gabriel Valley, the South Bay area and metropolitan
areas of the City and County of Los Angeles. The Bank also serves Orange
County.
The banking and financial services business in California generally,
and in the Bank's market areas specifically, is highly competitive. The
increasingly competitive environment is a result primarily of changes in
regulation, changes in technology and product delivery systems, and the
accelerating pace of consolidation among financial services providers. The
Bank competes for loans and deposits and customers for financial services with
other commercial banks, savings and loan associations, securities and brokerage
companies, mortgage companies, insurance companies, finance companies, money
market funds, credit unions and other nonbank financial service providers.
Many of these competitors are much larger in total assets and capitalization,
have greater access to capital markets and offer a broader array of financial
services than the Bank. In order to compete with the other financial services
providers, the Bank principally relies upon local promotional activities,
personal relationships established by officers, directors and employees with
its customers, and specialized services tailored to meet its customers' needs.
In those instances where the Bank is unable to accommodate a customer's needs,
the Bank will arrange for those services to be provided by its correspondents.
To compete with major financial institutions, the Bank relies upon
specialized services, responsive handling of customer needs, local promotional
activity, and personal contacts by its officers, directors, and staff, as
opposed to large multi-branch banks which compete primarily by rate and
location of branches.
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For customers whose loan demands exceed the Bank's lending limit, the Bank
seeks to arrange for such loans on a participation basis with correspondent
banks.
In the past, an independent bank's principal competitors for deposits
and loans have been other banks (particularly major banks), savings and loan
associations, and credit unions. To a lesser extent, competition was also
provided by thrift and loans, mortgage brokerage companies, and insurance
companies. In the past several years, the trend has been for other financial
intermediaries to offer financial services traditionally offered by banks.
Other institutions, such as brokerage houses, credit card companies, and even
retail establishments, have offered new investment vehicles such as
money-market funds or cash advances on credit card accounts. This led to
increased cost of funds for most financial institutions. Even within the
Banking industry, the trend has been towards offering more varied services,
such as discount brokerage, often through affiliate relationships. The
direction of federal legislation seems to favor and foster competition between
different types of financial institutions and to encourage new entrants into
the financial services market. However, it is not possible to forecast the
impact such developments will have on commercial banking in general, or on the
Bank in particular.
Effect of Governmental Policies and Recent Legislation
Banking is a business that depends on rate differentials. In general,
the difference between the interest rate paid by the Bank on its deposits and
its other borrowings and the interest rate received by the Bank on loans
extended to its customers and securities held in the Bank's portfolio comprise
the major portion of the Company's earnings. These rates are highly sensitive
to many factors that are beyond the control of the Bank. Accordingly, the
earnings and growth of the Company are subject to the influence of domestic and
foreign economic conditions, including inflation, recession and unemployment.
The commercial banking business is not only affected by general
economic conditions but is also influenced by the monetary and fiscal policies
of the federal government and the policies of regulatory agencies, particularly
the Federal Reserve Board. The Federal Reserve Board implements national
monetary policies (with objectives such as curbing inflation and combating
recession) by its open-market operations in United States Government
securities, by adjusting the required level of reserves for financial
institutions subject to its reserve requirements and by varying the discount
rates applicable to borrowings by depository institutions. The actions of the
Federal Reserve Board in these areas influence the growth of bank loans,
investments and deposits and also affect interest rates charged on loans and
paid on deposits. The nature and impact of any future changes in monetary
policies cannot be predicted.
From time to time, legislation is enacted which has the effect of
increasing the cost of doing business, limiting or expanding permissible
activities or affecting the competitive balance between banks and other
financial institutions. Proposals to change the laws and regulations governing
the operations and taxation of banks, bank holding companies and other
financial institutions are frequently made in Congress, in the California
legislature and before various bank regulatory and other professional agencies.
The likelihood of any major legislative changes and the impact such changes
might have on the Company are impossible to predict. See "Item 1. Business -
Supervision and Regulation."
Supervision and Regulation
Bank holding companies and banks are extensively regulated under both
federal and state law. Set forth below is a summary description of certain
laws which relate to the regulation of the Company and the Bank. The
description does not purport to be complete and is qualified in its entirety by
reference to the applicable laws and regulations.
The Company
The Company, as a registered bank holding company, is subject to
regulation under the Bank Holding Company Act of 1956, as amended (the "BHCA").
The Company is required to file with the Federal
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Reserve Board quarterly and annual reports and such additional information as
the Federal Reserve Board may require pursuant to the BHCA. The Federal
Reserve Board may conduct examinations of the Company and its subsidiaries.
The Federal Reserve Board may require that the Company terminate an
activity or terminate control of or liquidate or divest certain subsidiaries or
affiliates when the Federal Reserve Board believes the activity or the control
of the subsidiary or affiliate constitutes a significant risk to the financial
safety, soundness or stability of any of its banking subsidiaries. The Federal
Reserve Board also has the authority to regulate provisions of certain bank
holding company debt, including authority to impose interest ceilings and
reserve requirements on such debt. Under certain circumstances, the Company
must file written notice and obtain approval from the Federal Reserve Board
prior to purchasing or redeeming its equity securities.
Under the BHCA and regulations adopted by the Federal Reserve Board, a
bank holding company and its nonbanking subsidiaries are prohibited from
requiring certain tie-in arrangements in connection with any extension of
credit, lease or sale of property or furnishing of services. Further, the
Company is required by the Federal Reserve Board to maintain certain levels of
capital. See "Item 1. Business - Supervision and Regulation - Capital
Standards."
The Company is required to obtain the prior approval of the Federal
Reserve Board for the acquisition of more than 5% of the outstanding shares of
any class of voting securities or substantially all of the assets of any bank
or bank holding company. Prior approval of the Federal Reserve Board is also
required for the merger or consolidation of the Company and another bank
holding company.
The Company is prohibited by the BHCA, except in certain statutorily
prescribed instances, from acquiring direct or indirect ownership or control of
more than 5% of the outstanding voting shares of any company that is not a bank
or bank holding company and from engaging directly or indirectly in activities
other than those of banking, managing or controlling banks or furnishing
services to its subsidiaries. However, the Company, subject to the prior
approval of the Federal Reserve Board, may engage in any, or acquire shares of
companies engaged in, activities that are deemed by the Federal Reserve Board
to be so closely related to banking or managing or controlling banks as to be a
proper incident thereto. In making any such determination, the Federal Reserve
Board is required to consider whether the performance of such activities by the
Company or an affiliate can reasonably be expected to produce benefits to the
public, such as greater convenience, increased competition or gains in
efficiency, that outweigh possible adverse effects, such as undue concentration
of resources, decreased or unfair competition, conflicts of interest or unsound
banking practices. The Federal Reserve Board is also empowered to
differentiate between activities commenced de novo and activities commenced by
acquisition, in whole or in part, of a going concern.
The FRB has determined, by regulation, that certain activities are so
closely related to banking as to be a proper incident thereto within the
meaning of the BHC Act. These activities include, but are not limited to:
opening an industrial loan company, industrial bank, Morris Plan Bank, mortgage
company, finance company, credit card company, or factoring company; performing
certain data processing operations; providing investment and financial advice;
operation as a trust company in certain instances; selling traveler's checks,
U.S. Savings Bonds, and certain money orders; providing certain courier
services; providing real estate appraisals; providing management consulting
advice to non affiliated depository institutions in some instances; acting as
an insurance agent for certain types of credit related insurance; leasing
property or acting as agent, broker, or advisor for leasing property on a "full
payout basis"; acting as a consumer financial counselor, including tax planning
and return preparation; performing futures, options, and advisory services,
check guarantee services and discount brokerage activities; operating a
collection or credit bureau; or performing personal property appraisals.
Recent amendments to this list allow bank holding companies to own
savings associations, arrange commercial real estate equity financing, engage
in certain securities brokerage activities, underwrite and deal in government
obligations and money market instruments, conduct foreign exchange advisory and
transactional services, act as a futures commission merchant, provide
investment advice on financial futures
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and options on futures, provide consumer financial counseling, provide tax
planning and preparation, operate a check guarantee service, operate a
collection agency, and operate a credit bureau. The Company has no present
intention to engage in any of such newly permitted activities.
The FRB has determined that certain other activities are not so
closely related to banking as to be a proper incident thereto within the
meaning of the BHC Act. Such activities include: real estate brokerage and
syndication; real estate development; property management; underwriting of life
insurance not related to credit transactions; and, with certain exceptions
previously noted, securities underwriting and equity funding. The area of
securities underwriting is under review and will likely be expanded. In the
future, the FRB may add or delete from the list of activities permissible for
bank holding companies.
Under Federal Reserve Board regulations, a bank holding company is
required to serve as a source of financial and managerial strength to its
subsidiary banks and may not conduct its operations in an unsafe or unsound
manner. In addition, it is the Federal Reserve Board's policy that in serving
as a source of strength to its subsidiary banks, a bank holding company should
stand ready to use available resources to provide adequate capital funds to its
subsidiary banks during periods of financial stress or adversity and should
maintain the financial flexibility and capital-raising capacity to obtain
additional resources for assisting its subsidiary banks. A bank holding
company's failure to meet its obligations to serve as a source of strength to
its subsidiary banks will generally be considered by the Federal Reserve Board
to be an unsafe and unsound banking practice or a violation of the Federal
Reserve Board's regulations or both. This doctrine has become known as the
"source of strength" doctrine. Although the United States Court of Appeals for
the Fifth Circuit found the Federal Reserve Board's source of strength doctrine
invalid in 1990, stating that the Federal Reserve Board had no authority to
assert the doctrine under the BHCA, the decision, which is not binding on
federal courts outside the Fifth Circuit, was recently reversed by the United
States Supreme Court on procedural grounds. The validity of the source of
strength doctrine is likely to continue to be the subject of litigation until
definitively resolved by the courts or by Congress.
The Company is also a bank holding company within the meaning of
Section 3700 of the California Financial Code. As such, the Company and its
subsidiaries are subject to examination by, and may be required to file reports
with, the California State Banking Department.
Finally, the Company is subject to the periodic reporting requirements
of the Securities Exchange Act of 1934, as amended, including but not limited
to, filing annual, quarterly and other current reports with the Securities and
Exchange Commission.
The Bank
The Bank, as a national banking association, is subject to primary
supervision, examination and regulation by the Comptroller of the Currency (the
"Comptroller"). If, as a result of an examination of a Bank, the Comptroller
should determine that the financial condition, capital resources, asset
quality, earnings prospects, management, liquidity or other aspects of the
Bank's operations are unsatisfactory or that the Bank or its management is
violating or has violated any law or regulation, various remedies are available
to the Comptroller. Such remedies include the power to enjoin "unsafe or
unsound practices," to require affirmative action to correct any conditions
resulting from any violation or practice, to issue an administrative order that
can be judicially enforced, to direct an increase in capital, to restrict the
growth of the Bank, to assess civil monetary penalties, and to remove officers
and directors. The FDIC has similar enforcement authority, in addition to its
authority to terminate a Bank's deposit insurance in the absence of action by
the Comptroller and upon a finding that a Bank is in an unsafe or unsound
condition, is engaging in unsafe or unsound activities, or that its conduct
poses a risk to the deposit insurance fund or may prejudice the interest of its
depositors. The Bank is not currently subject to any such actions by the
Comptroller or the FDIC.
The deposits of the Bank are insured by the FDIC in the manner and to
the extent provided by law. For this protection, the Bank pays a semiannual
statutory assessment. See "Item 1. Business - Supervision and Regulation
Premiums for Deposit Insurance." The Bank is also subject to certain
regulations of the
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Federal Reserve Board and applicable provisions of California law, insofar as
they do not conflict with or are not preempted by federal banking law.
Various other requirements and restrictions under the laws of the
United States and the State of California affect the operations of the Bank.
Federal and California statutes and regulations relate to many aspects of the
Bank's operations, including reserves against deposits, interest rates payable
on deposits, loans, investments, mergers and acquisitions, borrowings,
dividends, locations of branch offices, capital requirements and disclosure
obligations to depositors and borrowers. Further, the Bank is required to
maintain certain levels of capital. See "Item 1. Business - Supervision and
Regulation - Capital Standards."
Restrictions on Transfers of Funds to the Company by the Bank
The Company is a legal entity separate and distinct from the Bank.
The Company's ability to pay cash dividends is limited by state law.
There are statutory and regulatory limitations on the amount of
dividends which may be paid to the Company by the Bank. The prior approval of
the Comptroller is required if the total of all dividends declared by a
national bank in any calendar year exceeds the bank's net profits (as defined)
for that year combined with its retained net profits (as defined) for the
preceding two years, less any transfers to surplus.
The Comptroller also has authority to prohibit the Bank from engaging
in activities that, in the Comptroller's opinion, constitute unsafe or unsound
practices in conducting its business. It is possible, depending upon the
financial condition of the bank in question and other factors, that the
Comptroller could assert that the payment of dividends or other payments might,
under some circumstances, be such an unsafe or unsound practice. Further, the
Comptroller and the Federal Reserve Board have established guidelines with
respect to the maintenance of appropriate levels of capital by banks or bank
holding companies under their jurisdiction. Compliance with the standards set
forth in such guidelines and the restrictions that are or may be imposed under
the prompt corrective action provisions of federal law could limit the amount
of dividends which the Bank or the Company may pay. The Superintendent may
impose similar limitations on the conduct of California-chartered banks. See
"Item 1. Business - Supervision and Regulation - Prompt Corrective Regulatory
Action and Other Enforcement Mechanisms" and - "Capital Standards" for a
discussion of these additional restrictions on capital distributions.
At present, substantially all of the Company's revenues, including
funds available for the payment of dividends and other operating expenses, is,
and will continue to be, primarily dividends paid by the Bank and exercise of
options and warrants to purchase shares of the Company.
The Bank is subject to certain restrictions imposed by federal law on
any extensions of credit to, or the issuance of a guarantee or letter of credit
on behalf of, the Company or other affiliates, the purchase of or investments
in stock or other securities thereof, the taking of such securities as
collateral for loans and the purchase of assets of the Company or other
affiliates. Such restrictions prevent the Company and such other affiliates
from borrowing from the Bank unless the loans are secured by marketable
obligations of designated amounts. Further, such secured loans and investments
by the Bank to or in the Company or to or in any other affiliate is limited to
10% of the Bank's capital and surplus (as defined by federal regulations) and
such secured loans and investments are limited, in the aggregate, to 20% of the
Bank's capital and surplus (as defined by federal regulations). Additional
restrictions on transactions with affiliates may be imposed on the Bank under
the prompt corrective action provisions of federal law. See "Item 1. Business
- - Supervision and Regulation - Prompt Corrective Action and Other Enforcement
Mechanisms."
Capital Standards
The Federal Reserve Board, the Comptroller and the FDIC have adopted
risk-based minimum capital guidelines intended to provide a measure of capital
that reflects the degree of risk associated with a banking organization's
operations for both transactions reported on the balance sheet as assets and
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transactions, such as letters of credit and recourse arrangements, which are
recorded as off balance sheet items. Under these guidelines, nominal dollar
amounts of assets and credit equivalent amounts of off balance sheet items are
multiplied by one of several risk adjustment percentages, which range from 0%
for assets with low credit risk, such as certain U.S. Treasury securities, to
100% for assets with relatively high credit risk, such as business loans.
A banking organization's risk-based capital ratios are obtained by
dividing its qualifying capital by its total risk adjusted assets. The
regulators measure risk-adjusted assets, which includes off balance sheet
items, against both total qualifying capital (the sum of Tier 1 capital and
limited amounts of Tier 2 capital) and Tier 1 capital. Tier 1 capital consists
primarily of common stock, retained earnings, noncumulative perpetual preferred
stock (cumulative perpetual preferred stock for bank holding companies) and
minority interests in certain subsidiaries, less most intangible assets. Tier
2 capital may consist of a limited amount of the allowance for possible loan
and lease losses, cumulative preferred stock, long term preferred stock,
eligible term subordinated debt and certain other instruments with some
characteristics of equity. The inclusion of elements of Tier 2 capital is
subject to certain other requirements and limitations of the federal banking
agencies. The federal banking agencies require a minimum ratio of qualifying
total capital to risk-adjusted assets of 8% and a minimum ratio of Tier 1
capital to risk-adjusted assets of 4%.
In addition to the risk-based guidelines, federal banking regulators
require banking organizations to maintain a minimum amount of Tier 1 capital to
total assets, referred to as the leverage ratio. For a banking organization
rated in the highest of the five categories used by regulators to rate banking
organizations, the minimum leverage ratio of Tier 1 capital to total assets is
3%. For all banking organizations not rated in the highest category, the
minimum leverage ratio must be at least 100 to 200 basis points above the 3%
minimum, or 4% to 5%. In addition to these uniform risk-based capital
guidelines and leverage ratios that apply across the industry, the regulators
have the discretion to set individual minimum capital requirements for specific
institutions at rates significantly above the minimum guidelines and ratios.
In August 1995, the federal banking agencies adopted final regulations
specifying that the agencies will include, in their evaluations of a bank's
capital adequacy, an assessment of the exposure to declines in the economic
value of the bank's capital due to changes in interest rates. The final
regulations, however, do not include a measurement framework for assessing the
level of a bank's exposure to interest rate risk, which is the subject of a
proposed policy statement issued by the federal banking agencies concurrently
with the final regulations. The proposal would measure interest rate risk in
relation to the effect of a 200 basis point change in market interest rates on
the economic value of a bank. Banks with high levels of measured exposure or
weak management systems generally will be required to hold additional capital
for interest rate risk. The specific amount of capital that may be needed
would be determined on a case-by-case basis by the examiner and the appropriate
federal banking agency. Because this proposal has only recently been issued,
the Bank currently is unable to predict the impact of the proposal on the Bank
if the policy statement is adopted as proposed.
