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EXHIBIT 99.1
Annual Report of the Bank of Hemet
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders and
Board of Directors of The Bank of Hemet:
We have audited the accompanying consolidated balance sheets of THE BANK OF
HEMET (a California corporation) and subsidiaries as of December 31, 2000 and
1999, and the related consolidated statements of operations, changes in
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 2000. These consolidated financial statements are the
responsibility of the Bank'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 auditing standards generally accepted
in the United States. 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 Hemet
and subsidiaries as of December 31, 2000 and 1999, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2000 in conformity with accounting principles generally accepted in
the United States.
ARTHUR ANDERSEN LLP
Orange County, California
January 24, 2001
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THE BANK OF HEMET AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
December 31,
---------------------------------
2000 1999
------------- -------------
CASH AND DUE FROM BANKS $ 6,683,000 $ 6,404,000
FEDERAL FUNDS SOLD 21,503,000 14,501,000
------------- -------------
Total Cash and Cash Equivalents 28,186,000 20,905,000
INVESTMENT SECURITIES HELD TO MATURITY
Market values of $18,388,000 at December 31, 2000 and
$24,903,000 at December 31, 1999, respectively 18,342,000 24,972,000
LOANS 242,769,000 220,992,000
ALLOWANCE FOR LOAN LOSSES (2,466,000) (2,416,000)
------------- -------------
Loans, net 240,303,000 218,576,000
PREMISES AND EQUIPMENT, net 1,537,000 1,799,000
ACCRUED INTEREST RECEIVABLE 1,504,000 1,530,000
OTHER REAL ESTATE OWNED 2,000 54,000
OTHER ASSETS 2,360,000 2,433,000
------------- -------------
$ 292,234,000 $ 270,269,000
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
DEPOSITS
Noninterest bearing demand deposits $ 32,277,000 $ 35,266,000
Savings and interest-bearing demand deposits 67,653,000 66,426,000
Money market deposits 3,892,000 3,480,000
Time deposits of $100,000 or more 22,211,000 14,182,000
Time deposits less than $100,000 141,811,000 127,317,000
------------- -------------
Total Deposits 267,844,000 246,671,000
ACCRUED INTEREST PAYABLE AND OTHER LIABILITIES 1,666,000 1,992,000
------------- -------------
269,510,000 248,663,000
------------- -------------
COMMITMENTS AND CONTINGENCIES (Note 6)
STOCKHOLDERS' EQUITY
Common stock, no par value-
Authorized - 20,000,000 shares
Issued and outstanding - 866,820 at December 31, 2000
and 865,252 at December 31, 1999 4,014,000 3,918,000
Retained earnings 18,710,000 17,688,000
------------- -------------
Total Stockholders' Equity 22,724,000 21,606,000
------------- -------------
$ 292,234,000 $ 270,269,000
============= =============
The accompanying notes are an integral part of these
consolidated balance sheets.
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THE BANK OF HEMET AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
2000 1999 1998
------------ ------------ ------------
INTEREST INCOME
Loans, including fees $ 20,206,000 $ 17,399,000 $ 17,102,000
Investment securities 1,346,000 1,340,000 1,610,000
Federal funds sold 907,000 642,000 704,000
------------ ------------ ------------
Total Interest Income 22,459,000 19,381,000 19,416,000
------------ ------------ ------------
INTEREST EXPENSE
Transaction and savings deposits 2,222,000 2,225,000 2,216,000
Time deposits of $100,000 or more 1,031,000 567,000 501,000
Time deposits less than $100,000 7,657,000 5,946,000 6,468,000
Other borrowings 57,000 2,000 0
------------ ------------ ------------
Total Interest Expense 10,967,000 8,740,000 9,185,000
------------ ------------ ------------
Net Interest Income 11,492,000 10,641,000 10,231,000
PROVISION FOR LOAN LOSSES 0 0 0
------------ ------------ ------------
Net Interest Income after Provision for Loan
Losses 11,492,000 10,641,000 10,231,000
------------ ------------ ------------
NONINTEREST INCOME
Fees and service charges on deposits 436,000 476,000 518,000
Other charges and fees 94,000 122,000 118,000
Other income 1,179,000 1,227,000 727,000
------------ ------------ ------------
Total Noninterest Income 1,709,000 1,825,000 1,363,000
------------ ------------ ------------
NONINTEREST EXPENSE
Salaries and employee benefits 4,590,000 4,471,000 3,735,000
Premises and equipment 1,110,000 1,064,000 1,066,000
Other real estate owned, net (19,000) (146,000) (101,000)
Other expenses 2,220,000 2,421,000 2,036,000
------------ ------------ ------------
Total Noninterest Expense 7,901,000 7,810,000 6,736,000
------------ ------------ ------------
Income before Provision for Income Taxes 5,300,000 4,656,000 4,858,000
PROVISION FOR INCOME TAXES 2,199,000 1,948,000 2,035,000
------------ ------------ ------------
Net Income $ 3,101,000 $ 2,708,000 $ 2,823,000
============ ============ ============
EARNINGS PER SHARE
Basic Earnings Per Share $ 3.58 $ 3.19 $ 3.34
Diluted Earnings Per Share $ 3.56 $ 3.15 $ 3.23
The accompanying notes are an integral part of these
consolidated statements.
