1
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, 1993
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OF 15(d) OR THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 0-10198
BANK OF SAN FRANCISCO COMPANY HOLDING COMPANY
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(Exact name of Registrant as specified in its charter)
Delaware 94-3071255
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
550 Montgomery Street, 10th Floor
San Francisco, California 94111
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(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (415) 781-7810
Securities registered pursuant to Section 12(b) of the Act:
Title of Class Name of Each Exchange on Which Registered
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Class A Common Stock, $0.01 Par Value American Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K [X].
The aggregate market value of the voting stock held by non-affiliates of the
Registrant on February 18, 1994, was $5,044,881, computed by reference to the
closing sales price of the Class A Common Stock as reported by the American
Stock Exchange.
The Registrant had 8,899,801 shares of Class A Common Stock outstanding on
February 18, 1994.
Documents Incorporated by Reference:
The definitive Proxy Statement for the Registrant's 1994 Part III
Annual Meeting of Shareholders.
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BANK OF SAN FRANCISCO COMPANY HOLDING COMPANY
1993 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENT
PART I
Page
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Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
The Company and the Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Business Strategies if Capital-Raising Efforts are not Successful . . . . . . . . . . . . . . . . 6
Private and Business Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Trust and Securities Division . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Development of The San Francisco Company-Asia . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Capital Management Group . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Real Estate Investment and Development Activities . . . . . . . . . . . . . . . . . . . . . . . . 12
Lending Activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Problem Asset Portfolio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Correspondent Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Employees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Competition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Regulatory Directives and Orders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Regulation and Supervision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . . . . . . . . . 29
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters . . . . . . . . . . . . . . 30
Item 6. Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations . . . . . . . . 32
Item 8. Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
Item 9. Changes in and disagreements on Accounting and Financial Disclosures . . . . . . . . . . . . . . . . . 82
PART III
Item 10. Directors and Executive Officers of the Registrant . . . . . . . . . . . . . . . . . . . . . . . . . . 82
Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82
Item 12. Security Ownership of Certain Beneficial Owners and Management . . . . . . . . . . . . . . . . . . . . 82
Item 13. Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K . . . . . . . . . . . . . . . . . . . 82
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PART I
ITEM 1 - BUSINESS
THE COMPANY AND THE BANK
Bank of San Francisco Company Holding Company (the "Company"), a
Delaware corporation, is a one-bank holding company, registered under the Bank
Holding Company Act of 1956, for Bank of San Francisco (the "Bank"), a
California state chartered bank organized in 1978 whose deposits are insured by
the Federal Deposit Insurance Corporation (the "FDIC"), subject to applicable
limits. The Company was organized in California in 1981 and reincorporated (by
way of a merger into a wholly-owned subsidiary) in Delaware in 1988. The Bank,
which the Company acquired through a reorganization in 1982, is the only direct
subsidiary of the Company and accounts for over 99% of the consolidated assets
of the Company. The Bank delivers its services from its headquarters building,
Bank of San Francisco Building, at 550 Montgomery Street (at Clay Street), San
Francisco, California 94111, and its phone number is (415) 781-7810.
The Company's Class A Common Stock, par value $0.01 per share (the
"Class A Common Stock"), is listed on the American Stock Exchange (the "AMEX").
The closing price for the Class A Common Stock on February 18, 1994 was $1.69.
The Bank currently specializes in providing private banking and trust
and investment management services for individuals, as well as business banking
for such individuals, their businesses and other businesses, primarily in the
San Francisco banking market. See "-- Private and Business Banking." The
Company's and the Bank's new management, headed by Kent D. Price, intend to
expand the Bank's business franchise by focusing on the further development and
marketing of such services in the San Francisco area and throughout the West
Coast of the United States, as well as to wealthy or high-income individuals
and their businesses in the Pacific Basin. The Company intends to facilitate
this strategy by developing a network of "Strategic Alliance Partners" in the
United States and in Pacific Basin countries (some of whom may also be, or be
affiliated with, investors in the Company) to locate and assist in the
identification and servicing of such clients. Because the Company anticipates
that such clients will have a substantial need for and interest in a variety of
debt and equity investment products, with both U.S. and international
components, the Company also intends to form a Capital Management Group (which
may operate initially as a division of the Bank but is ultimately expected to
be established as a direct Company subsidiary) to develop, manage and market
investment services and products, including products developed and managed by
Strategic Alliance Partners and other investment managers. The Company's plans
to expand its business in the Pacific Basin, to develop the Strategic Alliance
Partners relationships, and to establish the Capital Management Group are
contingent upon raising substantial amounts of additional capital, which the
Company intends to accomplish through a private placement of Class A Common
Stock and other securities.
During the period from 1991 through 1993, the Company suffered an
aggregate of $41.6 million in losses, primarily as a result of defaulted loans
secured by real estate and losses on direct real estate development activities.
The Company and the Bank succeeded in avoiding insolvency during this period
only through the injection of a total of $32.0 million of new capital by the
Company's controlling stockholder, Mr. Putra Masagung. These losses
nevertheless caused impairments of capital and the breach of various regulatory
restrictions that have led to the issuance of orders by both state and federal
bank regulatory authorities (the "Orders") imposing restrictions and
requirements on both the Bank's and the Company's business activities and
requiring the timely resolution of problem assets. See "-- Regulatory
Directives and Orders."
In response to these problems, the new management team headed by Mr.
Price, who officially took office in October 1993, has developed plans to:
o return the Company to profitability by improving the financial
performance of the Bank's existing businesses and evaluating the Bank's
alternatives for resolving the problem assets. Management believes that
the Bank's earnings can be increased through both expense reduction and
revenue enhancement and has implemented a number of steps to achieve
these goals;
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o reinvigorate and expand the Bank's core private and business banking
activities and expand the provision of trust, investment management
and securities transactional services to existing and new clients in
San Francisco and throughout the West Coast of the United States; and
o build Pacific Basin private banking, trust and investment management
services through the Strategic Alliance Partner relationships fostered
by the new "The San Francisco Company-Asia," which will initially be
established as a new division of the Bank.
Although management can provide no assurance that the foregoing general
goals will be achieved, management has developed a three-phase implementation
plan.
Phase I - Stabilization and Recapitalization. In phase one, focusing on
stabilization and recapitalization, and lasting at least through 1994, the
Company intends to:
o raise additional capital from new investors in a way that will permit
them to participate in the results of the Company's new business
strategy while protecting them, to a defined extent, from losses
arising out 5of a specified portfolio of the Bank's problem assets.
The Company anticipates that this goal will be accomplished by
including, as part of the securities sold to the new investors, Risk
Protection Rights (the "Rights") to receive a greater proportion of
the Company's equity without additional consideration to compensate
the new investors, to the defined extent, for unanticipated losses and
related expenses incurred in the administration, carrying and
resolution of such problem assets;
o establish plans to resolve the Bank's problem assets in an orderly
manner, either through a sale to a single buyer or by disposing of
such assets in an orderly manner as part of a long-term workout;
o extend and expand existing asset management services provided by the
Bank and establish the new Capital Management Group;
o establish The San Francisco Company-Asia and commence implementation of
the Strategic Alliance Partnerships;
o increase core deposits and reduce funding costs through improved
management of assets and liabilities;
o continue its efforts to regain lost private banking deposits while
maintaining and expanding existing private banking relationships; and
o concentrate on expense reduction, including both interest and
non-interest expense items.
Phase II - Redirection. In phase two, focusing on redirection of the
Company's business strategies and extending over an estimated period of three
years, the Company intends to concentrate on:
o cultivating the Strategic Alliance Partner relationships;
o developing Pacific Basin private banking services and relationships;
o developing Pacific Basin trust services; and
o developing the Capital Management Group's investment products,
including in-house and management capabilities for Asian investment
products and the use of Strategic Alliance Partner services for U.S.
and other products.
Phase III - Expansion. Assuming full implementation of the Company's
strategic redirection is achieved, management intends to develop the Company's
new and existing core businesses by:
o emphasizing fee income from investment management and other core
businesses;
o expanding into new geographical markets; and
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o maintaining a strong capitalization structure that provides
institutional flexibility and permits the implementation of alternative
growth strategies.
NEW MANAGEMENT
In order to implement these strategic plans, the Company and the Bank
have focused on recruiting executives with significant business experience and
contacts in San Francisco, the West Coast of the United States and throughout
the Pacific Basin. Such executives include:
Kent D. Price Mr. Price has served as Chairman and Chief Executive
Officer of the Company and the Bank since September
1993. He served as Executive Vice President,
Private Banking and Corporate Development, of Bank
of America from 1991 to 1993; Chief Financial
Officer and Executive Vice President of Bank of New
England Corporation from 1990 to 1991; Chief
Operating Officer, Chief Financial Officer and
Director of Barr Rosenberg Investment Management in
1990; and Deputy Chairman and Chief Executive
Officer of Chloride Group PLC in London from 1986 to
1989. Mr. Price served previously as a senior
officer at Citibank in Asia and Europe and has
overseen Asian businesses with operations in Taiwan,
Hong Kong, China, Singapore and India.
Steven R. Champion Mr. Champion has served as Vice Chairman and Chief
Financial Officer of the Company and the Bank, and
Chief Investment Officer of the Bank, since August
1993. He served as Chief International Investment
Officer of Bank of America from 1992 to 1993;
President and Chief Executive Officer of The R.O.C.
Taiwan Fund from 1989 to 1992; and President and
Chief Executive Officer of International Investment
Trust Company Limited in Taipei, Taiwan from 1987 to
1992. From 1980 to 1987 he was Vice President and
General Manager of the Taipei Branch for Continental
Illinois National Bank and Trust Company of Chicago,
with which he also held positions in Hong Kong and
Jakarta.
Rodney D. Freed Mr. Freed has served as President of the Company and
the Bank since February 1993. He was an Investment
Manager of the Gunung Agung Group, an Indonesian
multinational conglomerate controlled by Mr. Putra
Masagung's family, from 1990 through 1992. He
served as Singapore Country Manager for The Chase
Manhattan Bank, N.A. from 1987 to 1990, as Taiwan
Country Manager from 1982 to 1987 and held other
positions with Chase in Indonesia, Japan, Thailand
and Vietnam.
C. William Criss, Jr. Mr. Criss has served as Executive Vice
President/Senior Credit Officer since August 1993 and
Executive Vice President, Special Assets, since
1992. Mr. Criss was a Principal of Wright Houlihan
& Associates in 1992, President and Chief Executive
Officer of East West Financial Group and East West
Bank, N.A. from 1989 to 1991 and Vice President and
General Manager of Chase Bank International, San
Francisco from 1982 to 1989.
Stephen V.R. Spaulding Mr. Spaulding has served as Executive Vice President
of the Bank and Managing Director of Private and
Business Banking since September 1993. He was
President of Chase Manhattan Trust Company of
California from 1992 to 1993, Senior Vice President
and Manager, United States Private Banking Division
of Bank of America, from 1987 to 1992, and Director
of the San Francisco office of Bank of America's
United States Private Banking Division from 1984 to
1987. He has also worked in Singapore and the
Philippines.
Suzanne S. Chapman Ms. Chapman was hired in November 1993 to become
Senior Vice President and Treasurer of the Bank.
She was President of Chapman Advisors, an
asset/liabilities management and investment
consulting firm, in 1993 and served as Senior Vice
President and Chief Investment Officer of Team Bank,
Dallas, Texas from 1989 to 1992 and as Vice
President and Portfolio Manager of First City
National Bank of Houston from 1987 to 1989.
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Thomas M. Foster Mr. Foster was retained by the Bank in November 1993
to provide advice and consultation with respect to
asset restructurings and to manage the problem asset
portfolio. He has been retained by other banks in
the United States to advise on recapitalization and
asset disposition plans and has substantial
experience in troubled bank restructuring and asset
sales. Prior to 1988, Mr. Foster was a national
banking partner with Arthur Andersen & Co., and in
that capacity served as principal advisor to a
number of large banks in connection with their
restructurings and recapitalizations.
Richard V. Fulp Mr. Fulp was retained by the Bank in August 1993 to
provide advice and consultation as Managing Director
of the Trust and Securities Division of the Bank.
He was an Executive Vice President of Trust, Private
Banking, Capital Markets, Seafirst Insurance and
Retail Investment Products Division, and had
substantial responsibilities for International and
Domestic Clearing and Custody, Institutional Trust,
Personal Trust, Corporate Trust and Domestic Private
Banking at Bank of America and Seattle First
National Bank from 1987 to 1993; and was a Senior
Vice President and Manager of the Trust and
Investment Division at Seattle First National Bank
from 1980 to 1987.
STRATEGIC ALLIANCE PARTNERS
Management intends that the Strategic Alliance Partners will be banks,
securities firms, investment managers and brokerage houses in the United States
and banks, investment management firms and other firms with compatible
investment products in a number of Asian countries. To the extent possible,
management intends to extend arrangements with the Strategic Alliance Partners
beyond traditional correspondent relationships. The Company will encourage,
subject to applicable regulatory constraints, Strategic Alliance Partners, or
certain investors therein, to be investors in the Company. As the strategic
alliances are developed, management expects that Strategic Alliance Partners
will have detailed operating agreements with the Company or the Bank with
respect to (i) payment of compensation among the Company, the Bank and
Strategic Alliance Partners for business generated by the Company, the Bank and
the Strategic Alliance Partners in each other's countries and (ii) business
facilitated by the Company and the Bank between the Strategic Alliance
Partner's country and other Strategic Alliance Partners. Through these
relationships, the Bank and the Company intend to gain access to financial
products, services and markets not otherwise available to a bank of a similar
size. Correspondingly, the Bank intends to provide the Strategic Alliance
Partners with access to a broad range of financial products, services and
markets.
Potential Strategic Alliance Partners, five of whom have entered into
Memoranda of Understanding with the Bank calling for the further negotiation of
specific business arrangements, are expected to be located in the United
States, China, Hong Kong, India, Indonesia, Korea, the Philippines, Singapore,
Taiwan, Thailand and Vietnam. Management has segmented the Asian market into
three distinct target markets that will serve as the focus of The San Francisco
Company-Asia's business efforts. The first market segment is comprised of
China, Hong Kong, Korea and Taiwan. The second market segment is comprised of
Singapore, Thailand, Indonesia, and the Philippines. The last market segment
will include India and such other countries as management may in the future
add.
Management believes that a number of the Bank's much larger banking
competitors on the West Coast of the United States have de-emphasized the
provision of on- and off-shore private banking and associated trust, securities
and investment management services as a result of the intensive management
focus and personal service requirements needed to maintain high quality and
personalized services. However, management believes that such services are in
demand in San Francisco and on the West Coast generally, and that such services
will be heavily in demand in the rapidly developing Asian economies,
particularly when provided by a bank whose business focus is from the West
Coast of the United States. Therefore, management believes that the Company's
primary organizational focus on such services will provide a competitive
advantage in such geographical markets.
While certain of the executives of the Bank have significant
experience and business contacts with potential Strategic Alliance Partners,
neither the Company nor the Bank has engaged in the activities contemplated by
or with Strategic Alliance Partners. Therefore, no assurance can be given that
the Strategic Alliance Partners business plan will be implemented, or that, if
implemented, the plan will be successful financially.
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SHORT-TERM ACTION PLANS FOR THE BANK
In addition to its capital raising efforts, management has identified
the following short-term objectives for the Bank:
o Maintain the Bank's existing client base. Management intends to
achieve this objective through focused calling programs by the new
Chief Executive Officer and other senior officers, to explain the
Bank's current strategic efforts and to ensure a continuing level of
service quality. Management believes that, once additional capital
has been injected (of which no assurance can be given) and the Bank's
stability can be demonstrated, existing and former clients will
increase and reestablish their relationships (particularly depository
relationships) with the Bank.
o Reduce operating and interest costs. During the third and fourth
quarters of 1993, Bank staff levels were reduced by eight full time
equivalency positions, and an additional 14 full-time equivalency
positions have been identified for elimination in 1994 out of
approximately 120 full-time equivalency employees at the end of 1993.
The Bank is analyzing the feasibility of out-sourcing its data and
item processing, a program that management estimates, based on savings
experienced by other banks undertaking similar out-sourcing, could
save the Bank at least 15% per year in such costs, if pursued.
Currently, the Bank is incurring significant levels of professional
fees and consulting charges as a result of its need for assistance in
regulatory compliance, business planning, credit policy development,
problem assets management and legal matters. If the Company succeeds
in its capital raising efforts, management believes a substantial
portion of such professional fees can be eliminated, particularly
expenses arising in connection with efforts to raise capital, to
respond to regulatory requirements and, as they are disposed of, to
resolve problem assets. In addition, management has implemented an
overall cost reduction program designed to assess all Bank costs on a
line item basis, and expects to reduce Bank expenses by a substantial
amount as a result of such program. Management estimates that the
combined effect of the foregoing cost reduction initiatives, if
realized, could provide in excess of $2.0 million per year in annual
pre-tax savings to the Bank. It should be noted, however, that if the
Company succeeds in its capital raising efforts and begins to
implement its new business plan, management anticipates that the cost
savings achieved through these initiatives will be substantially
offset by personnel and other expenses incurred in implementing the
new business plan.
o Increase fee and net interest income. Since August 1, 1993, the Bank
has maintained the majority of its investment portfolio in overnight
funds in order to preserve liquidity. The Bank is currently
diversifying its portfolio into higher yielding securities generally
having maturities of less than one year. If the Company succeeds in
its capital raising efforts, and in order to further enhance yields,
the Bank intends to increase the proportion of its investment
portfolio invested in higher yielding securities having maturities of
more than one year. (It should be noted however, that longer- term
maturities may give rise to additional investment risks based upon
interest rate fluctuations.) In order to increase non-interest
income, the Private and Business Banking Division is reducing waived
service charges and has initiated fees for various other services for
which competitor banks currently charge, but for which the Bank has
not historically charged. The program is intended to assist in
generating fee revenue while maintaining sensitivity to competitive
pressures. Management has also conducted a review of pricing
strategies. In that connection, transaction account deposit rates
have been reduced to levels that, management believes, remain
competitive with the rates offered by the Bank's local market
competitors but that represent a reduction relative to the Bank's
previous pricing policies. To further increase income, the Bank has
formalized arrangements with several mortgage providers for single-
and multi-family mortgage production for a fee. The Bank will
actively solicit residential mortgage loans from its private banking
clients to maintain in the Bank's portfolio and anticipates that it
will eventually reestablish a full-service mortgage department to
originate and service residential mortgages. In addition, the Bank
has begun to actively solicit its homeowner association clients for
opportunities to originate collateralized and specific purpose loans.
Management estimates that the combined effect of the foregoing revenue
enhancement initiatives, if realized, could provide in excess of $1.0
million per year in annual pre-tax increased revenue.
o Reduce volatile liabilities. The Bank has implemented certain
programs intended to respond to the Orders requirement that the Bank
improve its liquidity by decreasing its dependence on volatile
liabilities. Management has formalized the role of the Bank's
Asset/Liability Management Committee (the "ALCO") in monitoring
liquidity, and the ALCO has taken steps to link asset growth planning
with funding
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capabilities. In addition, liquidity is tracked on a daily basis at
both the account type and business unit level. The Bank's liquidity
forecasting process has been enhanced, with business unit managers
assuming increased responsibility for accuracy of liquidity forecasts.
In specific response to the Orders requirement to eliminate dependency
upon volatile liabilities, management has placed an increased emphasis
on generating core deposits. One method of implementing this emphasis
is to develop local market certificate of deposit products designed to
generate core deposits from the Bank's primary service area. The Bank
is currently marketing one such product.
To a great extent, achievement of these objectives is dependent upon a
number of economic, financial and business factors which are impossible to
predict. Therefore, no assurance can be given that these objectives can be
achieved.
BUSINESS STRATEGY IF CAPITAL-RAISING EFFORTS ARE NOT SUCCESSFUL
Largely as a result of expenses associated with the administration of
the Bank's problem assets and the level of non- interest earning assets,
management anticipates that the Company will suffer a loss of between $1.5 and
$2.0 million in the first quarter of 1994. If the Company does not succeed in
raising new capital on terms deemed to be acceptable by April 1994, in the
absence of a change in the Company's business strategy, management anticipates
that the Company's losses could lead the Bank to be in violation of the
leverage capital ratio (7%) required by the Orders and could result in further
regulatory actions that would, among other things, severely restrict the Bank's
ability to develop new lines of business. Under such circumstances, management
anticipates that it would be necessary to reduce the Bank's deposit
liabilities, accelerate plans to reduce expenses (including personnel expenses)
and continue to attempt to dispose of problem assets on an orderly basis. Such
reductions could adversely affect the Company's and the Bank's ability to
retain key management employees. Although management believes that, under such
circumstances, such a business strategy would permit the Bank to continue in
business and eventually to resolve the problem assets, management cannot
predict whether such a strategy would cause such an erosion in the value of the
Bank's business franchise that it could appear prudent to seek a sale or merger
with another bank.
PRIVATE AND BUSINESS BANKING
Private and Business Banking at the Bank combines highly personalized
service with an array of products to meet the complex needs of its primary
clients -- executives, professionals and high net worth or high income
individuals and the private and closely held businesses with which such
individuals are associated. The Bank has specialized in private banking since
it began operations in 1979. In the San Francisco area, the Bank's focus on
serving the needs of its clients has led it to offer a range of services,
including general credit and depository services and specialized corporate
escrow services and asset management and trust services.
The Bank seeks to concentrate on establishing relationships with
private and closely held businesses and their owners and operators. In
particular, the Bank seeks relationships with individuals whose financial needs
require customized banking programs.
The Bank places a high degree of importance on providing exceptional
client service. To facilitate providing such a high degree of service, the
Bank has recruited highly experienced banking professionals who understand and
can meet the needs of the Bank's target market. The Bank assigns its
professionals to serve small groups of personal clients rather than
periodically reassigning such professionals to different areas or shifting them
into administrative positions. This policy is intended to address one of the
most serious customer complaints in the banking industry, the lack of
continuity in account officers. The Bank seeks to enable its clients to have
confidence that their private bankers understand their financial situations and
are accessible when needed.
The Bank also places a high degree of importance on responding quickly
to its clients' needs. The Bank's Loan Committee meets frequently to consider
and respond to all types of credit requests. In addition, each client
relationship is supported, not only by an individual banking officer, but also
by a team familiar with each client's needs and situation, so that the client
is aware that another Bank employee other than the primary banking officer is
familiar with and is able to respond to such client's needs.
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The internal organization of the Bank was designed to facilitate the
cooperation among the client's primary banker and various specialists to
provide investment and depository services. As a result of regulatory approval
to engage in the trust business in 1990, management has broadened, and intends
to further broaden, the range of banking services offered to the Bank's
clients. See "-- Trust and Securities Division."
MARKET AREA AND CUSTOMER BASE
Northern California has a highly diversified economic base, including
high technology electronic manufacturing, scientific research, real estate
construction, retail and wholesale trade and transportation. Much of the
diversity in the economic base is attributable to the service sector, including
finance, accounting, insurance, communications, law, consulting and tourism.
While many of the Bank's loans have been and continue to be collateralized by
real estate, and a significant portion of the Bank's clients' net worth has
historically consisted of real estate holdings, the Bank's deposit and lending
relationships have not been concentrated among borrowers within a specific
trade, service or industrial activity.
The Bank opened a Sacramento regional office in January 1991.
However, that opening coincided with a significant downturn in the California
economy, and the Bank sold the Sacramento office in December 1993 in
conjunction with the requirements of the Orders and a redirection of the Bank's
strategic focus. See "-- Regulatory Directives and Orders."
MEDIUM AND LONG-TERM OBJECTIVES FOR PRIVATE BANKING
Management's medium- and long-term objectives for Private Banking
include:
o Local Marketing Goals. Implementation of a marketing strategy focused
(consistent with the ALCO objectives) to take advantage of a perceived
service void that management believes to exist with respect to
privately and closely held businesses and their owner/operators as a
result of large bank consolidations. Management intends that the
customers in this market "niche" will be aggressively targeted as
potential customers for all Bank products and services, including
products and services to be developed in the future in connection with
management's new strategy to focus on trust and investment services
and products. In addition, management believes that many of the
Bank's former clients can be "reclaimed" once the Bank is
recapitalized.
o Development of Strategic Alliances. Integrate fully the products and
services provided by Private Banking with The San Francisco
Company-Asia, which the Bank anticipates will provide the distribution
system and the institutional affiliations for the Bank through the
Strategic Alliance Partners throughout the United States and Asia,
with particular focus on the Pacific Basin. As described below,
management intends to offer Private Banking products and services
throughout Asia, and to further expand its business franchise in San
Francisco and throughout the West Coast of the United States.
o Cross Sales of Products. Institutionalize cross-sales of Bank
products and services among various core business units. As the Bank
and the Company develop an expanding base of investment and trust
products, cash management, and other fee-based services, management
intends that each business unit will be responsible for addressing the
needs of all clients and, in doing so, selling products and services
developed and maintained by other Bank business units. In addition,
the Company expects that the Strategic Alliance Partners will make new
investment products available to the Bank's private banking customers.
TRUST AND SECURITIES DIVISION
The Bank's Asset Management and Trust Services Department (including
escrow services), the Stock Option Service Department and the Association Bank
Services Department, which historically had been separately managed, have been
operated under the same management structure since the third quarter of 1993 as
the Bank's Trust and Securities Division.
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10
TRUST SERVICES
The Bank received regulatory approval to provide trust services in
September 1989, and the Bank's Asset Management and Trust Division, which
commenced operations on April 1, 1990, has sought to combine the personalized
services of Private Banking and comprehensive investment management. Since
1990, the Bank has worked with the investment consulting firm of Rogers, Casey
& Associates, Inc. to provide the Bank's clients with the capability of
selecting and evaluating established investment parameters based on each
customer's requirements, such as income needs, capital growth goals and risk
tolerance. In conjunction with Rogers, Casey & Associates, Inc., the Bank
selects independent investment managers and monitors performance and continued
suitability for the needs and objectives of the client. The Bank offers its
clients separate securities management and non-liquid asset management, as well
as a credit line accessible by a checking account. The Bank also provides
traditional services such as the administration of probates and trusts, as well
as corporate cash management. At December 31, 1993 and 1992, trust services
were being provided on assets totaling $25.7 million and $50.5 million,
respectively.
The Bank's Trust and Securities Division now includes corporate escrow
services, which offer facilities and services for temporary deposits of funds,
securities, personal property and other assets by the Bank's corporate clients
for business transactions, court actions and other purposes. At December 31,
1993 and 1992, the Corporate Escrow Services Department managed approximately
$9.2 million and $10.7 million in deposits, representing approximately 4.4% and
3.7% of the Bank's total deposits, respectively.
Management believes that the four types of services the Bank offers
have been well received by those clients that the Bank has identified as its
target markets: (i) individual management of portfolios through outside money
managers, (ii) mutual fund investments for clients who do not require
individual management, (iii) liquidity management services and (iv) custodial
services offered through a third party custodian. Management believes that the
individualized management of accounts with balances below $5.0 million presents
the Bank with a market niche that is not well served by larger banks and trust
companies in the San Francisco area.
Management believes that trust products and services offer a high
degree of strategic compatibility with the Bank's other core businesses, and
that the initiation of the Capital Management Group should be highly compatible
with the Asset Management and Trust Department's current investment approach
and provide the Bank with increased competitive capabilities. In addition,
management believes that international trust capabilities (including the
establishment of an off-shore capability) would offer attractive products to
overseas clients. Management intends to market the Trust and Securities
Division services both domestically and internationally. In the United States,
the Bank targets clients, including individuals, corporations, charitable
institutions and investment funds (mutual funds, partnerships, etc.), that have
(i) a minimum of $1.0 million in assets needing investment management and/or
U.S.-based custodial services, (ii) a need for securities execution, typically
with an associated credit requirement, and/or (iii) a need for escrow services.
International marketing efforts will focus on non-U.S. citizens with assets in
excess of $2.5 million who reside in the Pacific Basin and who require
custodial or fiduciary services. It is anticipated that those efforts will be
facilitated by investment management or deposit relationships developed by The
San Francisco Company-Asia.
Management believes that the Trust and Securities Division's products
and services will provide direct support for investment management products
offered by the Capital Management Group, as well as providing stand-alone
services based both domestically and offshore, including trusteeship services,
securities custodial services, escrow services (domestic only) and discount
brokerage services (domestic issues and ADRs only). Management intends that
these products will be marketed primarily through (i) domestic private bankers
in the Private Banking Division, who will be the primary source of
introductions to domestic trust and securities clients, (ii) The San Francisco
Company-Asia, which will have responsibility for sourcing Asian-based and U.S.-
based Asian clients with a need for U.S.-based trust or custodial services,
either directly or in cooperation with the relevant Strategic Alliance Partner,
(iii) institutional sales by the Capital Management Group, which will be
responsible for identifying collateral business that will result from the
Capital Management Group's business activities, and (iv) the business
development staff of the Trust and Securities Division, who will be primarily
responsible for marketing the Capital Management Group's products and services
to take advantage of leads developed through the preceding business units or
other outside sources. Management intends to structure the Trust and
Securities Division effectively as a partnership between the Trust and
Securities Division, outside third parties (Strategic Alliance Partners and
other sources of business) and other business units. Because the Bank
currently does not offer many such services offshore, The San Francisco
Company-Asia has not yet been established and the Capital Management Group is
in
-8-
11
the early stages of development, there can be no assurance that the marketing
plans of the Trust and Securities Division will be successful.
STOCK OPTION SERVICES
Originated in 1984, the department of the Bank known as Stock Option
Services provides a broad range of traditional brokerage services combined with
a program to facilitate the exercise of stock options by employees of publicly
held companies who hold options to purchase the stock of publicly held
companies. The stock option exercise program administered by Stock Option
Services offers employees who hold options to purchase stock of public
companies the opportunity to exercise, hold or sell their option shares at a
minimum cost. This department also offers its customers a wide range of
traditional brokerage services to assist customers in related transactions.
In this program, the Bank makes loans to holders of stock options of
publicly traded companies for the purpose of enabling them to exercise their
options and sell the stock thus acquired. The Bank works with stock transfer
and employee benefits officers to coordinate the payment of the option exercise
price to the company granting such options, the provision for the payment of
taxes related to the exercise of such options, the issuance and subsequent sale
of the underlying stock and the distribution of the net sale proceeds. At
December 31, 1993 and 1992, the total amount of the Bank's stock option loans
outstanding was $1.7 million and $26.1 million, respectively. Such amounts can
vary substantially based upon the timing of the exercise of stock options as
well as market conditions.
Historically, approximately 35% of Stock Option Services' clients have
generated over 90% of the fee income of the Trust and Securities Division.
These clients are the focus of Stock Option Services' customer service
activities; however, this concentration of fee income and service activities
exposes the Bank to the possibility of losing certain important clients. For
example, certain clients moved their accounts to a competitor in late 1993
after the Bank employees responsible for those accounts were hired by that
competitor, and others moved accounts as a result of safety and soundness
concerns. This concentration of accounts also leaves the Bank vulnerable to
losing a large source of fee income with the departure of a few clients. In
addition, management believes that prevailing capital market conditions, which
may reduce the volume of transactions, are likely to affect fee levels
generated by Stock Option Services. Accordingly, management considers the fee
income produced by this activity to be highly volatile, and there can be no
guarantee that income levels from the activity can be maintained at current
levels.
Stock Option Services is a substantially self-funding activity with
associated deposit balances closely tracking outstanding loan balances.
Because Stock Option Services' deposits are primarily non-interest bearing
demand deposit accounts, the Bank benefits from them by reducing its cost of
funds. Management believes that most of these clients are in industries that
continue to present growth opportunities. Accordingly, stock option programs
should represent a continuing component of such clients' overall compensation
programs. In addition, management believes that the current client base should
represent referral sources for future business development activities for other
Bank products and services. As the Bank and the Company expand the Private
Banking business, the executives who utilize their company's stock option
program with the Bank are natural prospects for other services.
ASSOCIATION BANK SERVICES
Established in 1987, Association Bank Services operates throughout
California and is a major provider of deposit and financial management services
to homeowner and community associations in the State. The Bank offers deposit
accounts for operating funds and reserves, loans, assessment collection
services and investment services to homeowner and community associations. In
addition, the Bank offers lockbox and courier services, expedited deposit
processing and special handling of accounts to simplify banking operations.