In January 1995, the federal banking agencies issued a final rule
relating to capital standards and the risks arising from the concentration of
credit and nontraditional activities. Institutions which have significant
amounts of their assets concentrated in high risk loans or nontraditional
banking activities and who fail to adequately manage these risks, will be
required to set aside capital in excess of the regulatory minimums. The
federal banking agencies have not imposed any quantitative assessment for
determining when these risks are significant, but have identified these issues
as important factors they will review in assessing an individual bank's capital
adequacy.
In December 1993, the federal banking agencies issued an interagency
policy statement on the allowance for loan and lease losses which, among other
things, establishes certain benchmark ratios of loan loss reserves to
classified assets. The benchmark set forth by such policy statement is the sum
of (a) assets classified loss; (b) 50 percent of assets classified doubtful;
(c) 15 percent of assets classified substandard; and (d) estimated credit
losses on other assets over the upcoming 12 months.
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Federally supervised banks and savings associations are currently
required to report deferred tax assets in accordance with SFAS No. 109. See
"Item 1. Business -- Supervision and Regulation -- Accounting Changes." The
federal banking agencies recently issued final rules, effective April 1, 1995,
which limit the amount of deferred tax assets that are allowable in computing
an institution's regulatory capital. The standard has been in effect on an
interim basis since March 1993. Deferred tax assets that can be realized for
taxes paid in prior carryback years and from future reversals of existing
taxable temporary differences are generally not limited. Deferred tax assets
that can only be realized through future taxable earnings are limited for
regulatory capital purposes to the lesser of (i) the amount that can be
realized within one year of the quarter-end report date, or (ii) 10% of Tier 1
Capital. The amount of any deferred tax in excess of this limit would be
excluded from Tier 1 Capital and total assets and regulatory capital
calculations.
Future changes in regulations or practices could further reduce the
amount of capital recognized for purposes of capital adequacy. Such a change
could affect the ability of the Bank to grow and could restrict the amount of
profits, if any, available for the payment of dividends. The banking agencies
have issued a final rule which requires them to revise their risk based capital
guidelines to ensure that their standards take adequate account of interest
rate risk ("IRR"). These amendments to risk-based capital guidelines had not
been finalized for banks as of December 31, 1995.
The following table presents the amounts of regulatory capital and the
capital ratios for the Bank, compared to its minimum regulatory capital
requirements as of December 31, 1995.
December 31, 1995
-----------------
Minimum
Capital
Requirement Actual Ratio
----------- ------ -----
Leverage ratio 10.52% 4.0%
Tier 1 risk-based ratio 14.92 4.0
Total risk-based ratio 16.19 8.0
Prompt Corrective Action and Other Enforcement Mechanisms
Federal law requires each federal banking agency to take prompt
corrective action to resolve the problems of insured depository institutions,
including but not limited to those that fall below one or more prescribed
minimum capital ratios. The law required each federal banking agency to
promulgate regulations defining the following five categories in which an
insured depository institution will be placed, based on the level of its
capital ratios: well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized and critically undercapitalized.
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In September 1992, the federal banking agencies issued uniform final
regulations implementing the prompt corrective action provisions of federal
law. An insured depository institution generally will be classified in the
following categories based on capital measures indicated below:
"Well capitalized" "Adequately capitalized"
------------------ ------------------------
Total risk-based capital of 10%; Total risk-based capital of 8%;
Tier 1 risk-based capital of 6%; and Tier 1 risk-based capital of 4%; and
Leverage ratio of 5%. Leverage ratio of 4% (3% if
the institution receives the
highest rating from its
primary regulator)
"Undercapitalized" "Significantly undercapitalized"
------------------ --------------------------------
Total risk-based capital less than 8%; Total risk-based capital less than 6%;
Tier 1 risk-based capital less than 4%; or Tier 1 risk-based capital less than 3%; or
Leverage ratio less than 4% (3% if the Leverage ratio less than 3%.
institution receives the highest rating
from its primary regulator)
"Critically undercapitalized"
-----------------------------
Tangible equity to total assets less than 2%.
An institution that, based upon its capital levels, is classified as
"well capitalized," "adequately capitalized" or "undercapitalized" may be
treated as though it were in the next lower capital category if the appropriate
federal banking agency, after notice and opportunity for hearing, determines
that an unsafe or unsound condition or an unsafe or unsound practice warrants
such treatment. At each successive lower capital category, an insured
depository institution is subject to more restrictions. The federal banking
agencies, however, may not treat an institution as "critically
undercapitalized" unless its capital ratio actually warrants such treatment.
The law prohibits insured depository institutions from paying
management fees to any controlling persons or, with certain limited exceptions,
making capital distributions if after such transaction the institution would be
undercapitalized. If an insured depository institution is undercapitalized, it
will be closely monitored by the appropriate federal banking agency, subject to
asset growth restrictions and required to obtain prior regulatory approval for
acquisitions, branching and engaging in new lines of business. Any
undercapitalized depository institution must submit an acceptable capital
restoration plan to the appropriate federal banking agency 45 days after
becoming undercapitalized. The appropriate federal banking agency cannot
accept a capital plan unless, among other things, it determines that the plan
(i) specifies the steps the institution will take to become adequately
capitalized, (ii) is based on realistic assumptions and (iii) is likely to
succeed in restoring the depository institution's capital. In addition, each
company controlling an undercapitalized depository institution must guarantee
that the institution will comply with the capital plan until the depository
institution has been adequately capitalized on an average basis during each of
four consecutive calendar quarters and must otherwise provide adequate
assurances of performance. The aggregate liability of such guarantee is
limited to the lesser of (a) an amount equal to 5% of the depository
institution's total assets at the time the institution became undercapitalized
or (b) the amount which is necessary to bring the institution into compliance
with all capital standards applicable to such institution as of the time the
institution fails to comply with its capital restoration plan. Finally, the
appropriate federal banking agency may impose any of the additional
restrictions or sanctions that it may impose on significantly undercapitalized
institutions if it determines that such action will further the purpose of the
prompt correction action provisions.
An insured depository institution that is significantly
undercapitalized, or is undercapitalized and fails to submit, or in a material
respect to implement, an acceptable capital restoration plan, is
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subject to additional restrictions and sanctions. These include, among other
things: (i) a forced sale of voting shares to raise capital or, if grounds
exist for appointment of a receiver or conservator, a forced merger; (ii)
restrictions on transactions with affiliates; (iii) further limitations on
interest rates paid on deposits; (iv) further restrictions on growth or
required shrinkage; (v) modification or termination of specified activities;
(vi) replacement of directors or senior executive officers; (vii) prohibitions
on the receipt of deposits from correspondent institutions; (viii) restrictions
on capital distributions by the holding companies of such institutions; (ix)
required divestiture of subsidiaries by the institution; or (x) other
restrictions as determined by the appropriate federal banking agency. Although
the appropriate federal banking agency has discretion to determine which of the
foregoing restrictions or sanctions it will seek to impose, it is required to
force a sale of voting shares or merger, impose restrictions on affiliate
transactions and impose restrictions on rates paid on deposits unless it
determines that such actions would not further the purpose of the prompt
corrective action provisions. In addition, without the prior written approval
of the appropriate federal banking agency, a significantly undercapitalized
institution may not pay any bonus to its senior executive officers or provide
compensation to any of them at a rate that exceeds such officer's average rate
of base compensation during the 12 calendar months preceding the month in which
the institution became undercapitalized.
Further restrictions and sanctions are required to be imposed on
insured depository institutions that are critically undercapitalized. For
example, a critically undercapitalized institution generally would be
prohibited from engaging in any material transaction other than in the ordinary
course of business without prior regulatory approval and could not, with
certain exceptions, make any payment of principal or interest on its
subordinated debt beginning 60 days after becoming critically undercapitalized.
Most importantly, however, except under limited circumstances, the appropriate
federal banking agency, not later than 90 days after an insured depository
institution becomes critically undercapitalized, is required to appoint a
conservator or receiver for the institution. The board of directors of an
insured depository institution would not be liable to the institution's
shareholders or creditors for consenting in good faith to the appointment of a
receiver or conservator or to an acquisition or merger as required by the
regulator.
In addition to measures taken under the prompt corrective action
provisions, commercial banking organizations may be subject to potential
enforcement actions by the federal regulators for unsafe or unsound practices
in conducting their businesses or for violations of any law, rule, regulation
or any condition imposed in writing by the agency or any written agreement with
the agency. Enforcement actions may include the imposition of a conservator or
receiver, the issuance of a cease and desist order that can be judicially
enforced, the termination of insurance of deposits (in the case of a depository
institution), the imposition of civil money penalties, the issuance of
directives to increase capital, the issuance of formal and informal agreements,
the issuance of removal and prohibition orders against institution-affiliated
parties and the enforcement of such actions through injunctions or restraining
orders based upon a judicial determination that the agency would be harmed if
such equitable relief was not granted.
Safety and Soundness Standards
In July 1995, the federal banking agencies adopted final guidelines
establishing standards for safety and soundness, as required by FDICIA. The
guidelines set forth operational and managerial standards relating to internal
controls, information systems and internal audit systems, loan documentation,
credit underwriting, interest rate exposure, asset growth and compensation,
fees and benefits. Guidelines for asset quality and earnings standards will be
adopted in the future. The guidelines establish the safety and soundness
standards that the agencies will use to identify and address problems at
insured depository institutions before capital becomes impaired. If an
institution fails to comply with a safety and soundness standard, the
appropriate federal banking agency may require the institution to submit a
compliance plan. Failure to submit a compliance plan or to implement an
accepted plan may result in enforcement action.
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In December 1992, the federal banking agencies issued final
regulations prescribing uniform guidelines for real estate lending. The
regulations, which became effective on March 19, 1993, require insured
depository institutions to adopt written policies establishing standards,
consistent with such guidelines, for extensions of credit secured by real
estate. The policies must address loan portfolio management, underwriting
standards and loan to value limits that do not exceed the supervisory limits
prescribed by the regulations.
Appraisals for "real estate related financial transactions" must be
conducted by either state certified or state licensed appraisers for
transactions in excess of certain amounts. State certified appraisers are
required for all transactions with a transaction value of $1,000,000 or more;
for all nonresidential transactions valued at $250,000 or more; and for
"complex" 1-4 family residential properties of $250,000 or more. A state
licensed appraiser is required for all other appraisals. However, appraisals
performed in connection with "federally related transactions" must now comply
with the agencies' appraisal standards. Federally related transactions include
the sale, lease, purchase, investment in, or exchange of, real property or
interests in real property, the financing or refinancing of real property, and
the use of real property or interests in real property as security for a loan
or investment, including mortgage-backed securities.
Premiums for Deposit Insurance
Federal law has established several mechanisms to increase funds to
protect deposits insured by the Bank Insurance Fund ("BIF") administered by the
FDIC. The FDIC is authorized to borrow up to $30 billion from the United
States Treasury; up to 90% of the fair market value of assets of institutions
acquired by the FDIC as receiver from the Federal Financing Bank; and from
depository institutions that are members of the BIF. Any borrowings not repaid
by asset sales are to be repaid through insurance premiums assessed to member
institutions. Such premiums must be sufficient to repay any borrowed funds
within 15 years and provide insurance fund reserves of $1.25 for each $100 of
insured deposits. The result of these provisions is that the assessment rate
on deposits of BIF members could increase in the future. The FDIC also has
authority to impose special assessments against insured deposits.
The FDIC implemented a final risk-based assessment system, as required
by FDICIA, effective January 1, 1994, under which an institution's premium
assessment is based on the probability that the deposit insurance fund will
incur a loss with respect to the institution, the likely amount of any such
loss, and the revenue needs of the deposit insurance fund. As long as BIF's
reserve ratio is less than a specified "designated reserve ratio," 1.25%, the
total amount raised from BIF members by the risk-based assessment system may
not be less than the amount that would be raised if the assessment rate for all
BIF members were .023% of deposits. On August 8, 1995, the FDIC announced that
the designated reserve ratio had been achieved and, accordingly, issued final
regulations adopting an assessment rate schedule for BIF members of 4 to 31
basis points effective on June 1, 1995. On November 14, 1995, the FDIC further
reduced deposit insurance premiums to a range of 0 to 27 basis points effective
for the semi-annual period beginning January 1, 1996.
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Under the risk-based assessment system, a BIF member institution such
as the Bank is categorized into one of three capital categories (well
capitalized, adequately capitalized, and undercapitalized) and one of three
categories based on supervisory evaluations by its primary federal regulator
(in the Bank's case, the Comptroller). The three supervisory categories are:
financially sound with only a few minor weaknesses (Group A), demonstrates
weaknesses that could result in significant deterioration (Group B), and poses
a substantial probability of loss (Group C). The capital ratios used by the
Comptroller to define well-capitalized, adequately capitalized and
undercapitalized are the same in the Comptroller's prompt corrective action
regulations. The BIF assessment rates are summarized below; assessment figures
are expressed in terms of cents per $100 in deposits.
Assessment Rates Effective Through the First Half of 1995
Group A Group B Group C
-------------------------------------
Well Capitalized . . . . . . . . . . . . 23 26 29
Adequately Capitalized . . . . . . . . . 26 29 30
Undercapitalized . . . . . . . . . . . . 29 30 31
Assessment Rates Effective through the Second Half of 1995
Group A Group B Group C
-------------------------------------
Well Capitalized . . . . . . . . . . . . 4 7 21
Adequately Capitalized . . . . . . . . . 7 14 28
Undercapitalized . . . . . . . . . . . . 14 28 31
Assessment Rates Effective January 1, 1996
Group A Group B Group C
-------------------------------------
Well Capitalized . . . . . . . . . . . . 0* 3 17
Adequately Capitalized . . . . . . . . . 3 10 24
Undercapitalized . . . . . . . . . . . . 10 24 27
*Subject to a statutory minimum assessment of $1,000 per semi-annual
period (which also applies to all other assessment risk
classifications).
At December 31, 1995, the Bank was well capitalized (Group A).
A number of proposals have recently been introduced in Congress to
address the disparity in bank and thrift deposit insurance premiums. On
September 19, 1995, legislation was introduced and referred to the House
Banking Committee that would, among other things: (i) impose a requirement on
all SAIF member institutions to fully recapitalize the SAIF by paying a
one-time special assessment of approximately 85 basis points on all assessable
deposits as of March 31, 1995, which assessment would be due as of January 1,
1996; (ii) spread the responsibility for FICO interest payments across all
FDIC-insured institutions on a pro-rata basis, subject to certain exceptions;
(iii) require that deposit insurance premium assessment rates applicable to
SAIF member institutions be no less than deposit insurance premium assessment
rates applicable to BIF member institutions; (iv) provide for a merger of the
BIF and the SAIF as of January 1, 1998; (v) require savings associations to
convert to state or national bank charters by January 1, 1998; (vi) require
savings associations to divest any activities not permissible for commercial
banks within five years; (vii) eliminate the bad-debt reserve deduction for
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savings associations, although savings associations would not be required to
recapture into income their accumulated bad-debt reserves; (viii) provide for
the conversion of savings and loan holding companies into bank holding
companies as of January 1, 1998, although unitary savings and loan holding
companies authorized to engage in activities as of September 13, 1995 would
have such authority grandfathered (subject to certain limitations); and (ix)
abolish the OTS and transfer the OTS' regulatory authority to the other federal
banking agencies. The legislation would also provide that any savings
association that would become undercapitalized under the prompt corrective
action regulations as a result of the special deposit premium assessment could
be exempted from payment of the assessment, provided that the institution would
continue to be subject to the payment of semiannual assessments under the
current rate schedule following the recapitalization of the SAIF. The
legislation was considered and passed by the House Banking Committee's
Subcommittee on Financial Institutions on September 27, 1995, and has not yet
been acted on by the full House Banking Committee.
On September 20, 1995, similar legislation was introduced in the
Senate, although the Senate bill does not include a comprehensive approach for
merging the savings association and commercial bank charters. The Senate bill
remains pending before the Senate Banking Committee.
The future of both these bills is linked with that of pending budget
reconciliation legislation since some of the major features of the bills are
included in the Seven-Year Balanced Budget Reconciliation Act. The budget
bill, which was passed by both the House and Senate on November 17, 1995 and
vetoed by the President on December 6, 1995, would: (i) recapitalize the SAIF
through a special assessment of between 70 and 80 basis points on deposits held
by institutions as of March 31, 1995; (ii) provide an exemption to this rule
for weak institutions, and a 20% reduction in the SAIF-assessable deposits of
so-called "Oakar banks;" (iii) expand the assessment base for FICO payments to
include all FDIC-insured institutions; (iv) merge the BIF and SAIF on January
1, 1998, only if no insured depository institution is a savings association on
that date; (v) establish a special reserve for the SAIF on January 1, 1998; and
(vi) prohibit the FDIC from setting semiannual assessments in excess of the
amount needed to maintain the reserve ratio of any fund at the designated
reserve ratio. The bill does not include a provision to merge the charters of
savings associations and commercial banks.
In light of ongoing debate over the content and fate of the budget
bill, the different proposals currently under consideration and the uncertainty
of the Congressional budget and legislative processes in general, management
cannot predict whether any or all of the proposed legislation will be passed,
or in what form. Accordingly, the effect of any such legislation on the Bank
cannot be determined.
Interstate Banking and Branching
In September 1994, the Riegel-Neal Interstate Banking and Branching
Efficiency Act of 1994 (the "Interstate Act") became law. Under the Interstate
Act, beginning one year after the date of enactment, a bank holding company
that is adequately capitalized and managed may obtain approval under the BHCA
to acquire an existing bank located in another state without regard to state
law. A bank holding company would not be permitted to make such an acquisition
if, upon consummation, it would control (a) more than 10% of the total amount
of deposits of insured depository institutions in the United States or (b) 30%
or more of the deposits in the state in which the bank is located. A state may
limit the percentage of total deposits that may be held in that state by any
one bank or bank holding company if application of such limitation does not
discriminate against out-of-state banks. An out-of-state bank holding company
may not acquire a state bank in existence for less than a minimum length of
time that may be prescribed by state law except that a state may not impose
more than a five year existence requirement.