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THE BANK OF HEMET AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
COMMON STOCK
------------------------------ RETAINED
SHARES AMOUNT EARNINGS
------------ ------------ ------------
BALANCE, December 31, 1997 844,252 $ 3,666,000 $ 16,562,000
Common stock cash dividend
at $2.40 per share -- -- (2,027,000)
Net income for the year -- -- 2,823,000
------------ ------------ ------------
BALANCE, December 31, 1998 844,252 3,666,000 17,358,000
Stock options exercised 21,000 252,000 --
Common stock cash dividend
at $2.80 per share -- -- (2,378,000)
Net income for the year -- -- 2,708,000
------------ ------------ ------------
BALANCE, December 31, 1999 865,252 3,918,000 17,688,000
Stock options exercised 1,568 22,000 --
Tax benefit on stock options -- 74,000 --
Common stock cash dividend
at $2.40 per share -- -- (2,079,000)
Net income for the year -- -- 3,101,000
------------ ------------ ------------
BALANCE, December 31, 2000 866,820 $ 4,014,000 $ 18,710,000
============ ============ ============
The accompanying notes are an integral part of these
consolidated statements.
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THE BANK OF HEMET AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
2000 1999 1998
------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 3,101,000 $ 2,708,000 $ 2,823,000
Adjustments to Reconcile Net Income to
Net Cash Provided by Operating Activities:
Depreciation and amortization 356,000 339,000 299,000
Deferred income tax (benefit) (20,000) (13,000) 199,000
Gain on sale of other real estate owned (26,000) (158,000) (174,000)
Write-down of other real estate owned 0 0 12,000
Accretion of discount on investments (115,000) (54,000) (36,000)
Decrease (increase) in accrued interest receivable 26,000 (389,000) 781,000
Decrease (increase) in other assets 93,000 251,000 (409,000)
Increase (decrease) in accrued interest payable and other liabilities (326,000) 525,000 (417,000)
Tax benefit on stock options exercised 74,000 0 0
------------- ------------- -------------
Net Cash Provided by Operating Activities 3,163,000 3,209,000 3,078,000
------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities of investment securities 28,697,000 35,183,000 101,130,000
Purchases of investment securities (21,952,000) (35,220,000) (101,142,000)
Net increase in loans (21,811,000) (13,858,000) (16,125,000)
Purchases of premises and equipment (94,000) (598,000) (203,000)
Proceeds from sales of other real estate owned 162,000 1,033,000 1,589,000
------------- ------------- -------------
Net Cash Used in Investing Activities (14,998,000) (13,460,000) (14,751,000)
------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in demand, savings, and money market deposits (1,350,000) (192,000) 12,104,000
Net increase (decrease) in time deposits 22,523,000 16,478,000 (929,000)
Proceeds from the exercise of stock options 22,000 252,000 0
Cash dividends paid (2,079,000) (2,378,000) (2,027,000)
------------- ------------- -------------
Net Cash Provided by Financing Activities 19,116,000 14,160,000 9,148,000
------------- ------------- -------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 7,281,000 3,909,000 (2,525,000)
------------- ------------- -------------
CASH AND CASH EQUIVALENTS, Beginning of Year 20,905,000 16,996,000 19,521,000
------------- ------------- -------------
CASH AND CASH EQUIVALENTS, End of Year $ 28,186,000 $ 20,905,000 $ 16,996,000
============= ============= =============
Supplemental information
Interest paid $ 10,838,000 $ 8,696,000 $ 9,212,000
Income taxes paid $ 2,410,000 $ 1,753,000 $ 2,105,000
Loans to Facilitate Sale of Other Real Estate Owned $ 0 $ 0 $ 37,000
Transfer from Loans to Other Real Estate Owned $ 84,000 $ 852,000 $ 726,000
The accompanying notes are an integral part of these
consolidated statements.
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THE BANK OF HEMET AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000, 1999 AND 1998
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. Principles of Consolidation and Nature of Operations
The consolidated financial statements include the accounts of The Bank of
Hemet, and its primary wholly owned subsidiary, BankLink Corporation
(BankLink) (collectively referred to as "the Bank"). BankLink is a
provider of data processing services for banks. The Bank was incorporated
in California in 1974 and operates five branches in communities located in
the Inland Empire area of Southern California. The Bank's primary source
of revenue is providing commercial and industrial income-producing real
estate loans to small and middle-market businesses and individuals. The
Bank offers a full range of commercial banking services. All significant
intercompany accounts and transactions have been eliminated in the
consolidated financial statements.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to
make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates.