Deposits from homeowner and community associations are a key component of the
Bank's core deposit base. At December 31, 1993 and 1992, the Association Bank
Services Division accounted for approximately $45.1 million and $53.5 million
in deposits, representing approximately 21.5% and 18.7% of the Bank's total
deposits, respectively. A substantial portion of the Association Bank Services
deposits are broken down into individual accounts that are 100% covered by FDIC
insurance. The Bank also offers a certificate of deposit arbitrage (CD
Arbitrage) program designed to invest a customer's funds in other insured
financial institutions up to a maximum of $100,000 per institution (for which
the Bank is paid a fee based on the average CD Arbitrage investments
outstanding).
-9-
12
In August 1993, the manager and much of the staff of Association Bank
Services left the Bank to join a competitor, whose services have been actively
marketed to the Bank's customer base. As of December 31, 1993, the deposit
base of Association Bank Services was approximately 15.7% below the prior year.
There can be no assurance that the Bank will be able to stem the losses in such
deposits. However, Association Bank Services' new management team has invested
significant effort in visiting with and providing quality service to all
existing clients, and the Bank has succeeded in maintaining much of its primary
customer base in the area. Association Bank Services will focus its near-term
efforts on staff re-training, maintaining the quality of its customer service
activities and continued defensive marketing. When and if the Bank is
adequately recapitalized, management intends to increase its proactive
marketing efforts and expand its lending activities to this customer base.
Although a substantial portion of the individual Association Bank
Services deposit accounts are fully insured, a small number of "account
managers" control significant numbers of such individual accounts, thus
concentrating control of such deposits in the discretionary authority of a few
individuals. Accordingly, a decision by several such account managers to
withdraw their business from the Bank could have a significant impact on the
Bank's core deposits, and thus on the Bank's liquidity.
In addition to responding to competitive pressures in this area, one
of management's short-term objectives with respect to Association Bank Services
is to increase margins by seeking to increase pricing by working with clients
to ensure that they understand the cost of providing the products and services
they receive. Further, management intends to increase revenue by cross-
selling other Bank services and products, such as services and products
provided by the Capital Management Group, in order to increase the perceived
value that such clients derive from Bank products and services.
The long-term strategic objectives for Association Bank Services
include increasing deposits by expanding the client base through "private
labeling" of services to local banks (i.e., offering the Bank's association
banking administrative services to other banks to allow them to market the
services to their customers in their own name) and through identification of
other client groups to which similar services can be provided.
THE DEVELOPMENT OF THE SAN FRANCISCO COMPANY-ASIA
Many large West Coast banks have refrained from effectively
participating in the private banking market (both domestic and offshore) and
the private and closely held business markets due to an inability to provide
the high levels of service such markets require. Although many independent
niche financial services companies currently exist that compete in The San
Francisco Company-Asia's target markets, management believes the size of the
private Asian banking market is large and is growing at a rapid pace.
Management's strategy is to obtain a small but profitable share of the Asian
private banking market and a larger share of the local domestic market through
a product delivery system that management believes will result in a competitive
advantage to the Company and the Bank. The Company intends to organize The San
Francisco Company-Asia as a new division of the Bank to target wealthy
individuals who require private banking, trust and investment management
services both in Asia and the United States, and who are willing to pay for the
highest level of service quality.
STRATEGIC ALLIANCE PARTNERS
Management intends to implement this strategy in concert with a select
group of Strategic Alliance Partners, comprised of financial institutions and
other financial services organizations both in the United States and key Asian
locations. Management believes that establishing strategic alliance
partnerships with these institutions will be mutually beneficial to them and to
the Company, and that, by building on the existing customer bases and product
capabilities that Strategic Alliance Partners will make available, the business
envisioned for The San Francisco Company-Asia will develop more rapidly than
would otherwise be possible.
Management intends to extend its Strategic Alliance Partnerships
beyond traditional correspondent relationships to include referrals of products
such as loan and deposit products, and will strongly encourage, subject to
local regulatory constraints, each Strategic Alliance Partner, or certain
investors therein, to be an investor in the Company. As the strategic
alliances develop, management anticipates that each Strategic Alliance Partner
will enter into detailed operating agreements with the Company and the Bank
with respect to (i) payment of compensation among the Company, the Bank and
Strategic Alliance Partners for business generated by the Company, the Bank and
the Strategic Alliance Partners in each other's countries and (ii) business
facilitated by the Company and the
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13
Bank between the Strategic Alliance Partner's country and other Strategic
Alliance Partners. In addition, it is anticipated that Strategic Alliance
Partners will supply the Company and the Bank with investment products and
services originating in each Strategic Alliance Partner's country that can be
sold to domestic clients of the Company and the Bank, and to clients of other
Strategic Alliance Partners. In return, the Company and the Bank would supply
Strategic Alliance Partners with investment products and services originated in
the U.S. or otherwise available to the Bank or the Company.
Management expects Strategic Alliance Partners to possess the
following characteristics: (i) they should be financial institutions with both
distribution and product capability or, in the alternative, offer specific
investment products that are found desirable by the Company and other Strategic
Alliance Partners; (ii) they should possess a strong local presence in their
home markets but perceive a need to develop or enhance their international
network; (iii) they should have client bases that include individuals who
utilize offshore private banking, trust and/or investment management products
and services; (iv) they should be managed in an entrepreneurial style; and (v)
they should be financially healthy companies, often possessing affiliations
with strong business groups or having strong ties with wealthy families.
Potential Strategic Alliance Partners, five of whom have entered into Memoranda
of Understanding with the Bank calling for further negotiations of specific
business arrangements, are expected to be located in the United States, China,
Hong Kong, India, Indonesia, Korea, the Philippines, Singapore, Taiwan and
Thailand.
Although the ultimate structure of the Strategic Alliance Partner
program will be developed in conjunction with the Strategic Alliance Partners
selected, management has established several guiding principles. Senior
management of the Company and the Bank will assume responsibility for
establishing relationships and monitoring all Strategic Alliance Partner
activity while the Bank also acts as a market clearing house and product
development facilitator between and among Strategic Alliance Partners. Each
Strategic Alliance Partner will develop annually, in collaboration with the
Company and the Bank, a business and marketing plan that identifies local
client product and service needs, including U.S.-based product needs and other
Asian-based product needs, and local product and service capabilities,
including the needs of The San Francisco Company-Asia U.S.-based clients and
other Strategic Alliance Partner clients. It is intended that there will be
periodic meetings of Strategic Alliance Partners to discuss product, service
and marketing opportunities and the ongoing structure of the Strategic Alliance
Partner program.
A fee arrangement will be developed to compensate Strategic Alliance
Partners for business generated from referred clients. Fees will be paid by
The San Francisco Company-Asia and by other Strategic Alliance Partners who may
be beneficiaries of the business, and may be paid as a one-time fee or an
on-going payment stream, depending upon the type of business generated.
Management intends that The San Francisco Company-Asia will hire
private bankers who have experience attracting business that closely matches
the Bank's target client base. In conjunction with seeking to attract and hire
such bankers, The San Francisco Company-Asia will develop a competitive
compensation structure that rewards the development of profitable banking
relationships.
MARKET SEGMENTS
Management has segmented Asia into three distinct target markets that
will serve as the focus of The San Francisco Company- Asia's business efforts.
The first market segment is comprised of China, Hong Kong, Korea and Taiwan.
The second market segment is comprised of Singapore, Thailand, Indonesia,
Malaysia, Viet Nam and the Philippines. The last market segment will include
India and such other countries as management may add in the future.
PRODUCT AND SERVICE OFFERINGS
Based upon the structure of each market and the capabilities of
individual Strategic Alliance Partners in those markets, management intends
that The San Francisco Company-Asia will develop specific product marketing
plans for (i) delivery of investment and service products developed and managed
by the Capital Management Group, (ii) delivery of trust products developed and
managed by the Trust and Securities Division and (iii) delivery of credit,
deposit and other fee products developed and managed by the Private and
Business Banking Division. The San Francisco Company-Asia will serve as the
sales and marketing conduit for such internally developed and managed products
and services and will also act as the marketing conduit for products and
services of the Strategic Alliance Partners.
-11-
14
While senior management of the Company and the Bank believe that The
San Francisco Company-Asia business plan can be successfully implemented,
neither the Company nor the Bank has engaged in such activity. Therefore, no
assurance can be given that The San Francisco Company-Asia can be developed
successfully by the Bank. Initially, the Bank will incur significant start-up
expenses that may not be recouped if the proposed new division cannot be
developed to generate a sufficient volume of profitable business. Moreover,
the success of this new division will depend, at least in part, on the
successful organization and development of the proposed Strategic Alliance
Partners network and the proposed Capital Management Group. These other
proposed lines of business are also start-up ventures whose success cannot be
assured.
CAPITAL MANAGEMENT GROUP
Management intends to establish the Capital Management Group as
promptly as practicable if the Company raises sufficient new capital. It is
planned that the Capital Management Group will develop and manage investment
products and services to be marketed domestically and in Asia through the
Bank's and the Company's business units, including the domestic Private and
Business Banking Division, the Trust and Securities Division, The San Francisco
Company-Asia and the Capital Management Group's own institutional sales force,
as well as through Strategic Alliance Partners.
The Company intends that the Capital Management Group will offer a
wide range of products and services through these marketing channels, but does
not necessarily intend to manage every fund internally. The group will
"private label" or directly offer certain funds managed by Strategic Alliance
Partners or other investment managers, and will primarily concentrate in
developing its expertise in managing emerging markets investments, particularly
in Asia. Management intends to hire an experienced Asian equities research
specialist who, in conjunction with Mr. Champion, will lead the Bank's efforts
in the development of investment products. Investment management by the group
will be made available both for individual accounts and through collective
investment vehicles.
IMPLEMENTATION PLANS
Management has established a plan to implement the Capital Management
Group's business strategy in three phases. In the first phase of the plan,
expected to commence in mid-1994, the group will be established as a separate
division within the Bank, and thereafter hire staff, develop investment
information, structure Strategic Alliance Partner relationships and develop its
capacity to manage investment products and provide investment services.
The second phase of the implementation plan involves the possible
reorganization of the group as a wholly-owned or majority-owned subsidiary of
the Company and the launch of such basic investment products as cash and medium
term fixed income funds, either managed in-house or on a "private label" basis.
Management expects that the initial goals of this phase of the plan will be
completed in late 1994 or early 1995.
The third phase of the plan, which is expected to overlap with the
second phase will involve launching emerging markets investment products and
services, such as a "Greater China" equity fund, and more sophisticated
domestic products, which may be managed by a domestic Strategic Alliance
Partner. Management expects this phase to be underway in early or mid-1995.
The foregoing implementation strategy is contingent upon the Company
raising a sufficient amount of new capital, the receipt of necessary regulatory
approvals, the general financial condition of the Company and the Bank, and the
progress of the Bank in identifying and entering into agreements with Strategic
Alliance Partners. No assurance can be given that this strategy can be pursued
in the manner outlined in view of the many contingencies involved, such as the
need to structure appropriate arrangements with particular Strategic Alliance
Partners and market behavior, that are beyond the Company's control.
REAL ESTATE INVESTMENT AND DEVELOPMENT ACTIVITIES
Management intends to withdraw the Bank from all real estate
development activities as promptly as practicable. From 1985 through 1992, the
Bank was engaged in commercial and residential real estate development through
Bank of San Francisco Real Estate Investors ("BSFRI"), a wholly-owned
subsidiary of the Bank. Then-
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15
applicable regulations and practices of the FDIC and the Federal Reserve Board
permitted state-chartered bank subsidiaries of bank holding companies to engage
in real estate investment activities if such activities were permitted under
state law (as was the case in California). The Bank's approval for engaging in
real estate investment and development activities was suspended after November
1991 pursuant to the terms of a Memorandum of Understanding with the FDIC and
the State Banking Department (the "MOU"), and the Bank agreed to discontinue
its real estate investment activities not later than December 1993. In
addition, under FDICIA (see "-- Regulation and Supervision -- Federal Deposit
Insurance Corporation Improvement Act of 1991"), the Bank is no longer
permitted to engage in real estate development activities and must dispose of
assets acquired for such purposes by December 19, 1996. The Bank has applied
to the FDIC for authority to continue to hold the last three of its real estate
development assets in order to provide for their orderly resolution and
believes that it will receive permission to do so. If BSFRI must dispose of
certain of its real estate investments, however, there can be no guaranty that
BSFRI will be able to dispose of such assets at a profit or without incurring a
loss. See "-- Regulation and Supervision."
BSFRI's activities were substantially cut back after 1989. During
1991, BSFRI sold one home; during 1992 BSFRI sold two homes and one parcel of
unimproved land; and during 1993, BSFRI sold no properties. At December 31,
1993 and 1992, real estate investment totaled $1.5 million and $1.9 million, or
approximately 0.6% and 0.6%, respectively, of the Company's total assets,
excluding real estate accounted for as Bank premises (which totaled $2.2
million and $2.1 million, respectively).
LENDING ACTIVITIES
Historically, the Bank concentrated its lending activities in
commercial and financial loans, in real estate construction and development
loans and real estate mortgage loans made primarily to individuals and
businesses in the San Francisco area and, for a brief period, in the Sacramento
area. The Bank also provides financing for the exercise of employee stock
options and for equipment leasing. The Bank offers credit for private or
closely held businesses ranging from $250,000 to $2.5 million and offers credit
to high net worth and high income individuals ranging from $150,000 to $1.5
million. The Bank has no foreign loans.
At December 31, 1993 and 1992, the Bank had net loans outstanding of
$141.1 million and $226.8 million, respectively, which represented
approximately 67.2% and 79.4% of the Bank's total deposits at those dates and
approximately 61.1% and 71.0% of the total assets of the Company. During 1993,
the Bank originated $87.8 million of new loans, compared with $100.8 million of
new loans during 1992. The interest rates charged on the Bank's loans have
varied with the degree of risk, maturity and amount of the loans and have been
subject to competitive pressures, money market rates, funds availability and
governmental regulations. Approximately 92.0% of the Bank's loans have
interest rates that either adjust with the Bank's prime rate or mature within
90 days.
As of December 31, 1993 and 1992, approximately 66.7% and 53.5%,
respectively, of the Bank's loans were secured by real estate. While these
percentages indicate an increase, total loans secured by real estate actually
declined to $99.9 million as of December 31, 1993 from $126.3 million as of
December 31, 1992. A loan may be secured by real estate even though the
purpose of the loan is not to facilitate the purchase or development of real
estate and even though the principal source of repayment is not the sale of the
real estate serving as collateral. However, in accordance with the terms of
the MOU, and subsequently the Orders, as later defined, the Bank has agreed to
diversify its risk by reducing the Bank's exposure to real estate lending and
investment. See "-- Regulation and Supervision."
LENDING POLICIES AND PROCEDURES
The Bank's lending policies are established by the Bank's senior
management and approved by the Board of Directors of the Bank and its Loan
Committee. The Bank is required by regulation to limit its maximum outstanding
balance to any one borrower to 25% of capital on secured loans and to 15% of
capital on unsecured loans. Secured loans are defined as loans secured by a
first deed of trust or possessory collateral. All loans for up to $1.0 million
require the approval of at least two officers. All loans in excess of $1.0
million to $2.5 million must be approved by the Bank's Loan Committee, chaired
by the Chief Credit Officer and comprised of the Bank's Chief Executive Officer
and senior lenders. All loans in excess of $2.5 million must be approved by
the Loan and
-13-
16
Investment Committee of the Board of Directors of the Bank, comprised of five
directors. The Loan and Investment Committee also must review all extensions
of credit in which the Bank's total liability equals or exceeds $500,000.
The Bank assesses the lending risks, economic conditions and other
relevant factors related to the quality of the Bank's loan portfolio in order
to identify possible credit quality risks. The Bank relies primarily on its
own internal credit review staff, which is independent of the lending
divisions, to evaluate the loan portfolio. The Credit Administration
Department reviews all new and renewed credits in excess of $250,000 on a
continuous basis and reports the results of its findings to the Audit Committee
of the Bank's Board of Directors. Results of reviews by the Credit
Administration Department as well as examination of the loan portfolio by state
and federal regulators are also considered by management in determining the
level of the allowance for loan losses. In addition, the allowance for loan
losses is reviewed and measured against the analysis of individual credits when
the potential for loss exceeds amounts assigned to assets of similar risk
classifications because of collateral values, payment history or economic
conditions. (The Bank discontinued leasing activities, which in any event were
not material, in 1991.)
When a borrower fails to make a required payment on a loan, the loan
is classified as delinquent. If the delinquency is not cured, workout
procedures are generally commenced and the loan is transferred to the Bank's
Special Assets Department. If workout proceedings are not successful,
collection procedures, which may include collection demands, negotiated
restructures, foreclosures and suits for collection, are initiated. In
general, loans are placed on non-accrual status after being contractually
delinquent for more than 90 days, or earlier, if management believes full
collection of future principal and interest on a timely basis is unlikely.
When a loan is placed on non-accrual status, all interest accrued but not
received is charged against interest income. During the period in which a loan
is on non-accrual status, any payment received may be used to reduce the
outstanding loan balance. A non-accrual loan is restored to an accrual basis
when principal and interest payments are being paid currently and full payment
of principal and interest is expected. Loans that are well secured and in the
process of collection remain on accrual status.
The Bank may restructure loans as a result of a borrower's inability
to service the obligation under the original terms of the loan agreement.
Restructures are executed only when the Bank expects to realize more from a
restructured loan than from allowing it to be foreclosed or seeking other forms
of collection.
CREDIT QUALITY
In its lending operations, the Bank continues to take steps to
strengthen its credit management practices and to improve the overall quality
of the loan portfolio. Such steps include instituting more stringent
underwriting standards and restricting lending to small businesses,
corporations and individuals for cash flow, inventory funding and other
investments. As a result of the decline in California real property values and
the desire to reduce concentrations of real estate loans, the Bank has
substantially eliminated its origination of land acquisition and development
loans other than lending to community redevelopment projects, loans to
facilitate sale of other real estate owned and funding outstanding commitments.
See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -- Valuation Allowances."
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17
COMPOSITION OF LOAN PORTFOLIO
The composition of the Bank's loan portfolio at December 31 is
summarized as follows:
At December 31,
--------------------------------------------------------------------------------
(Dollars in Thousands) 1993 1992 1991 1990 1989
--------------------------------------------------------------------------------
Commercial and financial $109,008 $166,364 $183,858 $160,321 $156,076
Real estate construction 14,023 37,659 61,756 86,587 72,796
Real estate mortgage 26,479 31,690 35,749 32,729 15,240
Net lease financing 230 363 490 522 1,234
--------------------------------------------------------------------------------
149,740 236,076 281,853 280,159 245,346
Deferred fees and discounts, net (550) (863) (1,162) (1,257) (1,441)
Allowance for possible loan losses (8,050) (8,400) (8,411) (5,052) (4,178)
--------------------------------------------------------------------------------
Total loans, net $141,140 $226,813 $272,280 $273,850 $239,727
================================================================================
The following table presents the loan portfolio at December 31, 1993
based upon various contractually scheduled principal payments allocated to
maturity categories. This table does not reflect anticipated prepayment of
loans.
One to After
Within Five Five
(Dollars in Thousands) One Year Years Years Total
-------------------------------------------------------------
Commercial and financial $69,320 $37,250 $ 2,438 $109,008
Real estate construction 1,808 6,369 5,846 14,023
Real estate mortgage 4,041 14,549 7,889 26,479
Net lease financing 230 -- -- 230
-------------------------------------------------------------
Total loans $75,399 $58,168 $16,173 $149,740
=============================================================
Loans due in one year or more include $11.6 million with fixed
interest rates and $62.8 million with floating or adjustable rates.
Commercial and Financial Loans. The Bank offers a variety of
commercial and financial lending services, including revolving lines of credit,
working capital loans, equipment financing, letters of credit and loans to
facilitate the exercise of stock options. These loans are typically secured by
cash deposits, accounts receivable, equipment, inventories, investments, real
estate and securities. The Bank's commercial and financial loans typically
bear a floating rate of interest based on the prime rate. The Bank's
commercial and financial loans are primarily in principal amounts of at least
$100,000 and generally have terms of one year or less. As of December 31, 1993
and 1992, the Bank had commercial and financial loans outstanding of $109.0
million and $166.4 million constituting approximately 77.2% and 73.3% of the
Bank's gross loans, respectively. As of December 31, 1993, approximately 63.6%
of the Bank's gross commercial and financial loans were scheduled to mature
within one year. During 1993, no single commercial client accounted for more
than 2.8% of the Bank's outstanding loan financings.
In underwriting commercial and financial loans, the Bank focuses
on the net worth, income, liquidity and cash flows of the borrower or borrowers
and, in the case of secured loans, the value of the collateral. The Bank's
borrowers who secure their loans typically use personal or business real estate
in the San Francisco area as collateral. As of December 31, 1993 and 1992,
approximately 49.2% and 37.3%, respectively, of the Bank's total commercial and
financial loans were secured by real estate.
At December 31, 1993 and 1992, the total amount of the Bank's
stock option loans outstanding was $1.7 million and $26.1 million,
respectively. See "-- Trust and Securities Division."
Construction Lending and Real Estate Mortgage Lending.
Historically, the Bank has made loans to finance the construction of
commercial, industrial and residential properties and to finance land
development. The Bank's real estate construction loans typically have had
maturities of less than two years, have had a floating rate
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of interest based on the Bank's prime lending rate, have been secured by deeds
of trust and usually have not exceeded 70% of the appraised value of the
property at origination. Bank policy generally limits real estate construction
loans to 75% of the appraised value of the property after development. From
time to time, the Bank sought participants to share in the funding of real
estate construction loans. At December 31, 1993 and 1992, real estate
construction and mortgage loans constituted approximately 27.1% and 29.4%,
respectively, of the Bank's gross loans outstanding. In 1993, management
decided to reduce the Bank's real estate construction lending activities in
order to help further diversify the Bank's loan portfolio. Accordingly, gross
real estate construction loans outstanding as a percentage of gross loans
outstanding fell to 9.4% at December 31, 1993 from 16.0% at December 31, 1992.
The Bank's real estate mortgage loans typically are secured by
first or second deeds of trust on either commercial or residential property,
and have original maturities of three years or more. Such loans have been
non-revolving and generally have had maturities that do not exceed ten years.
Repayment terms generally include principal amortization over a negotiated
term, with balloon principal payments due upon maturity of the loans. The
typical purpose of these loans is the acquisition of real property securing the
loan. The primary sources of repayment have been the properties' cash flow in
the case of commercial real estate loans and the borrower's cash flow in the
case of residential real estate. The secondary source of repayment is the sale
of the real property securing the loan. Real estate mortgage loans accounted
for approximately 17.7% and 13.4% of the Bank's gross loans outstanding as of
December 31, 1993 and 1992, respectively.
From 1990 through 1991, the Bank had a Residential Lending
Division whose objective was to originate residential and multi-family mortgage
loans through a network of retail, wholesale and correspondent sources for
resale in the secondary market for residential loans. During the third quarter
of 1991, as a result of the Division's marginally profitable operations,
management decided to substantially reduce the Bank's residential lending
activities and began winding down the operations of the Residential Lending
Division. In the fourth quarter of 1991, the Bank sold its mortgage servicing
portfolio of approximately $21.0 million at a profit. The Bank has retained
$5.5 million in residential loans in its portfolio, which it has determined
will be held to maturity, and plans to re-enter a segment of the market through
its Private Banking Division if the Company is successful in raising sufficient
new capital. At December 31, 1993 and 1992, residential mortgage loans
accounted for $5.5 million and $5.5 million, or 3.8% and 2.3% of gross loans
outstanding, respectively.
PROBLEM ASSET PORTFOLIO
The Bank's problem assets portfolio consists of non-performing loans,
real estate held after foreclosure or in substance foreclosure on assets
securing loans ("other real estate owned" or "OREO"), real estate with an
impaired value that was originally acquired by the Bank for its own development
and loans that are performing but otherwise have undesirable characteristics
(as a result, for instance, of impaired collateral or adverse developments with
respect to the borrower's ability to service the loan out of the cash flow of
the securing property). As a result of the Bank's rapid growth and the
deteriorating economic condition of the California real estate markets, a
significant number of loans and investments made by the Bank from 1985 through
1992 have subsequently proven difficult or impossible to recover without
incurring losses. As of December 31, 1993, the Bank had $22.9 million in
problem loans and $33.8 million in problem assets (OREO and real estate
investments).
In the fourth quarter of 1993, the Bank reduced its problem asset
portfolio by $15.2 million, from $72.0 million to $56.8 million, in accordance
with the requirements of the Orders (See "-- Regulatory Directives and
Orders"), through resolutions, charge offs and improvements in loan quality.
In management's opinion, the quality of the portfolio improved in late 1993
through negotiating pay-downs and obtaining additional collateral for such
problem assets. Management intends to further reduce the problem asset
portfolio and to implement plans that will maximize the resolution value of
such assets. Of the $56.8 million of problem assets in the Bank's portfolio at
December 31, 1993, loans and properties classified by the Bank as other real
estate owned comprised 57.0% of the total value of the problem asset portfolio.
Management's attention is focused primarily on these assets. Of the total
value of the problem asset portfolio, $11.1 million, or 19.5%, is held on a
non-accrual basis. Based upon information currently available, Management
currently believes that the Bank has made sufficient provision to its allowance
for possible loan and lease losses and specific reserves to absorb expected
losses that might result from the Bank's current strategies to resolve the
problem assets. There can be no assurance, however, that existing or
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future provisions to allowance for possible loan and lease losses will be
sufficient to absorb actual losses with respect to existing classified assets
or other assets that may cause losses to the Bank in the future.
The Bank maintains a Special Assets Department to monitor and attempt to
resolve the problem asset portfolio with the objective of maximizing value.
The Special Assets Department is currently staffed with seven
full-time-equivalency positions. At such time as staff levels have been
sufficiently reduced as a result of the reduction in the number of problem
assets, management intends that the Special Assets Department will be absorbed
into the Credit Administration Department. Individual workout plans have been
developed for each asset managed by the Special Assets Department, and a
tracking system to monitor compliance with these plans has also been
established. In addition, the Bank has engaged Thomas M. Foster, who was
responsible for structuring the "bad bank" concept at two large U.S. financial
institutions, to identify and evaluate alternative methods to maximize value
from the problem assets and to advise the Bank on the structure and the terms
of the Rights.
While it is management's current intention to resolve the problem
assets on an asset by asset basis, management is also exploring other
alternatives, including the possible sale of part or all of the problem asset
portfolio to a single buyer. Among other things, Mr. Foster is helping
management to determine whether to attempt to structure such a sale.
Management expects that such a sale would be likely to entail further
writedowns of the problem assets sold in recognition of the administrative
expenses and the cost of money assumed by the buyer, together with the
requirement imposed by typical buyers in such transactions that they be able to
achieve a substantial return on their investments. Management anticipates that
such a sale would be undertaken, if at all, only after a successful completion
of capital raising efforts by the Company.
Management believes that the resolution process could be accelerated
if the California economy in general, and Bay Area real estate market in
particular, performs better than anticipated in 1994. In addition, even if a
sale to a single buyer is effected, management may ultimately deem it prudent
to sell assets at an increased discount to provide for a more rapid liquidation
process in order to reduce expense and the distraction to management caused by
the continuing need to administer these problem assets. There can be no
assurance, however, that the Bank or the Company will be able to liquidate,
resolve or otherwise dispose of any problem assets, or that any liquidation,
resolution or disposal of such assets will be made at acceptable values or
without the incurrence of significant additional losses to the Bank or the
Company.
CORRESPONDENT BANKS
The Bank has correspondent relationships with eleven banks for the
purpose of check clearing, selling federal funds, buying and selling investment
securities, the safekeeping of investment portfolio and related record keeping,
stock registration and stock transfer services, credit card issuance and
servicing, and issuance of letters of credit.
EMPLOYEES
At December 31, 1993, the Company, primarily through the Bank, employed 123
persons, consisting of 117 full-time and 6 part-time employees.
COMPETITION
The banking business in California, and specifically the market area served
by the Bank, is highly competitive. The Bank competes for loans and deposits
with other commercial banks, including some of the country's and the world's
largest banks, savings and loan associations, finance companies, money market
funds, brokerage houses, credit unions and non-financial institutions. By
virtue of their larger amounts of capital, many of the financial institutions
with which the Bank competes have significantly greater lending limits than the
Bank and perform certain functions, including corporate trust services and
international banking services, which are not presently offered directly by the
Bank although such functions may be offered indirectly by the Bank through
correspondent institutions. In addition, certain regulatory restrictions which
have been imposed on the Bank by federal and state regulators may prohibit the
Bank from engaging in certain activities and place the Bank at a competitive
disadvantage to other financial institutions.
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The Bank's strategy for meeting its competition has been to concentrate on
discrete segments of the market for financial services, particularly small to
medium-sized businesses and their owners, professionals, corporate executives,
affluent individuals, real estate developers having existing relationships with
the Bank and homeowners and community associations, by offering specialized and
personalized banking services to such clients.
From time to time, legislation has been and continues to be proposed or
enacted which has the effect of increasing the cost of doing business for
banks, limiting the permissible activities of banks, or affecting the
competitive balance between banks and other financial institutions or between
large banks and small banks. It is difficult to predict the competitive impact
that these and other changes in legislation may have in the future on
commercial banking in general or on the business of the Bank in particular.
REGULATORY DIRECTIVES AND ORDERS
FEDERAL RESERVE BOARD DIRECTIVE
As a result of the Federal Reserve Bank of San Francisco's (the "FRB")
examination of the Company as of June 30, 1991, the FRB on April 20, 1992
issued a letter (the "Directive") prohibiting the Company, without the FRB's
prior approval, from (i) paying any cash dividends to its stockholders, (ii)
incurring any new debt or increasing existing debt, (iii) repurchasing any
outstanding stock of the Company or (iv) acquiring or entering into an
agreement to acquire any entities or portfolios. The Company has been notified
that it is in a "troubled condition" for purposes of Section 914 of the
Financial Institutions Recovery, Reform and Enforcement Act ("FIRREA").
Accordingly, the Company must notify the FRB 30 days in advance of adding or
replacing any director or senior executive officer. All directors and officers
who have been submitted to the FRB for approval have been approved as the new
management team and additional directors have been identified for approval.
CEASE AND DESIST ORDERS
On August 18, 1993, the Bank, without admitting or denying any alleged
charges, stipulated to Cease and Desist Orders (the "Orders") issued by the
FDIC and the California State Banking Department (the "SBD") that became
effective August 29, 1993 (the "Orders Effective Date"), and that superseded
the MOU. The Orders directed, among other things, that the Bank: (a) achieve
and maintain a 7% leverage capital ratio on and after September 30, 1993; (b)
pay no dividends without the prior written consent of the FDIC and the
California Superintendent of Banks (the "Superintendent"); (c) reduce the $88.6
million in assets classified "Substandard" or "Doubtful" as of November 30,
1992 (the date of the most recent full-scope FDIC and SBD Report of Examination
of the Bank), to no more than $75.0 million by October 31, 1993, with further
reductions to no more than $60.0 million by December 31, 1993, no more than
$50.0 million by March 31, 1994 and no more than $40.0 million by August 31,
1994; (d) have and retain management whose qualifications and experience are
commensurate with their duties and responsibilities to operate the Bank in a
safe and sound manner, notify the FDIC and the Superintendent at least 30 days
prior to adding or replacing any new director or senior executive officer and
comply with certain restrictions in compensation of senior executive officers;
(e) maintain an adequate reserve for loan losses; (f) not extend additional
credit to, or for the benefit of, any borrower who had a previous loan from the
Bank that was charged off or classified "Loss" in whole or in part; (g) develop
and implement a plan to reduce its concentrations of construction and
development loans; (h) not increase the amount of its brokered deposits above
the amount outstanding on the Orders Effective Date ($20.0 million) and submit
a written plan for eliminating reliance on brokered deposits; (i) revise or
adopt, and implement, certain plans and policies to reduce the Bank's
concentration of construction and land development loans, reduce the Bank's
dependency on brokered deposits and out of area deposits, and to improve
internal routines and controls; (j) reduce the Bank's volatile liability
dependency ratio to not more than 25% by December 31, 1993, and not more than
15% by March 31, 1994; (k) eliminate or correct all violations of law set out
in the most recent Report of Examination, and take all necessary steps to
ensure future compliance with all applicable laws and regulations; and (l)
establish a committee of three independent directors to monitor compliance with
the Orders and report to the FDIC and the Superintendent on a quarterly basis.