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The Interstate Act also permits, beginning June 1, 1997, mergers of
insured banks located in different states and conversion of the branches of the
acquired bank into branches of the resulting bank. Each state may permit such
combinations earlier than June 1, 1997, and may adopt legislation to prohibit
interstate mergers after that date in that state or in other states by that
state's banks. The same concentration limits discussed in the preceding
paragraph apply. The Interstate Act also permits a national or state bank to
establish branches in a state other than its home state if permitted by the
laws of that state, subject to the same requirements and conditions as for a
merger transaction.
In October 1995, California adopted "opt in" legislation under the
Interstate Act that permits out-of-state banks to acquire California banks that
satisfy a five-year minimum age requirement (subject to exceptions for
supervisory transactions) by means of merger or purchases of assets, although
entry through acquisition of individual branches of California institutions and
de novo branching into California are not permitted. The Interstate Act and
the California branching statute will likely increase competition from
out-of-state banks in the markets in which the Company operates, although it is
difficult to assess the impact that such increased competition may have on the
Company's operations.
Community Reinvestment Act and Fair Lending Developments
The Bank is subject to certain fair lending requirements and reporting
obligations involving home mortgage lending operations and Community
Reinvestment Act ("CRA") activities. The CRA generally requires the federal
banking agencies to evaluate the record of a financial institution in meeting
the credit needs of their local communities, including low and moderate income
neighborhoods. The Bank's compliance with CRA is monitored by the
Comptroller, which assigns the Bank a publicly available CRA rating. An
assessment of CRA compliance is required by both the Comptroller and the
Federal Reserve Board in connection with applications for approval of certain
activities such as mergers with or acquisitions of other banks or bank holding
companies. In April of 1995, the federal regulatory agencies issued a
comprehensive revision to the rules governing CRA compliance. In assigning a
CRA rating to a bank, the new regulations place greater emphasis on
measurements of performance in the areas of lending (specifically the bank's
home mortgage, small business, small farm and community development loans),
investment (the bank's community development investments) and service (the
bank's community development services and the availability of its retail
banking services), although examiners are still given a degree of flexibility
in taking into account unique characteristics and needs of the bank's community
and its capacity and constraints in meeting such needs. The new regulations
also require increased collection and reporting of data regarding certain kinds
of loans. Although the new regulations became generally effective on July 1,
1995, various provisions have different effective dates, and the new CRA
evaluation criteria will go into effect for examinations beginning on July 1,
1997. Although management cannot predict the impact of the substantial changes
in the new rules on the Bank's CRA rating, it will continue to take steps to
comply with the requirements in all respects.
In addition to substantial penalties and corrective measures that may
be required for a violation of certain fair lending laws, the federal banking
agencies may take compliance with such laws and CRA into account when
regulating and supervising other activities. The Comptroller has rated the
Bank "satisfactory" in complying with its CRA obligations.
In May 1995, the federal banking agencies issued final regulations
which change the manner in which they measure a bank's compliance with its CRA
obligations. The final regulations adopt a performance-based evaluation system
which bases CRA ratings on an institution's actual lending service and
investment performance rather than the extent to which the institution conducts
needs assessments, documents community outreach or complies with other
procedural requirements. In March 1994, the Federal Interagency Task Force on
Fair Lending issued a policy statement on discrimination in lending. The
policy statement describes the three methods that federal agencies will
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use to prove discrimination: overt evidence of discrimination, evidence of
disparate treatment and evidence of disparate impact.
Accounting Changes
In February 1992, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 109, "Accounting for Income Taxes," which superseded SFAS No.
96 of the same title. SFAS No. 109, which was adopted by the Company effective
January 1, 1993, employs an asset and liability approach in accounting for
income taxes payable or refundable at the date of the financial statements as a
result of all events that have been recognized in the financial statements and
as measured by the provisions of enacted tax laws. Adoption by the Company of
SFAS No. 109 did not have a material impact on the Company's results of
operations.
In May 1993, the FASB issued SFAS No. 114, "Accounting by Creditors
for Impairment of a Loan". SFAS No. 114 prescribes the recognition criterion
for loan impairment and the measurement methods for certain impaired loans and
loans whose terms are modified in troubled debt restructurings. SFAS No. 114
states that a loan is impaired when it is probable that a creditor will be
unable to collect all principal and interest amounts due according to the
contracted terms of the loan agreement. A creditor is required to measure
impairment by discounting expected future cash flows at the loan's effective
interest rate, or by reference to an observable market price, or by determining
that foreclosure is probable. SFAS No. 114 also clarifies the existing
accounting for in-substance foreclosures by stating that a collateral-dependent
real estate loan would be reported as real estate owned only if the lender had
taken possession of collateral.
SFAS No. 118 amended SFAS No. 114, to allow a creditor to use existing
methods for recognizing interest income on an impaired loan. To accomplish
that it eliminated the provisions in SFAS No. 114 that described how a creditor
should report income on an impaired loan. SFAS No. 118 did not change the
provisions in SFAS No. 114 that require a creditor to measure impairment based
on the present value of expected future cash flows discounted at the loan's
effective interest rate, or as a practical expedient, at the observable market
price of the loan or the fair value of the collateral if the loan is collateral
dependent. SFAS No. 118 amends the disclosure requirements in SFAS No. 114 to
require information about the recorded investments in certain impaired loans
and about how a creditor recognizes interest income related to those impaired
loans. The Company adopted SFAS No. 114 and No. 118 as of January 1, 1995.
The Bank had previously measured the allowance for loan losses using methods
similar to that prescribed in SFAS 114. As a result, no additional provision
was required by the adoption of this pronouncement.
In December 1990, FASB issued SFAS No. 106, "Employers' Accounting for
Post-Retirement Benefits Other Than Pensions" effective for fiscal years
beginning after December 15, 1992. In November 1992, FASB issued Statement of
Financial Standards No. 112, "Employers' Accounting For Post-Employment
Benefits," effective for fiscal years beginning after December 15, 1993. SFAS
No. 106 and SFAS No. 112 focus primarily on post-retirement health care
benefits. The Company does not provide post-retirement benefits, and SFAS No.
106 and SFAS No. 112 will have no impact on net income in 1996.
In May 1993, the FASB issued SFAS No. 115 "Accounting for Certain
Investments in Debt and Equity Securities" addressing the accounting and
reporting for investments in equity securities that have readily determinable
fair values and for all investments in debt securities. These investments
would be classified in three categories and accounted for as follows: (i) debt
and equity securities that the entity has the positive intent and ability to
hold to maturity would be classified as "held to maturity" and reported at
amortized cost; (ii) debt and equity securities that are held for current
resale would be classified as trading securities and reported at fair value,
with unrealized gains and losses included in operations; and (iii) debt and
equity securities not classified as either securities
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held to maturity or trading securities would be classified as securities
available for sale, and reported at fair value, with unrealized gains and
losses excluded from operations and reported as a separate component of
shareholders' equity. The Company adopted SFAS No. 115 in 1993. The adoption
of SFAS 115 did not have a material impact on the financial position or results
of operations of the Bank.
EMPLOYEES
As of December 31, 1995, the Company had three employees, its
President ,Chief Executive Officer and Chief Financial Officer. At December
31, 1995, the Bank had 115 full-time employees or equivalents. Of these
employees, 11 held titles of senior vice president or above. At December 31,
1995, none of the executive officers of the Bank served pursuant to written
employment agreements. None of the Company's or the Bank's employees are
represented by a labor union. The Company considers its relationship and the
Bank's relationship with each company's respective employees to be excellent.
Item 2. PROPERTIES
The principal offices of the Company are located in a
multi-story office building located at 16030 Ventura Boulevard, Encino,
California 91364 for which it pays a monthly rental of $60,000. The lease
contains a ceiling on cost on living adjustments of 5% per year. The lease is
renewable. The Bank also has certain month to month or short term leases for
offices in West Los Angeles, the South Bay, Ventura and the San Gabriel Valley.
Each of these leases is short term in nature and is not material to the
Company. Management believes that the existing leases will provide for their
space requirements for the foreseeable future, at least until the completion of
the proposed merger with Home Interstate Bancorp.
21
22
Item 3. LEGAL PROCEEDINGS
In the normal course of business the Bank occasionally becomes
a party to litigation. In the opinion of management, based upon consultation
with legal counsel, pending or threatened litigation involving the Bank will
have no adverse material effect upon its financial condition, or results of
operations. For further information, see Note 15 to the Consolidated Financial
Statements of the Company.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were presented for a vote of shareholders during
fourth quarter 1995.
Item 4(A). EXECUTIVE OFFICERS OF THE COMPANY
Set forth below are brief summaries of the background and business experience
of each of the directors and executive officers of the Company and the Bank as
of December 31, 1995:
POSITION AND POSITION AND DIRECTOR OF
------------ ------------ -----------
OFFICE WITH CU OFFICE WITH THE COMPANY AND BANK
-------------- --------------- ----------------
NAME AGE BANCORP BANK SINCE:
---- --- ------- ---- ------
Kenneth L. Bernstein 53 Director Director 1994
Stephen G. Carpenter 56 Chairman, Chief Chairman, Chief 1992
Executive Officer Executive Officer
Richard H. Close 51 Director, Director, 1981
Secretary Secretary
Paul W. Glass 50 Director Director 1984
Ronald S. Parker 51 Director Director 1993
David I. Rainer 39 Director, Director, 1992
President, Chief President, Chief
Operating Officer Operating Officer
None of the directors or officers of CU Bancorp or CU Bank were
selected pursuant to any arrangement or understanding other than with the
directors and officers of CU Bancorp and CU Bank acting in their capacities as
such. There are no family relationships between any two or more of the
directors, or officers.
Set forth below are brief summaries of the background and business
experience, including principal occupation, of the directors.
KENNETH L. BERNSTEIN, was elected to the Board of CU Bancorp and CU
Bank in December 1993, and assumed the positions in February 1994. He is the
President of BFC Financial Corporation and has served in such capacity since
1965. BFC Financial Corporation performs a variety of service for both the
finance industry and clients of that industry.
22
23
STEPHEN G. CARPENTER, joined CU Bank in 1992 from Security Pacific
National Bank where he was Vice Chairman in charge of middle market lending
from July 1989 to June 1992. Mr. Carpenter was previously employed at Wells
Fargo Bank from July 1980 to July 1989, where he was an Executive Vice
President. He assumed the additional role of Chairman of CU Bank in February,
1994 and Chairman of CU Bancorp in 1995.
RICHARD H. CLOSE has been a principal in the law firm of Shapiro,
Rosenfeld & Close, a Professional Corporation, in Los Angeles, California,
since 1977.
PAUL W. GLASS is a certified public accountant and has been a
principal in the accountancy firm of Glass & Rosen, in Encino, California,
since 1980.
RONALD S. PARKER has been the Chairman of Parker, Mulcahy &
Associates, a regional merchant banking firm, since May 1992. Prior to that he
was the Executive Vice President and Group Head of the Corporate Banking Group
of Security Pacific National Bank from March of 1991 to May of 1992. He held a
similar position at Wells Fargo National Bank from 1984 to 1991. Mr. Parker
resigned from the Board in December 1993. He was reappointed in 1994.
DAVID I. RAINER was appointed Executive Vice President of CU Bank in
June 1992 and assumed the position of Chief Operating Officer in late 1992. He
assumed the additional title of President of CU Bank in February, 1994 and
President and Chief Operating Officer of CU Bancorp in 1995. He was elected to
the Board of Directors of CU Bancorp and California United Bank in 1993. From
July 1989 to June 1992, Mr. Rainer was employed by Bank of America (Security
Pacific National Bank) where he held the position of Senior Vice President.
From March 1989 to July 1989, Mr. Rainer was a Senior Vice President at Faucet
& Company, where he co-managed a stock and bond portfolio. From July 1982 to
March 1989, Mr. Rainer was employed by Wells Fargo Bank, where he held the
positions of Vice President and Manager.
No director, officer or affiliate of CU Bancorp or of CU Bank, no
owner of record or beneficially of more than five percent of any class of
voting securities of CU Bancorp or no associate of any such director, officer
or affiliate is a party adverse to CU Bancorp or CU Bank in any material
pending legal proceed
The following are officers of CU Bancorp and the Bank as of December
31, 1995:
POSITION AND POSITION AND
OFFICES WITH THE OFFICES WITH OFFICER
NAME AGE COMPANY THE BANK SINCE
---- --- ------- --------- -----
STEPHEN G. CARPENTER 56 Director, Chief Chairman, Chief 1992
Executive Officer Executive Officer
DAVID I. RAINER 39 Director, Director, 1992
President, Chief President, Chief
Operating Officer Operating Officer
ANNE WILLIAMS 38 Chief Credit Chief Credit 1992
Officer Officer
PATRICK HARTMAN 46 Chief Financial Chief Financial 1992
Officer Officer
23
24
Set forth below are brief summaries of the background and business
experience, including principal occupation, of the executive officers of CU
Bancorp who have not previously been discussed herein.
PATRICK HARTMAN has been employed by CU Bank since November, 1992.
Prior to assuming his present positions he was Senior Vice President/Chief
Financial Officer for Cenfed Bank for a period during 1992. Mr. Hartman held
the post of Senior Vice President/Chief Financial Officer of Community Bank,
Pasadena, California, for thirteen years.
ANNE WILLIAMS joined CU Bank in 1992 as Senior Loan Officer. She was
named to the position of Chief Credit Officer in July 1993. Prior to that time
she spent five years at Bank of America / Security Pacific National Bank, where
she was a credit administrator in asset based lending, for middle market in the
Los Angeles Area. Ms. Williams was trained at Chase Manhattan Bank in New
York, and was a commercial lender at Societe Generale in Los Angeles and Boston
Five Cents Savings Bank where she managed the corporate lending group.
24
25
PART II
ITEM 5. MARKET FOR COMPANY'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
See Item 7 "Management's Discussion and Analysis of Financial
Condition and Results of Operations" for information relative to the market for
the Company's Common Stock.
Holders of Company's Common Stock
As of the close of business on December 31, 1995 there were 416 record
holders of the Company's issued and outstanding Common Stock.
ITEM 6. SELECTED FINANCIAL DATA
CU BANCORP AND SUBSIDIARY
Amounts in thousands of dollars, except per share data and amounts expressed as
percentages
AS OF THE YEARS ENDED DECEMBER 31,
1995 1994 1993 1992 1991
---- ---- ---- ---- ----
CONSOLIDATED BALANCE SHEET DATA
Securities held to maturity $ 66,735 $ 74,153 $ 88,034 $ 84,724 $ 59,533
Securities available for sale 6,345
Net loans 183,696 167,175 134,148 193,643 273,126
Total earning assets 289,276 261,328 251,559 281,723 429,480
Total assets 325,309 304,154 279,206 353,923 516,762
Total deposits 284,510 264,181 238,928 318,574 473,125
Total shareholders' equity 33,006 29,744 26,990 24,632 32,598
Regulatory risk based capital ratio 16.19% 15.40% 16.71% 12.87% 12.31%
Regulatory capital leverage ratio 10.52% 10.44% 9.16% 6.12% 6.91%
Allowance for loan losses to:
Period end total loans 3.64% 4.25% 4.63% 6.28% 4.33%
Nonperforming loans 677% 20,631% 473% 95% 75%
Nonperforming assets 677% 20,631% 283% 95% 59%
CONSOLIDATED OPERATING RESULTS
Net interest income $ 15,536 $ 13,881 $ 14,431 $ 20,625 $ 25,681
Other operating income 2,065 5,408 26,423 21,499 10,537
Provision for loan losses 0 0 450 17,090 14,267
Operating expenses 12,554 14,735 36,883 37,493 27,843
Net income (loss) 2,894 2,574 2,098 (8,190) (3,637)
Fully diluted income/(loss) per $ .60 $ .56 $ 0.47 $ (1.90) $ (0.83)
common & equivalent share
Net interest margin 5.68% 5.99% 5.86% 6.07% 6.99%
Return on average shareholders' 9.38% 9.12% 8.12% (26.06)% (10.27)%
equity
Return on average assets 0.97% 0.97% 0.69% (1.89)% (0.76)%
Cash dividends per common share $ .08 ----- ----- ----- $ 0.150
26
ITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS
OVERVIEW
The Company earned $2.9 million, or $0.60 per share, during in 1995, compared
to $2.6 million, or $0.56 per share, in 1994 and $2.1 million, or $.47 per
share in 1993. Composition of the earnings has changed substantially in 1995.
Prior to that, a substantial portion of the Bank's earnings had been
attributable to the Mortgage Banking operation, which was sold in November
1993. The Mortgage origination operation contributed about two thirds of the
earnings for 1993, and approximately 56% of the earnings in 1994 were
attributable to a gain on the sale of mortgage servicing rights retained when
the origination operation was sold. Since then, the earnings of the core
commercial bank have grown steadily as the mortgage related income has been
eliminated. For the year ended December 31, 1995, income related to sales of
mortgage servicing was less than 8% of the Bank's earnings.
The Bank's asset quality ratios continue to be exceptionally strong. At
December 31, 1995, nonperforming assets were $1 million, compared with $36
thousand in 1994. The Bank did not have any real estate acquired through
foreclosure at December 31, 1995 or December 31, 1994. The Bank's allowance for
loan losses as a percent of both nonperforming loans and nonperforming assets
at December 31, 1995 was 677%, compared to 1994 levels of 20,631%.
Capital ratios are strong, substantially exceeding levels required for the
"well capitalized" category established by bank regulators. The Total
Risk-Based Capital Ratio was 16.19%, the Tier 1 Risk-Based Capital Ratio was
14.92%, and the Leverage Ratio was 10.52% at December 31, 1995, compared to
15.40%, 14.12%, and 10.44%, respectively, at year-end 1994. Regulatory
requirements for Total Risk-Based, Tier 1 Risk-Based, and Leverage capital
ratios are a minimum of 8%, 4%, and 3%, respectively, and for classification as
well capitalized, 10%, 6%, and 5%, respectively.