On September 8, 1999,the Bank announced that its Board of Directors
approved the termination of the Acquisition Agreement with Pacific
Community Banking Group ("PCBG"). The Acquisition Agreement provided for
the acquisition of the Bank by PCBG and the payment of the merger
consideration to the Bank's shareholders upon consummation of the
acquisition. The merger consideration that was to be paid would have been
funded in part with proceeds from an initial public offering of PCBG
expected to have been underwritten by an underwriting group. A major
condition of the Acquisition Agreement was that PCBG shall have entered
into a firm commitment underwriting agreement for an initial public
offering by PCBG. PCBG was not able to satisfy that condition by the time
provided in the Acquisition Agreement after which either party could
unilaterally terminate the Acquisition Agreement. The Bank's write-off of
$216,000 in PCBG merger-related professional fees and other expenses was
recorded in noninterest expense for the year ended December 31, 1999.
B. Investment Securities Held to Maturity
Securities are classified as held to maturity and are carried at cost,
decreased by the amortization of premiums and increased by the accretion
of discounts, as applicable. The Bank has the positive intent and ability
to hold its investment securities to maturity, and does not anticipate
selling any portion of the investment securities portfolio for liquidity
or other purposes.
C. Loans
Loans are stated at the amount of unpaid principal, reduced by an
allowance for loan losses and deferred net loan origination fees. Interest
on loans is recognized over the terms of the loans and is calculated on
principal amounts outstanding. Loan origination fees, offset by certain
direct loan origination costs, are deferred and amortized as an adjustment
of the loan yield using the effective interest method. As unearned
revenue, the net unrecognized fees and costs are reported as reductions of
the loan balance.
Accrual of interest on loans is discontinued when management believes,
after considering economic and business conditions, and collection
efforts, that the borrower's financial condition is such that collection
of interest is doubtful. Income is subsequently recognized only to the
extent cash payments are received until, in management's judgment, the
borrower's ability to make periodic interest and principal payments is no
longer doubtful, in which case the credit is returned to accrual status.
The Bank considers a loan to be impaired when based upon current
information and events, it believes that it is probable the Bank will be
unable to collect all amounts due according to the contractual terms of
the loan agreement. The Bank measures impairment on a loan by loan basis
using either the present value of expected future cash flows discounted at
the loan's effective interest rate, or the fair value of the collateral if
the loan is collateral dependent. The Bank excludes from its impairment
calculations smaller balance, homogeneous loans such as consumer
installment loans and lines of credit, and direct finance leases. In
determining whether a loan is impaired or not, the Bank applies its normal
loan review procedures. Loans for which an insignificant delay, i.e., less
than 90 days past due, or an insignificant shortfall in the amount of
payments is anticipated, but the Bank expects to collect all amounts due,
are not considered for impairment.
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D. Allowance for Loan Losses
The allowance for loan losses is maintained at a level considered adequate
to provide for losses that are inherent in the portfolio. Management makes
periodic credit reviews of the loan portfolio and considers current
economic conditions, historical loan loss experience, assessments of
problem credits and other factors in determining the adequacy of the
allowance. The allowance is based on estimates and ultimate losses may
vary from the current estimates. These estimates are reviewed periodically
and, as adjustments become necessary, they are reported in earnings in the
periods in which they become known. The allowance is increased by
provisions charged to operating expense and reduced by net charge-offs.
E. Premises and Equipment
The Bank's buildings, furniture, equipment and leasehold improvements are
stated at cost less accumulated depreciation and amortization, which is
charged to expense on a straight-line basis over the estimated useful
lives of the assets or, in the case of leasehold improvements, over the
life of the leases, whichever is shorter. Maintenance and repairs are
charged directly to expense as incurred. Improvements to premises and
equipment which extend the useful lives of the assets are capitalized.
Gains and losses resulting from the disposal of premises and equipment are
included in current operations. Rates of depreciation are based on the
following depreciable lives: buildings, 30 years; furniture, five to seven
years; equipment, three to five years; and leasehold improvement, the
shorter of fifteen years or the lease term.
F. Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include
cash on hand, amounts due from banks, and Federal funds sold. Generally,
Federal funds are sold for one-day periods.
G. Other Real Estate Owned
Other real estate owned represents real estate acquired by foreclosure or
deed in lieu of foreclosure in satisfaction of commercial and residential
real estate loans and is carried at the lower of the recorded investment
in the property or its fair value, less estimated carrying costs and costs
of disposition. At the time of foreclosure, the value of the underlying
loan is initially recorded at fair value at the date of foreclosure,
establishing a new cost basis by a charge to the allowance for loan
losses, if necessary. Any subsequent write-downs are charged to
noninterest expense. Operating expenses of such properties, net of related
income and gains or losses on their disposition, are recorded in
noninterest expense.
H. Income Taxes
The Bank applies an asset and liability approach in accounting for income
taxes payable or refundable at the date of the financial statements as a
result of all events that have been recognized in the financial statements
and as measured by the provisions of enacted tax laws. Additionally,
deferred tax assets are evaluated and a valuation allowance is established
if it is "more likely than not" that all or a portion of the deferred tax
asset will not be realized.