As of December 31, 1993, the Bank met all industry-wide capital
requirements (see "-- Regulation and Supervision -- Federal Deposit Insurance
Corporation Improvement Act -- Prompt Corrective Action") but failed to meet
the 7% leverage capital ratio imposed by the Orders. This failure occurred
because the leverage ratio is calculated by dividing Tier 1 capital by average
assets at each month-end, and the Bank's primary action to meet
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the required leverage ratio during the fourth quarter -- the sale of its
Sacramento branch -- could not be effectuated until December 4, 1993 due to
delays in the approval by the FDIC and the SBD of such sale.
As to the other requirements of the Orders and the Restoration Plan,
the Bank believes that it is in compliance with each, with the exception of the
SBD's order requiring the Bank to correct its capital impairment. See "--
Capital Impairment Orders." However, no outside verification of such compliance
has been performed, and the Bank's compliance is subject to review by the FDIC
and the SBD at their next examination of the Bank scheduled to begin February
28, 1994. No assurance can be given that capital, in addition to that raised
pursuant to the Offering, can be raised if the Bank requires such additional
capital to remain in compliance with capital adequacy requirements or to pursue
the new strategic focus of the Bank and the Company. In addition, because of
its asset quality, operating losses, volatile liability dependency and
liquidity problems, the Bank is potentially subject to further regulatory
sanctions that are generally applicable to banks that are not adequately
capitalized.
In response to the Orders, management has submitted a business plan
to the FDIC and the SBD for approval. It is expected that the business plan
will be approved by the FDIC and the SBD after the examination scheduled by
both agencies to begin on February 28, 1994 is substantially completed.
Management believes that the Bank will be able to take the actions contemplated
by such plan without need for further FDIC approval, subject to the general
requirement that the Bank return to profitability and be operated safely and
soundly. A number of the restrictions imposed by the Orders will remain in
effect until the Orders are officially lifted. Although management anticipates
the FDIC and the SBD will lift the Orders once the Bank's problem assets are
fully resolved, no assurance can be given as to when all conditions precedent
to the lifting of the Orders will be fulfilled. The Company also is subject to
certain restrictions imposed by the FRB pursuant to the Directives that may
prevent the Company from taking steps to establish new businesses (or new
subsidiaries) at the Company level until similar conditions precedent are
fulfilled. However, management believes that, initially, all new lines of
business that the Company plans to enter may be operated directly within the
Bank.
CAPITAL IMPAIRMENT ORDERS
The California Financial Code (the "Financial Code") requires the
Superintendent to order any bank whose contributed capital is impaired to
correct such impairment within 60 days of the date of his or her order. Under
Section 134(b) of the Financial Code, the "contributed capital," defined as all
shareholders' equity other than retained earnings, of a bank is deemed to be
impaired whenever such bank has deficit retained earnings in an amount
exceeding 40% of such contributed capital. Under Section 662 of the Financial
Code, the Superintendent has the authority, in his or her discretion, to take
certain appropriate regulatory action with respect to a bank having impaired
contributed capital, including possible seizure of such bank's assets. A bank
that has deficit retained earnings may, subject to the approval of its
shareholders and of the Superintendent, readjust its accounts in a
quasi-reorganization, which may include eliminating its deficit retained
earnings, under Section 663 of the Financial Code. However, a bank that is not
able to effect such a quasi-reorganization or otherwise to correct an
impairment of its contributed capital within 60 days of an order to do so from
the Superintendent must levy and collect an assessment on its common shares
pursuant to Section 423 of the California Corporations Code.
A bank must levy such an assessment within 60 days of the
Superintendent's order; the assessment becomes a lien upon the shares assessed
from the time of service or publication of such notice of assessment. Within
60 days of the date on which the assessment becomes delinquent, a bank subject
to the Superintendent's order must sell or cause to be sold to the highest
bidder for cash as many shares of each delinquent holder of the assessed shares
as may be necessary to pay the assessment and charges thereon.
As of December 31, 1993, the Bank had contributed capital of $49.2
million and deficit retained earnings of $31.8 million, or approximately 64.6%
of contributed capital, within the meaning of Section 134(b) of the Financial
Code. Thus, under Section 134(b) of the Financial Code, the Bank's contributed
capital was impaired as of that date in the approximate amount of $12.0
million. On November 6, 1992, February 17, 1993, November 16, 1993 and
February 7, 1994, the Superintendent issued orders to the Bank to correct the
impairment of its contributed capital within 60 days. The Bank has not
complied with these orders. As the sole shareholder of the Bank, the Company
(not the Company's shareholders) will receive any notices of assessment issued
by the Bank. The Bank is in violation of this California law requiring it to
assess the shares of the Bank (which are all held by the Company) in order to
correct the impairment of the bank's capital.
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The Bank's capital impairment may be corrected through earnings, by
raising additional capital or by a quasi- reorganization, subject to the
approval of the SBD, in which the Bank's deficit retained earnings would be
reduced or eliminated by a corresponding reduction in the Bank's contributed
capital. The Bank is addressing the possibility of obtaining approval of a
quasi-reorganization with the SBD. If the SBD refuses to grant permission for
such a quasi-reorganization, as of December 31, 1993, the Bank would have been
required to raise $30.2 million in new capital in order to correct its impaired
contributed capital (because the ratio of deficit retained earnings to
contributed capital may not exceed 40%, $2.50 of new capital must be raised for
every dollar of impairment). In response to the February 7, 1994 order
requiring the Bank to correct its impaired capital within 60 days, the Bank
notified the SBD in writing that it did not believe it will be in a position to
comply with the order within 60 days, and requested the SBD's cooperation as
the Company implements its plan for an offering, and as the Company continues
discussions with SBD staff regarding a quasi-reorganization. It is the policy
of the Superintendent not to grant a quasi- reorganization unless a Bank can
establish that (a) it has adequate capital, (b) the problems that created past
losses and the impairment of capital have been corrected and (c) it is
currently operating on a profitable basis and will continue to do so in the
future.
No assurance can be given that the Bank's capital condition will not
deteriorate further as a result of operating losses prior to a
quasi-reorganization. In addition, because a quasi-reorganization requires
that the Bank reduce its assets and liabilities to market value at the time of
the reorganization, the Bank's capital could be further reduced from its
present level as a result of such a reduction in the market value of the Bank's
assets over its liabilities. Finally, there can be no assurance that,
following a correction of the Bank's capital impairment, whether through a
quasi-reorganization or an infusion of sufficient capital, the Bank's capital
position will not continue to erode through future operating losses. As long
as the Bank's contributed capital is impaired, the Superintendent is authorized
to take possession of the property and business of the Bank, or to order the
Bank to comply with the legal requirement and levy an assessment on the shares
of the Bank held by the Company sufficient to correct the impairment. As the
Company is the sole shareholder of the Bank, the assessment would be made on
the Company. The Company does not have the funds to satisfy such an
assessment. Management believes, however, that the Superintendent has never
exercised his bank takeover powers under Section 134 solely on the basis that a
bank's capital is impaired under the standards set forth in Section 134.
In order to permit a quasi-reorganization of a bank's capital, the
SBD requires, among other things, that a bank demonstrate that it is adequately
capitalized and that it is capable of operating profitably. Management
believes, although it cannot assure, that the Bank will be able to so
demonstrate at such time as the Bank's problem assets are substantially
resolved, and that it will then be possible for the Bank to effect a
quasi-reorganization. Management also believes that, because it is
anticipated that the Bank will have high leverage and risk-based capital ratios
after an offering, it is unlikely that the Superintendent would seek to take
action solely on the basis of impaired capital under the Section 134
definition. There can be no assurance, however, that other circumstances such
as insufficient liquidity (See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Liquidity") or further
operating issues could not arise that would provide incentive to the
Superintendent to utilize the powers granted by Section 134.
REGULATION AND SUPERVISION
Bank holding companies and banks are subject to extensive supervision
and regulation. The following summaries of certain statutes and regulations
affecting banks and bank holding companies do not purport to be complete. Such
summaries are qualified in their entirety by reference to such statutes and
regulations.
THE COMPANY
The Company, as a bank holding company, is subject to regulation under
the Bank Holding Company Act of 1956, as amended (the "Holding Company Act"),
and is registered with and subject to the supervision of the FRB. It is the
policy of the FRB that each bank holding company serve as a source of financial
and managerial strength to its subsidiary banks and not conduct its operations
in an unsafe or unsound manner.
The Holding Company Act generally restricts the Company from engaging
in any business other than managing or controlling banks or furnishing services
to its subsidiaries. Among the exceptions to such restrictions are certain
activities which, in the opinion of the FRB, are so closely related to banking
or to managing or
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controlling banks as to be a proper incident to banking. The Company also is
generally prohibited from acquiring direct or indirect ownership or control of
more than 5% of any class of voting shares of any company unless that company
is engaged in activities permissible for bank holding companies and the Company
receives the prior approval of the FRB.
The Company and its subsidiaries are prohibited from engaging in certain
tie-in arrangements in connection with any extension of credit, sale or lease
of property or provision of services. For example, with certain exceptions,
the Bank is not permitted to condition an extension of credit on a customer
obtaining other services provided by it or the Company, or on a promise by the
customer not to obtain other services from a competitor. In addition,
applicable federal law imposes certain restrictions on transactions between the
Bank and its affiliates. As an affiliate of the Bank, the Company is subject,
with certain exceptions, to the provisions of federal law imposing limitations
on, and requiring collateral for, loans by the Bank to any affiliate.
The Holding Company Act also requires the Company to obtain the prior
approval of the FRB before acquiring all or substantially all of the assets of
any bank or ownership or control of the voting shares of any bank if, after
giving effect to such acquisition, the Company would own or control, directly
or indirectly, more than 5% of any class of voting shares of such bank.
Moreover, the Holding Company Act prohibits the Company from acquiring any
voting shares of, interest in, or all or substantially all of the assets of, a
bank located outside of California unless such an acquisition is specifically
authorized by the law of the state in which such bank is located.
Finally, the Company is subject to restrictions on its operations
imposed by the Directive, as a result of its examination of the Company during
1991. See "-- Regulatory Directives and Orders -- Federal Reserve Board
Directives."
THE BANK
The Bank is a California state-licensed bank and is subject to
regulation, supervision and periodic examination by the SBD and the FDIC. The
Bank is not a member of the Federal Reserve System, but is nevertheless subject
to certain regulations of the FRB. The Bank's deposits are insured by the FDIC
to the maximum amount permitted by law, which is currently $100,000 per
depositor in most cases.
The regulations of state and federal bank regulatory agencies govern
most aspects of the Bank's business and operations, including but not limited
to, the scope of its business, its investments, its reserves against deposits,
the timing of the availability of deposited funds, the nature and amount of any
collateral for loans, the payment of dividends, potential expansion, including
real estate development activities, and the maximum rates of interest allowed
on certain deposits.
The Bank is subject to regulatory and operating restrictions pursuant
to several orders and directives issued by the FDIC and SBD. These orders,
restrictions and directives are discussed in full in "Regulatory Directives and
Orders," and are mentioned below as applicable.
CHANGE IN BANK CONTROL
The Holding Company Act and the Change in Bank Control Act of 1978,
as amended (the "Change in Control Act"), together with regulations of the FRB,
require that, depending on the particular circumstances, either FRB approval
must be obtained or notice must be furnished to the FRB and not disapproved
prior to any person or company acquiring "control" of a bank holding company,
such as the Company, subject to exemptions for certain transactions. Control
is conclusively presumed to exist if an individual or company acquires 25% or
more of any class of voting securities of the bank holding company. Control is
rebuttably presumed to exist if a person acquires 10% or more but less than 25%
of any class of voting securities and either the company has registered
securities under Section 12 of the Securities Exchange Act of 1934, as amended
(the "Exchange Act"), or no other person will own a greater percentage of that
class of voting securities immediately after the transaction. Finally, the
Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the
"Hart-Scott Act"), together with regulations of the Federal Trade Commission,
may require certain filings to be made with the Federal Trade Commission and
the United States Department of Justice, and certain waiting periods to expire,
prior to consummation of an acquisition of a bank holding company's voting
securities.
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CAPITAL ADEQUACY REQUIREMENTS
The Company is subject to the FRB's capital guidelines for bank holding
companies while the Bank is subject to the FDIC's regulations governing capital
adequacy for nonmember banks. As noted below, the Federal banking agencies
have solicited comments on a proposed regulation which would impose additional
capital requirements on banks based on the interest rate risk inherent in a
bank's portfolio.
The FRB has established a minimum leverage ratio of 3% Tier 1 capital
1/ to total assets for bank holding companies that have received the highest
composite regulatory rating (a regulatory measurement of capital, assets,
management, earnings and liquidity) and that are not anticipating or
experiencing any significant growth. All other institutions will be required
to maintain a leverage ratio of at least 100 to 200 basis points above the 3%
minimum.
FRB regulations require bank holding companies to maintain a minimum
ratio of qualifying total capital to risk-weighted assets of 8.00%. Risk-based
capital ratios are calculated with reference to risk-weighted assets, including
both on and off-balance sheet exposures, which are multiplied by certain risk
weights assigned by the FRB to those assets. At least one-half of the
qualifying capital must be in the form of Tier 1 capital.
In certain circumstances, the FRB may determine that the capital
ratios for a bank holding company must be maintained at levels which are higher
than the minimum levels required by the guidelines. A bank holding company
which does not achieve and maintain the required capital levels may be issued a
capital directive by the FRB to ensure the maintenance of required capital
levels.
The Bank failed to meet its regulatory capital requirements at March
31, 1993 and, therefore, was required to file a Capital Restoration Plan
pursuant to the "prompt corrective action" system imposed by FDICIA. As a
condition of FDIC approval of the Bank's Capital Restoration Plan, the Company
has agreed to guarantee that the Bank will comply with the Capital Restoration
Plan. The Company's guarantee requires that the Bank will comply with the
Capital Restoration Plan until the Bank has met its minimum capital
requirements on average during each of four consecutive calendar quarters. The
Company's liability under the guarantee is limited to the lesser of 5% of the
Bank's total assets at the time it became under capitalized or an amount which
is necessary (or would have been necessary) to bring the Bank into compliance
with all of its capital requirements as of the time it fails to comply with its
capital restoration plan. The Bank's capital is also impaired under California
law, permitting the Superintendent to take possession of the Bank unless its
capital impairment is cured through contribution of additional capital by the
Company to the Bank or through a quasi-reorganization of the Bank. See "--
Regulatory Directives and Orders -- Capital Impairment Order."
The FDIC has established risk-based and leverage capital regulations
for state nonmember banks which are similar to the FRB's capital guidelines for
bank holding companies. In addition to these capital requirements, the Orders
require the Bank to meet an individual minimum capital requirement after
September 30, 1993 of 7% Tier 1 capital to total average assets (leverage
ratio). The Bank's leverage capital ratio reached 6.7% as of December 31,
1993. However, because a reduction in the Bank's assets through the sale of
the Bank's Sacramento Office on December 4, 1993, which reduced the Bank's
level of assets to total capital, the Bank did not meet the 7% leverage capital
ratio on average for the fourth quarter of 1993 as required. For further
information with respect to the Bank's failure to meet its regulatory capital
requirements, see "-- Regulatory Directives and Orders."
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1/ Tier 1 capital is generally defined as the sum of the core capital
elements less goodwill and certain intangibles. The following items are
defined as core capital elements: (i) common stockholders' equity; (ii)
qualifying noncumulative perpetual preferred stock; and (iii) minority
interests in the equity accounts of consolidated subsidiaries.
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PAYMENT OF DIVIDENDS
The Company
As a result of prior regulatory examinations, on April 20, 1992, the
FRB prohibited the Company from paying any cash dividends to its shareholders
without prior FRB approval. The ability of the Company to pay dividends in the
future will depend in large part on the Company's ability to satisfy the
concerns of the FRB as set forth in the April 20, 1992 letter regarding the
financial performance of the Company, the ability of the Bank to make dividend
payments to the Company. The Bank's ability to make dividend payments is
dependent upon the ability of the Bank to return to profitability, to satisfy
the regulatory concerns expressed in the Orders, and the ability of the Bank to
cure its capital impairment or obtain approval from the SBD to conduct a quasi-
reorganization to reduce or eliminate the Bank's deficit retained earnings.
See "-- Regulatory Directives and Orders -- Capital Impairment Order."
The Bank
Any future payment of dividends by the Bank is subject to meeting the
state law requirement that amount of funds available for a cash dividend shall
be the lesser of retained earnings of the bank or the bank's net income for its
last three fiscal years (less the amount of any distributions to shareholders
made during such period). If the above test is not met, cash dividends may be
paid with the prior approval of the SBD, in an amount not exceeding greatest of
the bank's retained earnings, net income for its last fiscal year, or the
amount of its net income for its current fiscal year. The Bank is not
presently permitted to pay any dividends to the Company because it has
sustained net losses throughout the period 1991 through 1993. As a result of
these losses, the Bank had deficit retained earnings of $31.8 million as of
December 31, 1993 and currently the Bank's capital is impaired in the amount of
$12.0 million, giving the Superintendent the power to take possession of the
Bank in the event its capital impairment is not cured. See "-- Regulatory
Directives and Orders -- Capital Impairment Orders."
Accordingly, any future payment of cash dividends will depend upon
the Bank correcting its capital impairment, meeting applicable capital
requirements, maintaining an adequate allowance for loan and lease losses,
satisfying the terms of the Orders outstanding against it and its ability to
conduct profitable operations.
FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991
General
FDICIA primarily addresses the safety and soundness of the deposit
insurance funds, supervision of and accounting by insured depository
institutions and prompt corrective action by the federal bank regulatory
agencies for troubled institutions. FDICIA gives the FDIC, in its capacity as
federal insurer of deposits, broad authority to promulgate regulations to
assure the viability of the deposit insurance funds including regulations
concerning safety and soundness standards. FDICIA also places restrictions on
the activities of state-chartered institutions and on institutions failing to
meet minimum capital standards and provides enhanced enforcement authority for
the federal banking agencies. FDICIA has strengthened FRB regulations
regarding insider transactions.
Prompt Corrective Action
FDICIA amended the Federal Deposit Insurance Act (the "FDIA") to
establish a format for closer monitoring of insured depository institutions and
to enable prompt corrective action by regulators when an institution begins to
experience difficulty. The general thrust of these provisions is to impose
greater scrutiny and more restrictions on institutions as they descend the
capitalization ladder.
FDICIA establishes five capital categories for insured depository
institutions: (a) Well Capitalized;2/ (b)
- -----------------------------------
2/ Well Capitalized means a financial institution with a total risk-based
ratio of 10% or more, a Tier 1 risk-based ratio of 6% or more and a leverage
ratio of 5% or more, so long as the institution is not subject to an order,
written agreement, capital directive or prompt corrective action directive to
meet and maintain a specific capital level for
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26
Adequately Capitalized;3/ (c) Undercapitalized;4/ (d) Significantly
Undercapitalized;5/ and (e) Critically Undercapitalized.6/ All insured
institutions (i.e., the Bank) are barred from making capital distributions or
paying management fees to a controlling person (i.e., the Company) if to do so
would cause the institution to fall into any of the three undercapitalized
categories.
Undercapitalized institutions are subject to several mandatory
supervisory actions, including increased monitoring and periodic review of the
institution's efforts to restore its capital, submitting an acceptable capital
restoration plan, restricted asset growth, and limits on acquisitions, new
branches or new lines of business. A parent holding company of an
undercapitalized bank is expected to guarantee that the bank will comply with
the bank's capital restoration plan until the bank has been adequately
capitalized, on the average, for four (4) consecutive quarters. Such guarantee
is limited to the lesser of 5% of the bank's total assets at the time it became
undercapitalized or the amount necessary to bring the bank into full capital
compliance.
Significantly undercapitalized institutions and undercapitalized
institutions that fail to submit and implement adequate capital restoration
plans are subject to the mandatory provisions applicable to undercapitalized
institutions and, in addition, may be required to: sell additional capital,
including voting shares; restrict transactions with affiliates; restrict
interest rates paid on deposits; restrict asset growth or reduce total assets;
terminate, reduce or alter any risky activities; elect new directors and
install new management; cease accepting deposits from correspondent depository
institutions; or divest or liquidate certain subsidiaries. A bank holding
company may be required to divest itself of any affiliate of the institution
(other than another insured depository institution) under certain conditions.
Critically undercapitalized institutions face even more severe restrictions.
In addition, significantly undercapitalized institutions will be
prohibited from paying any bonus or raise to a senior executive officer without
prior agency approval. No such approval will be granted to an institution
which is required to but has failed to submit an acceptable capital restoration
plan.
FDICIA also provides that if a well or adequately capitalized or
undercapitalized institution is in an unsafe or unsound condition or is
engaging in an unsafe or unsound practice, its capital category may be
downgraded to achieve a higher level of regulatory scrutiny and prompt
corrective action. FDICIA restricts the solicitation and acceptance of and
interest rates payable on brokered deposits by insured depository institutions
that are not well capitalized and has added new bases for which a conservator
or receiver may be appointed for undercapitalized and critically
undercapitalized institutions and under certain other circumstances not
relating to capital levels. Finally, FDICIA establishes a risk-based
assessment system for calculating a depository institution's semiannual deposit
insurance premium under which institutions pay premiums based upon their
capital classification and supervisory risk.
Brokered Deposits
FDICIA restricts the acceptance of brokered deposits by insured
depository institutions that are not well capitalized. It also places
restrictions on the interest rate payable on brokered deposits and the
solicitation of such deposits. An undercapitalized institution will not be
allowed to solicit brokered deposits by offering rates of interest
- ----------------------------------
any capital measure.
3/ Adequately Capitalized means a total risk-based ratio of 8% or more, a Tier
1 risk-based ratio of 4% or more and a leverage ratio of 4% or more (3% or more
if the institution has received the highest composite rating in its most recent
report of examination) and does not meet the definition of a Well Capitalized
institution.
4/ Undercapitalized means a financial institution with a total risk-based
ratio of less than 8%, a Tier 1 risk-based ratio of less than 4% or a leverage
ratio of less than 4%.
5/ Significantly Undercapitalized means a financial institution with a total
risk-based ratio of less than 6%, a Tier 1 risk-based ratio of less than 3% or
a leverage ratio of less than 3%.
6/ Critically Undercapitalized means a financial institution with a ratio of
tangible equity to total assets that is equal to or less than 2%.
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that are significantly higher than the prevailing rates of interest on insured
deposits in the particular institution's normal market areas or in the market
area in which such deposits would otherwise be accepted.
The FDIC has promulgated final regulations with respect to the ability
of insured depository institutions in each of the new capitalization categories
to accept brokered deposits. Under the regulations, undercapitalized
institutions are prohibited from accepting funds obtained directly or
indirectly though a deposit broker. Adequately capitalized institutions may
accept brokered deposits only if a waiver is first obtained from the FDIC.
Well capitalized institutions are permitted by the regulations to accept
brokered funds without restriction. For purposes of the brokered deposit
regulation the FDIC has stated that the term "well capitalized" means an
institution whose leverage and risk-based capital ratios are at least one to
two percentage points higher than those currently required by applicable
regulations, and which has not been notified that it is in a troubled
condition.
In addition to the above restrictions on acceptance of brokered
deposits, FDICIA provides that no pass-through deposit insurance will be
provided to employee benefit plan deposits accepted by an institution which is
ineligible to accept brokered deposits under applicable law and regulations.
Under the Order, the Bank is required to submit a written plan to the
FDIC for eliminating its reliance on brokered deposits, and to provide the
Regional Director of the FDIC and the SBD with monthly written reports
outlining the Bank's progress under the plan. The FDIC has granted the Bank
permission to renew brokered deposits for one year from September 23, 1993
through September 23, 1994, provided that the Bank continues to meet the
definition of an adequately capitalized institution. At December 31, 1993, the
Bank had brokered deposits of $20.0 million. These brokered deposits mature on
March 31, 1994. The Bank has no reason to believe that all $20.0 million of
these deposits will not be renewed or replaced.
Conservatorship and Receivership
FDICIA adds grounds to the previously existing list of reasons for
appointing a conservator or receiver for an insured depository institution
including: (a) substantial dissipation of assets or earnings due to an unsafe
or unsound practice or any violation of law or regulation; (b) existence of an
unsafe or unsound condition; (c) any willful violation of a cease and desist
order; (d) any concealment of assets, records, books or papers from any federal
or state bank regulatory agency; (e) likely inability of the institution to
meet obligations in the normal course of business; (f) losses threatening
capital; (g) the institution becomes undercapitalized where certain factors are
present suggesting the institution may not become adequately capitalized; or
(h) the institution is critically undercapitalized or otherwise has
substantially insufficient capital.
FIRREA provides other grounds upon which a receiver or conservator may
be appointed for a state bank. These other grounds include "having
substantially insufficient capital," incurrence or likely incurrence of losses
that will deplete all or substantially all of a bank's capital with no
reasonable prospect for that capital to be replenished without federal
assistance, or a violation of law or regulation which is likely to weaken the
condition of the institution.
Deposit Insurance Premiums
As of January 1, 1993, the FDIC charges higher deposit insurance
premiums on banks which pose greater risks to the deposit insurance fund.
Under the rule, a bank is required to pay an annual insurance premium ranging
from 0.23% to 0.31% for domestic deposits, depending upon the bank's risk
classification. A bank's risk classification is determined by the FDIC
according to the bank's capital ratios and the FDIC's evaluation of the bank
based upon federal and state supervisory examinations and other relevant
information. Under the classification system, the FDIC has assigned the Bank
its highest risk classification and set the Bank's deposit insurance premium at
0.31%.
Restrictions on Insured State Bank Activities and Investments
Recently enacted FDIC regulations generally prohibit an insured state
bank from directly engaging as principal in any activity that is not
permissible for a national bank, and also prohibit majority-owned subsidiaries
of an insured state bank from engaging in any activity that is not permissible
for a subsidiary of a national bank, unless the bank meets and continues to
meet applicable minimum capital standards and the FDIC determines that
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28
the conduct of the activity by the bank and/or its majority-owned subsidiary
will not pose a significant risk to the deposit insurance funds.
If consent to engage in the activity is denied, the bank is required
to cease the activity not later than one year from the denial. However, the
FDIC may condition or restrict the conduct of any impermissible activity during
this phase-out period. If the activities of a subsidiary are denied consent by
the FDIC, the bank is required to divest its interest in the subsidiary as
quickly as prudently possible, but in no event later than December 19, 1996.
Alternatively, the bank may discontinue the impermissible activity, but this
must be effected within one year of the date of denial.
These new regulations also impose new restrictions on real estate
investments, requiring that undercapitalized banks with subsidiaries holding
impermissible equity investments in real estate cease the activity as soon as
practicable, but no later than June 8, 1994, and divest the subsidiary or the
real estate investments owned by the subsidiary as soon as practicable, but in
no event later than December 19, 1996. State banks also must obtain the prior
consent of the FDIC before making real estate loans other than in compliance
with guidelines established for national banks. The Bank has conducted real
estate investment activities through its subsidiary BSFRI. The Bank's approval
to engage in these activities was suspended after November 1991 pursuant to the
terms of the MOU and the Bank agreed to discontinue its real estate activities
by December 1993. The book value of these investments was $1.5 million as of
December 31, 1993. As required by FDICIA, the Bank has filed an application to
continue the orderly divestiture of its real estate investments until December
19, 1996.
Proposed Standards on Safety and Soundness
Pursuant to the requirements of FDICIA, recently proposed FDIC and
FRB regulations provide new standards for safety and soundness applicable to
banks and bank holding companies. The proposed regulations establish
managerial, operational, asset quality and earnings standards for state
nonmember banks as well as bank holding companies, i.e., requiring banks and
bank holding companies to maintain a ratio of classified assets to total
capital and ineligible allowances no greater than 1.25% of risk weighted
assets, and to maintain minimum earnings sufficient to absorb losses without
impairing capital. A bank's "minimum earnings" are deemed sufficient if the
bank's earnings during its last four quarters would be sufficient for the bank
to maintain compliance with its minimum capital requirements for the next four
quarters. Due to the Bank's operating losses during each quarter of 1993, the
Bank will not be in compliance with this regulation if adopted. In addition,
the proposed safety and soundness standards would prohibit excessive
compensation or compensation which could lead to material financial loss for
the bank or bank holding company.
These regulations are subject to change; therefore, the ultimate
impact on the Company and the Bank of final regulation in this area cannot be
predicted at this time.
Extensions of Credit to Insiders and Transactions with Affiliates
The Federal Reserve Act and FRB regulations, which are applicable to
state nonmember banks under regulations of the FDIC, place limitations and
conditions on loans or extensions of credit to: a bank's or bank holding
company's executive officers, directors and principal shareholders (i.e., in
most cases, those persons who own, control or have power to vote more than 10%
of any class of voting securities); any company controlled by any such
executive officer, director or shareholder; or any political or campaign
committee controlled by such executive officer, director or principal
shareholder.
Loans extended to any of the above persons must comply with
loans-to-one-borrower limits, require prior full board approval when aggregate
extensions of credit to such person exceed specified amounts, must be made on
substantially the same terms (including interest rates and collateral) as, and
following credit-underwriting procedures that are not less stringent than,
those prevailing at the time for comparable transactions with non-insiders, and
must not involve more than the normal risk of repayment or present other
unfavorable features. Regulation O also prohibits a bank from paying an
overdraft on an account of an executive officer or director, except pursuant to
a written pre-authorized interest-bearing extension of credit plan that
specifies a method of repayment or a written pre-authorized transfer of funds
from another account of the officer or director at the bank.
The provisions of Regulation O summarized above reflect substantial
strengthening as a result of the adoption of FDICIA. FDICIA also resulted in
an amendment to Regulation O which provides that the aggregate
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limit on extensions of credit to all insiders of a bank as a group cannot
exceed the bank's unimpaired capital and unimpaired surplus. An exception to
this limitation is provided, until February 18, 1994, for banks with less than
$100.0 million in deposits. The aggregate limit applicable to such banks is
two times the bank's unimpaired capital and unimpaired surplus, provided the
bank meets or exceeds all applicable capital requirements.
Government Monetary Policy
The earnings of the Bank and, therefore, the earnings of the Company,
are and will be affected by the policies of regulatory authorities, including
the FRB. An important function of the FRB is to regulate the national supply
of bank credit. Among the instruments used to implement these objectives are
open market operations in U.S. Government securities, changes in reserve
requirements against bank deposits, and changes in the discount rate which
banks pay on advances from the Federal Reserve System. These instruments are
used in varying combinations to influence overall growth and distribution of
bank loans, investments and deposits, and their use may also affect interest
rates on loans or interest rates paid for deposits. The monetary policies of
the FRB have had a significant effect on the operating results of commercial
banks in the past and are expected to continue to do so in the future. The
effect, if any, of such policies upon the future business earnings of the
Company and the Bank cannot be predicted.
RECENT REGULATIONS AND GUIDELINES
Interest Rate Risk
As required by FDICIA, the federal banking agencies have solicited
comments on a proposed method of incorporating an interest rate risk component
into the current risk-based capital guidelines, with the goal of ensuring that
institutions with high levels of interest rate risk have sufficient capital to
cover their exposure. Interest rate risk is the risk that changes in market
interest rates might adversely affect a bank's financial condition. Under the
proposal, interest rate risk exposures would be quantified by weighing assets,
liabilities and off-balance sheet items by risk factors which approximate
sensitivity to interest rate fluctuations. Institutions identified as having
an interest rate risk exposure greater than a defined threshold would be
required to allocate additional capital to support this higher risk. Higher
individual capital allocations could be required by the bank regulators based
on supervisory concerns.
As the federal banking agencies have solicited comments on this
proposal but have not yet proposed regulations to implement any interest rate
risk component into the risk-based capital guidelines, the ultimate impact on
the Company and the Bank of final regulation in this area cannot be predicted
at this time.
State Bank Sales of Nondeposit Investments
Securities activities of state non-member banks, as well as their
subsidiaries and affiliates, are governed by FDIC regulations. The FDIC has
taken the position that bank sales of alternative investment products, such as
mutual funds and annuities, raise substantial bank safety and soundness
concerns involving consumer confusion over the nature of the products offered,
and the potential for mismanagement of sales programs for such investments
which could expose a bank to liability under the anti-fraud provisions of
federal securities laws.
Accordingly, the FDIC has issued guidelines to state non-member banks
which recommend, among other things, establishing a compliance and audit
program to monitor the bank's mutual funds sales activities and compliance with
applicable federal securities laws, providing full disclosure to customers
about the risks of such investments (including the possibility of loss of
principal investment), conducting securities activities of bank subsidiaries or
affiliates in separate and distinct locations, and prohibiting bank employees
involved in deposit-taking activities from selling investment products or from
giving investment advice.