The Bank's strong capital and asset quality position allows the Bank to
continue to grow its core business which provides relationship based services
to middle market customers and positions the Bank for its acquisition
strategy. During the year ended December 31, 1995, the Bank generated
approximately $135 million in new loan commitments, compared with about $121
million and $101 million for the comparable periods of 1994 and 1993.
The Bank announced actions taken in 1995 and early 1996 that supplement the
Bank's successful internal growth with strategically selected mergers and
acquisitions. In March of 1995, the Bank had announced the signing of an
agreement to acquire Corporate Bank, a Santa Ana based community bank with
approximately $70 million in assets. This purchase was completed in January of
1996. In January 1996, the Bank also announced the signing of an agreement to
merge with Home Interstate Bancorp, the parent of Home Bank, based in the South
Bay. This merger, targeted to be completed near the end of the second quarter
of 1996, would create a combined bank with over $800 million in assets and 22
branches.
BALANCE SHEET ANALYSIS
LOAN PORTFOLIO COMPOSITION AND CREDIT RISK
The Bank's loan portfolio at December 31, 1995 has maintained the high
standards of credit quality that have been established as the commercial loan
portfolio has been built over the past three years. Non performing assets have
been reduced to insignificant levels and exposures to real estate have been
greatly reduced to consist primarily of loans secured by real estate made to
the Bank's core middle market customers as a secondary part of their total
business relationship.
Total loans at December 31, 1995 increased by $16 million during the year.
Portfolio growth in the last three quarters of 1995 were partially offset by
the decline of $6 million in the first quarter of 1995. Loan paydowns for the
first quarter were unusually high, with Entertainment related loans declining
$7 million as a number of project related loans paid off, combined with
normal payoffs and seasonality in the commercial portfolio.
26
27
The Bank's focus on middle market lending, in its infancy at year-end 1992,
gained momentum in 1993 and further accelerated in 1994. Total loans
increased $34 million during 1994. Offsetting this, the remaining Held for
Sale mortgages of $10.4 million at December 31, 1993 were sold in the first
quarter of 1994. Excluding this planned liquidation, loans increased by $44
million, or 34%, for the year ended December 31, 1994.
TABLE 1 LOAN PORTFOLIO COMPOSITION
Amounts in thousands of dollars
1995 1994 1993 1992 1991
--------------------------------------------------------------------------------------
Commercial & Industrial Loans $164,966 87% $142,885 82% $ 93,549 67% $ 87,999 43% $127,553 45%
Real Estate Loans:
Commercial 20,190 10 26,528 15 28,901 21 35,751 17 38,437 1
Held for Sale 0 0 10,426 7 40,167 19 40,350 14
Mortgages 5,470 3 4,773 3 6,559 5 36,320 18 52,785 19
Construction 0 416 1,226 2,392 1 14,368 5
Term federal funds sold 0 0 0 4,000 2 12,000 4
-------- --- -------- --- -------- --- -------- --- -------- ---
Total loans net of unearned
fees $190,626 100% $174,602 100% $140,661 100% $206,629 100% $285,493 100%
======== === ======== === ======== === ======== === ======== ===
TABLE 1A: LOAN PORTFOLIO MATURITIES AT DECEMBER 31, 1995
(in Thousands)
WITHIN AFTER ONE AFTER
ONE BUT WITHIN FIVE
YEAR FIVE YEARS YEARS TOTAL
-------- ---------- ------ --------
Commercial & Industrial Loans $126,834 $33,029 $5,103 $164,966
Real Estate - Commercial & Mortgage 6,918 15,797 2,945 25,660
-------- ------- ------ --------
Total loans $133,752 $48,826 $8,048 $190,626
======== ======= ====== ========
Loans due after one year with
predetermined interest rates $3,911 $1,464
Loans due after one year with
floating or adjustable rates 44,915 6,584
------- ------
$48,826 $8,048
======= ======
Table 1a above summarizes the maturities of the loan portfolio based upon the
contractual terms of the loans. The Bank does not automatically rollover any
loans at maturity. Maturing loans must go through the Bank's normal credit
approval process in order to receive a new maturity date.
The Bank lending effort is focused on business lending to middle market
customers. Current credit policy permits commercial real estate lending
generally only as part of a complete commercial banking relationship with a
middle market customer. Commercial real estate loans are secured by first or
second liens on office buildings and other structures. The loans are secured by
real estate that had appraisals in excess of loan amounts at origination.
Monitoring and controlling the Bank's allowance for loan losses is a continuous
process. All loans are assigned a risk grade, as defined by credit policies, at
origination and are monitored to identify changing circumstances that could
modify their inherent risks. These classifications are one of the criteria
considered in determining the adequacy of the allowance for loan losses.
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28
The amount and composition of the allowance for loan losses is as follows:
TABLE 2 ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
Amounts in thousands of dollars
DECEMBER 31,
1995 1994 1993 1992 1991
---- ---- ---- ---- ----
Amounts in thousands of dollars
Commercial & Industrial Loans $6,594 $7,096 $5,699 $11,597 $11,147
Real estate loans - Held for Sale 0 0 67 368 90
Real estate loans - Mortgages 0 0 225 249 28
Real estate loans - Construction 0 0 10 62 100
Other loans 0 0 0 19 0
------ ------- ------ ------- -------
Loans 6,594 7,096 6,001 12,295 11,365
Unfunded commitments and letters of
credit 336 331 512 691 1,002
------ ------ ------ ------- -------
Total Allowance for loan losses $6,930 $7,427 $6,513 $12,986 $12,367
====== ====== ====== ======= =======
Adequacy of the allowance is determined using management's estimates of the
risk of loss for the portfolio and individual loans. Included in the criteria
used to evaluate credit risk are, wherever appropriate, the borrower's cash
flow, financial condition, management capabilities, and collateral valuations,
as well as industry conditions. A portion of the allowance is established to
address the risk inherent in general loan categories, historic loss experience,
portfolio trends, economic conditions, and other factors. Based on this
assessment a provision for loan losses may be charged against earnings to
maintain the adequacy of the allowance. The allocation of the allowance based
upon the risks by type of loan, as shown in Table 2, implies a degree of
precision that is not possible when using judgments. While the systematic
approach used does consider a variety of segmentations of the portfolio,
management considers the allowance a general reserve available to address risks
throughout the entire loan portfolio.
Activity in the allowance, classified by type of loan, is as follows:
TABLE 3 ANALYSIS OF THE CHANGES IN THE ALLOWANCE FOR LOAN LOSSES
Amounts in thousands of dollars
1995 1994 1993 1992 1991
---- ---- ---- ---- ----
Balance at January 1 $7,427 $6,513 $12,986 $12,367 $4,128
----- ----- ------ ------ -----
Loans charged off:
Real estate secured loans 529 486 3,266 4,425 1,220
Commercial loans secured and unsecured loans 543 820 6,582 12,562 5,422
Loans to individuals, installment and other loans 17 107 901 813 258
-- --- --- --- ---
Total charge-offs 1,089 1,413 10,749 17,800 6,900
----- ----- ------ ------ -----
Recoveries of loans previously charged off:
Real estate secured loans 58 586 393 249 15
Commercial loans secured and unsecured 522 1,735 3,189 1,001 819
Loans to individuals, installment and 12 6 244 79 38
-- - --- ---- ----
Total recoveries of loans previously charged off 592 2,327 3,826 1,329 872
--- ----- ----- ----- ----
Net charge-offs 497 (914) 6,923 16,471 6,028
Provision for loan losses 0 0 450 17,090 14,267
-- - --- ------ ------
Balance at December 31 $6,930 $7,427 $6,513 $12,986 $12,367
===== ===== ===== ====== ======
Net loan charge-offs (recoveries) as a percentage
of average gross loans outstanding during the
year ended December 31 .28% (0.61)% 3.49% 6.70% 2.36%
==== ======= ===== ===== =====
The Bank's policy concerning nonperforming loans is more conservative than is
generally required. It defines nonperforming assets as all loans ninety days
or more delinquent, loans classified nonaccrual, and foreclosed, or in
substance foreclosed real estate. Nonaccrual loans are those whose interest
accrual has been discontinued because the loan has become ninety days or more
past due. In addition, it includes loans where there exists reasonable doubt
as to
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29
the full and timely collection of principal or interest. When a loan is placed
on nonaccrual status, all interest previously accrued but uncollected is
reversed against operating results. Subsequent payments on nonaccrual loans are
treated as principal reductions. At December 31, 1995, nonperforming loans
amounted to $1 million compared with $36 thousand at December 31, 1994.
Potential problem loans are defined as loans as to which there are serious
doubts about the ability of the borrowers to comply with present loan repayment
terms. It is the policy of the Bank to place all potential problem loans on
nonaccrual status. At December 31, 1995, therefore, the Bank had no potential
problem loans other than those disclosed in Table 4 as nonperforming loans.
TABLE 4: NONPERFORMING ASSETS
Amounts in thousands of dollars
DECEMBER 31,
1995 1994 1993 1992 1991
---- ---- ---- ---- ----
Loans not performing (1) $1,024 $36 $ 378 $ 8,978 $14,955
Insubstance foreclosures 0 0 1,000 4,652 1,512
------ --- ------- ------- -------
Total nonperforming loans 1,024 36 1,378 13,630 16,467
Other real estate owned 0 0 920 0 4,564
------ --- ------- ------- -------
Total nonperforming assets $1,024 $36 $2,298 $13,630 $21,031
====== ==== ====== ======= =======
Allowance for loan losses as a percent of:
Nonperforming loans 677% 20,631% 473% 95% 75%
Nonperforming assets 677 20,631 283 95 59
Nonperforming assets as a percent of total assets 0.3 0 0.8 3.8 4.2
Nonperforming loans as a percent of total loans 0.5 0 1.0 6.6 5.8
Note 1:
Loans not performing $1,024 $36 $ 9 $ 2,895 $4,783
Performing as agreed 0 0 369 1,075 1,531
Partial performance 0 0 0 5,008 8,641
------ --- ------- ------- --------
Not performing $1,024 $36 $ 378 $ 8,978 $14,955
====== === ======= ======= ========
Nonaccrual:
Loans $1,024 $36 $ 378 $ 7,728 $11,357
Troubled debt restructurings 0 0 0 1,250 1,326
Loans past due ninety or more days(a): 0 0 0 0 2,272
(a) Past due with respect to principal and/or interest and continuing to
accrue interest.
SECURITIES
The Securities Held to Maturity portfolio totaled $67 million at December 31,
1995, compared with $74 million at year-end 1994. In the fourth quarter of
1995, the Bank performed a one-time reassessment of the designations of
securities as held to maturity or available for sale, in accordance with a
special report issued by the Financial Accounting Standards Board on the
subject of investments. As a result of this assessment, $5.9 million of
collateralized mortgage obligations were transferred out of the held to
maturity portfolio into the available for sale portfolio.
The Securities Available for Sale portfolio totaled $6.3 million at December
31, 1995, with no investments being included in this category in 1994.
Included in the December 31, 1995 balance is an unrealized gain of $143
thousand.
There have been no realized gains or losses on securities in 1995 or 1994.
Gains of $77 thousand were realized in 1993. At December 31, 1995, there were
unrealized gains of $623 thousand and losses of $244 thousand in the securities
held to maturity portfolio.
Additional information concerning securities is provided in the footnotes to
the accompanying financial statements.
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OTHER REAL ESTATE OWNED
There was no Other Real Estate Owned on the Bank's balance sheet at December
31, 1995 and 1994. The Bank's policy is to carry properties acquired in
foreclosure at fair value less estimated selling costs, which is determined
using recent appraisal values adjusted, if necessary, for other market
conditions. Loan balances in excess of fair value are charged to the allowance
for loan losses when the loan is reclassified to other real estate. Subsequent
declines in fair value are charged against a valuation allowance for other real
estate owned, created by charging a provision to other operating expenses.
The Bank has not had any significant expenses related to Other Real Estate
Owned in 1995 or 1994. In 1993, expenses related to Other Real Estate Owned
totaled $234 thousand.
DEPOSIT CONCENTRATION
Prior to 1992, the Bank's focus on real estate-related activities resulted in a
concentration of deposit accounts from title insurance and escrow companies.
As the Bank has changed its focus to commercial lending, the amounts of title
and escrow related deposits has declined for the past three years. These
deposits are generally noninterest bearing transaction accounts that contribute
to the Bank's interest margin. Noninterest expense related to these deposits
is included in other operating expense. The Bank monitors the profitability of
these accounts through an account analysis procedure.
The Bank offers products and services allowing customers to operate with
increased efficiency. A substantial portion of the services, provided through
third party vendors, are automated data processing and accounting for trust
balances maintained on deposit at the Bank. These and other banking related
services, such as deposit courier services, will be limited or charged back to
the customer if the deposit relationship profitability does not meet the Bank's
expectations.
Noninterest bearing deposits represent nearly the entire title and escrow
relationship. These balances have been reduced substantially as the Bank
focused on middle market business loans. The balance at December 31, 1995, was
$20 million compared to $44 million at December 31, 1994. The bank has
greatly reduced their reliance on title and escrow deposits, with these
relationships representing approximately 7% of deposits in 1995, and 17% at
year end 1994.
TABLE 5 REAL ESTATE ESCROW AND TITLE
INSURANCE COMPANY DEPOSITS AMOUNTS IN
THOUSANDS OF DOLLARS
AVERAGE BALANCE
YEAR ENDED 12 MONTHS ENDED
DECEMBER 31, 1995 DECEMBER 31, 1995
----------------- -----------------
PERCENT OF PERCENT PERCENT OF PERCENT
TOTAL OF TOTAL OF
AMOUNT DEPOSITS CLASS AMOUNT DEPOSITS CLASS
-------- --------------- ------ ------ --------------- --------
1995 Balances
Noninterest bearing demand deposits $19,633 6.9% 20.9% $21,747 7.6% 23.1%
Interest-bearing demand & savings deposits 877 .3 .5 1,274 .5 .7
------- --- -------
Total deposit concentration $20,510 7.2% $23,021 8.1%
======= ==== ======= ====
1994 Balances $45,645 17.3% $46,171 19.8%
======= ===== ======= =====
The Bank had $45 million in certificates of deposit larger than $100 thousand
dollars at December 31, 1995. The maturity distribution of these deposits is
relatively short term, with $31 million maturing within 3 months and $43
million maturing within 12 months.
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31
LIQUIDITY AND INTEREST RATE SENSITIVITY
The objective of liquidity management is to ensure the Bank's ability to meet
cash requirements. The liquidity position is managed giving consideration to
both on and off-balance sheet sources and demands for funds.
Sources of liquidity include cash and cash equivalents (net of Federal Reserve
requirements to maintain reserves against deposit liabilities), securities
eligible for pledging to secure borrowings from dealers pursuant to repurchase
agreements, loan repayments, deposits, and borrowings from a $25 million
overnight federal funds line available from a correspondent bank. Potential
significant liquidity requirements are withdrawals from noninterest bearing
demand deposits and funding of commitments to loan customers.
From time to time the Bank may experience liquidity shortfalls ranging from one
to several days. In these instances, the Bank will either purchase federal
funds, and/or sell securities under repurchase agreements. These actions are
intended to bridge mismatches between funding sources and requirements, and are
designed to maintain the minimum required balances. The Bank has had no Fed
Funds purchased or borrowings under repurchase agreements during 1994 or 1995.
During 1994 and 1995, loan growth for the Bank outpaced growth of deposits from
the Banks commercial customers. The Bank funded this growth, combined with the
Bank's reduced concentration in title and escrow deposits, in part with
certificates of deposit from customers from outside the Bank's normal service
area. These out of area deposits are certificates of deposit of $90,000 or
greater, that are priced competitively with similar certificates from other
financial institutions throughout the country. At December 31, 1995, the Bank
had approximately $83 million of these out of area deposits, up from $55
million at December 31, 1994. The Bank's experience with raising out of area
deposits for the past two years indicates that the balances are quite stable
when priced to the current market.
The Bank's portfolio of large certificates of deposit (those of $100 thousand
or more), includes both deposits from its base of commercial customers and out
of area deposits. At December 31, 1995 this funding source was 17% of average
deposits, compared to 16% at December 31, 1994.
TABLE 6 INTEREST RATE MATURITIES OF EARNING ASSETS AND FUNDING LIABILITIES AT
DECEMBER 31, 1995
Amounts in thousands of dollars
AMOUNTS MATURING OR REPRICING IN
-------------------------------------------------------------------------
MORE THAN MORE THAN MORE THAN
3 MONTHS BUT 6 MONTHS BUT 9 MONTHS BUT
LESS THAN LESS THAN LESS THAN LESS THAN 12 MONTHS
3 MONTHS 6 MONTHS 9 MONTHS 12 MONTHS & OVER
Amounts in thousands of dollars ----------- ------------ ------------ ----------- ---------
Earning Assets
Gross Loans $184,535 $ 421 $ 294 $ 82 $ 5,293
Investments 6,973 4,505 5,049 5,109 51,444
Federal funds sold & other 32,500 0 0 0 0
-------- -------- ------- ------- -------
Total earning assets 224,008 4,926 5,343 5,191 56,738
-------- -------- ------- ------- -------
Interest bearing deposits:
Savings and interest bearing demand 74,413 0 0 0 0
Time certificates of deposit:
Under $100 33,766 17,141 5,451 7,390 7,118
$100 or more 31,164 8,233 1,100 2,351 2,284
Non interest bearing demand deposits 13,920 0 0 0 0
-------- -------- ------- ------- -------
Total interest bearing liabilities 153,263 25,374 6,551 9,741 9,402
-------- -------- ------- ------- -------
Interest rate sensitivity gap 70,745 (20,448) (1,208) (4,550) 47,336
-------- -------- ------- ------- -------
Cumulative interest rate sensitivity gap 70,745 50,297 49,089 44,539 91,875
Off balance sheet financial instruments 0 0 0 0 0
- - -- - -
Net cumulative gap $ 70,745 $ 50,297 $49,089 $44,539 $91,875
======== ======== ======= ======= =======
Adjusted cumulative ratio of rate sensitive
assets to rate sensitive liabilities(1) 1.46% 1.28% 1.27% 1.23% 1.45%
===== ===== ===== ==== =====
(1) Ratios greater than 1.0 indicate a net asset sensitive position. Ratios
less than 1.0 indicate a liability sensitive position. A ratio of 1.0
indicates risk neutral position.