I. Earnings per Share
Basic earnings per share ("EPS") is computed by dividing income available
to common stockholders by the weighted average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution
that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock or resulted in the issuance
of common stock that then shared in the earnings of the Bank. The
following is a reconciliation of the numerators and denominators used in
the calculation of basic EPS and diluted EPS for the years ended December
31, 2000, 1999 and 1998.
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Earnings Shares EPS
---------- ---------- -----
For the Year Ended 2000
Basic Earnings Per Share $3,101,000 866,176 $3.58
Effect of Dilutive Stock Options -- 5,717 (0.02)
---------- ---------- -----
Diluted Earnings Per Share $3,101,000 871,893 $3.56
========== ========== =====
For the Year Ended 1999
Basic Earnings Per Share $2,708,000 848,627 $3.19
Effect of Dilutive Stock Options -- 11,777 (0.04)
---------- ---------- -----
Diluted Earnings Per Share $2,708,000 860,404 $3.15
========== ========== =====
For the Year Ended 1998
Basic Earnings Per Share $2,823,000 844,252 $3.34
Effect of Dilutive Stock Options -- 30,373 (0.11)
---------- ---------- -----
Diluted Earnings Per Share $2,823,000 874,625 $3.23
========== ========== =====
J. Postretirement Benefits and Stock Options
The Bank has a salary continuation plan for certain key management
personnel. The plan provides for payments for fifteen years commencing
upon reaching age 65, or death. The Bank measures the obligations to
provide these future postretirement benefits over the estimated remaining
years of benefit. Salary continuation expense was $42,000, $39,000, and
$39,000 for the years ended December 31, 2000, 1999 and 1998,
respectively. The Bank is committed to pay $1,875,000 over the pay out
periods of the plan.
The Bank does not record any compensation cost in connection with the
stock options issued to various officers of the Bank. The Bank elected to
disclose the pro forma impact of compensation costs on net income and
diluted EPS. The fair value of each option grant is estimated on the date
of grant using Black-Scholes option pricing model. (See Note 7).
The Bank established a 401(k) plan effective August 1, 1997. Employees who
have completed one year of service and meet certain other requirements are
eligible for enrollment. Employees may contribute a percentage of their
salary pursuant to IRS regulatory maximums, and under the plan, the Bank
matches 50% of the first 6% of salary contributed using forfeitures and
cash. Participants vest immediately in their own contributions. Vesting in
the Bank's contributions occurs immediately for employees with five years
of credited service. Vesting is prorated for employees with less than five
years of credited service at the rate of 20% per year. The Bank's expense
for contributions to this plan was $62,000, $46,000 and $36,000 during
2000, 1999 and 1998, respectively. Effective February 1, 2001, the Bank's
match will increase to 60% of the first 6% of salary contributed using
forfeitures and cash.
K. New Accounting Pronouncements and Reclassifications
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting
for Derivative Instruments and Hedging Activities." This statement
establishes accounting and reporting standards for derivative instruments
and for hedging activities. The new standard was amended by SFAS No. 137
and SFAS No. 138 which extends the effective date to 2001. Management has
implemented SFAS No. 133 as of January 1, 2001. The impact of
implementation was not material to the Bank's financial statements or
results of operations.
In September 2000, the FASB issued SFAS No. 140 "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities", a
replacement of SFAS No. 125. This statement revises the standards for
securitizations and other transfers of financial assets and collateral,
and requires certain disclosures. The disclosures discussed in paragraphs
15 & 17 of SFAS No. 140 are effective as of December 31, 2000. These
disclosures were not material to the Bank's financial statements. The
other provisions of SFAS No. 140 are effective for fiscal years ending
after March 31, 2001. Management believes that the adoption of the
remaining provisions of this standard will not have a material impact on
the Bank's financial statements.
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2. INVESTMENT SECURITIES HELD TO MATURITY
The amortized cost and fair value of investment securities held to
maturity are as follows at December 31, 2000 and 1999:
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
----------- ----------- ----------- -----------
December 31, 2000
U.S. government agencies $18,342,000 $ 48,000 $ (2,000) $18,388,000
=========== =========== =========== ===========
December 31, 1999
U.S. government agencies $24,972,000 $ 0 $ (69,000) $24,903,000
=========== =========== =========== ===========
Investment securities with a book value of $14,034,000 and $12,099,000 at
December 31, 2000 and 1999, respectively, were pledged to secure public
deposits and for other purposes as required or permitted by law. The
estimated fair values of pledged securities were $14,078,000 and
$12,045,000 at December 31, 2000 and 1999, respectively.
The amortized cost and fair values of investment securities held to
maturity at December 31, 2000, by contractual maturity, are as follows:
Amortized Estimated
Cost Fair Value
----------- -----------
Due in one year or less $14,015,000 $14,059,000
Due after one year through five years 4,001,000 4,003,000
Due after five years through ten years -- --
Due after 10 years 326,000 326,000
----------- -----------
Total $18,342,000 $18,388,000
=========== ===========
U.S. government agency securities of $326,000 at December 31, 2000
represent preferred stock of the Federal Home Loan Bank (FHLB), which has
no maturity date.