Banks are also required to establish qualitative standards for the
selection and marketing of the investments offered by the bank and maintain
appropriate documentation regarding suitability of investments recommended to
bank customers.
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State Legislation
As a California state-licensed bank, the Bank is subject to the
California banking laws and to regulation, supervision and periodic examination
by the SBD.
The California banking laws, among other matters, regulate: (a) the
process of issuance of a banking permit, including the application for, term of
and surrender or revocation of the permit; (b) the conduct of the banking
business, including banking days, banking offices, preservation and disposal of
records, borrowing by the bank and pledges of assets; (c) accounts, including
types of deposit accounts and claims made thereon; (d) reserves, including
forms, computations, limitations and exemptions; (e) loans, including
limitations on obligations to the bank by borrowers in general and by the
bank's officers, directors and employees; (e) mergers, consolidations and
conversions of banks, including changes in control of banks; and (f)
liquidation and dissolution of banks.
Other
Various other legislation, including proposals to overhaul the bank
regulatory system and to limit the investments that a depository institution
may make with insured funds, is introduced into Congress from time to time.
The Company cannot determine the ultimate effect that any potential
legislation, if enacted, would have upon the financial condition or operations
of the Company or the Bank.
TAXATION
The effective tax rates (benefit) for the years ended December 31,
1993, 1992 and 1991, were 1.7%, (1.7)% and (23.9)%, respectively. For each of
the years ended December 31, 1993, 1992 and 1991, the federal statutory tax
rate applicable to the Company was 34%. The tax benefits reported in 1992 and
1991 are attributable to the Company's ability to carryback net operating
losses for 1992 and 1991 against net operating income from prior periods.
Because the Company has utilized all of its ability to carryback net operating
losses, much of the 1993 and 1992 losses, and future losses, if any, must be
carried forward to offset future net operating income. In addition, the actual
benefit rate may be less than the current statutory rate due to tax
differentials and the alternative minimum tax. As of December 31, 1993, the
Company has net operating loss carryforwards for federal tax purposes of
approximately $23.0 million which expire in 2007 and onwards, and for
California tax purposes of approximately $15.0 million, which expire in 1997
and 1998. The Company has rehabilitation tax credit carryforwards for federal
tax purposes of approximately $250,000, which expires in 2004 and 2005. In
addition, the Company has minimum tax credits of approximately $230,000 which
have no expiration. Utilization of the net operating loss carryforwards, and
rehabilitation and minimum tax credit carryforwards may be limited on an annual
basis under current tax law due to the change in ownership in 1992 and a
possible change in ownership in future years. It is anticipated that a change
in ownership will occur as a result of capital raising efforts in the first
half of 1994.
ITEM 2 - PROPERTIES
The following table sets forth certain information concerning the Bank's
significant real property lease commitments:
Square Expiration of Renewal
Banking Offices Footage Current Lease Period(s)
- --------------- ------- ------------- ---------
550 Montgomery Street 75,488 2022 Option for additional
San Francisco, CA 14 years
351 California Street 7,721 1995 N/A
San Francisco, CA
The Bank has a long term lease on 550 Montgomery Street, an 89,000 square
foot, historically significant office building on Clay and Montgomery Streets
in San Francisco's Financial District. The building serves as the
administrative and banking headquarters of the Company and the Bank. The Bank
leases 75,488 square feet, and the remainder is currently being subleased to
third parties.
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The lease on 550 Montgomery Street is currently held by Bank of San
Francisco Building Company (BSFBC), a California limited partnership in which
the Bank and BSFRI have 34.5% and 2.5% partnership interests, respectively. At
December 31, 1993, the Bank's and BSFRI's investment in BSFBC totaled $2.0
million and $156,000, respectively. The Bank anticipates that its lease
agreement may be renegotiated or that the Bank may acquire additional shares of
BSFBC. The impact of such activities is not presently determinable.
As a result of moving the Bank's headquarters to 550 Montgomery Street,
the Bank subleased its facilities at 351 California Street to an unrelated
third party. The lease and subleases expire on June 30, 1995.
The net rental expense and occupancy expenses for all leases of premises
were approximately $2.1 million for both years ended December 31, 1993 and 1992.
ITEM 3 - LEGAL PROCEEDINGS
LITIGATION
Because of the nature of its business, the Company and its subsidiaries,
including the Bank, are from time-to-time, a party to legal actions. At
December 31, 1993, the Company and/or the Bank are defendants in certain
lawsuits for which the damages sought are substantial as described below.
The Bank is currently involved in three lawsuits, of which two were
brought by former employees of the Bank in the California superior court; one
former employee has alleged that the Bank and the Bank's former Chief Executive
Officer (at the time of the termination) intentionally or negligently
misrepresented their intentions regarding his employment contract, and failed
to pay monies due under the employment contract, and that the Bank wrongfully
terminated the employment contract. The former employee has sought damages of
approximately $1.7 million under his contract claims. The other former
employee alleges that the Bank, and the Bank's Chief Executive and Chief
Financial Officers (at the time of that employee's termination) recruited the
plaintiff with false representations and fraudulent omissions with respect to
the financial condition of the Bank. The former employee claims to have
resigned from secure employment and was subsequently terminated. The former
employee has sought unspecified damages. The third lawsuit relates to a former
borrower of the Bank in a cross complaint asserting that the Bank was
fraudulent or negligent in its handling of certain transactions. The complaint
is seeking damages of $3.3 million under his claims.
The Bank has denied these allegations and is vigorously defending these
proceedings. The disposition of these proceedings could have a material
adverse effect on the Company's financial position or results of operation,
however, management cannot predict the specific outcome of these actions.
Accordingly, the accompanying financial statements do not include any
adjustments that might result from the outcome of the uncertainties.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.
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PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED SHAREHOLDER MARKET
MARKET INFORMATION
The Company's Class A Common Stock is listed on the American Stock
Exchange under the symbol "BOF." The closing sale price for the Class A Shares
on the American Stock Exchange on February 18, 1994, was $1.69. The following
table sets forth the high and low closing sale prices for the Class A Shares on
the American Stock Exchange for each calendar quarter during 1992 and 1993.
1993 1992
-------------------------------- ------------------------------
Quarter High Low High Low
-------------------------------- ------------------------------
First $3.50 $1.25 $4.13 $2.75
Second 2.68 1.12 4.13 2.38
Third 1.62 1.00 4.25 2.00
Fourth 1.33 0.75 2.25 1.00
The Series B Preferred Shares had been listed on the American Stock
Exchange since their issuance in October 1988. In March 1990, the Company
received approval from the Securities and Exchange Commission to delist the
Series B Preferred Shares, pursuant to Rule 12d2-2(d), under the Securities
Exchange Act of 1934, as amended. The Series C Preferred Shares have never
been listed on any exchange or traded in any other public market.
HOLDERS
As of December 31, 1993, the number of holders of record of the
Company's Class A Shares and Series B Preferred Shares was 471 and 14,
respectively, which management believes is in each case substantially less than
the number of beneficial owners whose shares are held in nominee names. None
of the Class B Common Stock is outstanding. At December 31, 1993, there was
only one holder of record of the Company's Series C Preferred Shares.
DIVIDENDS
The Company is subject to dividend restrictions under the Delaware
General Corporation Law and regulations and policies of the FRB. The Company's
Series B Preferred Shares participate equally, share for share, in cash
dividends paid on the Class A Shares in addition to receiving the cash
dividends to which they are entitled. The Board of Directors suspended the
dividend on the Class A Shares and the Series B Preferred Shares.
The payment of cash dividends by the Bank to the Company is subject
to certain regulatory restrictions set forth in the California Financial Code.
The Bank and the Company have amended the Certificate of Determinations of
Rights, Preferences, Privileges and Restrictions of the 8% Series B Convertible
Preferred Stock issued by the Bank to the Company to provide that dividends on
the Bank's 8% Series B Convertible Preferred Stock shall be cumulative from
year to year. The Bank's Board of Directors has decided to suspend future
payment of dividends on the Preferred Stock to the Company, and the FRB
Directive prohibits the Company from paying any dividends without the prior
approval of the FRB. See "-- Regulatory Directives and Orders" for a
discussion of these restrictions.
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ITEM 6 - SELECTED FINANCIAL DATA
The following table sets forth certain selected consolidated financial data
of the Company at and for the years ended December 31:
(Dollars in Thousands) 1993 1992 1991 1990 1989
-------------------------------------------------------------------------------
FINANCIAL CONDITION DATA:
Total assets $231,021 $319,155 $402,699 $393,225 $331,025
Total loans 149,740 236,076 281,853 280,159 245,346
Total mortgage loans held-for-sale -- -- 6,826 31,385 12,796
Total securities held-to-maturity 6,351 4,910 3,276 7,122 17,254
Total securities available-for-sale 14,940 -- -- -- --
Total securities held-for-sale -- 18,731 20,457 16,883 10,723
Total deposits 210,111 285,685 373,199 363,577 305,506
Other borrowings 1,303 15,308 10,832 686 1,954
Shareholders' equity 17,455 15,676 16,181 25,579 20,772
OPERATING DATA:
Total interest income $18,155 $23,885 $36,742 $39,596 $32,124
Total interest expense 7,420 11,295 19,226 20,774 16,422
-------------------------------------------------------------------------------
Net interest income 10,735 12,590 17,516 18,822 15,702
Provision for loan and lease losses 3,554 9,828 11,437 1,600 2,100
-------------------------------------------------------------------------------
Net interest income after
provision for loan and lease losses 7,181 2,762 6,079 17,222 13,602
Total non-interest income 4,879 4,790 6,173 5,240 6,190
Total non-interest expense 22,146 30,119 24,276 18,310 15,144
-------------------------------------------------------------------------------
Income (loss) before taxes (10,086) (22,567) (12,024) 4,152 4,648
Provision (benefit) for income taxes 169 (390) (2,870) 1,677 1,875
-------------------------------------------------------------------------------
Net income (loss) $(10,255) $(22,177) $(9,154) $ 2,475 $2,773
===============================================================================
OTHER DATA:
Return on average assets (3.5)% (6.2)% (2.2)% 0.7% 1.0%
Return on average equity (57.5) (153.0) (39.2) 10.7 14.4
Average equity to average assets 6.1 4.1 5.6 6.4 6.6
Equity to assets at period end 7.6 4.9 4.0 6.5 6.3
Interest rate spread for period 4.4 4.6 4.5 5.4 5.4
Net yield on average earning assets 4.6 4.5 4.8 5.8 6.1
Non-performing assets to total assets 18.8 16.8 13.5 3.4 1.3
Average interest-earning assets to
average interest-bearing liabilities 103.5 96.6 104.7 106.0 111.0
Non-interest expenses to average assets 7.6 8.9 5.9 5.0 5.2
Net interest income, after provision for
loan and lease losses, to non-interest expense 32.4 9.2 25.0 94.1 89.8
Net loan charge-offs as a percent of
average loans 2.0 3.9 2.7 0.3 0.4
Allowance for loan and lease losses as a
percent of loans 5.4 3.6 3.0 1.8 1.7
PER SHARE DATA:
Common shares outstanding,
end of period 8,899,801 8,901,994 2,282,674 2,263,554 1,834,712
Preferred shares outstanding,
end of period 916,591 316,591 437,500 437,500 437,500
Common Shares:
Book value per common share $(0.08) $1.08 $5.95 $9.47 $9.14
Income (loss) per share (1.15) (4.18) (4.13) 0.97 1.17
Cash dividend declared per common share -- -- 0.10 0.10 --
Dividend payout ratio -- -- -- 10.3% --
-31-
34
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company recorded a net loss of $10.3 million for the year ended
December 31, 1993, following net losses of $22.2 million and $9.2 million for
the years 1992 and 1991, respectively. These net losses were principally due
to the high level of the provision for loan losses and declines in net interest
income during each of 1993, 1992 and 1991. In addition, the Company's non-
interest expense reached extremely high levels at 96.1%, 105.0% and 56.6% of
total revenues for the years 1993, 1992 and 1991, respectively.
The Company's provision for loan losses and the increase in the loan loss
allowance as a percentage of outstanding loans reflects management's concern
over the decline in the credit quality of the Bank's loan portfolio, regulatory
examinations, and the high level of net loan charge-offs during the period 1991
through 1993. Although the Company's provision for loan losses was reduced to
$3.6 million in 1993, from $9.8 million in 1992 and $11.4 million in 1991, the
allowance for loan losses as a percentage of loans grew from 3.0% in 1991 to
5.4% in 1993. The Company's net loan charge-offs, primarily associated with
unsecured commercial loans, loans secured by real estate, and loans to
facilitate the development of real estate, amounted to $3.9 million in 1993 as
compared to $9.8 million in 1992 and $8.1 million in 1991.
The Company's net interest income was reduced to $10.7 million in 1993 from
$12.6 million in 1992, a 14.7% decline, following a 28.1% decline in net
interest income in 1992 from $17.5 million in 1991. These declines in net
interest income were principally due to a reduction in average earning assets
from $362.2 million in 1991 to $286.0 million in 1992, a 21% decline, and a
further reduction to $234.8 million in 1993, a decline of 18%.
The Company's non-interest expenses were largely driven by expenses
associated with managing its high level of non-earning assets (average
non-earning assets were 19.6% of total average assets in 1993, 20.1% in 1992
and 12.6% in 1991) in addition to legal, accounting and consulting expenses
related to the Company's loan collection and recapitalization efforts. These
costs comprised 17.5% of the Company's non-interest expense in 1991, climbing
to 40.3% in 1992 and comprised 29.1% of non-interest expense during 1993.
At December 31, 1993, total assets and deposits of $231.0 million and
$210.1 million, respectively, had declined 27.6% and 26.5%, respectively, from
amounts reported at December 31, 1992. Loans, net of deferred loan fees, were
$149.2 million, a decrease of 36.6% from the amount reported at December 31,
1992. At December 31, 1992, total assets, deposits and net loans were $319.2
million, $285.7 million and $235.2 million, respectively, a decline of 20.7%,
23.4% and 16.2%, respectively, from amounts reported at the close of 1991. The
declines in assets and loans during 1991, 1992 and 1993 reflect the result of
the general economic conditions in Northern California and more particularly
the depressed value of real estate collateral in the San Francisco Bay Area
from which the repayment of a substantial portion of the Company's loans is
based. In addition, the declines followed substantial operating losses of the
Company, beginning in 1991 and continuing through 1993. These operating losses
were the major cause of the Company's failure to meet its capital adequacy
requirements causing it to reduce its assets in order to meet regulatory
capital adequacy requirements and the resulting MOU and Orders which generally
require the Bank to reduce its classified assets, concentration of real estate
related credits, volatile liability dependence, and maintain its liquidity and
increase its capital. See "-- Regulatory Directives and Orders" for a full
description of the Directive and the Orders.
In response to the significant problems experienced by the Company during
the period from 1991 through 1993 the Company restructured its management by
hiring a number of senior level banking executives to develop a new strategic
business plan for the Company. The new business plan contemplates several
measures, including without limitation, raising additional capital, eliminating
problem assets, commencing new lines of business, hiring additional personnel
for such new lines of business, and establishing a new relationship with
Strategic Alliance Partners. See "BUSINESS." As of December 31, 1993,
implementation of the new business plan had just commenced. If the Company is
successful in raising sufficient capital and disposing of a substantial portion
of its problem assets, of which no assurance can be given, implementation of
the other components of the business plan may become feasible. To the extent
that the new business plan is implemented in the future, recent financial
trends experienced by the Company may not be indicative of future trends;
however, due to the numerous factors affecting the successful implementation of
the new business plan, many of which are beyond the control of the Company, no
prediction can be made with respect to the nature or extent of future financial
trends.
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35
RESULTS OF OPERATIONS - YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991
NET INTEREST INCOME
Yields Earned and Rates Paid
One of the fundamental measures of the Bank's results of operations is net
interest income. Net interest income is the difference between the combined
yield earned on interest earning assets and the combined rate paid on interest
bearing liabilities. Net interest income is also dependent on whether the
balance of interest earning assets equals, exceeds or is less than the balance
of interest bearing liabilities. If an excess in the balance of interest
bearing liabilities over interest earning assets exists, then the positive
interest rate spread between yields earned and rates paid may need to be
increased in order to achieve a positive net interest position.
The following table presents the consolidated average balance sheets of the
Company, together with the total dollar amounts of interest income and expense,
and weighted average interest rates for each of the years in the three year
period ended December 31, 1993. Where possible, the average balances are
calculated on a daily average basis. When this information is not available,
average balances are calculated on a monthly basis.
1993 1992
----------------------------------- -------------------------------------
Average Income/ Yield/ Average Income/ Yield/
(Dollars in Thousands) Balance Expense Rate Balance Expense Rate
----------------------------------- -------------------------------------
Assets
Interest-earning assets:
Federal Funds and time deposits $ 20,237 $ 594 2.9% $ 11,812 $ 428 3.6%
Investment securities 17,128 902 5.3 25,244 1,750 6.9
Loans, net (1) 197,446 16,659 8.4 248,960 21,707 8.7
------------------------------------ -------------------------------------
Total earning assets 234,811 18,155 7.7 286,016 23,885 8.4
------------------------------------ -------------------------------------
Non-interest earning assets 57,153 72,078
----------- ------------
Total assets $291,964 $358,094
=========== ============
Liabilities and Equity
- ----------------------
Interest-bearing liabilities:
Interest-bearing deposits $220,996 6,966 3.2 $283,652 10,746 3.8
Other borrowings 5,891 454 7.7 12,558 549 4.4
------------------------------------ -------------------------------------
Total interest-bearing liabilities 226,887 7,420 3.3 296,210 11,295 3.8
------------------------------------ -------------------------------------
Non-interest bearing liabilities 47,271 47,393
Stockholders' equity 17,806 14,491
Total liabilities and ---------- -----------
stockholders' equity $291,964 $358,094
========== ===========
Net interest income $10,735 $12,590
========== =========
Primary interest rate spread 4.4% 4.6%
========= =========
Margin as a percent of earning assets:
Interest income 7.7% 8.4%
Interest expense 3.1 4.0
--------- ---------
Spread on earning assets 4.6% 4.4%
========= =========
1991
--------------------------------
Average Income/ Yield/
(Dollars in Thousands) Balance Expense Rate
--------------------------------
Assets
Interest-earning assets:
Federal Funds and time deposits $ 13,766 $ 780 5.7%
Investment securities 25,354 2,219 8.8
Loans, net (1) 323,098 33,743 10.4
Total earning assets 362,218 36,742 10.1
Non-interest earning assets 52,089
-------
Total assets $414,307
==========
Liabilities and Equity
- ----------------------
Interest-bearing liabilities:
Interest-bearing deposits $339,765 18,850 5.6
Other borrowings 6,179 377 6.1
--------------------------------
Total interest-bearing liabilities 345,944 19,227 5.6
--------------------------------
Non-interest bearing liabilities 45,010
Stockholders' equity 23,353
Total liabilities and ----------
stockholders' equity $414,307
==========
Net interest income $17,515
=========
Primary interest rate spread 4.5%
---------
Margin as a percent of earning assets:
Interest income 10.1%
Interest expense 5.3
---------
Spread on earning assets 4.8%
=========
(1) Non-performing loans have been included in the average loan balances.
Interest income is included on non-accrual loans only to the extent to which
cash payments have been received and full principal repayment is probable.
The dollar amount of interest income and interest expense fluctuates
depending on changes in the respective interest rates and on changes in the
respective amounts (volume) of the Bank's earning assets and interest bearing
liabilities. For each category of interest earning asset and interest bearing
liability, information is provided in the
-33-
36
following table for changes attributable to (i) changes due to volume (change
in average balance multiplied by prior year's rate), and (ii) changes in rate
(changes in rates multiplied by prior year's average balances). Changes
attributable to the combined impact of volumes and rates have been allocated to
changes due to volume.
1993 versus 1992 1992 versus 1991
----------------------------- --------------------------------
(Dollars in Thousands) Rate Volume Net Rate Volume Net
----------------------------- --------------------------------
Interest-earning assets:
Federal funds and time deposits $ (60) $ 227 $ 167 $ (253) $ (99) $ (352)
Investment securities (363) (485) (848) (297) (172) (469)
Loans, net (683) (4,366) (5,049) (5,043) (6,993) (12,036)
------------------------------ --------------------------------
Total interest-earning assets (1,106) (4,624) (5,730) (5,593) (7,264) (12,857)
------------------------------ --------------------------------
Interest-bearing liabilities:
Interest-bearing deposits (1,633) (2,147) (3,780) (5,680) (2,425) (8,105)
Other borrowings (312) 217 (95) (65) 238 173
------------------------------ --------------------------------
Total interest bearing liabilities (1,945) (1,930) (3,875) (5,745) (2,187) (7,932)
------------------------------ --------------------------------
Change in net interest income $ 839 $(2,694) $(1,855) $ 152 $(5,077) $ (4,925)
============================== ================================
The Company's interest income decreased during the three year period ended
December 31, 1993 due mainly to a 35.2% decrease in average loans and to a
lesser extent to a decrease in average yields on loans during the period. The
decrease in the loan portfolio primarily resulted from a decision to reduce the
size of the Company's assets to comply with regulatory capital requirements,
loan repayments, foregone interest on non-performing assets and foreclosures of
real estate in settlement of loans. The weighted average yield on loans
decreased during the three year period primarily due to the Bank's prime rate
declining from 8.5% during 1991 to an average of 6.3% in 1992 and to 6.0% in
1993.
Interest income on investment securities was $1.5 million in 1993 compared
to $2.2 million in 1992. Although average portfolio balances were $37.4
million in 1993 compared to $37.1 million in 1992, average portfolio yields
were 4.0% in 1993 compared to 5.9% in 1992. The lower average yields reflect
the overall decline in market interest rates and lower average yield realized
from reinvestment.
Interest expense for 1993 was $7.4 million, a decrease of $3.9 million, or
34.3% during 1993, as compared to 1992. This decrease was primarily
attributable to a decrease in average interest bearing liabilities of $69.3
million to $226.9 million, or 23.4%, as compared to 1992, and to a decline in
average interest rates. The average cost of deposits and borrowings for 1993
was 3.3% as compared to 3.8% for 1992.
Interest expense for 1992 was $11.3 million, a decrease of $7.9 million, or
41.3% during 1992, as compared to 1991. This decrease was primarily
attributable to a decrease in average interest bearing liabilities of
approximately $49.7 million, or a 14.5% decrease, from 1991, and to a decline
in short term interest rates. The average cost of deposits and borrowings for
1992 was 3.8% as compared to 5.6% for 1991.
PROVISION FOR LOAN LOSSES
During 1993, 1992, and 1991, the Bank provided $3.6 million, $9.8 million
and $11.4 million, respectively, to its allowance for loan losses. Net charge
offs recorded for 1993, 1992 and 1991 were $3.9 million, $9.8 million, and $8.1
million, respectively. The substantial loan loss provisions made in 1991 and
1992 reflect management's assessment of the decline in the credit quality in
the Bank's loan portfolio and the impact of declining economic conditions in
California and particularly the real estate values which served as collateral
for many of the Bank's loans. Accordingly, during the years 1991 and 1992, the
Company's loan loss provisions were largely loan loss reserves allocated to
specific classified and non-performing loans. The loan loss provision in 1993
reflects an increase in the level of unallocated allowance for loan losses to
provide for credit risk that may occur in the future on loans that are not
presently classified or non-performing, but may become so based on economic
conditions, financial trends and lingering uncertainties. See "-- Allowance
for Loan Losses" herein.
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37
SUMMARY OF lOAN lOSS EXPERIENCE
Net loan charge-offs for the years ended December 31, 1993, 1992 and 1991
were $3.9 million, $9.8 million, and $8.1 million, respectively. As a
percentage of average total loans, net loan charge-offs were 2.0%, 3.9% and
2.7% for 1993, 1992, and 1991, respectively.
In 1993, loan losses from the deterioration in borrowers' financial
condition and the value of collateral securing loans occurred as a result of
the recession in California. A summary of significant charge-off activity
during 1993 is as follows:
o Unsecured loans charged off totaled $290,200 and was comprised of five
loans. The single largest charge-off was $174,400.
o The charge-offs related to commercial and financial loans totaled $2.1
million and were comprised of 19 loans. The single largest charge-off was
$600,000. The purpose of this loan was for working capital and to acquire
partnership interest in two limited partnerships. This loan is secured by
UCC filings and securities agreements on various partnerships and trusts.
The loan was classified as non-accrual in the second quarter 1993 and a
partial charge-off was recorded in the third quarter of 1993.
o The charge-offs related to real estate construction loans totaled $137,300
and were comprised of two related loans. The related loans were secured by
a first deed of trust on land under development located in Northern
California. This property was classified as non-accrual during the third
quarter of 1992 and transferred to in-substance foreclosure during the
fourth quarter of 1993 when an updated appraisal indicated that the
borrower's equity in the property had deteriorated.
o The charge-offs related to real estate mortgage loans totaled $1.1 million
and were comprised of six loans. The single largest charge-off was
$761,800. This loan was secured by a fourth deed of trust on commercial
property and the purpose of the loan was for real estate investment. The
loan was classified as non-accrual during the second quarter of 1993 and
the charge-off recorded during the fourth quarter reflected a deterioration
in the collateral value and a weakness in the guarantors' financial
condition.
o The charge-offs related to the sale of the Sacramento Regional Office
totaled $402,000. This charge-off was incurred as a result of selling
$28.0 million in loans at the Bank's carrying value, less an allocated
allowance.
In 1992, loan losses were due, in part, to lower appraised values of the
real estate used to secure many of the Bank's loans. In addition, the
continuing weakness of the California economy during 1992 caused many borrowers
to experience cash flow and liquidity problems which prevented them from
meeting their contractual obligations. A summary of significant charge-off
activity during 1992 is as follows:
o An unsecured loan in the amount of $1.2 million and partial charge-offs of
$3.5 million on two secured loans to a real estate investor who ceased
payments, abandoned his investments and filed bankruptcy in 1992.
o A partial charge-off amounting to $1.6 million on a loan secured by
commercial/residential rental units whose appraised value deteriorated
substantially based on an updated appraisal in the third quarter of 1992.
o Partial charge-offs amounting to $863,000 on two loans to a real estate
developer secured by undeveloped residential real property whose appraised
value deteriorated substantially based on updated appraisals obtained in
March 1993, and where the borrower ceased making payments in December 1992.
o A partial charge-off amounting to $300,000 to a borrower whose cash flow
and liquidity were impaired and was forced to liquidate assets in 1992 to
repay the remaining loan balance.
o A partial charge-off amounting to $255,000 on a loan secured by undeveloped
residential real property whose value deteriorated based on an updated
appraisal at December 1992.
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38
NON-INTEREST INCOME
Non-interest income increased $89,000 or 1.8% in 1993 as compared to 1992,
primarily as a result of an increase in brokerage fee income related to the
exercise of stock options of $586,000 and a decrease in service charge and fee
revenue and other income of $631,000 related to trust management fees, escrow
service fees, referral fees on CD arbitrage, and deposit products and services
because of lower transaction volumes and lower average deposit balance
outstanding, and lower levels of assets under management through trust
services.
The following table provides a detail of non-interest income for the years
ended December 31:
(Dollars in Thousands) 1993 1992 1991
------------------------------------------------
Service charges and fees $ 173 $ 223 $ 282
Income from BSFBC 263 202 245
Loan brokerage and servicing fees 324 201 671
Gain on sale of mortgage servicing rights -- -- 730
Stock option commissions and fees 2,906 2,320 2,353
Other income 1,213 1,844 1,892
------------------------------------------------
Total non-interest income $4,879 $4,790 $6,173
================================================
NON-INTEREST EXPENSE
For the year ended December 31, 1993, non-interest expense decreased $8.0
million, or 26.5%, from the year ended December 31, 1992. The reduction was
attributed primarily to lower compensation related expenses, a lower level of
costs related to asset and credit quality, and a lower level of legal and
consulting costs related to the Company's loan collection and recapitalization
efforts.
The following table provides a detail of non-interest expense for the years
ended December 31:
(Dollars in Thousands) 1993 1992 1991
-----------------------------------------------
Salaries and related benefits $ 8,325 $ 9,858 $10,132
Occupancy expense 2,054 2,061 2,092
Professional fees 2,326 3,426 2,055
Equipment expense 849 938 923
FDIC insurance premiums 849 816 683
Data processing 457 478 500
Loss on sale of Sacramento Regional Office 420 -- --
Operating lease depreciation 382 422 492
Telephone 314 274 392
Other operating expenses 2,044 3,125 4,822
-----------------------------------------------
Total operating expenses 18,020 21,398 22,091
Net cost of real estate operations 4,126 8,721 2,185
-----------------------------------------------
Total non-interest expense $22,146 $30,119 $24,276
===============================================
The decrease in compensation related expenses of $1.5 million in 1993 to
$8.3 million, or 15.6% from the 1992 level, resulted from lower staffing
levels, lower levels of incentive compensation paid, and lower levels of other
benefits for executive officers. The decrease in compensation expense of 2.7%
in 1992 from 1991 was due primarily to staffing reductions and lower bonus and
commission payments. A significant portion of the compensation expense
included performance-based incentives of $526,000, $920,000, and $1.4 million
for 1993, 1992 and 1991, respectively.
The Company's expenses for professional services were $2.3 million in 1993
compared to $3.4 million and $2.1 million in 1992 and 1991, respectively. The
Company includes in professional fees the costs of legal, accounting,
-36-
39
and management consulting services. Professional service costs
decreased in 1993 by $1.1 million compared to 1992 as a result of lower costs
related to the Company's loan collection and recapitalization efforts.
Professional service expenses were high in 1992 as a result of the substantial
activities undertaken by the Company to complete its 1992 recapitalization, and
the increase in professional services required to manage the resolution of
classified and non-performing assets during that year.
The decrease of $4.6 million in net cost of real estate operations related
to asset and credit quality from $8.7 million in 1992 to $4.1 million in 1993
reflects lower levels of classified assets and lower levels of loans migrating
to classified or non- performing status because of the stabilization of
borrowers' financial conditions and the quality of the underlying collateral on
loans. In 1992, the Bank's operating costs related to the resolution of its
problem assets were 300% higher than in 1991. The increase in 1992 of $6.5
million over 1991 was primarily the result of an increase in the provision for
losses in the amount of approximately $5.5 million in 1992 from approximately
$1.7 million in 1991 caused by a deterioration in the value of the Company's
real estate investments and other real estate owned.
The approximate $1.1 million decrease in other operating expenses resulted
primarily from cost reduction initiatives in miscellaneous expenses and
customer related service expenses.
In 1993, the Bank recorded loss provisions totaling $3.3 million for 15
other real estate owned assets compared to $5.5 million in 1992 on 17
properties, an improvement of 40.0%. In addition to the provisions, the Bank
recognized $712,000 in losses on the sale of 11 real estate properties acquired
in settlement of loans in 1993 compared to $467,000 on five properties in 1992.
The Bank recognized recoveries and gains on sale of other real estate owned
totaling $1.7 million on four properties in 1993 compared to $1.0 million in
1992 on five properties. In 1992, the Bank's loss on sale and provision for
loss on real estate properties acquired in settlement of loans was $4.5 million
higher than in 1991. The increase in losses of 205.0% in 1992 over 1991 levels
was primarily the result of continued deterioration in the Company's real
estate investments. No recoveries were recorded in 1991.
The Bank recorded a loss provision of $250,000 for one real estate
investment property compared to $662,000 in 1992 on three properties, an
improvement of 62.2%. In addition to the provisions, the Bank recognized a
loss of $54,000 on the sale of one real estate investment in 1992 compared to
none in 1993. The Bank recognized gains on sale of real estate investments
totaling $749,000 in 1992 on two properties. No gains were recognized in 1993.
In 1991, the Bank had no losses related to real estate investments. The
losses in 1992 levels were the result of deterioration in real estate property
values. In 1991, the Bank recorded a gain of $40,000 on the sale of one real
estate property.
FINANCIAL CONDITION
TOTAL ASSETS
With the recurring operating losses during 1993, 1992 and 1991 and the
failure of the Company and the Bank to consistently meet its regulatory capital
requirements, management of the Company implemented a strategy of reducing the
Company's total assets in order to more easily meet its regulatory capital
ratios and an aggressive loan work-out program to reduce the level of the real
estate related and other problem loans. As a result, the Company's assets
decreased 27.6% in 1993 from $319.2 million at December 31, 1992 to $231.0
million at December 31, 1993. The reduction in total assets also resulted in
part from the sale of $28.0 million of loans in the sale of the Sacramento
Regional Office.