31
32
Assets and liabilities shown on Table 5 are categorized based on contractual
maturity dates. Maturities for those accounts without contractual maturities
are estimated based on the Bank's experience with these customers. Noninterest
bearing deposits of title and escrow companies, having no contractual maturity
dates, are considered subject to more volatility than similar deposits from
commercial customers. The net cumulative gap position shown in the table above
indicates that the Bank does not have a significant exposure to interest rate
fluctuations during the next twelve months.
CAPITAL
Total shareholders' equity was $33 million at December 31, 1995, compared to
$30 million at year-end 1994. This increase was due to earnings, plus the
exercise of stock options and warrants. The Bank is guided by statutory
capital requirements, which are measured with three ratios, two of which are
sensitive to the risk inherent in various assets and which consider off-balance
sheet activities in assessing capital adequacy. During 1995 and 1994, the
Bank's capital levels substantially exceeded the "well capitalized" standards,
the highest classification established by bank regulators.
TABLE 7 CAPITAL RATIOS
REGULATORY STANDARDS
--------------------
DEC 31, DEC 31, WELL -
1995 1994 CAPITALIZED MINIMUM
------- ------- ----------- --------
Total Risk Based Capital 16.19% 15.40% 10.00% 8.00%
Tier 1 Risk Based Capital 14.92 14.12 6.00 4.00
Equity to Average Assets 10.52 10.44 5.00 3.00
In February of 1995, the Company declared a dividend of $.02 per share payable
March 13, 1995 to shareholders of record February 20, 1995. The Company also
declared a dividend of $.02 per share for the quarter ended June 30, 1995,
payable September 4, 1995 to shareholders of record August 15, 1995. During
the third quarter, the company declared a dividend $.02 per share, payable
November 27 to shareholders of record November 13. For the fourth quarter of
1995, the company declared a dividend of $.02 per share, payable February 28 to
shareholders of record January 31. The dividend payout ratio was 13% for the
year ending December 31, 1995. No dividends were paid in 1994 .
The common stock of the Company is listed on the National Association of
Securities Dealers Automated Quotation (Nasdaq) National Market Systems where
it trades under the symbol CUBN.
TABLE 8 STOCK PRICES - UNAUDITED
1995 1994
------------------- ------------------
HIGH LOW HIGH LOW
----- ----- ----- -----
First Quarter $7.50 $6.75 $7.50 $6.50
Second Quarter 7.50 6.88 7.00 5.75
Third Quarter 8.75 6.94 7.50 6.00
Fourth Quarter 10.25 8.38 8.00 6.75
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EARNINGS BY LINE OF BUSINESS
Prior to the sale of the mortgage origination operation in November, 1993, the
Bank operated a commercial bank and a mortgage bank as two distinct business
segments. Since 1994, real estate lending is generally only done as part of a
commercial banking relationship. After 1993, therefore, the Bank operates as
only a single segment, the commercial banking operation. Table 9 shows the
pre-tax operating contributions.
TABLE 9 PRE-TAX OPERATING CONTRIBUTION BY LINE OF BUSINESS (i)
Amounts in thousands of dollars
1995 1994 1993
------ ------ --------------------------------------------
COMMERCIAL MORTGAGE
CONSOLIDATED CONSOLIDATED CONSOLIDATED BANKING BANKING
------------ ------------ ------------ ------- -------
Net interest income $15,536 $13,881 $14,431 $13,844 $587
Provisions for loan losses 0 0 450 200 250
- - --- --- ---
Risk adjusted net interest income 15,536 13,881 13,981 13,644 337
Noninterest revenue 1,682 2,836 24,940 1,032 23,908
----- ----- ------ ----- ------
Total revenues 17,218 16,717 38,921 14,676 24,245
------ ------ ------ ------ ------
Salaries and related benefits 6,834 6,335 11,020 6,151 4,869
Other operating expenses 5,720 7,800 25,416 7,738 17,678
----- ----- ------ ----- ------
Total operating expenses 12,554 14,135 36,436 13,889 22,547
------ ------ ------ ------ ------
Operating income 4,664 2,582 2,485 787 1,698
Gain on sale of mortgage origination 1,483
operation
Gain on sale of mortgage servicing 383 2,572
portfolio
Restructuring charge (600)
Reserve for branch relocation - - (447)
------ ------ ------
Income before taxes $5,047 $4,554 $3,521 $787 $1,698
====== ====== ====== ==== ======
(i) Inter-divisional transactions for 1993 have been eliminated at the
division level.
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34
NET INTEREST INCOME AND INTEREST RATE RISK
Net interest income is the difference between interest and fees earned on
earning assets and interest paid on funding liabilities. Net interest income
was $15.5 million for the year ended December 31, 1995 compared to $13.9
million in 1994 and $14.4 million in 1993. The change in 1995 is attributable
to changes in volume and deposit mix. The Bank's net interest income has
improved with the growth of the commercial loan portfolio from 1994 to 1995.
This improvement was offset in part by the change in deposit mix away from non
interest bearing title and escrow deposits, and the increase in certificates of
deposit. The change in 1994 is primarily attributable to lower levels of
average loans and deposits in 1994 being offset by favorable rate variations.
TABLE 10 ANALYSIS OF CHANGES IN NET INTEREST INCOME (1)
Amounts in thousands of dollars
Increases(Decreases)
YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31,
1995 COMPARED TO 1994 1994 COMPARED TO 1993
--------------------------------- -------------------------------------
Volume Rate Total Volume Rate Total
------ ----- ------ ------- ------ -------
Interest Income
Loans, net $3,032 $1,625 $4,657 $(4,466) $2,015 $(2,451)
Investments 124 691 815 1,149 175 1,324
Federal Funds Sold 531 444 975 213 251 464
----- ------ ------ ------- ------ ------
Total interest income 3,687 2,760 6,447 (3,104) 2,441 (663)
----- ------ ------ ------- ------ ------
Interest Expense
Interest bearing deposits:
Demand 341 (457) (116) 185 (49) 136
Savings (22) 40 18 (73) 13 (60)
Time Certificates of deposit:
Under $100 2,761 531 3,292 (179) 197 18
$100 or more 1,129 557 1,686 (177) 166 (11)
Federal funds purchased/Repos 0 0 0 (79) (0) (79)
Other borrowings (70) (18) (88) (135) 18 (117)
----- ------ ------ ------- ------ ------
Total interest expense 4,139 653 4,792 (458) 345 (113)
----- ------ ------ ------- ------ ------
Net interest income $(452) $2,107 $1,655 $(2,646) $2,096 $ (550)
====== ====== ====== ======== ====== ========
(1) The change in interest income or interest expense that is attributable to
both change in average balance and average rate has been allocated to the
changes due to (i) average balance and (ii) average rate in proportion to the
relationship of the absolute amounts of the changes in each.
Yields on earning assets were approximately 8.9% for the year ended December
31, 1995, compared to 7.8% in 1994 and 7.6% in 1993. The higher average yield
on earning assets in 1995 is the result of both an increase in the prime rate
from an average of 7.1% in 1994 to an average of 8.8% in 1995, and an
increasing percentage of assets being held in loans.
The higher average yield on earning assets in 1994 is largely due to the higher
yield on loans as the prime rate began to rise in 1994. The average prime rate
of 7.1% compares with 6% for 1993. Through October 8, 1993, net interest
income continued to benefit from an interest rate swap agreement, discussed
below.
Rates on interest bearing liabilities resulted in an average cost of funds of
4.2% in 1995, compared with 3.0% for the comparable period of 1994 and 2.9% for
1993. In addition to the generally higher level of interest rates in 1995,
certificates of deposit represent a higher proportion of the funding
liabilities, rather than lower cost money market or savings accounts.
Expressing net interest income as a percent of average earning assets is
referred to as margin. Margin was 5.66% for 1995, compared to 5.99% in 1994
and 5.85% for 1993. The Bank's margin is strong because it has funded itself
with a
34
35
significant amount of noninterest bearing deposits. Margin in 1995 is somewhat
lower than 1994 due to the lower level of non interest bearing title and escrow
deposits in the current year. Margin in 1994 was higher than 1993 as the
benefits of rising interest rates offset the maturing of the interest rate swap
agreement discussed below.
Through October 8, 1993, the Bank continued to benefit from an interest rate
swap agreement entered into October 8, 1991, which had a notional amount of
$100 million. Under this arrangement, the Bank received a fixed rate of 8.18%
and paid interest at prime rate, which was 6.0% during 1993. The income earned
from the interest rate swap agreement was $0 in 1994 and 1995, compared to
$1.7 million in 1993.
TABLE 11 AVERAGE BALANCE SHEETS AND ANALYSIS OF NET INTEREST INCOME
Amounts in thousands of dollars
1995 1994 1993
------------------------------ ------------------------------ ------------------------------
Interest Interest Interest
Income or Yield or Income or Yield or Income or Yield or
Balance Expense Rate Balance Expense Rate Balance Expense Rate
------- ------- ---- ------- -------- ---- ------- ------- ----
Interest Earning Assets
Loans, Net(1) $170,511 $18,693 10.96% $141,878 $14,036 9.89% $188,967 $16,487 8.72%
Investments(2) 70,569 3,818 5.41 66,891 2,966 4.43 37,534 1,558 4.15
Certificates of Deposit
in other banks 48 2 4.17 1,010 39 3.88 4,102 123 3.00
Federal Funds Sold 32,614 1,893 5.80 22,100 918 4.15 15,927 454 2.85
-------- ------- ----- -------- ------- ----- -------- ------- ----
Total Earning Assets 273,742 24,406 8.92 231,879 17,959 7.74 246,530 18,622 7.55
------- ----- ------- ---- ------- ----
Non Earning Assets
Cash & Due From Banks 22,294 29,559 41,243
Other Assets 7,774 7,351 15,645
-------- -------- --------
Total Assets $303,810 $268,789 $303,418
======== ======== ========
Interest Bearing Liabilities
Demand $ 87,815 1,614 1.84 $ 71,821 1,730 2.41 $ 64,179 1,594 2.48
Savings 9,101 273 3.00 9,893 255 2.58 12,741 315 2.47
Time Certificates of Deposits
Less Than $100 68,103 4,289 6.30 22,144 997 4.50 26,577 979 3.68
More Than $100 40,959 2,459 6.00 19,713 773 3.92 24,737 784 3.17
Federal Funds Purchased/
Repos 0 0 0 0 0 0 2,712 79 2.91
-------- ------- ----- -------- ------- ---- -------- ------- ----
Total Interest Bearing
Liabilities 205,978 8,635 4.19 123,571 3,755 3.04 130,945 3,751 2.86
Non Interest Bearing Deposits 58,088 0 0 109,004 0 0 137,485 0 0
-------- ------- ----- -------- ------- ---- -------- ------- ----
Total Deposits 264,066 8,635 3.27 232,575 3,755 1.61 268,431 3,751 1.40
Other Borrowings 3,791 235 6.20 4,909 323 6.58 6,964 440 6.32
-------- ------- ----- -------- ------- ---- -------- ------- ----
Total Funding Liabilities 267,857 8,870 3.31 237,484 4,078 1.72 275,395 4,191 1.52
------- ----- ------- ---- ------- ----
Other Liabilities 5,085 3,264 2,175
Shareholders' Equity 30,868 28,006 25,848
-------- -------- --------
Total Liabilities and
Shareholders' Equity $303,810 $268,754 $303,418
======== ======== ========
Net Interest Income $15,536 5.68% $13,881 5.99% $14,431 5.85%
======= ==== ======= ==== ======= ====
Shareholders' Equity to
Total Assets 10.16% 10.42% 8.52%
===== ===== ====
(1) Non-accrual loans are included in average loan balances, and loan fees
earned have been included in interest income on loans.
(2) Tax exempt securities do not materially affect reported yields.
OTHER OPERATING INCOME
A significant portion of other operating income in 1994 was earned as mortgage
servicing rights were sold for a gain of $2.6 million. The Bank reported a gain
of $383 thousand on the sale of mortgage servicing in 1995, representing final
35
36
settlement payments received related to open issues on servicing sales from
prior quarters. At year end 1995, the Bank did not own any further servicing
rights.
The majority of other operating income for 1993 was earned as the Mortgage
Banking Operation originated and sold mortgage loans.
The Mortgage Banking Operation earned fee income on loans originated and gains
as loans were sold to permanent investors. Loans for which servicing was
retained were conventional mortgages under approximately $200 thousand which
were sold to the Federal National Mortgage Association, the Federal Home Loan
Mortgage Corporation, and other institutional investors. Excess servicing
rights were capitalized, and related gains recognized, based on the present
value of the servicing cash flows discounted over a period of seven years.
When loan prepayments occurred within this period, the remaining capitalized
cost associated with the loan was written off.
The servicing rights were retained by the Bank following sale of the mortgage
origination operation. The Bank entered into an agreement with the Federal
National Mortgage Association and the Federal Home Loan Mortgage Corporation to
dispose of any remaining portion of this portfolio by the end of 1994 because,
with the sale of the mortgage origination operation, the Bank was no longer a
qualified seller/servicer of such loans. During 1994, the bank sold the
retained servicing rights realizing gains of $2.6 million in 1994 and $383
thousand in 1995.
The trends and composition of other operating income are shown in the following
table.
TABLE 12 OTHER OPERATING INCOME
Amounts in thousands of dollars
1995 1994 1993
---- ---- ----
COMMERCIAL MORTGAGE
CONSOLIDATED CONSOLIDATED BANKING BANKING CONSOLIDATED
------------ ------------ -------- -------- ------------
Documentation fees $104 $99 $104 $826 $930
Gain on sale of SBA loans 262 65
Other service fees and charges 1,177 1,100 851 399 1,250
Gain on sale of mortgage servicing 383 2,572
Gain on sale of other real estate owned 139 585
Gain on sale of mortgage origination operation 1,483 1,483
Processing fees 1,143 1,143
Capitalization of excess servicing rights 207 207
Fees on loans sold 15 1,182 1,182
Premium on sales of mortgage loans (8) 18,022 18,022
Gain on sale of securities 77 77
Service income 980 2,129 2,129
------ ------ ------ ------- -------
Total $2,065 $5,408 $1,032 $25,391 $26,423
====== ====== ====== ======= =======
OPERATING EXPENSE
Total operating expenses for the Bank were $12.6 million year ended December
31, 1995 , compared to $14.7 million in 1994 and $36.9 million for 1993. The
year ended December 31, 1995 reflected lower expenses, in part because of a
reduction in FDIC insurance premiums paid, from $.23 to $.04 per $100 of
deposits. The current level of operating expense is deemed to be adequate and
will be leveraged further as the core middle market business is expanded.
The Bank restructured its branch operations functions in 1994, re-engineering
its entire work flow and information handling activities. This resulted in a
one time charge of $600 thousand for severance pay and other expenses
associated with the changes to the operating policies and procedures. Operating
expense for the commercial bank excluding this charge was
36
37
$12.6 million in 1995, compared to $14.1 million in 1994 and $13.9 million in
1993. Operating expenses for the consolidated Bank declined in 1994, primarily
due to the sale of the mortgage origination operation at the end of 1993.
Expenses for the Mortgage Banking Division were $22.5 million in 1993. Premium
on sales of mortgage loans included in other operating income is directly
related to these expenses and subject to the same factors and conditions. The
premium on sales of mortgage loans was $18.0 million in 1993.
PROVISION FOR LOAN LOSSES
The Bank has made no provision for loan losses in 1995 or 1994 , compared with
$450 thousand for 1993. No loan loss provision has been deemed necessary for
1995 and 1994, due to the declining levels of nonperforming assets, net
recoveries received in 1994, and the strong reserve position. The relationship
between the level and trend of the allowance for loan losses and nonperforming
assets, combined with the results of the ongoing review of credit quality,
determine the level of provisions.
LEGAL AND REGULATORY
In the normal course of business the Bank occasionally becomes a party to
litigation. In the opinion of management, based upon consultation with legal
counsel, the Bank believes that pending or threatened litigation involving the
Bank will have no adverse material effect upon its financial condition, or
results of operations.
Since June 1992, the Bank has developed a very positive and proactive
relationship with its primary regulators. Results of regular safety and
soundness examinations have documented the progress the Bank has achieved.
Management is committed to the continuation of this process and maintaining our
high standing with our regulators. The following comments refer to regulatory
situations that existed in prior years that are reflected in the prior period
financial statements provided herein. All of these situations have been
successfully resolved and repaired as management transitioned the Bank to its
present condition and performance.
In June 1992, the Bank entered into an agreement with the Office of the
Comptroller of the Currency (OCC), the Bank's primary federal regulator, which
required the implementation of certain policies and procedures for the
operation of the bank to improve lending operations and management of the loan
portfolio. In November 1993, after completion of its annual examination, the
OCC released the Bank from the Formal Agreement. Following this, the Federal
Reserve Bank of San Francisco ("Fed") notified the Company on November 29,
1993, that the Memorandum of Understanding, which it had signed, was terminated
because the requirements of the agreement were satisfied.
MARKET EXPANSION AND ACQUISITIONS
The Bank is committed to expanding the market penetration of the commercial
bank, including the creation of new branches and pursuing acquisition
opportunities. During 1995, the Bank converted its former loan production
offices in Ventura County, the San Gabriel Valley and the South Bay to full
service banking offices in improved facilities. This expanded the Bank's
branch system to five full service locations serving the greater Los Angeles
area.
37
38
In March, 1995, the Company entered into an agreement to acquire Santa Ana
based Corporate Bank. The agreement was subsequently amended in October 1995
and the transaction was completed on January 12, 1996 for stock and cash. This
acquisition brings two Orange County branches to the Bank, representing an
important geographic expansion.