3. LOANS, NET
The Bank's loans, commitments, and standby letters of credit have been
granted to customers primarily in the Inland Empire area of Southern
California. Prevailing economic conditions, including real estate values
and other factors may affect certain borrowers' ability to repay loans.
Although management believes the level of allowance for loan losses is
adequate to absorb losses inherent in the loan portfolio, declines in the
local economy and/or increases in the interest rate charged on adjustable
rate loans may result in increasing loan and other real estate owned
losses that cannot be reasonably estimated at December 31, 2000. The most
significant category of collateral is real estate, principally commercial
and industrial income-producing properties. At December 31, 2000, the
Bank's loan portfolio included approximately $8,620,000 of fixed rate
loans. The loan portfolio consisted of the following at December 31, 2000
and 1999:
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2000 1999
------------- -------------
Commercial $ 7,481,000 $ 8,932,000
Real Estate 235,049,000 210,838,000
Installment 580,000 580,000
All other loans (including overdrafts) 233,000 1,277,000
------------- -------------
243,343,000 221,627,000
Deferred loan origination fees, net (574,000) (635,000)
------------- -------------
242,769,000 220,992,000
Allowance for loan losses (2,466,000) (2,416,000)
------------- -------------
Total Loans, net $ 240,303,000 $ 218,576,000
============= =============
Non-accruing loans totaled approximately $48,000 and $702,000 at December
31, 2000 and 1999, respectively. Interest income that would have been
recognized on non-accrual loans if they had performed in accordance with
the terms of the loans was approximately $0, $29,000 and $277,000 for the
years ended December 31, 2000, 1999 and 1998, respectively. At December
31, 2000 and 1999, respectively, the Bank had an insignificant amount of
loans past due 90 days or more in interest or principal and still accruing
interest.
At December 31, 2000 and 1999, loans that were considered impaired totaled
$1,953,000 and $2,627,000, respectively, all of which had a related
allowance for loan loss aggregating $67,000 and $145,000, respectively.
Impaired loans amounting to $48,000 and $702,000 were on a non-accruing
basis at December 31, 2000 and 1999, respectively. Substantially all of
the impaired loans were collateral dependent and were measured using the
fair value of the collateral. For the years ended December 31, 2000, 1999
and 1998, the Bank recognized interest income on these impaired loans of
$134,000, $170,000 and $115,000, respectively. The average outstanding
principal balance of impaired loans was $2,290,000, $2,969,000 and
$4,010,000 during 2000, 1999 and 1998, respectively.
Prior to the implementation of SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities," the
Bank originated first and second mortgages for resale on the secondary
market to Federal Home Loan Mortgage Corporation (FHLMC), and Federal
National Mortgage Association (FNMA). Gains or losses on the sales of
these loans were recognized at the time of sale. The Bank retained
servicing rights to these loans. Servicing arrangements provide for the
Bank to maintain all records related to the servicing agreement, to assume
responsibility for billing mortgagors, to collect periodic mortgage
payments, and to perform various other activities necessary to the
mortgage servicing function. The Bank receives as compensation a servicing
fee based on the principal balance of the outstanding loans. Servicing fee
income amounted to approximately $41,000, $49,000 and $57,000 during 2000,
1999 and 1998, respectively. The total unpaid principal balance of the
mortgage servicing portfolio amounted to approximately $12,774,000 and
$15,066,000 at December 31, 2000 and 1999, respectively.
The activity in the allowance for loan losses is summarized as follows:
2000 1999 1998
----------- ----------- -----------
Balance at Beginning of Year $ 2,416,000 $ 2,232,000 $ 2,116,000
Recoveries on loans previously charged off 66,000 222,000 298,000
Loans charged off (16,000) (38,000) (182,000)
Provision charged to operating expense -- -- --
----------- ----------- -----------
Balance at End of Year $ 2,466,000 $ 2,416,000 $ 2,232,000
=========== =========== ===========
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As part of its normal banking activities, the Bank has extended credit to
certain directors and officers and the companies with which they are
associated (related parties). All related party loans were current as to
principal and interest as of December 31, 2000 and 1999. In management's
opinion, these loans were made in the ordinary course of business at
prevailing market rates and terms. Total commitments for such loans
amounted to $3,160,000 and $2,754,000 at December 31, 2000 and 1999, of
which $357,000 and $738,000 were undisbursed, respectively. New loan
commitments to related parties totaled $1,058,000 and there were no
expired loan commitments on such loans in 2000. Advances on existing
commitments were $0 in 2000, with repayments of $652,000.
4. PREMISES AND EQUIPMENT
Major classifications of premises and equipment are summarized as follows:
December 31,
----------------------------
2000 1999
----------- -----------
Land $ 211,000 $ 211,000
Buildings 1,005,000 1,002,000
Furniture and equipment 1,767,000 1,916,000
Leasehold improvements 371,000 384,000
----------- -----------
3,354,000 3,513,000
Less: Accumulated depreciation and amortization (1,817,000) (1,714,000)
----------- -----------
Total $ 1,537,000 $ 1,799,000
=========== ===========
The amount of depreciation and amortization included in operating expense
was $356,000, $339,000, and $299,000 for the years ended December 31,
2000, 1999, and 1998, respectively.