CASH AND CASH EQUIVALENTS
The Bank maintains cash and cash equivalents, such as federal funds sold,
at levels management believes are sufficient to meet the liquidity needs of its
deposit customers. At December 31, 1993 the Company's cash and cash
equivalents were $25.8 million or 12.3% of total deposits and 74.1% of
non-interest bearing deposits. See also "Liquidity" herein for a further
discussion of the Bank's other sources of liquid assets.
-37-
40
INVESTMENT ACTIVITIES
The Bank maintains a securities portfolio consisting of United States
Government and Federal agency securities, collateralized mortgage obligations,
investments in certificates of deposits at other financial institutions, and
mutual funds. The balance of the investment securities maintained by the Bank
in excess of the requirement of applicable regulations and the Orders reflect
management's objective of ensuring compliance with liquidity requirements.
Most securities are held in safekeeping by an independent custodian.
In May 1993, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt & Equity Securities." The Statement addresses the accounting and
reporting for investments in equity securities that have a readily determinable
fair value and for all investments in debt securities. The Statement requires
that all securities be classified, at acquisition, into one of three
categories: held-to-maturity securities, trading securities, and
available-for-sale securities. Held-to-maturity securities are those
securities the Bank has the intent and ability to hold to maturity and are
carried at amortized cost. Trading securities are those securities that are
bought and held principally for the purpose of selling in the near term and are
reported at fair value, with unrealized gains or losses included in current
earnings. Available-for-sale securities are those securities that do not fall
into the other two categories and are reported at fair value, with unrealized
gains or losses reported as a separate component of shareholders' equity. This
Statement is effective for fiscal years beginning after December 15, 1993,
however, earlier implementation is permitted. The Bank elected to implement
SFAS No. 115 effective as of December 31, 1993.
The Bank determines the classification of all securities at the time of
acquisition. In classifying securities as being held- to-maturity, trading, or
available-for-sale, the Bank considers its collateral needs, asset/liability
management strategies, liquidity needs, interest rate sensitivity and other
factors in determining its intent and ability to hold the securities to
maturity.
Investment securities held-to-maturity include United States Treasury and
Federal agency securities, investments in certificates of deposit, and an
equity investment in Federal Home Loan Bank of San Francisco (FHLB) membership
stock. The objectives of these investments are to increase portfolio yield,
and to provide collateral to pledge for federal, state and local government
deposits and other borrowing facilities. The investments held-to-maturity have
an average term to maturity of 20 months at December 31, 1993. The investments
held-to-maturity are carried at amortized cost. At December 31, 1993, the
investment portfolio includes $3.1 million in fixed rate investments and $3.3
million in adjustable-rate investments.
Investment securities available-for-sale may include United States Treasury
and Federal agency securities, mutual funds, and collateralized mortgage
obligations. These securities are typically used to supplement the Bank's
liquidity portfolio with the objective of increasing yield. Investment
securities available-for-sale are accounted for at fair value. Unrealized
gains and losses are recorded as an adjustment to equity and are not reflected
in the current earnings of the Bank. If the security is sold any gain or loss
is recorded as a charge to earnings and the equity adjustment is reversed. At
December 31, 1993, the Bank held $14.9 million classified as investments
available-for-sale. At December 31, 1993, $60,000 was charged against equity
to reflect the market value adjustment to the securities available-for-sale.
Investment securities previously identified as held-for-sale include United
States Treasury and Federal agency securities, mutual funds, and collateralized
mortgage obligations. These securities were typically used to supplement the
Bank's liquidity portfolio with the objective of increasing yield. Investment
securities held-for-sale were accounted for at the lower of cost or market.
Unrealized losses were reflected in the current earnings of the Bank. At
December 31, 1992, the Bank had $18.7 million in securities held-for-sale that
were liquidated during 1993. In 1993 and 1992, gains or losses on the sale of
securities held-for- sale were charged to earnings.
-38-
41
The table below sets forth certain information regarding the carrying
values and market values and the weighted average yields of the Bank's
investment securities portfolio by maturity at December 31, 1993:
Within One Year One to Five Years Total Investment Securities
------------------- ------------------- -------------------------------
Carrying Average Carrying Average Carrying Market Average
(Dollars in Thousands) Value Yield Value Yield Value Value Yield
------------------- ------------------- -------------------------------
U.S. Treasury and agency securities $ 3,079 3.6% $ 1,003 3.2% $ 4,082 $ 4,083 3.5%
Collateralized mortgage obligations 996 3.6 -- -- 996 998 3.6
Mutual funds -- -- -- -- 14,940 14,940 4.4
FHLB stock -- -- -- -- 1,273 1,273 3.7
------------------- ------------------- -------------------------------
Total $ 4,075 3.6% $ 1,003 3.2% $21,291 $21,294 4.0%
================== ================= =============================
No investment securities had a maturity of more than five years at December
31, 1993. The mutual funds and FHLB stock have no term to maturity.
LOANS
During 1993, the Company reduced its total loans by $86.4 million from
$236.1 million at December 31, 1992. The reduction in total loans resulted in
part from the sale of $28.0 million of loans in connection with the sale of the
Bank's Sacramento Regional Office and the reduction of its classified loans
from $52.2 million at December 31, 1992 to $22.9 million at December 31, 1993.
During 1993, there were $4.4 million in newly classified loans, whereas in
1992, the were $31.7 million in newly classified loans. For a description of
the composition of the loan portfolio and a description based upon various
contractually scheduled repayments, see "BUSINESS -- The Company and the Bank
- -- Lending Activities -- Composition of Loan Portfolio."
CLASSIFIED ASSETS
Federal regulations require banks to review their assets on a regular basis
and to classify them if any weaknesses are noted. Banks must maintain adequate
allowances for assets classified as "Substandard" or "Doubtful" and to
immediately write off those assets classified as "Loss". The Bank has a
comprehensive process for classifying assets and asset reviews are performed on
a periodic basis. In addition to identifying adversely classified assets, the
Bank identifies certain assets as "Special Mention", which do not currently
expose the Bank to a sufficient degree of risk to warrant a more adverse
classification but do possess credit deficiencies or potential weaknesses
deserving management's close attention. Assets that do not possess credit
deficiencies are not classified and are labeled "Pass" in the following tables.
The Bank stratifies its loan portfolio based on collateral type concentrations
and delinquency trends. The objective of the review process is to identify any
trends and determine the levels of loss exposure to the Bank that would require
an adjustment to the valuation allowance.
Classified assets include non-accrual loans, other real estate owned, real
estate investments and performing loans that exhibit credit quality weaknesses.
Certain loans identified as in-substance foreclosed are included in other real
estate owned. The table below outlines the Bank's classified assets as of
December 31, 1993 and 1992:
(Dollars in Thousands) 1993 1992
-----------------------
Loans - performing $11,847 $34,374
Non-accrual loans 11,086 17,811
Other real estate owned 32,372 35,457
Real estate investments 1,468 1,891
-----------------------
Total classified assets $56,773 $89,553
=======================
The Bank is required by the Orders to reduce its classified assets, as
defined by the Orders, to no more that $60.0 million by December 31, 1993, no
more than $50.0 million by March 31, 1994 and no more than $40.0 million by
August 31, 1994. At December 31, 1993, the Bank had $50.7 million in such
assets. However, no assurance can be given that the Bank will be able to meet
its future requirements for the reduction of its classified assets as these
requirements occur.
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42
Management cannot foresee when the present weakness in the regional real
estate market will abate, and a lengthy continuation of this weakness could
increase the amount of the Bank's non-performing assets and, in addition, could
have an adverse effect on the Bank's efforts to collect its non-performing
loans or otherwise liquidate its non-performing assets on terms favorable to
the Bank. Accordingly, there can be no assurance that the Bank will not
experience additional increases in the amount of its non-performing assets or
experience significant additional losses in attempting to collect the
non-performing loans or otherwise liquidate the non- performing assets which
are presently reflected on the Bank's statement of financial condition.
Moreover, the Bank has been incurring substantial asset-carrying expenses, such
as the expenses of maintaining and operating properties included among the
Bank's other real estate owned classification, and the Bank may continue to
incur asset-carrying expenses in connection with such loans and assets until
its non-performing loans and assets are collected or liquidated.
NON-PERFORMING ASSETS
When a borrower fails to make a required payment on a loan, the loan is
classified as delinquent. If the delinquency is not cured, workout procedures
are generally commenced and the loan is transferred to the Bank's Special
Assets Department. If workout proceedings are not successful, collection
procedures, which may include collection demands, negotiated restructures,
foreclosures, suits for collection and borrower bankruptcy, are initiated. In
general, loans are placed on non-accrual status after being contractually
delinquent for more than 90 days, or earlier if management believes full
collection of future principal and interest on a timely basis is unlikely.
When a loan is placed on non-accrual status, all interest accrued but not
received is charged against interest income. During the period in which a loan
is on non-accrual status, any payment received may be used to reduce the
outstanding loan balance. A non-accrual loan is restored to an accrual basis
when principal and interest payments are paid current and full payment of
principal and interest is expected. Loans that are well secured and in the
process of collection remain on accrual status.
The Bank may restructure loans as a result of a borrower's inability to
service the obligation under the original terms of the loan agreement.
Restructures are executed only when the Bank expects to realize more from a
restructured loan rather than allowing it to go into foreclosure or other form
of collection.
At December 31, 1993 and 1992, other real estate owned, including
in-substance foreclosed loans, was $32.4 million and $35.5 million,
respectively. In-substance foreclosed loans are those in which the borrower
has little or no equity in the collateral based on its fair value, the borrower
has effectively abandoned control of the collateral so that many of the risks
and rewards of ownership have been passed to the lender, and repayment of the
loan can only be expected from the operation or sale of the collateral. At
December 31, 1993 and 1992, in-substance foreclosed loans were $19.1 million
and $23.6 million, respectively. As of December 31, 1993 and 1992, all other
real estate owned and real estate investments were classified.
Non-performing assets include non-accrual loans, in-substance foreclosed
assets and real estate foreclosures. Non-performing assets were $43.5 million
at the end of 1993, down from $53.3 million in 1992. Loans past due 90 days or
more and accruing are included in the schedule of non-performing assets.
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43
The following table provides information on all non-performing assets
at December 31:
(Dollars in Thousands) 1993 1992 1991 1990 1989
--------------------------------------------------------------------
Non-accrual loans $11,086 $17,811 $11,781 $ 8,076 $ 2,774
Other real estate owned 32,372 35,457 39,927 3,915 1,600
--------------------------------------------------------------------
Total non-performing assets $43,458 $53,268 $51,708 $11,991 $ 4,374
====================================================================
Non-performing assets as a percentage
of total loans and OREO outstanding 23.9% 19.7% 16.1% 4.2% 1.8%
Loans past due 90 days or more and accruing -- $ 182 $ 2,513 $ 1,270 --
Loans restructured and in compliance
with modified terms $ 1,967 -- 3,146 2,560 $ 2,630
In addition to the loans disclosed in the foregoing table, the Bank had
approximately $3.9 million in loans on December 31, 1993 that were between 31
and 89 days delinquent. In the opinion of management, these loans have a
greater than ordinary risk that the borrowers may not be able to perform under
the terms of their contractual arrangements. Approximately $2.0 million of
these loans are secured by first or subordinate deeds of trust on real estate.
At December 31, 1993, the Bank had two loans totaling $330,000 that were
less than 90 days delinquent and on non-accrual status. The performance
history of these loans demonstrated that the borrower may not be able to
perform under the terms of the contractual arrangements. As of December 31,
1993, the Bank had no loans that were more than 90 days delinquent with accrued
interest income that was included in income.
The following table provides a stratification of non-performing assets,
which includes non-accrual loans and other real estate owned, by collateral
type as of December 31, 1993 and 1992.
(Dollars in Thousands) 1993 1992
--------------------------
Real Estate:
Residential $ 5,117 $ 5,875
Residential development 12,175 12,118
Commercial 700 9,420
Commercial development 1,632 --
Land under development 748 6,687
Raw land 18,573 14,821
Other 4,513 4,348
--------------------------
Total non-performing assets $43,458 $53,269
==========================
At December 31, 1993, 83.0% of non-performing assets are real estate or
loans secured by real estate located in Northern California. Raw land consists
of land acquired for the purpose of future residential or commercial
development.
Non-performing assets secured by subordinate deeds of trust totaled $3.1
million as of December 31, 1993. As of December 31, 1993, $19.1 million in
other real estate owned was classified as "in-substance foreclosure" of which
$1.1 million was secured by second deeds of trust.
Restructured loans totaled $2.0 million and zero at December 31, 1993 and
1992, respectively. For the years ended December 31, 1993 and 1992, interest
income foregone on restructured loans was $166,000 and zero, respectively.
-41-
44
VALUATION ALLOWANCES
The Bank charges current earnings with provisions for estimated losses on
loans receivable, other real estate owned, and real estate investments. The
provisions take into consideration specifically identified problem loans, the
financial condition of the borrowers, the fair value of the collateral,
recourse to guarantors, and other factors.
During 1993, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 114 "Accounting by Creditors for Impairment
of a Loan" (SFAS No. 114). Among the requirements of SFAS No. 114 is that the
value of an impaired loan be measured based on the present value of expected
future cash flows or at the fair value of the collateral if the loan is real
estate dependent. Loans historically classified as in-substance foreclosure
will no longer be included in Other Real Estate Owned, but rather will remain
in the loan portfolio. SFAS No. 114 is effective beginning in 1995, but,
earlier implementation is permitted. The Company elected not to implement SFAS
No. 114 for the period ended December 31, 1993. The effect of SFAS No. 114 on
the Company's financial statements is unknown at this time because the complex
analysis to implement this standard has not been completed.
Allowance for Loan Losses
Prior to 1991, the Bank's method of analyzing the adequacy of its allowance
for loan losses generally relied on the application of historic loan loss
ratios and specific allocations of loss allowances based on specific credit
reviews. In 1991, the Bank revised its methodology because of deterioration in
the credit quality of the loan portfolio, resulting from weakness in the
economy and the oversupply of properties similar to the properties
collateralizing many of the Bank's loans. The Bank has continued to refine the
allowance methodology to ensure that all known risks, trends, and facts are
utilized in determining the adequacy of the allowance for loan losses.
Fair value of the underlying collateral is based on current market
conditions, appraisals, and estimated sales values of similar properties, less
an estimated discount for selling and other expenses. In addition, the Bank
establishes a specific loss allowance based on the asset classification and
credit quality grade. This specific loss allowance is utilized to ensure that
allowances are allocated based on the credit quality grading to capture
inherent risks. In addition, the Bank carries an "unallocated" loan loss
allowance to provide for losses that may occur in the future in loans that are
not presently classified, based on present economic conditions, trends, and
related uncertainties.
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45
The following table summarizes the loan loss experience of the Bank for the
years ended December 31:
(Dollars in Thousands) 1993 1992 1991 1990 1989
----------------------------------------------------------------
Balance of allowance for loan
losses at beginning of period $8,400 $8,411 $5,052 $4,178 $2,800
Loans charged off:
Commercial, financial and unsecured (2,407) (6,315) (5,653) (634) (285)
Real estate (1,254) (3,750) (2,495) (205) (568)
Sale of Sacramento loans (402) -- -- -- --
Net lease financing (24) (190) (31)
----------------------------------------------------------------
Subtotal (4,063) (10,065) (8,172) (1,029) (884)
Recoveries of previous losses:
Commercial and financial 148 221 40 237 162
Real estate construction 6 5 16 -- --
Net lease financing 5 -- 38 66 --
----------------------------------------------------------------
Subtotal 159 226 94 303 162
----------------------------------------------------------------
Net loans charged off (3,904) (9,839) (8,078) (726) (722)
Provision for loan losses 3,554 9,828 11,437 1,600 2,100
----------------------------------------------------------------
Balance of allowance for loan and
lease losses at end of period $8,050 $8,400 $8,411 $5,052 $4,178
================================================================
Ratio of the allowance to total loans 5.4% 3.6% 3.0% 1.8% 1.7%
Ratio of the allowance to non-performing loans 72.6 47.2 71.4 62.6 150.6
Ratio of net charge-offs to average loans 2.0 3.9 2.7 0.3 0.4
The following table provides an allocation of the allowance for loan losses
by collateral type at December 31:
1993 1992 1991
-------------------------- ------------------------ -----------------------
(Dollars in Thousands) Balance Percent(1) Balance Percent(1) Balance Percent(1)
-------------------------- ------------------------ -----------------------
Commercial and financial $3,781 72.8% $5,496 70.5% $4,260 65.2%
Real estate construction 635 9.4 1,958 15.9 2,304 21.9
Real estate mortgage 839 17.7 670 13.4 932 12.7
Lease financing -- -- 2 0.2 3 0.2
Unallocated 2,795 -- 274 -- 912 --
----------------------- --------------------- ---------------------
Total $8,050 100.0% $8,400 100.0% $8,411 100.00%
======================= ===================== ======================
1990 1989
------------------------ -----------------------
Balance Percent(1) Balance Percent(1)
------------------------ -----------------------
Commercial and financial $1,723 57.2% $1,455 63.6%
Real estate construction 437 30.9 453 29.7
Real estate mortgage -- 11.7 -- 6.2
Lease financing -- 0.2 7 0.5
Unallocated 2,892 -- 2,263 --
--------------------- ----------------------
Total $5,052 100.0% $4,178 100.0%
===================== ======================
(1) Percent refers to the percent of loans in each category to total loans.
-43-
46
Allowance for Losses on Other Real Estate Owned
Real estate acquired through foreclosure and in-substance foreclosed loans
are recorded at fair value at the time of transfer to OREO. In 1992, the Bank
adopted a policy in which the Bank periodically obtains either an appraisal or
market valuation analysis on all other real estate owned. If the valuation
analysis indicates a decline in the market value of the property, a specific
loss allowance is established. The Bank provides a charge against current
earnings for estimated losses on foreclosed property when the carrying value of
the property exceeds its fair value net of estimated selling expenses. Fair
value is based on current market conditions, appraisals, and estimated sales
values of similar properties, net of an estimated discount for selling and
other expenses.
The following table summarizes the other real estate owned loss experience
of the Bank for the periods shown:
(Dollars in Thousands) 1993 1992 1991
---------------------------------------------
Balance of allowance for losses - beginning $6,632 $1,672 --
Charge-offs (6,982) (531) --
Provision 3,336 5,491 $1,672
---------------------------------------------
Balance of allowance for losses - ending $2,986 $6,632 $1,672
=============================================
The Bank recorded net gains on sale of other real estate owned totaling
$1.7 million in 1993 and $975,000 in 1992. The gains in 1993 were related to
four properties. The Bank recorded losses on sale of other real estate owned
totaling $712,000 in 1993 and $467,000 in 1992. The losses in 1993 were
related to 11 properties. The OREO properties are shown net of allowance for
losses.
During 1993, the Bank transferred a loan with a carrying value of $1.6
million collateralized by commercial real estate to in- substance foreclosure.
The collateral securing this loan requires seismic upgrading and may be located
on property containing hazardous materials. The Bank may perform further
testing and investigation on the property to obtain additional information
concerning the cost of the seismic upgrades and the nature and extent of any
contamination. Management has not determined a final strategy for resolution
of this non-performing asset at this time, and no specific provision has been
made in the accompanying financial statements for these uncertainties.
Resolution of these uncertainties may have a significant effect on the Bank's
results of operations.
Allowance for Losses on Real Estate Investments
Real estate investments are recorded at the lower of cost or fair value.
Periodically, the Bank obtains either an appraisal or market valuation analysis
on all real estate investments. If the valuation analysis indicates a decline
in the market value of the property subsequent to the date of acquisition, a
specific loss allowance is established. The Bank provides a charge against
current earnings for estimated losses on real estate investments when the
carrying value of the property exceeds its fair value less estimated selling
expenses. Fair value is based on current market conditions, appraisals, and
estimated sales values of similar properties, less an estimated discount for
selling and other expenses.
The following table summarizes the real estate investments loss experience
of the Bank for the years ended December 31:
1993 1992
--------------------------------
Balance of allowance for losses - beginning $462
Charge-off -- $(200)
Provision 250 662
--------------------------------
Balance of allowance for losses - ending $712 $ 462
================================
Deposits
The Bank had total deposits of $210.1 million and $285.7 million at
December 31, 1993 and 1992, respectively. As of December 31, 1993, deposits
consisted of demand deposits totaling $34.9 million, money
-44-
47
market accounts totaling $35.0 million, savings and NOW accounts totaling $56.5
million and time deposits totaling $83.7 million. As of December 31, 1993, the
Bank had a total of approximately 6,000 deposit accounts consisting of
approximately 1,400 demand deposit accounts with an average balance of
approximately $25,000 each, approximately 930 money market accounts with an
average balance of approximately $37,700 each, approximately 2,800 savings and
NOW accounts with an average balance of approximately $20,200 each and 870 time
accounts with an average balance of approximately $73,200 each (excluding
brokered deposits). The Bank's deposits and, correspondingly, its liquidity,
is largely dependent upon three sources of deposits: deposits acquired through
its Association Bank Services function, brokered placement of certificates of
deposit and deposits solicited through the Bank's money desk. These sources of
deposits comprised 50.7% of the Bank's total deposits at December 31, 1993.
Certificates of deposit having a balance of at least $100,000
(including brokered placements of certificates of deposit) represented
approximately 24.8% of the Bank's total deposits as of December 31, 1993. As
of December 31, 1993, 86.3% of the Bank's certificates of deposit of at least
$100,000 mature in less than 90 days, 11.1% between 90 days and one year and
2.6% greater than a year. The aggregate average maturity of all of the Bank's
certificates of deposit of at least $100,000 was 90 days as of December 31,
1993, and the aggregate amount of all such certificates of deposit as of
December 31, 1993 was $32.2 million. Concentrations of large certificates of
deposit have been classified by bank regulatory authorities as volatile
liabilities associated with certain risks, including the risks of reduced
liquidity if a bank is unable to retain such deposits and reduced margins if
its interest costs are increased by a bank in order to retain such deposits.
See "-- Regulation and Supervision." As a result of the Orders the Bank was
required to submit a plan to the FDIC and SBD to reduce its dependence on
volatile liabilities.
Deposits from homeowner and community associations are a key
component of the Bank's core deposit base. See "-- Trust and Securities
Division -- Association Bank Services". At December 31, 1993 and 1992, the
Association Bank Services function accounted for $45.1 million and $53.5
million in deposits, representing approximately 21.5% and 18.7% of the Bank's
total deposits, respectively. During 1993, Association Bank Service customer
deposits declined 15.7% from a year earlier. In August 1993, the manager and
much of the staff of the Association Bank Services function left the Bank to
join a competitor, whose services have been actively marketed to the Bank's
customer base. There can be no assurance that the Bank will be able to stem
the loss of such deposits.
The Bank has an agreement with a major retail brokerage firm for the
placement of the Bank's certificates of deposit. As of December 31, 1993 and
1992, the Bank had outstanding certificates of deposit placed through this
brokerage firm of $20.0 million (constituting all of the Bank's brokered
deposits) and $54.5 million, or 9.5% and 19.1% of Bank's total deposits,
respectively, and approximately 8.7% and 17.1% of the Bank's total assets.
During 1993 and 1992 certificates of deposit placed through this brokerage firm
averaged $36.3 million and $16.3 million, respectively, with high and low
balances for 1993 of $54.5 million and $20.0 million, which were outstanding
for 90 and 180 days, respectively. Such brokered deposits had an average
original term to maturity of approximately six months. All of the Bank's
brokered deposits as of December 31, 1993 mature in March 1994.
In March 1993, the Bank initiated a money desk for the purpose of
attracting additional deposits. These deposits are gathered principally from
other financial institutions and municipalities outside of the Bank's market
area. As of December 31, 1993, the Bank had outstanding money desk deposits of
$41.5 million or 19.8% of Bank's total deposits. During 1993, the money desk
deposits averaged $26.4 million, with a high balance of $42.4 million. As of
December 31, 1993, money desk deposits had an average remaining maturity of
approximately seven months.
The Bank's ability to accept brokered placements of certificates of
deposit was restricted in the first quarter of 1992 under FDICIA and FDIC
regulations that prohibit adequately capitalized banks from accepting or
renewing such deposits. The Bank is currently accepting brokered deposits
pursuant to a temporary waiver of such prohibition received in September 1993
which expires in September 1994. As required by the Orders, the Bank has
submitted a plan to the FDIC and the SBD to eliminate reliance on brokered
deposits and to reduce its dependency on out of area deposits and volatile
liabilities. See "-- Regulatory Directives and Orders and Regulation and
Supervision." However, because these deposits presently comprise approximately
44.3% of the Bank's total deposits, no assurance can be given that these
deposits, in the near future, can be replaced with other core deposits.
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48
The following table sets forth the maturities, as of December 31, 1993, of
the Bank's interest-bearing deposits and other interest-bearing liabilities:
Over 3 Over More Than
3 Months Months to 6 Months 1 Year to
(Dollars in Thousands) or Less 6 Months to 1 Year 5 Years Total
------------------------------------------------------------------------------
Interest-Bearing Liabilities:
Money market accounts $ 35,050 $ 35,050
Savings and NOW accounts 56,453 $ 56,453
Time deposits 39,347 $ 20,753 $ 22,052 $ 1,597 $ 83,749
Other borrowings 170 8 1,125 -- 1,303
------------------------------------------------------------------------------
Total interest-bearing
liabilities $131,020 $ 20,761 $ 23,177 $ 1,597 $176,555
==============================================================================
OTHER BORROWINGS
The Bank's other borrowings at December 31, 1993 totaled $1.3 million, as
compared to $15.3 million at December 31, 1992. The Bank's other borrowings
include advances from the FHLB and Federal Reserve Bank of San Francisco
("Federal Reserve Bank"), reverse repurchase agreements, and senior liens on
real estate acquired in the settlement of loans.
The Bank has a short term line of credit with the Federal Reserve Bank of
up to $4.7 million secured by loans in the Bank's portfolio, and an additional
short term line of credit with the FHLB of up to $4.0 million secured by
pledged loans and securities. At December 31, 1993, the Bank had no borrowings
outstanding with the FHLB or Federal Reserve Bank. At December 31, 1992, $9.8
million was outstanding on the Bank's line of credit with the FHLB. During
1993 and 1992, the Bank did not borrow at the discount window at the Federal
Reserve Bank.
ASSET AND LIABILITY MANAGEMENT
Banking is a business which depends on rate differentials. In general, the
difference between the interest rate paid by the Bank on its deposits and its
other borrowing 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 Bank's earnings. These rates are highly sensitive to many
factors which are beyond the control of the Bank. Accordingly, the earnings
and growth of the Bank are subject to the influence of domestic economic
conditions, including inflation, recession and unemployment.
The most important component of the Bank's earnings is the difference
between the rates earned on its assets as compared to the rates paid on its
liabilities. The difference between the amount of assets and the amount of
liabilities which are subject to interest rate risk is referred to as the
"gap." The gap represents the risk and the opportunity inherent in mismatching
asset and liability interest rate changes. If more assets than liabilities are
interest rate sensitive at a given time in a rising interest rate environment,
net interest income increases. In a declining interest rate environment with
the same "gap", net interest income decreases. If more liabilities change
rates than assets, the same scenarios produce the opposite effects.
The Bank's risk management policies are established by the ALCO. The ALCO
meets semi-monthly to formulate the Bank's strategies. The basic
responsibilities of the ALCO include the management of interest rate risk,
liquidity, funding, and asset and liability products. The Bank's approach is
to measure interest rate risk, assess and determine if the risk level is
acceptable and to develop strategies to either reduce excessive risk or
recognize the trade-offs between risk and return.
-46-
49
The following table shows the repricing opportunities for the Bank's
interest-earning assets and interest-bearing liabilities at December 31, 1993:
Over 3 Over More Than
3 Months Months to 6 Months 1 Year to Over
(Dollars in Thousands) or Less 6 Months to 1 Year 5 Years 5 Years Total
----------------------------------------------------------------------------
Interest-Earning Assets:
Investment securities and
cash equivalents $ 37,470 $ 1,305 $ 510 -- -- $ 39,285
Loans (1) 125,616 23 1,456 $ 2,937 $ 8,622 138,654
----------------------------------------------------------------------------
Total interest-earning assets 163,086 1,328 1,966 2,937 8,622 177,939
----------------------------------------------------------------------------
Interest-Bearing Liabilities:
Interest-bearing deposits 130,850 20,753 22,052 1,597 -- 175,252
Other borrowings 170 8 1,125 -- -- 1,303
---------------------------------------------------------------------------
Total interest-bearing liabilities 131,020 20,761 23,177 1,597 -- 176,555
---------------------------------------------------------------------------
Interest bearing assets over (under)
interest bearing liabilities $ 32,066 $(19,433) $ (21,211) $ 1,340 $ 8,622 $ 1,384
===========================================================================
Cumulative primary gap $ 32,066 $ 12,633 $ (8,578) $ (7,238) $ 1,384
===========================================================================
Gap as a percentage of total assets 13.9% 5.5% (3.7)% (3.1)% 0.6%
(1) Excludes non-accrual loans.
The maturity/rate sensitivity analysis is a static view of the balance
sheet with assets and liabilities grouped into certain defined time periods,
and thus only partially depicts the dynamics of the Bank's sensitivity to
interest rate changes. Such an analysis does not fully describe the complexity
of relationships between product features and pricing, market rates and future
management of the balance sheet mix. As a result, assets and liabilities
indicated as repricing within the same period may in fact reprice at different
times and different rates. The Company's net interest margins on average
earnings assets for the years ended December 31, 1993, 1992 and 1991, were
4.6%, 4.5% and 4.8%, respectively.
LIQUIDITY
In 1992 and 1993, the Company's principal source of liquidity has been
new capital from the issuance of its capital stock. As of December 31, 1993,
the Company's liquidity was substantially exhausted and the Company will not
able to meet its short-term liabilities without an additional capital infusion
or through short-term borrowings. Such borrowings, if they become available,
are subject to the prior approval of the FRB pursuant to the terms of the FRB
Directive.
Liquidity is the Bank's ability to meet the present and future needs
of its clients for loans and deposit withdrawals. The Bank's liquidity
generally decreases as a result of increases in the Bank's loans and other
assets, and fluctuations in the maturities of deposits in the Bank can have a
significant effect on the Bank's liquidity. The sources of the Bank's
liquidity include deposits, other liquid assets and short-term borrowings. The
most important source of these assets are core deposits. Core deposits are
defined as all deposits from its customer base except time deposits of $100,000
or greater. At December 31, 1993, the Bank's core deposits were $116.0
million, representing a 49.1% decrease from core deposits of $228.0 million at
December 31, 1992, which in turn represents a 28.5% decrease from core deposits
of $318.9 million at December 31, 1991. The Bank's liquid assets, which
includes cash and short term investments, at December 31, 1993 totaled $47.4
million, an increase of 9.7% from $43.2 million at December 31, 1992. The Bank
currently has a short-term line of credit at the discount window with the
Federal Reserve Bank of up to $4.7 million secured by loans in the Bank's
portfolio. As of December 31, 1993, the Bank had not drawn on its line of
credit with the Federal Reserve Bank. As of December 31, 1993, the Bank had
pledged loans and securities enabling the Bank to borrow up to $4.0 million
from the Federal Home Loan Bank of San Francisco, and the Bank had not drawn on
this line of credit.
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50
The Bank's ability to generate liquidity through deposits from
homeowner and community associations, $45.1 million or 21.5% of deposits at
December 31, 1993, has become the subject of intense competition during 1993.
In addition, out of area deposits solicited through the Bank's money desk,
$41.5 million or 19.8% of deposits at December 31, 1993 are the subject of an
Order requiring the Bank to reduce its reliance on such deposits.