Table 13 is an approximation of how the Bank's balance sheet would have
appeared had the acquisition of Corporate Bank closed by December 31, 1995:
On January 10, 1996, the Bank announced an agreement to merge with Home
Interstate Bancorp, parent of Home Bank, based in the South Bay. The merger
with Home Bank is expected to be completed in mid - 1996, and will create a
Bank with 22 branches and over $800 million in assets.
Table 13: Pro Forma Balance Sheet
Pro Forma
California United Corporate Bank Combined
----------------- --------------- --------
Bank
----
Cash and due from banks $28,376 $ 4,479 $ 32,855
Federal funds sold 32,500 13,000 45,500
------ ------ ------
Total cash and cash equivalents 60,876 17,479 78,355
Securities held to maturity 66,735 66,735
Securities available for sale 6,345 4,336 10,681
Loans, net 183,696 46,079 228,675
Other real estate owned 0 0 0
Premises and other assets 7,657 1,635 13,186
----- ----- ------
Total Assets $325,309 $69,529 $397,632
======== ======= ========
Demand deposits $ 94,099 $26,354 $120,453
Savings and interest bearing demand 74,413 22,511 96,924
Time deposits 115,998 12,258 128,256
------- ------ -------
Total deposits 284,510 61,123 345,633
Other Liabilities 7,796 1,628 12,504
Shareholders' equity 33,003 6,778 39,495
------ ----- -------
Total Liabilities and shareholders' equity $325,309 $69,529 $397,632
======== ======= ========
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page
- --------------------------------------------------- ----
1. Report of Independent Public Accountants dated January 19, 1996 39
2. Consolidated Statements of Financial Condition as of December 31, 1995 and 1994; 40
3. Consolidated Statements of Income for the Years Ended December 31, 1995, 1994, and 1993, 41
4. Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31,
1995, 1994, and 1993; 42
5. Consolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994, and 1993; 43
6. Notes to Consolidated Financial Statements - December 31, 1995 44
38
39
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors of CU Bancorp and Subsidiary:
We have audited the accompanying consolidated statements of financial
conditions of CU Bancorp and Subsidiary (the Company) as of December 31, 1995
and 1994, and the related consolidated statements of income, changes in
shareholders' equity and cash flows for each of the three years then ended.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of CU Bancorp and Subsidiary as
of December 31, 1995 and 1994, and the results of its operations and its cash
flows for each of the three years then ended in conformity with generally
accepted accounting principles.
ARTHUR ANDERSEN LLP
Los Angeles, California
January 19, 1996
39
40
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
CU BANCORP AND SUBSIDIARY
DECEMBER 31,
Amounts in thousands of dollars, except share data 1995 1994
----- -----
ASSETS
Cash and due from banks $28,376 $35,397
Federal funds sold 32,500 20,000
------ ------
Total cash and cash equivalents 60,876 55,397
Securities held to maturity (Market value of $67,114 and $71,423 66,735 74,153
at December 31, 1995 and 1994, respectively)
Securities available for sale, at market value 6,345 0
----- -
Total Securities 73,080 74,153
Loans, (Net of allowance for loan losses of $6,930 and
$7,427 at December 31, 1995 and 1994, respectively) 183,696 167,175
Premises and equipment, net 1,111 996
Other real estate owned, net 0 0
Accrued interest receivable and other assets 6,546 6,433
----- -----
Total Assets $325,309 $304,154
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Demand, non-interest bearing $94,099 $112,034
Savings and interest bearing demand 74,413 67,896
Time deposits under $100 70,866 47,836
Time deposits of $100 or more 45,132 36,415
------ ------
Total deposits 284,510 264,181
Accrued interest payable and other liabilities 7,793 10,229
----- ------
Total liabilities 292,303 274,410
------- -------
Commitments and contingencies
Shareholders' equity:
Preferred stock, no par value:
Authorized -- 10,000,000 shares
No shares issued or outstanding in 1995 or 1994 -- --
Common stock, no par value:
Authorized - 24,000,000 shares
Issued and outstanding - 4,636,462 in 1995, and 4,467,318 in 1994 27,264 26,430
Retained earnings 5,841 3,314
Unrealized gain on securities available for sale, net of taxes 83 --
Unearned Compensation (182) --
----- ---
Total Shareholders' equity 33,006 29,744
------ ------
Total liabilities and shareholders' equity $325,309 $304,154
======== ========
The accompanying notes are an integral part of these consolidated
statements.
40
41
CONSOLIDATED STATEMENTS OF INCOME CU BANCORP AND SUBSIDIARY
FOR THE YEARS ENDED DECEMBER 31,
Amounts in thousands of dollars, except per share data 1995 1994 1993
-------- -------- --------
REVENUE FROM EARNING ASSETS:
Interest and fees on loans $18,693 $14,036 $14,761
Benefits of interest rate hedge transactions 0 0 1,726
Interest on taxable investment securities 3,781 2,947 1,525
Interest on tax exempt securities 37 19 33
Interest on time deposits with other financial institutions 2 39 123
Interest on federal funds sold 1,893 918 454
------ ------ ------
Total revenue from earning assets 24,406 17,959 18,622
------ ------ ------
COST OF FUNDS:
Interest on savings and interest bearing demand 1,887 1,985 1,909
Interest on time deposits under $100 4,289 997 979
Interest on time deposits of $100 or more 2,459 773 784
Interest on federal funds purchased & securities sold under 0 0 79
agreements to repurchase
Interest on other borrowings 235 323 440
------ ------ ------
Total cost of funds 8,870 4,078 4,191
------ ------ ------
Net revenue from earning assets before provision for loan 15,536 13,881 14,431
losses
PROVISION FOR LOAN LOSSES 0 0 450
------ ------ ------
Net revenue from earning assets 15,536 13,881 13,981
------ ------ ------
OTHER OPERATING REVENUE:
Capitalization of excess servicing rights 0 0 207
Servicing income - mortgage loans sold 0 980 2,129
Service charges and other fees 1,682 1,121 955
Fees on loans sold 0 15 1,182
Premium on sales of mortgage loans 0 (8) 18,022
Other fees and charges - mortgage 0 143 2,368
Gain on sale of mortgage servicing portfolio 383 2,572 0
Gain on sale of mortgage origination operation 0 0 1,483
Gain on sale of other real estate owned 0 585 0
Gain on sale of investment securities (before taxes of $11 in 1993) 0 0 28
Gain on sale of securities available for sale (before taxes of $20 in 0 0 49
1993) - - --
Total other operating revenue 2,065 5,408 26,423
----- ------ ------
OTHER OPERATING EXPENSES:
Salaries and related benefits 6,834 6,335 11,020
Selling expenses - mortgage loans 0 333 12,193
Restructuring Charge 0 600 0
Other operating expenses 5,720 7,467 13,670
------ ------ ------
Total operating expenses 12,554 14,735 36,883
------ ------ ------
Income before provision for income taxes 5,047 4,554 3,521
Provision for income taxes 2,153 1,980 1,423
------ ------ ------
NET INCOME $2,894 $2,574 $2,098
====== ====== ======
EARNINGS PER COMMON AND EQUIVALENT SHARE $0.60 $0.56 $ 0.47
===== ===== ======
The accompanying notes are an integral part of these consolidated financial
statements.
41
42
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
CU BANCORP AND SUBSIDIARY
COMMON STOCK
----------------------------------------------------------------------------
Amounts in thousands of dollars except share data UNREALIZED GAIN
NUMBER RETAINED ON SECURITIES UNEARNED
OF SHARES AMOUNT EARNINGS AVAILBLE FOR SALE COMPENSATION TOTAL
----------------------------------------------------------------------------
Balance at December 31, 1992 4,366,850 $25,990 $(1,358) $24,632
Exercise of stock options 57,456 260 0 260
Net income for the year 0 0 2,098 2,098
--------- ------- ------- --- ----- -------
Balance at December 31, 1993 4,424,306 26,250 740 26,990
Exercise of stock options 1,000 5 0 5
Exercise of director warrants 42,012 175 0 175
Net Income for the year 0 0 2,574 2,574
--------- ------- ------- --- ----- -------
Balance at December 31, 1994 4,467,318 26,430 3,314 29,744
Exercise of stock options 15,120 87 87
Exercise of director warrants 135,024 562 562
Cash dividend declared ($.08 per share) (367) (367)
Restricted stock issued 19,000 185 $(185) 0
Compensation expense 3 3
Unrealized gains on securities available
of sale, net of tax $83 83
Net Income for the year 0 0 2,894 0 0 2,894
--------- ------- ------- --- ----- -------
Balance at December 31, 1995 4,636,462 $27,264 $ 5,841 $83 $(182) $33,006
========= ======= ======= === ===== =======
The accompanying notes are an integral part of these consolidated statements
42
43
CONSOLIDATED STATEMENTS OF CASH FLOWS
CU BANCORP AND SUBSIDIARY
Amounts in thousands of dollars FOR THE YEARS ENDED DECEMBER 31,
1995 1994 1993
----- ----- ----
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $2,894 $2,574 $2,098
------ ------ ------
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for depreciation and amortization 553 459 821
Amortization of real estate mortgage servicing rights 0 15 983
Provision for losses on loans and other real estate owned 0 0 450
Provision (benefit) of deferred taxes 1,138 (1,180) 1,510
Gain on sale of investment securities, net 0 0 (77)
Increase/(decrease) in other assets (785) 3,781 2,628
Increase/(decrease) in other liabilities (2,845) (3,035) 2,582
(Increase)/decrease in accrued interest receivable (526) (766) 494
Increase/(decrease) in deferred loan fees (130) 160 48
Capitalization of excess mortgage servicing rights 0 0 (207)
Increase/(decrease) in accrued interest payable 412 (24) (11)
Net amortization of (discount)/premium on investment securities 610 972 48
Accrued benefits from interest rate hedge transactions 0 0 485
------ ------ ------
Total adjustments (1,573) 382 9,754
------ ------ ------
Net cash provided by operating activities 1,321 2,956 11,852
------ ------ ------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from investment securities sold or matured 17,782 52,882 78,545
Purchase of investment securities (17,176) (39,973) (81,826)
Net decrease in time deposits with other financial institutions 0 1,377 1,979
Net (increase)/decrease in loans (16,391) (33,187) 58,997
Purchases of premises and equipment, net (668) (531) 290
------ ------ ------
Net cash provided (used in) by investing activities (16,453) (19,432) 57,985
-------- -------- ------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase/(decrease) in demand and savings deposits (11,418) (11,949) (81,848)
Net increase/(decrease) in time certificates of deposit 31,747 37,202 2,202
Proceeds from exercise of stock options and director warrants 649 180 260
Cash dividend paid (367) 0 0
------ ------ ------
Net cash provided (used) by financing activities 20,611 25,433 (79,386)
------ ------ --------
Net increase (decrease) in cash and cash equivalents 5,479 8,957 (9,549)
Cash and cash equivalents at beginning of year 55,397 46,440 55,989
------ ------ -------
Cash and cash equivalents at end of year $60,876 $55,397 $46,440
======= ======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the year:
Interest $8,457 $4,102 $4,179
Taxes 2,400 2,201
Supplemental disclosure of noncash investing activities:
Loans transferred to OREO 0 700 1,503
The accompanying notes are an integral part of these consolidated statements
43
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CU BANCORP AND SUBSIDIARY
DECEMBER 31, 1995
(Amounts in thousands unless otherwise specified)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES --
CU Bancorp, a bank holding company (the Company), is a California corporation.
The accounting and reporting policies of the Company and its subsidiary conform
with generally accepted accounting principles and general practice within the
banking industry. The following comments describe the more significant of those
policies.
(a) Principles of consolidation --
The accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiary, California United Bank N.A. (the
Bank). All significant transactions and accounts between the Company and the
Bank have been eliminated in the consolidated financial statements.
(b) Investment portfolio --
The Bank's investment portfolio is separated into two groups, Securities Held
to Maturity and Securities Available for Sale. Securities are segregated in
accordance with management's intention regarding their retention. Accounting
for each group of securities follows the requirements of SFAS 115 "Accounting
for Certain Investments in Debt and Equity Securities". The adoption of SFAS
115 in 1993 did not have a material impact on the financial position or results
of operations of the Bank.
The Bank has the intent and ability to hold Securities Held to Maturity until
maturity. Securities in this classification are carried at cost, adjusted for
amortization of premiums and accretion of discounts on a straight-line basis.
This approach approximates the effective interest method. Gains and losses
recognized on the sale of investment securities are based upon the adjusted
cost and determined using the specific identification method.
Securities Available for Sale are those where management has the willingness to
sell under certain conditions. This category of securities is carried at
current market value with unrealized gains or losses recognized as a tax
affected adjustment to shareholders' equity in the statement of financial
condition.
(c) Loans --
Loans are carried at face amount, less payments collected, allowance for loan
losses, and unamortized deferred fees. Interest on loans is accrued monthly on
a simple interest basis. The general policy of the Bank is to discontinue the
accrual of interest and transfer loans to non-accrual (cash basis) status where
reasonable doubt exists with respect to the timely collectibility of such
interest. Payments on non-accrual loans are accounted for using a cost recovery
method. No interest income is recorded on non-accrual loans.
Loan origination fees and commitment fees, offset by certain direct loan
origination costs, are deferred and recognized over the contractual life of the
loan as a yield adjustment.
The allowance for loan losses is maintained at a level considered adequate to
provide for losses that can reasonably be anticipated. Management considers
the nature of the portfolio, current economic conditions, historical loan loss
experience, and other factors in determining the adequacy of the allowance. The
allowance is based on estimates and ultimate losses may differ from current
estimates. These estimates are reviewed periodically and as adjustments become
necessary, they are charged to earnings in the period in which they become
known. The allowance is increased by provisions charged to operating expenses,
increased for recoveries of loans previously charged-off, and reduced by
charge-offs.
The Bank adopted SFAS 114, "Accounting by Creditors for Impairment of a Loan,"
and SFAS 118, "Accounting by Creditors for Impairment of a Loan-Income
Recognition and Disclosures," as of January 1, 1995. SFAS 114 requires that
impaired loans be measured based on the present value of expected future cash
flows discounted at the loan's effective interest rate. When the measure of
the impaired loan is less than the recorded balance of the loan, the impairment
is
44
45
recorded through a valuation allowance included in the allowance for loan
losses. The Bank had previously measured the allowance for loan losses using
methods similar to the prescribed in SFAS 114. As a result, no additional
provision was required by the adoption of this pronouncement.
The Bank considers all loans where reasonable doubt exists as to the payment of
interest or principal to be impaired loans. All loans that are ninety days or
more past due are automatically included in this category. An impaired loan
will be charged off when the Bank determines that repayment of principal has
become unlikely or subject to a lengthy collection process. All loans that are
six months or more past due and not well secured or in the process of
collection are charged off.
(d) Mortgage Banking Division --
The bank's real estate Mortgage Banking Division became operational in 1988.
The mortgage origination operation was sold November 10, 1993. The Bank
carried the first trust deed loans generated and held for sale by this
Operation at the lower of aggregate cost or market. As of December 31, 1993,
cost approximated market value. All loan inventory held for sale by this
division had been sold prior to the end of 1994.
During 1993, the Bank capitalized $207 in connection with the right to service
real estate mortgage loans originated in that Operation. This excess servicing
asset, included in other assets, was initially capitalized at its discounted
present value and amortized over a period of five to seven years. Amortization
for 1995, 1994, and 1993, was $0, $15, and $983 respectively.
(e) Premises and equipment --
Premises and equipment are carried at cost, less accumulated depreciation and
amortization. Depreciation is computed on the straight-line method over the
estimated useful life of the asset. Amortization is computed on the
straight-line method over the useful life of leasehold improvements or the
remaining term of the lease, whichever is shorter.
(f) Other real estate owned --
Other real estate owned, acquired through direct foreclosure or deed in lieu of
foreclosure, is recorded at the lower of the loan balance or estimated fair
market value. When a property is acquired, any excess of the loan balance over
the estimated fair market value is charged to the allowance for loan losses.
Subsequently, the assets are recorded at the lower of the new cost basis at
foreclosure or fair market value less estimated selling expenses. Subsequent
write-downs, if any, are included in other operating expenses in the period in
which they become known. Gains or losses on sales are recorded in conformity
with standards which apply to accounting for sales of real estate. The Bank had
no real estate owned at December 31, 1995, and at December 31, 1994.
(g) Interest Rate Derivatives --
The Company enters into interest rate hedge agreements which involve the
exchange of fixed and floating rate interest payments periodically over the
life of the agreement without the exchange of the underlying principal amounts.
The differential to be paid or received is accrued as interest rate change and
recognized over the life of the agreements as an adjustment to interest
expense.
Fees received in connection with loan commitments are deferred in other
liabilities until the loan is advanced and are then recognized over the term of
the loan as an adjustment of the yield. Fees on commitments that expire unused
are recognized in fees and commission revenue at expiration. Fees received for
guarantees are recognized as fee revenue over the term of the guarantees.
(h) Income taxes --
As discussed in Note 8, effective January 1, 1993, the Bank adopted the
Statement of Financial Accounting Standards No. 109 (SFAS No. 109), "Accounting
for Income Taxes." Under SFAS No. 109, deferred tax assets or liabilities are
computed based on the difference between the financial statement and income tax
basis of assets and liabilities using the enacted marginal tax rate. Deferred
income tax expenses or credits are based on the changes in the asset or
liability from period to period.
45
46
(i) Earnings per share (amounts in whole numbers) --
Earnings per share are computed based on the weighted average number of shares
and common stock equivalents outstanding during each year of 4,857,221 in 1995,
4,593,103 in 1994, and 4,489,861 in 1993, retroactively restated for stock
dividends and stock splits. Common stock equivalents include the number of
shares issuable on the exercise of outstanding options and warrants reduced by
the number of shares that could have been purchased with the proceeds from the
exercise of the options and warrants plus any tax benefits, based on the
average price of common stock.