The Bank occupies its office premises under separate long-term,
noncancelable leases which expire in various years through 2004. All
leases are accounted for as operating leases. At December 31, 2000, future
minimum lease commitments under all noncancellable leases are as follows:
Lease
Commitments
-----------
2001 $ 325,000
2002 208,000
2003 96,000
2004 5,000
---------
Total $ 634,000
=========
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5. INCOME TAXES
The current and deferred amounts of the provisions for (benefit from)
income taxes for the years ended December 31, 2000, 1999, and 1998
consisted of the following:
Years Ended December 31,
---------------------------------------------
2000 1999 1998
----------- ----------- -----------
Current:
Federal $ 1,649,000 $ 1,461,000 $ 1,320,000
State 570,000 500,000 516,000
----------- ----------- -----------
Total 2,219,000 1,961,000 1,836,000
----------- ----------- -----------
Deferred:
Federal (17,000) (28,000) 197,000
State (3,000) 15,000 2,000
----------- ----------- -----------
Total (20,000) (13,000) 199,000
----------- ----------- -----------
$ 2,199,000 $ 1,948,000 $ 2,035,000
=========== =========== ===========
Deferred taxes arise from temporary differences between income reported
for financial reporting purposes and that reported for federal and state
income tax purposes. The tax effects of the principal temporary
differences resulting in deferred taxes were:
Years Ended December 31,
---------------------------------------
2000 1999 1998
--------- --------- ---------
Expenses reported on a different basis for tax purposes $ 15,000 $ 20,000 $ 231,000
Depreciation computed differently on tax returns than for
financial statements (18,000) (17,000) (16,000)
Deferred compensation (17,000) (16,000) (16,000)
--------- --------- ---------
($ 20,000) ($ 13,000) $ 199,000
========= ========= =========
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Total tax expense differed from the amount computed using the federal
statutory rate as follows:
2000 1999 1998
----------------------- ----------------------- -----------------------
Percent Percent Percent
of Pretax of Pretax of Pretax
Amount Income Amount Income Amount Income
---------- --------- ---------- --------- ---------- ---------
Tax expense at
federal statutory
rate $1,802,000 34.0% $1,583,000 34.0% $1,652,000 34.0%
State income tax,
net of federal tax
benefit 374,000 7.1 340,000 7.3 342,000 7.0
Other 23,000 0.4 25,000 0.5 41,000 0.9
---------- ------ ---------- ------ ---------- ------
Total $2,199,000 41.5% $1,948,000 41.8% $2,035,000 41.9%
========== ====== ========== ====== ========== ======
At December 31, 2000 and 1999, the components of the net deferred tax
asset which is included in other assets on the accompanying consolidated
balance sheets were as follows:
2000 1999
--------- ---------
Allowance for loan losses $ 590,000 $ 590,000
Deferred compensation 278,000 261,000
State income tax 194,000 170,000
Depreciation 88,000 70,000
Other (211,000) (172,000)
--------- ---------
Total $ 939,000 $ 919,000
========= =========
6. COMMITMENTS AND CONTINGENCIES
In order to meet the financing needs of its customers in the normal course
of business, the Bank is a party to financial instruments with off-balance
sheet risk. These financial instruments include commitments to extend
credit and standby letters of credit. Commitments to extend credit are
agreements to lend to a customer as long as there is no violation of any
condition established in the contract. Commitments generally have fixed
expiration dates or other termination clauses and may require payment of a
fee. Since many of the commitments are expected to expire without being
drawn upon, the total commitment amounts do not necessarily represent
future cash requirements. Standby letters of credit are conditional
commitments issued by the Bank to guarantee the performance of a customer
to a third party. The Bank does not enter into any interest rate swaps or
caps, or forward or future contracts.
The nature of the off-balance sheet risk inherent in these instruments is
the possibility of accounting losses resulting from (1) the failure of
another party to perform according to the terms of a contract that would
cause a draw on a standby letter of credit, or (2) changes in market rates
of interest for those few commitments and undisbursed loans which have
fixed rates of interest. To minimize this risk, the Bank uses the same
credit policies in making commitments and conditional obligations as it
does for on-balance sheet instruments. The decision as to whether
collateral should be required is based on the circumstances of each
specific commitment or conditional obligation.
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To varying degrees, these instruments involve elements of credit and
interest rate risk in excess of the amount recognized in the consolidated
balance sheets. The Bank's exposure to credit loss in the event of
non-performance by the other party to the financial instruments for
commitments to extend credit and standby letters of credit is represented
by the contractual amount of those instruments. At December 31, 2000, the
Bank had commitments to extend credit of approximately $9,377,000 and
obligations under standby letters of credit of approximately $459,000.
Management does not believe there will be any material losses as a result
of these letters of credit and loan commitments.