The Bank's ability to generate liquidity through acceptance of
brokered placements of certificates of deposit was restricted in the first
quarter of 1992 under FDICIA and new FDIC regulations that prohibit
undercapitalized banks from accepting or renewing such brokered deposits and
prohibit adequately capitalized institutions from accepting or renewing such
deposits unless such institutions obtain a waiver of such prohibition from the
FDIC. Under the Orders, the Bank was required to submit a written plan to the
FDIC and the SBD for eliminating its reliance on brokered deposits, and to
provide the Regional Director of the FDIC and the Superintendent with monthly
reports outlining the Bank's progress under such plan. The FDIC has granted
the Bank a one-year waiver expiring in September 1994 to permit renewal of
brokered deposits, provided that the Bank continues to meet the definition of
an adequately capitalized institution. If the Bank fails to meet the
definition of an adequately capitalized institution or fails to demonstrate
substantial progress towards elimination of dependency on brokered deposits,
the Bank may be unable to obtain an extension of such waiver. If the Bank is
unable to eliminate its brokered deposits by September 23, 1994 or is unable to
obtain an extension of the waiver, the Bank will be in violation of the Orders
and could be subject to the termination of the Bank's federal deposit
insurance, imposition of civil monetary penalties or possession of the Bank's
property and business and ultimate liquidation thereof. See "-- Regulation and
Supervision." The Bank's brokered placements of certificates of deposit
totaled $20.0 million, or approximately 9.5% of the Bank's total deposits and
approximately 8.7% of the Bank's total assets, as of December 31, 1993. All of
such brokered deposits will reach maturity on March 31, 1994.
In order to reduce the Bank's reliance on volatile liabilities in
general and on brokered deposits specifically, the following steps are being
taken:
o A Liability Manager has been hired to work with Private and
Business Banking officers in the development and marketing of
core deposit programs.
o A new local area certificate of deposit product has been
developed and was rolled-out in early February, 1994.
o The San Francisco Company-Asia is a deposit driven strategy
with deposits expected to exceed loans by a ratio of 2:1.
Additionally, once the Bank is recapitalized, management believes that
some level of deposits that left the Bank over "safety and soundness" concerns
will return, and that marketing deposit products to new customers will be more
successful.
Although management believes that the Bank's ability to eliminate its
brokered deposits, and reduce its reliance on out of area and volatile
liabilities can be accomplished through local deposit marketing efforts
following a recapitalization of the Bank, the success of which cannot be
assured, and because brokered deposits and out of area deposits presently
comprise over 29% of the Bank's total deposits, it is not expected that, in the
near future, these deposits can be replaced with core deposits. Nor can any
assurance be given that the Bank will be able to successfully implement its
plans, find alternate sources of deposits and avoid violation of the Orders.
See "-- Regulatory Directives and Orders."
CAPITAL
Shareholders' equity stood at $17.5 million at December 31, 1993, an
increase of $1.8 million from $15.7 million at December 31, 1992. However,
during the period from 1991 through 1993, the Company suffered an aggregate of
$41.6 million in losses, primarily as a result of defaulted loans secured by
real estate and losses on direct real estate development activities. The
Company and the Bank succeeded in avoiding insolvency during this period only
through the injection of a total of $32.0 million in new capital by the
Company's controlling stockholder, Mr. Putra Masagung.
-48-
51
Pursuant to federal law, the Company is subject to the Federal Reserve
Board's capital guidelines of the FRB and the Bank is subject to the FDIC's
regulations governing capital adequacy for banks that are not members
("non-member banks") of the Federal Reserve System. Due to net losses incurred
by the Company during the 1991 and 1992 fiscal years, as of March 31, 1993, the
Company and Bank failed to meet such capital adequacy requirements applicable
to bank holding companies and to banks and have continued periodically to fail
to meet such capital adequacy requirements through 1993. As a result of the
Bank's failure to meet its minimum capital requirements during 1991, on
November 15, 1991 the Bank entered into a MOU. The MOU required the Bank to
restore its capital and its allowance for loan losses to acceptable levels or
to sell the Bank. In response to the MOU, management of the Bank established
and filed with the SBD and the FDIC a capital plan to determine an appropriate
range of capital ratios within which the Bank could operate in a safe and sound
manner, and to execute the appropriate strategy to ensure that the Bank
maintained capital within a desirable range. After certain interim actions, as
a result of a failure to meet regulatory capital requirements at March 31,
1993, the Bank was required to file a Capital Restoration Plan (the
"Restoration Plan") in compliance with the "Prompt Corrective Action" system
imposed by the FDICIA, and that plan was approved by the FDIC on September 8,
1993. As a condition of FDIC's approval of the Restoration Plan, the Company
agreed to guarantee that the Bank will comply with the Restoration Plan until
the Bank has met its minimum capital requirements on average during each of
four consecutive calendar quarters. The Company's liability under the
guarantee is limited to the lesser of 5% of the Bank's total assets at the time
it became undercapitalized, $15.3 million or an amount necessary (or that would
have been necessary) to bring the Bank into compliance with all of its capital
requirements as of the time it fails to comply with the Restoration Plan. The
Company currently does not have sufficient funds to satisfy the guarantee, and
would be in default thereunder if called upon to do so. See "-- Supervision
and Regulation" for further information concerning FDICIA's "Prompt Corrective
Action" system.
Under California law, if a bank's deficit retained earnings exceed 40% of
its contributed capital, its capital is deemed to be impaired, and the bank is
required to levy an assessment on its shares to correct the impairment. The
SBD has issued four Impairment Orders to the Bank dated February 7, 1994,
November 16, 1993, February 17, 1993 and November 16, 1992. At December 31,
1993, the Bank had contributed capital of $49.2 million and deficit retained
earnings of $31.8 million resulting in a $12.0 million capital impairment. See
"-- Regulatory Directives and Orders -- Capital Impairment Order" for more
discussion on the Bank's impairment of capital.
On July 13, 1992, the Company had completed (i) the sale to the Company's
controlling stockholder of 5,600,000 shares of Class A Common Stock (the "Class
A Shares") at $2.50 per share and warrants which will enable the Company's
controlling stockholder to acquire 1.0408 additional Class A Shares at $2.50
per share for every Class A Share issued by the Company for an aggregate
purchase price of $14,000,000, under an Amended Stock Purchase Agreement dated
April 10, 1992 (the "Amended Stock Purchase Agreement"), (ii) the sale to
certain directors of the Company and executive officers and directors of the
Bank of 314,000 Class A Shares, also at $2.50 per share, for an aggregate
purchase price of $785,000, and (iii) the issuance of a Subordinated Term Note
to Donald R. Stephens for $715,000.
In connection with the transactions contemplated by the Amended Stock
Purchase Agreement, Mr. Stephens agreed with the Company's controlling
stockholder to convert or exchange his $715,000 Subordinated Term Note for
Class A Shares at a ratio of one (1) Class A Share for every $2.50 of principal
of the Subordinated Term Note, subject to stockholder approval. Mr. Stephens
also agreed to waive or forego any interest owing on the Subordinated Term Note
as of the date of such conversion or exchange. The stockholders of the Company
authorized Mr. Stephens to convert or exchange the Subordinated Term Note for
Class A Shares at the Company's 1992 Annual Meeting of Stockholders held on
September 15, 1992, and the Company issued an additional 286,000 Class A Shares
to Mr. Stephens as a result of the conversion of his Subordinated Term Note.
As a consequence of the acquisition of the 5,600,000 Class A Shares by the
Company's controlling stockholder on July 13, 1992, a change of control of the
Company was effected.
On October 29, 1992, the Company entered into an agreement which was
subsequently amended on November 20, 1992 (as amended, the "October 29 Letter
Agreement") with the Company's controlling stockholder whereby it was agreed
that the Company's controlling stockholder would purchase up to 600,000 shares
of Series C Preferred Share at a price of $20.00 per share, completed by a
specified date and the Company would grant to the Company's controlling
stockholder an option (the "Series C Preferred Stock Option") to purchase up to
an additional 400,000 Series C Preferred Shares at a price of $20.00 per share,
exercisable in whole or in part at any time before a
-49-
52
specified date. The Company's controlling stockholder acquired 300,000 shares
as of December 31, 1992, 300,000 shares on February 26, 1993, 200,000 shares on
August 27, and 100,000 shares on September 30, 1993, of Series C Preferred
Stock.
The Series C Preferred Shares purchased by the Company's controlling
stockholder are mandatorily convertible, subject to obtaining stockholder
approval of the conversion feature, into forty (40) Class A Shares (i.e., at a
conversion price of Fifty Cents ($0.50) per share) and forty (40) warrants (the
"Warrants"), each of which entitles the holder to purchase an additional Class
A Share at Fifty Cents ($0.50) per share. As a consequence, the Company's
controlling stockholder has the right to acquire a substantial number of
additional Class A Shares and control a substantial percentage of the voting
power of the Company. Based upon the current capitalization of the Company, if
the Company's controlling stockholder (i) exercised the Series C Preferred
Stock Option, and (ii) converted all of the Series C Preferred Shares owned by
him into Class A Shares (at a conversion price of Fifty Cents ($0.50) per
share) and Warrants, and (iii) exercised all of the Warrants, then the
Company's controlling stockholder would receive an additional 72,000,000 Class
A Common Shares and would own approximately 96.3% of the total number of issued
and outstanding common shares.
Mr. Kaharudin Latief of Jakarta, Indonesia is presently in the process of
providing notice to the FRB and applying to the SBD for approval to acquire
shares of the Series C Preferred Stock. If and when regulatory clearance is
received, Mr. Latief plans to acquire from the Company's controlling
stockholder 300,000 shares of Series C Preferred Stock (or the shares of Class
A Common Stock and Warrants into which such shares of Series C Preferred Stock
are converted) through cancellation of an unsecured, personal loan in the
amount of $6.0 million which Mr. Latief previously extended to the Company's
controlling stockholder. The Company's controlling stockholder used the
proceeds of this loan to acquire 300,000 shares of the Series C Preferred Stock
from the Company. If Mr. Latief consummates this transaction, and if the
conversion feature of the Series C Preferred Stock is approved by the Company's
stockholders, Mr. Latief would hold 12 million shares of Class A Common Stock
at an exercise price of $0.50 per share. Mr. Latief's ownership percentage
would be 26.7% and the Company's controlling stockholder's new common ownership
would decline to approximately 65.9%.
The Company and the Bank are subject to general regulations issued by the
FRB, FDIC, and SBD which require maintenance of a certain level of capital and
the Bank is under specific capital requirements as a result of the Orders. As
of December 31, 1993, the Company was in compliance with all minimum capital
requirements and the Bank was in compliance with all minimum capital
requirements, except for the minimum leverage ratio of 7% mandated by the
Orders. Because the sale of the Sacramento Regional Office occurred late in
the fourth quarter of 1993, the Bank's ratio of Tier 1 capital at December 31,
1993 to the Bank's average assets during that quarter was 6.7%.
The following table reflects both the Company's and the Bank's capital
ratios with respect to minimum capital requirements in effect as of December
31, 1993.
Minimum
Capital
Company Bank Requirement Orders
-----------------------------------------------------
Leverage ratio 6.7% 6.7% 4.0% 7.0%
Tier 1 risk-based capital 8.0 8.0 4.0 N/A
Total risk-based capital 9.5 9.5 8.0 N/A
Management believes that the Company and the Bank must raise additional
capital in order to obtain greater assurance that the Company and the Bank will
be able to meet their minimum capital requirements on an ongoing basis and to
pursue perceived opportunities and management's new strategic initiatives. See
"-- Regulatory Directives and Orders" for additional information.
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53
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Report of Independent Public Accountants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . 52
Consolidated Statements of Financial Condition,
December 31, 1993 and 1992 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
Consolidated Statements of Operations, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . 54
Years ended December 31, 1993, 1992 and 1991
Consolidated Statements of Changes in Shareholders' Equity, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55
Years ended December 31, 1993, 1992 and 1991
Consolidated Statements of Cash Flows, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . 56
Years ended December 31, 1993, 1992 and 1991
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58
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REPORT OF INDEPENDENT ACCOUNTANTS
The Board of Directors and Shareholders of
Bank of San Francisco Company Holding Company:
We have audited the accompanying consolidated statements of financial condition
of Bank of San Francisco Company Holding Company and subsidiaries (the Company)
as of December 31, 1993 and 1992 and the related consolidated statements of
operations, changes in shareholders' equity and cash flows for each of the
years in the three-year period ended December 31, 1993. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Bank of San
Francisco Company Holding Company and subsidiaries at December 31, 1993 and
1992 and the results of their operations and their cash flows for each of the
years in the three-year period ended December 31, 1993 in conformity with
general accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming
the Bank of San Francisco Company Holding Company will continue as a going
concern. As discussed in Note 2 to the consolidated financial statements, the
Company's recurring losses from operations; noncompliance of the Company and
its wholly-owned subsidiary, the Bank of San Francisco (the Bank), with the
Orders to Cease and Desist issued jointly by the Federal Deposit Insurance
Corporation (FDIC) and the California State Banking Department (SBD); the
Bank's noncompliance with the Impairment Orders issued by the SBD; the
Company's inability to make scheduled liability payments without additional
capital contributions or other sources of liquidity; and the uncertainty
relating to the potential unfavorable outcome of pending litigation and
contingent liabilities discussed in Note 17 to the consolidated financial
statements, raise substantial doubt about the Company's ability to continue as
a going concern. The ability of the Company to continue as a going concern is
dependent upon many factors, including increasing and maintaining its capital
ratios, obtaining additional capital contributions and returning the Company to
profitable operations. Management's plans in regard to these matters are
described in Note 2 to the financial statements. The accompanying financial
statements do not include any adjustments that might result from the outcome of
these uncertainties.
January 25, 1994, except as to note 2,
which is as of February 7, 1994
San Francisco, California KPMG Peat Marwick
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BANK OF SAN FRANCISCO COMPANY HOLDING COMPANY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1993 AND 1992
(Dollars in Thousands Except Per Share Data) Notes 1993 1992
----------------------------------------
ASSETS:
Cash and due from banks $ 8,333 $ 19,597
Federal funds sold 17,500 --
---------------------------
Cash and cash equivalents 25,833 19,597
Investment securities held-to-maturity (Market: 1993, $6,353; 1992, $4,993) 3 6,351 4,910
Investment securities available-for-sale 4 14,940 --
Investment securities held-for-sale (Market: 1992, $19,038) 5 -- 18,731
Loans 6 149,740 236,076
Deferred loan fees 6 (550) (863)
Allowance for loan losses 7 (8,050) (8,400)
---------------------------
Loans, net 141,140 226,813
Other real estate owned 8 32,372 35,457
Real estate investments 9 3,643 4,017
Premises and equipment, net 10 3,592 4,588
Interest receivable 946 1,485
Other assets 2,204 3,557
---------------------------
Total assets $231,021 $319,155
===========================
LIABILITIES AND SHAREHOLDERS' EQUITY:
Non-interest bearing deposits $ 34,859 $ 52,772
Interest bearing deposits 175,252 232,913
---------------------------
Total deposits 11 210,111 285,685
Other borrowings 12 1,303 15,308
Other liabilities and interest payable 2,152 2,486
---------------------------
Total liabilities 213,566 303,479
---------------------------
Commitments and contingencies 17
Shareholders' Equity: 14
Preferred Stock (par value $0.01 per share) -- --
Series B - Authorized - 437,500 shares
Issued and outstanding - 16,591 shares 116 116
Series C - Authorized - 1,800,000 shares
Issued and outstanding - 900,000 and 300,000, respectively 18,000 6,000
Common stock (par value $0.01 per share)
Class A - Authorized - 20,000,000 shares
Issued and outstanding - 8,899,801 and 8,901,944 in 1993 and 1992, respectively 89 89
Class B - Authorized - 28,635 shares
Issued and outstanding - None -- --
Additional paid in capital 34,577 34,583
Deficit (35,101) (24,846)
Employee purchase and option plans (166) (266)
Unrealized loss on securities available-for-sale (60) --
---------------------------
Total shareholders' equity 17,455 15,676
---------------------------
Total liabilities and shareholders' equity $231,021 $319,155
===========================
The accompanying notes are an integral part of the consolidated financial
statements.
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BANK OF SAN FRANCISCO COMPANY HOLDING COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991
(Dollars in Thousands Except Per Share Data) Notes 1993 1992 1991
-----------------------------------------------------
Interest income:
Loans $ 16,659 $ 21,707 $ 33,743
Investments 1,451 2,152 2,945
Dividends 45 26 54
---------------------------------------
Total interest income 18,155 23,885 36,742
---------------------------------------
Interest expense:
Deposits 11 6,966 10,746 18,850
Other borrowings 454 549 376
---------------------------------------
Total interest expense 7,420 11,295 19,226
---------------------------------------
Net interest income 10,735 12,590 17,516
Provision for loan losses 7 3,554 9,828 11,437
---------------------------------------
Net interest income after provision for loan losses 7,181 2,762 6,079
---------------------------------------
Non-interest income:
Service charges and fees 173 223 282
Income from limited partnership 9/18 263 202 245
Loan brokerage and servicing fees 324 201 671
Gain on sale of mortgage servicing rights -- -- 730
Stock option commissions and fees 2,906 2,320 2,353
Other income 1,213 1,844 1,892
---------------------------------------
Total non-interest income 4,879 4,790 6,173
---------------------------------------
Non-interest expense:
Salaries and related benefits 8,325 9,858 10,132
Occupancy expense 10 2,054 2,061 2,092
Professional fees 2,326 3,426 2,055
Equipment expense 849 938 923
FDIC insurance premiums 849 816 683
Data processing 457 478 500
Loss on sale of Sacramento Regional Office 420 -- --
Operating lease depreciation 382 422 492
Telephone 314 274 392
Other operating expenses 2,044 3,125 4,822
---------------------------------------
Total operating expenses 18,020 21,398 22,091
Net cost of real estate operations 4,126 8,721 2,185
---------------------------------------
Total non-interest expense 22,146 30,119 24,276
---------------------------------------
Loss before income taxes (10,086) (22,567) (12,024)
Provision (benefit) for income taxes 13 169 (390) (2,870)
---------------------------------------
Net loss $(10,255) $(22,177) $ (9,154)
=======================================
Loss per share:
Weighted average shares outstanding 8,901,276 5,314,357 2,278,499
Net loss $(1.15) $(4.18) $(4.13)
The accompanying notes are an integral part of the consolidated financial
statements.
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57
BANK OF SAN FRANCISCO COMPANY HOLDING COMPANY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991
Employee Unrealized
Purchase Loss on Total
Additional Retained and Securities Share-
Preferred Common Paid-in Earnings Option Available- holders'
(Dollars in Thousands) Stock Stock Capital (Deficit) Plans for-Sale Equity
----------------------------------------------------------------------------
Balances at January 1, 1991 $ 3,000 $ 21 $16,192 $ 6,950 $ (584) $25,579
Exercise of stock options -- 1 28 -- -- 29
Net change in employee stock
ownership plans -- 1 49 -- 142 192
Common Stock dividend
($0.05 per share) -- -- -- (281) -- (281)
Preferred Stock dividend (note 14) -- -- -- (184) -- (184)
Net loss -- -- -- (9,154) -- (9,154)
-----------------------------------------------------------------------------
Balances at December 31, 1991 3,000 23 16,269 (2,669) (442) 16,181
Net change in employee stock
ownership plans -- -- (4) -- 176 172
Conversion of stock (2,884) 4 2,880 -- -- --
Net proceeds from sale of stock 6,000 59 14,726 -- -- 20,785
Conversion of subordinated debt -- 3 712 -- -- 715
Net loss -- -- -- (22,177) -- (22,177)
-----------------------------------------------------------------------------
Balances at December 31, 1992 6,116 89 34,583 (24,846) (266) 15,676
Net change in employee stock
ownership plans -- -- (6) -- 100 94
Net proceeds from sale of stock 12,000 -- -- -- -- 12,000
Unrealized loss on securities
available-for-sale -- -- -- -- -- $ (60) (60)
Net loss -- -- -- (10,255) -- -- (10,255)
-----------------------------------------------------------------------------
Balances at December 31, 1993 $18,116 $ 89 $34,577 $(35,101) $ (166) $ (60) $17,455
=============================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
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58
BANK OF SAN FRANCISCO COMPANY HOLDING COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991
(Dollars in Thousands) 1993 1992 1991
---------------------------------------
Cash Flows from Operating Activities:
Net loss $(10,255) $(22,177) $(9,154)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Provision for loan losses 3,554 9,828 11,437
Depreciation and amortization expense 770 990 929
Net loss (gain) on other real estate owned and real estate investment 2,629 4,917 (2,162)
Loss (gain) on investment securities held-for-sale 67 235 (39)
Decrease in mortgage loans held-for-sale -- 6,826 24,559
Loss from stock option lending program -- -- 605
Decrease in interest receivable 539 1,078 556
Increase (decrease) in interest payable (213) (362) 37
Decrease in deferred loan fees (313) (299) (95)
Deferred income tax expense (benefit) -- 528 (588)
----------------------------------------
Net cash flows provided by (used in) operating activities (3,222) 1,564 26,085
---------------------------------------
Cash Flows from Investing Activities:
Proceeds from maturities of investment securities 28,200 1,608 500
Decrease in investment securities -- -- 3,345
Purchase of investment securities (29,404) (3,242) --
Proceeds from sales of investment securities held-for-sale 24,472 21,533 5,564
Purchase of investment securities held-for-sale (20,808) (20,042) (9,099)
Net decrease (increase) in loans 51,253 29,745 (46,483)
Loans sold in sale of branch 27,934 -- --
Recoveries of loans previously charged off 159 226 94
Purchases of premises and equipment (124) (159) (1,182)
Premises and equipment sold in sale of branch 350 -- --
Decrease in other assets sold in sale of branch 201 -- --
Proceeds from sales of real estate investment 7,563 10,500 2,926
Acquisition of real estate owned (3,790) (1,358) (1,549)
Net decrease (increase) in other assets 1,152 3,155 (1,388)
---------------------------------------
Net cash provided by (used in) investing activities 87,158 41,966 (47,272)
---------------------------------------
Cash Flows from Financing Activities:
Net increase (decrease) in deposits (42,459) (87,514) 9,622
Net increase (decrease) in other borrowings (14,005) 4,640 10,311
Deposits sold in sale of branch (33,115) -- --
Net increase (decrease) in other liabilities (121) 361 (935)
Dividends paid on common and preferred stock -- -- (465)
Net proceeds from sale of preferred stock 12,000 6,000 --
Net proceeds from sale of common stock -- 14,793 56
Net proceeds from issuance of subordinated debt -- 715 --
---------------------------------------
Net cash provided by (used in) financing activities (77,700) (61,005) 18,589
---------------------------------------
Increase (decrease) in cash and cash equivalents 6,236 (17,475) (2,598)
Cash and cash equivalents at beginning of year 19,597 37,072 39,670
---------------------------------------
Cash and cash equivalents at end of year $25,833 $19,597 $37,072
=======================================
The accompanying notes are an integral part of the consolidated financial
statements. (continued)
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59
BANK OF SAN FRANCISCO COMPANY HOLDING COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991
(continued)
(Dollars in Thousands) 1993 1992 1991
---------------------------------------
Supplemental Disclosure of Cash Flow Information:
Cash paid during the year for:
Interest $ 7,632 $11,666 $19,190
Income taxes 106 65 601
Supplemental Schedule of Noncash Investing and Financing Activities:
Net transfer of loans to other real estate owned 2,943 5,967 36,012
Conversion of subordinated debt to common stock -- 715 --
The accompanying notes are an integral part of the consolidated financial
statements.
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60
BANK OF SAN FRANCISCO COMPANY HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1993 AND 1992
Note 1: Statement of Accounting Policies
Organization
Bank of San Francisco Company Holding Company (Company) is a Delaware
corporation and a bank holding company registered under the Bank Holding
Company Act of 1956, as amended. The Company was organized in 1981 under the
laws of the State of California. In July 1988, the Company changed its state
of incorporation from California to Delaware by means of a merger of the
Company into a newly formed wholly owned Delaware subsidiary. Bank of San
Francisco (Bank), a state chartered bank, was organized as a California banking
corporation in 1978 and became a wholly owned subsidiary of the Company through
a reorganization in 1982.
The Bank and Bank of San Francisco Realty Investors (BSFRI) acquired
partnership interests of 34.5% and 2.5%, respectively, in Bank of San Francisco
Building Company (BSFBC), a California limited partnership which holds the
leasehold interest in the Company's headquarters building located at 550
Montgomery Street, San Francisco, California. The Company accounts for its
investment in BSFBC using the equity method.
On December 4, 1993, the Bank consummated its agreement to sell its
Sacramento Regional Office. The Bank sold $28.0 million in loans or 10% of the
Bank's assets at the time of the sale. The purchaser assumed total deposits of
$33.5 million or 13% of the Bank's total deposits at the time of the sale. A
loss on sale of $420,000 was recognized in 1993.
Principles of Consolidation
The accompanying financial statements include the accounts of the Company,
the Bank, and the Bank's wholly owned subsidiary, BSFRI, formerly BSF Equities.
All material intercompany transactions have been eliminated in consolidation.
Other ventures and partnerships in which the Company or any of its
subsidiaries have a significant ownership interest are accounted for by the
equity method. These investments are recorded as real estate investments, and
gains or losses upon disposition of these investments are recorded in gain/loss
on sale of real estate.
Cash and Cash Equivalents and Statements of Cash Flows
Cash equivalents are defined as short-term, highly liquid investments both
readily convertible to known amounts of cash and so near maturity that there is
insignificant risk of changes in value because of changes in interest rates.
Generally, only investments with maturities of three months or less at the time
of purchase qualify as cash equivalents. Cash and cash equivalents include
cash and due from banks, time deposits with other financial institutions, and
Federal funds sold.
The Bank is required to maintain non-interest bearing cash reserves equal
to a percentage of certain deposits. In 1993 and 1992, the average reserve
balances outstanding were $5.7 million and $6.5 million, respectively.
Generally, the Bank does not maintain compensating balance arrangements.
Investment Securities
At December 31, 1993, the Company adopted Statement of Financial Accounting
Standards "Accounting for Certain Investments in Debt and Equity Securities"
(SFAS No. 115) which requires the classification of debt and equity securities
into one of three categories; held-to-maturity, trading, or available-for-sale.
The investments classified as held-to-maturity are carried at amortized cost
because management has both the intent and ability to hold these investments to
maturity. The investments classified as trading are carried at fair value with
any gains and loss reflected in earnings. All other investments are classified
as available-for-sale and are carried at fair value
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61
with any unrealized gains and loss included as a separate component of
shareholder's equity. The impact of adopting SFAS No. 115 had no material
effect on the Company's financial statements at December 31, 1993.
Investment securities include both debt and equity securities. At December
31, 1993, Bank maintained two securities portfolios; debt securities
held-to-maturity, and debt and equity securities available-for-sale.
Investment securities held-to-maturity are carried at amortized cost and
discounts or premiums are accreted or amortized to income over the expected
term of the investment based on prepayment assumptions. Discounts or premiums
are adjusted periodically to reflect actual prepayment experience. The gain or
loss on all investment securities sold is determined based on the specific
identification method. The estimated fair value is based on market price.
Loans Receivable
Loans are stated at the principal amount outstanding, net of the allowance
for loan losses, deferred fees and unearned discount, if any. The Bank holds
loans receivable primarily for investment purposes. A significant portion of
the Bank's loan portfolio is comprised of adjustable rate loans.
Interest on loans is calculated using the simple interest method on the
daily balances of the principal amount outstanding. The accrual of interest is
discontinued and any accrued and unpaid interest is charged against current
income when the payment of principal or interest is 90 days past due, unless
the amount is well-secured and in the process of collection. Subsequent
interest payments on loans in non-accruing status are recorded as income to the
extent of cash received, provided that the future collection of the recorded
principal is probable.
Lease financing receivables, net of unearned income, are included in loans.
Unearned income and residual values related to lease financing receivables are
recognized in income over the life of the lease under a method that yields an
approximately level rate of return on the unrecovered lease investment.
Loan Fees
The Bank charges nonrefundable fees for originating loans. Loan
origination fees, net of the direct costs of underwriting and closing the
loans, are deferred and amortized to interest income using the interest method.
Unamortized net fees and costs on loans sold or paid in full are recognized as
income. Other loan fees and charges, which represent income from delinquent
payment charges, and miscellaneous loan services, are recognized as interest
income when collected.
Allowance for Loan Losses
The Company charges current earnings with a provision for estimated credit
losses on loans receivable. The provision considers both specifically
identified problem loans and credit risks not specifically identified in the
loan portfolio. The allowance for loan losses takes into consideration
numerous factors including the financial condition of the borrowers, the fair
value of the collateral prior to the anticipated date of sale, delinquency
trends, collateral concentrations and past loss experience.
Losses are recognized as charges to the allowance when the loan is
considered uncollectible or at the time of foreclosure. Recoveries on loans
receivable previously charged off are credited to allowance for loan losses.
Premises and Equipment
Premises and equipment are stated at historical cost less accumulated
depreciation and amortization. Depreciation on furniture, fixtures and
equipment is computed on the straight-line method over the estimated useful
life of each type of asset. Estimated useful lives are from three to seven
years. Leasehold improvements are amortized over the term of the applicable
lease or their estimated useful life, whichever is shorter.
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62
Real Estate Investments
The Company, through BSFRI, has acquired property for development and sale
and has made investments in joint ventures and partnerships. Real estate
acquired for development and sale is recorded at the lower of cost (adjusted
for subsequent development costs) or fair value net of estimated selling costs.
Interest costs are capitalized when properties are in the development stage.
Investments in real estate joint ventures and partnerships are reported using
the equity method of accounting.
Other Real Estate Owned
Other real estate owned (OREO) includes loans receivable that have either
been repossessed in settlement of debt (foreclosures) or substantially
repossessed ("in-substance foreclosures"). In-substance foreclosures occur
when the market value of the collateral is less than the legal obligation of
the borrower and the Bank expects the payment of the loan to come only from
sale of the collateral. At the date of transfer, OREO is recorded at fair
value net of estimated selling costs.
The Company provides a charge against current earnings for estimated losses
on foreclosed property when the carrying value of the property exceeds its fair
value net of estimated selling expenses. The Bank obtains an appraisal or
market valuation analysis on all other real estate owned periodically. If the
periodic valuation indicates a decline in the fair value below recorded
carrying value, an allowance for OREO losses is established. Fair value is
based on current market conditions, appraisals, and estimated sales values of
similar properties, net of estimated selling and other expenses.
Other Assets
Other assets includes equipment owned by the Bank and leased to third
parties under an operating lease which is stated at cost less accumulated
depreciation. Depreciation is computed using a straight-line method over five
years.
Income Taxes
Prior to 1987, the Company filed consolidated Federal income and combined
California franchise tax returns, using the cash method of accounting.
Beginning in 1987, as required by the Tax Reform Act of 1986, the Company filed
consolidated tax returns using the accrual method of accounting. Deferred
income taxes reflect timing differences between income reported in the
consolidated financial statements and in the income tax return.
Effective January 1, 1993, the Company changed its method of accounting for
income taxes to adopt Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes" (SFAS No. 109). Under the asset and liability
method prescribed by SFAS No. 109, deferred tax assets and liabilities are
recognized for the future tax consequences of differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases (temporary differences). Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rate is recognized in income in the period of enactment.
Under SFAS No. 109, deferred tax assets are recognized for deductible
temporary differences and operating loss and tax credit carryforwards, and then
a valuation allowance is established to reduce that deferred tax asset if it is
"more likely than not" that the related tax benefits will not be realized. The
adoption of SFAS No. 109 did not have a material impact on the Company's
January 1, 1993 net deferred tax asset. Additionally, the adoption of this
accounting method did not have a material impact on tax expense and net income
for 1993.
Non-Interest Income
Fees for other customer services represent fees earned for the brokerage of
certificates of deposit and commissions earned in connection with the Bank's
stock option lending program and other banking services. Fees for services are
recorded as income when the services are performed.
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Loss per Share
Loss per share is calculated using the weighted average number of common
shares outstanding divided into net loss. The potential conversion of the
Series C Preferred Shares and warrants are not included as common stock
equivalents due to the dilutive effect on per share calculations of operating
losses.
Reclassifications
Certain reclassifications were made in the prior years' financial
statements to conform to current year presentation.
Note 2: Regulatory Orders and Going Concern Considerations
The Company
As a result of the Federal Reserve Bank's (FRB) examination of the Company
as of June 30, 1991, the FRB on April 20, 1992 issued a letter prohibiting the
Company, without the prior approval of the FRB, from:
1. Paying any cash dividends to its shareholders;
2. Incurring any new debt or increasing existing debt;
3. Repurchasing any outstanding stock of the Company; and
4. Acquiring or entering into an agreement to acquire any entities or
portfolios.
The Company has been classified in "troubled condition" for purposes of
Section 914 of FIRREA. Accordingly, the Company must submit to the FRB in
advance an application for approval of any new director or executive officer.