(j) Statements of cash flows --
The Company presents its cash flows using the indirect method and reports
certain cash receipts and payments arising from customer loans and deposits,
and deposits placed with other financial institutions on a net basis. For
purposes of reporting cash flows, cash and cash equivalents include cash and
due from banks and federal funds sold. Generally, federal funds are sold for
one-day periods.
(k) Post-retirement benefits --
The Company provides no post-retirement benefits. Accordingly, the accounting
prescribed by Statement of Financial Accounting Standards No. 106 "Accounting
for Post-Retirement Benefits" has no effect on the Company's consolidated
financial statements.
(l) Stock-Based Compensation
In October 1995, the FASB issued SFAS No. 123 "Accounting for Stock-Based
Compensation". SFAS 123 requires all companies to change what they disclose
about their employee stock-based compensation plans, recommends that they
change how they account for these plans and requires those companies who do not
change their accounting to disclose what their earnings and earnings per share
would have been if they had changed their method of accounting pursuant to this
pronouncement. The Company has elected to continue to account for their
Stock-Based Compensation in accordance with Accounting Principles Board Opinion
(APBO 25) and to adopt only the disclosure requirements of SFAS 123. As a
result, the adoption of SFAS 123 will not have an impact on the financial
position or results of operations of the company.
(m) Reclassifications --
Certain amounts have been reclassified in the prior years to conform to
classifications followed in 1995.
(n) Accounting Estimates --
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
2. NATURE OF OPERATIONS --
The Bank engages in the commercial banking business serving the greater
Southern California metropolitan area, with offices located in the San Fernando
Valley, West Los Angeles, the San Gabriel Valley , the South Bay portion of
the County of Los Angeles, and Ventura County. The Bank's primary focus is to
engage in middle market lending to businesses, professionals, the entertainment
industry and high net-worth individuals. Retail or consumer banking business
is generally limited to the owners, officers and employees of its commercial
customers, and customers of accounting and business management firms with which
the Bank regularly does business. Deposit services which the Bank offers
include personal and business checking accounts and savings accounts, insured
money market deposit accounts, NOW accounts, and time certificates of
deposits, along with IRA and Keogh accounts. The Bank also provides other
customary banking services incidental to maintaining the commercial customer
relationships.
46
47
3. AVERAGE FEDERAL RESERVE BALANCES --
The average cash reserve balances required to be maintained at the Federal
Reserve Bank, under the Federal Reserve Act and Regulation D, were
approximately $2.4 million and $6.0 million for the years ended December 31,
1995 and 1994, respectively.
4. INVESTMENT PORTFOLIO --
A summary of Securities Held to Maturity at December 31, 1995 and 1994, is as
follows:
HELD TO MATURITY GROSS GROSS
BOOK UNREALIZED UNREALIZED MARKET
VALUE GAINS LOSSES VALUE
----- ----- ------ -----
1995
U.S. Treasury securities $66,704 $623 $ (244) $67,083
U.S. Government agency securities 31 -- 31
------- ---- ------- -------
Total investment portfolio $66,735 $623 $ (244) $67,114
======= ==== ======= =======
1994
U.S. Treasury securities $67,140 -- $(2,535) $64,605
U.S. Government agency securities 105 -- -- 105
State and municipal bonds 750 $ 9 -- 759
Mortgage-backed securities 5,725 -- (204) 5,521
Federal Reserve Bank stock 433 -- -- 433
------- ---- ------- -------
Total investment portfolio $74,153 $ 9 $(2,739) $71,423
======= ==== ======= =======
A summary of Securities Available for Sale for December 31, 1995 is as follows:
AVAILABLE FOR SALE GROSS GROSS
BOOK UNREALIZED UNREALIZED MARKET
VALUE GAINS LOSSES VALUE
------ ---- -- ------
1995
Mortgage -backed securities $5,769 $143 $5,912
Federal Reserve Bank stock 433 -- -- 433
------ ---- -- ------
$6,202 $143 $0 $6,345
====== ==== == ======
Investments with a book value of $27,900 and $29,200 were pledged as of
December 31, 1995 and 1994, respectively, to secure court deposits and for
other purposes as required or permitted by law. Included in interest on
investments in 1995, 1994, and 1993, is $0, $19, and $33, respectively, of
interest from tax-exempt securities.
Actual maturities may differ from contractual maturities because issuers may
have the right to call or prepay obligations with or without call or prepayment
penalties.
The amortized cost and market value of Securities Held to Maturity as of
December 31, 1995, by maturity, are shown below.
AMORTIZED MARKET
COST YIELD VALUE
---- ----- -----
Due in one year or less $21,714 5.3% $21,691
Due after one through five years 45,021 5.6 45,423
------- -------
$66,735 $67,114
======= =======
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48
At December 31, 1995, the securities available for sale portfolio consisted of
Federal Reserve Bank stock and mortgage backed securities. The Federal Reserve
Bank stock, with a 6% yield, has no stated maturity. The actual maturity of
the mortgage-backed securities is determined by the rate of repayment of the
loan pools collateralizing the securities. Actual cash maturities of the
Bank's mortgage-backed securities, with an approximate yield of 7%, are
expected to be from one to five years.
In December 1995, as permitted by a Special report of the Financial Accounting
Standards Board "A Guide to Implementation of Statement 115 on Accounting for
Certain Investments in Debt and Equity Securities", the Bank made a one time
transfer of investment securities into the Available for Sale portfolio. These
securities had an amortized cost and market value of $5,769 and $5,912,
respectively.
At December 31, 1994, there were no Securities Available for Sale.
Proceeds from the sales and maturities of debt securities during 1995, 1994,
and 1993 were $17,722, $52,882, and $78,545, respectively. Gains of $0, $0,
and $77 were realized on those transactions. There were no realized losses on
sales in 1995, 1994, and 1993.
5. LOANS --
The loan portfolio, net of unamortized deferred fees of $522 at December 31,
1995, and $652 at December 31, 1994, consisted of the following:
DECEMBER 31,
1995 1994
------------ --------
Commercial and industrial loans $164,966 $142,885
Commercial real estate loans 20,190 26,528
Real estate loans -- mortgages 5,470 4,773
Real estate loans -- construction 0 416
-------- --------
Gross Loans 190,626 174,602
Less - Allowance for loan losses (6,930) (7,427)
-------- --------
Net loans $183,696 $167,175
======== ========
At December 31, 1995, the Bank had $1,000 in impaired loans, against which a
loss allowance of $318 has been provided. The recorded loss allowance
for all impaired loans has been calculated based on the present value of
expected cash flows discounted at the loan's effective interest rate. All
impaired loans are on nonaccrual status, and as such no interest income is
recognized. The Bank had an average investment in impaired loans of
approximately $352 for the year ended December 31, 1995.
Total non-performing loans were $4,000 and $36 at December 31, 1995 and 1994,
respectively. The interest income, which would have been recognized had
non-accrual loans been current, amounted to $ 82, $6, and $469, in 1995, 1994,
and 1993, respectively. No interest income has been reported on non-accrual
loans for the years 1995, 1994, or 1993.
An analysis of the activity in the allowance for loan losses is as follows:
1995 1994 1993
------ -------- --------
Balance, beginning of period $ 7,427 $ 6,513 $ 12,986
Loans charged off (1,089) (1,413) (10,749)
Recoveries on loans previously charged off 592 2,327 3,826
Provision for loan losses 0 0 450
------- ------- --------
Balance, end of period $ 6,930 $ 7,427 $ 6,513
======= ======= ========
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6. LOANS TO RELATED PARTIES --
There were no loans to directors and their affiliates for the years ended 1995
and 1994.
7. PREMISES AND EQUIPMENT --
Book value of premises and equipment is as follows:
December 31,
1995 1994
------ ------
Furniture, fixtures and equipment $4,056 $3,796
Leasehold improvements 834 690
------ ------
Cost 4,890 4,486
Less - accumulated depreciation and amortization 3,779 3,490
------ ------
Net Book Value $1,111 $ 996
====== ======
The amounts of depreciation and amortization included in noninterest expense
were $553, $459, and $821 for the years ended December 31, 1995, 1994 and 1993,
respectively, and are based on estimated lives of 1 to 10 years for furniture,
fixtures and equipment, and leasehold improvements.
The Bank leases facilities under renewable operating leases. Rental expense for
premises included in occupancy expenses were $833 in 1995, $741 in 1994,
$1,133 in 1993. As of December 31, 1995, the approximate future lease payable
under the lease commitments is as follows:
Year ended December 31,--
1996 $ 851
1997 851
1998 811
1999 790
2000 215
Thereafter 0
------
$3,518
======
8. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
Financial instruments are defined as cash, evidence of an ownership interest in
an entity or a contract that both imposes contractual obligations and rights to
exchange cash, and/or other financial instruments on the parties to the
transaction.
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments:
Cash, Due From Banks and Federal Funds Sold
For these short term investments, the carrying amount is a reasonable estimate
of fair value.
Securities
Quoted market prices are available for substantially all of the securities
owned by the Bank, both in the Held to Maturity and Available for Sale
portfolios. These market quotes have been used to estimate fair value.
50
Loans
The fair value of loans was estimated by discounting the future cash flows
using current market rates adjusted for approximated credit risk, operating
costs and interest rate risk inherent in the portfolios. Future cash flows are
aggregated based upon the payment terms and maturities of the loans. The
discount rate is calculated as the sum of the risk-free rate, a credit quality
factor, an operating expense factor and a prepayment option price. The
risk-free rate is based on the U.S. treasury curve for the stated maturity.
The credit quality factor is based on a combination of the Bank's loss
experience and industry standards for various categories of loans. The
operating expense factor is based on an internal analysis of the Bank's costs
to deliver and service products.
Deposit Liabilities
Fair value for deposit liabilities without contractual maturities is equal to
the carrying value of those liabilities. This includes the bank's demand
deposits, NOW, savings and money market accounts. Fair value for certificates
of deposit are calculated by discounting the future cash flows using a current
market rate. The Bank's certificate of deposit portfolio has a fair value
which reasonably approximates carrying value, due to the short duration of the
portfolio.
Off Balance Sheet Items
The Bank's loan commitments are generally for variable rate loans representing
current market rates of interest. The Bank's letters of credit are generally
short term and are at terms consistent with the current market. Current
valuation of these off balance sheet instruments is immaterial. See footnote
11 for further description of these commitments.
DECEMBER 31, 1995 DECEMBER 31, 1994
BOOK VALUE, ESTIMATED BOOK VALUE, ESTIMATED
NET FAIR VALUE NET FAIR VALUE
----------- ---------- ----------- ----------
Cash & Due From Banks $ 28,376 $ 28,376 $ 35,397 $ 35,397
Federal Funds Sold 32,500 32,500 20,000 20,000
Securities 72,937 73,459 74,153 71,423
Loans 183,696 191,352 167,175 175,023
Certificates of Deposit 115,998 116,798 84,251 84,251
Other Deposit Liabilities 168,512 168,512 179,930 179,930
Other Borrowed Money 3,768 3,768 3,794 3,794
Off Balance Sheet Items 0 0 0 0
Estimations of fair value of financial instruments are subject to significant
uncertainty because active and liquid markets do not exist for a majority of
them. The estimates include assumptions concerning financial conditions, risk
characteristics, expected future losses, and market interest levels, among
other factors, and if changed could have a significant impact on them. The
resulting presentations of estimated fair value is not necessarily indicative
of the value realizable in an actual exchange of financial instruments.
9. INCOME TAXES -
The provisions (benefits) for income taxes for the years ended December 31,
1995, 1994 and 1993 for financial reporting were as follows:
1995 1994 1993
------ ------ ------
Current -
Federal $ 614 $ 2,876 $ (89)
State 401 284 2
------ ------ ------
Total current provision 1,015 3,160 (87)
------ ------ ------
Deferred -
Federal 891 (1,404) 1,268
State 247 224 242
------ ------ ------
Total deferred provisions 1,138 (1,180) 1,510
------ ------ ------
Total provisions for income taxes $2,153 $1,980 $1,423
====== ====== ======
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51
As of December 31, 1995 and 1994, the temporary differences which give rise to
a significant portion of deferred tax assets and liabilities are as follows:
DECEMBER 31, DECEMBER 31,
1995 1994
------------ ------------
Allowance for loan losses $ 3,084 $ 3,348
Deferred loan fees 0 294
Depreciation 138 196
Other expense accruals 898 1,631
-------- -------
Total deferred tax assets 4,120 5,469
-------- -------
Accretion of discounts on securities (140) 0
Unrealized gain on securities available for sale (60) 0
State tax expense (188) (353)
Other (1) (1)
-------- -------
Total deferred tax liabilities (389) (354)
Valuation allowance (1,218) (1,404)
-------- -------
Net deferred tax asset $ 2,513 $ 3,711
======== =======
The Bank maintains a valuation reserve against net deferred tax assets to
reflect the inherent uncertainty of the ultimate realization of those assets.
The value of the Bank's largest deferred tax assets represent expenses, such
as the loan loss provision, which will become deductible on a future tax
return when an actual loss is incurred. Realization of deferred tax assets
are dependent on the availability of taxable income in the future or prior
years to offset these deductions. Because the State of California does not
currently allow net operating loss carrybacks, realization of deferred tax
assets related to California Franchise Taxes is subject to a greater degree of
uncertainty.
The provisions (benefits) for income taxes varied from the Federal statutory
rate of 34% for 1995, 1994, and 1993, for the following reasons:
1995 1994 1993
-------------------- ------------------ ----------------------
Amount Rate Amount Rate Amount Rate
------ ----- ------ ---- ------ ------
Provisions (benefit) for income at $1,716 34.0% $1,548 34.0% $1,198 34.0 %
statutory rate
Interest on state and municipal bonds
and other tax exempt transactions (22) (.5%) (25) (.5%) (25) (.7)%
State franchise taxes, net of federal
income tax benefit 428 8.5% 335 7.3% 256 7.3 %
Other, net 31 .6% 122 2.7% (6) (0.2)%
------ ---- ------ ---- ------ ----
$2,153 42.6% $1,980 43.5% $1,423 40.4 %
====== ==== ====== ==== ====== ====
The total net deferred tax of $2,513 in 1995 and $3,711 in 1994 is included in
Other Assets in the Consolidated Statements of Financial Condition.
At December 31, 1993, the Company had a California Franchise Tax carryforward
of $1.9 million, with the entire operating loss carryforward being utilized in
1994. The Bank had no operating loss carryforwards at December 31, 1994 or
1995.
10. SHAREHOLDERS' EQUITY -
The Company has three employee stock option plans. The 1983 plan, which
authorized the issuance of 400,075 shares of common stock, and the 1985 plan,
which authorized the issuance of 350,000 shares of common stock, expired in
1993 and 1995 respectively. The 1993 plan, authorizing the issuance of
400,000 shares of common stock, expires in 2003. Options are granted at a
price not less than the fair market value of the stock at the date of grant.
Options under these
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52
plans expire up to ten years after the date of grant. The options granted
under the 1983 and 1985 plans are incentive stock options, as defined in the
Internal Revenue Code. Options under the 1993 plan can be either incentive
stock options or non- qualified options. No shares remain available for future
grants for the 1983 and 1985 plans, although outstanding options remain and are
exercisable over the period designated by those plans.
In 1987, a special stock option plan was approved that is limited to directors
of the Company and provides for the issuance of 120,960 shares of common stock.
The plan expires in 1997. Options granted under the plan are non-qualified
stock options. Each of the directors of the Company, at the time the special
stock option plan was approved, received stock options to purchase 15,120
shares at $5.78 per share, which was in excess of the then prevailing market
price. Options expire 10 years after the date of grant. There are no remaining
options available for grant under the 1987 special stock plan.
In 1994, a non-employee director stock option plan was approved that provides
for the issuance of 200,000 shares of common stock. The plan expires in 2004.
Options granted under the plan are non-qualified stock options. During 1994,
options were granted to purchase 27,500 shares at $6.25 per share , which was
equal to the market price at the date of grant. During 1995, 27,500 options
were granted at $6.88 per share. Options expire 10 years from the date of grant
The following table summarizes information on stock options outstanding for the
years ended December 31, 1995 and 1994, as follows:
1995 1994
---- ----
Average Average
Price Shares Price Shares
----- ------ ----- ------
Options outstanding beginning of year $5.98 629,410 $5.55 355,906
Granted $7.07 125,500 $6.59 289,500
Exercised $5.78 (15,120) $4.75 (1,000)
Canceled $8.91 (8,270) $7.78 (14,996)
------- -------
End of year $6.14 731,520 $5.98 629,410
======= =======
During 1994, 1,000 non-qualified stock options under the 1985 plan were
exercised at $4.75 per share. In 1995, 15,120 non-qualified stock options under
the 1987 plan were exercised at $5.78 per share. No other stock options were
exercised in 1994 or 1995.
The following information is presented concerning the stock option plans as of
December 31, 1995:
SHARES SUBJECT TO NUMBER OF SHARES
OPTION RANGE OF EXERCISE PRICES EXERCISABLE
----------------- ------------------------ ----------------
Employee plans
1983 Plan 49,030 $5.00 29,418
1985 Plan 243,250 $4.75 - $15.21 139,690
1993 Plan 256,000 $6.63 - $7.13 68,603
Non employee directors plan
1987 Plan 30,240 $5.78 30,240
1994 Plan 153,000 $6.25 - $6.85 6,875
In 1984, certain members of the Board of Directors were granted warrants to
purchase up to 360,067 shares of common stock at $4.17 per share, primarily for
guaranteeing a capital note issued by the Company. These warrants became
exercisable when the capital note was paid off in 1987, and had a maturity date
of February 15, 1995. During 1995, all outstanding warrants were exercised.
During 1995 and 1994, warrants for 135,024 and 57,012 shares were
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53
exercised. In 1994, warrants to purchase 7,500 shares of common stock at the
fair market value at date of grant of $7.00 per share, with an expiration date
of February 1, 1999 , were issued to the former chairman of the board.