At December 31, 2000, the Bank has available a borrowing line of credit
with the FHLB in the amount of $10,009,000 using previously approved
residential and commercial real estate mortgage loans totaling $15,239,000
to secure the line of credit. There were no amounts outstanding as of
December 31, 2000 and 1999, respectively. The maximum and average amounts
advanced from this line of credit were $7,046,000 and $859,000 during
2000.
The Bank has approval to borrow under the Discount Window Program of the
Federal Reserve Bank of San Francisco collateralized by investment
securities. There were no amounts outstanding as of December 31, 2000 and
1999, respectively. The maximum and average amounts advanced from this
line were $5,000,000 and $14,000 during 2000.
The Bank has available repurchase lines of credit with two broker/dealers
at December 31, 2000. These lines are subject to normal terms for such
arrangements. There was no utilization of these lines during 2000. At
December 31, 2000, investment securities with a market value of
approximately $3,985,000 were available for these repurchase lines of
credit.
The Bank is required to maintain reserve balances with the Federal Reserve
Bank. The amounts of these reserve balances at December 31, 2000 and 1999
were $696,000 and $525,000, respectively.
On May 2, 2000, the Bank announced that it settled a class action lawsuit
filed by former Inland Savings and Loan shareholders on terms which were
not material to the Bank's business, results of operation, or financial
condition. In connection with the 1992 acquisition of Inland, the Bank had
issued Preferred stock to shareholders of Inland. The Preferred stock was
automatically converted to the Bank's common stock in 1995. In 1997 the
named plaintiffs sued the Bank and certain of its directors regarding the
manner in which the Bank implemented the conversion, as governed by
certain provisions of the merger agreement. The settlement was approved by
the Superior Court of Riverside County, California on June 16, 2000.
Distribution of settlement proceeds was made by a court appointed fund
administrator to class members on August 25, 2000.
In addition, the Bank is a defendant in various legal proceedings
resulting from normal banking business. In the opinion of management and
the Bank's legal counsel, the disposition of such litigation will not have
a material effect on the Bank's consolidated financial condition or
results of operations.
7. STOCK OPTION PLAN
The Bank grants incentive and nonqualified stock options to certain
full-time salaried officers and management level employees. In June 1994,
the Bank established a stock option plan which authorized the issuance of
75,000 shares, of which 31,000 shares were granted in 1994, 21,000 shares
were granted in 1997, 5,000 shares were granted in 1999, and 22,000 shares
were granted in 2000 to various officers of the Bank. At December 31,
2000, 17,200 shares of common stock were reserved for grant under the plan
which includes 4,000 shares forfeited during 1996 and 17,200 shares
forfeited during 2000. The stock options are exercisable at a price equal
to market value on the date of grant. Options expire not more than ten
years after the date of grant. Options are exercisable at 20% of the
options outstanding per year.
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Transactions in plan for the three years ended December 31, 2000 are as
follows:
Weighted
Average
Exercise
Options Price Per
Outstanding Share
----------- -----------
Balance, December 31, 1997 46,968 $16.69
Options exercised --
Options granted --
--------
Balance, December 31, 1998 46,968 $16.69
Options exercised (21,000) $12.00
Options granted 5,000 $35.00
--------
Balance, December 31, 1999 30,968 $20.82
Options exercised (1,568) $14.01
Options granted 22,000 $31.30
Options forfeited (17,200) $26.13
--------
Balance, December 31, 2000 34,200 $27.42
========
Exercisable at December 31, 2000 8,800 $19.01
The Bank does not record any compensation cost in connection with the
stock options issued to various officers of the Bank. The Bank's pro forma
net income and diluted earnings per share assuming the Bank recorded
compensation cost in 2000, 1999 and 1998 for the options granted in 1997,
1999 and 2000 in accordance with SFAS No. 123, "Accounting for Stock-Based
Compensation" would not have a material effect of the Bank's consolidated
results of operations or diluted EPS. The method of accounting required
under SFAS No. 123 is not applicable for options granted prior to January
1, 1996.
The pro forma impact of compensation costs on net income and diluted
earnings per share as presented above may not be representative of the
impact which could be realized in future years.
8. OTHER EXPENSES
The following is a breakdown of other expenses for the years ended
December 31, 2000, 1999 and 1998:
2000 1999 1998
---------- ---------- ----------
Data processing and other outside services $ 366,000 $ 318,000 $ 326,000
Deposit insurance assessments 77,000 85,000 84,000
Professional fees 369,000 654,000 418,000
Office supplies, postage and telephone 519,000 480,000 488,000
Other 889,000 884,000 720,000
---------- ---------- ----------
Total $2,220,000 $2,421,000 $2,036,000
========== ========== ==========
9. FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value estimates of financial instruments for both assets and
liabilities are made at a discrete point in time based on relevant market
information and information about the financial instruments. Because no
active market exists for a significant portion of the Bank's financial
instruments, fair value estimates are based on judgments regarding current
economic conditions, risk characteristics of various financial
instruments, prepayment assumptions, future expected loss experience and
other such factors. These estimates are subjective in nature and involve
uncertainties and matters of significant judgment and therefore cannot be
determined with precision. Changes in assumptions could significantly
affect the estimates.