The Bank
Orders to Cease and Desist
On August 18, 1993, the Bank stipulated to Orders to Cease and Desist
(Orders) issued jointly by the Federal Deposit Insurance Corporation (FDIC) and
the State Banking Department (SBD), whereby the Bank agreed to correct alleged
unsafe and unsound practices disclosed in the FDIC and SBD Reports of
Examination as of November 30, 1992. The Orders supersede the Memorandum of
Understanding that the Bank had been operating under since November 15, 1991.
As a result of the Orders, the Bank is classified as a "troubled institution"
by the FDIC.
The Orders, which became effective on August 29, 1993, require that the
Bank: (a) achieve and maintain a 7% leverage capital ratio on and after
September 30, 1993; (b) pay no dividends without the prior written consent of
the FDIC and the California Superintendent of Banks (the "Superintendent"); (c)
reduce the $88.6 million in assets classified "Substandard" or "Doubtful" as of
November 30, 1992 (the date of the most recent full-scope FDIC and SBD Report
of Examination of the Bank), to no more than $75.0 million by October 31, 1993,
with further reductions to no more than $60.0 million by December 31, 1993, no
more than $50.0 million by March 31, 1994 and no more than $40.0 million by
August 31, 1994; (d) have and retain management whose qualifications and
experience are commensurate with their duties and responsibilities to operate
the Bank in a safe and sound manner, notify the FDIC and the Superintendent at
least 30 days prior to adding or replacing any new director or senior executive
officer and comply with certain restrictions in compensation of senior
executive officers; (e) maintain an adequate reserve for loan losses; (f) not
extend additional credit to, or for the benefit of, any borrower who had a
previous loan from the Bank that was charged off or classified "Loss" in whole
or in part; (g) develop and implement a plan to reduce its concentrations of
construction and development loans; (h) not increase the amount of its brokered
deposits above the amount outstanding on the Orders Effective Date ($20.0
million) and submit a written plan for eliminating reliance on brokered
deposits; (i) revise or adopt, and implement, certain plans and policies to
reduce the Bank's concentration of construction and land development loans,
reduce the Bank's dependency on brokered deposits and out of area deposits, and
to improve internal routines and controls; (j) reduce the Bank's volatile
liability dependency ratio to not more than 25% by December 31, 1993, and not
more than 15% by March 31, 1994; (k) eliminate or correct all violations of law
set out in the most recent Report of Examination,
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and take all necessary steps to ensure future compliance with all applicable
laws and regulations; and (l) establish a committee of three independent
directors to monitor compliance with the Orders and report to the FDIC and the
Superintendent on a quarterly basis.
Failure to comply with the above Orders could result in the termination of
the Bank's federal deposit insurance, imposition of civil money penalties
against the Bank or other responsible parties, or possession of the Bank's
property and business and ultimate liquidation thereof by the SBD.
Management of the Bank believes that the Bank is in substantial compliance
with the Orders, with the possible exception of the requirement of immediate
compliance with all laws and regulations (see "-- Impairment Orders" below) and
the requirement that the Bank attain a 7% leverage capital ratio by September
30, 1993. The Bank was not in compliance with its leverage capital requirement
of 7% at September 30, 1993 or for the quarter ended December 31, 1993. The
Bank's average leverage capital ratio for the fourth quarter of 1993 was 6.7%.
To satisfy the Bank's capital requirements and support future profitable
operations, the Company plans to raise additional capital through a private
placement of at least $15.0 million of the Company's securities.
The Bank has complied with the Orders in other respects. It has reduced
classified assets in accordance with the specified time schedule; appointed new
senior management; established a Business Plan for 1994 and a plan for
eliminating reliance on brokered deposits, implemented bank policies on loan
concentrations, asset/liability management, loan loss allowances and internal
controls; and established a Regulatory Committee to monitor compliance with the
Orders. However, no assurances can be given as to whether the Orders and other
applicable regulatory restrictions will be lifted.
Prompt Corrective Action
The Bank's failure to meet minimum capital requirements as of March 31,
1993 resulted in the imposition of operating restrictions pursuant to the
"prompt corrective action" provisions of FDIC Improvement Act of 1991 (FDICIA).
In accordance with FDICIA, the Bank submitted a capital restoration plan for
meeting regulatory capital requirements (the Plan), which was approved by the
FDIC on September 8, 1993. As part of the Plan, the Company agreed to
guarantee the Bank's performance under the Plan for up to five percent (5%) of
the Bank's assets or the amount needed to bring the Bank into compliance. The
Plan also specified that capital would be raised through the sale of the Bank's
Sacramento office (which occurred on December 4, 1993) and through capital
contributions by investors. At September 30, 1993, the Bank and the Company
were in compliance with the minimum regulatory capital requirements; however,
the Plan and the Company's guarantee will remain in effect until the Bank
maintains compliance with the minimum capital ratio requirements for four
consecutive calendar quarters.
Failure to maintain minimum capital requirements or to implement the Plan
can result in the imposition of additional restrictions upon the Bank's
activities and increased supervision and review.
Impairment Orders
Under California law, if a bank's deficit retained earnings exceed 40% of
its contributed capital, its capital is deemed to be impaired, and the bank is
required to levy an assessment on its shares to correct the impairment. The
SBD has issued four impairment orders to the Bank dated February 7, 1994,
November 16, 1993, February 17, 1993 and November 16, 1992 (the "Impairment
Orders"). At December 31, 1993, the Bank had contributed capital of $49.2
million and deficit retained earnings of $31.8 million.
The Impairment Orders require the Bank to correct the impairment within 60
days by levying an assessment on the Company as the Bank's sole shareholder.
The Bank has not levied an assessment against its shares nor has it otherwise
corrected the impairment, and, therefore, is in violation of this law. In
addition, in the November 16, 1993 Impairment Order, the SBD specifically
reserved the right to take such other action as the Superintendent may deem
appropriate or necessary, which may include taking possession of the Bank's
property and business, including ultimately liquidating the business and
affairs of the Bank.
The Company plans to correct the Bank's capital impairment by requesting
the SBD to approve a quasi-reorganization of the Bank. In a
quasi-reorganization, the Bank's deficit retained earnings would be reduced or
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65
eliminated by netting the deficit retained earnings against paid-in capital.
Management believes that approval for such a quasi- reorganization would only
be granted by the SBD upon the Bank raising sufficient additional capital for
the Bank to sustain profitable operations and meet all of its regulatory
capital requirements in the future. Should the SBD deny approval for a quasi-
reorganization of the Bank, the Bank would be required to raise additional new
capital of $30.2 million, inclusive of any amounts which might be raised in an
offering, to cure the capital impairment at December 31, 1993. Any operating
losses thereafter would further impair the Bank's capital and give rise to
further capital assessments.
No assurance can be given that the Bank's capital condition will not
deteriorate further prior to the quasi-reorganization as a result of operating
losses. In addition, because a quasi-reorganization requires that the Bank
adjust its assets and liabilities to market value at the time of the
reorganization, the Bank's capital could be further reduced from its present
level. Finally, there can be no assurance given that, following a correction
of the Bank's capital impairment, whether through a quasi-reorganization or an
infusion of sufficient capital, the Bank's capital position will not continue
to erode through future operating losses.
Going Concern Considerations
During the period 1991 through 1993, the Company suffered an aggregate of
$41.6 million in losses, primarily as a result of defaulted loans secured by
real estate and losses on direct real estate development activities. The
Company and the Bank succeeded in avoiding insolvency during this period only
through the injection of a total of $32.0 million of new capital by the
Company's controlling stockholder. The Company's and the Bank's recurring
losses from operations, the Bank's noncompliance with the Orders and Impairment
Order, the Company's inability to make scheduled liability payments without
additional capital contributions or other source of liquidity, and the
uncertainty related to the potential unfavorable outcome of pending litigation
and contingent liabilities raise substantial doubt about the Company's ability
to continue as a going concern.
The ability of the Company to continue as a going concern is dependent upon
many factors, including increasing and maintaining its capital ratios,
obtaining additional capital contributions and returning the Company to
profitable operations. In response to these problems, the Company has hired a
new management team to develop a business strategy and capital plan to raise
new capital and return the Company to profitability. The Company intends to
raise additional capital in 1994. If the Company does not succeed in raising
new capital, the Company will not be able to pay its operating expenses, and
continuing losses would result in the Bank being in violation of the leverage
capital ratio of 7.0% required by the Orders and could result in further
regulatory actions that would, among other things, severely restrict the Bank's
ability to develop new lines of business.
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Note 3: Investment Securities Held-to-Maturity
The carrying and estimated market values of investment securities
held-to-maturity at December 31 are as follows:
Carrying Unrealized Unrealized Market
(Dollars in Thousands) Value Gains Losses Value
----------------------------------------------
1993:
U.S. Treasury and agency securities $4,082 $ 2 $ (1) $4,083
Collateralized mortgage obligation (CMO) 996 1 -- 997
Federal Home Loan Bank stock 1,273 -- -- 1,273
----------------------------------------------
Total $6,351 $ 3 $ (1) $6,353
==============================================
1992:
U.S. Treasury and agency securities $3,683 $ 83 -- $3,766
Federal Home Loan Bank stock 1,227 -- -- 1,227
----------------------------------------------
Total $4,910 $ 83 -- $4,993
==============================================
At December 31, 1993, the Company had no securities sold under agreements
to repurchase. At December 31, 1993 and 1992, $2.1 million and $3.7 million,
respectively, of securities were pledged as collateral for treasury, tax, loan
deposits, public agency, bankruptcy and trust deposits.
The average yield on investments securities was 3.6% and 4.0% at December
31, 1993 and 1992, respectively. The FHLB stock has no stated maturity. The
maturity on the CMO is estimated based on the prepayment experience of similar
investment securities. U.S. Treasury and agency securities and CMOs held by
the Company have maturities of less than one year, with the exception of $2.0
million and $600,000 in investment securities with a maturity of over one year
at December 31, 1993 and 1992, respectively.
Note 4: Investment Securities Available-for-Sale
The carrying and estimated market values of investment securities
available-for-sale at December 31, 1993 are as follows:
Original Unrealized Unrealized Market
(Dollars in Thousands) Cost Gains Losses Value
----------------------------------------------
Mutual funds $15,000 -- $(60) $14,940
==============================================
There is no stated maturity on these securities. In 1993, the Bank
included an unrealized loss of $60,000 as a separate component of stockholder's
equity. There were no investment securities available for sale at December 31,
1992.
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Note 5: Investment Securities Held-for-Sale
The carrying and estimated market values of investment securities
held-for-sale at December 31, 1992 are as follows:
Carrying Market
(Dollars in Thousands) Value Value
------------------------
Money market certificates $ 1,023 $ 1,023
Collateralized mortgage obligations 5,393 5,486
Mortgage-backed securities 12,315 12,529
------------------------
Total $18,731 $19,038
========================
During 1993, 1992 and 1991, the Bank recognized gains of zero, $13,000,
$113,000; and losses of $67,000, $248,000, and $82,000 on sale of investment
securities held-for-sale, respectively. At December 31, 1992, $5.3 million of
these securities were sold under agreements to repurchase.
The average yield on investment securities held-for-sale was 6.1% and 6.4%
during the years ended December 31, 1993 and 1992, respectively.
Note 6: Loans Receivable
The Bank's loan portfolios at December 31 are summarized as follows:
(Dollars in Thousands) 1993 1992
-------------------------
Commercial and financial $109,008 $166,364
Real estate construction 14,023 37,659
Real estate mortgage 26,479 31,690
Net lease financing 230 363
-------------------------
Total loans 149,740 236,076
Deferred fees (550) (863)
Allowance for loan losses (8,050) (8,400)
-------------------------
Total loans, net $141,140 $226,813
=========================
At December 31, 1993 and 1992, non-accrual loans totaled $11.1 million and
$17.8 million, respectively, and loans past due 90 days or more and still
accruing totaled zero and $182,000, respectively. For the years ended December
31, 1993, 1992 and 1991, interest income foregone on non-accrual loans was
$797,000, $713,000, and $904,000, respectively. Restructured loans totaled
$2.0 million and zero at December 31, 1993 and 1992, respectively. For the
years ended December 31, 1993 and 1992, interest income foregone on
restructured loans was $166,000 and zero, respectively.
There were $12.1 million of fixed rate commercial loans at December 31,
1993 with a weighted average yield of 8.1%. Total fixed rate commercial loans,
most of which mature in more than five years, comprised approximately 8.1% of
the Bank's fixed rate loan portfolio at December 31, 1993.
The Company makes commercial and financial loans secured by real estate,
which are principally located in Northern California. At December 31, 1993
loans secured by deeds of trust on property located in these areas represented
63.0% of the Bank's loans. The primary source of repayment of commercial and
financial loans is the borrower's or property's debt service capacity while the
secondary source of repayment is the underlying real estate collateral.
At December 31, 1993, 9.4% of the Bank's loan portfolio was composed of
loans secured by properties that were under construction or contract for
construction.
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Note 7. Allowance for Loan Losses
Changes in the Company's allowance for loan losses for the years ended
December 31 were as follows:
(Dollars in Thousands) 1993 1992 1991
------------------------------------
Balances at beginning of the year $8,400 $8,411 $5,052
Additions to allowance for loan losses 3,554 9,828 11,437
Loans charged off (4,063) (10,065) (8,172)
Recoveries of loans charged off 159 226 94
------------------------------------
Balances at end of the year $8,050 $8,400 $8,411
====================================
Note 8: Other Real Estate Owned
Other real estate owned (including in-substance foreclosures) at December
31 consist of the following:
(Dollars in Thousands) 1993 1992
-----------------------
Real Estate:
Residential $ 3,695 $ 4,927
Residential development 12,704 13,498
Commercial -- 8,733
Commercial development 819 --
Land under development 1,632 8,214
Raw land 16,508 5,646
Other -- 1,071
-----------------------
Subtotal 35,358 42,089
Allowance for losses (2,986) (6,632)
-----------------------
Total $32,372 $35,457
=======================
At December 31, 1993 and 1992, other real estate owned included $19.1
million and $23.6 million, respectively, of in-substance foreclosed loans. At
December 31, 1993 and 1992, other real estate owned was comprised of 22 and 29
properties, respectively, with the largest single property totaling $7.0
million and $4.3 million, respectively.
The following table summarizes the other real estate owned loss experience
of the Bank for the periods shown:
(Dollars in Thousands) 1993 1992 1991
--------------------------------------
Balance of allowance for losses - beginning $6,632 $1,672 --
Charge-offs (6,982) (531) --
Provision 3,336 5,491 $1,672
--------------------------------------
Balance of allowance for losses - ending $2,986 $6,632 $1,672
======================================
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Note 9: Real Estate Investments
Real estate investments at December 31 consist of the following:
(Dollars in Thousands) 1993 1992
-----------------------
Residential development $ 954 $ 947
Commercial development 1,226 1,406
General and limited partnership investment in Bank premises 2,175 2,126
-----------------------
Subtotal 4,355 4,479
Allowance for losses (712) (462)
-----------------------
Total $3,643 $4,017
=======================
At December 31, 1993 and 1992, real estate investments included two
residential development properties, one commercial land available for
development, and the general and limited partnership investments in BSFBC. In
1993 and 1992, the Bank earned $263,000 and $202,000, respectively, from BSFBC.
Note 10: Premises and Equipment
Premises and equipment at December 31 consist of the following:
(Dollars in Thousands) 1993 1992
----------------------
Leasehold improvements $3,103 $3,289
Furniture and equipment 5,073 5,555
----------------------
Subtotal 8,176 8,844
Less: Accumulated depreciation and amortization (4,584) (4,256)
----------------------
Total $3,592 $4,588
======================
The amount of depreciation and amortization included in non-interest
expense was $770,000, $990,000, and $929,000 in 1993, 1992 and 1991,
respectively. Total rental expense net of sublease income and other occupancy
expenses for the Company premises were $2.1 million in 1993, 1992 and 1991.
At December 31, 1993, the approximate future minimum net rental payments
under non-cancelable operating leases, with terms ranging from three to thirty
two years, for the Company's premises are as follows:
(Dollars in Thousands) Amount
------------
1994 $ 1,589
1995 1,549
1996 1,472
1997 1,524
1998 1,577
Thereafter 37,840
------------
Total $45,551
============
Lease payments are subject to annual rent adjustments to reflect changes in
the consumer price index. During 1993, 1992 and 1991, the Company received
$59,000, $30,000 and $14,000 of sublease income, respectively.
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Note 11: Deposits
Deposit balances by deposit programs offered by the Bank at December 31 are
as follows:
1993 1992
----------------------- -------------------------
Average Average
(Dollars in Thousands) Balance Rate Balance Rate
------------------- ----------------------
Demand deposit accounts $ 34,859 0.0% $ 52,772 0.0%
Savings and NOW accounts 35,050 2.5 68,119 2.9
Money market accounts 56,453 2.9 71,815 3.5
Time accounts 83,749 3.8 92,979 4.8
------------------- ----------------------
Total $210,111 2.6% $285,685 3.3%
=================== ======================
Total deposit balances averaged $264.7 million and $328.6 million during
1993 and 1992, respectively, with average interest rates of 2.6% and 3.3%,
respectively. The weighted average stated rates on deposits as of December 31,
1993 and 1992 was 3.0% and 3.1%, respectively.
Domestic time deposits in amounts of $100,000 or more by time remaining to
maturity at December 31 are as follows:
(Dollars in Thousands) 1993 1992
----------------------
Three months or less $27,765 $51,690
Three months to six months 1,917 3,319
Six months to one year 1,674 2,268
Over one year 810 400
----------------------
Total $32,166 $57,677
======================
Interest expense on time deposits in amounts of $100,000 or more was $2.0
million, $1.8 million and $3.8 million in 1993, 1992, and 1991, respectively.
Time deposit accounts in amounts of $100,000 or more averaged $54.7 million and
$34.9 million during 1993 and 1992, respectively, with weighted average rates
of 3.7% and 4.1%, respectively. The weighted average stated interest rate on
such deposits at December 31, 1993 and 1992 was 3.3% and 3.7%, respectively.
Brokered deposits included above totaled $20.0 million and $54.6 million, and
money desk deposits totaled $41.5 million and zero at December 31, 1993 and
1992, respectively.
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Note 12: Other Borrowings
Other borrowings at December 31 are as follows:
Maximum
Balance Stated Average Average Balance
(Dollars in Thousands) Outstanding Rate Balance Rate Outstanding
-------------------------------------------------------------
1993:
Borrowings for employee stock ownership plan $ 162 5.7% $ 213 5.7% $ 255
Mortgage indebtedness 1,141 10.0 703 9.5 1,813
Securities sold under agreements to repurchase -- -- 1,917 3.7 11,201
Other borrowings - FHLB line of credit -- -- 3,975 3.4 9,800
-------------------------------------------------------------
Total $ 1,303 9.5% $ 6,808 4.3% $23,069
=============================================================
1992:
Borrowings for employee stock ownership plan $ 255 5.7% $ 342 5.9% $ 348
Securities sold under agreements to repurchase 5,253 3.7 3,120 4.2 14,115
Other borrowings - FHLB line of credit 9,800 4.3 9,438 4.4 10,000
-------------------------------------------------------------
Total $15,308 4.1% $12,900 4.4% $24,463
=============================================================
The terms of the borrowings outstanding at December 31, 1993 provide for
the repayment of $1.2 million during 1994 and the remainder in 1995.
The Bank has an approved FHLB line of credit, of which $4.0 million was
available at December 31, 1993, based on the collateral pledged. At December
31, 1993 and 1992, $6.4 million and $13.4 million of loans and securities are
pledged as collateral against other borrowings. The Bank is required to hold
FHLB stock as a condition for maintaining its line of credit.
The Bank's other borrowings include senior liens of other real estate
owned. The rates and terms of these borrowings vary. As of December 31, 1993,
the real estate owned securing the senior liens had a carrying value totaling
$1.8 million.
Note 13: Income Taxes
The provision (benefit) for Federal and state income taxes consists of:
(Dollars in Thousands) 1993 1992 1991
------------------------------------
Current:
Federal $ (968) $(2,333)
State $ 169 50 51
------------------------------------
Total current 169 (918) (2,282)
------------------------------------
Deferred:
Federal -- 528 (588)
State -- -- --
------------------------------------
Total deferred -- 528 (588)
------------------------------------
Total provision (benefit) for income taxes $ 169 $ (390) $(2,870)
====================================
The provision for state taxes for 1993 and 1992 consists of the minimum
amount of franchise taxes due.
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In 1992 and 1991, during which period the Company accounted for income
taxes under the deferred method as described in APB Opinion No. 11, deferred
taxes arose from timing differences in the recognition of revenues and expenses
for tax and financial reporting purposes. The tax effects of the principal
items resulting in deferred tax expense (benefit) were the difference between:
(Dollars in Thousands) 1992 1991
-------------------------
Accrual and cash basis income $(127) $ (70)
Book and tax provision for loan losses 648 (228)
Book and tax depreciation (111) (5)
Book and tax treatment of leases (13) (20)
Book and tax recognition of rehabilitation tax credit (153) (6)
Book and tax treatment for provision for 351 California lease 47 (56)
Book and tax treatment for other real estate owned 243 (252)
Other, net (6) 49
-------------------------
Total $528 $(588)
=========================
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets and deferred tax liabilities at December 31,
1993 are presented below:
(Dollars in Thousands) 1993
------------
Deferred Tax Assets:
Book loan loss reserve in excess of tax $ 2,348
Other provisions 376
Provision for losses for real estate 2,212
Net operating losses 9,100
Tax credits 489
Income recognized on leased property 1,772
Capitalized costs 390
Other 93
------------
Total deferred tax assets 16,780
Valuation allowance (14,341)
------------
Total deferred tax assets, net 2,439
------------
Deferred Tax Liabilities:
Net book value of premises and equipment in excess of tax (1,751)
Loan origination costs (223)
Difference in recognition of income from partnerships (43)
State tax (28)
Taxable income in excess of book for rehabilitation credit (394)
------------
Total deferred tax liabilities (2,439)
------------
Net deferred taxes $ --
============
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73
The Bank provided a valuation allowance for deferred tax assets as the
utilization of the net operating loss carryforwards and rehabilitation and
minimum tax credit carryforwards may be limited on an annual basis under
current tax law due to the change in ownership in 1992 and possible changes in
ownership in future years.
The total tax provision (benefit) differs from the statutory Federal rates
for the reasons shown in the following table:
1993 1992 1991
------------------------------------
Tax benefit at the statutory federal rate (34.0)% (34.0)% (34.0)%
Limitation on utilization of net operating loss carryback due to
tax rate differential, alternative minimum tax and
utilization of prior taxable income 34.1 32.0 9.0
State income taxes, net of federal tax benefit 1.7 0.2 0.3
Non-deductible expenditures and non-taxable income (0.1) 0.1 0.8
------------------------------------
Total effective tax provision (benefit) rate 1.7% (1.7)% (23.9)%
====================================
At December 31, 1993 and 1992, there is no deferred income tax receivable.
The tax benefits reported in 1992 and 1991 were attributable to the
Company's ability to carryback net operating losses for 1992 and 1991 against
net operating income of prior periods. Because the Company has utilized all of
its ability to carryback net operating losses, much of the 1993 and 1992
losses, and future losses, if any, must be carried forward to offset future net
operating income. In addition, the actual benefit rate may be less than the
current statutory rate due to tax differentials and the alternative minimum
tax. As of December 31, 1993, the Company has net operating loss carryforwards
for federal tax purposes of approximately $23.0 million which expire in 2007
and onwards, and for California tax purposes of approximately $15.0 million,
which expire in 1997 and 1998. The Company has rehabilitation tax credits
carryforwards for federal tax purposes of approximately $250,000, which expire
in 2004 and 2005. In addition, the Company has minimum tax credits of
approximately $230,000 which have no expiration.
Note 14: Shareholders' Equity (See Note 2: Impairment Orders)
The new capital invested by the Company's controlling stockholder in 1993
and 1992 was $12.0 million and $20.0 million, respectively. The capital was
raised from the issuance of shares of Series C Perpetual Preferred Shares
(Series C Preferred Shares) at twenty dollars ($20.00) per share.
Description of Capital Stock
The authorized capital stock of the Company consists of 20,000,000 Class A
Shares, par value $0.01 per share, 28,635 shares of Class B Common Stock, par
value $0.01 per share, and 2,500,000 shares of preferred stock, par value $0.01
per share, of which 1,800,000 are designated as Series C Preferred Shares and
437,500 are designated as Series B Preferred Shares. The remainder is
undesignated.
In accordance with the Orders and the FRB Directive issued on April 20,
1992, the Bank is prohibited from paying dividends without the prior written
consent or approval of the FDIC, the Superintendent of Banks and the Federal
Reserve Bank.
Description of Class A Shares and Class B Common Stock
As of December 31, 1993 there were 8,899,801 Class A Shares outstanding.
The Company has not issued any Class B Common Stock at this time; however, the
outstanding Series B Preferred Shares are convertible into shares of the Class
B Common Stock at the option of the holders thereof. Thus the Company has
reserved for issuance sufficient shares of the Class B Common Stock to be
issued upon the conversion of any Series B Preferred Shares.
Dividends
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Subject to the rights and preferences of any preferred stock outstanding,
each Class A Share and each share of Class B Common Stock is entitled to
receive dividends if, as and when declared by the Board of Directors of the
Company. Subject to the rights of the Series B Preferred Shares and the Series
C Preferred Shares, dividends must be paid on both the Class A Shares and the
Class B Common Stock, together with the Series B Preferred Shares and the
Series C Preferred Shares, at any time that dividends are paid on either. Any
dividend so declared and payable in cash, capital stock of the Company or other
property will be paid equally, share for share, on the Class B Common Stock,
Class A Shares, Series B Preferred Shares, Series C Preferred Shares and on any
other participating series of preferred stock issued in the future; provided,
however, that the Company may issue dividends consisting solely of its Class A
Shares on the Class A Shares, and dividends consisting solely of its Class B
Common Stock on the Class B Common Stock.
Liquidation Rights
In the event of the liquidation, dissolution or winding up of the Company,
holders of the Class A Shares and Class B Common Stock are entitled to share
equally, share for share, in the assets available for distribution, subject to
the liquidation preferences of the Series B Preferred Shares and Series C
Preferred Shares and the rights of any other class or series of preferred stock
then outstanding.
Description of Preferred Stock
The Board of Directors of the Company is authorized by the Certificate of
Incorporation to provide for the issuance of one or more series of preferred
stock. The Board of Directors has the power to fix various terms with respect
to each such series, including voting powers, designations, preferences,
dividend rates, conversion and exchange provisions, redemption provisions, and
the amounts which holders are entitled to receive upon any liquidation,
dissolution, or winding up of the Company. To date the Board of Directors has
authorized only the issuance of the Series B Preferred Shares and the Series C
Preferred Shares. Pursuant to the Amended Stock Purchase Agreement, the
Company's Certificate of Incorporation and Bylaws were amended to provide that
additional securities, including additional shares of any class of preferred
stock, can be issued only if unanimously approved by the Board of Directors or
by stockholders holding a majority of the voting power of the Company.
Voting Rights
Holders of Class A Shares and Class B Common Stock (when and if issued) are
entitled to one vote per share. Except as described bellow, holders of Class A
Shares and Class B Common Stock vote together as a single class, together with
holders of the Company's Series B Preferred Shares and Series C Preferred
Shares, on all matters including the election of directors. The Board of
Directors is presently authorized to have 14 members. The Board of Directors
is a classified Board with staggered terms providing for a maximum of three
classes of directors, which are as nearly equal in number as possible, and with
one class elected each year for a maximum term of three years. Holders of
Class A Shares and Class B Common Stock are not entitled to vote cumulatively
for the election of directors.
The holders of Class A shares and Class B Common Stock are entitled to vote
as separate classes on any modification to the rights of either class of stock
and as otherwise required by law. As part of the transactions contemplated by
the Amended Stock Purchase Agreement, the stockholders of the Company
eliminated multiple voting rights of the Series B Preferred Shares and the
Class B Common Stock.
Description of Series B Preferred Stock
The Company issued the Series B Preferred Shares during 1988. As of
December 31, 1993, there were 16,591 Series B Preferred Shares outstanding.
Dividends
Holders of the Series B Preferred Shares are entitled to receive, when
funds of the Company are legally available for payment, an annual cash dividend
of Fifty-Six Cents ($0.56) per share, payable quarterly in January, April, July
and October of each year. Dividends on the Series B Preferred Shares are
cumulative.
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Payment of dividends on the Series B Preferred Shares shall be junior to
payment of dividends at the stated rate of all other series of preferred stock
that the Company may issue in the future and that are designated senior to the
Series B Preferred Shares. Dividends on the Series B Preferred Shares will be
declared and paid or set apart for payment in full for all previous dividend
periods (i) before the payment or setting apart of any funds or assets for the
payment of any dividends on the Class A Shares or Class B Common Stock or any
other class of stock, except preferred stock ranking on a parity with or senior
to the Series B Preferred Shares, and (ii) before any purchase or other
acquisition for value of any Class A Shares or Class B Common Stock or any
future class of stock except preferred stock ranking on a parity with or senior
to the Series B Preferred Shares; provided, however, that the Company may issue
dividends consisting solely of its Class A Shares on the Class A Shares, and
dividends consisting solely of its Class B Common Stock on the Class B Common
Stock.
After payment of dividends at the stated rate on all series of preferred
stock that the Company may issue in the future and that are designated senior
to the Series B Preferred Shares and on any other preferred stock of the
Company that is on a parity with the Series B Preferred Shares, and payment of
dividends at the stated rate on the Series B Preferred Shares, holders of the
Series B Preferred Shares will participate pro rata with the holders of Class A
Shares and Class B Common Stock and Series C Preferred Shares, on the basis of
number of shares owned, in all other dividends by the Company to its
stockholders, except that, as noted above, the Company may issue dividends
consisting solely of its Class A Shares on the Class A Shares, and dividends
consisting solely of its Class B Common Stock on the Class B Common Stock.
Liquidation Rights
In the event of any liquidation, dissolution, receivership, bankruptcy, or
winding up of the Company, voluntarily or involuntarily, the holders of the
Series B Preferred Shares are entitled to receive the sum of Seven Dollars
($7.00) per share, plus any accrued and unpaid dividends thereon, before any
distributions will be made to the holders of the Class A Shares or Class B
Common Stock or any other class of stock junior in preference upon liquidation,
but after or concurrent with distributions to be made at the stated rate on
preferred stock of any series ranking on a parity with or senior in preference
upon liquidation to the Series B Preferred Shares, and will be entitled to no
other distribution.
Conversion
The holders of Series B Preferred Shares are entitled at any time to
convert their Series B Preferred Shares into Class B Common Stock of the
Company at the conversion ratio of one Series B Preferred Share convertible
into one share of Class B Common Stock, upon payment of a conversion fee of
Seven Dollars ($7.00) per share, subject to adjustment under certain
conditions.
The Amended Stock Purchase Agreement required that at least 90% of the
Series B Preferred Shares be converted into Class A Shares on a share-for-share
basis. Holders of 408,865 Series B Preferred Shares so converted on July 13,
1992, and a total of 420,909 Series B Preferred Shares had been so converted as
of December 31, 1992. The remaining shares outstanding are 16,591.
Voting Rights
The holders of the Series B Preferred Shares are entitled to one vote per
Series B Preferred Share on all matters on which shareholders are entitled to
vote. Holders of the Series B Preferred Shares have full voting rights and
powers equal to the voting rights and powers of the holders of the Class B
Common Stock. Holders of the Series B Preferred Shares are entitled to vote
generally for the election of directors and vote with the holders of the Class
A Shares, the Class B Common Stock and Series C Preferred Shares as a single
class, except that the holders of the Series B Preferred Shares are entitled to
vote as a class on any modification to the rights of the Series B Preferred
Shares and otherwise as required by law.
Description of Series C Preferred Stock
At December 31, 1993, 900,000 shares of Series C Preferred Shares are
outstanding. A total of 600,000 shares were issued during 1993 and 300,000
were issued during 1992.
Dividends
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Holders of the Series C Preferred Shares are entitled to receive, if, as
and when declared by the Board of Directors an annual cash dividend of One
Dollar and Eighty Cents ($1.80) per share, payable semi-annually in April and
October of each year. Dividends on the Series C Preferred Shares are
noncumulative.