On June 29, 1995, the Company's shareholders approved adoption of a CU Bancorp
1995 Restricted Stock Plan, providing for the issuance of Common Stock to
employees, subject to restrictions on sale or transfer. The restrictions on
sale or transfer expire over a period of five years. During 1995, 19,000
restricted shares were issued with a market value of $185. This amount
was recorded as unearned compensation and is shown as a separate component of
shareholders' equity. Unearned compensation is being amortized to expense over
the five year vesting period, with expense of $3 recorded for 1995.
11. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK AND COMMITMENTS AND
CONTINGENCIES --
The consolidated statements of financial condition do not reflect various
commitments relating to financial instruments which are used in the normal
course of business. These instruments include commitments to extend credit,
standby and commercial letters of credit, and interest rate floor and swap
agreements. Management does not anticipate that the settlement of these
financial instruments will have a material adverse effect on the Bank's
financial position.
These financial instruments carry various degrees of credit and market risk.
Credit risk is defined as the possibility that a loss may occur from the
failure of another party to perform according to the terms of the contract.
Market risk is the possibility that future changes in market prices may make a
financial instrument less valuable.
The Bank primarily grants commercial and real estate loan commitments with
variable rates of interest and maturities of one year or less to customers in
the greater Los Angeles area. The contractual amounts of commitments to extend
credit and standby and commercial letters of credit represent the amount of
credit risk. Since many of the commitments and letters of credit are expected
to expire without being drawn, the contractual amounts do not necessarily
represent future cash requirements. For interest rate floor and swap
agreements, the notional amounts do not represent exposure to credit loss.
Commitments to extend credit are legally binding loan commitments with set
expiration dates. They are intended to be disbursed, subject to certain
conditions, upon request of the borrower. The Bank evaluates the
creditworthiness of each customer. The amount of collateral obtained, if deemed
necessary by the Bank upon the extension of credit, is based upon management's
evaluation. Collateral held varies, but may include securities, accounts
receivable, inventory, personal property, equipment, and income- producing
commercial or residential property.
Standby letters of credit are provided to customers to guarantee their
performance, generally in the production of goods and services or under
contractual commitments in the financial markets. Standby letters of credit
generally have terms of up to one year.
Commercial letters of credit are issued to customers to facilitate foreign and
domestic trade transactions. They represent a substitution of the Bank's
credit for the customer's credit. Such letters of credit are generally short
term in nature and are collateralized by the merchandise covered by the
transaction. At December 31, 1995 and 1994 there were $1.0 million and $1.5
million outstanding, respectively. These amounts reduce the availability under
the applicable customer's loan facility.
Interest rate swaps and floors may be created to hedge certain assets and
liabilities of the Bank. These transactions involve either an exchange of fixed
or floating rate payment obligations on an underlying notional amount. In the
case of a rate floor, there is a guaranteed payment of a rate differential on a
notional amount, should a specific market rate fall below a specific agreed
upon level. Credit risk related to interest rate swaps is limited to the
interest receivable from the counterparty less the interest owed that party or,
in the case of rate floors, to interest receivable on the differential between
the specific rate contracted in the floor agreement and actual rates in effect
at various settlement dates. Market risk fluctuates with interest rates.
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The following is a summary of various financial instruments with off-balance
sheet risk at December 31,1995 and 1994:
DECEMBER 31,
------------
AMOUNTS IN MILLIONS OF DOLLARS 1995 1994
---- ----
Standby letters of credit $ 3 $ 7
Undisbursed loans 87 69
In response to continued economic declines and anticipating interest rate
declines, the Bank entered into an interest rate swap agreement effective
October 8, 1991, for $100 million. Terms of this agreement were that the Bank
would receive a fixed rate of 8.18% over two years in exchange for paying the
average prime rate. Accrued benefits from this transaction amounted to $1,726
in 1993, and are included in interest income. Amounts due the Bank or
counterparty were settled quarterly. This agreement expired on October 8, 1993.
In the normal course of business, the Company occasionally becomes a party to
litigation. See footnote 15.
12. OTHER OPERATING EXPENSES --
Other operating expenses included the following:
1995 1994 1993
---- ---- ----
Promotional expenses $273 $264 $393
Data processing for customers 564 737 920
Director and advisory fees 104 107 146
Legal fees 109 455 1,370
Other professional fees 356 419 495
Messenger services 357 408 583
Other data processing fees 438 301 455
Regulatory assessments 357 648 1,036
Expenses for other real estate owned 1 22 234
Amortization of mortgage servicing rights 0 15 983
Occupancy expense 1,840 1,710 2,488
Reserve for branch relocation 0 58 447
Other 1,321 2,323 4,120
------ ------ -------
Total operating expenses $5,720 $7,467 $13,670
====== ====== =======
13. CONDENSED FINANCIAL INFORMATION OF CU BANCORP --
At December 31, 1995 and 1994, the condensed unconsolidated balance sheets of
the Company are as follows:
DECEMBER 31,
1995 1994
---- ----
Balance Sheets
Cash $ 590 $ 426
Prepaid expenses 0 0
Investment in California United Bank N.A. 32,681 29,507
------ ------
Total assets $33,271 $29,933
======= =======
Other liabilities $268 $189
Shareholders' equity 33,003 29,744
------ ------
Total liabilities and shareholders' equity $33,271 $29,933
======= =======
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For the years ended December 31, 1995, 1994, and 1993, the condensed
unconsolidated statements of income of the Company are as follows:
DECEMBER 31,
1995 1994 1993
---- ---- ----
Statements of Income
Equity in earnings of the Bank $3,090 $2,785 $2,265
Operating expenses 210 221 167
Interest Income 14 9 0
------ ------ ------
Net income $2,894 $2,573 $2,098
====== ====== ======
For the years ended December 31, 1995, 1994 and 1993, the condensed
unconsolidated statements of cash flows are as follows:
Amounts in thousands of dollars
1995 1994 1993
---- ---- ----
Cash flows from operating activities
Net income $ 2,894 $ 2,573 $ 2,098
Equity in undistributed earnings of subsidiaries (3,090) (2,785) (2,265)
Other, net 78 115 85
------- ------- -------
Net cash (used) by operations (118) (97) (82)
Cash flows from financing activities
Proceeds from exercise of stock options and director warrants 649 180 260
Cash dividend paid (367) -- --
------- ------- -------
Net cash provided by financing activities 282 180 260
Net increase in cash and cash equivalents 164 83 178
Cash and cash equivalents at beginning of the year 426 343 165
------- ------- -------
Cash and cash equivalents at end of year $ 590 $ 426 $ 343
======= ======= =======
Under National banking law, the Bank is limited in its ability to declare
dividends to the Company to the total of its net income for the year, combined
with its retained net income for the preceding two years less any required
transfers to surplus. The effect of this law was to preclude the bank from
declaring any dividends at December 31, 1994 and 1993. The Bank has received
permission from the OCC to pay dividends to the Company in 1995, in
anticipation of the cash dividends paid by the Company. No dividends were
actually paid by the Bank in 1995,1994 or 1993.
14. SUBSEQUENT EVENTS
In March of 1995, the Bank had announced the signing of an agreement to acquire
Corporate Bank, a Santa Ana based community bank with approximately $70 million
in assets. This purchase was completed in January 1996, with Corporate Bank
being acquired in exchange for the issuance of approximately 649 thousand
shares of CU Bancorp common stock and $1.7 million cash. The acquisition of
Corporate Bank will be reflected using the purchase method of accounting in the
first quarter of 1996. Also in January 1996, the Bank announced the signing of
an agreement to merge with Home Interstate Bancorp, the parent of Home Bank,
based in the South Bay. Home Bank provides retail and business banking from
its principal office in Signal Hill and fourteen additional branch locations.
The agreement with Home Bank provides for the combination to be effected
through the exchange of common stock, and is expected to be accounting for as a
pooling of interests. This merger, which is targeted to be completed near the
end of the second quarter of 1996, would create a combined bank with over $800
million in assets and 22 branches.
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15. LEGAL MATTERS
In the normal course of business the Bank occasionally becomes a party to
litigation. In the opinion of management, based upon consultation with legal
counsel, the Bank believes that pending or threatened litigation involving the
Bank will have no adverse material effect upon its financial condition, or
results of operations.
Until third quarter 1995, the Bank was a defendant in multiple lawsuits related
to the failure of two real estate investment companies, Property Mortgage
Company, Inc., ("PMC") and S.L.G.H., Inc. ("SLGH"). The lawsuits, consisted of
a federal action by investors in PMC and SLGH (the "Federal Investor Action"),
at least three state court actions by groups of Investors (the "State Investor
Actions"), and an action filed by the Resolution Agent for the combined and
reorganized bankruptcy estate of PMC and SLGH (the "Neilson" Action). An
additional action was filed by an individual investor and his related pension
and profit sharing plans (the "Individual Investor Action"). Other defendants
in these multiple actions and in related actions include financial
institutions, title companies, professionals, business entities and
individuals, including the principals of PMC and SLGH. The Bank was a
depository bank for PMC, SLGH and related companies and was a lender to certain
principals of PMC and SLGH ("Individual Loans"). Plaintiffs alleged that
PMC/SLGH was or purported to be engaged in the business of raising money from
investors by the sale and issuance of interests in loans evidenced by
promissory notes secured by real property. Plaintiffs alleged that false
representations were to the Bank's conduct with regard to the depository
accounts, the lending relationship with the principals and certain collateral
taken , pledged by PMC and SLGH in conjunction with the Individual Loans. The
lawsuits alleged inter alia violations of federal and state securities laws,
fraud, negligence, breach of fiduciary duty, and conversion as well as
conspiracy and aiding and abetting counts with regard to these violations. The
Bank denied all allegations of wrongdoing. Damages in excess of $100 million
were alleged, and compensatory and punitive damages were sought generally
against all defendants, although no specific damages were prayed for with
regard to the Bank. A former officer and director of the Bank was also been
named as a defendant.
The Bank entered into a settlement agreement with the representatives of
the various plaintiffs, which has now been consummated, with the dismissal of
all of the above referenced cases, with prejudice, against the Bank, its
officers and directors, with the exception of the officer/director previously
named pending. Court approval of these settlements has been received. In
connection with the settlement, the Bank released its security interest in
certain disputed collateral and cash proceeds thereof, which the Bank received
from PMC, SLGH, or the principals, in connection with the Individual Loans.
This collateral had been a subject of dispute in the Neilson Action, with both
the Bank and the representatives of PMC/SLGH asserting the right to such
collateral. All the Individual Loans have been charged off. The Bank also
made a cash payment to the Plaintiffs in connection with the settlement. The
effect of this settlement on CU Bancorp or the Bank's financial statements was
immaterial. In connection with the settlement the Bank assigned its rights, if
any, under various insurance policies, to the Plaintiffs. The settlement does
not resolve the claims asserted against the officer/director. The Bank is
still providing a defense to its former director/officer who continues as a
defendant and who retains his rights of indemnity, if any, against the Bank
arising out of his status as a former employee. At this time the only viable
claims which appear to remain against the former director/employee are claims
of negligence in connection with certain depository relationships with
PMC/SLGH. While the Bank's Director and Officer Liability Insurer has not
acknowledged coverage of any potential judgment or cost of defense, the Insurer
is on notice of the action and has participated in various aspects of the case.
16. REGULATORY MATTERS
Since June 1992, the Bank has developed a very positive and proactive
relationship with its primary regulators. Results of regular safety and
soundness examinations have documented the progress the Bank has achieved.
Management is committed to the continuation of this process and maintaining a
high standing with the regulators. The following comments refer to regulatory
situations that existed in prior years that are reflected in the prior period
financial statements provided herein. All of these situations have been
successfully resolved and repaired as management transitioned the Bank to its
present condition and performance.
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On November 2, 1993, the Office of the Comptroller of the Currency
("OCC"), after completion of their annual examination of the Bank, terminated
the Formal Agreement entered into in June, 1992. In December 1993, the Fed
terminated the Memo of Understanding entered into in August, 1992.
The Formal Agreement had been entered into in June 1992 and required the
implementation of certain policies and procedures for the operation of the Bank
to improve lending operations and management of the loan portfolio. The Formal
Agreement required the Bank to maintain a Tier 1 Risk Weighted Capital ratio of
10.5% and a 6.0% Tier 1 Leverage Ratio. The Formal Agreement mandated the
adoption of a written program to essentially reduce criticized assets, maintain
adequate loan loss reserves and improve bank administration, real estate
appraisal, asset review management and liquidity policies, and restricted the
payment of dividends.
The agreement specifically required the Bank to: 1) create a compliance
committee; 2) have a competent chief executive officer and senior loan
officer, satisfactory to the OCC, at all times; 3) develop a plan for
supervision of management; 4) create and implement policies and procedures for
loan administration; 5) create a written loan policy; 6) develop and implement
an asset review program; 7) develop and implement a written program for the
maintenance of an adequate Allowance for Loan and Lease Losses, and review the
adequacy of the Allowance; 8) eliminate criticized assets; 9) develop and
implement a written real estate appraisal policy; 10) obtain and improve
procedures regarding credit and collateral documentation; 11) develop a
strategic plan; 12) develop a capital program to maintain adequate capital
(this provision also restricts the payment of dividends by the Bank unless (a)
the Bank is in compliance with its capital program; (b) the Bank is in
compliance with 12 U.S.C. Section 55 and 60 and (c) the Bank receives the
prior written approval of the OCC District Administrator); 13) develop and
implement a written liquidity, asset and liability management policy; 14)
document and support the reasonableness of any management and other fees to any
director or other party; 15) correct violations of law; and 16) provide reports
to the OCC regarding compliance.
The Memorandum of Understanding was executed in August 1992 and required
1) a plan to improve the financial condition of CU Bancorp and the Bank; 2)
development of a formal policy regarding the relationship of CU Bancorp and the
Bank, with regard to dividends, inter-company transactions, tax allocation and
management or service fees; 3) a plan to assure that CU Bancorp has sufficient
cash to pay its expenses; 4) ensure that regulatory reporting is accurate and
submitted on a timely basis; 5) prior approval of the Federal Reserve Bank
prior to the payment of dividends; 6) prior approval of the Federal Reserve
Bank prior to CU Bancorp incurring any debt and 7) quarterly reporting
regarding the condition of the Company and steps taken regarding the Memorandum
of Understanding.
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Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURES
NONE.
Part III
Incorporated by reference from Registrant's definitive proxy statement to be
filed within 120 days of fiscal year ended December 31, 1995.
Part IV. Exhibits, Financial Statement Schedules and Reports on Form 8 K.
(A)
(1) and (2) Financial Statements and Financial Statement
Schedules - See index at Item 8 of this report.
(3) Exhibits
2. Plan of Acquisition, Reorganization
arrangement, liquidation or succession.
a) Amended and Restated Agreement and Plan
of Reorganization between CU Bancorp,
California United Bank, N.A. and Corporate
Bank dated October 11, 1995 -- incorporated
by reference from Registrant's Registration
Statement on Form S-4 dated October 26,
1995 (33-63729).
b) Agreement and Plan of Reorganization
dated January 10, 1996 between CU Bancorp
and California United Bank, N.A. and Home
Interstate Bancorp and Home Bank and
Exhibits thereto.
c) Amendment Number One to Agreement and
Plan of Reorganization between CU Bancorp
and California United Bank, N.A. and Home
Interstate Bancorp and Home Bank.
10. Material Contracts
a) CU Bancorp Restricted Stock Plan
11. Statements re computation of per share
earnings
See footnote 1(i) to the financial
statements included at Item 8 of this
report.
21. Subsidiaries of the Registrant
27. Financial Data Schedule
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
Date: March 28, 1996 C U BANCORP
STEPHEN G. CARPENTER
By
Stephen G. Carpenter
President and Chief
Executive Officer
PATRICK HARTMAN
By
Patrick Hartman
Chief Financial Officer
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Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the Registrant and in the capacities and on the dates indicated.
Signature Title Date
- --------- ------- ----
KENNETH BERNSTEIN Director March 28, 1996
_________________
Kenneth Bernstein
STEPHEN G. CARPENTER
__________________________________ Director, March 28, 1996
Stephen G. Carpenter Chairman/
Chief Executive
Officer
________________________________ Director March 28, 1996
Richard H. Close Secretary
PAUL W. GLASS
___________________________________ Director March 28, 1996
Paul W. Glass
RONALD S. PARKER Director March 28, 1996
____________________
Ronald S. Parker
DAVID I. RAINER
____________________ Director, March 28, 1996
David I. Rainer President, Chief
Operating Officer
Supplemental Information to be Furnished with Reports Filed Pursuant to Section
15(d) of the Act by Registrant Which Have Not Registered Securities Pursuant
to Section 12 of the Act.
The proxy statement with respect to the annual meeting of the shareholders
shall be furnished to shareholder subsequent to the filing of this Form 10-K
and shall also be furnished to the Securities and Exchange Commission.
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EXHIBIT INDEX
2. Plan of Acquisition, Reorganization arrangement, liquidation or
succession.
a) Amended and Restated Agreement and Plan of
Reorganization between CU Bancorp,
California United Bank, N.A. and Corporate
Bank dated October 11, 1995 --
incorporated March 28, 1996 by reference
from Registrant's Registration Statement
on Form S-4 dated October 26, 1995
(33-63729).
b) Agreement and Plan of Reorganization dated
January 10, 1996 between CU Bancorp and
California United Bank, N.A. and Home
Interstate Bancorp and Home Bank and
Exhibits thereto.
c) Amendment Number One to Agreement and Plan
of Reorganization between CU Bancorp and
California United Bank, N.A. and Home
Interstate Bancorp and Home Bank.
10. Material Contracts
a) CU Bancorp Restricted Stock Plan
11. Statements re computation of per share earnings
See footnote 1(i) to the financial statements
included at item 8 to this report.
21. Subsidiaries of the Registrant
27. Financial Data Schedule
61