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The Bank intends to hold the majority of its assets and liabilities to
their stated maturities. Thus, management does not believe that the bulk
sale concepts applied to certain problem loans for purposes of measuring
the impact of credit risk on fair values of said assets is reasonable to
the operations of the Bank and does not fairly present the values
realizable over the long term on assets that will be retained by the Bank.
Therefore, the Bank does not intend to realize any significant differences
between carrying value and fair value through sale or other disposition.
No attempt should be made to adjust stockholders' equity to reflect the
following fair value disclosures as management believes them to be
inconsistent with the philosophies and operations of the Bank.
In addition, the fair value estimates are based on existing on-and
off-balance sheet financial instruments without attempting to estimate the
value of existing and anticipated future customer relationships and the
value of assets and liabilities that are not considered financial
instruments. Significant assets and liabilities that are not considered
financial assets or liabilities include the branch network, deferred tax
assets, other real estate owned, and premises and equipment.
The following methods and assumptions were used to estimate the fair value
of financial instruments.
Investment Securities
For U.S. government agency securities, fair values are based on market
prices. For other investment securities, fair value equals quoted market
price, if available. If a quoted market price is not available, fair value
is estimated using quoted market prices for similar securities.
Loans
The fair value for loans with variable interest rates is the carrying
amount. The fair value of fixed rate loans is derived by calculating the
discounted value of future cash flows expected to be received by the
various homogeneous categories of loans. All loans have been adjusted to
reflect changes in credit risk.
Deposits
The fair value of demand deposits, savings deposits, and money market
deposits are defined as the amounts payable on demand at year end. The
fair value of fixed maturity certificates of deposit is estimated based on
the discounted value of the future cash flows expected to be paid on the
deposits.
Commitments to Extend Credit and Standby Letters of Credit
The fair value of commitments is estimated using the fees currently
charged to enter into similar agreements, taking into account the
remaining terms of the agreements and the present creditworthiness of the
parties involved. For fixed rate loan commitments, fair value also
considers the difference between current levels of interest rates and
committed rates. The fair value of these unrecorded financial instruments
is not material to the Bank's financial position or fair value disclosures
at December 31, 2000 and 1999 (see Note 6).
The estimated fair values of the Bank's financial instruments are as
follows:
Carrying Value Fair Value
-------------- ------------
DECEMBER 31, 2000
Financial Assets
Cash and cash equivalents $ 28,186,000 $ 28,186,000
Investment securities 18,342,000 18,388,000
Loans, net 240,303,000 242,741,000
Financial Liabilities
Deposits 267,844,000 268,367,000
DECEMBER 31, 1999
Financial Assets
Cash and cash equivalents $ 20,905,000 $ 20,905,000
Investment securities 24,972,000 24,903,000
Loans, net 218,576,000 220,580,000
Financial Liabilities
Deposits 246,671,000 246,548,000
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10. REGULATORY MATTERS
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Bank must meet specific capital guidelines that
involve quantitative measures of the Bank's assets, liabilities, and
certain off-balance sheet items as calculated under regulatory accounting
practices. The Bank's capital amounts and classification are also subject
to qualitative judgments by the regulators about components, risk
weighting and other factors. Failure to meet minimum capital requirements
can initiate certain mandatory and possibly additional discretionary
actions by regulators that, if undertaken, could have a direct material
effect on the Bank's financial statements. Management believes the Bank
meets all capital adequacy requirements to which it is subject as of
December 31, 2000. The most recent notification from the Federal Deposit
Insurance Corporation categorized the Bank as well capitalized under the
regulatory framework for prompt corrective action. There are no conditions
or events since that notification that management believes have changed
the capital category of the Bank.
A comparison of the Bank's actual regulatory capital with minimum
requirements for adequately capitalized and well capitalized banks, as
defined by regulation, is shown below.
To be Adequately To be Well
Actual Capitalized Capitalized
---------------------- ------------------------ -------------------------
Amount Ratio Amount Ratio Amount Ratio
----------- ------- ------------- ------- ------------- -------
AS OF DECEMBER 31, 2000
Tier 1 Risk-Based Capital
(To Risk Weighted Assets) $22,724,000 9.13% *$9,952,000 *4.0% *$14,930,000 *6.0%
Total Risk-Based Capital
(To Risk Weighted Assets) $25,191,000 10.12% *$19,906,000 *8.0% *$24,885,000 *10.0%
Tier 1 Capital
(To Average Assets) $22,724,000 7.97% *$11,406,000 *4.0% *$14,259,000 *5.0%
AS OF DECEMBER 31, 1999
Tier 1 Risk-Based Capital
(To Risk Weighted Assets) $21,606,000 9.57% *$9,031,000 *4.0% *$13,548,000 *6.0%
Total Risk-Based Capital
(To Risk Weighted Assets) $24,022,000 10.64% *$18,063,000 *8.0% *$22,581,000 *10.0%
Tier 1 Capital
(To Average Assets) $21,606,000 8.21% *$10,519,000 *4.0% *$13,150,000 *5.0%
* Greater than or equal to.
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