Payment of dividends on the Series C Preferred Shares shall be junior to
payment of dividends at the stated rate on the Series B Preferred Shares and
all other series of preferred stock that the Company may issue in the future
and that are designated senior to the Series C Preferred Shares. Dividends on
the Series C Preferred Shares will be declared and paid or set apart for
payment in full for a particular dividend period before the payment or setting
apart of any funds or assets for the payment of any dividends on the Class A
Shares or Class B Common Stock or any other class of stock, except Series B
Preferred Shares and other preferred stock ranking on a parity with or senior
to the Series C Preferred Shares; provided, however, that the Company may issue
dividends consisting solely of its Class A Shares on the Class A Shares, and
dividends consisting solely of its Class B Common Stock on the Class B Common
Stock.
After payment of dividends at the stated rate on the Series B Preferred
Shares and all other series of preferred stock that the Company may issue in
the future and that are designated senior to the Series C Preferred Shares and
payment of dividends at the stated rate on the Series C Preferred Shares, and
on any other preferred stock of the Company that is on a parity with the Series
C Preferred Shares, holders of the Series C Preferred Shares will participate
pro rata with the holders of Class A Shares, Class B Common Stock, and Series B
Preferred Shares on the basis of number of shares owned, in all other dividends
by the Company to its stockholders, except that, as noted above, the Company
may issue dividends consisting solely of its Class A Shares on the Class A
Shares, and dividends consisting solely of its Class B Common Stock on the
Class B Common Stock.
Liquidation Rights
In the event of any liquidation, dissolution, receivership, bankruptcy, or
winding up of the Company, voluntarily or involuntarily, the holders of the
Series C Preferred Shares are entitled to receive the sum of Twenty Dollars
($20) per share, plus any declared and unpaid dividends thereon, before any
distributions will be made to the holders of the Class A Shares or Class B
Common Stock or any other class of stock junior in preference upon liquidation,
but after distributions at the rate of Seven Dollars ($7.00) per share on the
Series B Preferred Shares and after or concurrent with distributions to be made
at the stated rate on any other preferred stock of any series ranking on a
parity with or senior in preference upon liquidation to the Series C Preferred
Shares and will be entitled to no other distributions.
Conversion
The Series C Preferred Shares are not currently convertible but will become
so upon approval of a conversion feature by the holders of a majority of the
Company's Class A Shares and Series B Preferred Shares (voting as a single
class). The Company intends to seek such approval at its Annual Meeting of the
stockholders. Although there is no assurance that such approval will be
obtained, the members of the Company's Board of Directors have unanimously
indicated that they will recommend to the stockholders that the conversion
feature be approved.
If the conversion feature of the Series C Preferred Shares is approved by
the stockholders of the Company, each Series C Preferred Share will become
convertible into: (i) forty (40) Class A Shares (i.e., at a conversion price
of Fifty Cents ($0.50) per Class A Share); and (ii) 40 Warrants (the
"Warrants"), each of which will entitle the holder thereof to purchase one
Class A Share at Fifty Cents ($0.50) per share, which Warrants shall expire on
December 31, 1995. If the Company's shareholders approve the conversion
feature of the Series C Preferred Shares at the 1994 Annual Meeting, the Series
C Preferred Shares outstanding will be mandatorily converted into Class A
Shares and Warrants on that date and if, at the Annual Meeting, the Company's
shareholders also approve a proposed amendment to the Company's Certificate of
Incorporation, any Series C Preferred Shares that are issued after June 30,
1993 but are outstanding on December 31, 1993 will be mandatorily converted
into Class A Shares and Warrants.
Voting Rights
The holders of the Series C Preferred Shares are entitled to one vote per
Series C Preferred Share on all matters on which stockholders are entitled to
vote. Holders of the Series C Preferred Shares are entitled to vote generally
for the election of directors and vote with the holders of the Class A Shares,
the Class B Common Stock and the
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Series B Preferred Shares as a single class, except that the holders of the
Series C Preferred Shares are entitled to vote as a class on any modifications
to the rights of the Series C Preferred Shares and otherwise as required by
law.
The Company had various stock option plans which provided for the issuance
of up to 400,000 Class A Common Shares. The stock option plans expired by
their terms in January 1992 except that options granted prior to that date
remain in effect and exercisable during the term of the options. Generally,
options were granted at a price not less than the fair market value of the
stock at the date of grant, were exercisable in increments of 40% after two
years after the date of the grant and 20% each year thereafter, and expire ten
years after the date of the grant.
Shares Options Outstanding
--------------------------------
Available Number Price
for Grant of Options Per Share
--------------------------------------------------
Balances at December 31, 1990 78,646 294,175 $4.00 - $11.00
Options granted (152,600) 152,600 4.13 - 5.91
Options exercised -- (2,400) 4.00
Options cancelled 92,650 (92,650) 4.00 - 10.00
--------------------------------------------------
Balances at December 31, 1991 18,696 351,725 4.00 - 5.91
Options granted (173,471) 173,471 3.63
Options cancelled 154,775 (167,007) 4.00 - 5.38
--------------------------------------------------
Balances at December 31, 1992 -- 358,189 3.63 - 5.38
Options cancelled -- 259,989 3.63 - 5.38
--------------------------------------------------
Balances at December 31, 1993 -- 98,200 $3.63 - $5.38
==================================================
Outstanding stock options for the purchase of 1,500 shares exercisable at
$5.38, 6,000 shares exercisable at $5.00, 37,379 shares exercisable at $4.00
and 53,321 shares exercisable at $3.63 were outstanding at December 31, 1993.
Note 15: Regulation
In accordance with FIRREA, the FRB and the FDIC established capital
regulations requiring the Company and Bank to maintain minimum: (i) tier 1
capital equal to 4% of total assets, as defined; (ii) tier 1 capital equal to
4% of risk-weighted assets; and (iii) total capital, as defined, equal to 8% of
risk-weighted assets, as defined.
The following table sets forth the Company's and the Bank's capital ratios
compared to minimum capital requirements as of December 31, 1993 and the
requirements contained in the Orders:
Minimum
Capital
Company Bank Requirement Orders
---------------------------------------------------------
Leverage 6.7% 6.7% 4.0% 7.0%
Tier 1 risk-based capital 8.0 8.0 4.0 N/A
Total risk-based capital 9.5 9.5 8.0 N/A
The FDICIA requires each federal banking agency to implement prompt
corrective actions for institutions that it regulates. In response to this
requirement, the FDIC adopted final rules, effective for December 19, 1992,
based upon FDICIA's five capital tiers: well capitalized, adequately
capitalized, undercapitalized, significantly undercapitalized, and critically
undercapitalized. Under FDICIA, the FDIC is required to take supervisory
action against financial institutions that are not deemed either well
capitalized or adequately capitalized. The rules generally provide that a bank
is adequately capitalized if its total risk-based capital ratio is 8% or
greater, its Tier
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1 capital to risk based assets is 4% or greater, its leverage ratio is 4% or
greater, and the financial institution is not subject to a capital directive.
At December 31, 1993, the Bank was subject to a capital directive.
The capital directive requires that the Bank maintain a Leverage
Capital ratio equal to or greater than 7.0%. At December 31, 1993, the Bank's
leverage capital ratio was 6.7%.
Note 16: Employee Benefit Plans
Employee Stock Ownership Plan
The Company has established an Employee Stock Ownership Plan ("ESOP") for
the benefit of its employees. During 1985, the ESOP borrowed $500,000 from a
third party financial institution at a floating rate based upon 90% of the
institution's current prime rate. Repayment of the principal occurred in seven
annual installments of $71,000 through June 30, 1992 and was completed as
scheduled. The proceeds from this borrowing, which was not guaranteed by the
Company, were used to purchase 62,500 Class A Shares at a price of $8.00 per
share. During 1988, the ESOP established a loan for $650,000 from a third
party financial institution at a floating rate based upon 95% of the current
prime rate. At December 31, 1988, the ESOP had drawn $325,000 from this loan.
Repayment of the principal is scheduled in quarterly payments of $23,000
through March 31, 1995. Payment on this loan started in the fourth quarter of
1988. The proceeds from the borrowing were used to purchase 28,571 shares of
the Company's Series B Preferred Shares at a price of $7.00 per share, and to
purchase the Company's Class A Shares throughout 1988. The stock purchased is
pledged as collateral for the loan. During 1989, the ESOP drew the remaining
$325,000 from this loan. The proceeds from the borrowing were used to purchase
50,000 shares of the Company's Class A Shares at a price of $5.00 per share,
and the remaining amount will be used to purchase Company stock in the future.
During 1993 and 1992, the ESOP did not purchase any shares of the Company's
stock. The ESOP expired by its terms in January 1992.
The Company has determined that its contribution to the ESOP will be
sufficient to cover the yearly debt service on the ESOP's borrowings. At
December 31, 1993, the Company had provided a total of approximately $1.8
million in contributions to the ESOP since its inception in 1985. During 1993,
1992 and 1991, the Company contributed $120,000, $240,000, and $240,000,
respectively, to the ESOP.
Employee Stock Purchase Plan
The Company's Board of Directors adopted an Employee Stock Purchase Plan
("ESPP") for the benefit of substantially all employees in March 1990, which
was approved by the Company's stockholders in July 1990.
A total of 25,000 shares of the Company's Class A Shares have been made
available for purchase under the Plan, and a total of 25,000 shares of Class A
Shares have been made available for matching awards under the Plan. The
purchase price of the shares available under the Plan is the lesser of (i) 85%
of the fair market value of such shares on the first day of the purchase
period, or (ii) 85% of the fair market value of such shares on the last day of
such purchase period.
At December 31, 1993, the Company had outstanding 8,592 Class A Shares
under the ESPP, approximately 23.0% of which represented matching shares. At
December 31, 1992, the Company had outstanding 10,784 Class A Shares under the
ESPP. The Company's Board of Directors suspended this Plan as of December 31,
1991.
Employee 401K Plan
The Company provides a 401k plan for its employees. The Company provides
matching contributions up to 2% of the employees qualifying earnings. During
1993, 1992, and 1991, the Company included $81,000, $90,000 and $95,000,
respectively in non-interest expense in order to recognize contributions to the
401k Plan.
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Note 17: Commitments and Contingencies
Lending and Letter of Credit Commitments
In the normal course of its business, the Bank has entered into various
commitments to extend credit which are not reflected in the consolidated
financial statements. Over 90% of such commitments consist of the undisbursed
balance on personal and commercial lines of credit and of undisbursed funds on
construction and development loans. At December 31, 1993 and 1992, the Bank
had outstanding loan commitments, which are primarily adjustable rates,
totaling approximately $29.6 million and $91.0 million, respectively. In
addition, the Bank had outstanding letters of credit, which represent
guarantees of obligations of Bank customers, totaling $12.1 million and $17.0
million at December 31, 1993 and 1992, respectively. The actual liquidity
needs or the credit risk that the Company will experience will be lower than
the contractual amount of commitments to extend credit because a significant
portion of these commitments is expected to expire without being drawn upon.
The Bank's outstanding loan commitments are made using the same underwriting
standards as comparable outstanding loans. The credit risk associated with
these commitments is considered in management's determination of the allowance
for loan losses.
Litigation
Because of the nature of its business, the Company and its subsidiaries,
including the Bank are from time-to-time a party to legal actions. At December
31, 1993, the Company and/or the Bank are defendants in certain lawsuits for
which the damages sought are substantial as described below.
The Bank is currently involved in three lawsuits, of which two were brought
by former employees of the Bank in the California superior court; one former
employee has alleged that the Bank and the Bank's former Chief Executive
Officer (at the time of the termination) intentionally or negligently
misrepresented their intentions regarding his employment contract, and failed
to pay monies due under the employment contract, and that the Bank wrongfully
terminated the employment contract. The former employee has sought damages of
approximately $1.7 million under his contract claims. The other former
employee alleges that the Bank, and the Bank's Chief Executive and Chief
Financial Officers (at the time of that employee's termination) recruited the
plaintiff with false representations and fraudulent omissions with respect to
the financial condition of the Bank. The former employee claims to have
resigned from secure employment and was subsequently terminated. The former
employee has sought unspecified damages. The third lawsuit relates to a former
borrower of the Bank in a cross complaint asserting that the Bank was
fraudulent or negligent in its handling of certain transactions. The complaint
is seeking damages of $3.3 million under his claims.
The Bank has denied these allegations and is vigorously defending these
proceedings. The disposition of these proceedings could have a material
adverse effect on the Company's financial position or results of operation,
however, management cannot predict the specific outcome of these actions.
Accordingly, the accompanying financial statements do not include any
adjustments that might result from the outcome of the uncertainties.
Other Contingencies
During 1993, the Bank transferred a loan with a carrying value of $1.6
million collateralized by commercial real estate to in- substance foreclosure.
The collateral securing this loan requires seismic upgrading and may be located
on property containing hazardous materials. The Bank may perform further
testing and investigation on the property to obtain additional information of
the cost of the seismic upgrades and the nature and extent of any
contamination. Management has not determined a final strategy for resolution
of this non-performing asset at this time, and no specific provision has been
made in the accompanying financial statement for these uncertainties.
Resolution of these uncertainties may have a significant effect on the Bank's
results of operations.
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Note 18: Related Party Transactions
In the ordinary course of business, the Bank makes loans to directors,
officers, shareholders and their associates on substantially the same terms,
including interest rates and collateral, as in comparable loan transactions
with unaffiliated persons, and such loans do not involve more than the normal
risk of collection. The following table sets forth the activity related to
loans to directors, officers and principal shareholders and their associates
for the year ended December 31, 1993:
(Dollars in Thousands) Amount
-------------
Balance at December 31, 1992 $ 2,938
New loans or disbursements 4,706
Principal reductions (cash repayments) (7,148)
-------------
Balance at December 31, 1993 $ 496
=============
The Company accounts for its investment in BSFBC, a California limited
partnership, using the equity method. Condensed statements of financial
condition and operations of BSFBC at December 31 are as follows:
CONDENSED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED)
(Dollars in Thousands) 1993 1992
------------------------
Assets:
Cash $1,380 $1,063
Receivables 25 56
Fixed assets, net 6,860 7,080
------------------------
Total assets $8,265 $8,199
========================
Liabilities and Partner's Equity:
Notes payable $2,297 $2,409
Other liabilities 207 43
Partners' equity 5,761 5,747
------------------------
Total liabilities and partner's equity $8,265 $8,199
========================
CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)
(Dollars in Thousands) 1993 1992 1991
-------------------------------------
Rental income $1,845 $1,846 $1,865
Other income 101 99 124
-------------------------------------
Total income 1,946 1,945 1,989
Total expense 1,004 1,456 1,302
-------------------------------------
Net income of partnership $ 942 $ 489 $ 687
=====================================
The Bank's and BSFRI's equity in earnings of BSFBC in 1993, 1992 and 1991
was approximately $263,000, $202,000, and $245,000, respectively. Such income
is included in the Bank's other income in the Company's Consolidated Financial
Statements.
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Note 19: Fair Value of Financial Instruments
The following disclosures of the estimated fair value of financial
instruments are made in accordance with the requirements of Statement of
Financial Accounting Standards No. 107 "Disclosures about Fair Value of
Financial Instruments" (SFAS No. 107). The estimated fair value amounts have
been determined by the Company using available market information and
appropriate valuation methodologies. However, considerable judgement is
necessarily required to interpret market data to develop the estimates of fair
value. Accordingly, the estimates presented herein are not necessarily
indicative of the amount the Company could realize in a current market
exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
The carrying amount and estimated fair values of the Company's financial
instruments at December 31 are as follows:
1993 1992
------------------------------- -------------------------------
Carrying Fair Carrying Fair
(Dollars in Thousands) Amount Value Amount Value
------------------------------- -------------------------------
Financial Assets:
Cash and cash equivalents $ 25,833 $ 25,833 $ 19,597 $ 19,597
Investment securities 21,291 21,293 23,641 24,032
Loans, net 141,140 145,350 226,813 226,682
Financial Liabilities:
Deposits 210,111 209,934 285,685 285,607
Other borrowings 1,303 1,361 15,053 15,053
The following methods and assumptions were used to estimate the fair value
of each major classification of financial instruments at December 31, 1993 and
1992:
CASH AND CASH EQUIVALENTS: Current carrying amounts approximate estimated fair
value.
TIME DEPOSITS WITH OTHER FINANCIAL INSTITUTIONS: Due to the short term nature
of time deposits with other financial institutions (original maturities of 90
days or less), current carrying amounts approximate market.
INVESTMENT SECURITIES HELD-TO-MATURITY AND AVAILABLE-FOR-SALE: For securities
held-to-maturity and available-for-sale, current market prices were used to
determine fair value.
LOANS RECEIVABLE: The carrying amount of loans is net of unearned fee income
and the reserve for possible losses. To estimate fair value of the Company's
loans, primarily adjustable rate, commercial and real estate secured loans,
each loan collateral type is segmented into categories based on fixed or
adjustable interest rate terms, maturity, estimated credit risk, and accrual
status. The fair value of loans is calculated by discounting cash flows
expected to be received through the estimated maturity using estimated market
discount rates that reflect the credit and interest rate risk inherent in the
loan. The estimate of maturity is based on the Bank's historical experience
with repayments for each loan classification, modified, as required, by an
estimate of the effect of current economic and lending factors.
DEPOSIT LIABILITIES: The fair value of deposits with no stated maturity, such
as non-interest bearing demand deposits, savings and NOW accounts, and money
market and checking accounts, is equal to the amount payable on demand as of
December 31, 1993. The fair value of time deposits is based on the discounted
value of contractual cash flows. The discount rate is estimated using the
rates currently offered for deposits of similar remaining maturities.
BORROWED FUNDS: Due to the terms of these borrowings, current carrying amounts
approximate estimated fair value. A total of $1.2 million matures in June
1994.
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OFF BALANCE SHEET INSTRUMENTS: The estimated fair value of off balance sheet
instruments, principally letters of credit and loan commitments, is
approximately the face value of commitment fees collected.
Note 20: Bank of San Francisco Company Holding Company
Condensed statements of financial condition and operations of Bank of San
Francisco Company Holding Company at December 31 are as follows:
CONDENSED STATEMENTS OF FINANCIAL CONDITION
(Dollars in Thousands) 1993 1992
-------------------------
Assets:
Cash and short term investments $ 249 $ 351
Loan -- 149
Other real estate owned 96 --
Investment in subsidiary 17,407 15,423
Other assets 252 5
-------------------------
Total assets $18,004 $15,928
=========================
Liabilities:
Borrowings for Employee Stock Ownership Plan $ 162 $ 255
Other liabilities 387 (3)
-------------------------
Total liabilities 549 252
-------------------------
Stockholders' equity 17,455 15,676
-------------------------
Total liabilities and shareholders' equity $18,004 $15,928
=========================
CONDENSED STATEMENTS OF OPERATIONS
(Dollars in Thousands) 1993 1992 1991
-------------------------------------
Income:
Interest earned $ 13 $ 30 $ 105
Dividends from subsidiary -- -- 80
-------------------------------------
Total income 13 30 185
-------------------------------------
Expense:
Provision for loan losses 53 -- --
Other expense 409 53 29
-------------------------------------
Total expense 462 53 29
-------------------------------------
Income (loss) before equity in undistributed net loss of subsidiary (449) (23) 156
Equity in undistributed net loss of subsidiary (9,806) (22,154) (9,310)
-------------------------------------
Net loss $(10,255) $(22,177) $(9,154)
=====================================
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CONDENSED STATEMENTS OF CASH FLOWS
(Dollars in Thousands) 1993 1992 1991
-------------------------------------
Cash Flows from Operating Activities:
Net loss $(10,255) $(22,177) $(9,154)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Equity in undistributed net loss of subsidiary 9,806 22,154 9,310
Provision for loan losses 53 -- --
-------------------------------------
Net cash flows provided by (used in) operating activities (396) (23) 156
-------------------------------------
Cash Flows provided by (used in) investing activities:
Principal collected on loans -- 10 76
Investment in Bank (11,850) (22,000) (1,003)
Net decrease (increase) in other assets (246) (2) 43
-------------------------------------
Net cash used in investing activities (12,096) (21,992) (884)
-------------------------------------
Cash Flows provided by (used in) financing activities:
Proceeds from sale of Preferred Stock 12,000 6,000 --
Proceeds from sale of Common Stock -- 15,500 56
Dividend paid on Preferred Stock -- -- (653)
Decrease on dividend accrual on Preferred Stock -- -- 188
Net increase in other liabilities 390 (3) (254)
Other net -- 8 --
-------------------------------------
Net cash provided by (used in) financing activities 12,390 21,505 (663)
-------------------------------------
Decrease in cash and cash equivalents (102) (510) (1,391)
Cash and cash equivalents at beginning of year 351 861 2,252
-------------------------------------
Cash and cash equivalents at end of year $ 249 $ 351 $ 861
=====================================
Note 21: Quarterly Information (Unaudited)
The following table sets forth the condensed operating results of the
Company for each quarter of the two year periods ending December 31, 1993, and
is qualified in its entirety by the more detailed information and financial
statements contained elsewhere in this report:
1993 Quarters Ended
---------------------------------------------------------
(Dollars in Thousands Except Per Share Data) March 31 June 30 Sept. 30 Dec. 31
---------------------------------------------------------
Interest income $4,826 $4,922 $4,445 $3,962
Interest expense 1,947 2,056 1,845 1,572
---------------------------------------------------------
Net interest income 2,879 2,866 2,600 2,390
Provision for loan losses 141 2,641 618 154
Non-interest income 1,226 1,249 1,333 1,071
Non-interest expense 6,466 5,465 5,260 4,955
---------------------------------------------------------
Loss before income taxes (2,502) (3,991) (1,945) (1,648)
Provision for taxes 68 20 15 66
---------------------------------------------------------
Net loss $(2,570) $(4,011) $(1,960) $(1,714)
=========================================================
Loss per common share:
Average common shares outstanding 8,901,994 8,901,994 8,901,324 8,899,818
Net loss $(0.29) $(0.45) $(0.22) $(0.19)
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1992 Quarters Ended
---------------------------------------------------------
(Dollars in Thousands Except Per Share Data) March 31 June 30 Sept. 30 Dec. 31
---------------------------------------------------------
Interest income $ 6,942 $ 6,500 $ 5,134 $ 5,308
Interest expense 3,625 3,030 2,503 2,136
---------------------------------------------------------
Net interest income 3,317 3,470 2,631 3,172
Provision for loan losses 2,250 3,250 4,050 278
Non-interest income 1,488 1,002 876 1,424
Non-interest expense 6,212 7,878 7,585 8,443
---------------------------------------------------------
Loss before income taxes (3,657) (6,656) (8,128) (4,125)
(Benefit) provision for taxes (425) 12 12 12
---------------------------------------------------------
Net loss $(3,232) $(6,668) $(8,140) $(4,137)
=========================================================
Loss per share:
Average common shares outstanding 2,282,456 2,282,395 7,724,673 8,901,994
Net loss $(1.44) $(2.95) $(1.05) $(0.46)
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ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item will be furnished in the
Company's definitive Proxy Statement and is incorporated herein by
reference.
ITEM 11 - EXECUTIVE COMPENSATION
The information required by this Item will be furnished in the
Company's definitive Proxy Statement and is incorporated herein by
reference.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item will be furnished in the
Company's definitive Proxy Statement and is incorporated herein by
reference.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item will be furnished in the
Company's definitive Proxy Statement and is incorporated herein by
reference.
PART IV
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. List of documents filed as a part of the report.
The following financial statements are included in Item 8 of this
report:
Report of Independent Public Accountants;
Consolidated Balance Sheets at December 31, 1993 and 1992;
Consolidated Statements of Income for the years ended December 31,
1993, 1992, and 1991;
Consolidated Statements of Shareholders' Equity for the years
ended December 31, 1993, 1992 and 1991;
Consolidated Statements of Cash Flow for the years ended December
31, 1993, 1992 and 1991;
Notes to Consolidated Financial Statements.
2. Financial Statement Schedules
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All financial statement schedules are omitted because they are not
applicable or not required, or because the required information is
included in the Consolidated Financial Statements or the notes
thereto.
3. List of Exhibits (numbered in accordance with Item 601 of Regulation S-K):
Exhibit 3.1 Certificate of Incorporation of Bank of San Francisco (Delaware) Holding Company, dated June 23, 1988 (1)
Exhibit 3.2 Agreement and Plan of Merger of Bank of San Francisco (Delaware) Holding Company, a Delaware corporation
and Bank of San Francisco Company Holding Company, a California Corporation, dated June 24, 1988 (1)
Exhibit 3.3 Certificate of Amendment of the Certificate of Incorporation of Bank of San Francisco Company Holding
Company, dated May 22, 1989 (1)
Exhibit 3.4 Certificate of Amendment of the Certificate of Incorporation of Bank of San Francisco Company Holding
Company, dated September 21, 1989 (1)
Exhibit 3.5 Bylaws of Bank of San Francisco (Delaware) Holding Company, dated June 23, 1988 (1)
Exhibit 3.6 First Amendment to Bylaws of Bank of San Francisco Company Holding Company, dated July 19, 1989 (1)
Exhibit 3.7 Second Amendment to Bylaws of Bank of San Francisco Company Holding Company, dated June 6, 1990 (1)
Exhibit 4.1 Certificate of Designations of Rights, Preferences, Privileges and Restrictions of 8% Series B Convertible
Preferred Stock of Bank of San Francisco Company Holding Company, dated July 28, 1988 (1)
Exhibit 4.2 Amended Certificate of Designations of Rights, Preferences, Privileges and Restrictions of 7% Series B
Convertible Preferred Stock of Bank of San Francisco Company Holding Company, dated October 7, 1988 (1)
Exhibit 4.3 Certificate of Correction of Certificate of Incorporation, dated June 18, 1990 (1)
Exhibit 4.4 Amended and Restated Certificate of Designations of Rights, Preferences, Privileges and Restrictions of 9%
Series C Perpetual Preferred Stock of Bank of San Francisco Company Holding Company, dated November 30,
1992
Exhibit 10.1 Sales agreement dated October 23, 1986 between Bank of San Francisco Realty Investors (BSFRI) and Bank
of America with respect to the lease on 550 Montgomery Street, San Francisco, California (2)
Exhibit 10.2 Lease dated November 1, 1960 between The Lurie Company and Bank of America, with respect to premises
at 550 Montgomery Street (2)
Exhibit 10.3 Consent to Assignment of Lease, dated October 8, 2986, between The Lurie Company and Bank of San
Francisco and Bank of San Francisco Realty Investors, with respect to premises at 550 Montgomery
Street (2)
Exhibit 10.4 Assignment of Lease, dated October 17, 1986, by Bank of America to Bank of San Francisco and Bank of
San Francisco Realty Investors, with respect to premises at 550 Montgomery Street (2)
Exhibit 10.5 Nominee Agreement between Bank of San Francisco Realty Investors and 550 Partners, with respect to
premises at 550 Montgomery Street (2)
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Exhibit 10.6 Partnership Agreement, dated October 23, 1996, by and among Bank of San Francisco, Bank of San
Francisco Realty Investors, and D.R. Stephens Separate Property Trust, with respect to 550 Montgomery
Street (2)
Exhibit 10.7 Lease dated May 1, 1987, between Bank of San Francisco Building Company and Bank of San Francisco with
respect to premises at 550 Montgomery Street, San Francisco, California (Bank Space and Office Space
Leases) (3)
Exhibit 10.8 Bank of San Francisco Company Holding Company Employee Stock Ownership Plan, restated and amended as
of January 1, 1989 (1)
Exhibit 10.9 Agreement dated January 17, 1990 between Bank of San Francisco and Rogers, Casey & Associates, Inc.
with respect to investment consulting services (1)
Exhibit 10.10 Employee Stock Purchase Plan (4)
Exhibit 10.11 Letter Agreement with the Board of Governors of the Federal Reserve Board, dated April 21, 1989 (1)
Exhibit 10.12 Escrow Agreement dated December 31, 1990 between Bank of San Francisco Company Holding Company and
Bank of San Francisco with respect to the Employee Stock Purchase Plan (5)
Exhibit 10.13 Bank of San Francisco Company Holding Company 401(k) Profit Sharing Plan (5)
Exhibit 10.14 Amended and Restated Indemnification Agreements dated October 29, 1991 between Bank of San Francisco
Company Holding Company and each director and executive officer of the Company (7)
Exhibit 10.15 Indemnification Agreement dated November 25, 1991 between Bank of San Francisco and each director and
executive officer of the Bank (8)
Exhibit 10.16 Stock Purchase Agreement dated as of April 10, 1992 between Bank of San Francisco Company Holding and
Peninsula Holdings (9)
Exhibit 10.17 First amendment to Stock Purchase Agreement dated May 14, 1992 between Bank of San Francisco Company
Holding Company and Putra Masagung (9)
Exhibit 10.18 Second amendment to Stock Purchase Agreement dated June 18, 1992 between Bank of San Francisco Company
Holding Company and Putra Masagung (9)
Exhibit 10.19 Agreement Respecting Assignment, Assumption, Consent and Amendments dated as of May 8, 1992 among Bank
of San Francisco Company Holding Company, Peninsula Holdings and Putra Masagung
Exhibit 10.20 Subscription Agreement dated as of October 29, 1992 between Bank of San Francisco Holding Company and
Putra Masagung
Exhibit 10.21 First Amendment of Bank Space and Office Space lease, dated July 8, 1992 between Bank of San Francisco
and Bank of San Francisco Building Company, with respect to premises at 550 Montgomery Street, San
Francisco, California
Exhibit 10.22 Employment Agreements dated October 1, 1993 between Messrs. Champion and Price and Bank of San
Francisco Company Holding Company and the Bank of San Francisco.
Exhibit 10.23 The Bank of San Francisco Company Holding Company 1993 Executive Stock Option Plan
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Exhibit 10.24 The Bank of San Francisco Company Holding Company 1993 Non-Employee Directors Stock Option Plan
Exhibit 21 Subsidiaries of registrant (6)
___________________________
Footnotes to List of Exhibits:
* Indicates filed herewith.
(1) Incorporated by reference from the exhibits included with the
Registrant's Form S-2 Registration Statement (Registration No.
33-34985), previously filed with the Commission.
(2) Incorporated by reference from exhibits included in the
Company's Annual Report on Form 10-K for the year ended
December 31, 1986, previously filed with the Commission.
(3) Incorporated by reference from exhibits included with the
Company's Annual Report on Form 10-K for the year ended
December 31, 1987, previously filed with the Commission.
(4) Incorporated by reference from exhibits included with the
Company's Form S-8 Registration Statement (Registration No.
33-35649), previously filed with the Commission.
(5) Incorporated by reference from exhibits included with the
Company's Annual Report on Form 10-K for the year ended
December 31, 1990, previously filed with the Commission.
(6) Incorporated by reference from exhibits included with the
Company's Annual report on Form 10-K for the year ended
December 31, 1990, previously filed with the Commission.
(7) Identical agreements have been signed by each executive
officer and director of the Company.
(8) Identical agreements have been signed by each executive
officer and director of the Bank.
(9) Incorporated by reference from exhibits included with the
Company's Proxy Statement for the Special Meeting of
Stockholders' held on June 25, 1992, previously filed with the
Commission.
(b) Reports on Form 8-K filed in the fourth quarter of 1993:
Form 8-K filed December 15, 1993, Sale of Sacramento Regional Office
dated December 4, 1993.
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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.
BANK OF SAN FRANCISCO COMPANY
HOLDING COMPANY
By: /s/ Kent D. Price
-------------------------------
Kent D. Price
Chairman of the Board and
Chief Executive Officer
Date: February 22, 1994
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 in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Kent D. Price Chairman of the Board and February 22, 1994
- ------------------------------------------- -----------------
Kent D. Price Chief Executive Officer
(Principal Executive Officer)
/s/ Steven R. Champion Vice Chairman of the Board and February 22, 1994
- ------------------------------------------- -----------------
Steven R. Champion Chief Financial Officer
/s/ Rodney D. Freed President and February 22, 1994
- ------------------------------------------- -----------------
Rodney D. Freed Chief Operating Officer
/s/ Donna Miller Casey Director February 22, 1994
- ------------------------------------------ -----------------
Donna Miller Casey
/s/ Carl D. Gustavson Director February 22, 1994
- ------------------------------------------- -----------------
Carl D. Gustavson
/s/ David R. Holbrooke Director February 22, 1994
- ------------------------------------------- -----------------
David R. Holbrooke, M.D.
/s/ Willard D. Sharpe Director February 22, 1994
- ------------------------------------------- -----------------
Willard D. Sharpe
/s/ Gordon B. Swanson Director February 22, 1994
- ------------------------------------------- -----------------
Gordon B. Swanson
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